In the next 10 years, 66% of all small-business owners in Canada expect to retire. But, if other stats stand, it’s likely few of your clients who are business owners have a succession plan.
A 2006 Canadian Federation of In-dependent Business survey of 9,000 independent business owners found that less than 10% have a formal, written business succession plan.
“Succession planning is not on the radar screen of most business owners,” says Terry Noble, vice chairman and a national partner at Deloitte Canada. Succession planning, he says, is not helpful in running a business day to day, so entrepreneurs are reluctant to waste their precious time on something that inevitably will change.
But, says Scott Hayman, executive vice president and head of client services at Northwood Stephens Private Counsel in Toronto, if a succession plan is in place, a business owner can be ready when opportunity knocks. A client recently told Hayman that developing an exit strategy early in the game was the best thing he had done for his business. The owner ended up selling the business about a decade before he originally thought he would, says Hayman: “A plan was ready when an opportunity arose.”
How can you help your business-owner clients ensure a smooth transition to retirement? Lead them through the key steps in preparing for succession:
> Plan Ahead.
“It takes a lot of time to structure a good business plan if you want to have the best people involved,” says Bernie Clermont, regional financial planning consultant for RBC Wealth Management Services in Ottawa.
But just getting an entrepreneur to talk about retiring at all can be a struggle. “Many see themselves working forever,” he says.
It’s up to you as the advisor to administer the reality check and push your client to define goals. Does the business owner want to get family members involved? Does he or she want to continue working in some capacity after selling the business? What does the business owner’s lifestyle look like? What is he or she going to do on that first day of not running a business? Can your client go on vacation without fear?
Noble considers this last item an important litmus test because it indicates that the business has some continuity — an essential component of succession. “The best thing for these people is that they can go to Florida for six weeks every winter and the company doesn’t miss a beat,” he says.
Business-owner clients also need to start early in identifying and grooming their successors, whether it’s a current employee or a family member. Some business owners may need to cover the gap between retirement and the time their children are ready to take over the business by recruiting a bridging management team, adds Lawrence Barns, CEO of the Canadian Association of Family Enterprise in Oakville, Ont. Having a backup team is a good idea anyway, because it creates a safety net.
None of these things happen overnight. Preparing for succession in the prevailing timeline of 12 to 18 months is not good enough. “The perfect scenario is a minimum of three years, but, ideally, five,” says Wellington Holbrook, senior vice president of operations in Western Canada for Business Development Bank of Canada. In fact, he says, planning earlier rather than later could make a significant difference in terms of how financially comfortable the business owner is when he or she hands over the keys.
Besides, things don’t always work out the way we expect. During his 12 years at the BDC, Holbrook has witnessed many occasions in which company owners have been forced out the door earlier than expected. Health issues, for instance, can radically accelerate the process. Those without a plan are relying on luck — and that’s no way to plan for retirement. “Without a plan, it’s like flipping a coin,” he says.
> Protect Your Client.
It’s common sense for business owners to have a contingency plan in place. What happens to the business, for instance, if the person in charge falls out of a plane? The plan should address succession, insurance and taxation, Noble says. But there is more to protecting your client than arranging help for the worst-case scenarios.
For instance, your client may choose to take the “preferred shareholder” route to retirement. (The corporate reorganization of shares allows the new owners to finance what could be an onerous financial obligation.) This requires a shareholders’ agreement.
@page_break@While highly detailed shareholders’ agreements are an expected component when a management team or employee takes over the business, Myron Knodel, manager of tax and estate planning with Investors Group Inc. in Winnipeg, says some owners balk at expecting such a rigid contract among family members. “With family, it’s a situation in which people say, ‘We’re getting along; why do we need this?’” he says.
But that’s a mistake. Your client needs to be reminded that families aren’t static entities. Children get married, they lose interest in the business, or they can become ill or disabled. A sound contract protects the business from being controlled by outsiders.
> Finding The Talent.
It’s all about finding the right talent. A Deloitte study early this year found that the talent crunch — finding and retaining the right people — is the top issue for business owners.
The difficulty, according to Knodel, is that entrepreneurs like to run everything themselves. But good talent needs to be hired and nurtured, challenged and empowered — or it will walk away.
You can help your clients find the right balance by working out a way to offer incentives to talented employees — without giving away the family farm. One strategy, for instance, is to provide stock options over a number of years, culminating in a complete buyout.
> Bring In Outside Help.
Suc-cession planning can be complicated. If you deal regularly with business-owner clients, you may need to work closely with valuators, accountants, lawyers, counsellors and family-business mediators.
“Don’t be afraid to bring in outside experts to help,” advises Hayman.
Taxation, for example, is a major aspect to consider when preparing for the sale of a business. Even if a parent gives the business to a child, there are tax implications for both parties. There’s a deemed disposition at fair market value, which triggers taxes. “So, you need to know what your options are, from a tax standpoint, and put in place a plan that is structured in such a way that it will minimize taxes,” Knodel says.
You can bring in an accountant and a lawyer to make sure a company is positioned in such a way that it’s eligible for exemptions. “We call it going through a process of purifying your company,” Knodel says.
Financing probably will also play a large role in a client’s succession plan. Very few small business owners retire debt-free, according to Clermont.
When an insider is buying the company, your client must factor in the need to finance the transition. “You need to make sure that the business is in a position to support that debt after the owner leaves, so that there is not such a burden of debt on the business that it is no longer flexible and able to react to the market realities,” says Holbrook.
> Know What The Business Is Worth.
Even if your client is considering passing the business along to a relative — possibly at a discount to provide an incentive — it’s always a good idea to have a third-party valuation, Knodel says. Only then can you have any direction on how to structure a payout for the owner. This is usually the point at which you would oversee an estate freeze, whereby the current value of the business is converted into preferred shares so that any future growth of the company is attributed to the new owners.
Over time, the new owner will redeem these shares, Knodel says: “It’s not a situation in which the curtain falls and the [former] owner is out. It usually occurs over a period of time. The new owner will take earnings from the business and use them to redeem or cancel or remove those preferred shares.”
If it is a child who is acquiring the company, Knodel generally recommends a plan that goes one step further and includes a provision for the child to buy life insurance on the business-owner parent’s life so that the estate will be paid out when both parents die. “You don’t want a situation in which one child is running the business, the other child is not and the parent passes away,” he says. Liquidation of the outstanding shares by the estate can close a company’s doors forever.
Holbrook says intellectual property is one element that business owners often don’t take into consideration when valuing their business. “There’s usually more value in a business than they appreciate,” he says. “It’s not just the amount of equity or profitability.” Intangibles such as relationships and reputation — the things that can’t be touched or smelled — also factor into the success of a business, he says.
In fact, when an outside firm buys a business, there’s often a one- or two-year window in which the current owner is expected to stick around to ensure a smooth transition, says Andrew Pigott, business valuator and transition consultant for the Succession Bridge in Oakville, Ont. There’s often an earn-out factor built into the price as well. “The buyer will pay a higher price if the owner is prepared to go on the hook for some of the future performance,” he says.
> Ask Clients To Play Favourites.
Your client should be discouraged from passing the family business equally to all the children so they have to figure out what to do with it. “The most unsuccessful business relationships are said to be 50/50 partnerships,” Knodel says. Disagreements can last for years with no resolution. “It handcuffs the business,” he adds.
You must encourage your client to give one child the final word. “It’s one of the most difficult things,” Knodel admits. “But if you have one child with better business sense, you need to groom that child, and put him or her in control.”
Communication is tantamount. Your client’s family members need to be aware of the plan, even if the business is going to be sold outright. “The worst thing a business owner can do is create something he thinks is fair,” Knodel says, “and then find out later that family members’ thoughts on the subject are different.” IE
Succession net Safety
Ensure that your clients who own small businesses are ready to make a safe transition to retirement
- By: Wendy Cuthbert
- May 29, 2007 May 29, 2007
- 09:59