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29 Jun 2017

Backwards succession planning


3 min

An all too familiar tale with dire consequences

Succession plans often include passing on the family business to children.  We often find retired company directors that appoint their children as directors.  While there is nothing wrong with this concept, if not properly managed it can create dire results for retired directors.  Take the following case in point as an example of ‘backwards succession planning’.

I dealt with a matter where the director’s son, two years earlier, became a company director when his father retired, who also succeeded his father as director.  This kind of legacy in the small to medium enterprise space is common.  The entity’s shares are transferred to the new director and the previous director retires with the comfort of passing the family business down to their child.  The new director then goes on trading the company as it was left to them.  Or sometimes, due to inexperience or misplaced vigour, they get finance on the newest and best machinery, which takes what was otherwise a well-run business to insolvency.

In this matter, the company ended up in liquidation and it became alarmingly apparent that the retired director had a lot more to worry about than facing his mates down at the pub over his son’s failed attempt at running the company.  The alarm being…neither the new or retiring director advised the company’s suppliers of the change in directorship.  When the company failed, it quickly became evident that numerous company creditors held personal guarantees from the retired director.  Even more surprising, there were even older suppliers still holding personal guarantees of the director’s grandfather.  As a result, two retired directors, both with recoverable assets, were now being pursued for personal guarantees for company debts that they had no control or interest over! This means that over 12 years—two years since the father’s retirement and the 10 years prior for the grandfather’s retirement—suppliers weren’t asked to complete new credit applications and update the personal guarantees to the new director.

We also see people exposed to personal liability when they change from a sole trader or a partnership to a company structure. It’s rare that suppliers are advised of the change and therefore the old accounts (in a name of the sole trader or partnership) continue to be used without any thought to update them to the company details.

Any adviser assisting with succession planning must be aware of this personal guarantee issue, particularly when companies are passed down in families, lest an aggrieved retired director blame their advisor and seek them to compensate creditor losses.

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