Nobody likes to think about it, but it’s inevitable that one day you will leave your business.
Whether you decide to sell up, retire or have to get out of business due to health reasons, it’s important that you plan for that day.
A succession plan is a strategy which determines the best way for you to exit your business while ensuring the business continues. The plan determines who will take leadership and/or ownership of the business when you leave.
A good succession plan enables a smooth transition with less likelihood of disruption to operations. By planning your exit well in advance you can maximise the value of your business and enable it to meet future needs.
Failing to invest the time on a succession plan may lead to your lawyer and accountant picking up the pieces of a broken business when it is too late, in an effort to realise something of value for you or your surviving family.
The two main options for exiting a business are passing it on to the family or selling to a third party that will continue the business. There is however one important process in each of these; plan; plan some more, and then plan just a little bit more.
“Retention planning” – Keep it in the family
Many owners choose to keep the business in the family when they leave, so your aim is to retain the business in the family. If you plan to transfer your business to a family member you need to consider the legal obligations as well as the impact on family relationships. Don’t assume they want to follow in your footsteps and honestly assess their ability to run your business. There’s little point anointing the favorite child if they’re going to run the business poorly and your legacy is gone in a few short years.
You must enlist your trusted advisors to guide you in this process. If the family member is not ready, then you have time to make them ready because you are planning now, not later.
“Buy-sell planning” – Sell to a Third Party
This may take the form of selling the business to external parties like employees or like businesses, or an existing partner you own the business with. It is very often a competitor, supplier or client.
Employees/Existing Partners – encompasses amongst other things utilising your intimate knowledge of your business and your employees/partner to enrol them in the possibility of taking over. Finance may very well be an issue as they will be unlikely to have the resources to buy you outright, so you will be funding their buy-in over time.
Businesses – engaging a professional to sell your business for you, including the engagement of experts, valuers and other advisors. It takes time for them to know your business the way they should before they assist with its sale. Do not rush this, ever.
Is your business “Investment Ready”? – More often than not we hear “my business is my superannuation”. Well in that case it’s time to realise your life’s investment so it better be for as much as you can get. The market will dictate to a large degree the value of your nest egg but if you have a strategy in place years before sale you can maximise the price as best you can.
Whichever the option both require extensive and careful planning.
Cash and Tax….
A significant difference to both of these options is the sale price or maybe even the lack of one! Family retention may mean that you personally receive no cash for passing the business on (or a trickle of funds not a lump sum), yet there are legal and tax consequences when legal title pass – not a fair deal I hear you say! This is all the more reason to plan what you can do now to perhaps eliminate or reduce nasty tax consequences and avoid the “no cash but tax to pay scenario”.
If you do decide or it is inevitable that you will sell to a third party, then of course you want to maximise the value of your business and pay as little tax. Maximising the value of a business takes time. Yes, more planning with this too. Be ready to sell at a moment’s notice, so in other words once you have decided to exit the business in say 5 years time then planning starts now. But if it’s ten years why wait? The reason for this is simple. If you decide to sell and have all the necessary plans in place to do so, then if someone comes along in 3 years time not the “desired” 5 or 10 years and offers perhaps somewhat less than what you thought was the right price, ask yourself a few simple questions:-
- How much less is it really?
- What are the tax consequences? – It’s a number crunching revision of what you should already have in your plan.
- What can you do with that money now that will derive good enough returns over the next number of years that essentially derives the same result as holding out to your desired time frame?
- What is the industry climate at the moment? Is it a glut of sellers and no buyers or plenty of buyers and no sellers? Will the trend continue?
You cannot make an informed decision for you and your family unless you have the necessary planning “done and dusted”. When an offer or opportunity presents all you need to do is dust off the plan and revise; much easier than doing from scratch while the buyer is already looking at an alternative acquisition.
Financiers; Love them or….
We know they have a necessary function. They’ve been with us through the building phase of our business when we had nothing and they’re a constant reminder at reporting time that we owe them money. While you, the sole owner/main proprietor/ significant owner, is still kicking the dirt all is good, but if your health takes a turn guess who starts getting nervous because there is perhaps no-one to run the business. Suddenly the tight finance restrictions become tighter, you have to convince them that your wife, or child can run the business in your immediate absence but what if they can’t, what if your health means you can’t return? If the business cannot function without you then what have you got to sell, and quickly? Pressure from the financier is the last thing a family business needs at a time when difficult business decisions need to be made. If a succession plan has been drafted, whether family retention or sale to a third party it can be rolled out and implemented immediately.
Partners & Ownership Structures in Business
Many businesses have different ownership structures that involve numerous companies and trusts that make exiting the business complex. In addition, businesses can involve one family with numerous family members involved in the business or multiple families with family members involved in the business that all believe they have something at stake whether it be via real ownership (shares) or implied ownership (inheritance). The last thing needed is uncertainty at a time direction and cool heads must prevail due to an untimely illness or death.
An essential document that may be required is a Buy-sell agreement. The last thing any partner in business wants is to suddenly be in business with the wife, husband or children of a deceased business owner that left “everything I own to my wife and children”. A Buy-sell agreement can give the surviving partner rights to acquire the deceased partner’s interest at a price determined via the agreement with time to fund the acquisition. Insurance may be available to be taken out and insure the life of the business owners whereby the surviving partner uses the insurance proceeds to acquire the deceased’s business interest.
Buy-sell agreements are legally binding contracts which control when owners can sell their interests, who can buy an owner’s interest, and at what price. They are mostly used to ensure the smooth continuation of a business after a potentially disruptive event, such as an owner’s retirement, incapacity, or death.
A word on taxes
- Plan a sale and taxes can be minimised within the current legislation
- Fail to plan and you will pay dearly for it.
Do I need a succession plan?
A succession plan is essential to securing the future of your business and to maximise your family’s well being. Without a plan, the future of your business will be left to chance if you hand over the reins, sell in haste or once you’ve gone.
With so much at stake a succession plan is vital and will help you to:
- Hand over the reins to the right family member(s) at the right time;
- Maximise the value of your business if you decide to sell;
- Unlock that value by enhancing the marketability of your business; and
- Exit your business with maximum profitability and the foundations laid for its continued success.
Some statistics ^1
- Evidence suggests very few family businesses survive past the first generation
- 1/3rd of family businesses continue into the second generation
- 1/6th (16%) survive the third generation
- Less than 30% of business owners aged 51-60 have a written business succession plan, and more than 70% have no plan at all
^1 Source AXA Australia Family Business Research Unit Monash University
A successful business succession plan can take considerable time to prepare. You can choose to begin planning now, or be one of the statistics and hope that your advisors can work out a solution at the least appropriate time for your family and/or surviving business partner.
DISCLAIMER: The above information is general in nature, and must be tailored to your personal circumstances. The information is provided as a guide only.