Jun 17

A practical guide to succession planning for family-owned businesses…

Right before our website and blog were hacked, we were on the case of why we thought Manchester United’s succession planning strategy is bad for business in an article written by our Engagement Director.

After reading that article, I am then moved to ask;

What then is a good succession planning strategy and more so, for family owned business?

Succession-PlanningA case for succession planning for family businesses should never be underestimated. It is worth knowing that a family business is the oldest and most common model of economic organization.

The majority of businesses not only in Uganda but throughout the world that range from groceries to the large multinational organizations can be considered family businesses.

When we take a look at the private sector in Uganda, one will realise that they are either run by the founders or their children, but with high controls from their parents, irrespective of age. The fact that we do not have many businesses that have stood the test of time (of course with the few exceptions especially some with Asian descent), is a clear sign of poor succession planning in many if not most family owned businesses. We must therefore understand that succession is the greatest long-term challenge that most family owned businesses face. Taking an example of the once flourishing business like Zzimwe Construction Ltd which was battling debts with its financiers and suppliers a few months after the demise of the founder is an exemplary case of poor succession planning.

Unfortunately, it is only a few cases that will come out strongly in the media as several other thousands of businesses just get swept under the carpet. On the other hand, one may talk of the Mulwana family that has seamlessly transitioned to the next generation. The other Ugandan cases include the Mehta and Madhvani Groups that have existed for years and now have their third generation taking up key positions of leadership and responsibility.

Thus, the owner’s/ owners’ willingness to plan for their succession (both ownership and management) is often the key determining factor whether their business survives or not. Psychological, cultural and social factors often pile up the pressure against passing on the business to the next generation.

From the “lack of trust” to “nobody will manage the business as i have done” to “the business being killed by a successor” and “reluctance to let-go of power of the businesses they founded”, or even “the worries to be seen to favour some children over others” are just a few examples of the complex forces encouraging the avoidance of succession planning.

Overcoming these obstacles and striking a balance between the different interests of owners, the business itself and the family, requires a well-structured and systematic approach towards succession planning. Transitions must pass through these five distinct stages, all of which need careful planning and management.

This guide therefore, identifies the key issues that need to be considered to prepare a succession plan which balances your needs with those of your family, other shareholders if any and the business for a smooth transition. It is very important to note that succession planning covers two basic matters; i.e. ownership and management. They are strongly interlinked but do need separate consideration.

ONE

A major misconception about succession planning in family owned business is an assumption that the owners’ children shall come and manage the business to progress to the next level. The first step then to succession planning is establishing the goals and objectives of the plan. It involves ascertaining the present situation and current constraints, observing the reality of the current and desired situation and making realistic recommendations by the business owner, family and the business.

The objectives may include;

  • The family continuing to own and manage the business.
  • Continuing family ownership with outside management.
  • Selling the business to key executives, employees, competitors or other outsiders.
  • Re-organising the business to sell part and retain part.
  • Winding up and liquidating the business to make investments.

TWO

The second stage of a family business succession plan involves the financial needs of the owner and his or her spouse. Many family business owners are usually “cash poor” but “rich on paper,” and are dependent on the business to provide for their retirement in a lifestyle to which they have become accustomed. Some owners may want to start a “new” life in retirement and branch out and (finally) do those things they have put on hold for the many years they spent building and running the business. They may want to travel, spend more time with the grandchildren, become more involved in community activities or serve on non-profit boards among others. At this stage, one must assess if the business shall be able to support the owner and his or her spouse after the succession and the children, who shall be the “new” owners.

Succession Planning copy222THREE

Thirdly, the business owners must address the issues of future management in the succession plan.

For many business owners, it is very hard to give-up the control of the business.

Whether management of the business will rest in the hands of the next generation, in the hands of key employees, or a combination of both, the business owner must learn to delegate and work “on the business,” not just “for the business.” When it comes to management, it is not advisable to provide all children, or relatives, whether active in the business or not, with an equal standing in the business after you leave it. The interests of those in the business usually conflict with those who are not. It is important that only family members who will have responsibility for the management of the business have the necessary talents, desires and skills to keep the business running successfully over the long term. If not, the transfer of management may damage the business by hindering growth or even causing its total failure. It is therefore recommended that a gradual transfer of roles and responsibilities gives the successor time to grow into his or her new position and allows the business owner time to adjust to his diminishing role. Thus, a lead-time of at least five years to select and mentor a successor is important for a smooth transition.

FOUR

The fourth stage in planning for the future shareholding structure

Often, a major concern for family business owners with children who are active in the business is how to treat all of the children equally in the business succession process. The other concern is when to give up control of the business and how to be guaranteed sufficient retirement income. It is usually advisable to discuss the issues frankly with all family members since they may make incorrect assumptions which can lead to disappointment and the breakup of family-owned businesses. It is usually advisable for the succession plan to be in writing and let the family and close associate to be aware of its contents and know where the plan is kept. It is also crucial to seek advice on the tax implications arising as a result of any proposed planning.

Here below, we explore the different ways of passing on the ownership to your children

  • Selling (as opposed to gifting) the business to the active children results in all children being treated equally. The sale price would be the fair market value of the business determined by an independent appraisal. Typically, the purchase price will be paid in installments with interest. An added advantage of a sale is that it provides an income stream for the business owner’s retirement needs. The problem with a sale, however, is that it is not tax-efficient. The purchasers must use after-tax personal income to make the principal payments, and the business owner must pay a capital gains tax on any gain realized on the sale, plus ordinary income taxes on the interest payments.
  • Gift or sell the business to all of the children, but transfer voting shares to the active children and non-voting shares to the inactive children. In addition, grant to either the business or the active children the right to call (purchase) the non-voting shares of the inactive children. Conversely, grant the inactive children the right to put (sell) their non-voting shares to the business or the active children. The purchase price and payment terms for the puts and calls must be in writing.
  • If the active children have been instrumental in the success of the business, give them credit for their involvement in the business, particularly if their compensation packages (salaries) have been less than the going rate. This credit can be in the form of lifetime gifts of business interests or a larger portion of the business owner’s estate (in the form of business interests) compared to the inactive children.
  • For the active children, the most pressing need is likely the assurance (in writing) that they will eventually control the business upon the owner’s death, disability or retirement. For the business owner, the need to control the business for the time being is likely to be of utmost importance. Therefore, the parties can enter into a buy-sell agreement that allows the business owner to retain the voting shares until his death, disability or retirement.
  • When more than one child is active in the business, specific criteria that the children must meet in order to receive voting shares can be established. For example, earning a University degree or obtaining outside relevant work experience should be common requirements.
  • If the decision is made to gift the business to the active children, a salary continuation agreement can be used to provide the business owner with retirement benefits. Alternatively, the business owner can remain as a consultant to the business or serve as a board member in order to receive some compensation.

FIVE

The last key aspect to consider is a transfer tax component of business succession planning. This involves strategies to transfer ownership of the business while minimizing the inheritance or gift and estate taxes. Gift tax and estate tax consequences deserve special attention since unanticipated taxes can be so substantial that the business may need to be liquidated to pay the tax.

This may not be much of a bother now in Uganda since the inheritance tax charge currently is zero.

Business-succession-planningIn conclusion, it is worth noting that given the number and complexity of transition and succession options available, effective business succession planning requires time, the assistance of outside advisors, the input of family members [especially the owner (and the owner’s spouse) concerning his or her goals], and the willingness to address interpersonal conflicts that can arise during the planning process.

It is always a dangerous mistake to regard succession planning as simply a question of transferring a tried and tested way of running the business from one generation to the next. It is actually a system change encompassing a transition to a different type of business structure with a different culture, procedures, goals and objectives and ground rules.

So, once completed, the business succession plan will provide peace of mind for the business owner and key employees, personal satisfaction for family members and new opportunities for the business itself.

Brian Ahabwe KakuruBrian is the Managing Director at BLEGSCOPE®, and has over 9 years of management consultancy experience notably in the finance and banking industry, MSMEs, FMCG companies and in the service industry. You can follow him on twitter: @BrianAhabweK

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