Overview

In Australia, some 97%¹ of all businesses are classified as family and privately owned. Together, these account for a combined wealth of around 4.3 trillion Australian dollars¹. Of these, a significant proportion will meet the Australian Bureau of Statistics’ definition of a ‘small business’ – that is, a business employing less than 20 people². As such, a considerable amount of wealth is tied up in small business.

However, whilst small business is in general currently very strong, one of the key concerns for this sector is the level of preparedness for succession planning that it has in place. A 2006 study by the Royal Melbourne Institute of Technology (or RMIT University), found that 81% of the owners and operators of family businesses (and the majority of these would meet the Australian Bureau of Statistics' definition of a small business) plan to retire over the next ten years¹.

Of further concern from the RMIT University’s 2006 study, is that when it comes to business succession planning, 80.3% of the current CEOs of these family businesses have not documented management succession plans; 75.2% have not documented ownership succession plans, and 65.1% indicate that the family has not agreed upon the succession plans and succession of the next CEO¹.

In recognition of the issues that will arise over the next two decades when the owners of these small and family operated businesses succeed out of their business, AusIndustry, the Australian Government’s agency for delivering products, services and information, which support industry, research and innovation³, have, in conjunction with Ernst & Young, developed a Succession Planning process. The aim of this process is to:

‘Assist small business owners to develop strategies to exit their businesses in a manner that realises maximum value and marketability of their business while ensuring business continuity’.

Along with assisting owners as mentioned above, by following the process, the skills of small business owners and their advisers will be enhanced in the key areas of changing leadership, retirement funding and maximising the saleability of the business, along with obtaining an awareness of key skills that will underpin the entire succession planning process – such as risk, project and stakeholder management.

This process and the key topics that make up each stage in the process will be discussed in more detail later in this Overview under the heading ‘The Succession Planning Process’.

For now, let us go back to the beginning to establish what succession planning actually is, and why it is necessary to have a succession plan in place.

What is succession planning?

In broad terms, succession planning relates to the planning process undertaken by a business owner or leader to determine the best means of exit from ownership and/or leadership of the business, and which also ensures the continuity of the business.The Succession Plan is the formal document that should arise as a result of working through the various steps involved in the succession planning process. The Succession Plan should set out all the key elements that were considered and decided in the planning processes.

Whilst the general concept of succession planning has continually evolved over the past few years, a consistent and approved definition as to what is Succession Planning has yet to be formulated and agreed upon. Some of the many reasons as to why succession planning has not had a formalised definition include:

The fact that it covers so many different topics and subtopics makes it difficult to be given an all-encompassing definition;
The fact that whilst it should be all-encompassing, certain parts of the process have been defined by many organisations as ‘Succession Planning’ in their own right, limiting a more universal definition to be reached; and
The fact that the very term ‘Succession Planning’ itself is not a universal term, and is indeed known by many other names such as ‘Transition Planning’ and ‘Generation Planning’.

For the purpose of this Succession Planning Knowledge Base, the definition that we have adopted is the one which we believe fits best within the overall process and the key topics that will be covered as part of the process. Our definition is as follows:

‘Succession Planning is the process undertaken to ensure the continuity of the business into the future, regardless as to who is the owner and/or strategic and operational management of the entity.’

With succession planning now defined, it is necessary to now consider why a succession plan should be put in place. This is covered in the following section.

Why have a succession plan in place?

As can be seen above, the definition of succession planning refers to the process to ensure continuity of the business. Whilst most people presume succession (of either ownership or leadership within the business) occurs when the current owner or leader retires, retirement is just one of many events that can trigger succession.

For instance, what would happen in the event an owner and leader of a business suddenly died? Would the business still be able to survive? More to the point, would the value of the business to the owner’s estate be lost if an appropriate succession plan has not been put in place?

In general, succession planning is needed for both planned and unplanned succession. Planned succession is something that an owner is able to plan in advance for. The two main examples of this type of succession are retirement and sale of the business. Unplanned succession refers to situations where succession occurs generally as a result of unpreventable circumstances. The three main examples of this type of succession are death, total permanent disability or incapacity. Such circumstances may include bankruptcy, physical or mental disablement.

A good succession plan will encompass both planned components of succession, such as when the owner intends to exit the business, and how – along with appropriate estate planning and replacement leadership strategies should unplanned succession occur. By having the succession plan cover these points, the chances for continuity of the business would greatly improve than where no succession plan has been put in place. After all, a death can quickly reduce the likelihood for continuity in the business, especially when there is nobody capable of assuming leadership and running the day-to-day affairs of the business.

With succession planning defined and why a succession plan should be in place, it is important to now discuss the succession planning process that should be undertaken to ensure that an effective succession plan is developed.

The succession planning process

Whilst succession planning comprises many distinct and differing topics, a logical process can be utilised to ensure that the majority of key topics that should be considered in a succession plan are covered at the appropriate time.

The following diagram sets out what we have developed and what we believe could be considered to be a logical process that can be applied to succession planning activities:

As can be seen, the process starts off with an evaluation of the current position and ends with the owner being ready for succession – whenever that time may occur.

The top of the process diagram might be considered the ‘core’ process. This represents the areas and key topics that will fundamentally make up the succession plan. Underlying the key process is the category ‘Managing Your Succession Plan’, which consists of major considerations of risk, project and stakeholder management. This category must always be monitored and updated as the succession planning progresses to ensure that the succession planning process is not compromised at any stage, as this may alter the outcome of the succession.

For each stage in the process diagram shown above, key topics are given that should be considered during that stage. For each key topic identified under a stage in the process, a number of key issues which might also arise are given. These should be addressed to ensure that the succession plan developed as a result of this process is both comprehensive and relevant.

We will now look at each of the key stages identified in the process diagram and provide a brief overview as to key sub-topics and issues which will later be covered in more detail in this workbook.

1. Evaluate Your Position

This is the primary stage of the process where the current position is evaluated. This is not only in terms of the business’ goals and objectives, including its present financial performance/ position and forecast future financial performance/position, but also addresses where the owner and leader are personally at that point in time.

The final key component to this stage is identifying the level of preparedness of both the business and the owner for succession. Whilst no key topics have been identified at this point, a financial adviser should be able to assist with an evaluation of the business’ current financial position.

A self-assessment as to the current position of the business and the owner personally, will need to be performed by the individual undertaking the planning process.

To assist with determining the preparedness for succession planning, we have developed a Succession Planning Self Assessment tool, which is available on line at the SBSP home page and then by clicking the Assessment Tool link..

2. Set Your Goals

After evaluating the current position, the next stage in the process is for goals to be set by the owner of the small business. The key topic in this section and the various issues that make up this topic are as follows:

Owner’s goal setting
- Personal goal setting
  - Lifestyle / life balance
  - Risk profile
  - Family Agenda
  - Timetable
- Financial goal setting
  - What is a financial plan
  - Role of financial planners
  - Personal insurance
  - Government incentives
  - Personal holdings structures (including business ownership)
  - Tax planning
  - Superannuation & Retirement (see the ‘Funding Your Retirement’ stage in the process)
- Business’ goal setting

3. Plan Your Strategy

As a follow on to the goal setting stage in the process, the third stage relates to the key decision that the owner must make. This decision is the ‘Succession Strategy.’ As succession can take two different streams, the owner must choose which is the most appropriate for their situation. These two different streams are:

Changing Leadership (or management) whilst still maintaining their ownership, or
Exiting from Ownership.

With changing leadership, certain factors would need to be addressed which impact upon business continuity whilst the owner is not running the business on a day-to-day basis and protecting their investment. The key considerations for this stream will be discussed in the stage of the process below that deals with ‘Changing Leadership’.

By succeeding from ownership, there is a presumed change in leadership, and as such, some of the considerations that will be discussed in this stage will focus more on transactional management issues. The key considerations for this stream will be discussed in the ‘Exiting from Ownership’ stage of the process below.

It is possible for owners to decide in favour of parts of both these strategies: that is, succeed partly from ownership and partly from leadership roles. Whilst this is not specifically covered as a separate option in this Knowledge Base, the key topics and issues identified under both streams would still be relevant, and therefore the succession plan should incorporate the considerations given to key topics and issues identified under both streams.

The key topic in this section and the various issues that make up this topic are as follows:

Succession strategy
Changing Leadership or Exiting from Ownership as an exit strategy
Other people’s views
Assessment against goals decided in the ‘Setting Your Goals’ stage of the process
Vision (for the business and the individual)
Financial considerations
Stakeholder reactions (employees, suppliers, customers)
Timeframe available
Owner’s ongoing involvement
Management capabilities.

4. Changing Leadership

Should a decision be made under the succession strategy stage of the process to exit from the leadership role but not the ownership, then the key topics relate to how the owner will protect their investment and ensure the continuity of the business without needing to be present to run the business on a day-to-day basis.

As such, it becomes necessary to examine the elements that ensure business continuity. That is, it is necessary to examine and ensure the right people and that the policies, processes and systems that make up the business are in place prior to succeeding from leadership of the business.

There are five key topics in this section, with various issues making up each of them. These are:

Who Leadership Should Ascend To
- Internal (employees), external (new management) or family (leadership ascends to relative)
- Ongoing mentoring requirements
- Availability of suitable candidates
- Cost.

Key People to the Business
- Customer management
- Supplier management
- Employee management
  - Retention strategies
  - Recruitment strategies
  - Remuneration strategies
  - Mentoring/training strategies.

Finance & Working Capital
- Debt vs Equity
- Debt factoring
- Cost of debt
- Cash flow.

Policies, Processes & Systems
- Computer systems
- Human Resources Processes & Policies
- Accounts Payable/receivable processes
- Purchasing/dispatch processes.

Structure Documents for Continuity
- Partnership Agreement
- Trust Deed
- Shareholder Agreement
- Contracts (customer & supplier).

5. Exiting From Ownership

Should a decision be made under the succession strategy stage of the process to exit from ownership, then the key topics relate to how the owner will manage the transactional process to ensure it gets the best possible financial outcome upon succession.

As such, it becomes necessary to examine all the elements that impact upon selling the business and maximising its sale price.

There are five key topics in this section, with various issues making up each of them. These are:

Methodologies
Management buy-out
Trade sale (assets vs business)
Employee ownership
Community buy-out
Merger.

Business Valuation
What methods there are
Who advises on business valuations
Factors impacting valuations (risk profile, assets liquidity, IRR, owner’s ongoing role)
Profitability
Growth expectations
Maintaining revenue and cash flow streams
Due Diligence process (what is it/does it do; what is involved; who advises on it).

Locating Investors & Marketing the Business
How to find investors
How to market the business
Who advises on these areas
Information Memorandum (what it is and what it does, what is involved, and who advises on it).

Taxation Consequences of Ownership Exit
Small Business Rollover concessions
Capital Gains Tax implications
Structural implications (i.e. trust and company have different taxation implications).

Finance & Working Capital
Debt vs Equity
Debt factoring
Cost of debt
Cash flow.

Note: This is a duplicate topic and will be covered only once in the ‘Changing Leadership’ section.

6. Funding Your Retirement

Regardless of whether the succession strategy chosen is to change leadership or exit from the ownership, retirement funding is a major succession planning topic that must also be considered. Without considering this stage of the process in-depth, it is unlikely that many of the goals set in the first part of the succession planning process will be achieved.

In this stage, the key topic and the various issues that make up this topic are:

Superannuation & Retirement
- Benefit Withdrawal:
  - When to commence withdrawals
  - Lump sum payouts
  - Pension payouts
  - Combination of lump sum and pension payouts
- Fund Considerations:
  - Type (self managed, master trust or corporate)
  - Risk profile (investments selected)
  - Management fees payable
  - Death benefit nomination
- Contributions Considerations:
  - Amount and timing
  - Type (undeducted, deducted etc)
  - Spousal considerations (super splitting)
  - Transferring contributions
- Taxation Considerations:
  - Retirement tax concessions
  - Taxation of beneficiaries
  - Small business tax rollovers.

7. Managing Your Succession Plan

Underpinning the whole Succession Planning process are three key management considerations that must be reviewed and updated appropriately as the plan progresses to ensure that the succession planning process is not compromised at any stage, as this may in turn alter the succession outcome. These three key management considerations are:

Risk Management;
Project Management; and
Stakeholder Management.

Risk Management

The first underlying management item is Risk. Part of risk management deals with the risk of unplanned events occurring, such as death. Other concepts relevant to risk management relate to general risk management issues that may be identified as the process progresses.

In this stage, the two key topics and the various issues that make up each of them are:

Estate Planning
Personal Wills
Power of attorney
Testamentary trusts
Death benefit nomination
Structuring
Loan accounts
Executors.

Risk Management
Level of risk (acceptable, monitoring required, urgent attention required)
Risk identification
Risk prevention strategies
Risk management strategies
Risk registers.

Project Management

The second of the three management considerations that underpin the whole succession planning process is Project Management. Project management deals with establishing appropriate timeframes, documentation and the key skills of project management in general.

In this stage, the three key topics and the various issues that make up each topic are as follows:

Timeframes
When the exit plan will commence
When each step in the process should be achieved
When the plan should be completed.

Documentation of a Succession Plan
Why have a succession plan
What is included in a written succession plan
Who should assist in writing the document.

Project Management
Key succession planning team
Delegation of responsibility, authority and influence
Monitoring progress (Work Breakdown Structure & GANTT Chart tools)
Closing out of Succession Planning Project.

Stakeholder Management

The final management consideration that underpins the whole Succession Planning process is Stakeholder Management. A failure to appropriately identify and communicate with stakeholders can have a disastrous impact on any project. Succession planning is no different. If the stakeholders are not communicated with properly, the goals set at the start of the succession planning process and the desired succession outcomes, may not be reached.

In this stage, the key topic and the various issues it comprises are:

Stakeholder Identification, Communication & Management
- Stakeholder Identification, including:
  - Owners
  - Management and employees
  - Key customers and suppliers
  - Potential new leaders/owners
- Stakeholder Communication & Management, including:
  - What information needs to be communicated
  - Methods of stakeholder communication
  - Timing and regularity of communication
  - Dissent management strategies.

8. Ready For Succession

This is the final phase in the succession planning process. By this time, , the Succession Plan will have been completed. The owner will now either be in the process of implementing the Plan, have it in readiness for future implementation, or will already have begun putting it into practice.

There are no key topics that have been identified for this stage of the process, as it is up to the owner to determine when they should implement the plan that has been devised as part of the succession planning process to succeed from the business.

The Worked Example and contact points about succession planning

Following this Overview is background information for the Worked Examples which are used throughout this Knowledge Base. Time should be taken to read this background information to become familiarised with the underlying circumstances that will assist the understanding of each of the key topics in the succession planning process follow directly after. This background information is used in all worked examples except for the Topics ‘Structure Documents for Continuity’ and ‘Estate Planning’ where separate legal examples are used to enhance the topic understanding.

On behalf of AusIndustry and Ernst & Young, we hope that this Succession Planning Knowledge Base is of benefit, and helps to raise awareness and understanding amongst owners of small business of the many key topics and issues they need to consider when planning succession from their business.

Should advice be needed on succession planning and its impact upon business, please contact an adviser. Alternatively, the advisers listed in the Advisor Directory have registered their businesses as being able to assist with succession planning queries.

If there are any queries with regard to the Knowledge Base or the website please, consult the website at: www.sbsp.com.au,in first instance, or alternatively, send an email to the administrator at sbsp.administrator@au.ey.com and he will forward any queries to the appropriate contact person who will endeavour to respond within one business week.

Yours Sincerely

AusIndustry Ernst & Young

Signed in Perth, Western Australia, August 2007.