Overview

What is business succession planning? This question was posed in a recent report* based on a nationwide survey of Australian Family Businesses. The authors concluded that in addition to a property or business entity being transferred, so is a family occupation, a family heirloom and family values.

Family business transfers contain two elements: succession and inheritance. Succession can be referred to as the transfer of management and control where family members participate either actively or passively in the business. Inheritance refers to the transfer of assets and ownership.

What does succession planning involve?

In short, according to the authors, succession planning is not an event but a process involving:

• the transfer of managerial control;
• the transfer of assets and ownership;
• the transfer of an occupation;
• putting into place appropriate structures including selecting, developing and communicating with successors;
• the grooming of children as (potential) successors;
• managing the timing and translation of roles and status;
• planning and managing the entry and exit of family members;
• estate planning; and
• wealth preservation to ensure the continuity of the business.

Business Succession Planning – an Estate Planning Safety Net

Australian research has shown that the great majority of business owners have no exit strategy in place.   It seems that most would simply shut down their business when they decided to retire with some optimists clinging to the hope that they would find a timely buyer.

A small minority had either sought advice or had a strategy in place.  Typical of such strategies where there are multiple non family owners are buy/sell agreements (also known as business succession agreements) which are usually underpinned by life insurance policies.  This type of arrangement is intended to operate in the event of the death of one partner and there is a role for this type of arrangement. 

Buy/sell agreements of this type are best where the value of the business is fairly predictable and stable year in year out.  Problems arise where the life cover does not keep pace with the value of the business and the provisions in the agreement are not flexible enough to deal with this eventuality particularly with an untimely death of a partner.  The outcome can result in the family of the deceased partner being under compensated for their share of the business which under the agreement is transferred to the surviving partner/s.

Another common form of business succession agreement can be a shareholder’s agreement which sets out the terms on which the interest of a departing or deceased shareholder can be disposed of.  

However, while these strategies may have their flaws, only a small number of business owners have one in place, with the great bulk of business owners having no provision in the event of a premature death other than perhaps some life insurance to pay out business debt.

The RetireLaw Advantage

As lawyers whose main focus is estate planning, many of our clients are business owners and very few have buy/sell or shareholder agreements in place.  

For those that don’t, we pay special attention to the business interests particularly where a number of family members are employed.  While some clients have exit strategies planned, others do not and we explore with the clients the implications for the family should the business owner die unexpectedly. 

Once we have a clear idea of the extent of the business interests we discuss with the business owner and their spouse/partner what they would like to see happen to the business.  In our experience, too many business owners do not place great value on the business even though in most cases it has provided them and their family with a good income and the opportunity to build up both business and private assets.

Often working with their accountant, in most cases the source of our involvement, we explore a range of options as to how the business might be retained for the family’s medium to long term benefit. 

As lawyers whose estate planning approach is based on the use of beneficiary controlled testamentary trusts, we recommend that the modern estate planning Wills have additional testamentary trust provisions dealing with business assets where appropriate. 

Whereas our estate planning approach normally has the family’s private assets allocated initially between the spouses/partners and then on the death of the last spouse/partner to their children, a different path is mapped out for the business assets.

This separate path has us tailoring a testamentary trust with special provisions to deal with the business assets.  These often include companies, trusts, real estate, stock or intellectual property, the ownership or control of which can be transferred once probate has been granted into such a trust.  Normally, we structure this trust so that it has several trustees, unlike the testamentary trusts for the private assets where each beneficiary has sole control of their trusts.

Often with business assets the only people who really understand the business structures, finances etc are the Willmaker and his or her accountant and for this reason we generally recommend that the trustees of the special trust holding the business assets are the spouse and the accountant – in the event of no spouse/partner we would suggest that some or all the children be co-trustees with the accountant. 

Usually the spouse and/or other family members are the beneficiaries of this trust and as such will receive the income, profits and dividends flowing from the business assets.

For there to be an effective and readily managed trust, special provisions are included in the trust terms embedded in the business owner’s Will to provide guidance for the trustees so as to ensure maximum flexibility and control over the business interests and their future. 

In effect such a trust allows the surviving spouse and the accountant (or other appropriate person/s such as children who have worked in the business for an extended period of time) to take time deciding the business’s future.  This may include “grooming” the business for sale over the next year or two, or simply building on the work of the deceased owner and ensuring the family continues to benefit from the business over the long term.

Such provisions are not intended to be a substitute for buy/sell or shareholder agreements but where such arrangements are unlikely to apply, such as where a business is owned by a family or a sole owner, they can be the next best thing.  Of course, if after signing a Will with such provisions, the Willmaker sells the business, which will happen more often than not if for no other reason than the business owner needs to fund his or her retirement, the provisions in the Will are normally redundant and have no effect.  

While too few families have the advantage of modern estate planning Wills in place, for those with business assets such Wills with appropriate business succession trust provisions in place provide a safety net so that the family will not be disadvantaged if left to deal with a significant estate asset they may be unfamiliar with. 

Finally, a well drafted Will with business succession provisions of the type outlined in this article, may offer a much smoother transfer of business assets from one generations of the family to another with no CGT implications.   Further advantages of such an approach are the income tax minimisation and asset protection opportunities attaching to testamentary trusts that the beneficiaries will appreciate.

*Australian Family and Private Business Survey (Boyd Partners Ltd and RMIT) 2003