Business succession: a legal and tax guide

Succession: one of the biggest decisions in a company's life

For many Danes, a family-owned business is not just a livelihood. It is a life project. When the time comes to let the next generation take over, or to sell to an external party, it is crucial to do it right.

Business succession (generationsskifte) is the transfer of ownership of a company, typically from parents to children, but it can also be to key employees, to an external buyer or to a combination. The process is complex because it involves:

• The legal transfer of ownership and responsibility
• Tax planning for both seller and buyer
• Inheritance planning and securing the family's future
• A management transition

This guide gives you an overview of the most important models and documents.

The three main models for succession

Model 1: a direct sale to the next generation

The simplest model: you sell the company, or the shares, to your child at market price. The advantage is simplicity. The disadvantage is that the child has to finance a purchase at full price.

Tax: capital-gains tax can arise for you as the seller, and the child has to take out a loan or use saved capital.

When it makes sense: when the child has access to financing and there are no other heirs to consider.

Model 2: transfer with succession

The succession rules in Danish tax law allow a business to be transferred to close family members without triggering capital-gains tax for the seller at the time of transfer. The tax is instead passed to the recipient, who pays it when they one day sell. The basis is:

• Section 33 C of the Withholding Tax Act for personally owned businesses
• Section 34 of the Share Capital Gains Tax Act for shares

Conditions for succession (shares):

• The recipient must be within the close family (including children, grandchildren, siblings, siblings' children and a spouse)
• The company's activity must not predominantly consist of passive capital investment (the so-called "money-box" rule: real property, cash, securities and the like must not exceed 50%)
• Succession can be combined with a reduction for the deferred tax, which reduces the gift-tax base

When it makes sense: when the seller wants to give the next generation an advantage and the company has a significant latent capital gain.

Model 3: management buyout (MBO)

A transfer to key employees rather than family. The ordinary family-succession rules do not apply here, but there is a corresponding succession option on transfer to a close employee (section 35 of the Share Capital Gains Tax Act). The agreements can be structured with payment over time, an earn-out and gradual co-ownership.

Advantages: the key employees know the business, and there is continuity in operations.

Legal requirement: a well-documented transfer agreement and a solid shareholders' agreement are crucial.

Gift tax or sale price?

When the company is transferred to a family member below market value, the difference can be regarded as a gift. Gift tax is as a rule 15% for gifts to children and other close relatives above the annual threshold.

Succession and gift tax: the combination makes it possible to transfer on favourable terms. The child receives the company, and the deferred tax (the latent gain) can give a reduction in the gift-tax base. The reduction is calculated either as a "passivpost" under section 33 D of the Withholding Tax Act or as the present value of the deferred tax, whichever is more favourable. In practice, many successions can therefore be carried out with limited gift tax.

The calculations are complex and depend on the type of business and the individual circumstances. An accountant specialising in succession is indispensable, and it is the accountant who calculates the specific reduction.

Note that under the Estate and Gift Tax Act there can be special rules on reduced gift tax on the transfer of businesses and shares when the conditions, including for succession, are met. Check the current rates and conditions with your adviser.

Will and lasting power of attorney: inheritance planning in context

A succession should always be coordinated with the rest of the inheritance planning. Questions to clarify:

• What happens to the company if you die before the transfer is completed?
• Do you have an updated will?
• Is your lasting power of attorney in place if you lose capacity?
• Is there separate property or other marital-agreement arrangements that affect the inheritance of the company?

A will is especially important if you have children from previous relationships, or if you want to distribute the inheritance differently from the default of the Inheritance Act.

The shareholders' agreement as a foundation

Whichever model you choose, there should be an updated shareholders' agreement when two or more people own the company. The agreement governs:

• Who owns what, and with what voting weights
• What happens if an owner wants to sell (pre-emption, drag-along, tag-along)
• What happens on an owner's death
• What happens on divorce
• Decision-making processes and mechanisms for breaking a deadlock

A succession carried out without a shareholders' agreement is a recipe for future conflict.

Share transfer: the legal steps

When the shares are transferred, it must be documented formally:

1. A general-meeting decision, if the articles require it
2. A transfer agreement: the written agreement on terms, price and payment
3. Updating the register of owners: the company's register of owners
4. Any registration with the Danish Business Authority on changes in management or ownership that must be registered

Without a well-documented transfer agreement and an updated register of owners, the transfer is legally vulnerable.

The time horizon: start in good time

A good succession takes time, typically 2 to 5 years from the first consideration to final completion:

• Years 1 to 2: preparation, including valuation, the choice of model and any optimisation of the company structure
• Years 2 to 3: a gradual transfer of management, where the next generation takes over responsibility and customer contacts
• Years 3 to 5: the formal legal and tax transfer

Companies that are suddenly forced into a succession, for example because of illness or death, have far fewer options for tax planning and risk a lower price.

Holding structure and succession

Many owners have a holding structure, where a holding company owns the shares in the operating company. This can give advantages in a succession:

• Dividends can, under certain conditions, flow tax-free up to the holding company and be saved there
• It is often easier to sell the operating company while keeping the holding company
• Succession can be arranged via the holding structure

If you are considering setting up a holding structure before the succession, it can give advantages, but it takes time and should be planned well before a planned sale. Your accountant can assess whether it makes sense in your situation.

What does a succession cost?

The costs vary with the complexity:

Element	Estimated cost
Accountant (financial planning and tax)	DKK 20,000 to 100,000
Lawyer (legal documents and negotiation)	DKK 15,000 to 75,000
Business broker (with an external buyer)	2 to 5% of the sale price
Gift tax (depends on the model)	0 to 15%

The legal documents, that is the transfer agreement, the shareholders' agreement and the will, make up a small part of the total costs, but they are critical. They are what determine what happens if something goes wrong.

Retaining key employees

One of the biggest risks in a succession is that key employees leave the company in connection with the change of ownership, either because they are unsure about the future or because competitors use the period of uncertainty.

Lock-up agreements: a binding period, typically 1 to 3 years after the change of ownership, possibly combined with a retention bonus at the end, gives the new owner time to build relationships and ensure that knowledge is transferred.

Co-ownership: in connection with an MBO or a succession, key employees can be offered co-ownership on favourable terms. This creates motivation but requires a well-thought-out shareholders' agreement.

Communication: key employees who are kept in the dark about the succession are more likely to look elsewhere. Communicate early and honestly within what you can disclose.

Typical mistakes and pitfalls

Mistake 1: planning too late

Many only start thinking about succession when their energy fades. That is often too late for optimal tax planning and for a smooth transition. Start the planning several years before the expected transfer.

Mistake 2: no valuation

"What is the company worth?" is a question owners often answer incorrectly, either too high or too low. The tax authorities have their own valuation methods and can challenge a transfer at too low a price. Have an independent valuation carried out as the basis for the negotiations.

Mistake 3: unclear ownership

Do you own the company alone, or are there other owners with rights in connection with the transfer? A lack of overview of the ownership can block the whole process. Make sure the register of owners is up to date and that a shareholders' agreement governs what happens on a change of ownership.

Mistake 4: spouse and financial arrangements

If you have shared marital property, the value of the company is included in the division on divorce or death. This can create conflict if the company is transferred to one child while other heirs expect a share. Consider separate property for the company via a marital agreement, and coordinate with an updated will.

Getting started

A successful succession rests on three legs: the right model chosen in good time, the right tax advice from a specialist accountant, and the right legal documents, including a transfer agreement, a shareholders' agreement and an updated will. It is the documents that determine what happens if something goes wrong.

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This article is informative and does not constitute legal or tax advice. Succession involves complex tax assessments. Contact your accountant or a specialist adviser.