When people talk about a succession plan, what do they really mean? Ray Cummings, principal of Greenoak Advisory, shares his views on how professional advisors can best help clients achieve a result that is right for them.
Succession planning can mean different things to different people, ranging from sale of a family business, inducting siblings into the business or introducing new management. On the other hand, it might not even be about sell-down or dilution but, rather, growing the business, albeit with an exit strategy in mind.
Estate planning vs. succession planning
By definition, estate planning is about what happens to a person’s assets when they die, such as the control of trusts.
“Theoretically, however, a succession plan should address what happens to assets while you’re alive, as well as when you die,” says principal of Greenoak Advisory, Ray Cummings.
“But people often separate the two into different exercises. In particular, they defer estate planning because they do not like to contemplate their own death.”
Where do I start on a succession plan?
Planning for succession can be a lengthy process.
“It may sound obvious, but a large part of the process is helping people to articulate what they want before getting to the accounting aspect – collating structure charts, financial statements and the like,” Cummings says.
“You need to sit down with a client and ask them what they want to do and why.”
As such, it is not unusual to feel less like an accountant and more like a counsellor.
“I have often found myself in a position where I am talking to business owners about issues that have nothing to do with tax,” Cummings reveals.
“Frequently you’re the only person they can open up to about various issues. Sometimes it can become quite emotional.”
“A succession plan should address what happens to assets while you’re alive, as well as when you die.” Ray Cummings
Regardless, he maintains that this is an essential part of the process and one that lets both advisor and client understand where they are headed.
Having nutted out the what, why, who and the when, Cummings starts collating background information such as structure charts, financials and valuation of the business and its various assets. He refers to this as the “how” part of the process, involving the analysis and modelling of transactions, determining tax consequences and formatting draft financials.
When all this is agreed and approved, the process is ready for implementation.
Key tax issues
Not surprisingly, two of the most obvious tax issues to arise are Capital Gains Tax (CGT) and the potential operation of employee share plan provisions.
Capital Gains Tax
In situations involving the disposal of the business itself, shares and other assets, there is potential for CGT liability. However, other issues may also arise.
“For example, let’s say the parents have a company structure and decide to issue shares to their kids, which is fairly easy to do these days over the internet,” Cummings says.
“Unfortunately, it is not uncommon for an advisor to find out about it after the event.”
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A pre-CGT structure may have "freshened up" the company’s underlying pre-CGT assets, but at a minimum the new shares issued are post- CGT and will therefore dilute the pre-CGT holding.
Equally, if the shares were issued post-CGT, it is important to take into account CGT value-shifting provisions.
“People don’t think about such things because all they do is issue a few more shares to the kids and don’t do it at market value,” Cummings warns.
“This will run square into CGT value-shifting provisions and create a capital gain.”
Employee share plan provisions
According to Cummings, some broad issues relating to employee share plan provisions also need consideration.
“To take a simple example: the owner of a company decides to gift $10,000 of shares to an employee. Given employee share plan provisions, in a standard case tax would have to be paid up front,” he says.
Although it is possible to defer the tax, the succession plan would have to be designed so that it had a real risk of forfeiture in that the employee had the prospect of losing the shares if they failed to meet certain performance criteria. The tax would be deferred, but the amount would be based on the value of the shares at the deferral point. So, if the shares were then worth $20,000, the employee would have to pay tax on the $20,000.
“From a commercial point of view, you will be in a very different place,” Cummings says.
“Under the first option, the employee has an absolute entitlement to the shares on day one, whereas under the second the employee faces the prospect of losing the shares.”
Do I need a formal document?
Naturally, clients are reticent to pay fees for something in which they do not see any value.
“For a simple transaction, such as the transfer of shares, you would probably just go ahead and do it,” Cummings concedes.
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However, for a private business group involving significant value and multiple entities where some assets are held individually, some in a trust or trusts and others in superannuation, the complexity multiplies.
“In these cases, it is often advisable and indeed necessary to set out the whole process in a formal document,” Cummings states.
“This document also forms the basis for the implementation of the succession plan, as it would contain all the key information and various steps to implement the plan.”
The accountant’s role
The question of whether a lawyer or accountant should drive the implementation of a succession plan used to be a vexed one. In Cummings’ view, however, there is no right or wrong answer.
An accountant can either be central to the coordination of other advisors or play a support role. In larger private groups, business, accounting, tax and legal issues frequently become complicated, and it is important that all advisors work together to resolve them.
What other issues should I be aware of?
It is also important that advisors clearly articulate their roles to a client at the outset, and not overly complicate things by launching into possible tax consequences, Cummings believes.
“Clients need to understand the critical role they have in determining the what, why, who and the when of a succession plan,” he says.
“An advisor’s first task is to listen, listen, listen and to help the client articulate [their desired outcome]. Only when this has been done should an advisor sit down to work out the ‘how’.”