Succession planning is one of the key issues facing SMEs over the next decade. As the wave of baby boomers owning about 80 per cent of Australia’s SMEs valued at roughly $3.5 trillion retire, it will pose huge problems retirees who built their businesses using personal property as security.

There’s a spanner in Australia’s business works and it will hit SMEs hard this decade as the baby-boomer-owned SMEs plan their retirement: Unlike Europe, most of Australian’s businesses are secured by property loans.

This reflects three things: The baby boomer’s psychology regarding property; the huge capital gains in Australia’s real-estate market that have funded business growth over the past four decades; and the Australian banks’ practice of using housing as collateral against business borrowings.

But that may all be about to change as the dynamics shift sharply when SME owners pass on the baton to the next generation.

The heart of the problem is this: Baby boomers bought cheap property and enjoyed strong capital gains on residential and commercial properties. This meant they often chose to secure their business loans against property to fund growth. Their successors will not have such opportunity.

Subsequent generations have entered the property market at inflated prices and usually already carry large mortgages, so their capacity to gear up to purchase a business upon the owner’s retirement is limited. Secondly, this means that they will not enjoy the capital gains of their predecessors as a source of working capital, which will severely limit their capacity to run the business.

Many retiring baby boomers will simply sell their businesses to a third party but many hope to hand over their businesses to a chosen successor – either a family member or key member of management, and each of these options come with a raft of problems.

These can be as simple as inheritance disputes among siblings, the need to remove personal property that has to date been used as security for the business, or to help a trusted non-family second-in-command find the funds for a management buy-out.

Fortunately for many companies, there is a solution. Debtor finance can allow successors to raise the purchase price, or pay-out siblings, all while removing personal risk from the business. Following are two scenarios and examples of how debtor finance can help.

Scenario 1 – Removing personal property from the business

Often a business owner seeking to retire wishes to pass the business to a chosen successor but the business is secured by the retiree’s personal property.

In this example, the successor’s father owned a furniture manufacturing business of which the son was a manager, valued at $1.2 million. The father wanted his son to inherit but had $1 million in bank borrowings – a charge over company assets and over the father’s two investment units worth $750,000 each.

The father was prepared to sell the business to the son for half its real value and was happy to allow the son to repay that purchase price over 10 years.

However, he did not want to retain the charges over his investment units because if the business failed under his son’s guidance, then the father’s retirement was in jeopardy.

The company needed $1 million in working capital. It had $2 million in receivables and the son was able to raise $1.5-$1.6 million against these debtors. The bank received a cheque of $1 million and released the security over the father’s investments.

Knowing the investment units were safe, the father transferred the business to the son for $600,000, which the son could either pay off over 10 years or in one lump sum if he preferred.

Scenario 2 – Inheritance disputes

Often more than one sibling will inherit a share of a business from their parents on retirement. In this situation, one sibling may have had an active interest in the company and the other may have no interest in the business and will want to be bought out. If the other sibling can’t raise the funds for the buyout, then the company will be put up for sale to a third party to buy out the disinterested sibling.

Sometimes, a parent may demand that one sibling pay a disinterested sibling their half while still issuing that sibling with a 50 per cent share in the company.

The children can raise funds against the business’s debtors to solve this dilemma.

Scenario 3 – The management buyout by a family member or management member

Often when an SME retires, he may wish to pass the business to a family member or key member of management. Unfortunately, that person may not have the money to pay for the business – money that the owner needs to fund his retirement.

This means that the company may need to seek an external buyer. Rather than be forced to leave the company should the new owner bring in their own management, and start from scratch, family members or existing managers may be able to raise the funds against the debtors for a management buyout. This gives them the chance to buy a business they know inside and out with an established customer base, in a sector they understand.