Family Business Succession Planning

Succession planning strategies for your Business

A unique set of dynamics must be considered when dealing with transition in the context of a family business, and in particular in the context of family business succession planning, where one generation of the family is to take over the operation of the business from the previous generation who are reaching retirement age. Transition from the first generation to the second generation is one step which can be managed successfully – though, as discussed below, even that transition can cause difficulties. The transition to the third generation can be far more problematic, particularly for large successful businesses. Emotional issues peculiar to family scenarios often cloud decisions, which would normally be made purely on economic and business grounds.

Operators and non-operators

Transition issues are more difficult to resolve where some members of the next generation are involved in the business and some are not. Particularly in smaller family businesses, the majority of the family’s accumulated wealth can be tied up in the business, which may not produce returns sufficient to provide:

  • A reasonable income for the operators of the enterprise;
  • A retirement income for retired parents;
  • A living for the next generation who run the business; and
  • A return for siblings not involved in the operation of the business, but who have some expectation that the family business is there to ‘provide’ for them.

In this context it is relevant to draw a distinction between the operators, who are involved in the management of the business, and the non‑operators who have no involvement and are just passive investors if they hold equity.

If the bulk of the family’s wealth is tied up in the business, the parents who are planning for retirement and undertaking a family business succession strategy, may need to rely on a sale of the business, as part of their retirement strategy, to the operators to fund their retirement. This will invariably involve assumption of debt by the operators. In any business succession phase, and in difficult economic times – or both – the operators may experience difficulties in repaying funds borrowed from a bank, leading to obvious financial hardship. By the same token, the retired parents should be entitled to a comfortable retirement, which is preferably not dependent on the ongoing profitability of the business. The only alternative may be a sale of the business and that may not be suitable to the operators and the sentimentalists in the family.

If the family business is the major source of family wealth, the parents’ desire for equality between all children may lead to further complications if there are not sufficient non-business assets to provide an inheritance for the non-operators.

Often, a family business is left by the parents to their children – both operators and non‑operators – on the understanding that the operators will be entitled to a reasonable salary, with profits divided between the operator and non‑operator equity holders. This scenario leads to its own set of complications:

  • a reluctance of the operators to manage and develop the business in a situation where the benefits of their hard work are being shared by the operators and their non-operator siblings, and where the operators often consider that they are not being fairly recompensed for their efforts;
  • even if the parents give the operators an option to buy out the non‑operators, the funding of such buy out, whether requiring bank finance or through some vendor finance provided by the siblings at the parents’ direction, can still result in financial hardship for the business and stress for both lender and borrower;
  • non-operators will want to see a dividend stream, whereas the operators may want to retain funds for capital expenditure, working capital and debt reduction;
  • the non‑operators may put pressure on the operators to buy them out, if, as is common, the cash returns on their investment are low; and
  • if that is not possible, then the pressure may be on for the business to be sold, and the operators may lose their livelihood – and the business they have worked for many years to develop.

Bonus for operators

It is common for the next generation to have a role in management of the business for many years, at less than market salaries, on the understanding that those operators will be recompensed on their parents’ retirement as part of the family business succession plan or through their parents’ wills. In such circumstances it is important for due recognition to be given to the efforts of those operators – working for less than market salaries, often for long hours well in excess of normal employee requirements, and where those operators may have passed up other opportunities to stay loyal to the family business.

Often complicating this can be spoken or tacit understandings (more often than not, unrecorded and misunderstood down the track) that the efforts of a family successor working in the business for many years would be rewarded in any ultimate distribution of assets. In these situations there can understandably be a large degree of reluctance for operators to have to pay for a share of the value in the business they have helped to create. Similarly, it can be difficult for non-operators to appreciate and, much less, quantify, what may have only been voiced between the patriarch and matriarch, and the operator. Certainty and communication are critical here.

 

Whether you are planning for retirement, looking at transitioning out of your business or are already retired and looking at what more you can do, Transition Planning is here to assist you.

Transition Planning Australia’s retirement planning tools, information and guidance will help you make the right decisions for your life after work and for the future of your business. For more information about developing a plan for your next phase and to discuss your Family Business Succession Planning, speak with Transition Planning Australia today.

 

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