Funding the transfer of the business to the next generation

Passing the baton

So you have built up a successful business that is providing you and your family, including adult children involved in the business, with a decent standard of living.

You know that you will want to retire at some stage and will not be looking to reduce your standard of living. But how do you extract a retirement income from a business that you plan to keep in the family rather than sell?

I always recommend family businesses run a “fire drill”. Sit down with your family and team of advisors, and assume you had to exit the business within the next 30 days due to an uninsured illness.  If you required an income of $55,000 per year (choose your own target, but this is the amount required for a comfortable retirement in Australia), how would the business and the future owners fund this?

Why have a funding plan for business succession?

Benefits include the following:

  • Ensures that a business continues to exist following the retirement of the current business owner
  • Identifies the assets (physical and human) that are core to the business success
  • Gives the children involved in the business peace of mind of knowing who will be involved in the business in the future
  • Gives each party and his/her family the security of knowing that they will have the income to support themselves following the transition
  • Helps the business transition more smoothly and with the least disruption

There are two issues here: one is the transfer of management control, and the other is transfer of ownership. You may think they are the same, but they have many different features.

I will deal with management in a future article, but for now let’s concentrate on the transfer of ownership. This can be further complicated if you have children working in the business and others pursuing separate careers.

If your children have been working in the business, and you have not been thinking about business succession, then often your business financials and their personal financials will be unattractive to a third party lender. Selling the business to them outright may not be an option.

Possible planning tips to ease transition:

  1. Make sure you have been taking superannuation contributions out of the business over the years to build up your retirement fund so you are not totally reliant on the equity in the business.
  2. Reduce the business ownership of assets to those essential to its success. See what business assets you may like to take on personally, such as a business property that you could move to your SMSF and lease back to the business in return for a steady rental income.
  3. Structure your business so that it allows for the gradual transfer of shares or units over the years preceding your planned exit but prepares for a sudden one. A lender may be more willing to fund debt to new owners if a plan is in place and they can see the stability of the business is assured.
  4. Put a Vendor Finance arrangement in place for the remaining value of the business so that your children pay you capital and interest repayments over a fixed period, funding your retirement income. Terms can be favourable to them, but any agreement should be watertight and in writing to avoid confusion or disagreement.

You will need to have estate equalisation clauses in your will to ensure children not in the business will not lose out and become disgruntled.

You may retain some ownership interest providing you with dividend income in future years, but as mentioned above, you must be prepared to relinquish the “management” of the business.