Many Canadians have built their wealth by operating a small business. Now, with an aging workforce and an economy on the upswing, many owners are weighing the benefits of selling their business to a third party or of transitioning it to a family member.
However, while succession represents a significant financial event for business owners, only a small percentage of them considering such a move have developed a business succession plan.
Why? Many cite difficulty finding a suitable buyer with sufficient financing to close the purchase.
Yet planning in advance with a team of expert advisors can make a significant difference in what business owners will take home following the transition of their businesses.
There are two key considerations they need to make: maximizing business value and applying strategies that’ll help minimize tax on the sale of the business.
It’s therefore important to understand the factors that can make a business more attractive to a prospective purchaser.
Such factors can include the financial standing of the business, the quality of its products, the customer and supplier base, the firm’s market position, any competitive advantage the firm might have, and its managerial abilities.
Getting down to business
Recent research conducted by RBC and the Canadian Institute of Chartered Accountants finds almost one-third of private-sector chartered accountants surveyed expect their company to have a new owner in the next five years. That means there’ll be a lot of business owners out there looking for advice.
Take the fictional example of Robert Lalonde. Lalonde is looking to sell his incorporated giftware distribution business (GiftCo) to a third party. He’s built his business from scratch since his arrival in Canada 17 years ago. The business currently occupies about half of a 2,500-square-metre warehouse and distribution facility — bought six years ago — having outgrown its previously leased location. Last year, Lalonde purchased a piece of land just outside the city limits with an eye to building a larger facility in the next few years.
His business currently generates a healthy seven-figure revenue line, and a consistent annual profit of over $300,000. For several years, Lalonde has left cash in the business after paying his own salary, with the intention of using it to fund the development of a sideline business importing additional product lines from Europe. Over $800,000 currently sits in a corporate investment portfolio in fixed-income investments.
Lalonde’s business has shown steady and consistent growth for a number of years, having a broad and increasing customer base, and numerous long-term domestic and international suppliers.
Lalonde needs to:
Ask himself why he plans to sell the business. To obtain the best price from a prospective purchaser, Lalonde needs to be sure he has a valid and well-thought-out reason to sell. Business owners need to be wary of selling for economic or emotional reasons, as this can lead to a lower offer.
Build a strong team. Lalonde will also want to draw on the advice of an advisory team. This is likely to include:
Gather essential information
Lalonde will need to gather key information to incorporate into his succession plan. This will include at least three years of corporate tax returns and financial statements, as well as a list of fixtures, equipment, employees and customers, copies of loans, payment schedules and relevant lease agreements, and a summary of his professional advisors.
Be discreet. While negotiating the sale, Lalonde has to be very careful not to divulge information about his day-to-day business activities that could be used against him by his competitors. He should ask any potential buyer to sign a non-disclosure agreement and then provide financial information only to potential buyers who have paid a deposit. This will also help confirm whether a potential buyer is serious.
Maintain focus. It will also be important for Lalonde to not let the business decline while he’s preoccupied with the sale. He should maintain his premises, inventory levels, and normal business hours and practices.
Cutting the tax
There are a number of tax strategies that can be leveraged over time to avoid leaving money on the table during the sale of a business.
The following strategies can help Lalonde minimize the tax consequences when selling GiftCo to an outside buyer. Some strategies must be undertaken well before the closing date, so he should start as soon as he can.
If the purchaser is buying the shares of GiftCo, Lalonde may be able to claim the capital gains exemption if his shares qualify. To qualify, substantially all of his business assets must be “active Canadian business assets” at the time of sale and at least half of the assets must be active assets during the 24 months before the sale. But given the size of the investment portfolio, it’s quite likely assets will have to be removed from the company to purify it so it’ll meet tax requirements and potentially qualify for this exemption.
A corporate reorganization could be considered as a way of providing potential buyers with a clearer view of Lalonde’s operating business. This may include the separation of the land for future use from the corporation that contains the giftware distribution business. Involvement on the part of Lalonde’s accountant and lawyer would be required to arrange any restructuring needed for the business.
Lalonde should consider the pros and cons of setting up an individual pension plan or a retirement compensation arrangement, which may help to defer some of the tax upon a future sale and be a potential use of some of the funds in the investment portfolio.
If Lalonde’s sale of GiftCo is still a few years away and the value of his business is increasing, an estate freeze may allow for future capital gains to accrue for other family members and possibly multiply the use of the capital gains exemption.
Lalonde could consider using some of the sale proceeds to make a charitable donation in the year of sale. The donation tax credit may help him minimize the tax on any capital gains realized on the sale.
If Lalonde provides some of the financing for the purchaser in the form of vendor take-back financing, he may want to consider receiving the sale proceeds over several years to use the capital gain reserve to spread the gain over a longer period for tax purposes.
As Lalonde’s example shows, business owners looking to sell their businesses in the near future have a number of critical decisions to make in order to prevent accepting low offers and paying too much tax. To do so, they need to enlist the help of professionals who can walk them through the steps of a successful succession plan.