This article was originally published in the inFocus Spring '14 Issue
Have you spent a great deal of your working life creating a successful small to medium-sized business (SMB), only to realize that retirement is on the horizon?
Succession planning should become your priority several years before retirement or any transition approaches. It can take three to five years to put together an effective succession plan and execute it, while ensuring that you maximize your business sale or transfer price. If caught unprepared, you may have no other option than to simply close your business or dispose of it cheaply and inefficiently (think—tax).
This article is meant as a primer. How can you maximize the value of your business and after tax dollars, while ensuring a smooth transition of your business to new owners?
Common missteps that we see caused by planning failures include:
- Unreliable financial information;
- Overly centralized management;
- Non-transferable goodwill;
- Poor exit timing; and
- Too little, too late tax planning.
Steps to take and things to consider:
- Identify and target potential new owners
Assuming that your business will continue to operate indefinitely, there are several ways to sell the business, including selling to a third party, a family member, management, or to investors. Identifying at least two "special purchasers" has a massive impact on exit price. You must have two parties with special interests and/or synergies with your business to bid against each other.
- Ensure the company's financial information is
This will help potential successors and business valuators ascertain the value of your business. You may want to consider increasing the level of assurance on the annual financial statements, as buyers will be more trusting of statements that have been audited or at least thoroughly reviewed by a public accountant for several years.
Purchasers will also want to know the potential of your business in the future. For instance, a strong, recurring revenue stream increases the value of the company by instilling confidence in successors and, thereby, increasing the worth of the business. Prepare well-supported projections plotting out the next five years of profit expectation. Value is all about future expectations. History is simply a benchmark to help make assumptions about tomorrow's potential.
- Deciding on the right time to sell
Business, external and personal factors all come into play and should be considered. For instance, sell when:
- You have established upward sales/profit trends;
- Key management is aligned with your objectives and able to transition with the business;
- Tax planning is in place;
- The market is strong and there are purchasers readily available; and
- You are in a place of financial security, under no true compulsion to transact.
- Preparing your company
Mold your company so it possesses the qualities prospective buyers will be attracted to.
Purchaser objectives are to minimize risk while maximizing their return. The following suggestions are ways to increase the value of your business to prospective buyers:
- Build and maintain a strong, transferable customer list and reduce economic reliance on any one, or small group of customers;
- Create a stronger recurring revenue stream by putting in place long-term contracts or some other incentive/loyalty program;
- Maintain a strong and up-to-date physical infrastructure; and
- Have a knowledgeable and experienced management team (as prospective successors will want assurance that when you leave, key success factors, knowledge and skill remains with the business).
In order to increase the value of your business, it is important to create commercial saleable goodwill, and reduce any personal or individual goodwill, since the latter has nominal, if any, value to a new owner.
Ways to create commercial goodwill include:
- Decentralizing control and knowledge;
- Sharing contacts and transferring personal relationships to existing management; and
- Focusing on building the reputation of the business and brand (instead of any personal reputation).
- Capital gains exemption (if available)
When selling your business' shares, the capital gains exemption (CGE) is a great way to avoid paying taxes. The CGE is a tax benefit for individual shareholders of Canadian private businesses, which meet the qualifying conditions (as defined by the Income Tax Act). That is, each individual shareholder avoids paying taxes on up to $800,000 (as of 2014) of capital gains.
In order to ensure that the shares of a corporation will qualify, your business may need to be "purified". To "purify" the business, redundant and ineligible assets should be removed from the balance sheet and any non-business related expenses should be removed from the income statement. This process may need to precede the sale date by two years.
- Estate planning
Estate freezes, combined with family trust and holding company structures can potentially transfer a business to family members and provide significant tax benefits. This strategy allows you (the original owner) to retain (and withdraw over time) the current value of the corporation while transferring future growth to others.
Advantages of this strategy:
- The ultimate amount of income tax payable on death can be estimated; therefore, you can purchase sufficient life insurance to guarantee liquidity or be able to maintain enough funds to pay those taxes;
- Minimizes the potential future tax liability by income splitting;
- The current business value can be paid out over a period of time;You (the original owner) can retain control of the business while your family members join the business, allowing for a smoother transition; and
- Potentially allows multiple CGEs to be ultimately utilized among family members, thereby creating more tax savings overall.
- Determine the fair market value
Before selling your business, enlist a Chartered Business Valuator (CBV) to assist with calculating the value of your business. This will help manage expectations, while allowing you to take advantage of opportunities to enhance the value of your business prior to sale as described above. The CBV will help you to identify key value drivers, purchasers perceived risk considerations, economic and competitive issues as well as optimal timing and structure.
- Assemble a team well in advance
Start thinking transition five to seven years before it will happen to maximize value. It would be effective for you to assemble a team including management, your lawyer, accountant and a chartered business valuator, to help execute the above recommendations.
About the Author
Jim Muccilli is a Partner in the Valuations | Forensics | Litigation Group at Crowe Soberman. Jim has worked in this field for over 20 years and brings with him a vast knowledge in the areas of business valuation, loss quantification and forensic investigations. He is also a qualified expert witness.
This article was originally published in the in Focus Spring '14 Issue 5.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.