Business owners often spend years building an enterprise but devote far less attention to how it will continue when they are no longer able or willing to run it.
A succession plan provides a structured process for transferring ownership, control and management. It can apply when an owner retires, sells the business, transfers it to family members or must step away unexpectedly because of illness, incapacity or death.
The Australian Government recommends that business owners prepare succession arrangements before they intend to leave. Early planning gives the business, its successor, employees and customers more time to prepare for the transition.
Succession planning is broader than choosing a replacement
Choosing a future manager is only one part of succession planning.
A complete plan may need to address:
- who will own the business;
- who will manage its operations;
- whether ownership and management will pass to the same person;
- how the business will be valued;
- how an outgoing owner will be paid;
- how the transfer will be funded;
- what happens if an owner dies or becomes incapacitated;
- whether other owners have purchase rights;
- how key employees and customers will be retained; and
- which legal, taxation and financial steps must occur.
A proposed successor may be a family member, an employee, a business partner or an external purchaser. The right choice depends on the successor’s capability, interest, funding and suitability for the business. The Australian Government also recommends considering whether the successor has, or can develop, the necessary skills and can afford to acquire the business.
Ownership and management may need different solutions
The person best suited to manage a business may not be the person intended to own it.
For example, an owner may want children to benefit financially from the business while appointing an experienced manager to operate it. Alternatively, one family member may work in the business while others have no operational involvement.
Treating all beneficiaries identically can create difficulties where their skills, interests and contributions differ. Equal ownership may also produce deadlock if important decisions require agreement between family members who have different objectives.
A succession plan should distinguish clearly between:
- economic ownership;
- voting control;
- board or management responsibility;
- entitlement to income;
- access to information; and
- responsibility for business liabilities.
The legal structure affects the transition
Succession arrangements depend significantly on whether the business operates through a company, partnership, trust or sole-trader structure.
A sole trader and the business are not separate legal entities. If the owner dies or loses capacity, there may be no other person with immediate authority to continue the operation.
A company continues despite the death or departure of a shareholder, but control of the shares, board and voting rights must still be resolved.
A partnership agreement may contain provisions dealing with retirement, incapacity or death. Without clear provisions, the departure of a partner may destabilise the business or trigger disputes about valuation and ownership.
For a trust-operated business, succession may depend on control of the trustee, appointor powers and the terms of the trust deed. Those powers do not necessarily pass under an owner’s Will in the same way as personally owned assets.
Parke Lawyers provides guidance on business succession planning, including the relationship between ownership structures, estate planning and commercial agreements.
Shareholder and buy/sell agreements
Where a business has multiple owners, a shareholder, partnership or buy/sell agreement can establish what happens when one owner leaves.
The agreement may address:
- death or permanent incapacity;
- retirement;
- voluntary sale;
- serious illness;
- insolvency;
- misconduct;
- relationship breakdown;
- compulsory transfer events;
- valuation methodology;
- payment terms; and
- dispute resolution.
Without an agreed process, the remaining owners may be required to negotiate with an estate, family members or an external purchaser during an already difficult period.
A buy/sell arrangement can create a mechanism for transferring an owner’s interest following a specified event. Insurance may be used to help fund the purchase following death or total and permanent disability.
The insurance policy and transfer agreement must be coordinated. Insurance may provide money, but it does not necessarily compel the intended transfer of ownership.
Value the business realistically
A succession plan should include a reliable method of valuation.
Business value may depend on:
- maintainable earnings;
- assets and liabilities;
- intellectual property;
- customer concentration;
- recurring revenue;
- key-person dependence;
- market conditions;
- contractual rights; and
- industry risk.
The Australian Government recommends valuing the business regularly because its value may change significantly before the owner exits.
The valuation mechanism should also be stated in any relevant agreement. Possible approaches include:
- an agreed value reviewed annually;
- valuation by an independent expert;
- a formula based on earnings;
- market value; or
- a combination of methods.
An outdated or ambiguous valuation clause can create substantial conflict at the time of transfer.
Reduce dependence on the owner
A business that depends entirely on one owner’s knowledge, personal relationships or technical expertise may be difficult to sell or transfer.
Succession planning should therefore involve building a business that can function without constant reliance on the current owner.
Practical steps may include:
- documenting systems and procedures;
- delegating authority;
- developing management capability;
- securing important contracts;
- protecting intellectual property;
- maintaining accurate financial records;
- clarifying employee responsibilities;
- formalising customer and supplier arrangements; and
- ensuring critical passwords and records are accessible securely.
Documenting processes helps prevent essential knowledge from leaving when the owner exits. This is also a specific recommendation in the Australian Government’s succession-planning guidance.
Plan for incapacity, not only retirement
Many succession plans assume that the owner will choose when and how to leave.
That may not occur.
Illness, injury or loss of decision-making capacity can remove an owner from the business without warning. The plan should identify who can make decisions, access information, operate bank accounts and manage urgent responsibilities during that period.
Relevant arrangements may include:
- enduring powers of attorney;
- alternate directors;
- delegated banking authority;
- emergency management instructions;
- access to essential systems;
- insurance;
- shareholder-agreement provisions; and
- clear authority for senior employees.
The Australian Government recommends including the information another person would need to take over suddenly if the owner cannot continue because of illness, injury or another unexpected event.
Coordinate the business plan with the estate plan
A Will alone is not a complete business succession strategy.
The Will may control personally owned shares or business assets, but it may not override:
- shareholder agreements;
- company constitutions;
- partnership agreements;
- trust deeds;
- insurance arrangements;
- jointly owned property; or
- superannuation nominations.
Problems can arise where the Will gives shares to one beneficiary but an existing shareholder agreement requires those shares to be sold.
The succession plan should therefore be reviewed together with:
- the Will;
- enduring powers of attorney;
- company records;
- shareholder agreements;
- trust documents;
- insurance;
- superannuation arrangements; and
- taxation planning.
Family businesses require early discussion
Family business succession can involve both commercial and emotional issues.
One child may have worked in the business for many years while another has pursued a different career. The owner may want to treat family members fairly without dividing ownership in a way that damages the business.
Possible approaches include:
- transferring the business to the active family member;
- using other estate assets to benefit other beneficiaries;
- requiring the successor to purchase the business;
- transferring ownership gradually;
- retaining some assets outside the operating business; or
- establishing governance arrangements between family members.
The preferred outcome should be discussed early. Leaving family members to negotiate after an owner’s death or incapacity can increase conflict and reduce business value.
Prepare for an external sale
Succession planning is equally important where the intended exit is a sale to an unrelated purchaser.
An orderly sale process may require:
- accurate financial statements;
- due diligence records;
- transferable contracts;
- employee planning;
- intellectual-property protection;
- resolution of disputes;
- appropriate business structures;
- taxation advice; and
- transition assistance from the seller.
A succession plan can help a business prepare for transfer to a new owner and support a smoother sale process.
Review the plan regularly
A succession plan should remain current.
A review may be needed following:
- changes in ownership;
- a new shareholder or partner;
- changes in family circumstances;
- illness or incapacity;
- substantial growth or decline;
- restructuring;
- changes to the intended successor;
- new debt or guarantees;
- changes in taxation law; or
- updates to the owner’s estate plan.
The Australian Government recommends reviewing the plan regularly so that changes in the business or the owner’s personal life are captured.
Early planning preserves options
Succession planning is not only about retirement. It is about preserving the value and continuity of the business if ownership or control must change for any reason.
A clear plan can reduce uncertainty for co-owners, employees, customers, suppliers and family members. It also allows legal, financial and operational issues to be addressed while the owner is still available to make decisions.
Businesses considering an ownership transfer, family succession or eventual sale can obtain commercial and business law advice on structuring, shareholder arrangements and the legal steps required to implement the transition.
The strongest succession plans combine legal documents with practical preparation. They identify the intended outcome, establish who will control the business, provide a valuation and funding process, prepare the successor and remain capable of responding to an unexpected event.
This article provides general information only and is not legal, taxation or financial advice. Business owners should obtain advice appropriate to their ownership structure, objectives and circumstances.
Disclaimer: This article is for general informational purposes only and does not constitute legal, taxation, or financial advice. Readers should conduct their own research and seek professional advice before making business succession, ownership, or estate-planning decisions.