As business owners near retirement, they may have questions about transitioning the business. For example, who is going to take over the company? How much is the business worth? What is the best way to approach buyer negotiations? What is the most tax-efficient arrangement?
If you are a business owner, the sale of your company represents a major shift in your life and your family’s life. Having a strong team of professionals in your corner can help make the transition smoother. Here are some common issues you should assess and address before selling.
When should I start planning for the sale of my business?
You need to consider the sale of your business well before it happens. This includes developing an exit or succession plan at least five years in advance. If you delay planning, you may not reach your objectives. Early planning helps address retirement income needs should the business sell for less than its expected initial valuation.
Who is the best person to take over the business?
A business thrives with passionate operators devoted to its success. Many owners consider transitioning the business to family members; however, if the children are pursuing their own interests, it might be best to sell to a key dedicated and loyal employee or employees. Or perhaps an outside buyer in the same industry is a better choice. As a business owner, you have options.
What are the tax considerations when selling my business?
You and your financial advisors need to consider the tax issues involved in the succession plan, while having a team of professionals including accountants, lawyers, and estate planners to assist with the transition. Completing the transition in the most tax-efficient manner is critical—regardless of who is taking over the firm. You will want to keep the following tax considerations in mind.
When selling your company’s shares, you will have to pay tax on capital gains, even if you gift the shares to your kids. A capital gain is the difference between the fair market value and the adjusted cost base. Half of that amount is taxable at your marginal tax rate.
Lifetime capital gains exemption
The lifetime capital gains exemption may be available to shelter a significant amount of tax on the sale of qualified small business corporation shares. The 2018 exemption, indexed for inflation, is $848,252 per shareholder. For qualified farming or fishing property, the exemption is $1 million.
Receiving cash or debt as proceeds
Receiving cash for the sale is ideal, as it will provide you with the most options. However, receiving debt can be advantageous. If you take back debt in the form of a promissory note, you can defer capital gains tax. You can recognize the gain over a period of up to five years. If the sale is to your spouse or partner, or to a child or grandchild, you can take the gain over ten years.
Sale to key employees
If selling to a family member is not your primary option, then you may be looking internally within the corporation to set up a manager buyout. Employees can use debt financing to leverage the buyout—essentially, the employees would form a new corporation that would be used to purchase the shares.
Selling to a third party
Another common option is selling to a third party, such as a supplier, competitor, customer, or a public company. It can be a challenging pursuit; working with a team of experienced professionals—like an investment banker or business broker—is helpful. A lawyer can structure the sale and help minimize liabilities; an accountant can help manage taxes, and an experienced financial advisor who works with retirees can serve as a financial steward.
Sale of assets
From a tax perspective, a main planning point is how the purchase price of the assets will be allocated. The seller wants to allocate the purchase price to assets like land that give rise to capital gains when sold. The buyer wants to assign the purchase price to depreciable assets that can be fully written off in future years. If the business is sold for more than the value of the tangible assets, the amount exceeding the fair market value of those hard assets is referred to as “goodwill.”
The role of life insurance
The use of life insurance can play an important role in transition planning, especially if there is an immediate need for liquidity, such as when a shareholder dies. The tax-free death benefit from life insurance can be an effective means of buying out the value of that person’s shares, as provided in a shareholder agreement. It is important that the agreement define “value” as not including the value of the life insurance itself.
How do I increase my company’s attractiveness?
You will want to streamline and efficiently structure the business well in advance of a potential sale. Look for ways to cut costs and run operations more efficiently; finalize leases and other agreements. This will help increase your company’s value and profitability, and a buyer’s interest. Increased profitability may mean a buyer will pay more.
Buyers are looking for reassurance that the business will be able to thrive when the seller is gone. They will be looking to see that the company has documented procedures and processes in place that allow it to run smoothly even when the seller is no longer directly involved.
Ensure that your business looks professional—a new coat of paint and some renovations can go a long way. Just as you need to clean up the books, you also need to clean up the premises.
When preparing to sell, keep this checklist in mind:
- Improve all aspects of the business, and be prepared to continue running it as long as necessary.
- Get a clear idea of the business’s value, based on appraisals and industry standards. Do not overprice it, and always consider the buyer’s point of view.
- Work with a professional team with a strong network that includes expertise in accounting, legal and investments.
- Consider key employees or competitors as possible buyers.
- Be ready to produce at least two years of audited records and full documentation.
- In cases of seller financing, qualify the buyer. Do not expect a cash purchase.
- Always seek tax advice.
Business transitions require early planning. Families should be thinking ahead about whether there is potential for family succession, and business owners should develop their exit or succession plan early on to facilitate a smooth transition into retirement.
Did you know that you can book a free financial literacy presentation for your workplace or community group through CPA Canada? Sessions can be targeted towards different audiences (i.e. post-secondary students, entrepreneurs, seniors, New Canadians, etc.), and our presenters can come to you. Book a session today.
Bryan Sommer, CPA, CA, CFP, CIM, is a portfolio manager with CIBC Wood Gundy and holds the Chartered Professional Accountant designation. This article is based on “Enough for a Lifetime,” a chapter from his book, The Reveal: Stepping across the Line into Retirement.