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Business Succession Planning. Presented by: Chuck Burkett, CA, CFP, TEP Mark Grey-Dreaper, CA•CBV, CMAP. Introduction. Succession planning is a process – not an event Most businesses do not have a succession plan. Existence of a Succession Plan. Succession Planning….
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Business Succession Planning Presented by: Chuck Burkett, CA, CFP, TEP Mark Grey-Dreaper, CA•CBV, CMAP
Introduction • Succession planning is a process – not an event • Most businesses do not have a succession plan Existence of a Succession Plan
Succession Planning… • Stakeholders in the succession process • Customers • Employees • Suppliers • Competitors • Family • You
Establish a team of advisors… • Banker • Financial Advisor • Lawyer • Accountant • Business Valuator
Succession Options… • Transfer to a successor • Organize a management buy-out • Sell the business to a third party • Close and liquidate
Selling to a successor… • Often a family member • Could be a key employee • Plan for the successor’s development • Communication is very important
Management buy-out… • Involves a group of key employees • Ensures retention of key employees • Often the management team lacks financial resources • If vendor is providing financing, he may feel there is less risk in selling to management than to a third party • Building a cohesive team is key in a successful MBO • Communication is very important
Selling to a third party… • Buyers may include a competitor, an industry consolidator • May require the vendor to stay on for a period of transition • Consider things that can be done now to enhance the value of the business in the future
Close and liquidate… • Often the result of not having a succession plan • Normally results in the least amount of value being realized
Understanding Value… • The value of a business is a function of: • Ability to generate future cash flow • Therisk of those cash flows • Value of underlying assets • Presence of purchasers in the market • Determined at a specific point in time
Components of Business Value… Goodwill Cash Flow Approach (CCF / DCF) Intangible Assets Tangible Assets Asset Approach
Identifying Goodwill… Personal (Non-transferable) Individual (Semi-Transferable) Commercial (Transferable)
Capitalized cash flow formula… Value is a function of Cash Flow, Risk, and Growth Where: • CF1 represents expected cash flow for the next period. • R represents the required rate of return to investors. • G represents the level of long term growth in the core business.
Three Types of Sale… • Sale of assets • Proprietorship • Partnership • Corporation • Sale of shares • Corporation • Sale of partnership interest
Consideration may consist of… • Cash • Bank financing • Vendor take back (VTB) (3-5 years) • 1/3 - 1/3 - 1/3 • Non-competition agreement • Earnout where goodwill is uncertain
Tools in Succession Structuring… • Vendor financing • Tax strategies • Estate freeze
Vendor Financing… • Often necessary, particularly where significant goodwill is being sold. • A vendor’s willingness to offer financing will depend on the % of the transaction to be financed, amount of equity invested by the purchaser, and the vendor’s assessment of the buyer’s ability to be successful • Issues include: security, interest rate, repayment period, recourse in event of default
Income Tax Issues… • Sale of the assets of the corporation • A purchaser will generally prefer an asset purchase • Generally a more straight forward transaction • Purchaser does not assume contingent liabilities of the selling corporation • Purchaser gets to bump the tax basis of the assets to what was paid for them
Income Tax Issues… • Sale of the assets of the corporation • Generally will result in a higher tax liability to the vendor • Which assets are included in the sale? Are any liabilities being assumed? • Accounts Receivable • Prepaids • Tangible Capital Assets (equipment, land, buildings) • Goodwill & other Intangibles
Income Tax Issues… • Sale of assets of the corporation • After-tax proceeds remain in the corporation • Additional personal taxes are payable on distribution
Income Tax Issues… • Asset Sale – Planning • Allocation of the purchase price • Timing – CCA and recapture • Retiring allowance if company is being wound up • Owner-manager remuneration planning • Individual Pension Plan • Salary vs Dividends • Capital dividend elections
Income Tax Issues… • Sale of the shares of a corporation • Calculation of capital gain / loss • Tax is payable by the exiting shareholder • Individual • Holding company
Income Tax Issues… • Strategies to reduce tax on a gain of sale of shares • Sale of any unrealized losses in the year • Use net capital loss carry-forwards • Minimize income from other sources in the year • Claim Capital Gains Exemption • Make RRSP contributions • Claim a reserve for deferred proceeds (max. period 5 years)
Income Tax Issues… • Capital Gains Exemption • Lifetime limit of $750,000 of exemption available • The exemption is more properly described as a deduction. (the gain is reported and included in total income, then a deduction is claimed to offset the gain) • The deduction is only available to individuals, not where there is a sale of shares by a holding company
Income Tax Issues… • Capital Gains Exemption • The company sold must qualify • Must be a Canadian Controlled Private Corporation • At the time of sale, ~ 90% of the fair market value of the assets must be used in an active business • 24 months prior to sale, 50% or more of the fair market value of assets must have been used in an active business
Income Tax Issues… • Capital Gains Exemption • All or some of your claim will be denied if • If you have previously used all of your $750,000 lifetime limit • If you have claimed an Allowable Business Investment Loss if the past • If you have a cumulative net investment loss balance
Income Tax Issues… • Planning for Capital Gains Exemption • Ensure you are eligible • Ensure the company qualifies • If the company has non-active assets, consider strategies to remove these assets
Income Tax Issues… • Estate Freeze • Used very often in family successions • Can be a tool in an arm’s length sale • Generally structured to be a tax-free transaction
Estate freeze illustration… • Pre Freeze Dad & Mom Common Shares ($1mm) Opco
Estate freeze illustration… • Steps in the Estate Freeze • The company creates a class of preferred shares • A valuation is prepared to determine what the existing common shares are worth • The corporation makes an exchange with the common shareholders. The common shareholders receive preferred shares that have a value equal to their former common shares • The successor can then buy common shares for nominal value since all of the corporate value belongs to the preferred shareholders • Preferred shares are redeemed over time
Estate freeze illustration… • Post-Freeze Successor Dad & Mom Common Shares Preferred Shares ($1mm) Opco
Enhancing Value Prior to a Sale… • Appropriate management and staffing structure • Contracts and non-competition agreements with key staff • Up-to-date Information Systems • Labour-saving Technology • Processes and Training Systems to improve efficiency and reduce required level of skill and judgment • Transactions at economic rate • Efficient operations and stable margins • Upgrades well in advance of sale
Other Planning Prior to a Sale… • Eliminate or separately ID non-commercial Related Party Transactions and Redundant Assets • Books and legal affairs in order • Up-to-date Business Plans • Resolve / Identify and quantify high risks and contingencies • Appropriate tax structure and leverage • Realistic view of value and transaction structuring • Hire your Buyer!!
Valuation Summary… • Valuation issues are key to any succession plan • The issue should be addressed early and revisited as time passes • Value is not static; it is an on-going process • Value can be enhanced through strategic planning
Other resources… • Canadian Association of Family Enterprises (CAFE) • Canadian Federation of Independent Business (CFIB) • Others..
Thank You for Your Time! • Questions?
