Business Succession Strategy Weaknesses

In a previous series on why too many business owners fail to exit their business with maximum cash flow and profits, I identified 8 business exit strategy weaknesses that may contribute to a reduced business succession outcome for you.
My previous post in this series revealed how to eliminate or reduce tax payable when you exit your business through a powerful case study about the impact on final profits of tax payable by an Australian company at the time of business succession.

How Your Assets Are Structured Impacts Tax On Disposal Or Transfer Of Business Assets When You Exit Your Business – Case Study

Myra and Eddie developed a thriving print manufacturing company over their lifetime. Their children Beth and Robert both worked in the company. This was a family who really worked well together, so when Myra and Eddie were ready to retire from the company, they were confident about transferring the company to Beth and Robert as joint owners. They required no payment from their children for the business because their superannuation fund owned the factory (worth $5 million) from which the business operated.

The business would continue to pay rent to Myra and Eddie via their superannuation fund, which happened to be very tax effective and provided more than enough income for them to live comfortably. Myra and Eddie had also arranged for the factory to pass onto Beth and Robert as their beneficiaries, so they did not worry about ownership of their business premises.

The business succession appeared to be organised and settled, and they believed that everything was structured to be as tax effective as possible.  However, there was one big problem awaiting Beth and Robert that no one had considered. Not even their existing tax advisers and lawyers had anticipated this problem and its devastating effect, as they were not experienced with succession planning.

In this case, once Myra and Eddie passed on the factory via their superannuation to their beneficiaries, Beth and Robert, a massive tax liability resulted. As adult children receiving the proceeds of their parents’ superannuation accounts, up to 30% tax had to be paid on the account value. Inheriting the factory, valued at $5 million, would attract a tax bill of around $1.5 million.

There was no way Beth and Robert could afford to meet that liability without selling the factory. However, selling the factory caused another costly dilemma, because their business relied on the location and facilities in the factory to continue its operation. Relocating could not be arranged easily without incurring a lot of disruption and costs to the business.

The stress of the situation engendered undue tension between Beth and Robert. They began to argue about the options, leading Beth to decide that she wanted to sell out her half. Robert could not afford to buy out Beth. The situation became very difficult, affecting the business’s performance in a slow economic environment. Their business could not find finance in the prevailing market.

One simple solution would have been to use insurance over the couple’s lives to fund the anticipated tax liability payable on the transfer of the factory from Myra’s and Eddie’s super fund to the adult children.

Another option would have included a strategy to withdraw the business premises from Myra and Eddie’s super fund altogether. Under current tax law, no tax would be payable by Myra or Eddie provided they were aged 60 years or more; however, stamp duty would be payable on the transfer. It would be prudent to weigh up the transfer costs against the potential tax costs of transfer upon death before arranging, to ensure Myra and Eddie would not be disadvantaged. They could come to some arrangement with Beth and Robert to meet the transfer costs, which are likely to be a lot lower than the superannuation death tax that would apply.

You will find more specific information on how to reduce tax by choosing the best structure in Part 5 of my book, Your Business Succession: How To Exit Your Business For Maximum Cash Flow And Profit with specific solutions to Beth’s and Robert’s family’ succession problem.

How well prepared are you to exit your business with maximum cash flow and profits?

Take the FREE Business Exit Quiz (5 minutes of your time) and find out where your business succession strategy may be letting you down, and how to improve your chances of building a business for maximum profits and cash flow.

To Your Profitable Business Exit,
Leigh Riley

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Business Succession Strategy Weaknesses

In a previous series on why too many business owners fail to exit their business with maximum cash flow and profits, I identified 8 business exit strategy weaknesses that may contribute to a disappointing business succession outcome for you.

My previous post in this series revealed how transparent Terms Of Sale can seal the deal for a favourable business exit
and this post outlines a powerful case study about the impact on final profits of tax payable by an Australian company at the time of business succession.

How To Eliminate Or Reduce Tax Payable When You Exit Your Business – Case Study

In March 1994 the four Cabernet brothers inherited from their father a family-owned Australian wine company valued at $5 million. They inherited equal shares of 25% each at a cost base of $1.25 million each, made up of:

• Active Asset Land Value $3.5 million
• Plant and Equipment $1.32 million
• Goodwill $180,000 [Turnover $720,000]

In November 2008, the Cabernet family decided to exit the wine business and sold the company shares, which had grown in value to $16 million (i.e. $4 million each), comprising:

• Active Asset Land Value $12.0 million
• Plant and Equipment $3.5 million
• Goodwill $500,000  [Turnover $2 million]

The disposal effectively resulted in realised capital gains for each brother of $2,750,000.

Total Australian tax was calculated (after making use of available exemptions) and due on the sale proceeds for each brother. The amount of tax shared among them was $337,500 (i.e. $84,375 per brother, not including Medicare levy, which at 1.5% would be $41,250 each, assuming they all have private health insurance).
NB. This example uses the tax rates that applied in the year the business was sold (i.e. Australian tax rates as at 2008/2009).

If the Cabernet brothers had sought specialist advice and implemented proper tax planning strategies well before the sale, they could have reduced their combined tax liability by $247,500 to only $90,000 (not including Medicare levy). That’s a reduction in tax of $61,875 each, which could have been achieved without changing any of the circumstances in the existing scenario.

Eliminating Tax by Seeking Pre-Business Exit Tax Advice

Had the Cabernet family taken prior advice and been prepared to make just a few slight changes to the scenario before signing the contract of sale, they could have actually reduced their tax liability to nil, which would have saved them $337,500 in tax.

How is this possible?

Tax laws are complex, so your options will vary depending on where in the world your business is located. To fully understand what the Cabernets could have done to achieve a better outcome, you’ll need to understand the rules that apply in Australia. Specialist tax advisers have spent years understanding how the rules can be used to your benefit, so your safer option is always to obtain advice from an expert in capital gains tax law and business transfer in your country.

You will find more specific information on how to reduce tax by choosing the best structure in Chapter 16 of my book, Your Business Succession: How To Exit Your Business For Maximum Cash Flow And Profit with specific solutions to the Cabernet family’s  business exit problem.

How prepared are you to exit your business with maximum cash flow and profits?

Take the FREE Business Exit Quiz (5 minutes of your time) and find out where your business succession strategy may be letting you down, and how to improve your chances of building a business for maximum profits and cash flow.

To Your Profitable Business Exit,
Leigh Riley

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Business Exit Profits Key #2 | Video

One of your core business exit goals is to keep as much of the profit from the sale of your business as possible. To achieve this you want to have a business succession plan that takes advantage of Capital Gains Tax Concessions that are available to business owners who meet certain criteria.

View this short video to discover four types of Capital Gains Tax (CGT) Concessions that may boost your business exit profits.

Four tax concessions that may provide capital gains tax relief when you sell your business in Australia.

These only apply if your business meets the definition and eligibility criteria of a small business.

1. 15 Year Exemption provides 100% capital gains tax relief.  It means your business must have been operating for longer than 15 years without any change to its structure or ownership during that period and to qualify you must also meet certain further criteria.
2. 50% Reduction Exemption can provide 50% relief from capital gains tax, but only if you meet the eligibility criteria.
3. CGT Retirement Exemption provides 100% capital gains tax relief on up to $500,000, but only if you meet certain eligibility criteria which may vary with your circumstances.
4. CGT Rollover Relief provides 2 years automatic deferral of capital gains tax.  It applies only if you meet the eligibility criteria and you are using the proceeds from the sale of your business to purchase another business.

Capital Gains Tax Eligibility Rules

The eligibility rules are too complex to go into detail here, but you can read all the details in Chapter 16 of my book ‘Your Business Succession: How To Exit Your Business For Maximum Cash Flow And Profits’ which demonstrates the effects with real life case studies.

To be certain of your eligibility you should seek the advice of a qualified, certified practicing accountant (CPA or CA), and you want to do this well before leaving your business so you can make full use of the available concessions.

More Business Exit profits Keys

Read about the other six Business Exit Profits Keys in detail here.

Secure your own copy of my book ‘Your Business Succession: How To Exit Your Business For Maximum Cash Flow And Profits’ for real life business exit case studies that show you what you want to do to to ensure your cash flow and profits are maximised when you leave your business, through either planned or unplanned circumstances.

To Your Profitable Business Exit,
Leigh Riley

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Structural faults impact your business succession profitability

Business succession problems are the result of one or more of the five weaknesses I identified previously. Reason #1 was strategy weaknesses and this post explains the second reason that too many business owners experience business succession problems – structural faults.

Four structural faults have the potential to impact the success of your business succession, and therefore your business exit cash flow and profit.

The 4 structural faults that cause business succession problems:

1. Failing to build an appropriate management culture. Businesses that are reliant on the current owner to operate them are less attractive to buyers because there is a higher risk of losing business customers, staff and possibly suppliers when a change of ownership occurs.
   Potential buyers will usually be prepared to pay less for an owner-centric business, so it’s a problem that needs to be addressed and overcome as soon as possible—certainly well before you reach a succession event.When a business is operated without a management culture that doesn’t develop staff to the point where they’re capable of running the operation without the owner’s daily intervention, the opportunity to fully capitalize on the sale of the business is reduced.

   Lee Iacocca, manager of Ford and Chrysler until his retirement in 2001, said, ‘I hire people brighter than me and then I get out of their way.’  That’s the type of management culture you need to build in your business if it is to benefit your exit strategy.

2. Failing to consider tax implications on the sale or transfer of your business. The sale price of your business is NOT what counts. Your focus should be on what you keep after tax, because that’s what you will care about most when the time comes. You can make significant taxation savings with thoroughly considered tax planning strategies.

The tax rules and alleviation strategies vary from country to country of course. Each nation has its own complexities. I can’t emphasize strongly enough the importance of your seeking professional tax advice from an exit-planning specialist to identify the options specific to your circumstances. You will want to do this well before you think you are ready to sell or transfer your business, to maximize any available advantages.

Careful planning of your business structure, the sale, and well-considered treatment of the proceeds is essential to ensure you legally maximize your cash flow and profit from your business exit.

In Australia, it’s possible to significantly reduce the capital gains tax paid on the sale of a business using the available laws. The rules are complicated, which is a definite incentive to seek specialist tax advice. It is important that you understand the full implications of the ownership structure of your business and to seek out tax-planning options to ensure you are in the best position to take advantage of the rules.

A word of caution - restructuring your business during its operation can inadvertently exempt you from leveraging some of the available concessional rules. That’s why you want to obtain specialist tax advice from the commencement of the business, to ensure your business will be in the best position to utilize the rules and exemptions that may be available when you sell.

A specialist tax adviser can save you significant amounts of tax—sometimes ten to twenty times more than the specialist’s fees, so beware of the false economy of NOT seeking specialist advice to maximize the financial and lifestyle outcomes of your business succession.

3. Failing to consult a business succession planning specialist. This can result in poorly structured business assets, negatively impacting your business succession outcomes in terms of both cash flow and profit for both you and new owners of your business.

In one of my books “Your Business Succession” I detail a case study that demonstrates how poorly structured business assets can hinder business succession. I show you what can happen when succession planning advice is given by business advisers who lack sufficient specialist expertise in succession planning.

In Case Study # 5 of the book, I reveal multiple strategies that could have saved Myra and Eddie a lot of money and heartache if they had sought  advice from a team of succession planning specialists before the transfer of their family business.

4. Using estate planning as your succession strategy. Some business owners believe that identifying a business successor in their will is the same as having a succession plan, because they think that business succession is just a matter of appointing someone of their choice to take up ownership when they die.

There can be a lot of confusion about which assets can actually be passed on via an estate. Asset ownership is not always straightforward because of the structure of ownership. For example, assets held via a family trust, superannuation fund or company, or assets that are held jointly, rather than as tenants in common, will be dealt with differently from other assets, and may not form part of the estate for division among beneficiaries.

In the case of Joint Tenants, the joint owner automatically assumes ownership when the other joint owner dies; therefore, each party cannot will their part of the business to another person or party.

In the case of Tenants in Common, each party owns their share in the asset and can chose to make provision for that share to pass to anyone of their choosing upon their death.

Estate planning lawyers can help you understand what’s eligible to form part of your estate and able to be willed. However, they may have a limited understanding of the associated issues from a business succession planning perspective.

The bottom line is that a will can’t change the ownership structure of assets, with the result that many business owners inadvertently fail to provide for loved ones in their estate through poor advice or failing to seek advice from a team of business exit strategies specialists.

In a future blog series I’ll share some case studies that will help you to understand the influence of each of these business structure faults in detail, so you can plan how to overcome these problems before they can have any impact on your profitable business succession.

Business Exit Strategy Resources

If you want to make sure that you have the right business structure in place so that you can avoid the mistakes identified in this article, then you want to take advantage of these resources to make a start on your profitable business exit strategy now:

1. Take the Business Exit Quiz (5 minutes of your time) and find out where your exit strategy may be letting you down, and how to improve your chances of building a business with maximum cash flow and profit.
2. Read my book “Your Business Succession” to discover what you want to do to ensure you will not become the victim of the business succession structural faults outlined in this article.

To Your Profitable Business Exit,
Leigh Riley

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Every business owner’s dream is to eventually exit their business with maximum cash flow and profit, assuring a comfortable retirement income as a reward for their years of dedicated hard work  To achieve this you will need to maximize the price you receive when exiting if you want to enjoy the comfortable retirement you’ve been hoping for.

Alarming facts about small business owners and retirement savings

Australian statistics reveal that only 5% or retiring business owners will have sufficient retirement savings to be completely financially independent.  In the US the average retiring business person has enough savings to fund approximately 8 years of their retirement, but will on average live 17 to 18 years beyond retirement age.  Facts such as these really bring home the need to focus on succession strategies that will boost your business valuation so you can exit with maximize profits and retirement income.

5 reasons business owners miss out on maximum retirement income

While some business owners will be sufficiently prepared to reap the rewards of years of effort, the reality is that many will fail to maximize their business value in a way that could ease their financial burden during the next phase of their life.  Here are the 5 main reasons why:

1. Strategy Weaknesses involve 8 key areas of failure to have the end in mind when operating their business.  The strategic decisions made in the business do not adequately take into account market demand for the products and services they provide, nor the market conditions in which they operate. They lack a long term customer service focus, and fail to recognize the competitors they’re up against. Two types of competition exist -  competition for customers who use their services, and competition for potential purchasers of their business when they exit.
2. Structural Faults encompass 4 main areas of fault when a business lacks a management culture, and fails to understand the associated tax implications of the ownership structure of a business, particularly when exiting.  To protect yourself against structural faults I can’t emphasize strongly enough that you need to use a team of specialist advisers to collaborate and mitigate the 6 D’s of Succession.
3. Situational Errors takes into account the 6 identifiable situations that, without adequate contingency planning, can impact your business value and move your financial success beyond your control.
4. Sustainability Breakdown comprises the 3 factors that impede effective business continuity and your ability to handover your business whilst receiving full financial benefit for a lifetime of effort.
5. Steering Off Course involves leadership and management challenges and embodies the 4 business succession leadership challenges that you must overcome to ensure your business remains on track for maximum profits and income from enhanced business valuation and sale price when you exit your business.

How ready are you to take on the challenge of overcoming the 5 reasons too many business owners fail to achieve the profitable exit they had hoped for?

Business exit strategies to achieve maximum income for your retirement

1. Take the Business Exit Quiz (2 mins of your time) and find out where your exit strategy may be letting you down, and how to improve your chances of building a business for maximum profits and cash flow
2. Read my book “Your Business Succession” to discover what you want to do to ensure you will not become one of the poor statistics outlined earlier in this article
3. Contact our Business Succession Strategy office to plan your business succession strategy, so we can eliminate the stress of making the right decisions for your best chance of maximizing your business valuation for a profitable exit.

To Your Profitable Succession,

Leigh Riley

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Sole traders deserve a profitable exit strategy too

If  your business has no employees, and your family members are not interested in taking over your business when you leave, what is your best exit strategy to make sure you actually receive the cash flow and profits you’ve worked so hard to earn?

If you are a sole trader you may believe that you are at a disadvantage when leaving your business, but there are many options to help you  maximize the value of your business and therefore maximize the return on your investment.

7 tips for a profitable sole trader exit strategy:

• Make sure your business has a proven track record with financial accounts  and tax statements to verify the income and profits of your business.

• Keep your place of business organized and attractive.

• Document all client records, including contact details

• Establish and document systems for all procedures and processes to make it easy for someone else to fulfill your role when you exit your business.

• Communicate your success to your business associations, competitors and trading partners to make it a well known that your business is an attractive purchase proposition.

• When considering potential buyers don’t overlook the newer graduates and trainees that you meet at business associations. They may currently be working with your competitors, but aspiring to own their own business one day.  You can portray your business as an easier path to owing their own business with instant income, rather than building a business from scratch.

• When you’re comfortable, approach someone in your network to enter into an agreement with you to buy your business one day upon specified events occurring.  The events can be agreed with terms to include retirement or another matter causing you to leave the business,and the term should also include events such as sudden illness, accident or death.

This strategy will allow you to agree on a price for the time when you exit the business. Your agreement should include the terms of sale, and can even make provision for funding the purchase price.  This is known as the ‘friendly rival’ strategy.

Benefits of the ‘friendly rival’ exit strategy for sole traders

Any agreement you set up should be arranged by a team of experienced business exit strategy specialists and should make provision for the changing value of your business.

Due diligence must be given to the tax implications upon changeover.  The agreement should also provide for terms to protect your business asset from the contingencies, with insurance to cover sudden illness, accidents and death.

Putting a ‘friendly rival’ exit strategy in place will allow you the comfort of knowing you have a certain buyer when the time comes for you to leave your business, no matter what the circumstances. This will also provide you with assured financial security in the form of both cash flow and profit int the future and remove the pressure of finding a buyer if you ever have to leave suddenly.

FREE online tool to evaluate your exit strategy:

Start with the end in mind and sharpen your business strategy in a way that will enhance your proitable exit . Invest just 3 minutes to complete the FREE Business Succession Readiness Quiz and receive your FREE customized evaluation, plus a ‘To Do’ list of specific actions you want to take to ensure your profitable exit from your business.

Take the quiz now

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How Prepared Are You To Exit Your Business With Maximum Profit And Cash Flow?

My inspiration for writing my book ‘Your Business Succession – How to Enter, Execute and Exit Your Business For Maximum Cash Flow & Profit’ came from a true tale about business succession.

Business Succession Case Study: When Harry Met Sally And Greg

When I met Sally she had just transitioned into owning a business in which she had been employed for a number of years.

Sally’s employer, Harry, built a very successful business and was now ready to sell and retire. None of his children were equipped to take on the role of leading the business, but Harry recognized that Sally was the primary income generator on his sales team. In addition, she was trustworthy, dedicated, hardworking and results oriented.

The Succession Plan

Given the size of the private company, Harry knew he wouldn’t find a buyer very easily. His best option was to offer Sally and another employee, Greg, a substantial interest free loan with special terms  to take 60% ownership in two equal shares of 30% each. The remaining 40% of the company would be allocated in equal shares amongst Harry’s four children.

For Sally and Greg this was a fantastic opportunity to own a piece of the business they had worked so hard to build. Harry was prepared to take the risk of providing an interest free loan each to Sally and Greg, because he trusted them both.

Fortunately Harry was in the financial position to afford to wait for payment, and  did not require immediate cash inflow from the funds he had loaned. His secure asset base aside from the business, allowed him the luxury of funding his retirement without the need for immediate capital injection. Harry’s ability to do this is extremely rare amongst even the most successful of business owners.

Problems For Harry With The Succession Plan

Harry’s willingness to leave his future success vulnerable to the management styles and decisions of Sally and Greg really makes him stand out in the crowd.  Harry’s succession plan was not his best option, but he didn’t leave himself with a lot of choice. Due to lack of planning, and incomplete advice, it was the best solution he could think of for his business exit.

I became involved after Sally and Greg had taken over Harry’s business, when they were referred by Sally’s personal accountant, Josh. No formal agreement had been arranged at that stage – everything rested on a verbal agreement. Josh was diligent enough to appreciate that a verbal agreement was unacceptable as it left all parties vulnerable.

As a chartered accountant, Josh was handling the tax issues and was relying on my expertise to sort out all the contingencies relating to the business succession, including the debt owed back to Harry.

Josh engaged a lawyer colleague, Michael, to draw up the legal agreement. We all needed to arrange our various parts of the succession plan between Sally,  Greg and Harry.

I did not have the opportunity to work directly with Michael, but I certainly took care of my part in the process to the best of my ability. I feel certain that Michael also exercised his legal expertise within his range of knowledge as well.

However, it turned out that Michael’s main legal expertise was in the area of industrial relations, not succession planning.  This was as unhelpful as consulting a dermatologist about a bone fracture!

Tax Implications Overlooked

Josh, acting as the accountant on the matter, did not understand all the tax implications specifically related to succession planning, because his experience was limited to general business accounting, so he did not have the knowledge and skills to recognize the potential problems.

The outcome for Sally, Greg and Harry was totally unsatisfactory, in that it clearly did not solve all of their succession problems. Their succession plan was not structured in the most effective manner as the legal agreement amounted to little more than a shareholders’ agreement (Chapter 9 of  ‘Your Business Succession’ explains why a shareholders agreement is insufficient and is a weak strategy for effective succession planning).

The strategy had not addressed all the tax issues they would face in the future, nor did it provide an adequate agreement with clearly defined terms to cover all the identifiable succession triggers. Chapter 2 of  ‘Your Business Succession’ covers the 6 specific categories of Business Events, some of which are unexpected, that will lead to your business exit.

Succession Problems For Sally And Greg

This was a major problem especially when Greg had health issues that meant he could not arrange enough insurance to cover his commitment, and had insufficient assets to provide collateral as back-up for the debt outstanding.  This meant Sally would remain in a vulnerable financial position for a very long time because she was now solely responsible for repaying the debt to Harry.

From my observation, the resulting inadequate succession plan was largely due to failing to engage a team of cooperating professionals with succession planning knowledge, skills and expertise.  Adding to the problems was the fact that each professional had a blinkered approach, which left gaping holes in the strategy.

Each had expected the other to know their role. If only each had questioned the other with more understanding and communicated as a team to uncover the full extent of the problems. The worst part of this situation was that Sally and Greg’s understanding was so limited that they were unable to understand the gravity of their vulnerabilities.  Despite my repeated warnings with full explanations, I could not convince them of the need to revise their incomplete succession plan, particularly when Josh acting as their accountant, had assured them everything was in order.

I vowed never to let this happen again.  It really brought home to me the need to work in a team of experienced succession planning specialists. I decided then and there, that in future I would  work only with experts who were prepared to work as a cooperating team, for the greater good of the client! For me, that would be the only way to provide a complete business succession planning strategy that could stand the test of time.

Fortunately, I have now found that team, and choose to work directly with these noted succession planning specialists. This has added significantly to my ability to increase the value that I personally bring to my clients.

Education In Succession Planning

I was shocked to discover how little  information of sufficient quality was available about succession planning that was specific to the Australian context. I found plenty written by overseas authors, but these books were based on rules and tax laws that did not apply to Australian business owners.

Anything Australian that was available had focused only on specific aspects of succession planning and did not provide a complete picture. Such a limited focus had the potential to actually create many of the problems businesses being faced.  I resolved to try and change that situation once and for all, with my latest succession planning book, the Business Succession Profits Quiz and this educational blog.

Share Your Business Succession Story

The focus of this site and blog is an educational one, so feel free to comment on this post or to share your business exit story and perhaps prevent other business owners from failing to get the profitable exit their efforts deserve.

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