President of Sobel and Company, Professional Corporation
There's an aging population of owners looking to exit the family business and, between 2018 and 2025, they are expected to represent a transfer of up to $4-trillion in assets, according to PricewaterhouseCoopers. Yet less than half of family-owned businesses have a formal succession plan in place.
Many entrepreneurs hold off on an exit strategy until they retire or are too old or ill to continue, but there are potentially unexpected reasons that may require a departure from the business much sooner, including family obligations, financial necessity or other life changes. Not having a well-defined strategy in place can force hasty decisions that put the business at risk – and could leave money on the table.
Disposing of a private business is a lengthy, complicated process that usually requires careful planning to get the desired financial results, which can take as long as three to five years.
Establish the business's worth
The first step is to make every effort to maximize the attractiveness of your business to potential buyers and increase its net profit. This can be achieved by reviewing revenue recognition policies, diversification of revenue concentration, dropping low-margin customers, negotiating with or switching suppliers on cost, reducing or eliminating discretionary expenses, and divesting any assets that don't add value or are not required in the business operations. For valuation purposes, a buyer wants to see a two-to-three-year history of good profit, but it takes time to show the effects of all these changes.
There are different ways of valuating a business and various factors that can affect its worth, so engage a qualified adviser to establish a fair market value. Don't forget intangible assets such as patents, goodwill, copyrights, customer lists and trade names. And even if transferring or selling the company to family, avoid the mistake of claiming a low valuation of the business for tax purposes, as this can backfire if the Canada Revenue Agency disagrees. As with any transaction, don't forget to factor in GST/HST implications.
If you're a sole proprietor or corporation looking for an exit strategy, there are basically four ways to transfer out of your business.
1. Transfer to the next generation
Most entrepreneurs continue their legacy by transferring ownership of the business to their children, family members or a trusted non-family member through an estate freeze.
With an estate freeze, you'll receive preference shares while the new owners purchase new common shares for a modest amount. As cash flow becomes available, the preference shares are usually repurchased by the corporation, which provides you with income over several years. This strategy is beneficial due to the low upfront costs to the new owner, while reducing your personal taxes and funding your retirement.
2. Selling assets
Sole proprietorships can only sell assets, while corporations can sell assets or shares. A corporation also has many more tax planning opportunities.
During negotiations, you should involve your accountant to help determine the tax consequences of the purchase price allocation among assets. When a corporation sells the assets, the cash can be distributed to the shareholder(s) over several years, thereby minimizing their personal taxes. However, this type of income deferral strategy is on the CRA's radar, so be careful of any tax changes.
3. Selling shares
In the case of a corporation, ownership can be transferred to other individuals by selling shares. As the owner selling the shares, you may be able to take advantage of the lifetime capital gains exemptions, saving thousands of dollars in taxes, but in order to claim this exemption (which for 2017 is approximately $835,000), there are a number of conditions of eligibility. You'll need to speak with your accountant about these, as well as any changes needed to meet them.
Usually, you'll want to sell the shares while the buyer will want to purchase the assets due to differing tax treatments. Your accountant can help you understand the numbers and the negotiation process, and even provide creative solutions to satisfy everyone.
4. Winding down the operations
In some situations, selling an operating business – or shares in it – is not possible due to the nature of the business. This could be a one-person operation, such as an artist, musician, or hairstylist – any professional or specialist in a field who is their entire business and therefore cannot be replaced. Or, it could be a business that has become obsolete.
In this case, you'll need to take steps to sell whatever assets can be sold in order to maximize proceeds. Creditors will need to be paid or settlements made where available funds are insufficient to cover debts.
Once all receivables have been collected, any licences and registrations and government accounts such as payroll, sales tax, etc. should be cancelled to prevent further unauthorized use. Closing government accounts is mandatory, along with filing the appropriate reports.
Thinking about and creating a formal exit strategy well in advance of your actual departure from a business may seem odd. But given the complexities involved, it's actually a best practice that not only helps define your company's operation today, but it will help maximize your ROI in the future.