Due diligence in a family business: what to review before entering or transferring

Due diligence in a family business has characteristics that do not exist in a company with dispersed shareholders: the blurring of family and business interests, the frequent existence of related-party transactions between the company and its shareholders or relatives that may be pending regularisation, the acquired rights of family employees without formal contracts, undocumented implicit debt from shareholder loans, and uncertainty about whether the family business requirements for the Wealth Tax and ISD exemptions are met are specific risks that must be analysed.

Since 2010 · 16 years Tax agent AEAT

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Why BM Consulting

Specialised advice and personal service

At BMC we carry out specific due diligences for transactions in family businesses: purchases of shareholdings from heirs or family shareholders, entry of private equity funds into family businesses, and due diligence preceding generational transfer. Our report analyses both the business risks and the specific family-corporate dimension.

  • Related-party transactions between a family business and its shareholders (loans, property leases, management fees) must be priced at arm's length under Art. 18 LIS — undocumented or non-market transactions generate quantifiable tax contingencies that directly reduce the acquisition price.

  • The 95% ISD relief for family business transfers requires

    (1) genuine economic activity, (2) management function with remuneration exceeding 50% of the shareholder's total income, and (3) shareholding exceeding 5% individually or 20% on a family basis — failure of any condition removes the relief entirely.

  • Family employee employment risks are among the most underestimated in family business due diligence

    informal remuneration, unrecorded benefits, and missing employment contracts generate post-acquisition Labour Inspectorate exposure for the buyer.

  • The absence of a binding shareholder agreement is a material due diligence finding for any incoming investor — entry should be conditioned on simultaneous execution of a shareholder agreement governing transfer restrictions, governance, and dispute resolution.

How we work

From first contact to case completion

  1. Corporate and governance review

    We analyse the corporate structure of the family group, the articles of association and any existing shareholder agreement (or its absence), the minutes of the governance bodies, existing or potential conflicts of interest, and compliance with the family business's corporate governance requirements.

  2. Related-party transactions and shareholder loans

    We review all transactions between the company and its shareholders or relatives: loans from the company to shareholders, loans from shareholders to the company, property leases between the company and the family, services provided by relatives' companies, and directors' remuneration. We verify that they are documented and valued at arm's length.

  3. Tax due diligence: family business and related-party transactions

    We verify whether the company meets the family business requirements for the Wealth Tax exemption and ISD relief, analyse the related-party transactions from a transfer pricing perspective, and review the tax position of the last four financial years to identify material contingencies.

  4. Employment relations with family members

    We review the employment position of family employees: contracts, remuneration, Social Security contributions, undocumented informal benefits, and the existence of rights that could give rise to claims following the transfer.

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The problem

Due diligence in a family business has characteristics that do not exist in a company with dispersed shareholders: the blurring of family and business interests, the frequent existence of related-party transactions between the company and its shareholders or relatives that may be pending regularisation, the acquired rights of family employees without formal contracts, undocumented implicit debt from shareholder loans, and uncertainty about whether the family business requirements for the Wealth Tax and ISD exemptions are met are specific risks that must be analysed.

Our solution

At BMC we carry out specific due diligences for transactions in family businesses: purchases of shareholdings from heirs or family shareholders, entry of private equity funds into family businesses, and due diligence preceding generational transfer. Our report analyses both the business risks and the specific family-corporate dimension.

Process

How we do it

1

Corporate and governance review

We analyse the corporate structure of the family group, the articles of association and any existing shareholder agreement (or its absence), the minutes of the governance bodies, existing or potential conflicts of interest, and compliance with the family business's corporate governance requirements.

2

Related-party transactions and shareholder loans

We review all transactions between the company and its shareholders or relatives: loans from the company to shareholders, loans from shareholders to the company, property leases between the company and the family, services provided by relatives' companies, and directors' remuneration. We verify that they are documented and valued at arm's length.

3

Tax due diligence: family business and related-party transactions

We verify whether the company meets the family business requirements for the Wealth Tax exemption and ISD relief, analyse the related-party transactions from a transfer pricing perspective, and review the tax position of the last four financial years to identify material contingencies.

4

Employment relations with family members

We review the employment position of family employees: contracts, remuneration, Social Security contributions, undocumented informal benefits, and the existence of rights that could give rise to claims following the transfer.

Family business due diligence: reading between the lines

The due diligence of a family business is different from that of an institutional company. Not only because of the technical aspects — related-party transactions, informal corporate governance, the blurring of family and business assets — but because there is an emotional and relational dimension that influences how information is shared and how data is interpreted. Founders often have difficulty separating an objective view of the value they have built from the emotional expectations they hold about it.

At BMC we carry out due diligences on family businesses with the experience of having seen many such situations. We know where to look for the contingencies that do not appear in the accounting records, how to interpret the related-party transactions, and how to communicate findings constructively so that the transaction can proceed with the necessary safeguards.

The analysis of related-party transactions in a family business is frequently the most revealing chapter of the due diligence. These transactions — company loans to shareholders, leases of family-owned properties to the company, services provided by relatives’ companies, remuneration of director-family members — may not be correctly documented, may be priced at non-market rates, or may generate tax contingencies that the shareholders had not considered.

The purpose of the analysis is not to create problems but to quantify the contingencies so that they can be managed: through a reduction in the purchase price, through a price retention until regularisation, or through vendor warranties.

Family business requirements: a critical verification

If the family business transfer is to be structured with the 95% ISD relief, the family business requirements must be verified before closing. A buyer who acquires shareholdings in a family business expecting that the next transfer to their children will benefit from the relief, but discovers after closing that the company does not meet the genuine economic activity requirement, will have paid a price that included a tax benefit that does not exist.

We verify compliance with the requirements at the time of the transaction and analyse whether there is a risk that they will cease to be met in the future.

Corporate governance: making the unwritten rules explicit

Many family businesses operate with tacit governance rules that all shareholders know and respect but that are not set out in any binding document. When a new shareholder enters — a fund, an external partner, a second-generation family member — these tacit rules are no longer sufficient.

The due diligence identifies what rules exist tacitly and recommends which should be formalised in a shareholder agreement before the transaction closes.

Contact our specialist family business due diligence team for your next transaction.

FAQ

Frequently asked questions

A related-party transaction is any transaction between the company and a person or entity related to it: shareholders, directors, relatives of shareholders, or other companies in the family group. Spanish tax legislation (Article 18 LIS) requires these transactions to be carried out at arm's length, and the AEAT reviews them with particular scrutiny in family business audits. Undocumented related-party transactions or those with non-market pricing generate tax contingencies that may be significant, and that the buyer will want to know about before closing.
The requirements are: (1) the company must carry on a genuine economic activity (not be a mere asset-holding company); (2) one of the direct-line shareholders of the transferor — or the transferor themselves — must perform genuine management functions with remuneration exceeding 50% of their total employment and capital income; (3) the transferor's shareholding must exceed 5% individually or 20% on a family basis (spouse, ascendants, descendants, and collateral relatives to the second degree). If all of these requirements are not met at the time of transfer, the relief does not apply and the tax liability may be tens of thousands of euros or more.
Loans between the company and its shareholders (loans from shareholders to the company and, more problematically, loans from the company to shareholders) must be evidenced by a written agreement, must bear a market rate of interest, and must be repaid within the agreed timescales. Company loans to shareholders that are not repaid may be characterised by the AEAT as disguised dividends (with the consequent tax implications) or as disguised remuneration to the director. In family business due diligence, the analysis of these loans and their regularisation is frequently one of the most material chapters of the report.
The absence of a family protocol — or the existence of one without legal enforceability — is a material finding in family business due diligence because it means the rules on transfer of shareholdings, family admission to management, dividend policy, and dispute resolution are not defined in a binding manner. For an external investor entering a family business, this represents a risk of future conflict with the family shareholders on issues that are not regulated. The standard recommendation is to make entry conditional on the simultaneous signing of a shareholder agreement governing these matters.
A typical family business due diligence can be completed in three to four weeks from the availability of a complete data room. Complexity increases when the family group includes several companies, when related-party transactions are numerous, or when there is uncertainty about family business requirement compliance that requires additional analysis. It is common for contingencies identified during the due diligence to require clarification from the sellers, which can extend the process.
Family employees in family businesses frequently work under informal arrangements that create material acquisition risks: written employment contracts that do not reflect the actual remuneration (cash payments not on payroll), Social Security contributions based on below-market salaries, unrecorded working hours giving rise to overtime claims, undocumented benefits (company cars, expenses), and in some cases, an employee who has never had a formal contract at all. Following a change of ownership, these irregularities can generate claims from the employees themselves or findings in a Labour Inspectorate audit that the buyer becomes responsible for. The employment due diligence chapter in a family business must review all family employment relationships individually.

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Frequently asked questions

Questions about Due Diligence for Family Businesses

A related-party transaction is any transaction between the company and a person or entity related to it: shareholders, directors, relatives of shareholders, or other companies in the family group. Spanish tax legislation (Article 18 LIS) requires these transactions to be carried out at arm's length, and the AEAT reviews them with particular scrutiny in family business audits. Undocumented related-party transactions or those with non-market pricing generate tax contingencies that may be significant, and that the buyer will want to know about before closing.
The requirements are: (1) the company must carry on a genuine economic activity (not be a mere asset-holding company); (2) one of the direct-line shareholders of the transferor — or the transferor themselves — must perform genuine management functions with remuneration exceeding 50% of their total employment and capital income; (3) the transferor's shareholding must exceed 5% individually or 20% on a family basis (spouse, ascendants, descendants, and collateral relatives to the second degree). If all of these requirements are not met at the time of transfer, the relief does not apply and the tax liability may be tens of thousands of euros or more.
Loans between the company and its shareholders (loans from shareholders to the company and, more problematically, loans from the company to shareholders) must be evidenced by a written agreement, must bear a market rate of interest, and must be repaid within the agreed timescales. Company loans to shareholders that are not repaid may be characterised by the AEAT as disguised dividends (with the consequent tax implications) or as disguised remuneration to the director. In family business due diligence, the analysis of these loans and their regularisation is frequently one of the most material chapters of the report.
The absence of a family protocol — or the existence of one without legal enforceability — is a material finding in family business due diligence because it means the rules on transfer of shareholdings, family admission to management, dividend policy, and dispute resolution are not defined in a binding manner. For an external investor entering a family business, this represents a risk of future conflict with the family shareholders on issues that are not regulated. The standard recommendation is to make entry conditional on the simultaneous signing of a shareholder agreement governing these matters.
A typical family business due diligence can be completed in three to four weeks from the availability of a complete data room. Complexity increases when the family group includes several companies, when related-party transactions are numerous, or when there is uncertainty about family business requirement compliance that requires additional analysis. It is common for contingencies identified during the due diligence to require clarification from the sellers, which can extend the process.
Family employees in family businesses frequently work under informal arrangements that create material acquisition risks: written employment contracts that do not reflect the actual remuneration (cash payments not on payroll), Social Security contributions based on below-market salaries, unrecorded working hours giving rise to overtime claims, undocumented benefits (company cars, expenses), and in some cases, an employee who has never had a formal contract at all. Following a change of ownership, these irregularities can generate claims from the employees themselves or findings in a Labour Inspectorate audit that the buyer becomes responsible for. The employment due diligence chapter in a family business must review all family employment relationships individually.

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