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Succession planning – a Big Issue!

Business succession planning is a big issue for many Baby Boomers approaching retirement age. Why? The average age of a family business owner in NSW is now over 58 years old, and 68% of them plan to exit their business in less than 10 years time.

To use a real estate analogy, most business owners are like property investors who expect an income or rent return while they own and an increase in capital value when they sell. Put simply, they go into business to build their equity value and hopefully sell for a substantial gain. The reality sadly, is that most never get there!

Our experience with many businesses and large numbers of real estate agents has shown that a simple nine steps succession strategy solves the problem. It revolves largely around taking a strategic approach and taking the time required to plan and manage the succession. In other words don’t wait until you reach 64 years and 9 months of age before you contact an advisor. By taking our strategic approach to succession planning business owners find the process takes place over a minimum of five years, and the most successful plans over 10 or even 15 years.

There are many exit options open to business owners – the trick is to work out which one is most suitable for your business.

But in many cases owners can’t see the forest for the trees and miss the most obvious option: sell their business to existing key staff. Many business owners are susceptible to the risk of key staff leaving, taking with them valuable clients, company information and relationships, therefore having a negative impact on the overall value of the business.

Many listed companies have employee share plans, option plans and other profit schemes designed to reward employees based on their contribution to profitability. Unfortunately, many of these don’t work in small businesses. Shares are often difficult to value, normally illiquid, and the legal and accounting complexities involved are cost prohibitive for small business owners.

We have had some success in several real estate businesses introducing a custom designed vehicle which is both an employee incentive plan in the form of a profit share scheme and a mechanism for funding succession. In other words, the business owner is happy to contribute additional profits generated by key staff into a fund that is used by them to purchase equity in the business. As a part of the arrangement, key staff sign agreements that deliver increased benefits the longer they stay with the company. The business owner has the comfort of knowing that his key people are unlikely to leave because they now own equity and share in the business profits.

The advantages to all parties are obvious – Key staff now have an equity stake (real ownership with tangible value) in a business. They can increase the stake over time based on improved performance and also have the ability to make extra contributions from external sources, salary sacrifice, or even drawing down on their existing home loan.

The business owner has a predetermined sales strategy with identified buyers and an agreed valuation formula to calculate the selling price. They are also able to maximise the sales price, because it constantly increases along with improvements in performance of the business.

The system is a win-win because a buyer entering into the system over time benefits from the increased value of the business as performance improves. Key employees now have a reason to think and act like business owners.

For the many succession plans that fail due to the inability of potential shareholders (often younger and less financially secure) to fund the purchase, this plan represents a real alternative. The Peak Performance Trust offers a practical solution as well as ensuring employees/purchasers have an incentive to maximise their performance and that of the business at the same time.

Peak Performance Trusts in action – examples:

‘ABC Real Estate Pty Ltd’

Peak Performance Trust for shares-only investment

In the case of this client, the investment strategy for the Trust is simple – it will only ever purchase direct shares in the business, thereby giving participating employees an indirect ownership of the business’s equity. Its staff receive dividends and a bonus reward based on the profit performance of the business. If the business was to ever be sold, the PPT would benefit from the capital sale, and indirectly, the employees would receive part of that capital gain. Based on this simple strategy, the value of the PPT automatically replicates any change in the value of the business, therefore employees directly benefit (or otherwise) from any change in value which is largely driven by profit performance and is something that the employees can directly influence.


‘XYZ Real Estate Pty Ltd’

This business has also had success with setting up a trust for key employees – in this case a large property management base has been substantially expanded as the funds from the trust have been used to buy further property management books recently sold by a competitor in a nearby country town. The purchase was topped up with debt from Macquarie bank but the bulk of the funds came from the employee trust – employees are helping to fund the expansion of the business they now own a part of!

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Craig West

Craig West is the CEO and Founder of Succession Plus , Australias's largest business succession and exit planning consulting firms.