Business Succession, Family Transition, and the need for Shareholder AgreementsSubmitted by Nick Parnell on November 18th, 2015
Over the next decade, over 20 per cent of Canada's current baby boomer workforce will be at or over the age of retirement1. This shift presents a great opportunity for the younger generations looking to enter the workforce or advance in their careers, as well as a challenge for those transitioning into retirement, who will need to adapt to a new lifestyle, as well as create a plan for steady retirement income and address estate planning issues.
This shift in demographics also presents a large challenge for family owned businesses and their current leaders. Over the next 10 years, it is estimated that upwards of 75 per cent of these leaders will retire2. Many of these family run businesses may have discussed a possible transition, or perhaps even have a contingency plan in place, yet in many cases, still have no successor in place. Statistics on family run businesses show that only about 30 per cent will survive or transition to the second generation3. Even fewer than that make it to the third generation, and it is a low, single digit percentage that make it to the fourth generation. So what can families do to help ensure a successful transition? The key is to have these discussions early and often, and when possible, involve not only the family, but also important advisors such as your accountant, lawyer and financial planner. In addition to these conversations, take into account the the following special considerations4 I have summarized from Scarratt and Kraft's The Advisor's Guide to Business Succession Planning, 4th Edition in relation to the leaders of the business, as well as the potential family members involved:
- Expectations/tradition: What are the expectations of the individuals involved? Does(do) the current leader(s) expect the next generation to take over, and if so, does the next generation want to? Is additional training/development required? Is the business expected to be run the same and see the same growth, or is it acceptable/expected that there could be a shift in style, focus, etc.? Are there certain traditional elements in the business that the current leaders would like to see continue, or on the other hand, are able to relinquish if the new leaders take a different direction?
- Family dynamics/relationships: How do the family members get along? If there are multiple family members involved in the business, are they comfortable with business discussions rolling over into family time/events/conversations? Will there be an ability to separate business from free time? If there are family members who married into the family, are they expected to take on a business role as well, or is there worry that this may separate the family as there may be a decision making process with an alternative set of views? Are there concerns that this may cause the business to transfer to sibling A and their spouse and kids, versus equally between sibling A, B and C?
- Fair versus equal: This may be the most difficult decision for a leader in looking at a transition of the family business to the next generation. They may want to provide equally for multiple children or grandchildren, but struggle with fairness when it comes to splitting assets. For example, if child A works fulltime in the business, and has genuine interest in running it as well, yet child B has no interest at all in running the business and/or working in the business, is it fair that the shares are divided equally between the two? Likely not. Equal does not mean fair when it comes to this type of planning, and if it is important to provide both children with and equal distribution of assets, an alternate plan should and must be considered.
- Is a transaction necessary – Capital or income?: Another important consideration that the leader and successor must account for, and be on the same page in regards to, is a potential purchase. If the leader should require a sale of the business, rather than a transfer of this asset to the next generation, will they require immediate capital upfront, or are they okay accepting an income stream over time? This factor alone may make or break the decision to transfer to the next generation. If the current leader requires capital now, would the preferred successor have assets available to deliver this?
- Transfers and taxes: In the case that the leader would prefer to maintain some income flow, yet step away from full control of the business (or on death of the current leader), there likely will be a transfer of shares/share restructuring in which case the successor may not have to pay capital today, but now both leader and successor may need to account for tax liabilities. Consideration should be given the timing of these changes, as well as whether or not certain strategies, such as an estate freeze, would be the best solution.
- Trusts: The use of trusts can provide different options in regards to business succession/estate planning. Whether or not a trust is the best solution to your specific case should be discussed with your advisors. Trusts can be a helpful tool for income splitting, but can be very beneficial in relation to control of assets; they can also help aid in providing additional time for leaders to give thought to a variety of matters such as that of "fair versus equal."
Whether your family business is small or large, simple or complex, all these considerations are valuable discussion topics. Throughout this process, including your advisors such as your account, lawyer and financial planner is paramount. They can help with a number of factors from tax planning, corporate structures, trusts and estate and legal planning, to insurance and retirement planning, as well as providing structure to help fund, defer, reduce and offset tax liabilities. One final piece that brings all of these conversations together is a well structured shareholder agreement. Think of a shareholder agreement as a will or power of attorney for your business; at the end of the day it provides a set of instructions in regards to the important topics above, on how each and every circumstance should be handled. It provides clarity and direction for all members of the leadership team in the business, the successor, as well as the rest of the family for a number of relevant circumstances from death to disability, and from sale of the business, to succession. And believe me, it may just be the piece that keeps your family together through thick and thin.
1(no author/date of publication given. The Aging Workforce. Retrieved from http://beyondrewards.ca/Articles/Art10-05.html, November 18, 2015)
2(Scarratt, M.T., Kraft, J.W. (2010). Family Owned Business. The Advisor's Guide to Business Succession Planning, 4th Edition (p.60). Toronto: CCH Canadian Limited.)
3(Scarratt, M.T., Kraft, J.W. (2010). Family Owned Business. The Advisor's Guide to Business Succession Planning, 4th Edition (p.59). Toronto: CCH Canadian Limited.)
4(Scarratt, M.T., Kraft, J.W. (2010). Family Owned Business. The Advisor's Guide to Business Succession Planning, 4th Edition (pp. 60-65). Toronto: CCH Canadian Limited.)