Succession planning

You know you can’t work forever – and you certainly aren’t immortal. But plenty of business owners are living as though they’re completely infallible.

Some years ago, I remember someone bemoaning New Zealand business owners’ lack of ambition. This person said when owners have grown their businesses big enough to start to look overseas they then sell, as long as the sale price would allow them to join the Triple “B” and buy a bach, a BMW and a boat. Although I hadn’t heard of this club before, the point that stuck with me was the comment about the real value of a company being unlocked globally by its new owners. I think things have moved on significantly since then with New Zealand companies such as Seequent selling for $1.46 billion, Ziwi for around $1 billion and Partners Life also for $1 billion. Certainly, a lot more that a ticket to join the Triple “B” club! Gone are the days when companies sold for 3-4 times EBITDA (earnings before interest, tax, depreciation and amortisation) or maybe 7-8 times EBITDA if the buyer had Australian pension fund money looking for a home. Deals like Seequent are not referable to EBITDA at all, with technology companies increasingly being sold at multiples of sales instead – sometimes up to 45 times sales and beyond. How to get the best bang for your buck when selling your business While you are sitting at the beach or lake over Christmas, thoughts of selling your company may cross your mind. If so, there are lots of things you might need to start thinking about. Firstly, get sale ready. When a company is sold, there will almost certainly be some level of due diligence – typically covering finance, legal and tax. A buyer doesn’t want any nasty surprises. Preparing for this will involve ensuring everything is in order – making sure all agreements, processes and procedures are documented and all information likely to be needed is collated and ready to provide. Some businesses plan for this several years ahead and look to have their annual accounts prepared and audited. These actions, though worthwhile, are generally house-keeping tasks and won’t necessarily increase the value of your business. So what can add value, or at least bump-up the multiple of earnings that a purchaser is willing to pay? When it all boils down, the value of a business is based on the demonstrable track record of sustainable earnings, or the prospect of growth in earnings in the future - or, ideally the combination of both. Therefore, being able to prove the reliability of your revenue and profits, and the strength of your position in the industry is worthwhile. It’s also important to have a well thought out set of financial projections which demonstrate the growth prospects for the business and how these can be achieved. Is growth going to come from the existing product base, new product development or bolt-on acquisitions to increase presence and market share? How much will this cost, and what are the potential returns if actioned? The other key question a purchaser will want answered is around people, and most specifically you! What does the business look like with you – are key customer and supplier relationships shared across a management team, meaning your exit from the business is not detrimental to its performance? Answers to these questions are usually presented in an Information Memorandum (IM), a short sales document used to market the business to prospective purchasers. Detailed sell side due diligence reports can also be provided to prospective buyers. While this won’t generally stop buy side due diligence being undertaken, it can help buyers get to the heads of agreement stage more quickly and ensure all the information and materials are ready for due diligence questions. Once a heads of agreement (high level terms likely to be reflected in any future sale and purchase agreement entered into) has been signed, a buyer will typically be granted a period of time where they have exclusive rights to undertake due diligence, and formalise a contract and purchase price. If they decide to proceed, the buyer will submit the first draft of a sale and purchase agreement. The buyers and seller will negotiate the terms of the sale and purchase agreement with the document going backwards and forwards between the buyer’s lawyers and the seller’s lawyers. The document may go back and forwards several times while clauses are negotiated. Will you sell shares or assets? A business sale can involve shares in the company or its assets. The advantage of a share sale for the seller is they can walk away and often the sale proceeds are a tax-free capital gain. The disadvantage for a buyer is they inherit any “skeletons” buried within the company not identified during due diligence. Often the sale and purchase agreement will seek to put some of these risks back on the seller in the form of vendor warranties and indemnities. Under warranties and indemnities, the seller will have to refund part of the purchase price if specific things are identified or occur. Where the seller still wants to draw a line in the sand and not have to worry about warranties and indemnities, it is possible to obtain warranty and indemnity insurance. This is specialist insurance, and a premium is paid to the insurer to transfer the risk arising from warranties and indemnities post sale to the insurer. Typically, the warranty and indemnity insurer will want to review all due diligence reports and may require further due diligence to be undertaken or exclude certain risks. Where business assets are sold, the company’s past stays with the vendor with the business being transferred into an existing or new company owned by the purchaser. This involves changes of ownership of assets, assignment of business contracts and the transfer of employees. It can also involve the purchaser assuming agreed liabilities, such as leases and employee entitlements like holiday and sick pay. When business assets are sold, the vendor will need to wind up the selling company to access any capital gains tax free. What about tax? Purchase price allocation Purchase price allocation is where the parties agree what portion of the overall purchase price is allocated to the various assets acquired and liabilities assumed. This is a key area for negotiation. A purchaser will want to allocate as much of the purchase price as possible to items which will be tax deductible either upfront or at some point in the future, such as plant, patents and trading stock. The seller will want to allocate as much of the purchase price as possible to non-taxable items such as goodwill and trademarks to increase the amount of non-taxable goodwill that they realise. There is generally a natural tension between the seller’s best outcome and the purchaser’s best outcome, so Inland Revenue will generally accept the purchase price allocation agreed between unrelated parties as being a fair market price. GST The purchase price will be either inclusive of GST or have GST added on top. Generally, a seller will insist on the purchase price being “plus GST if any”. The purchase price can be zero rated for GST in certain circumstances, such as where an interest in land is included in the sale (ie, a lease) or where the sale is made to a purchaser outside New Zealand. GST zero rating can also apply to a going concern, ie, where what is being purchased is able to be operated on its own immediately after the purchase is complete without adding anything to it. As most business require premises, it is generally quite hard to have a situation where there is a going concern which isn’t already zero rated for GST due to an interest in land being transferred. There are many more things to consider, and if you are considering selling your business you should get your house in order sooner rather than later. There may be significantly more at stake that membership in the Triple “B” club!

When it comes to a business strategy that’s as important as succession planning, you can’t afford to leave things to chance. After all, what would happen if your personal situation suddenly changed and you wanted - or needed - to exit your business? Many private business owners are reluctant to invest in a succession plan they feel they won’t need for many years; however you will know better than anyone that getting your business to its current level took time and commitment. A succession plan needs the same attention. A solid exit strategy provides your business with a greater likelihood of long-term survival and ensure a better financial return. Without an effective plan, the future of the business may be put in jeopardy, especially when times get tough or your circumstances change unexpectedly. Also, a lack of preparation can create adverse tax consequences. For example, in the aged care sector we are seeing many small to medium sized businesses dealing with staffing and financial pressures. Owners are heavily involved in the day-to-day operations of their facilities, unable to focus on growth strategies or on their own health and wellbeing. Over time, this is unsustainable; sooner or later it will begin to affect the overall wellbeing of other staff, the business itself and its residents. Burn out is a reality throughout the industry and being well prepared for life’s unexpected events, as well as for the inevitability of growing older, can give you peace of mind and help to underwrite the future success of the business.Having an effective succession plan in place can also: • help maximise the value of your business • improve profitability and the sale price • help you analyse your organisation’s strengths, weaknesses and threats • help you plan for unexpected events and adjust to changing circumstances • enable you to transition the business on your terms not someone else’s • provide a strong blueprint comprising clear options and choices. Start early with a focus on self-care Succession planning isn’t a one-time event, it’s a process that should begin long before you plan to exit the business, so start working on your plan several years in advance. Don’t wait for a year of super profits, or a period of weak performance. Start early, so you can transition on your own terms, while you are in control with the widest range of options available to you. This is particularly important in the aged care sector where operators relying on selling their business as an exit strategy. They are vulnerable to an inadequate supply of skilled labour, and a buyers’ market that is more focussed than ever on strong cashflows. Begin your planning by understanding your current personal circumstances. Few business owners allow themselves this luxury, but it’s critical to establish a personal agenda and identify catalysts for change. You need to honestly consider: • how long you would like to stay active in your business • your health, wellbeing and the level of energy you bring to your business • your must haves, such as how you will finance your retirement • the current and future needs of your immediate family • whether your personal aspirations are aligned with the objectives of your business • your appetite for risk and how it’s aligned with your business’s strategic direction • the capital requirements for you and your business • the skills, experience and capability of your management team and/or your family, and whether they are capable of operating and growing the company without you. Understanding your personal bottom lines will shape your thinking about which approach is best for you. Develop your personal plan There are different succession and transition paths you can take to exit your business. Understanding the advantages and disadvantages of each is an important initial step in developing a plan that’s right for you. Some of these include: • continued family ownership and management • retaining ownership as an investor rather than as an owner/manager • selling part or all of your ownership stake • winding up the business. You need the right support team around you to help develop your personal plan. Helping to lead that team and work alongside you should be someone who understands the overall strategy you are working towards. Someone who can develop a decision-making framework to help drive the agenda and keep everyone, including you, focussed on progressing towards your goals. Your framework could include: • how you communicate with and involve other stakeholders/family members • dealing with your or a family member’s immediate health and wellbeing needs; perhaps you need some time out of your business just so you can think and plan • estate planning for you and your immediate family • a contingency plan to deal with unexpected life events - does someone know where the keys are? • a personal financial plan – have you got a retirement nest egg, or is that a requirement of your succession plan? What are your financial goals? • a tax plan - how will tax impact your financial goals? • a plan for the business. Develop your business plan Understanding where your business is at and what it is capable of will strongly influence whatever succession path you take. When you undertake a current state review, ask yourself: • how good is the financial base of the business? • is there a growth story and growth strategy, and is that plan being implemented? • is the ownership structure tidy, and are all necessary documents in place and up to date including shareholder agreements and financials? • is there appropriate tax governance and planning in place? • does the business routinely meet all its legal and regulatory obligations • are the right people working in the right positions within the business? • how much does the business rely on me? Whatever path you take, and especially if you decide to sell, allow time to ensure the business is investor ready. The better prepared you and the business are for transition, the more likely you are to achieve a successful succession as well as a fair price if you’re selling. Think about how the business operates, the information you can provide to potential buyers about the performance of the business, as well as the quality of your systems, procedures, and assets. Ask yourself: • could you respond to an unsolicited approach for your business? • can you articulate the key strengths and growth prospects of your business? • how would the business cope without you? • do you have a clear strategy for you, the business and your family that allows you to transition out in a controlled and healthy way – in other words, could you get out alive? Aged Care businesses operate in a highly regulated industry and the level of compliance they must satisfy from end to end in their business is significant. Systems, people, and processes need to be at or above industry requirements on an ongoing basis. Building the right habits within the business is critical to sustaining the level of performance aged care businesses need to meet the needs of their residents, staff and regulators. This means your business plan needs demonstrate the required standards of care and infrastructure if you want to the succession process to go smoothly. Although succession planning can be simply defined as the process of transferring the control and ownership of a business, developing and executing a succession plan is not nearly so simple. For a business owner, that planning involves dealing with some challenging questions about your personal circumstances and your business. If you take a methodical and thoughtful approach to that process, and start early (it’s never too early!) you can achieve that transition with a strong healthy business and your own health, allowing you to enjoy the fruits of your efforts for many years to come.