Succession planning: The funding conundrum

13 July 2021

Start with the end in mind. All business owners should have an idea on what their exit strategy is, even if they have only recently commenced in business. Working towards a business goal that fits in with your personal life plan helps with your decision making along the way.

There are generally four options regarding succession planning:

  1. Sell the business as a going concern.
  2. Sell 100 percent of the shares in the business (assuming it is a company).
  3. Sell some of the shares in the company
  4. Close the doors and sell down the assets piecemeal.

Option four is usually the least palatable as it involves selling stock, plant and equipment at fire-sale values and there is no recognition for any business Goodwill. However, even the first, second and third options can result in no Goodwill being recognised.

A business valuation will help indicate whether any Goodwill exists but ultimately it will be determined by a transaction between a willing buyer and willing seller.

An important consideration for any succession plan is how to fund the transfer. A going concern sale will usually involve the purchaser’s bank but depending on security and the bank’s appetite to lend, it may not cover the full purchase price. Borrowing from family or vendor finance are other options to consider.

For vendors who accept a loan as part settlement, it is important to seek legal advice. Care needs to be taken with regards to the terms and conditions of the loan, including repayment terms, interest rate, security, and default mechanisms.

A common succession planning strategy for companies is the gradual sell down of shares to employees who have demonstrated the skills and aptitude to move into managerial and ownership roles. These employees have generally worked in the business for a reasonable length of time and have a good understanding of the business.

This strategy helps with a smooth transition, especially for customers. However, it may take up to five years for the full handover to occur, depending on affordability.

Additionally, younger employees may not have the financial means to purchase the initial tranche of shares. In those situations, it’s not uncommon for the selling shareholder to lend some or all of the money to the purchasing shareholder to make the deal happen. The loan should be documented and it’s wise to seek legal advice and consider any tax implications. Repayments can be made via any dividends the new shareholder may receive.

With the amount of complexity involved with succession planning, it’s important to get professional advice. For assistance, get in touch with the Findex Accounting and Business Advisory team or find an adviser in your region.