Becoming Succession Ready: Financial Discipline
Updated: Feb 15
When contemplating your practice succession, it is essential to consider the potential risks in your business and assess your business's financial discipline.
When preparing for your practice succession, consistent financial performance over the last three to five years will provide confidence to a potential successor of what can be expected in the future. Ensuring your business is compliant, and well-organised will be tested during the due diligence process. It is worth putting the time into cleaning up any inconsistencies during your period of 'Becoming Succession Ready'. Excess debtors are an issue that should be addressed well before your business ownership changes hands. Matters like above-market salaries and below-market services fees should also be addressed as you become succession ready.
Having excessive debtors can be a problem for several reasons. If a significant portion of a business's revenue is tied up in accounts receivable, it can cause cash flow problems. If customers take a long time to pay their bills, or if there is a high risk of not paying, it can increase the risk of bad debts. Managing a large number of debtors can be time-consuming and costly. The business may need to devote more resources to chasing payments. Excessive debtors can reduce profitability if the business has to offer discounts or extended credit terms to customers to get them to pay on time. Excess debtors will be perceived negatively from a buyer's perspective and will likely impact business value.
It is common for practices to overpay staff members, particularly family members or key senior staff. Typically, for family members, if they are to continue in their roles, their salary may be adjusted down closer to market rates during the succession process. Any above-market compensation creates an expectation across the business and can create challenges if these rates need to be realigned. Of course, the total picture needs to be understood as there may be compelling reasons why a key staff member is worth above-market remuneration. If staff are being paid below market salary, it is common for key staff to receive a salary increase, particularly if they are quality performers in the business.
If a practice charge below market rates for its services, this may present a significant issue for a potential successor, particularly if the successor is external to the business. Reduced margins will likely bring reduced profits, which will impact the value of a practice. If a practice has chosen to compete on price and charge lower fees, this will present a real challenge to any successor to increase these fees. If this happens, it may harm the value and on retention amounts. Raising fees may lead to client and even staff departures – all matters that will decrease value. If your practice operates at the lower end of the market, from a fee perspective, it would be wise to address this issue and start promoting the value of your services and increasing your fees well before the ownership of your business changes hands.
It is common for various personal expenses to run through a practice that would not be part of the business operating model post-succession. The personal expenses will typically be normalised out of the practice's financials during your practice succession, including personal travel, interest & depreciation expenses, donations, personal home office expenses, personal mobile and internet expenses, personal usage of motor vehicle, personal club memberships, etc.
Presenting maintainable and sustainable financial records will go a long way to helping you achieve a successful practice succession.