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Having an unbiased third-party advisor can be particularly impactful for clients who have built a business from scratch, as it can be an emotional process to transfer and exit a business that one has grown and nurtured.josh hodge/AFP/Getty Images

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Family businesses are the backbone of many economies. However, the process of transitioning a family business from one generation to the next can be a daunting task.

Transferring ownership in any business can be a complex process, and when the business runs in the family, this transition involves additional emotional considerations and relationships that make it especially delicate. Not only is the long-term success of the company at stake, but also familial bonds.

As with any major life change, trusted advisors should guide families through these complexities by providing clients the necessary counsel and coaching, while working hard to preserve family dynamics.

Beyond providing prudent financial guidance, advisors can draw upon their deep knowledge of the family’s personal and financial goals to develop a roadmap for transitioning the business and open clear lines of communication with all stakeholders.

This typically involves arranging regular family meetings and facilitating discussions on structural issues that the succession plan must address, including remuneration, income distribution, shareholder agreements, and benefits plans that meet the family’s needs.

More than covering the logistics, it’s important to also be prepared for the differences in opinions within the family regarding how the business should be run. An advisor should be a neutral mediator, posing challenging but essential questions to clarify the fundamentals.

That may mean confirming if there’s interest among the children or siblings to take the reins of the business, explaining the differences between owning and working for a company, and the equalization plan for the family members who don’t wish to own or be involved with the business.

Having an unbiased third-party advisor can be particularly impactful for clients who have built a business from scratch, as it can be an emotional process to transfer and exit a business that one has grown and nurtured. Oftentimes, this means providing clients with a big-picture perspective and highlighting the long-term impacts a transition may have on their financial goals and well-being.

Succession planning and its implications

Family businesses are often rooted deeply in the family’s identity, bringing both pride and tradition, but also conflict and tension, particularly when determining who will take over and how to manage the business.

In some cases, the successor may be obvious – perhaps a son or daughter who has been working in the business for years. In other cases, the family may need to look outside for a successor. In either case, an advisor can encourage clients to identify suitable candidates and develop a plan for training and mentoring them.

Once there is an internal agreement regarding the ownership of the business, the roles of family members and the level of their involvement, advisors should work with the tax specialists and lawyers to structure a formal and comprehensive transition plan. This would outline clear goals and objectives of the transition, timelines, and interim steps to prepare the business for its new owner, structure the transfer, and identify tax implications.

Understanding the fair value of a business

A common concern about transitioning a family business to the next generation is how to ensure all family members are treated equitably. One of the best ways to handle these concerns is by establishing a fair market value for the business.

This assessment enables all stakeholders, including shareholders and employees, to comprehend the business value and potential for future growth and avoid any perception of unfair treatment among family members. By determining a fair and reasonable valuation, any decisions made concerning the transfer of ownership will be more transparent and assist in creating an equitable equalization plan for family members, whether that be with shares or cash.

Understanding the valuation of the business is also beneficial when preparing clients for unforeseen circumstances. While many families often only consider business transitions during conflicts or after a family member’s death, initiating the conversation early will prepare for unforeseen circumstances like disability, death, or divorce, and prevent significant financial losses due to the “fire sale” of assets.

The value of the business will likely change over time, which is why these conversations should be ongoing.

Preparing for unforeseen situations

When preparing for such unforeseen circumstances, advisors should provide clients with contingency plans such as leveraging insurance policies to pay the tax bill associated with transferring a family business, if any. This may include determining in advance if the business qualifies as a Canadian-controlled private corporation. If so, the sale may be tax-free based on the lifetime capital gains exemption, which is $971,190 of tax-free qualified capital gains on the sale of eligible businesses.

It may also be worth considering a Section 86 Estate Freeze, which determines and “freezes” the value of capital property for one shareholder while attributing the future growth of that capital property to another.

Estate freezes provide the added benefit of offsetting a pre-determined tax bill with life insurance. This ensures that if the owner of the business passes away, their life insurance proceeds will cover the tax bill owing, so that assets, or even the business in some circumstances, are not required to be sold to pay the tax bill.

Family comes first

Planning is not sufficient unless it’s communicated clearly, allowing for open discussions about its implications for everyone, even those who are not involved in the business such as spouses or family members of key stakeholders, who often feel left out of the loop.

It’s crucial to reinforce the agreement continuously, keep an open channel for communication, and not let business discussions take over family time by determining clear boundaries.

One of the best ways for a business to survive the test of time and preserve the family legacy is to remember the reason for building the business. Advisors can encourage clients to celebrate the past and participate in achieving the shared vision for the future, all while remembering that family is more valuable than any business.

Alexandra Horwood is a portfolio manager and investment advisor with Alexandra Horwood and Partners at Richardson Wealth Ltd. in Toronto. She is also a member of The Globe and Mail and SHOOK Research’s ranking of Canada’s Top Wealth Advisors.

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