Despite the fact that generational succession, which refers to the process of passing on one’s business to their children or other members of the family, seems to be an easy process, many families find themselves in conflict precisely when the parents, the business, and the children are at their most vulnerable. 

Generational succession should be handled with the same level of care and attention as if you were selling your company to a complete stranger. This will help to reduce the likelihood of misunderstandings and disagreements occurring.

In the event that you are interested in handing over your company to your children or other relatives, there are a few essential factors to take into consideration: 

Does the next generation have the capability and inclination to run the business? Do your children have a genuine interest in it? 

It is necessary to do a practical analysis to determine whether or not the company will be able to continue to flourish after the transition. The retiring generation may want generational succession in specific situations. 

This may be done for a variety of reasons, including the desire to keep the company within the family, to ensure that their legacy is carried on, or to provide a stable business future for the subsequent generation. All of these are valid objectives, but in order for them to be accomplished, there must be both the ability and the will to do so. 

Capital transfer: how much money will be taken out of the business during the transition?
What amount of money do the current company owners, often the parents who are quitting the firm, need to take from the business during the transition? The larger the amount of capital required, the greater the pressure on the company and its equity partners. 

In most circumstances, the entering generation will not have enough money to buy out the outgoing generation. This will need the suppliers making ongoing investments in the business or the company incurring further debt. 

In many circumstances, the retiring generation will choose to keep some degree of equity ownership. This might be a way to keep an interest in the firm or to stage their exit. In any situation, it is critical to chart the capital transfer from both a business and shareholder standpoint. This must be recorded and approved by the company first, followed by both generational groups. No generational shift should occur without a detailed and agreed-upon capital programme. 

Income needs: ensuring pay is on business terms.
In many SMEs, the owners arrange their income from the company to satisfy their needs rather than providing adequate compensation for the duties they do. This might lead to the firm paying either too much or too little. 

Compensation for directors and shareholders should be more formalised throughout generational transition. Compensation should be tailored to specific responsibilities, and any performance incentives should be explicitly defined. 

Operational and managerial control
Once the capacity and capital evaluations are done, it is critical to consider the transfer of control. This may be a very sensitive area. 

It is critical to plan and agree on how operational and managerial control will be maintained and transmitted. 

The strategy for operational and managerial control should be recorded and signed and agreed on by all stakeholders, with either timeframes for time-driven succession or milestones for event-based transitions. 

Transition timelines and expectations
Generational succession is often a process rather than an event, and it occurs gradually over time. The essential challenge is to determine and ensure that all stakeholders understand and accept the time period over which the transition will occur. This should be included into the established succession plan. 

The necessity for more formality and management structure
Generational succession often necessitates more formal management and decision-making procedures. This formality should result in a clear division of functions between management, the Board, and shareholders. 

In SMEs, these functions often blend, with no obvious separating lines or limits. Management should agree on and define their roles and duties, as well as clear key performance indicators (KPIs). 

Do you need any help or advice around estate planning and succession? Bates Cosgrave is here to help. Contact us on (02) 9957 4033.