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Successful entrepreneurs tend to plan every aspect of their business’s growth and operations. Yet, that doesn’t always include making the transition out of it.
Most entrepreneurs likely could use the help in that process as only one in 10 has a formal succession plan in place, according to a 2023 report from the Canadian Federation of Independent Business. It found more than $2-trillion in assets could change hands over the next decade as more than three-quarters of small business owners plan to exit their businesses.
“Most owners of small business corporations need deep transition planning that provides a good foundation toward getting the transaction value they need to achieve goals such as retirement,” says Jason Nicola, wealth advisor and client relationship manager at Nicola Wealth Management Ltd. in Vancouver.
“In a perfect world, you want to start planning five years before you intend to do the transaction, and two years is the absolute minimum to see a decent outcome,” he adds.
Among the factors to consider in business transitions are whether to sell to a third-party, pass ownership on to a family member or have current employees take the helm. Moreover, entrepreneurs must make these considerations in a shifting taxation landscape.
The recent change to the capital gains inclusion rate, increasing from 50 per cent to two-thirds, could affect their plans. That increases the importance of the lifetime capital gains exemption (LCGE), which is rising to $1.25-million this year, Mr. Nicola notes.
He adds that the new Canadian Entrepreneurs’ Incentive (CEI) reduces the inclusion rate on realized capital gains to one-third to a lifetime maximum of $2-million per business owner.
The programs are extremely valuable, “but you must make sure your business ticks all the boxes to be eligible,” Mr. Nicola says.
For example, both only apply for share sales. That may be the typical deal for transactions involving family members or an employee ownership group, but many owners are looking to third-party buyers increasingly.
“Oftentimes, a third-party buyer prefers an asset sale,” Mr. Nicola says.
He adds that share purchases can involve taking on a company’s legal liabilities. “And if they’re open to a share sale, they may want a lower price to compensate for that risk.”
For sellers, it’s not a matter of picking the deal with the higher price. After all, an asset sale may turn out to be not as lucrative as a share sale after accounting for the CEI and LCGE programs, Mr. Nicola says. Yet, business owners must plan to structure their businesses to have the flexibility to choose either option.
Other business owners, namely those planning to pass the business to family members, may face different planning complexities. “You might decide to gift the business,” he says.
Some entrepreneurs are in a strong enough financial position to give the business to family members. Even that involves planning as a capital gain likely will be realized resulting in taxes owing.
Still, most business owners do need to sell because the proceeds are required to fund their retirement. When that involves family succession, Mr. Nicola says one option is having family members initially buy a stake with their own savings and/or financing, then buy out the rest of the business over time using their share of the profits.
He says the family succession route often involves the longest planning runway because the next generation of ownership has to be mentored to prepare to take a leadership role.
Employee purchase strategies are another option. Although it’s a path less travelled, Mr. Nicola says these strategies are now more on the radar after the announcement of employee ownership trusts (EOTs) in the federal budget. EOTs, which already exist in the U.K. and the U.S., allow the owners to sell the business at market value and be repaid from the company’s profits over time.
Regardless of how the transition happens, retiring entrepreneurs need a comprehensive plan that may involve business brokers who can help to maximize profitability in a third-party sale, as well as lawyers and accountants who specialize in succession and transition.
Entrepreneurs also need wealth planning to tie the transition plan to their retirement, philanthropic and estate plans, Mr. Nicola says. That can include helping with value-added, tax-efficient strategies such as individual pension plans. These allow for “terminal funding” after the sale, providing a large lump-sum, tax-deductible contribution.
More broadly, wealth planning provides perspective of the big financial picture.
“Only then do you know what price you can afford to sell, instead of doing it in a vacuum only to realize after the fact that the sale price wasn’t enough,” Mr. Nicola says. “Most entrepreneurs are going to sell their business one day, either during their lifetime or via their estate. Securing the best outcome is dependent on careful planning and coordination amongst your advisory team.”
Disclaimer
Nicola Wealth Management Ltd. (Nicola Wealth) is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required securities commissions All investments contain risk and may gain or lose value. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances.
