There’s more to succession planning than meets the eye – failing to put a plan in place could erode the value of your business or, worse still, leave you financially unable to retire.
Most business owners will have heard the saying: ‘Failing to plan is planning to fail’.
SMEs put plans in place to grow their customer bases; they plan agendas for meetings; they plan for the nasty effects of natural disasters, theft or other loss by way of insurance; they even plan out daily schedules to ensure they can prioritise and juggle tasks effectively.
So it is quite surprising that so many Australian business owners have no formal succession plan in place.
One survey, conducted by Bentleys South Australia earlier this year, suggested that just 19 per cent of SMEs have an exit strategy. Even in My Business’ own reader survey, less than half (42.65 per cent) of respondents had succession strategies in place.
The reason for this seems to be something of a mystery. Perhaps it is because no one is broaching the subject with business owners, and they themselves are more focused on the here and now of running their businesses than the nitty-gritty details of planning their eventual exit.
With this in mind, we thought it would be useful for a great many SME owners and operators to get some insight into the issue of succession planning – what it involves, the options that are available, why it is best done in advance, the mistakes of other business owners, and how to ensure you walk away with the best deal for yourself and those left behind within the company.
Why having a plan is crucial
“Smart clients come to us early and say, ‘I’m five years away but I’m thinking about exiting; what do I need to do? What do I need to worry about? How do I get ready?’ Others leave it too late, and it just becomes a problem,” explains Craig West, chief executive of Succession Plus.
“We say to people, ‘You really need three to five years to get it right, to do it properly, to maximise the value, to make sure you get paid out, to make sure the funding works, to make sure the business survives’ … and to do that properly you need time, you need to make sure the staff transition over, the clients transition over; and those things all take time, they are just never going to happen quickly.”
Indeed, what becomes most apparent when business owners begin to examine their exit is the sheer scale of the task at hand – including the number of relevant stakeholders (everyone from co-directors and employees through to the tax man) and the level of documentation and preparation required at each step of the way. And then, of course, there is the process of maximising your business’ value to ensure the best possible payout.
Exploring these issues too late can have potentially devastating effects.
“The first thing is, they generally have to delay their retirement or their timing has to change. We just have to say, ‘You can’t do it that quickly if you want to maximise value’,” Craig says.
“It’s a little bit like going to a real estate agent today and saying you want to sell your house tomorrow – they will be able to sell it, but they won’t get the price, they won’t have all the right buyers there; it just hasn’t been prepared properly.”
Options when planning an exit
What options are available?
The good news is that you don’t necessarily need to know what path you want to take before starting work on your plan. Regardless of the ideas you may be toying with, the first step is almost always the same.
“Most small business owners have no idea what their business is worth. So they come to us saying: ‘I’ve got a business, I don’t know if I can sell it, I don’t even know what it’s worth, I don’t know how to value it’, and that is the starting point,” says Craig.
A sale is one of the most common means of exiting a company. However, according to Craig, it can take many months or even years to attract a buyer, go through due diligence and negotiate the sale price and conditions.
Another traditional option is to pass the business on to your children. Yet this often entails problems, such as the children being unwilling to take on the business or unable afford to do so.
An increasing number of smaller firms are looking at alternative exit strategies – and often these are more about ensuring the business and its employees are protected than securing every possible dollar of value for the person selling out.
“We are doing … things like employee share plans and management buyouts, where you can get some key staff [involved], and it solves two problems. One: the funding problem, because now you’ve got the ability to fund it through an employee share plan; but two: it also reduces the risk, and that big risk … about [the future of] key employees,” explains Craig.
In some instances, he advises, it is not the business itself that is worth selling, but rather the assets it has accrued.
“Maybe they are better off to not worry about the business but sell the building, because that would make a lot of money, or sell some equipment off or sell some assets to a competitor,” he says.
Choosing the right path
Of course, the option you choose will be highly personal – no one but you can make this decision.
Yet there are a number of factors that may influence your choice. Consider:
- The actual value of the business and any assets it owns.
- If you have children, whether they have the interest and ability to take over the business.
- Whether you will require the equity in your business to retire.
- The age at which you plan to retire.
- Whether you want an immediate or gradual exit from the business.
- How central you are to the business.
- The requirements of fellow directors/owners.
- The overall trajectory of your business (i.e. whether it is growing, shrinking or plateauing).
- Whether your superannuation has a direct interest in the business and/or its premises.
- What you plan to do once you exit the business.
- Whether you want the business to continue trading after you exit.
Don’t think you can sell on a whim
As Tony Kabrovski, partner at chartered accounting and business advisory firm HLB Mann Judd, recently pointed out to a gathering of SME owners in Sydney, the country’s ageing population has the potential to create a new problem for SME owners – a glut of businesses for sale as Baby Boomers look to cash out and retire.
“There’s going to be a lot of businesses for sale out there,” he said.
“What is that going to do to the value of your retirement asset?”
Tony quoted recent statistics from The MGI Australian Family and Private Business Survey, which show the average age of Australian SME owners is 56 years, with 20 per cent aged over 65 and 11 per cent aged over 70.
The figures also suggest that close to half (44 per cent) of all Australian SME owners plan to sell their businesses within the next decade.
According to Tony, this potentially poses a significant risk for business owners who view their company as their primary retirement asset.
“I think what’s going to happen is there is going to be disappointment with expectations with family businesses. Family businesses put blood, sweat and tears into their business with a view that that will be the goose that lays the golden egg and provide that retirement fund they’ve been aiming for,” he tells My Business.
“Then a lot of business owners are going to find themselves in a situation where they are not going to be able to fund their own retirement, and they may then hold on for a lot longer to their business. That will have a downward trend on valuation because a lot of the time with businesses, if your heart [isn’t in it] and you’re not passionate about your business, then that usually comes through in the numbers.”
Tony suggests that there are two key actions business owners can take to enhance the value of their retirement nest egg.
“Make it stand out,” he says.
“If you’re innovative and you’re unique, that will also increase the value. Things like, for family businesses, is your supply concentrated on a small number of suppliers or larger? The same with customers – have you got one or two key clients or do you have a number of customers that are spread, so there is less reliance placed on the top 10 or 20 per cent?”
The other option, which Tony says he is seeing in increasing numbers, is to transfer ownership of your commercial property into your self-managed super fund (SMSF).
“We’ve seen with a lot of family businesses that the property values go up quite consistently, and that then effectively becomes the retirement fund for a number of our clients – a retirement fund in the sense that it will continue to receive reasonable yields with rental payments,” he says.
According to Craig, a fairly straightforward way of enhancing the value of a business is to make the transition as smooth and risk-free as possible. And that means ensuring the transparency of job responsibilities, operating procedures and stock ordering processes, in addition to the financial information.
Part of this is making sure that your knowledge, expertise, processes and so forth are retained within the business, and not lost after your exit. However, it is equally important that any new owners are able to make as seamless a transition as possible.
“Every business deals with customers, suppliers, marketers – external third parties who are not part of the business, and you have to make sure that you can transition all of those things across; it’s not just about the key staff, it’s about all the relationships that any business has,” Craig says.
Of course, there is nothing more certain in life than death and taxes, and the tax man will want his share of the proceeds of any change of ownership of a business.
“I’ve had people that forget or ignore the fact they owe the bank a couple of million bucks. They forget to take into account the tax; so the business may be worth $5 million, but what you’re actually going to keep is probably $3 million because you’ve got to pay tax and there’s transaction costs and there’s stamp duty and there’s all sorts of other things,” says Craig.
“That’s where … that valuation is quite important, because you’ve got to understand exactly what we’re talking about – how much [is the business worth]? What are you going to pay in tax? What’s going to be left over?”
As such, it’s important to keep your valuation in mind as what you have to work with, rather than the amount you will receive at the end of the process.
At its most basic, succession is about success. Plan ahead to ensure the blood, sweat and tears you have invested in your business – over years or even decades – deliver the success you deserve.
Think succession planning isn’t important? Think again!
A recent study conducted by the University of New England found that having an effective exit plan in place is not only important to a business and its owners, but also to the overall economy.
Associate Professor Bernice Kotey from the UNE Business School says this is partly to do with the financial return on investment that such planning can deliver to owners exiting a business, as well as to the community who rely on the services of that business.
“The continuation of small businesses in regional Australia is especially important, as they contribute to sustaining regional and rural economics during downturns in the resources sector,” she says.
“Regional location is a major barrier to successful business exit. Other barriers include competition from large retailers, online shopping, inadequate support from local council such as unreliable forecast of economic conditions, crime rates and lack of access to medical and financial resources.”
Having an adequate succession plan in place goes a long way towards ensuring the financial security of business owners, particularly if they are selling to retire, which in turn reduces the pressure on government to provide welfare support.
Succession planning also places the business as well as possible for continued operation, ensuring ongoing employment for staff and suppliers.
And, as Bernice points out, it has flow-on economic benefits through the employment of external partners such as accountants, brokers and vendor finance providers.