What are the benefits of succession planning?

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During the pandemic, a greater work/life balance became more prevalent, with many employees re-evaluating their career paths. It has never been more important for professional services firms to retain talented workers and keep them challenged and motivated. In a competitive job market, these firms need a clear and effective succession plan to achieve this.

Promoting Talent

To secure the ongoing success of any business, promoting talent is key. This is especially relevant to those delivering high-value services, such as financial advice. The quality of the services provided by a business is directly linked to the quality of its staff. As we slowly try to recover from the pandemic, planning for succession has become even more important as a means of ensuring business continuity and driving productivity.

What is succession planning?

Essentially, succession can be defined as the transfer of the ownership and management of a business to facilitate growth, exit or retirement. When done well, a succession plan enables business owners to bring in new talent, develop specialist areas and bring new ideas to the table. As such, it can drive business growth.  

When considering a succession strategy, is important to consider employees’ needs and to make sure that the business is appropriately equipped to succeed. When setting up a strategy, there are a number of options you need to consider.   

Custodian model

Using the custodian model, staff are promoted to partner, with no requirement to purchase a stake in the business as an indication of their goodwill and commitment. Each partner receives a proportionate share of the profits generated by the business during their time of employment, and on retirement they receive no capital payment. Hence this model is often described as ‘naked in, naked out’.

Using this succession strategy can bring several advantages. Not only is it quite simple to administer, it is also more affordable, as there is no requirement to purchase an interest in the business. Furthermore, earnings at partner level are frequently higher, because there is no requirement to pay interest on any loans that may have been needed to acquire a stake in the business.

There are some downsides though, retiring partners don’t receive a capital payment on giving up their interest in the business and limited liability companies may also find it more difficult to adopt this succession model, although in some cases, Employee Ownership Trusts can help.

Hybrid custodian/equity model

Using a ‘hybrid’ succession model, employees are promoted to the role of partner or director and are invited to purchase equity in an LLP, or shares in a limited liability company, at a discounted price. When the individual retires or leaves the business, they are then obliged to sell their shares at a discounted price.

This approach has a number of benefits for both the employee and the business. Firstly, although there is a requirement to purchase an interest in the business, it is more affordable as it can be achieved at a discounted price. Equity holders will receive a capital sum on retirement, reflecting the growth in the business during their period of ownership, again at a discounted level. As the cost of buying a stake in the business is discounted, the impact of interest charges on borrowings is unlikely to be significant. For the business, this type of succession model could mean individuals are more motivated to succeed, as they have had to invest their personal money. A disadvantage of using this model mean that when new members are introduced or individuals retire, equity needs to be valued to establish the purchase and sale price of shares. Additionally, the tax position also becomes more complex and professional advice should be taken in this area.

Full equity model

Using this succession model, key staff are invited to purchase equity in a Limited Liability Company or an LLP at its full market value. In practice, this model is not used frequently, as the cost of buying a stake in the business is unaffordable for the key staff that the business wishes to retain.  

How do Employee Ownership Trusts work?

Employee Ownership Trusts, also known as EOTs, have started to become an increasingly popular way of transferring the ownership of a professional services business from the founding or current owners, to the workforce.

EOTs were introduced back in 2014, with the aim of encouraging owners to sell controlling stakes in their businesses to their employees. If a company owner transfers a controlling interest to an EOT established for the benefit of all staff, who are then treated on an equitable basis, there is no Capital Gains Tax liability arising on the sale.

EOTs are very tax-efficient and are gaining popularity as a succession strategy for professional and financial services firms. Depending on how the EOT is structured, exiting owners can sell their stake at the full market, or discounted value, according to its set up. For the benefit of all staff, the business’ equity is owned by a trust, and the profits are fairly distributed on a equitable basis. As a further incentive, annual bonuses to all staff of up to £3,600 pa, can be paid tax free.  

Future Planning

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Having an the most appropriate and effective succession strategy in place can help businesses to support their future growth plans and retain their key staff to drive productivity. If the current owners wish to retire, they will need to have the right people in place to replace them and planning ahead minimises any potential disruption when the time comes. Giving workers a clear and achievable pathway to promotion that allows them a take a stake in the business is a positive way to drive performance. While many workers are re-evaluating their life plans and looking for opportunities to achieve a better work/life balance, succession planning has risen in importance and businesses should review their strategies now to ensure they are fit for purpose.

For more information on successions planning please contact Ralph Mitchison below:

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