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Passing It On – Succession Planning for Business Owners

The concept of “succession planning” involves examining the manner in which the owner-manager plans to sell, transfer or otherwise liquidate a business – it is also referred to as business transition planning” or the “exit strategy”.  All business owners should have a succession plan and should revisit it from time to time to see whether changes in applicable laws or personal circumstances dictate an update to the plan.  As should be evident from the discussion below, it is never too early in the life cycle of a business to begin discussing succession planning.

The initial stages of a succession plan involve the gathering of information, including the business-owner’s objectives, the nature of the business, family dynamics, the client’s non-business assets, life insurance, shareholders’ agreements, existing wills and other estate planning documents.  Sources of information include the client, accountant, financial advisor, insurance advisor, business valuator and perhaps others.

It is vital that the planner spend time understanding the client’s objectives.  In some instances, the client wants to sell their business to an arm’s-length party for the maximum possible proceeds.  The client may or may not want continued involvement in the business after the sale.  It may be that the client has one or more children who are (or might become) interested in the business.  In some cases, key employees provide a possible succession plan.  Where one or more children will be involved, it is important to understand what role, if any, the “retiring” parent will have on an ongoing basis.  Often if a parent is going to be paid out over time from the business, they will want to retain voting control at least until payment is received.

If the ultimate plan is to sell the business to an arm’s length party, early planning can be vital to ensure substantial tax savings on the eventual disposition.  Proper corporate structuring from an early stage increases the likelihood of using the “capital gains exemption” to reduce or eliminate income tax payable on the sale proceeds.  The use of multiple shareholders (often through a family trust) can also multiply the tax savings available at the time of the sale.  Planning for the capital gains exemption cannot be done at the last minute – certain requirements must be met over a 24 month period prior to the sale.  Timing is crucial on an arm’s length sale – selling at a time when the business is most attractive to a buyer. Also, given the demographic trends in Canada, one might expect a surplus of businesses available for sale over the next 10-20 years – another good reason for early planning.

The most complex type of planning tends to be required when the goal is an intergenerational transfer of a business.  Some of the considerations include:

  • What does the parent (and his or her spouse) want/need financially for retirement?  What non-business assets are available?  Does the parent want cash upfront (i.e. the child arranges financing)? Or, is the company going to pay the parent out over time?
  • What level of involvement does the parent want/need in the business?  In some cases, the parent does not necessarily want involvement in the business, but feels that it is necessary for continuity and economic viability.
  • How do we minimize the tax burden on the transfer?  It is interesting to note that it is usually more tax-efficient to sell to an arm’s length party than to a related party (due to section 84.1 of the Income Tax Act, the details of which are beyond the scope of this article).
  • How do we maintain harmony in the family?  How do we equalize the parents’ estates among the children when not all of them have involvement in the business?

There is no question that every succession plan is different and requires different strategies to devise and implement.  All business owners should spend time considering the eventual disposition of their business.