Succession PlanningThe launching pad for advice

Some business statistics to consider…

• 2.7 million small businesses of which 70% family

• Average age of family business owners is 55

• Just under half of these business owners see themselves working in the business past 65

• 1/3rd of all family businesses passed to next generation successfully

• 20% take succession planning seriously

• 15% have documented Buy Sell Agreements

Sources:1 Treasurer Wayne Swan’s Federal Budget speech – 10 May 20112 KPMG and Family Business Australia Survey of the Next Generation of Family Business 20103 The MGI Australian Family and Private Business Survey 2010

Our Recent Experience Issues of Concern for Business Owners

• Not ending up in business with their business partner’s spouse if anything should happen to their business

partner

• Personal assets at risk for business debt

• Extracting full value from their “considerable personal investment – money, time and intellectual capital ”

• One child in the business and another with an independent career

• Business to child AND income for retirement?

• Staying too long – planning needed for life after business

• Shareholders• Unitholders• Partnership

– govern behaviour between unit holders, shareholders, partners – ie: “horizontal relationship”

– company constitutions, trust deeds: deal mainly with director/ trustee duties, powers and “vertical relationship”

• “Business Bible” – tailored to the business

Business owners agreements

Agreement

Exits

• Unfunded exits– Retirement– Resignation– Forced exits– Disputes

• Funded exits– Death– TPD– Trauma

BUSINESS OWNERS AGREEMENT

BUY SELL AGREEMENT

Funding mechanisms:-Vendor financeSale

Funding mechanisms:-Vendor financeInsurance

Ideally separate, either may deal with debt/ personal guarantees

Protection needs of different businesses

Asset ProtectionHigh debt to equityOwners may have: -

Given the bank personal guaranteesLoaned seed capital

Revenue ProtectionRevenue patternsGoodwill and turnover growingKey person dependence

Ownership protectionHigher equity, succession issuesLess key person dependenceShareholder/ beneficiary loan accounts

New business Established business Mature business

Case Studies(on a whiteboard)

Beneficiary Loan Accounts

SOLUTION: Asset protection insurance could have paid the loan back AND ensured that the sons ended up with ownership of the business and “real” control.

CASE STUDY #4Dad ran his business via a family trust with his 2 sons. Mum did not work in the business and had no income. As a result, most profits were distributed to her to help lower tax overall. As most of the profits were ploughed back into the business and the distributions were owed to Mum.

Unfortunately Mum died age 70. This was after decades of the business operating profitably. A few years later, Dad (71) re-married a lady who was 53. Her sons (aged in their 40s, now with young families of their own) did not get along with their new Step-mum

The lawyer advised him to put his house in joint names with his wife and to nominate her as beneficiary of his super. Additionally his wife would be executor/ beneficiary of his relatively small estate. The trust deed deed was amended so his sons would become trustees/ appointers of the trust on his death and therefore control the $2.5M business

A few years later, Dad died and the home and super went to the wife, whilst legal control of the business went to his sons. However, during probate the wife’s accountant discovered loan’s owing to her estate of $1.5M, comprising loans to the Son’s late mother (inherited by Dad on her death and Dad’s own loan account)

This effectively meant that real control of the business ended up in Wife #2’s hands, contrary to Dad’s wishes.

Dad Son Y

Business

Son XWife #2

Family Trust

Appointed Trustee

Beneficiary Loan Account

FAQ: Why a Beneficiary Loan Account? A trust must distribute its earnings. If it retains them, it is taxed at 46.5%. If they are distributed then beneficiaries are taxed at their Marginal Tax Rate (MTR). Beneficiaries can defer the receipt of “cash” to retain money in the business, thereby creating a Beneficiary Loan Account.

Dad realised he had succession issues and saw a lawyer to get his affairs in order. In the event he died, he wanted his wife to get the house and super and his sons to take control of his business.

Sam and Dave had grown up together, their families knew each other and they owned a car dealership together. Dave’s kids referred to his business partner as “Uncle Sam” and vice versa. They were advised to put a buy/sell agreement in place but rejected this advice because they were mates.

They had a handshake agreement that, in the event of either of their deaths, they would continue to look after each other’s families and pay the deceased’s salary to the deceased’s wife. She would inherit Dave’s shares.Some years later Dave died. Sam

continued to pay Dave’s salary to his wife, as promised.

This continued for 5 years, at which point Dave’s wife passed away.

Dave’s share of the business passed to Dave’s three daughters through his wife’s Estate. They had no interest in being in the business with Sam and were looking to be bought out, which suited Sam.

Sam informed Dave’s children that he and Dave had verbally agreed that each partner’s share in the business was worth $1.5m.

After an independent valuation during probate, Dave’s children informed Sam that they will sell their share to him for $2.5m.

Hostility between the two parties ensues. Sam points out that he can’t afford $2.5m without mortgaging all his assets.

Dave’s children appoint an independent director who informs Sam that his salary is too high and that this was a breach of his director’s duties, threatening to take it up with ASIC.

The independent director also threatens to report Sam to the ATO for falsifying statutory returns as he has paid Dave’s wife’s salary for 5 years, stating that she was an employee when in reality she never worked in the business.

In the end after costly legal negotiations, Sam paid Dave’s children $2.2m for their share of the business and all legal fees.

Mates who “don’t need a

buy/sell”

SOLUTION: Documented Buy/Sell agreement and adequate Ownership Protection

CASE STUDY #1

Sam Dave

Dave’s Wife

Dave’s Children

Continues to pay Dave’s salary

Car dealership

and block of land

Mum and Dad have built up a farm over decades. Their only son has worked in the farm for 20 years. Their 2 daughters have built successful independent careers for themselves

SonI have worked like a dog growing this farm for the past 18 years for pay that hasn’t reflected the hours I have worked. I now have my own family to think of, so my parents should handover the reins now. I believe I’m entitled to the whole farm plus one-third of the other assets when my parents pass away.

DaughtersWe have worked hard to build our own careers, if only we could have a free ride like our brother. We believe it is our right to each get one-third of the farm and one-third of mum and dad’s assets.

A number of issues can arise. Let’s look at them from each person’s perspective:

Mum & DadWhat if we pass the farm on now- before our death? Our farm provides us an income – what will we live on? It will better for us to pass it on at death as there will be no CGT.

Some other things to considerWhat if Mum was Dad’s second wife?What if one of the daughters was a step child?

Problems With Family

BusinessMum and Dad have non farm assets of $2million while their farm is worth $2million.

Daughter 1- 38 y/o

Daughter 2- 35 y/o

Independent Careers

Other assets $2m

Mum Dad

Works on the farm

Son 40 y/o

Family farm $2m

– Adviser: identifies and covers funded trigger events, assesses policy ownership for estate and tax

issues, identifies personal and business objectives, briefs and facilitate legal firm, ensures your

personal estate links to business insurance plan

– Accountant: knows you and your business extremely well, usually knows about any family issues,

knows your business structures and asset & debt positions, manages taxation implications,

values the business, briefs the adviser, helps manage funded succession & restructuring.

– Lawyer: prepares shareholders agreements, buy/sell agreements, estate and trust

documentation. Liaises with accountant and adviser. Identifies any additional estate risks in the

business structure.

Critical Factors for SuccessThree parties working together for a complete solution

Step 1 – Clarify your succession objectives

Understand why succession planning is important

Understand your business succession objectives

Understand the impact of your business succession objectives on your personal lifestyle

Document your business succession objectives

Identify key people in your business and the financial impact they have on the business

Step 2 – Formulate your strategy

Gathering Data

Discuss and confirm business structures, accounts and existing business valuations with your accountant

Identify any existing legal agreements

Embark on preliminary discussions with a solicitor to discuss the scope of work (if complex entities exist)

Document strategy in a Statement of Advice

Step 1 Clarify your succession objectives

Step 2Formulating your strategy

Step 3Implement your strategy for unplanned events and exits

Step 4Your personal succession planning

Step 5A facilitated meeting with your accountant and solicitor

Business Succession ProcessStep 6Your strategy review