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Need for Asset or Buy/Sell Strategy Need for Liability or Key Person Strategy
Simplifying the Valuation Issue
Third Party Buy/Sell Strategies Estate Equalisation Strategies
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Sole Proprietors and Family Businesses
Introduction This Page (and the links under the heading Overview of Alternative Strategies) contains a discussion of a number of strategies that can help deal with the unique challenges that face Sole Proprietors and Family Businesses (including Rural Businesses). It is not intended to be a definitive answer to the problems of any one family. Instead, it is intended to be a "toolkit" that helps a family to identify the issues and design a common sense strategy.
The Importance of Financial Success to Succession At the outset, it needs to be stated that the word "succession" contains within it the word "success". In a way, it is a lot easier to design and implement a Succession Plan for a Business if it is financially successful. From the Vendor's point of view, the Business needs to be "saleable". From the Purchaser's point of view, it needs to be "purchasable". In other words, the Business must have sufficient profitability to justify a Purchaser:
If the Purchaser borrows the Purchase Price, the proposition must be "creditworthy" from a lender's point of view. Without financial success, it will be difficult to sell any Business (particularly on the retirement or death of the Proprietor). Equally, the Proprietor's children (the "Second Generation") will be more interested in retaining ownership of the Business if it is financially successful and able to meet their financial needs. If the financial burden of a Business is too great or the financial rewards are inadequate, it is unlikely to be attractive to a Purchaser or the Second Generation. This is a harsh reality. However, what it means is that work has to be done to "Prepare a Business for Succession".
Primary Focus of Complete Succession From a management point of view, it is important to design business strategies that:
These management strategies are not the primary focus of this web site. Complete Succession is primarily concerned with the family, commercial, financial, legal and taxation implications of:
Transmission of Business or Equity to Family Through Proprietor's Will Most succession within a family takes place through the vehicle of the Proprietor's Will. Ownership of Business If the Proprietor owns the Business (or an Equity in the Business, e.g., where a husband and wife co-own the Business) in their own name, their interest will form part of their Estate upon their death and will be distributed by their Executor in accordance with the terms of their Will. This applies equally if the Business is owned by a Family Trust and the Proprietor controls the Trust through the ownership of shares in the Trustee Company. Their interest in the shares in the Trustee Company will form part of their Estate upon their death and will be distributed by their Executor in accordance with the terms of their Will. No Sale and Purchase Because the interest is transmitted to the Beneficiaries pursuant to a Will, there is no purchase and therefore no need to fund a Purchase Price (whether by way of loan or insurance). No Capital Gains Tax Similarly, there is no disposal from a Capital Gains Tax point of view, at least until the Beneficiaries on-sell their interest in the Business. Summary In one sense, this is the most tax- and cost-effective method of succession within a family. However, it is not always the most appropriate method for the particular Proprietor or their family. The Proprietor should carefully consider whether the transmission to the Beneficiaries is what they want to occur from a commercial and family point of view.
Two Important Family Considerations Family Succession will often result in the transmission of a Business from the parents (the "First Generation") to their children (the "Second Generation"). While the First Generation is normally driving the process, it is still important to consider the interests and wishes of the two generations. Children's Wishes A Will strategy might not be the most desirable if none of the family members wish to retain ownership of the Business. In this case, the First Generation might have to consider the sale of the Business during their lifetime. Proprietor's Financial Needs in Retirement It is usually desirable for a Proprietor to retire from active full-time involvement in the Business at some appropriate time in their life. One obstacle that prevents or delays a planned retirement is the lack of sufficient superannuation, investments and cash to fund their living expenses in retirement. If the Proprietor transmits the Business to their Beneficiaries through their Will, the Proprietor will never receive the capital value of their Equity in the Business as consideration for a sale. As a result, the capital value of their Equity will not contribute to their retirement strategy. The Proprietor must therefore consider what strategy will best help them to fund their living expenses in retirement. Financial Needs of Spouse This analysis assumes that the financial needs and strategies of the Proprietor will take into account the living expenses of their Spouse. In the case of a Retirement strategy, the funds payable to the Proprietor should be sufficient to fund the living expenses of both parties. In the case of a Death strategy, the funds payable to the Proprietor or their Estate could be distributed initially to the Spouse and, upon their subsequent death, to the children (i.e., the Second Generation). The Death strategy enables the ownership of the Business to be transmitted to the Second Generation through the vehicle of the Will (or a Family Buy/Sell Strategy), while the Insurance or Sale Proceeds could be distributed to the Spouse. If the Business was transmitted to the Spouse through the vehicle of the Proprietor's Will, many of the strategies discussed on this web site would need to be duplicated for the Spouse as well as the Proprietor. If Insurance Strategies were used, it would be necessary to have Insurance Policies with respect to both Parents, because it would not be possible to predict which Parent would die first. The Death strategy with respect to the primary Proprietor therefore assumes that:
Implications for Family Business Succession Planning The design of a Family Succession Plan therefore needs to take into account:
Click here to read about the implications of different approaches to these issues. The different approaches might not be relevant to every family. However, it can help to know that the other approaches are available, so that they can be considered and implemented, adapted or dismissed as appropriate.
Overview of Alternative Strategies Click here to read about alternative strategies and scenarios for Sole Proprietors and Family Businesses.
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Adviser Tip In the case of Retirement, a Complete Succession Plan can pre-agree the Purchase Price and specify a timeframe for payment. If you do not have adequate insurance for an Insurable Event, your Succession Plan can specify a timeframe for payment of the shortfall.
Ian Gray travels to most capital cities regularly throughout the year and is available for Meetings. Please click here to see his availability in Brisbane, Sydney, Melbourne, Adelaide and Perth. Please contact us to arrange an appointment or teleconference. |
