The essentials of succession planning
While it might be a tough topic to broach, it is inevitable that someday you will leave your business. You can’t know whether you’ll sell up, retire or leave due to health reasons, so is important that you prepare yourself for any eventuality.
A recent nationwide survey by the Australian Centre for Family Business at Bond University found more than 40% of family businesses are looking to transfer their wealth and operations to other people in the next five years. But the survey also found that most of the owners of those family businesses are not thinking about succession planning.
In an overwhelming majority, 93% of the survey’s respondents intend to transfer their business wealth within the family, but only 39% of respondents have a complete succession plan that nominates a chief executive successor. Research also shows that more than 65% of family businesses fail after having been passed to a second generation and another 20% fail when they’re passed on again.
The most common causes of business failure are:
- a lack of management skills, and inadequate consideration and planning for the ownership transition
- failure of parents to “let go”
- the problem of the “insider and the outsider” which relates to a failure of the head of the business to share knowledge and decision-making with all relevant parties
- the “disconnected shareholder” – that is, a dissatisfied family member who is not part of the decision-making hierarchy but constantly undermines authority and management, and
- “fighting over the spoils” when family members look critically at what one is receiving from the business and comparing it to what another receives.
These worrying indicators themselves warrant a simple to-do checklist for family businesses considering succession planning in the next few years.
Your 5-step succession planning checklist
1) Decide on who a successor should be
When choosing a successor from your family, think about what is best for the future of the business. Don’t let emotions cloud your judgement – understandably difficult, but vital. Also, be aware of the potential problems when choosing a family successor. Choosing just one may cause conflict if others are interested in taking over but if you appoint more than one successor, the business may be left without a clear leader.
Evaluate your situation by ensuring your successor has both the necessary skills and passion to take over the business – children, for example, should earn their right to be at the head of a business rather than having it handed to them as a mere birth right. A board of non-family members or an adviser may help provide an objective opinion.
Multi-generational family businesses often succeed when the decision to remain in business together is made by the children themselves, rather than the parents. Parents should continuously include their children in the decision-making process about succession and leave them to make their own decisions about their future prospects at a more appropriate time.
2) Train the successor
Owners of family businesses often make the fatal mistake of giving the business to their children or siblings with minimum notice and a lack of training. Succession planning is a systematic process, not a one-off incident – start teaching your successor about the business’ operations and finances. It takes years to get up to speed with everything.
Identify areas of expertise that are fundamental to your business and determine if your successor fits the bill. Conduct regular appraisals, give performance feedback and assign higher-level projects to prepare them for the tougher challenges they will face down the road.
Transfer of knowledge is critical to succession planning. Successors need to:
- learn about business through formal education and working outside the business
- learn about the family business, in particular the family network and network management skills, and
- learn to lead the family business by codifying knowledge and learning the tacit knowledge, training in operational and financial management, and thinking strategically in the business.
3) Work on a succession plan
A complete succession plan has to incorporate the core values of your business and should:
- answer questions about who will be in charge, how much of a stake they will acquire and at what cost
- include a shareholder or shareholders agreement
- include an estate plan
- include a timeline for the transfer of power
- be known to all parties
- include a valuation of the business. Such valuations require professional skills, given the intertwined nature of the business, the family, and the unique family factors that drive value
- include a financial security plan for the founder, and
- be in written form.
Also think about financial and legal issues such as:
- Are you planning to gift or sell the business to your family?
- Do you need to set up a trust as part of the succession?
- Would you prefer to receive a regular dividend from the business or a lump sum?
- Are there any legal or industry requirements to meet in relation to ownership of important positions?
- If you sell your business to a family member, are you giving them a loan or are they acquiring a loan from a financial institution to pay for the business?
- What are CGT implications of transferring interest in the business? Are there any concessions available?
Identify risks and common goals, potential conflicts and ask this office for assistance if necessary. Also consider if you need to transfer both ownership and management, if ownership will be equal among family members and if the management team should include non-family members.
You may have to continually revisit your plan, review and update it to reflect changes in business value, market conditions, your own health as well as the suitability of the successor you intend to pass it on to. Regularly review your plans with family to ensure they are aware of and happy with the development of the business.
4) Show your faith
If you do not show your confidence in the proposed successor and demonstrate to employees that you trust this nominated person to take over your business, your business is not likely to succeed after you’re gone. Ensure everyone knows who your successor is and how excited you are for her or him to take over the reins and develop the business. Do not force the successor to mimic your management style or business values.
5) Consider external options
If there is no one suitable within your business or family, consider looking externally too. There is no benefit in having an uninterested daughter or an incapable son running things. Look for candidates that have strong talents, skills that will complement the business, and a resourceful and enthusiastic approach towards work. If you end up selling or passing on your business to an outsider, you may be able to negotiate a provisional consulting and training period where you remain in the business to ensure a smooth transition.
The sooner a succession plan is put together, the better, but this is by no means an exhaustive list of all the factors you have to consider. Consult this office for professional advice before selling or passing on your business to your successor.