Business Succession Planning

How to stop your business from dying when you are no longer there

Please read this general guide with the advice of your Accountant and Adviser.

I have read enough. I want to start my Business Succession Plan right now.

We act for farmers. Where is the Farming Succession Information?

We act for Lawyers, Dentists, Accountants and Doctors. Where is the Professional Firm Succession Information?

Read the paper prepared for the Australian Taxation Institute on Business Succession Planning or view the power point presentation.

Until death us do part Michael, who is 55 years old, together with his beautiful wife Wendy, have two children. Michael is in partnership with his good friend Peter who is 32 years old and recently married. Michael and Peter run WestParts a successful machine parts business. Peter specialises in sales while Michael has the technical expertise. Together, they make a competitive combination. Through 7 years of hard work, endeavour and frugal drawings the business is now worth $1.4 million. Tragically, Michael suffers a stroke down the left side of his body and can’t continue working. Months pass and the business starts losing money. Peter can’t afford to hire someone to replace Michael, as Michael is still drawing a salary out of WestParts. Peter wants to buy out Michael’s interest in the business but Peter and Michael can’t agree on what the business is worth. In any event, Peter is unsure on how to fund the purchase as all of his personal property is already held by the bank to secure the business debt. Later that month Michael dies leaving all his assets (including his interest in WestParts) to his wife, Wendy. Michael’s funeral is still two days away but Peter is already in trouble... WestParts borrowed $230,000 to purchase a warehouse in Canning Vale. In addition, the bank overdraft is currently running at $23,000. Both debts are guaranteed by Michael and Peter. The bank manager is on the phone - Michael’s death has triggered an automatic default of both debts (as is the case in almost all loans and mortgages in Australia). The bank manager needs payment or to renegotiate the loan: "Will Wendy guarantee the loan?". The firm has lost one of its biggest assets - Michael’s technical knowledge. Peter must immediately find someone who can fill that role. Wendy can’t help run WestParts - how can she run a business and bring up her two children? Wendy’s once good relationship with Peter is souring over the dispute as to what is going to happen to the business and Michael’s usual salary. Peter is eventually able to re-finance the two loans at a higher interest rate. He manages to employ Rod, who has the necessary technical knowledge. Peter has to pay Rod $80,000 a year. Errors made before Rod started result in the loss of the firm’s best client. Peter is forced to take on further debt to keep the business afloat. In desperation, Peter tries to sell his share of the business. The offers are only a fraction of what the business was worth before Michael suffered the stroke. Grimly, Peter decides to struggle on. WestParts folds less than 12 months later. Peter is bankrupt and loses his family home. The business, for Peter and Michael, was not only their job but their life and financial security. The business was to provide for their retirement. Now it won’t even provide their family with a roof over their head.

Why should I plan for business succession?

If you suffer a heart attack, a stroke, an accident or die have you planned to:

• retain your business for your family; or
• sell and relinquish your interest to your partners, key employees or a third party?

You can ignore the opportunity to plan your own succession. (After all perhaps you will never die, get sick or suffer an accident.)

The result of your failure to plan? You are leaving your business susceptible to self-destruct.

This is known as "business euthanasia".

Less than 30% of business owners aged 51 to 60 have a written Business Succession Plan, and more than 70% have no plan at all.

For owners over the age of 60, half do not have a written plan for the orderly, or disorderly transfer of their business interests.

Only a third of family businesses continue into the second generation, and less than a sixth (that is 16%) survive to the third generation.

You had the ability, vision, and guts to build your business from nothing. Do you have the courage to face the challenges of the future? If not, your lawyer and accountant will do it for you (on the way back from your funeral, four cars back from the flowers).

Would you strive to make more sales and sign more contracts if you knew that within 24 hours of your partner’s death your business will share your partner’s coffin?

What is a Business Succession Plan and how does it help?

A Business Succession Plan is a financial and tax plan that can:

give your business every chance of survival when you are gone or suffer a long term illness or accident ensure your family and yourself receive the true value of your interest in the business allow for an orderly transition of ownership to the remaining partners, family members, or key employees - rather than suffer a fire sale

4. provide a ready market for your business interests
5. retain key employees

A Business Succession Plan considers the best way to:

• structure your affairs to reduce unnecessary Capital Gains Tax, Income Tax and Stamp Duty for you, your family and your remaining partners
• fund the transfer of your interest in the business to your outgoing partner
• trigger the events to allow the succession to take place, for example your business partner:
• gets a nasty and undignified divorce
• goes broke
• dies
• goes to jail
• becomes of unsound mine
• suffers a total and permanent disability
• suffers a trauma event, like a heart attack or a stroke and can't get back to meaningful work
• turns 60 and wants to retire

What type of agreements are best to reduce Capital Gains Tax and Income Tax

This all depends on what you want and what the tax implications are of the agreements based on your specific situation. No two businesses are alike.

1. Put & Call Option

As the withdrawing partner, you or your spouse and family sell your interest in the business to the remaining partners. Your remaining partners buy your interest in the business. The price or formulae to calculate the price is already agreed.

2. Mandatory Buy/Sell

In this agreement you and your partners have no option. If the Business Succession Plan is triggered you must sell and your business partners must buy your interest in the business.

This method has proved unpopular because the tax office generally declares that the day you signed such an agreement is the day you sold the business. The cost base calculation for the remaining partners may start on that day.

3. Agreement to enter into a Business Succession Plan

The first agreement ensures you (or your family) enter into another agreement if you suffer an accident, trauma event or die. This method attempts to overcome the tax problems in Mandatory Buy/Sell agreements as it reduces the likelihood of the tax office declaring that the sale took place on the day you signed the first agreement.

Where do my partners find the money to buy out my interest?

After you get your agreement in place you need to decide how the remaining partners will pay you for your interest in the business. Few people have cash reserves or available credit to make such a purchase, especially when the business is already hurting by your absence.

The safest and usually the most economic answer is insurance. There are 3 types of insurance that you should talk to your Adviser about:

Life Insurance (if you die) Trauma (if you suffer an event like a heart attack, stroke or cancer) Total and Permanent Disability (you lose a limb in a traffic accident)

You may be able to qualify for all 3 types of insurance.

The use of life insurance in a Business Succession Plan is an investment decision rather than a life insurance buying decision.

Tragically, many businesses (and the families they support) are living on a knife edge. Something as common as a heart attack, long stay in hospital or permanent disablement could destroy everything. Only by considering what the future may hold and planning for those contingencies can you be certain that your business will be providing for you and your family for years to come.

How do I hold the insurance?

Once again this depends on your and the businesses’ unique requirements. There are three ways you can hold the insurance:

1. Self Ownership

The insurance is paid out to you as the outgoing partner if you are living, or if you are dead to your family (for example, into a Testamentary Trust Will). While this appears simple and clean, the tax office may state that your remaining partners acquired your interest in the business at no consideration. This means that the remaining partners may be left with a mammoth capital gains tax bill when they come to sell or transfer that part of the business they acquired from you.

2. Cross Ownership

If your partner suffers a trauma event or dies (or any triggering event you decide on) then the insurance is paid to you as the remaining partner. If you suffer an agreed triggering event then the insurance is paid to your partner. The potential problem with owning the insurance this way is that it is difficult to remove or add partners to your business. Everything has to be restructured each time there is a change in the partnership. Also trauma is generally subject to Capital Gains Tax.

3. Insurance Trust

If you suffer an "agreed triggering event" then the insurance proceeds are paid to a trust. The trustees can be your spouse and the remaining partners. The trustees follow the rules set out in the trust. They transfer the business and deal with the money. The problem here is that, in the hands of third parties, Trauma insurance (and sometimes Total & Permanent Disability insurance) can be subject to Capital Gains Tax.
Taxation, such as Capital Gains Tax and Income Tax, make getting proper structured advice from your Accountant,  Adviser and Tax Lawyer important.

Where Do I Go From Here?

Speak with your Adviser about the above insurance policies. Your Adviser also has a questionnaire to help guide you through some of the above decisions.

Please have your Lawyer, Accountant or Adviser ring us on 08 9460 5000 to make a time for you, your Accountant and Adviser to come into our office. You and your business are unique. Your Business Succession Plan is tailored to your individual requirements. We discuss your Business Succession Planning with you in light of what you need and the tax laws. We charge $440 per hour for the consultation. Your Adviser or Accountant can complete a Business Succession Instruction Form and facsimile it to us on 08 9460 5001.

Some of the issues we discuss to develop the plan include:

• Who owns and runs my business after I am gone: my remaining partners? my family? our key employees? a competitor? an investor?
• What do I want to accomplish in the Business Succession Plan? Perpetuate the business? Transfer the business to the remaining partners? Get a family member in control?
• What is the business worth now? What is the business worth without me?
• How is the business valued: agree the value now and index it for inflation, on a formula, or some other way?
• When and how might I want to move out of the business? At a particular age? Over time? At a given profit level?
• What age do I retire? 60? 65? never?

Before we prepare the legal documents necessary for the Business Succession Plan, we give you a written fixed quote. We fully inform you before you make your decision.