The real problem with business succession in NZ

You have built up a great business that you are ready to exit. You have even planned succession—you have identified a successor (or successors) who are as keen and passionate about the business as you have been and bring the right energy to take it to its next phase.

The funding dilemma

Most internal succession will require vendor finance, as it is unusual for employees to have lump sums of cash to pay for shares or enough equity in homes to allow any cash up front. This is most likely if they have bought property within the last seven years. And given the outlook on property, there’s unlikely to be significant equity realisation in the next five years. So really, this comes down to the property market and both direct and indirect reliance on residential property to fund businesses.

Balancing growth and succession 

Vendor finance is dependent on business performance and is repaid through dividends. Depending on the valuation of the business, this could take at least five years and sometimes beyond. Now, you have competing goals between re-investing in the business to fund growth or paying dividends to repay vendor finance. This may cause friction between the outgoing and incoming shareholders, or even if their goals here are aligned, it can frustrate business growth. An appropriate board composition could assist with this, so the board is not composed only of the parties to the succession transaction. In addition to this conflict, banks’ consideration of cashflow lending (limited) also depends on a strong equity position on the balance sheet. 

Banking and security challenges

Even if these aspects of the succession plan are proceeding well, many industries or businesses require lending facilities to be in place to fund working capital in various scenarios. Often, those facilities are secured or guaranteed over the personal properties of the shareholders. So five or six years down the track, 50% of shares may be transferred, and now the exiting shareholder needs to exit and the new shareholder has enough equity to fund the remainder of the shares. But there is also the matter of the current banking facilities secured or guaranteed by the exiting shareholder… 

The broader economic impact

The issue is the reliance on residential property funding businesses, business growth, and business succession. This is now hindering both the growth and succession of businesses in a country predominantly consisting of SMEs (small and medium-sized enterprises), which has other flow-on effects for this economy in general. Often for medium-sized enterprises, it is harder to sell businesses outright as there are either the same funding issues or a very small pool of buyers, which makes it difficult to realise the value. 

Key actions for successful succession

So, because succession issues go beyond finding someone to carry on your business:

• Current business owners need to start thinking about succession early (like 10 years early)
• Identify potential succession or successors within your business and start the conversations, including the discussions on valuation and structure
• Start financing discussions early.  Think outside the box for funding working capital using other tools, such as inventory or debtor financing, and talk to banks about other working capital and succession financing options that might be available.
• Ensure that your governance structure balances the conflict between facilitating this transaction and the business’s requirements.

This is so important for the future of New Zealand business and the economy in general. If you need any assistance thinking this through, we are here to help.