OVERVIEW

Succession planning by business owners is tremendously neglected, and this can be extremely costly. Why do business owners so often neglect this important area? I can think of 2 main reasons. First, most business owners are so busy that they simply don’t have time (or think they don't). The second reason is that they probably don't realize how important it is. When your business is hurting because of a cyclical downturn, that's not a good time. When you have unexpected health issues, that’s not a good time either. And when you dead and buried, and your widow or partners have to deal with it, that's a really bad time. The best time to plan for succession is when your business is booming and your health is good.

Let's consider first of all the potential groups that can form part of business succession planning. Possible successors to your business are:

Family
Management
External buyers or investors

Finding someone to take over your business can be a problem: family members may not be interested or may be unsuitable, management may not have enough capital or may not be interested and external buyers may be hard to find, may not have enough capital or they drive too hard a bargain.

You should commence succession planning 2 or more years prior to potential ownership succession. Professional advice is a must to avoid costly mistakes. You need financial, accounting, legal and tax advice. Having access to the right advice can help you increase shareholder value, increase the price you receive, improve the terms of the deal, and minimize taxes. Ideally, you need someone to act as quarterback to the entire process, integrating the advice from accountants, lawyers and financial advisors (that's where I come in).

There are a number of factors to be considered as part of each succession plan:

Complexity: In terms of complexity, family succession deals are the simplest, management succession deals are in the middle, and external buyer deals are the most complex. External buyers are generally going to want to do a lot more due diligence and their interests in terms of deal structure and tax issues are going to be the most divergent from yours.
Time requirements: For external buyers, the time requirements are greater while for family buyers, the time requirements are the shortest, with management buyers somewhere in the middle. Even if you have no immediate plans to sell or pass on your business, planning now makes sense because changing circumstances, like a sudden health issue, may force your hand.
Cost: In line with the complexity of each deal, external buyer deals will have the highest legal and accounting costs while family succession deals generally will have the lowest costs.
Risk: The risk of deal failure (failure to close) is higher with external buyers. There is also a higher risk of breach of confidential information with external buyers so this process must be managed carefully.
Deal structure or terms: This is an important component of any deal and must not be neglected. Generally family successions will have the most favourable terms and deal structure, while external buyers, who have the most divergent interests from yours, will have the least favourable terms and structure.
Valuation and pricing: The right external buyer can result in the best price for your company. For example, if the external is a competitor, the advantages to them of reducing competition or acquiring a customer base may result in a higher price for your company. Favourable factors like that are less likely for a family or management buyout.
Tax efficiency: Because you are dealing with family members with similar interests, family succession deals can be structured very tax efficiently. External buyers on the other hand will have very different views on the tax situation. A good example of this is that external buyers will often prefer to buy assets rather than a corporation because of both tax advantages and elimination of contingent liabilities.

In the end, all deals involve trade-offs between competing factors, and you will seldom get everything you want in a deal.