Leaving your business in good hands

Cliff Dawson recently presented this paper at a meeting of the Whitehorse Business Group.

The old adage, “businesses which fail to plan, plan to fail”, is also very true in respect of succession planning. Most small businesses don’t give this much thought until it’s too late.

Family businesses in Australia represent a significant sector and a university study called the Australia family and Private Business Survey completed in 1997 and updated in 2003 identified some interesting factors. Over 75 percent of Australian businesses could be classified as family or privately owned. Their estimated value increased from $1.2 to $3.6 Trillion between 1997 and 2003.(represents 5 times the market capitalisation of the ASX. It’s by far the largest sector in our economy, the biggest employer, and the biggest contributor to our gross domestic product.

But these businesses are really heading towards a crisis situation. It’s a crisis of succession planning and wealth transfer. We’re seeing over the next decade or so a huge transfer of wealth, ownership and power in this family business sector. The survey found the average age of business owners to be 56 and that about half of all Australian family businesses will change hands as part of this process. (Some $1.6 Trillion in value over the next 10 years or so).

But alarmingly most of these businesses have made no proper plans to manage the process. The survey found that over 75% of these businesses did not have a formal succession plan.

The following are some key factors that we should consider when considering succession planning for our business.

1. Determine why you are in business and identify a succession plan or exit strategy early on and always keep your options open. Be flexible in your thinking but mindful that one day you’ll want to release your equity from your business one way or the other.

2. Operate and run your business each day so it would be attractive to potential equity participants whoever they may be. Organise your business so it doesn’t rely on you as the owner for its existence and performance.

3. Make sure you have good systems and procedures in place. Aim for a turnkey operation. Franchises do this very well. Unfortunately, most small businesses lack in this area.

4. Look after your employees who, for most businesses, are our most valuable asset. Look after them not only financially but in others ways as well. This is a key issue now. Learn how to connect with Gen Y & X employees and deal with intergeneration interaction and change in the work place.

Communicate clearly your expectations, career paths, job descriptions. Provide feed back and accountability. Articulate your vision and business plans with your staff. Who knows, some of your key employees may well be the right people to take over your business down the track.

5. Operate your business as if succession or transfer of ownership could happen at any time. Have a clear direction and plan for your business. Unforseen illness or death is often a critical time in the life of a family business and succession planing ideally should have been thought through prior to such an event.

6. Enjoy the financial rewards from your business along the journey. A healthy business should serve the owner not the owner being a slave to their business. It should allow you to accumulate wealth separate from your business which takes the pressure off relying on unlocking business equity one day – which may or may not meet your expectation.

Set financial targets and expectations for your business. Try bottom up budgeting rather than top down. Ask yourself “what do I expect to achieve financially out of my business?” and then put strategies in place to achieve this. You might get an unpleasant surprise.

7. Unlock the power of business value. Businesses are normally valued on a multiplier of sustainable future earnings. For example, an annual profit of say a $100,000 on a three times multiplier gives a business value of some $300,000. Every $10,000 increase in annual profits, represents a thirty thousand dollar increase in the capital value of your business upon sale or transfer of your business.

The key here is - work on building your business profitability and value should look after itself .

8. Consider the impact of taxation especially capital gains tax on your exit or succession planning strategy. After all, it’s the net bottom line cash in your pocket that you’re interested in upon the transfer or sale of your business. You need to seek good advice in this area. The Government’s recent changes to the capital gain tax legislation has opened up broader access to the small business concessions and it’s our view that most small businesses with good planning and advice should be able to significantly reduce their capital gains tax liabilities and in some cases eliminate it all together. But again planning and obtaining good advice is the key.

9. Key issues for a management buy in.

a) It needs to be affordable. Those taking up equity need to be able to service any loans or debt and obtain a reasonable pay back period on their investment.
b) Be flexible in the terms offered for a buy in. For example, a gradual buy in over time.
c) Offering a transition period where you as the owner stay on in a consulting or a scaled down role. This could be important to make sure that the business transfers in an effective and seamless way.
d) Assist with funding options to facilitate the transfer. May be vendor finance or your business bankers or other financial institutions. Think creatively about how you might put a package together to make it attractive for a management buy in.

10. Issues involving family succession.

a) Often these situations bring unique issues and problems that emanate out of family relationships. These can often be mitigated by clearly communicating and documenting expectations, job descriptions for each family member and articulating a plan and a vision for the business that is owned by the respective family members.
b) Be willing to let go and give family the chance to achieve and get on with running their part of the business. Give them the opportunity to fail. Long term success and lessons learned often come from earlier mistakes or business failures.
c) Show decisive leadership in your family business. Make the tough decisions as you need to. However, ensure that strong leadership will continue with the right family person ultimately taking over the reigns.
d) Look carefully at your estate planning and ensure it ties in with your family business arrangements. Ensure equitable outcomes for family members with appropriate transfer of business structures and investments.

Obtain good tax and legal advice in this very complex area. It is our experience that many family businesses and families often come unstuck in this area and it causes a lot of heart ache and friction between family members.

Published : 14 November 2007