Succession Planning Is Crucial

Succession planning, for a business owner selling to a child, follows pretty much the same protocol as finding a life partner. It parallels dating, going-steady, engaged and married. Jumping to marriage is usually a bad move in either setting.

Marriage should be the last step.  In the business case, that’s ownership.  The common mistake is to get caught up in the incidents of ownership and pay less attention to the rest. Control for example.  Ownership transfer is often the easiest part. There are established methods, techniques, protocols and plans.  The other steps tend to select a particular method of transfer.

When you transfer a business there are many pieces to consider:

  1. Transfer ownership
  2. Continuing income from value
  3. Continuing income from skill
  4. Control of strategy
  5. Control of tactics
  6. Control of administration
  7. Transfer relationships with customer, suppliers, managers, employees, lenders and external advisors.
  8. Communication with the family

The dating step usually starts with introduction to administration. How to collect receivables, to pay bills, organize work schedules, familiarization with processes, supervise people, transportation in and out, and customer service.

At the going-steady stage most newcomers begin to work on external relationships. Usually first with suppliers and customers. Lenders, lawyers and auditors will come later. The retiring parents must be careful to identify all of their relationships.  Keep a log for a year or so of who you talk to and why. Internal relationships move to dealing with supervisors instead of workers. HR, accounting, purchasing, manufacturing and so on.

Control of administration is near complete.

Tactical control is a big step for most aspiring owners.  Like engagement. Financing, new equipment or real estate, organizational structure, hiring key people, new product lines or discontinuing old ones.  Compared to administration, these decisions will not show results for a long time. It is harder to learn from doing. Parental experience is important. The ideal succession goal involves the transfer of all information and skill held by the parents.

Communication with the family should be complete by here.  The relationship is serious.

Strategic control will be last.  Leave the business or acquire another. Move out of the country or open a branch offshore.  Bring in more shareholders.  Do an IPO.  Changes that fundamentally change the nature of the business require considerable insight and that takes time to develop. The skills here are subtle and hard to transfer.

The wedding has arrived.  Transfer ownership. But how?  The other steps will tend to point the way.

If the child has followed all the steps, then a method that involves recognizing value and paying continuing income on that value will work.  Probably a freeze.  The advantage is tax deferral.  No point forcing children to borrow money that only the government will see. Consider what the deal means in terms of the parent’s financial needs and the child’s ability to pay.  Selling for cash, with taxes, a $10,000,000 business turns into $7.5 million of capital to supply income and provide parents’ estate.

If the business is well-managed enough for security, $10,000,000 still in the business may be safer.  If the child has not gone through the process, (they eloped in essence) get cash.  No complicated business can be run by a novice.

A sound beginning is the basis for a long strong marriage.  Start early. There is a long list of techniques to transfer ownership. From freeze, to pension funds, to holding companies and trusts.  Explore them all.  Some will materially reduce the tax liability and that reduces risk. Don’t forget that it is parental negligence to set the child up for failure.

Finally consider liquidity at death.  How do the frozen shares turn into cash in the estate. Second to die life insurance is the common technique.  It’s efficient.

Don’t forget the child may pass away first. Insure for value.  If Mom and Dad have been away from the business for 5 years or so, it may be very difficult to continue it successfully. The inability to provide continuing management is a huge discount factor in a sale to strangers.

Every business should have two succession plans.  An orderly one for a sale to a child and one that deals with the chaos of a parent’s death or serious disability before the orderly plan is implemented.

Uncontrolled succession is always problematic.

Insurance is your friend.  Money solves many problems or replaces the value lost when the business is sold or discontinued.  As David Cowper was fond of saying, “Life insurance lets you die neat.”

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  don@moneyfyi.com  866-285-7772

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