Business Succession Planning

Succession is not only about death. A business needs an answer for retirement, for a co-owner wanting out, for permanent disability and for irreconcilable disagreement, as well as for death. Most owners have thought about one of those and documented none.

The three questions

Every succession arrangement, however it is structured, has to answer the same three things.

Who takes over

The candidates are usually a co-owner, a family member, a key employee, or an outside buyer. Each raises different issues. A co-owner needs a mechanism and a price. A family member raises the question of whether the children not involved in the business are treated fairly, and whether the one who is has the ability and the desire to run it. A key employee usually needs to be given a path to ownership over time. An outside sale needs the business to be saleable, which is itself a planning exercise.

On what terms and at what price

A valuation method agreed in advance is worth more than a valuation argued about afterwards. The options range from a fixed formula, to an agreed multiple, to an independent valuer appointed under an agreed process. Each has drawbacks. A formula can become unrealistic; an independent valuation costs money and takes time. What matters is that the method is specified, binding, and capable of producing an answer without the parties agreeing.

Terms also mean payment terms. A lump sum, instalments, an earn-out, or a combination, and what security the departing owner or their estate has if payment is deferred.

Where the money comes from

This is where most arrangements fail. An agreement obliging the surviving owner to buy the deceased owner's half is worthless if they cannot fund it. The usual answers are insurance, a payment plan, or a sale of the business itself. Insurance-funded buy-sell arrangements are common and effective, but the policy ownership, the beneficiary and the agreement have to be aligned, and the tax treatment of the proceeds depends on how that is done.

Buy-sell agreements

A buy-sell agreement records what happens to an owner's interest on a trigger event. The matters it needs to deal with include:

• the trigger events, typically death, total and permanent disability, trauma, retirement and default
• whether the transfer is compulsory or an option, and who holds the option
• the valuation method and its timing
• how the purchase is funded, and what happens if the funding falls short
• the treatment of loan accounts and guarantees, which often exceed the value of the equity itself
• restraints on the departing owner, and release of their personal guarantees
• how the agreement interacts with the shareholders agreement, the trust deed and each owner's will

Personal guarantees deserve particular attention. An owner who exits but remains guarantor of the company's bank facility or lease has not actually exited.

Family succession

Where the business is going to a child, the plan has to deal with the children who are not receiving it. Equalising through other assets, through superannuation or through life insurance is common. So is transferring the business over time while retaining control, which raises questions about the trust deed, the company constitution and the tax consequences of each step.

Handing over control gradually is usually better than handing it over all at once, and both are better than leaving it to be sorted out afterwards.

Keeping the documents consistent

Succession arrangements fail most often because the documents disagree with each other. The shareholders agreement says one thing, the will says another, the trust deed does not permit what both assume, and the insurance is owned by the wrong entity. We review the set together, and say plainly where they conflict.

This page is general information. It is not legal or tax advice, and your own documents and circumstances will change the answer.