Corporate Succession
Most small to medium-sized business owners plan to retire within the next decade, and yet surprisingly few have much of an exit strategy in place.
The Canadian Federation of Independent Business has some eye-opening statistics. Within the next 10 years, 71% of small to medium businesses plan to exit ownership, with 41% planning to leave within five years. Retirement is the driving force behind this coming ownership exodus, even though 65% of these businesses don't have an exit strategy. And for the one-third of businesses that have an actual plan in place, most of those plans are informal.
Having an exit strategy in place well in advance yields significant benefits for current business owners. While some benefits may be financial, several non-financial benefits also arise and include an improved relationship with employees and family members involved in the business.
Many business owners assume that when they want to retire, a willing buyer will appear with the cash to write a cheque for the full value of the business. In reality it's more likely that:
- The buyer won't have cash
- The buyer will haggle over price
- The buyer will want the seller to continue working for a period of months or even years
- From a tax perspective, whatever is advantageous for the buyer will be a disadvantage to the seller and vice versa
The entire process likely will end up as a series of comprises.
Planning steps to a successful Exit Strategy
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Identify Potential Buyers
- Other shareholders
- Employees
- Family members
- Outsiders
- Competitors
Sell Shares or Assets
Typically, the vendor would prefer to sell shares whereas the buyer often would rather buy assets. The tax results will be different. Some of the factors to consider include:
- Does the corporation qualify for the small business gains exemption which could provide up to $500,000 of capital gains on a tax-free basis? Should we crystallize the exemption now?
- If the corporation does not qualify, what needs to be done to "purify" it so it does qualify?
- How can the small business gains exemption be multiplied?
- Is there an opportunity to generate tax-free "safe income" dividends?
- Is there a large amount of Refundable Dividend Tax On Hand (RDTOH) that might help reduce the tax cost of getting funds out of the corporation?
- Are there any tax-free capital dividends available?
Reducing Business Value
Are there ways of reducing the value of the business to make it easier to sell and, at the same time, provide a secure source of income to the retiring shareholder? Some planning strategies might include:
- Transfer cash/investments and non-core business assets from an operating company to a personal holding company
- Establish an Individual Pension Plan (IPP) and/or a Retirement Compensation Arrangement (RCA) to have your company finance your pension on a tax-deductible basis
- Have your company pay you a tax deductible retirement allowance to supplement your RRSP
Shareholder Buy-Out Triggering Events
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Buy-out at Death
The death of a shareholder is an event that is usually unpredictable and causes the most disruption.
In most situations, it's desirable to buy out the deceased's interest to avoid having the family as partners and to leave the remaining shareholder(s) in control.
Planning for the purchase and financing of the buy-out can be covered by life insurance.
Living Buy-out
A living buy-out is any sale of a business during the life of a shareholder.
The main events that would trigger a "living buy-out" include:
Sale For Disagreement, Incapacity, Bankruptcy
These are unpredictable events and planning for the purchase and financing can only be done in the most general sense.
Disability or Poor Health
A sale of a business or shares as a result of poor health is also an unpredictable event but the financing can be covered to some degree by disability/critical illness insurance.
Retirement Buy-Out
How does a retiring shareholder or business owner realize on his/her investment?
The sale of a business or shares due to retirement is an event which can and should be planned for, regardless of oneís retirement age.
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