How to start succession planning

Succession planning remains a big blind spot for many business owners, particularly those working in family business. But entrepreneurs must realise that this succession planning is too important to be left to chance, or to be rushed and done poorly.

In simple terms, succession planning is the development of a strategy for the transfer of the ownership, management and financial responsibility of the business.

It sounds simple, but succession planning is like a jigsaw – there are many pieces to it. And accountants, advisors, lawyers, insurers, bankers and human resource consultants all have a role to play. You might think this sounds a bit frightening, but a successful succession plan takes work and planning.

And succession planning for a family business will generally be more complex than for a non-family business. For example, there are more options in regard to the form of transfer of ownership (not all requiring payment for equity) and how that ownership will be held and dealt with in the future.

Most business owners require expert help to navigate and negotiate the labyrinth of issues – including capital gains tax, estate planning, retirement planning and stamp duty – that arise. Succession planning is not an event, but a process that takes place over a period of time. Don’t be in a rush – it’s too easy to get things wrong.

Succession planning also stirs up interpersonal and emotional issues, especially for family businesses. The problem of equity between family members is a common issue. And it is often difficult for the incumbent business owner to deal with these “people issues”.

It is important to understand the linkages between the retirement plan, the succession plan and estate plans, and to ensure these plans are made in the right order.

The first step in succession planning is the retirement plan. The head of the business needs to determine when he or she will start to step away from full-time employment which then sets the key parameter for the management succession timeline.

1. The retirement plan determines not only the timing of management succession but also how financially reliant the retiring owners will be on the business after retirement. This is an important factor in determining the form and timing of equity (ownership) succession.
2. The management succession plan will determine who will take over running the business, which in turn will influence the decision as to which family members should receive equity (ownership) in the business.
3. Once the succession plan has been determined, it will need to be incorporated into the estate plans of the current business owners.

Needless to say, tax and related issues are central to any succession planning.

In cases of family succession, it is not uncommon for owners to want to transfer the business (or equity in the business) to family members for less than its real value (or even gift it). If this is done, a taxable capital gain may arise. The capital gains tax rules in the tax law therefore need close attention, especially the CGT small business concessions.

So too do the tax rules surrounding the sale of a business. The transfer of shares in a business to family members could give rise to a capital gain (for example, gains in respect of goodwill or trademarks), but the sale of business assets may result in ordinary taxable income (such as gains from trading stock).

Overall, different tax issues need to be considered depending on the structure in which the business is held eg a company, a discretionary trust, etc. Unfortunately, this is complex and good professional advice should be sought.

Just some of the issues that need to be considered in succession planning include:

The plan needs to be a written document.
It needs to have input from the stakeholders. That can be obtained through one-on-one interviews and family group meetings.
What is the basis of engagement of family members ie how are they eligible for employment in the business?
What is their role?
How is their performance and salary appraised?
There is a need to determine management succession, ownership succession, funding, estate planning and asset protection. As noted above, tax and related issues become very important here and need to be carefully considered.
When are buy-outs of family members permitted? Who can buy? At what price?
A consideration of different business structures, and their appropriateness for the business, needs to be undertaken. What would work best – a sole trader set-up, a partnership, a company, a discretionary trust, or something else?
The form and timing of ownership transfers needs to be clarified.

Hopefully, this brief overview has given SME owners something to think about in terms of where their own succession planning is at. Don’t forget that it’s not just about tax and related issues. Important as they are, succession planning is much broader than that, and it is impossible to undertake any succession planning without taking the soft, or human, issues into account.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.

Sue Prestney is a Partner at MGI Melbourne and is currently National Chairperson of MGI Australia. Sue is also the Institute of Chartered Accountants’ spokesperson on SME issues. Sue is also the author of a new book from Thomson Reuters called Family Business Succession Guide, which is an essential guide for advisers to small business and for SMEs themselves.