The world is experiencing a period of significant intergenerational transfer of wealth. In many cases, this involves passing down family businesses to the next set of owners.
Working out the details of these transitions can be especially challenging and complicated. Taking a proactive, comprehensive approach to succession planning is a critical step in ensuring the financial wellbeing of the family as well as making certain the current owners' wishes are respected.
Why is succession planning important?
Succession planning is a process families can use to establish how their assets will be passed down to the next generation. It also ensures the beneficiaries and successors understand their future roles and responsibilities.
Falling short in this area could cause the family's hard work to crumble. All too frequently, these transitions don't have successful outcomes, causing many people to question whether wealth is being passed to the wrong hands too early.
In fact, research from the United States of America has revealed that 70 per cent of wealth transitions fail. The principal causes of failure revolve around the poor training and education of the heirs. That's why it's critical for business owners to start planning early so everyone knows what to expect and can prepare for their new responsibilities.
What are the obstacles?
Families may struggle with developing a comprehensive succession plan for a number of reasons. In some cases, there may not be an easy answer for who the next leader should be. It can be difficult to choose from among siblings, or perhaps some owners don't have a qualified descendent.
Furthermore, the topic isn't exactly pleasant to think about. Founders may have a fear of death or anxiety over losing control of their life's work. It's also natural for family members to avoid speaking about such a subject, particularly when day-to-day operations provide plenty of reasons to be busy with other matters.
No matter the situation, the key is to take a strategic, rational approach within suitable forums for discussion.
What makes a solid succession plan?
By setting aside time to formally discuss these matters, families can establish a clear process for transferring the business. That way, all of those involved can take the necessary measures to prepare for the change.
Here are some tips:
1. Lay the foundation for equity sales
If the transition process is reasonably long, say three to five years, it may be prudent to sell small tranches of equity to beneficiaries at full value. This also teaches responsibility to the successors to ensure they maintain the profitability of the business.
Individuals will need to arrange their own finances so they can secure their ownership. To enable borrowers to pay off their loans comfortably, businesses should adopt a prudent but practical dividend policy.
2. Clearly state the legacy
Together with strong family values, trust and respect, understanding the legacy of the founders will go a long way to ensuring that the heirs become custodians of the wealth of the family for future generations.
First- or second-generation businesses in Australia are often sold to extract wealth. However, BDO recommends the founders record their legacy in writing to educate their children and encourage them to be more responsible and respectful toward their inheritance.
3. Remember that fairness does not mean equal
When it comes to family business, fairness does not require sameness.
Some children may have no interest in the family business, and it may be inappropriate to have passive shareholders who focus only on what dividends they are likely to receive rather than how the business is functioning.
Where there are differences in involvement in the business, the issue of equity can be balanced up through other means, such as estate plans.
A final note
Above all, succession plans must have certainty. That means bankers, suppliers and key managers should all be informed.
When done correctly, this plan will position the business for success going forward. It also should provide peace of mind for the entire family.