Many family businesses founded by first-generation migrants, or brought to Australia from Malaysia, Singapore, Hong Kong, Taiwan, Indonesia or mainland China, reach the same turning point. The founders want to treat their children fairly, but not every child works in the business, and not every child should be making decisions about it.
A common instinct is to give each child an equal shareholding. Equal ownership can feel fair, but it often combines two very different things: the right to share in the value and profits of the business, and the right to control it. Separating ownership from control is one of the most useful tools in family business succession. This article explains some of the ways it can be done in Australia. It is general information only, and tax advice from a registered tax adviser is essential before any restructure.
The problems with equal shares
- Being outvoted. With three children holding equal shares, any two can outvote the third, including the one who runs the business day to day.
- Owners versus managers. Children who are not involved may want higher dividends now. Those running the business may want to reinvest. Both views can be reasonable, but they pull in different directions.
- Rewarding contribution. The child who has worked long hours for years may feel that an equal share ignores their contribution, while siblings may feel that a salary is reward enough.
- Deadlock. With two equal shareholders, a single disagreement can stop the business.
Tool 1: a holding company owned by a family trust
A common structure places the operating business under a holding company, with the holding company’s shares owned by a family discretionary trust or by separate trusts for each branch of the family. This can:
- separate the trading risks of the business from accumulated family wealth;
- allow the trustee to direct income among beneficiaries within the trust deed and the law; and
- give a clear place where control sits, through the trustee company and its directors and shareholders, and through the appointor or guardian role under the trust deed.
Who controls the trustee and who holds the power to replace the trustee are often more important for succession than who owns the shares of the operating company.
Tool 2: different classes of shares
Australian corporate law generally permits a company to issue different classes of shares, with different rights to vote, receive dividends and receive capital, if the company’s constitution provides for them. A family company might, for example, have:
- Voting shares, held by the family members (or the trust) responsible for managing the business;
- Non-voting ordinary shares, giving economic benefit to family members who are not involved in management; and
- Preference shares, giving a priority return or fixed entitlement, sometimes used to recognise a founder’s capital or to provide income to a retired parent.
The constitution, share issue documents and any shareholders agreement need to be drafted carefully and consistently. Existing companies often need their constitution amended, and changes to share rights may need approval from affected shareholders.
A tax caution. Different share classes are commonly used for genuine commercial and family reasons. However, Australian tax law contains dividend streaming and anti-avoidance rules that may apply where dividends or franking credits are directed to particular shareholders to obtain a tax benefit, and value shifting or private company loan rules can also be relevant. Changing share rights in an existing company may also have tax consequences. Obtain advice from a registered tax adviser before issuing or varying share classes.
Tool 3: a written dividend policy
Many family disputes are really about money flowing out of the business. A written dividend and distribution policy, agreed while relationships are good, can reduce argument later. It might cover:
- a target percentage of after-tax profit to be paid out, subject to the business’s needs and solvency;
- minimum cash reserves and borrowing limits before distributions are made;
- market-rate salaries for family members who work in the business, separate from dividends; and
- how the trustee will approach distributions to beneficiaries in different family branches.
Directors and trustees must still exercise their own duties, so a policy guides rather than binds their decisions.
Tool 4: an advisory committee or family council
Some families establish a family council or a small advisory committee, which may include a trusted family lawyer, a senior relative, the business’s CFO or an independent adviser, to be consulted before major decisions, such as selling property, taking on significant debt, admitting new shareholders, or making large trustee distributions. Its role is advisory, but it gives every branch of the family a voice and a forum to raise concerns early.
Shareholders agreement, exits and liquidity
A shareholders agreement should deal with deadlock, exit, valuation and transfer of shares, including what happens on death, divorce or a family member leaving the business. We cover these topics in more detail in other articles, so we note here only that share classes work best when they are supported by clear exit rules.
It can also help to give the next generation some liquid assets now, such as cash, investment property or a share portfolio, so that not all of each child’s inheritance is tied up in the business. Children who are not involved in the business are often more comfortable with non-voting shares if they have other assets of their own.
Composite example: a Malaysian-Chinese family business in Melbourne
This is a composite hypothetical drawn from common situations. Names and details are invented.
Mr and Mrs Ong built a food distribution business in Melbourne after migrating from Kuala Lumpur. Their eldest son runs the business, their daughter is a doctor in Sydney, and their youngest son lives in Singapore. The parents’ first idea was to give each child one third of the shares.
After discussion, the family considers a holding company owned by the family trust, with voting shares held by the trust whose trustee company is controlled by the parents and, over time, the eldest son. The daughter and youngest son benefit through the trust and through non-voting shares, supported by a written dividend policy and a family council that includes a senior uncle and the business’s CFO. The parents also give the daughter and youngest son investment assets now. The proposal is reviewed with their registered tax adviser before any shares are issued.
Frequently asked questions
Is it fair to give some children non-voting shares?
It can be, if the economic benefit is fair and the reasons are explained. Fairness does not always mean identical rights. Many families find that separating control from economic benefit reduces conflict, especially when supported by a dividend policy and family council.
Can we pay higher dividends to one class of shares than another?
Corporate law may allow it if the constitution provides for it, but dividend streaming and anti-avoidance rules may apply where this is done to obtain tax benefits. Tax advice is essential.
How often should the structure be reviewed?
At least whenever there is a major family event, such as a marriage, divorce, death, retirement or a child joining or leaving the business, and in any case every few years as the generations change.
How Chua Tan Associates can help
Chua Tan Associates advises family businesses across Australia on succession and structure, including holding companies, family trusts, share classes, constitutions, shareholders agreements, dividend policies and family councils. Our principal, Justin Chua, is a Nationally Accredited Mediator and Family Dispute Resolution Practitioner, and an Accredited Family Business Advisor, and can help families hold the difficult conversations these changes require. We are lawyers, and we work with registered tax advisers and overseas lawyers so that tax and cross-border issues are addressed together. We advise in English, Mandarin and Cantonese.
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Chua Tan Associates acts for families, executors, trustees and their professional advisers in estate planning, estate administration and estate disputes in Australia and across borders. To arrange a confidential consultation, please contact our Melbourne office on +61 3 9602 3988 or submit an enquiry. Advice is available in English, Mandarin and Cantonese.
Justin Chua (蔡智勋), lawyer and mediator, Chua Tan Associates, Melbourne. General information only, not legal or tax advice.
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