For all businesses, it is inevitable that the time will come when there will be a ‘changing of the guard’. The aim of a succession plan is to ensure that there can be an orderly transition of a business’s management and ownership so that the value of the business is retained.
Recent statistics show that:
- The average age of owners of a family business is 55
- More than 21 percent of business owners are over 65
- Around three-quarters do not have a documented succession plan, and will not seek expert advice in succession planning.
These figures suggest that the odds are reasonably high that such businesses could one day face disruption because of the resignation, retirement, illness or divorce of a key business partner.
Without a succession plan, the business may deteriorate if something happens to the owner or a key partner. Other partners or employees could be left without income, the business might be unsaleable or frozen for a lengthy period of time, or members of the owner’s or partner’s family may want to take their equity in cash, leaving those remaining in the business in a difficult position.
Funding mechanisms
Succession planning is all about structuring funding mechanisms and agreements for the future. Without one, a business hit by a disruptive event may go downhill fast.
A succession plan should:
- Safeguard all parties and reduce potential disputes
- Ensure continuing owners can purchase the remainder of the business at a fair price
- Allow continuity of the business in the face of adversity
- Provide protection from the loss of major clients
- Ensure that the necessary funding mechanisms are pre-determined if a payout is required
- Highlight the trigger events that may lead to a transfer of equity and control
- Provide continuing owners with a degree of financial security and stability.
Succession plans need to cover both management succession and ownership succession.
Management succession
This involves selecting and grooming a successor, and may take several years of preparation. The options include choosing among family members, forming a committee structure of family members or selecting a key employee to run the business.
There is no single correct method for selection, although from a practical perspective, a single successor usually minimises the conflicts and confusion that can arise under the direction of multiple leaders.
The chosen successor should learn about a range of areas within the business, including financial information, administration records and agreements, operations and technical data, marketing information, purchasing information, procedures and systems.
Ownership succession
It is equally important to place active ownership in the hands of those interested and capable of providing future direction, input and support for the business.
Different classes of share capital and shareholder agreements can be used to match the specific objectives of family members with their rights to ownership, such as:
- Separating ownership from management interests via different classes of share capital that carry dividend rights but not voting rights
- Restricting subsequent share transactions via the establishment of specific provisions dealing with, for example, the sale of family-owned share capital or the mandatory buyout of stockholder interests, etc
- Placing controls on the ability of external parties to acquire an interest in the business. This usually entails giving the family the right of first refusal before any capital can be sold, therefore limiting opportunities for outside investors to purchase an interest in the business.