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Zia Mody – Evolving Legal Landscape for Family Businesses

Investment Outlook , Published Feb 17, 2019

Zia Mody

Zia Mody

Founder and Managing Partner at AZB & Partners.

Two legal themes are likely to lead to better
governance practices and financial management by
Indian family businesses over the next few years.

Overview

Business families will talk more about business
succession planning than before,
particularly if an estate tax is introduced.
Secondly, the implementation of the Insolvency
and Bankruptcy Code, 2016 will
make business families increasingly cognizant
of the importance of personal wealth
planning as well as the impact of promoter
debt obligations on personal finances.

According to reports by Credit Suisse and
Bain earlier this year, Indian family-run businesses
were ranked as some of the world’s
best companies for shareholder value.

These companies outperformed their peers
in other regions, as well as non-family
owned companies over the last decade and
a half. At the same time, 2018 has been the
year of the NPA crisis, with periodic reports
of large-scale loan defaults by prominent
promoters and family businesses, with RBI
numbers indicating that the loan default
margin doubled over the period of a year.

Considering this background, two legal
themes are likely to feature strongly over
the next few years..

The first is the Indian estate tax. Broadly, this
is a tax levied on the inheritance of wealth
by the next generation. As it is targeted at
the redistribution of wealth, the rates levied
tend to be higher than income tax.
Although India does not currently have an
estate tax in place, it is expected to come in
at some stage. The significance is that globally,
estate tax regimes are not restricted to
liquid assets. Illiquid assets such as family
business shareholdings are also included in
the estate. If a similar model is adopted in
India which is likely, then considering that a
majority of businesses in India are family
owned, the introduction of such a tax could
create cash flow difficulties for the family,
and hurt the business, if a plan is not put in
place in advance.

As we wait for the law to come in, several
business families have already started planning
for a trust and other structures in anticipation
of the tax. This is likely to continue
shaping the way family businesses are held
and managed in India in the years to come.

A second key theme is the impact of implementation
of the Insolvency and Bankruptcy
Code, 2016 (“IBC”). Historically, it has been
a common practice for promoter families to
co-mingle business and personal assets,
and plough back all proceeds back into the
business. While this sort of single-minded,
long-term focus on the business may have
created value, it also meant that good governance
practices were not given sufficient
importance due to the conflation of business
with family finances. The IBC brought
about a shift in approach, by introducing a
creditor favourable regime and making it difficult for companies to practice
ever-greening of their business loans. A
recent Supreme Court ruling also held, for
example, that personal guarantors cannot
benefit from the imposition of moratorium
during the insolvency process and therefore
continue to be subject to independent and
co-extensive liability under the IBC.. As a
consequence, business families are increasingly
cognizant of the importance of personal
wealth planning, and the impact of
promoter debt obligations on personal finances.
It is likely that in the years going forward,
these developments will lead to better governance
practices and financial management
by Indian family businesses.

The significance is
that globally,
estate tax regimes
are not restricted
to liquid assets.

On a related note, business families are
talking more about business succession
planning than they have ever before, and
this will be a continuing theme going
forward as well, particularly if an estate tax
is introduced. Changing family circumstances
such as increasing global families, children
studying abroad, daughters playing
stronger professional roles and some public
high-value disputes are compelling families
to think about the relationship of the family
with the business in a more structured fashion.
Greater thought is going into how
family businesses can be managed in a
seamless fashion even after the demise of
the patriarch, how capability may be built in
the next generation or how professionals
may add value. Overall, the statutory push
to get women directors on board is salutary.
And this will surely be good for the economic
landscape.

The investment outlook cannot fail to evaluate
whether development is inclusive and
leading to positive socio-economic growth
at the grassroots. Philanthropy has received
a fillip due to companies being required to
make corporate social responsibility contributions
under law. Social business investments

forever-appreciating

have also seen an increase over the last
decade, and this will hopefully fulfill a dual
mission of socio-economic development
that is sustainable and not grant dependent.
Indian families, in making these investments,
extend their family legacies beyond
the board room. It is an investment
approach that is made across asset classes
including venture capital, private equity,
social impact bonds, and social venture
funds. Such impact investment globally is
set to cross over USD 465 billion by 2020. A
recent study with KPMG showed that the
market is estimated to grow by 16% through
to 2020.

I believe the path to this journey by Indian
family businesses will soon reach maturity.
And that will lead to a more mature separation
of roles between family members of
management and ownership with less friction
and the obvious resultant accretive positive
value creation.

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