Do you have a succession plan in place for your business? No matter what size of a company you run, a succession plan is one of the most important factors in ensuring its long-term success.
“It’s the foundation for what will happen to the business in the event of a life changing illness or disability, or in the event of the death of the business owner,” Tom Castonguay, certified financial planner, Shelter Bay Financial Corp., explains of succession planning. “Most entrepreneurs want to focus on building their businesses and working towards financial freedom, but without a succession plan, all their hard work and equity can disappear in an instant.”
“The foundation of a succession plan is the insurance to create cash when it’s needed most—in the event of disability, critical illness, or death,” Castonguay adds. “Most small business owners are instrumental to their business’ daily operations, and if they are not able to work, they’ll need cash to hire replacement staff. When an owner dies, their family or business partners will need cash to continue the business, deal with creditors, buy out the deceased’s shares—and to replace lost talent, productivity, and revenue.
“At the most basic level, a succession plan includes life, critical illness, and disability insurance. For multi-owner businesses, a buy/sell agreement is an absolute must, and it must be signed. An agreement spells out what will happen in certain conditions, such as the death, disability, or retirement of a shareholder. Will the remaining shareholders have the first right to buy out the shares, or will they be stuck with a new partner they didn’t foresee, like a spouse, the child of a deceased owner, or someone that bought the retiring owner’s shares? In the case of the deceased or disabled owner, how will the remaining shareholders buy out the shares, and what will the formula be to calculate the fair value? How will lenders feel about your business if a key shareholder is no longer involved – will it limit the remaining shareholders’ ability to borrow? Whether a company has a single owner or multiple shareholders, a company can quickly be destroyed if a key stakeholder dies.”
Castonguay notes, “There are strategies that manage these risks as a business grows, and those strategies transform into longer term tax planning and wealth building solutions. Even if a business has only seen moderate success, owners can use corporate revenue to create wealth beyond the value of the business for themselves and their family. These strategies guarantee financial success, no matter how the business does.”
“The biggest risk of not doing proper succession planning is that it can instantly and dramatically diminish the value the business,” Heather Barnhouse, partner, Dentons, agrees. “For business owners, often the most valuable asset they own is their business, and failing to plan for succession inevitably is a plan for the business to fail.”
“Many businesses cannot survive an unexpected or unplanned crisis event,” Barnhouse explains. “It can be argued that the inherent value of a business lies in its ability to continue to operate and generate revenue, and without a succession plan, the very viability of the business is threatened.
“Since death (but also other trigger events like disability) are often unplanned, the unexpected occurrence can seriously impede the ability to derive value from the asset (being the business) of the owner. Not only is the business, in many cases, reeling from the sudden unexpected loss of a founder or owner, but the death of an owner and shareholder also has certain tax consequences for the company, and for the owner’s estate. The death of an individual causes a deemed disposition of all of the assets owned by the individual, including the shares that individual owns in the company. If the company is very valuable, the tax bill can be significant and, without careful planning, can be devastating for the estate to pay.”
“The good and bad news,” Barnhouse adds, “is that succession plans are very customized. There is no ‘one size fits all’ because every business is unique. A good succession plan is customized to the particular owner and circumstances of the business, and it must also be reviewed from time to time to ensure that it is still appropriate as the market and industry evolve and mature, as economic conditions wax and wane, and as the regulatory environment (including the tax regime) changes.”
“It’s never too early to think about the next steps for the business and implement a plan for succession planning,” Barnhouse recommends, “even if that plan is modified or refined before it is ultimately implemented.”
Finances, however, aren’t the only factor to consider when it comes to business succession planning.
“In modern terms, we tend to now use the words ‘transition planning’ as we work with families and their advisors to provide communication and governance on the transformational side of the operation versus the transactional,” says Shauna Feth, FEA, executive director, Alberta Business Family Institute, University of Alberta School of Business. “The reason this is so important is because family enterprises are faced with very complicated interpersonal dynamics and are applying complex strategies to ensure the best possible outcomes for the family, business, and shareholders are achieved.”
“Transition plans are very complex and take years to complete, and even once complete, they need to be revisited on a consistent and ongoing basis,” Feth adds. “The result of a plan is not necessarily the end game; it is all of the two-way communication that takes place prior. Essentially, we need to support the family as they advance through a governance process that is systemically built on the three circle model of family business (Taigiuri & Davis). This systemic approach supports the family in setting up family meetings/councils, the business in establishing an advisory board, and the shareholders in developing a shareholders’ assembly.”
“The outcome of all of these governance structures is to find alignment on what the plan should look like,” Feth observes. That plan could include “Code of conduct; family values, vision, mission, family employment policies; family remuneration policies; etc. All of these then roll into the final plan.”
“We are currently facing a trillion plus transitions of assets in the family enterprise space in the next five to 10 years, and yet there are shockingly low numbers reported in terms of how many of these businesses are formally working toward the transition plan. We have seen it time and again in Canada: I could name many very public examples of what happens when the family does not communicate effectively and both the business and the family end up devastated and in litigation. That is an extreme example, but if business families don’t actively think about managing all of the individuals in the system, any number of negative impacts will result. We often hear of family members not talking to each other for years, not attending traditional family functions, etc., and in the end, if the business is still viable and running, but the family is sacrificed, we have to ask ourselves if it is a win.”
Feth concludes, “I urge business owners to do some research, find resources like our centre, and to search out advisors that have a specific interest in supporting the family as much as the business.”