In an interesting insight Dr. Suresh Surana Founder, RSM India shares his insights on succession planning in the MSME and SME industry and how the sector can work their way forward.
As per the Economic Survey 2021, India has more than 60 million MSMEs, which are the backbone of the economy, and play a crucial role in employment generation and in contribution to the GDP. The sector employs more than 110 million people, contributes roughly 30% to the GDP, and contributes half of the country’s exports.
Most of the SMEs in India have been family-owned businesses either first-generation businesses or businesses which have been managed by different generations of the same family over a number of years. Most of the SME (small and micro enterprises) do not have a proper structure, management depth and well-defined plan for succession. At the same time, the business risks have increased manifold in the past decade and further aggravated by the pandemic. It is necessary to take conscious steps to ensure the survival and continuity of the business which are outlined in this article.
Heavy reliance on the promoter for business continuity
In most SMEs, it is generally seen that, the business is managed by one key member while most of the other family members simply assist in operations. In case of any contingency (such as demise or incapability of such key member), it can directly impact business survival. For this purpose, other capable or second-generation family members may be trained and empowered, or the SME may even consider engaging experienced manager to take on the business mantle.
Financial Losses & Pandemic
Most SMEs are not adequately funded and cannot withstand losses or disruptions caused by the pandemic. It is necessary to ensure that the SME has adequate working capital and ability to withstand the losses. Some of the steps which can be done are:
- Keep a part of the annual profits earmarked for contingency and build reserve
- Avail bank finance – banks have priority sector lending and also special Covid related loans
- Induct financial partner
Protection or Personal Assets & Entity Structure
Most SMEs are organized as proprietorships or partnership firms. As a result, in the event the business incurs losses or is unable to meet its financial commitments, the personal assets of the proprietor or partners are liable to be attached. To ring fence the personal assets, SMEs may consider converting their business to Limited Liability Partnerships (LLPs) or One Person Company (OPC). This will also ensure succession from a legal perspective as the LLP and the OPC continues. Further, while availing bank loans, one may explore giving a particular property as collateral rather than personal guarantee of the promoter and his family members.
Next generation not interested in family business:
An important trigger which necessitates succession planning is that in some cases, the next generation may either have entrepreneurial ambitions outside the legacy business, or simply even lack the willingness or the confidence in taking on a leadership role. For this purpose, you may redefine business to enthuse next generation, particularly by using digital (convert a retail store to e-commerce or on-line model). This strategy may have a multi-pronged impact, firstly, attracting the second-generation wherein they can take liberty to remodel the business through digital means and secondly, also with a right approach, may result in increased business or client base.
Sell or consolidate business to reach a meaningful scale
In case where there are multiple businesses operating within the same SME group, you may also consider consolidating the business to achieve a reasonable scale and greater operational efficiency. In cases where the current scale of operations is insignificant, the alternate option would be to sell off the business.
Inheritance planning is crucial by clearly identifying the heirs who will succeed the business and who will manage the business (family disputes are a common reason for lack of succession). This can be done by a proper Will and use of nomination.
The importance of evaluating whether the current business structure as compared to other business models (LLP or company or partnership firm in place of proprietary concern) should be evaluated from a tax efficiency perspective, as each structure has its own pros and cons. It is notable that the current tax rates in India for businesses can be as low as 17.16% and as high as 42.744% and therefore, it is important to evaluate the business structure from a long-term perspective as well as tax perspective. It is important to also plan for appropriate remuneration, interest on capital and payment of rent for an efficient tax and fiscal plan.
Disclaimer: The opinions expressed in this blog are purely those of the author, and TheSMEIndia.com does not necessarily subscribe to it. TheSMEIndia.com will not be held liable for any direct or indirect damage caused to any person or organisation.