Deep down every manager knows they won’t be running a business until the day they die. That is why it is very important to have a succession place in make sure the transition from one leader to another is smooth and the business is not adversely affected by this move.

According to research from recruitment agency Hays, many businesses say they haven’t got the resources to worry about succession planning, and the cost of losing someone in a key role is increased in a small companies making managing this risk worth the time and effort.

Have a plan in place – stick to it

Planning is always the best way to handle an issue like succession. By developing a well-structured succession plan into the strategy of your business, many of the risks associated with a transfer of leadership can be avoided.

Creating one well in advance of your departure is always more likely to succeed and is create more long-term value than one that is simply allowed to continue without a plan.

According to the NSW Business Chamber, having a succession plan in place has a number of benefits for a business. The Chamber states, “it helps you to attract and retain the best staff who are committed to the business, which in turn should result in increased productivity and loyalty”.

A succession plan clarifies for everyone who is in charge and who can make key decisions. Plus, it ensures you have someone to handle emergencies if your star performer suddenly needs to take extended leave.

Don’t cut ties and run – stay connected 

Even once you have started at your new job, you shouldn’t lose contact with your former colleagues. If you left your job on good terms, this should not be too much of an issue.

According to Hays, because the business community can be a small one, it is were important you do not lose those relationships you developed at your old job. This is especially true if your former employees are now in a position of leadership. They may need your help and this is a good way to keep your legacy intact with the business.

“Everyone leaves an organisation at some stage,” says Hays CEO, Alistair Cox. “It’s your job to make sure that the organisation doesn’t miss a beat when your own time comes. And if you do it well, not only will you leave the organisation with your reputation intact, you will actually leave with your reputation enhanced,” says Mr Cox.

A central concern during succession planning in family businesses is whether adult children should be admitted into a self-managed super fund (SMSF). It is understandably a complex decision-making process, given that it impacts both personal and business succession planning. Moreover, it also plays a part in affecting family relationships and finances.

According to the Australian Taxation Office, there were 534,176 SMSFs in Australia as per the most recent count in June 2014. Clearly, many Australians are adopting this method of saving for their future. However, there are some important considerations SME owners should keep in mind before adding family members to an SMSF. Here are three key ones.

Is this a cost-effective method?

Because the fund’s fixed costs are shared over two generations of family members in the same SMSF, it can indeed minimise costs overall. However, financial woes can arise if the inter-generational SMSF has a portfolio including only one or two main assets to support the costs.

For instance, if the main high-value asset in the fund is the business property, it would need to either stay within the fund so that the adult children can continue to use the premises in the business or be sold in order to pay out the parent’s death benefits on their death. This can result in not only a funding issue but also further tax and stamp duty costs.

How will it impact family relationships?

Under Australian Law, there is a four-member limit for a SMSF. This can be problematic for families with more than three adult children. Another issue is if the members disagree on investment ideas or goals. It can also be difficult if the members have different risk tolerance levels. Combined, these factors could potentially cause family conflict.

How can legal advice help?

Since SMSF’s are so crucial for retirement savings and estate planning, expert legal advice can help manage the fund carefully. Each step of the legal process, from advice on the fund’s structure to ensuring that the SMSF is compliant with relevant legislation, can be eased with guidance from commercial lawyers.

 

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Family businesses can often struggle in a globally competitive market. The Harvard Business Review published in its January 2012 issue that approximately 70 per cent of American family-owned businesses fail before the second generation can even get a chance to lead. However, a smart solution is to build a strong succession plan so that the business can be prosperous for future generations too. “Smooth succession is an oxymoron… Succession in a family business is probably the most complex management challenge anybody faces” said Peter Davis, director of the division of family business studies at Wharton School of Business. Quoted in the very first volume of the Family Business Review from winter 1988, his words still ring true today.

Even in contemporary times, succession planning is rarely implemented. Indeed, PricewaterhouseCoopers’ 2014 global family business survey, titled ‘Up close and professional: the family factor’, found that only 16 per cent had a robust succession plan.

Often succession plans are not organised with strategy or finesse. This is particularly problematic for family businesses, as they may need to manage disputes between siblings or face problems when children have not been adequately groomed for leading the business. Quality training and skill building is critical for helping the business stay within the family.

Importance of legal consultation 

Wendy C. Handler wrote in an article for the Family Business Review in 1994 that “researchers in the field of family business agree that succession is the most important issue that most family firms face” because it requires passing down the baton of the business to the next generation. The safest way to procure a smooth transition is to solicit legal advice.

It is important to be objective, rational and practical with succession planning so that the best candidate for the job is selected and trained accordingly. Such objectivity can understandably be difficult when dealing with family members, and so drafting a succession plan with expert lawyers provides customisation for the needs of a family business.

Succession planning is an area every company will need to undertake, especially for small businesses where every member of staff is taking on a number of different roles and responsibilities.

However, succession planning is also something many businesses are struggling to manage, at least according to a recent study from Stanford University.

The research found that organisations with an effective succession plan in place are in a minority. In fact, only 46 per cent of companies that took part in the study have a programme in place to train individuals for high-ranking positions.

On other measures, the study recorded even lower results. When asked whether they have people to assume a leadership role like a CEO position, only 25 per cent reported that they met this condition.

To resolve this issue, the study’s authors suggested companies need to refine their succession plans so that there is a ready pool of candidates available for high-ranking positions. In particular, the study suggested seeking strategic assistance to navigate the succession planning process.

Scott Saslow, one of the authors of this research, emphasised how many businesses are unprepared for handling the succession process.

“[Many companies] fail to recognise the need for a strategy for this critical business process, they haven’t had great exposure to what other organisations are doing, and they haven’t thought through what their own organisation should be doing given its unique set of circumstances,” said Mr Saslow.

“This is more than lost upside opportunity; it puts many organisations at risk of having unstable executive leadership.”

For small businesses that want to be sure they are handing over their business effectively, having processes in place to manage this transition is going to become increasingly important in the future.

Many business owners will reach a point where they have put in a lot of hard work into their business and have established their organisation within a given sector. At this point, owners may find themselves looking to move on to their next challenge – which will mean either implementing a succession plan or selling the business.

For those who choose the latter option, there are a number of different steps that will need to be taken before you can hand over the keys to a new owner. Here are three of the most important steps:

1) Valuate your business

The first step to selling your business is calculating the value of your entire operations. There are a number of different factors that will need to be included in this price, including:

• Your stock and any other regular purchases that are scheduled;
• Current and projected revenue and profit figures;
• Any property, equipment or other permanent aspects of the business – this includes the remaining term of your current lease (if your business premises is leased);
• The goodwill your business has – this will be a general figure that represents the reputation and brand awareness your company has.

Once these different areas have been calculated, business owners will have a clear idea of how much their business is worth and what a fair asking price would be when they move to sell it.

2) Prepare a sale contract

Whenever a business is sold in Australia, there needs to be a sales contract which will lay out the legal rights and obligations that both parties have during the sale process. This will record the assets and liabilities associated with the business and how they are treated in the sale, along with any further information or conditions, such as: a restraint on the owners preventing them from competing with the new buyers, a requirement that the landlord agree to assign the lease and GST treatment.

Because of the number of legal requirements that accompany this process, it is advisable to have a lawyer draft this document for you.

3) Any final issues

Once the ownership of a business has been transferred, there are still a number of other areas which an owner will need to consider. These include any tax and GST from the sale process, any training you are obliged to provide to the new owner, the transfer of any licences or leasing agreements, business names and cancelling your Australian Business Number.

Family businesses are a significant and wealthy sector in the Australian economy, accounting for around 70% of all Australian businesses with an average turnover of $12 million per year. For many, the idea of being in business with family is attractive: being involved with people you know and trust, working towards a common goal, building wealth and opportunity for future generations and leaving a lasting legacy for the family. However, entering into such a business should not be done casually or without serious thought. If not properly prepared for, family business arrangements can quickly turn to disaster, souring once healthy relationships and resulting in financial loss and stress.

Governance agreements (such as a shareholder and unit trust agreements) are just as important when going into business with family members as they are when going into business with strangers. The most common traps when entering into business with family members include a lack of communication and understanding and a failure to agree on leadership, remuneration and exit arrangements. There may also be issues when family members marry or divorce, changing the structure of the family. It is easy to see how these issues could lead to disagreements. A survey undertaken in 2009 showed that only 34% of families in business had a formal board structure, only 12% had a constitution, and only 20% had a succession plan in place for their Chief Executive Officer.

Take the following scenario as an example of the pitfalls of entering or participating in a family business without a Governance Agreement in place.

Case Study – The Robinson Family

John and Mary Robinson are a couple in their 50s. They decide to go into business with John’s brother Robert and Robert’s wife, Jane. John and Mary have two adult children who also agree to work in the business. Robert and Jane have no children. Upon agreeing to start up a business together, they hire premises and set up a company, ‘Robinsons Pty Ltd’, of which they are all directors and shareholders. They have no written agreements as to remuneration, leadership, or succession. They have strong relationships and believe that they can agree as they go along about how the business should be run.
After two years, Robert and Jane divorce. Robert moves in with a new partner, Kate, who he later marries. Kate does not get along with John and Mary. Robert insists that Kate should be a part of the business. When John and Mary disagree, he loses interest in the business and expresses a desire to leave. However, John and Mary cannot afford to buy him out and do not want him to leave, given his expertise. They agree to allow Kate to play a role (for a considerable salary) and Robert agrees to stay in the business.

It goes from bad to worse

Meanwhile, John and Mary’s son Josh has married and had a baby with his wife. As a result he is working less in the business. John and Mary’s daughter Erin is annoyed that she is working harder and getting the same amount of profit as her brother. She discusses her concerns with her parents, who are afraid of angering Josh. They tell her they do not want to say anything about it.
After five years Kate decides that she wishes to leave the city. She and Robert become embroiled in a messy separation which leads to divorce. In their property settlement Kate claims an entitlement to business assets, resulting in significant financial loss.
After ten years Erin dies suddenly in an accident. Her husband inherits her entire estate, including her shares in the company. He has no interest in the business and sells the shares to a friend who John and Mary have never met.

The Importance of Governance Agreements

Unfortunately, people often only realise the need for governance agreements when it is too late. In the beginning they may think that the bond of family and the small size of the business make governance agreements superfluous. Legal structures may also seem daunting and costly. Ultimately, however, relationships can and do break down and substantial amounts of money could be lost without an appropriate agreement in place. The potential issues that could occur should be discussed and planned for. Every business, regardless of size, should have at the very least a Governance Agreement.

This Governance Agreement should cover:

• management of the business;
• dispute resolution;
• how directors and family members are remunerated;
• the process for declaring and distributing profits;
• how interests are issued to new members;
• what happens if a family member dies or is unable to work;
• succession planning for the exit and entrance of family members;
• how interests in the business can be disposed of;
• funding mechanisms for buying out family members;
• how interests are valued; and
• what happens if one family member wants to sell and the other does not.

Insurance

Insurance is a common funding mechanism to ‘buy out’ family members and can allow a business to continue to trade without disruption. Where insurance is being used, Jamie Forster, Principal of Elston Assure highlights issues which require consideration and where specialist advice should be sought:

• how will insurance be held and in what entity?
• determining the appropriate amount of cover balanced with the costs of cover;
• incorporating different types of cover as part of an overarching individual and business succession planning strategy, including the use of life cover, TPD, trauma and key man insurance;
• deductibility of premiums; and
• taxation treatment of benefits.

A Governance Agreement could have made life easier for the Robinsons

For example, John and Mary could have bought out Robert’s share, allowing him to cease work in the business and avoiding the later complications with Kate. Erin may have been better able to raise her concerns about profits and the division of labour, and could even have offered to buy Josh’s share. Upon Erin’s death, a Governance Agreement could have provided for her interest to pass to the surviving shareholders with an insurance pay-out for her husband, rather than her uninterested husband receiving her shares. Even if Erin’s husband were to inherit her shares, a Governance Agreement could have prevented him from selling to an outsider, keeping the business in the family’s hands.

Many of the benefits of a Governance Agreement come about before the document is even drafted. Discussing how the business will be governed raises potential issues which would not otherwise have been considered, allows family members to express differences of opinion and brings peace of mind to those involved. Even the most harmonious of families experience conflict, and it is better to air and plan for any grievances well before you are tied together in a business. Implementing a properly drafted Governance Agreement with appropriate advice from a business risk advisor will provide certainty for family members, creditors and employees and will ensure that your business is able to operate during the good times and the bad times.