Set expectations at the beginning

In New Zealand more than 60% of family owned businesses are transitioned to a second generation. However, this process can be fraught with difficulty and often lead to conflict between siblings and generations. Often this is due to the ‘expectations gap’ – that is differences in expectations between the various parties involved in the succession.

Often the expectations of each party when entering into an arrangement are not documented and so misunderstandings occur between the different parties. I recently worked with a client where this mismatch in expectations led to a severe breakdown in family relationships. Something that could easily have been avoided had these expectations been made clear from the outset of their business relationship.

Create a succession plan to document expectations as soon as possible

In this particular instance, the son had joined the family business ten years ago with a verbal understanding that he would succeed his father and take over the business in due course. This is a typical expectation for a family member entering a business even if they may not be the best person to succeed the parent.

The business had several tough years and then a period of growth. During this time the son was employed as a CEO and after about five or six years began asking his father who acted as Managing Director what was happening with succession. Several discussions were held over the years, however, no firm agreement on the way forward was reached. Following increasing pressure from the son, two years ago the father finally engaged advisers to help structure a succession transaction with his son.

Communicate to keep all beneficiaries happy

It was important to both parents that their three children were treated equally. And so this precluded the gifting of shares in the company to the son. Instead, the father proposed the son buy 49.9% of the equity in the company based on an independent market appraisal, over a period of 5 years, and use dividends and a supporting loan from the family trust to enable this. His view was the family estate would be boosted by the amount received for the shares from the son. The son would then get a one-third entitlement to this value in his inheritance.

The proposal came as a great shock to the son. It was his expectation that he would be succeeding his father as owner of the business. He had not considered that his father would expect him to buy the company, especially not at a commercial valuation.  He believed that he had created the value during his ten years as a CEO and that by buying a company at commercial rates he would be rewarding his two siblings for his effort in creating value.

Plan for the unexpected

It was a classic case of mismatched expectations. And it was around this time that the father was diagnosed with a terminal illness with only two to three years to live. Suddenly, the succession process took on a new urgency.

Complicating the issue was the appointment of a sibling as a trustee to the family trust that held the shares in the family business. As an aside, this is a problematic issue for many New Zealand family trusts. While there is a desire for family members to support their parents in the event they become incapacitated. If they are beneficiaries as well as a trustee this places them in a difficult conflict of interest position anytime a distribution of trust proceeds is considered.

The sister was of the opinion that the brother was lucky to have a job and should not be given a company without paying for it. This led to a conflict between the brother and sister. In particular, because the original succession proposal provided for the trust to maintain a 50.1% shareholding, in other words, control of the company. As CEO and a part-owner as proposed, this was unacceptable to the brother.

Finding a solution that rewards success

The son rightly identified that if he wanted to game the proposal, as CEO he would manage the business value down in order to secure the remaining 50.1% at a reasonable price.  This would disadvantage his siblings in the process. He also had to consider whether he wanted to buy the company or use what would be a substantial inheritance to retire. He also recognised if he were to exit the business, there would have been a negative impact on business value in the short term.

The outcome

Ultimately, a succession transaction was structured. The son was given an option to buy 50.1% of the shares in the company each year at a set value. The set value was an agreed increase over prior year EBITDA, therefore, incentivising the son to exceed this in-order to achieve greater dividend return on his shareholding. The remaining 49.9% shareholding was to be valued in the event of his death and the son to buy the shareholdings from siblings at an agreed 10% discount to market value. This was to reflect the brokerage cost of selling a business and to incentivise the purchase of the business by the son from the family trust.

One of the crucial elements of the succession proposal was agreed and the proposal documented the dividend payment policy to enable the structuring of loan payments to pay for the shares.

The above example illustrates the need for documented agreements from the outset of any business relationship, and in particular between family members. The more informal nature of these working relationships often leads to mismatched expectations which can cause conflict and compromise the business performance.

In particular, the succession of a valuable asset such as a business needs to be managed carefully and with transparency amongst all family members to ensure harmonious family relations. Often family estates can be worth many millions of dollars. Claims on this can be wide and varied, ranging from partners family members to charitable causes. Documenting the succession plan and disseminating provides clarity and transparency to all involved parties and helps maintain the integrity of the family unit. 

Read more about Succession planning at GECA. If you need help with a family member succession process, feel free to get in touch with Giles on 0800 758 766.

The post Family Business Succession Planning appeared first on GECA Chartered Accountants.

Succession is a problem facing many New Zealand business owners and a common solution is to pass ownership to a son or daughter who is working in the business. However, while this solution may appeal for its simplicity and retention of business ownership within the family, it can come with a number of issues that need to be considered as part of the succession process. These issues include:

• Value of business versus value of other family assets such as property.
• Structure of a business sale to a family member and how to fund it.
• Timing and parity of distributions of assets from one generation to another.

If not dealt with appropriately, consequences can be serious including wealth erosion and damaged family relationships.

Example Situation

Consider the following situation which represents a typical New Zealand family owned business.

The father founded the business 15 years ago and is the sole Shareholder and Director. His son joined the business 8 years ago and has worked his way up to General Manager over that time.  The business currently has 20 staff, a $5m turnover and budgeted EBITof $1m.

The son would like to succeed his father owning the business and has asked his father what his plans are for exit and succession.

To answer this, the father worked with his business adviser to create a Succession Plan with the following objectives:

• Sale of the business within five years, achieving an exit value of $6m, being a $2.5m increase above its current $3.5m value.
• Confidence his son would be able to meet the requirements and responsibilities of being both owner and CEO.
• Maintaining amicable family relations and parity of distributions between the parents and siblings in the event the ownership did transfer to one child.
• Positioning the business for sale to a third party in the event the succession to the son did not work out.

These objectives ensures the parents will have funds available to meet their future lifestyle requirements, provide their son with a business succession opportunity and provide for an alternate exit pathway if required.

Ownership Transfer Transaction Structure

Once a decision has been made to pass on some or all of the ownership in the business to a family member, it is necessary to consider how to structure the transaction to meet the needs of the both the Owner and the Successor. Consideration needs to be given to the following:

• The percentage of ownership that will be transferred, the timing of this and if it will be way of instalments.
• The valuation of the business at the time of share transfers.
• Whether the shares will be paid for or gifted.

One of the biggest issues present in a succession to a family member is how to fund the transaction.

Often the shares are gifted to the child, however, this creates issues of fairness with other family members who may question why someone is receiving a valuable asset when they are not. To maintain equity and fairness, this approach is often recognised by way of inheritance offset so the value of shares gifted to the child working in the business is offset against the amount other family members receive from the inheritance pool at the time of the parents passing. Again, this approach does present issues, primarily around asset valuation. A business asset may increase or decrease at markedly different rates than a property asset investment and the final amounts received by beneficiaries may differ as a result.

Selling Shares

A better approach to the issue of share transfers to a new generation is sell the shares to the family member at an agreed value.

To do this the business is valued by an independent valuer and this is used as the basis of structuring an ownership transfer.

In this situation above, it was decided to sell the son a 50% shareholding over 4 years subject to meeting various performance hurdles including year on year profit increases to achieve the exit value required by the owner. The transaction was structured as a loan that allowed the son to buy the shares in tranches with loan repayments funded by offset against his dividend entitlements.

So far so good. However, the sale of the remaining 50% ownership stake became contentious when a value was placed on it. The son proposed he should buy the remaining 50% at the original value placed on the business at the time of original valuation. However this meant the capital gain of approximately $2.5m in the business value would go to the son at the expense of the other siblings as part of an inheritance pool.

The alternative approach of valuing the remaining 50% stake at the time of sale in five years’ time led to adverse outcomes in that it the de-motivated the son to increase the value of the business as he would then have to pay for half of it, even if he would ultimately recovered a third of this value back through his inheritance entitlement.

A third approach was considered which was for the father to hold on to the 50% stake and have this as part of the inheritance assets. However, this would have led to the same situation as above where the son would have to pay market value to buy shares of his siblings if he wanted to maintain full ownership. Keeping the siblings on as minority owners typically creates issues managing the business and should be avoided where possible.

So as you can see, succession to a family member may appear to be the easiest option to exit your business but has a number of issues that need to be addressed to ensure a successful ownership transition and maintaining amicable family relations.

The most successful ownership transitions benefit from the experience and skills of a trusted business adviser who understands your circumstances and the nuances of various family relationships.  If you need advice to plan your succession and exit, call Giles now on 0800 758 766.

The post How to structure Business Succession to a family member appeared first on GECA Chartered Accountants.

The Institute of Directors estimates 50% of businesses are family owned, but many of those are left adrift without the specialist support they need.

That’s what Giles Ellis set out to fix when he established GECA in 2012. He’s passionate about helping family business owners work through thorny issues and get the best possible outcomes for their businesses. Giles’ experience and background dovetail nicely to perfectly meet the needs of family businesses. With more than 20 years’ experience in the corporate sector and an extensive governance career, Giles also brings coaching and facilitation expertise to the table – something he sees as critical to helping family businesses succeed.

One of the few experts in the field, Giles has seen it all. He can point to the three most common reasons why family businesses run into trouble, and what they can do to resolve their issues.

1. No succession planning

For any business, a lack of succession planning can be problematic – with no clear direction for the business, decision making becomes ad hoc, which can mean missed opportunities or waste.

In a family business, complicated personal relationships can make succession planning even more crucial.

As the original owner of the business gets older, retirement may seem imminent, but owners often find it hard to let go of the business which has played such a huge part of their lives for so many years. This makes it difficult for the potential successor, who may already be working in the business, and is keen to take over and implement their own ideas.

Giles explains: “One of the challenges is that owners don’t want to confront leaving the business. So they put off that discussion, then end up in tense positions with offspring asking to see the succession pathway or they’ll leave the business.”

This is where external mediation can help. Using his coaching skills, Giles works with family-owned businesses as a coach and facilitator, initiating tough conversations and guiding discussions to make sure they’re fair and productive. After 25 years in the accounting business, he’s not afraid to ask the hard questions – how will succession planning work? When will the founder retire? Who will take over? How will shares be divided? Often, says Giles, clearing the air and setting expectations is all that’s needed to ease tensions and set a clear path forward for the business.

2. A lack of formal structure

One of the advantages of a family-owned business is that everyone involved truly cares about making it a success – they can be expected to pitch in, make sacrifices and go the extra mile. In the early days, this can be an incredible boost. Family businesses can work flexibly, make do with less and get up and running much faster.

As the business grows, this informality can begin to have a downside, as it allows for a mismatch in expectation – some family members may begin to resent their remuneration, the time they spend or that they have little say in the direction of the business. Others who don’t work in the business may feel they deserve a cut. Tempers flare, decision making stalls as stakeholder opinions are negotiated, and the business can grind to a halt.

The solution, says Giles, is to put a more formal corporate structure in place. That could mean establishing a board or engaging separate management, but most important is to clarify roles and business direction.

This doesn’t just help protect personal and professional relationships, it also supports the business’s growth. A formal structure in place allows for the checks and balances critical to business health and success, such as KPIs, targets and independent assessment of management performance. It also gives the original business owner the confidence to step out of the day-to-day, and use his or her experience to make smarter strategic plans.

3. No specialised external support

Family businesses face unique challenges – personal relationships can spill over into the business and business spills over into personal life, adding extra complexity – which many businesses aren’t equipped to deal with.

When considering issues like governance, accounting, goal setting and reporting, family businesses need extra, specialised support.

“It’s not just a matter of ticking boxes – you’re dealing with people’s lives and families. The stakes are higher and the emotions are stronger. Family businesses need professional support from people who care about more than just numbers,” says Giles.

For example, when working with family businesses, Giles often begins with a workshop to get clarity over issues, put strategies in place, and establish business best-practices. This format allows time and space to cater for any extra tensions. His role continues after the workshops, coaching businesses through 90-day action plans, and being on hand to help resolve issues along the way.

Helping family businesses thrive

With the right external support, family businesses have a real advantage – made up of people who truly care about the business, they can often work faster, smarter and make the most of opportunity.

If you’re running into difficulty in your family business, or have big plans for its future, talk to GECA and our family business expert, Giles Ellis. Together we’ll help make sure your business thrives while protecting your family harmony.

Read other articles about family business here

Learn how GECA helps owners of family businesses grow their profits and increase their wealth

The post Avoid the three biggest family business mistakes with a specialist adviser appeared first on GECA Chartered Accountants.

Passing your business on to the next generation is the dream of many family business owners, but it’s not always that simple. According to some studies, only around a third of all family businesses successfully transition from one generation to the next.

Succession planning is tricky for any business, but doubly so when it comes to your family business. You run into all the usual issues around finding the right person to run it, passing on skills, and transferring ownership, along with the emotions and conflicts that go hand in hand with running a business with family.

Conflicts and complications

Succession planning can be complicated by a number of factors. One potential issue is conflicting goals and values between family members or generations. Some family members may be focused on maximising the value of the business, while others might wish to maintain the status quo. As younger family members move to take over, conflict can arise with older family members who may wish to retire on income provided by the business.

Death or divorce can also cause problems, particularly if an owner passes stock and voting rights on to a spouse who was not involved with the business.

That’s why it’s a smart idea to think about succession planning early. Without the added stress of an illness, divorce, or parent wishing to retire, it’s easier to manage emotions and find solutions that work for everyone.

Here’s how to start thinking about succession planning for your family business:

1. Goal setting

If your business is to survive, you, your co-owners, and any potential successors need to have common goals and objectives. Talking about these goals is a good place to start.

Set goals around ownership of the business, financial compensation, and growth. Even if you start by talking about succession, you may decide that selling the business is the better option for everyone involved.

Even if your family business is well-run and your family relationships are stable, it may be a good idea to bring in a neutral mediator to help ensure goal setting is fair, disputes are resolved, and everyone gets input into decisions.  

2. Seeking successors

These days, people don’t simply hand their business on to their oldest son. Many elements factor into choosing a successor – including skills and talents, experience in the business, and whether or not any of your potential successors actually want to take over. If you have a number of interested, capable successors on your hands, you’re lucky in some ways, but dividing a business between several people can also be complicated.

You will also need to think about the difference between ownership and management. If your potential successors don’t have the skills or experience necessary to run the business, you may need to bring in a professional outside manager or CEO, while your child or children retain ownership.  

3. Planning the changeover

Timing and logistics are the next step. Are you planning to retire completely, or take a step back while staying involved in the business as a board member? How will this work? How long will the handover take? Every business has key information and core processes that need to be passed on – what are yours and where are they stored?

If you have essential information stored in your head, how will you transfer it to the new owner? If you have never done so, consider documenting your key processes and business knowledge before it’s too late – there are software programs to make this simple and efficient.

4. Transitions and taxes

Selling the business, or even simply transferring ownership within a family, isn’t straightforward. Options include outright purchase, a gift or bequest from one family member to another, or a combination of the two.

Whatever the transition plan, you will need to have the business valued accurately in order to create a fair sale and purchase agreement, minimise tax implications for the new owners, and make sure stock is transferred promptly.

A specialist accountant can help you navigate these issues and make sure everyone involved gets what they are owed.

If you’re ready to start thinking about succession planning, contact Giles Ellis – At GECA we’re family business accounting experts.

Learn how GECA helps owners of family businesses grow their profits and increase their wealth.

The post You Must Start Family Business Succession Planning Early appeared first on GECA Chartered Accountants.

It’s never easy to leave a business you’ve been running for years. Whether you’re retiring or moving on to new pastures, closing or selling a business can be technically complicated and emotionally fraught. If your exit or shutdown is unplanned, these issues become even more complex. So, if you’re anywhere near retirement age, it’s a good idea to start thinking about your business exit strategy – what will happen if you have to leave unexpectedly.

Accountants talk about ‘the four Ds’ of unplanned business exits – death, disability, divorce, and departure. These are not necessarily enjoyable to think about, but they are important. Without a solid exit strategy, they can all lead to an unwanted closure of a thriving business or loss of value when a business does close.

A business advisor specialising in succession planning such as an accountant can help you plan for expected and unexpected exits, giving you peace of mind as you head towards retirement.

Dealing with the 4 Ds

Your death, or the death of a business partner, is obviously difficult to plan for. But like a personal will, it’s essential. If you have a family member or co-owner who will take over, an exit strategy will make the transition easier. If the business will be sold or closed after your death, this needs to be planned as well.

Disability covers sickness or injury – and although the unexpected can happen at any stage, it’s particularly important to plan for as you get older. If you’re suddenly unable to run your business, do you have someone to take over? Do you know how much your business is worth so you can sell it quickly if you need to? Without an exit strategy, you could lose the value of your business when you need it most.

If you or your business partner decides to depart the business for personal reasons, you may be able to follow your standard retirement strategy without too many issues. Divorce is a bit more complicated. In the worst-case scenario, you may be forced to sell your business in order to pay your spouse. Alternatively, you could lose expertise and essential business knowledge if you and your spouse were co-owner/operators. Either way, planning ahead can help make a painful personal situation a bit less complicated.

Here’s where many business owners go wrong:

Variations in value

Most business owners think they know roughly what their business is worth – but these estimates are often inaccurate. Many owners judge the value of their business at around what they need for a comfortable retirement, rather than what’s realistic for the current market. When the business ends up being worth much less, they end up disappointed and underfunded when they do retire.

On the other hand, some owners underestimate what their business may be worth, then fail to get the best price when they decide to sell. This also leaves owners with less ready cash for retirement.

Using a business advisor specialising in succession helps you find out exactly what your business is worth before you leave. This information makes it easier to plan your exit strategy – you’ll have a good idea of how much you’ll be left with when you leave, and you can look at other ways to extract value if you’re disappointed with the estimate. If you are forced to leave unexpectedly, you’ll be ready to sell or close without losing potential value.

Other ways to extract value

When it comes to letting go of your business, shutting your doors may be your best option if you can’t sell or hand the reins to a family member. Even if closing is the best option, there may be ways to extract value from the business before you go.

For example, if you’ve been around for a few years, your customer base could be valuable to a similar business. If you simply close without trying to extract that value, you could lose out.

Again, this is where a good advisor comes in. They will be able to find ways to get as much value as possible out of your assets – including your customer base, properties, and physical equipment. Whether you’re retiring on your own terms or leaving for an unexpected reason, extra cash is always welcome.

Leaving it too late

Failing to plan for your exit is one of the most common mistakes business owners make. If you wait until you want to retire, or you’re forced to leave because of illness, divorce, or the death of a business partner, you could end selling or closing too quickly and losing potential value.

Don’t wait until you want out – plan ahead and you’re more likely to get what your business is worth. A specialist advisor or accountant can help you formulate a plan and estimate value ahead of time, so you’re not left empty handed, no matter what happens.

If you need help with growth and succession, then we can help. Get in touch now to find out more about how a GECA Adviser can help plan your successful business exit strategy.

Learn how GECA helps owners of family businesses grow their profits and increase their wealth.

The post Planning for the unexpected: Why you should create an exit strategy before you need it appeared first on GECA Chartered Accountants.