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When should I start thinking about succession planning?

Tuesday, 13 November 2012 | By Craig Yeung

How early should I think about succession planning?

 

Should I make it clear from day one who I want to own the business after me?

 

Or is it something I only worry about once I have lots of shareholders/investors?

 

Succession planning is the process of outlining who will take over your business if and when you (or your co-founders) leave and how that change will occur. Generally speaking, the sooner you start thinking about succession planning the better.

 

This is because well-thought-out succession planning will help ensure that the business you have worked hard to establish and grow can continue when you are no longer a part of it (whether intentionally or unintentionally) or that the value of your investment can be realised when you need it to be.

 

Succession planning for start-ups

 

Succession planning is rarely on the priority list for many owners of start-up businesses. A key reason for this is that in the early days of these businesses the owner/founder of the business usually is the entire business, and therefore the business has little or no value without its founder.

 

Further, it is easy for succession planning to be low on the priority list during the early days when funds are tight. In addition, it is often difficult to identify who will, or who the founder would like to, own the business after the founder.

 

Finally, in the beginning the focus of start-up founders is on growing the business rather than thinking about what happens if they are no longer around for the business.

 

However, there is more to succession planning than simply outlining who you want to run your business after you.

 

For start-ups, a key part to early succession planning is understanding where business assets are owned and controlled. For example, is your business carried on by yourself as a sole proprietor or a company or a trust?

 

As a subsequent owner of your business will need to have (or have access to) those assets in order to carry on the business after you, it is important to structure your business in a way that provides for flexibility in ownership and changes in ownership of your business.

 

Getting your structure in place early

 

If you do not have a structure in place that allows ownership of your business to be transferred easily, it is going to be difficult to implement your succession strategy.

 

For example, it is much more difficult to transfer ownership of a family trust to a third party compared to transferring ownership of a company to a third party.

 

Therefore, from a succession planning viewpoint, it may be worthwhile to set up as a company instead of a trust so that your business can be easily transferred to a third party.

 

Similarly, it is difficult to introduce employees as part owners of your business if it is carried out through your family trust (or as a sole proprietor).

 

Therefore, if your strategy is that you want your employees to eventually take over your business, then you may want to consider using a company so that they may gradually increase their shareholding over time.

 

The issue to remember in structuring is that you will also need to balance these with tax considerations, as there will be tax and stamp duty consequences, to ensure that you put in place a strategy that works and, importantly, is tax effective.

 

Dealing with co-founders

 

Business succession planning has even greater importance where you own your business with others. For example, what if your co-founder becomes ill and can no longer work in the business – would the business “buy-out” the ill co-founder and find another co-founder and, if so, how could the business fund that?

 

One way that can be done is to have insurance arrangements in place that effectively provide funding to “buy-out” the co-founder on certain events, usually known as “buy-sell” or “business succession” arrangements.

 

For example, if a co-founder becomes incapacitated due to illness, then the business may use the insurance proceeds to “buy-out” the co-founder, so that the co-founder can realise their portion of the investment in the business without the business being crippled by trying to get finance to fund the purchase.

 

On the flip side, the arrangement could also protect you where you become unable to carry on your duties and provide an opportunity to “exit” and realise your investment while providing an opportunity for the business to carry on.

 

Such arrangements are not simple and you should definitely speak to your friendly local insurance, tax and legal advisers to ensure the arrangements are structured in a way that is tax effective and works for you.

 

Wills

 

As part of the succession strategy, it is also important to review your wills and power of attorneys to ensure that in your demise, the right assets go to the right people.

 

For example, if your business is operated by a company and you own all the shares, it is important that your will deals with those shares properly so that those shares (and control of the business) do not pass to an unintended beneficiary.

 

However, you will need to ensure that your will is also updated should you change your mind. For example, if you had agreed with your employees that they will take over your business when you reach the pearly gates, then make sure that you have updated your will so your estate does not give your shares to your Aunt Jane, which means all those employees then have to work for her.

 

Conclusion

 

I understand that succession is low on the priority list for most start-ups, but it is nevertheless important to at least give it some consideration to avoid hassles and costs down the track.