MDUDUZI LUTHULI: Never too early for entrepreneurs to think about exit strategies
Proper succession planning is an absolute must and should begin on day one of ownership, if not before
It may seem counterintuitive to be thinking about the exit strategy early on in your entrepreneurial journey, but you should be.
Tomorrow is not promised to anyone and if you truly believe your business holds any value, protecting that business should form a critical part of your business plan and growth strategy. Why build an asset if you won’t ensure its survival?
Small businesses rely heavily on their owners, so if you as a business owner or business partner had to die suddenly, what would become of your share in the business? How do you ensure your family members benefit from the work you’ve done? How does the business continue to run in your absence?
By making business succession arrangements early, owners help make a smooth transition and minimise any negative effects of their departure from the company.
In other words, proper succession planning is an absolute must and should begin on day one of ownership, if not before.
A smooth transition of ownership starts with making a handful of strategic decisions and organising company financials. When developing an exit strategy, gather and consolidate financial documents like company valuation data, inventory, tax returns and up-to-date financial records.
Proactively organising financial documents also protects the business in the event an owner must sell unexpectedly or a family member must handle the transition under more dire circumstances.
A buy-and-sell agreement ensures that on the death of a business owner, the company can continue to operate without interruption or interference, and the business owner’s family will receive what’s due to them in terms of the personal value the deceased business owner held in the company.
It does so by detailing how the remaining partners can buy out the share of the deceased partner by formalising key information such as a company’s sale price, the value of each owner’s share and ground rules spelling out who can or can’t be a buyer.
A buy-and-sell agreement also reduces the risk of conflicts that could arise between family members or partners who may put their best interests ahead of the company’s.
Such buy-and-sell agreements will normally be backed by a buy-and-sell insurance policy, which will mean that the proceeds of the policy will be used to buy out the deceased member’s interest in the business.
Theoretically, your co-owner needs to be prepared to buy out your shares at any moment. Since not everyone keeps liquid cash around in this magnitude, many businesses will fund their plan with insurance.
A business and/or business owner should enlist professional advice to craft the best agreement and ensure that it is properly executed. A financial adviser may collaborate with other types of professionals, including lawyers, accountants and those who specialise in valuing businesses. There are estate planning issues, tax-related concerns and money management considerations involved in succession planning and nobody is an expert at all those things.
There is no set checklist or flowchart involved in succession planning and the agreement should be updated periodically to reflect changes to the business valuation, such as possible increases to life insurance coverage funding the buy-and-sell agreement.
Valuations prepared by objective third parties tend to be viewed more favourably by potential buyers, including internal successors, than those calculated by business owners themselves.
All owners of small businesses must consider estate taxes in their succession plan. Estate taxes vary based on the value of the business and the overall size of the owner’s estate, including their other assets.
This should be a big focus, more especially for family-owned businesses as most of their net worth is tied up in the business. These families are often forced to sell their business to pay the taxes even though they want to continue to run it. To avoid this, estate tax planning should also be a part of the succession plan.
• Luthuli is an independent financial adviser and founder of Luthuli Capital.