I’ve often been asked by clients to assist in a trade sale of their business or a sale or hand over to the next generation. These all take different forms depending on the motivation of the parties concerned.
While there seems to be an increasing awareness of the need to prepare for transitioning the business, figures from the latest MGI Family Business Survey indicate that more than 75% of family businesses have no formal, written management or ownership succession plan.
I was recently asked what I thought were the secrets to good business succession for a family-owned business. A common scenario is where the mum and dad business founders want to retire and hand the business over to one or more siblings.
As in life generally, communication is the key. Differences can arise when the parties have a mistaken perception about the motives and actions of each other. Talking things through is therefore critical to avoid the potential for the parties to make assumptions and jump to sometimes erroneous conclusions.
I have listed below my Top 5 issues to include in your business succession discussions:
- Develop a Family Business Constitution
One of the best ways to ensure that the necessary issues are discussed is for the family to work through the process of documenting a family business constitution. As in all cases, its horses for courses. If your business is relatively small, the starting point may be to initially just cover the basics. You can build on it as time goes by. For larger businesses, it’s worth the effort to get it right and documents what the family has agreed and enables family members to clarify expectations, minimize conflict and maintain family relationships.
By identifying processes for communication, decision-making and handling disagreements and creating a clear set of guidelines for resolving issues before they escalate, a family business constitution helps to formalize procedures and relationships, reducing the potential for issues to become personal and emotional. - Get buy-in from the whole family
Involving all family members in the process, regardless of their current level of involvement in the business, is critical in ensuring that the plan is workable. Without everyone’s input, there may be underlying issues which can ultimately lead to resentment within the family.
If the business is not going to be passed on to all children equally, make sure your estate planning reflects this. Having an up to date Will that reflects your intentions is often overlooked.
Finally, it might sound obvious but it’s crucial to plan the involvement of the successor sibling to ensure that all knowledge and intellectual property is captured and passed on in a timely and effective manner. - Agree a business valuation framework
A business valuation framework should be Included in the Family Business Constitution so that all family members are clear on how the business will be valued. The key here is to make sure that it is workable and that the terminology is well defined so that there can be no room for misinterpretation. It is important for both the vendor parents and the purchasing sibling to feel that the transaction price is fair. However, it is just as important that siblings not involved in the business perceive equity in the process. - Review your business structures
There are two issues with this step. The first is to ensure that your current structure is right for you. Family (discretionary) trusts are very commonly used in family businesses. Whilst these may work well for a typical mum and dad family business they are unlikely to be appropriate where siblings are involved. With a family trust, you don’t own anything and therefore do not have an asset to bequeath in the event of your death. What happens if a sibling dies or there is a matrimonial split?
The second issue is to ensure that you take full advantage of some of the capital gains tax concessions currently available on the sale of a business. If structured correctly, it is possible to have a capital gain of up to $4m and pay no tax but there are many “hoops” to jump through in order to qualify, so get advice well before you’re ready to sell. - Consider implementing a put and call option arrangement
Whether a business will ultimately be transferred from mum and dad to one or more of the children, or whether a number of siblings are already owners of the business, one thing that is generally not well addressed is what happens if one of the owners dies or is seriously incapacitated. Often, the siblings of the deceased are left in business with the spouse or family of the deceased, sometimes with disastrous consequences. One way to deal with this is to put in place a Put and Call Option arrangement.
In the event of death or disablement of an owner, it provides the spouse or estate of the owner the right, but not the obligation, to force the remaining owners to buy out the ownership interest. It also provides the remaining owners with the right, but not the obligation, to force the spouse or estate of the deceased, to sell. This provides certainty for both parties. The buy out is often funded (either fully or partially) by having the parties take out life insurance.
Of course, having a framework to work through the process is vital but one thing you cannot predict is how people will react – their thoughts, feelings and concerns. Taking account of the human side of the planning process and having a process to deal with it is critical to the effectiveness of the final plans.
Creating an effective plan may seem quite a daunting task, especially when it involves getting the buy-in of all family stakeholders but if you break it down into bite sized chunks and set realistic deadlines for yourself, it can prove to be one of the most valuable exercises you will undertake for your business.