Every successful business owner will one day be faced with the dilemma of having to choose a successor. Giving up the reins of his or her business that has been built through years of hard work will not be easy and a smooth succession can only be achieved if the business owner is ready to sell or pass the reins to his or her heir(s).
There is no single business succession template as every situation is unique. However, all successful successions have similarities which I have highlighted in this article.
BEAT THE ODDS
The statistics on small business succession are discouraging as approximately 50% of small businesses that pass to the next generation of owners remain in business for only five years. The statistics concerning family owned-business are less encouraging as only 30% will survive under the control of the next generation and probably only half of those will survive to the following generation.
Although the reasons underpinning so many business succession failures are vast, common traits include lack of preparation and poor communication.
Most successful entrepreneurs and professionals will agree that a shareholder agreement is important as it establishes a solid business foundation for the shareholders. Essentially, the shareholder agreement is a negotiated document between the shareholders of a business which sets out the relationship of the shareholders. The shareholder agreement can also provide the initial steps for planning the business succession as it usually maps out the structural transition of the business in situations such as the death or disability of a shareholder, retirement of a shareholder, a marriage breakdown of a shareholder or the outcome of a feud between shareholders. A well-drafted shareholder agreement provides solutions by inserting specific clauses setting out the rights and responsibilities of the parties upon the happening of one or more of these situations.
HAVE A PLAN
Business succession planning is a process that should be considered sooner rather than later. To achieve a smooth succession of the business, it is best to develop a comprehensive plan that both achieves the retiring owner’s objections and serves the successor’s needs.
Ideally, the business owner(s) and the successor(s) would meet with a group of professionals (lawyers, accountants and other advisors) to discuss their individual goals and the various options to achieve these goals. At a minimum, the succession plan should identify the successor(s) and address the transfer of labour, the transfer of management and decision making (control) and the transfer of ownership.
IMPLEMENTING THE PLAN
Establishing a succession plan is a great first step. However, the more difficult task is often the implementation of that plan. All too often, plans are derailed due to a lack of willpower on behalf of the parties or because the plan is put on the backburner. For this reason, it is essential that someone take a leadership role once the succession plan is developed to establish a timetable for the stages of the succession. It will be incumbent upon the leader to ensure that all parties involved are made aware of the deadlines and that the deadlines are actually met. Parties should also recognize that the succession plan may change in light of unforeseeable events and should be flexible and open minded.
An owner must take into consideration tax consequences when implementing estate and business succession plans. If there are no plans in place, then at the time of his or her death, he or she will be deemed to have disposed of all of his or her assets at fair market value. This may result in a significant tax debt payable by his or her estate.
Deemed Disposition at Fair Market Value
One of the greatest concerns business owners face when planning for their estate and business succession is how to minimize the capital gains tax that will arise on the sale or other type of transfer of ownership. If, for example, a business owners leaves his or her shares of the business (or more precisely, the shares of the company operating the business) to beneficiaries through his or her Will, he or she will be deemed to have disposed of these shares at fair market value, thereby giving rise to a tax debt and less of the estate available for the beneficiaries.
Capital Gains Exemption
Every individual resident in Canada is entitled to a lifetime capital gains exemption of up to $750,000 upon disposition of shares of a qualifying small business corporation. However, specific criteria must be met in order to utilize the exemption. The capital gains exemption allows the business owner to contemplate several succession strategies such as an estate freeze.
The “estate freeze” is a technique that limits the growth of one’s capital property during your lifetime and the resulting tax on death by transferring the future growth in capital property to one’s heirs. Simply put, an estate freeze requires the owner to exchange his or her common shares for preferred shares of equal value (where the new preferred shares do not grow in value). Then family members (eg. children and grandchildren) are issued common shares which accrue all future growth.
SUCCESSION OF THE FAMILY BUSINESS – A WEB OF COMPLEXITIES
Succession of the “family business” is more delicate as it often involves the varying interests of the children and the concerns of the parents in being fair toward them. It is truly a balancing act between the needs of the business and the family.
Firstly, it is important to identify whether there is a viable family successor(s). It is also important to identify the goals of that successor(s) and to develop the right succession plan in light of those goals.
Secondly, it is essential to involve family members in the business at an early stage. This provides an opportunity for the “next generation” to familiarize themselves with the requirements of managing the business and being involved in the decision-making process. Such family involvement should be a key component of the family business succession plan.
Thirdly, it will be necessary for the family to address important and difficult issues such as management authority and family participation. The emergence of a strong corporate governance plan will only be possible if all interested parties participate in the generation of the plan and all recognize their responsibility in this plan. The ultimate goal is to have the parents recognize the need to pass the reins to the next generation and to have confidence that business is in good hands and will continue to thrive well into the future.
CONSULT WITH PROFESSIONALS
Business succession planning can strain the personal relationship of co-owners or your family members. However, maintaining the status quo and doing nothing is the worst option. It only postpones the issues and your legacy to your beneficiaries could be jeopardized. Letting go of the reins is seldom easy, but making well informed decisions will make the transition less stressful and better ensures a lasting and profitable business for your successor(s). Anyone considering issues of succession should consult his or her accountant, lawyer and any other professional advisor that may be necessary based on the needs and type of the business to receive the advice necessary to ensure that the transition is as smooth as possible.