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How To Overcome The Challenges Of Business Succession

As varied as the succession challenges discussed in one of our previous article, they can be overcome through careful planning and well thought out strategy some of which we will see here on How To Overcome The Challenges Of Business Succession.

Eight elements for establishing a family business ownership transfer action plan have been discussed by Neumann for HEC Montreal (2009). These have been adapted hereunder for the purpose of this article:

1.) Clarification of the terms of ownership distribution

Since the family business is part of a family’s estate, it is important to clarify the terms and conditions of distributing ownership even if the management of the company is passed on to only one family member. Issues like number of owners, number of shares to be held by each owner, terms of the division of ownership and share classes based on the type of involvement in management should be frankly discussed in open, such that all the individuals concerned have the chance to share their point of view.

How To Overcome The Challenges Of Business Succession

2.) Determination of the fair market value of the business

It is necessary to determine the fair market value of the business even if it is inherited or received as a gift. This is important for tax reasons, for the financiers (if they are involved), and also for the inheritors to establish the value of what is handed down to them when ownership is divided. Usually, the valuation involves thorough diagnosis of the business so as to reveal solvency, profitability and future earning potential; strengths and weaknesses in the areas of human resources, production, marketing, information systems, etc.

This diagnostic will be useful in guiding the owner-successor to determine actions to be taken and skills to be further developed to meet the future needs of the business. Since particular expertise is required here, seeking the assistance of an expert in the domain can lead credibility to the results.

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3.) Discussion of the model and preferred pace for the ownership transfer

A clear understanding of the nature of the required compensation is imperative. In other words, will the business be gifted by the current owner(s) or will they require compensation in exchange for the assets or shares to be transferred? Some of the many factors that come into consideration on this point, they are:

  • The financial position of the owner-transferor: This is essential to ensure that he has an adequate financial position; otherwise, it will be difficult for him to truly remove himself from the management of the business.
  • The financial position of the succeeding owner(s) of the business: This helps to guarantee ability to pay or work out a comfortable payment plan such as that discussed by Cornblatt (2013) – ‘Buying in without breaking the bank’.
  • Equity, in terms of the other members of the family: Payment (or promise of payment) of financial compensation at the time of the ownership transfer can serve to equalise the positions of the other family members.

4.) Determination of the optimal tax strategy given the circumstances

There are important tax consequences to handing over or selling a business. Usually, where there is a disposition, there is a capital gain which might imply a tax liability. This plan helps to ascertain what can be done to minimize the tax bill when the company is transferred. Due to the complex nature of this, it is important to call on experts like chartered accountants, tax experts and legal advisors with experience in business succession, to help. Whatever is the chosen tax strategy, it should be adapted to the choices made regarding division of ownership. Some scenarios to be considered in choosing the optimal strategy include:

  1. Would it be better to buy assets or shares? Or to adopt a combination of the two? The tax implications of each of these strategies are very different.
  2. Should the succeeding owner buy all the assets or only a portion amd leave the ownership of some with the owner-transferor?
  3. Should the estate freeze technique to be used? If yes, with what conditions?

5.) Analysis of different models for financing the transfer of ownership

The financing of the transfer should not be ignored. It is a crucial aspect of the process. A financing package must be found that will ensure the right balance between the financial needs of the owner-transferor, that of the succeeding owner(s), and the financial needs of the business. The following can aid sound decision making on this matter.

  • An inventory of the various sources of funds available should be taken. This includes:
  1. Personal means of the succeeding owner(s)
  2. Financial means of the transferring owner(s) so as to ascertain what his plans are: how much will be needed and when it should be.
  3. The different sources of financing presently available on the market to finance this kind of transaction.
  • Drawing up of scenarios that will follow succeeding owner(s) to determine their capacity (and the capacity of the business especially with regards to future plans) to meet the financial obligations associated with each of the scenarios.
  • These scenarios, will help put the succeeding owners in position to identify the key points of an ideal financing package: distribution between debt and equity financing; percentage of shares purchased upfront; timeliness for the purchase of remaining shares; the nature of contractual debt (secure debt, subordinated debt, line of credit, and so on). This will help in making a clear choice and begin negotiations with various financiers.

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6.) Due diligence review

The due diligence review should not be avoided; no matter the method if ownership acquisition. It affords the succeeding owner(s) the opportunity to answer such questions as: Are there aspects of the financial position of the business not covered? What about legal issues? Do you know all the contracts and relationships the company has? What are the consequences of having them? Do they have an effect on the value of the business? What is the company’s situation in terms of the tax authorities and in terms of environmental responsibilities? There are so many areas to look at that an in-depth review is necessary. It should be noted that, the financiers of the transaction will also perform their own due diligence before fully committing to the project.

7.) Legalizing the transfer strategy and finalizing the transaction

Appropriate legal structures are required for implementing the ownership transfer strategy. This could mean, for example, creating a management company or a new class of shares. Legal advisors will make sure the transaction has all the contracts and legal documents required. Typical among these are a solid shareholder agreement (which is essential when the ownership is shared among many persons) and a sales contract (including the representation and guarantee clauses). This is the contract that leads to closing the transaction.

8.) The assistance of experts should be readily utilized

If industry standards must be adhered to when perfecting ownership transfer, then there is no room for improvisation. Consequently, it would be important to consult with specialists like chartered accountants, legal advisors, bankers, venture capitalists and strategic planning specialists for proper guidance and advice.

Conclusion

It is important to point out that the solutions discussed above on how to overcome the challenges of business succession are no magic wands; as what works in one scenario, may not work in another. Consequently, business owners (wishing to transfer ownership) and succession experts (managing transition processes) should endeavour to understand the peculiar circumstances of the business and adapt what they think will work for them.

Chris Esther

An experienced blogger whose top aim is to share knowledge and give out information.

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