Succession planning (Part 2)

By Peter Cox December 14, 2017 Industry news

Another option for an owner exiting their business is to sell to a staff member or to a number of staff.

In the first part of these two articles (read it here) I examined how to go about selling a store to an outside party as part of the process of succession planning.

Another option for an owner exiting their business is to sell to a staff member or to a number of staff.

The process is the same as if you were selling the business to an outside party – that is, calculating the goodwill as well as negotiation as to the assets to be purchased.

However at this point generally speaking the similarities with selling to staff cease.

It is a fair assumption that, whilst many staff dream of one day owning and managing their own business (I started my own business over 20 years ago and rank it as the best financial and personal decision I have ever made), they probably do not have the financial resources to purchase the store outright.

How then to approach vendor finance in a way which both parties benefit with the end result being the transfer of ownership?

I promote and use what accountants call the “Lock Step salary” approach.

Let’s look at a case study where a staff member wishes to purchase the store.

 

Step 1 – Calculate goodwill

Here I’m using the “Super Profit” method to calculate goodwill, for details of which please refer to the article in the last (November) issue.

For the purposes of this case study, goodwill is calculated as at the end of the financial year based on the last say three years’ trading and average dollar investment in Stock, Debtors, Written Down Value (WDV) of fixed assets less trade creditors

Goodwill in this case is $150,000.

(You can find my series of articles on how to calculate the goodwill of a hardware store at www.petermcox.com.au. Also available there is a simple Goodwill Calculator – find it in the Free Financial Management Tools section.)

 

Step 2 – Calculate Lock Step

The agreed period of time for purchase is five years.

The agreed Uplift Factor is 3%.

The Uplift Factor is an agreed percentage increase in the outstanding goodwill at the end of in this example the financial year.

 

Step 3 – Calculate payment plan

With this information a payment structure can be put together based on a five year period (see below). Flexibility can be built in during the payment period which I will cover later in this article.

In this example, the staff member or members purchasing are “salary sacrificing” the purchase of goodwill.

Repayment intervals over the year need to be agreed to – each pay period, monthly or quarterly.

My experience has shown that six-monthly or a yearly repayment can be hard to make for staff members as they could have already spent their “after tax” dollars on other commitments.

Flexibility should be available in case the purchaser wishes to increase their payment, which of course will require future years’ commitments by the purchaser to be recalculated.

The repayment schedule from the vendor’s point of view is preferably the minimum goodwill payment.

Of course all of this needs to be contracted and the advice of a solicitor is required.

I cannot stress how important it is that, right at the start of this process, the appropriate legal documents are drawn up.

The structure of the sale will also need to be reviewed by the external accountant from the vendor’s viewpoint in relation to tax planning.

It would also be appropriate that the purchasing staff member or members should receive legal and accounting advice.

 


Peter Cox is a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail environments. Phone 0061 438 712 200 or visit www.petermcox.com.au

You can find all of Peter Cox's most recent Money Matters articles here.

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