Planning considerations for selling the family business
Not all family-run businesses are passed onto the next generation. One business owner’s dream or effort may not be easily transferred or resonate with the next generation of the family. Depending on the circumstances, which can include children or grandchildren unwilling or unable to take over the reins, some business owners – like our case study example – may decide to sell the business instead. What are some of the important planning considerations?
A successful entrepreneur in her early 60s, Carolyn* founded her business supplying custom picture frames, mat boards, DIY framing supplies and fine art printing services in the Greater Toronto Area in the 1980s. Having trained as a lab technician, Carolyn opted to become a stay-at-home parent after having her two children Charlotte and Jessica. Her lawyer husband Robert, now retired, was able to comfortably support the young family.
Carolyn’s journey into business was unexpected. A keen photographer, she was always frustrated by what she considered the ‘inadequate’ quality of picture frames available to showcase the many family portraits of her own children as well as those of her friends. With help from her father, a retired carpenter, Carolyn developed a number of unique, well-made frames, which soon prompted demand from family, friends and acquaintances. This small venture formed the basis of her vision, which grew with the aid of a small business loan.
With her young children now both at school, Carolyn’s manufacturing operation expanded rapidly amid a boom in demand for unique and quality home décor products. Carolyn was able to expand her product line, distributing frames, framing supplies and kits throughout North America. Her team has grown to the existing 100-plus employees, many of whom have remained with the company since its launch in 1984.
About 12 months ago, Carolyn started to consider the idea of succession and the possibility of selling the business after more than 30 years of exceptional hard work and effort. She is mindful that there is no logical successor for the business given neither daughter is interested in taking it over. Charlotte, 41, has her own young family and is based in New York, where she works as an investment banker; and Jessica, 39, is a managing editor at a magazine publishing group in Toronto.
But the catalyst for the decision to move forward with selling was a recent health scare for Carolyn. As a result, she has thought more seriously about retirement. The timing seems right: Carolyn feels ready to ‘let go’. Moreover, the company is in good shape with a history of profitability, a solid balance sheet and a good customer base. Once she sells the business, Carolyn plans to take a break and then take up a semi-retired lifestyle.
What does the sale preparation process involve?
Key considerations for Carolyn include determining the fair market value of the business and who the potential purchaser might be. There may be interest from internal purchasers, such as existing management, or external purchasers. The latter includes either a financial buyer (typically, an investor who isn’t already involved in the industry) or a strategic buyer, like a competitor who operates a larger business within the same industry and is looking to buy out a relatively smaller player.
Another major issue concerns whether the purchaser will be willing to buy the shares of the corporation or will they negotiate a better price for the assets instead.
Typically, buyers will prefer an asset deal over a share purchase for the simple reason that they are purchasing the operational portion of the business without acquiring the corporate history of the company and the liabilities that go along with it. Vendors, on the other hand, typically prefer to sell shares in order to access the Lifetime Capital Gain Exemption which can shelter approximately $866,000 of capital gains from taxation. In the end, a combination of these strategies, known as a hybrid transaction, may be the solution to suit the needs of both parties.
Another option is vendor financing, where Carolyn sells the business, including the assets, but is paid for it over time. This may make it easier for the buyer to be willing to purchase the entire business and not just the assets. Also, being paid over time for the sale of his business can be beneficial for Carolyn from a tax standpoint.
Working with an Advisor
While each individual’s situation is different and the experience of working with an Advisor is unique, here’s an overview of what Carolyn needs to consider and plan for to sell the business within the next three years:
- Determine what Carolyn wants to do. Does she want to sell the business completely and receive full payment for it now? Does she want to remain involved in the business? Or, is she willing to carry out vendor financing for the buyer?
- Once this is determined, the next step is to start looking for a buyer and put a plan in place with her accountant and Richardson Wealth’s tax and estate planning team to determine the most tax-efficient manner to conduct the sale. This should be considered not only from a corporate standpoint, but also from a personal tax and retirement-funding standpoint.
- Sell the business and bring in lawyers to draw up the sales contracts and manage how any liability will be dealt with going forward.
- Execute the sale itself.
The tax implications of selling a business are complex. Some companies may meet the requirements of a Qualified Small Business Corporation, which allows a business owner to realize up to $866,912 of capital gains on the sale of shares on a tax-free basis. It’s critically important, however, to speak with a tax professional to ensure the corporation qualifies for this purpose and your personal tax situation makes best use of the capital gains exemption.
Carolyn should also meet with a Richardson Wealth insurance specialist to review her existing corporate-owned insurance, which needs to be dealt with as well. If Carolyn is completely out of the business, then she can transfer the insurance coverage to herself personally, although this may result in deemed disposition of the cash value of the insurance in the company. Carolyn can also let the insurance go if she feels she no longer requires it, although she should seek professional advice before doing so. Alternatively, if Carolyn is still involved in the business, she should retain the insurance for herself or the new owners can take it over to pay out her estate in a vendor-financing arrangement.
The next step for Carolyn, with help from the advisory team at Richardson Wealth, is to address estate planning for the entire family with Carolyn updating her will to reflect her new circumstances.
Selling a business or planning succession is a process, not an event. To start planning your move, speak with a Richardson Wealth Advisor for an integrated perspective.
*A fictional family situation for illustrative purposes only.