Time to make a succession plan
As a business owner, you will eventually reach a point when you have to leave your company because of age, health concerns or a desire to pursue other life goals.
Canadian businesses are set to change hands
According to a 2023 report by the Canadian Federation of Independent Business (CFIB), 75% of business owners cited retirement as the reason for leaving their businesses.
More than three-quarters of small business owners plan to exit their businesses by 2033, according to the CFIB report. That translates into more than $2 trillion in business assets at play.
Many of those entrepreneurs exit their companies without a clear plan. This may be largely due to the fact that entrepreneurs are more focused on starting and building their businesses than on leaving them.
But putting together an exit strategy is an important part of your next phase.
Plan your exit strategy
For your exit strategy, you must identify a vision for the business and for yourself—through some personal soul searching and information gathering. Then, once you have identified an exit, you will need to begin planning and executing what it will take to achieve that exit.
Because exiting a business involves many steps, this process must begin long before the actual event takes place. Usually, advisors suggest an exit strategy begin at least two years before the exit.
When it comes to how owners intend to exit their businesses, the CFIB report indicates that:
- about 1 entrepreneur out of 4 (24%) will sell to a family member (successor)
- about 1 entrepreneur out of 4 (23%) will sell to their employees
- about 1 entrepreneur out of 2 (49%) will sell to a buyer with no personal connection the company
3 ways to exit your business
There are three common exit strategies for entrepreneurs who want to sell or pass on their business:
- Family transfer
- Transfer of ownership through a management or employee buyout
- Sale of the business to a third party
The first step in your process should be to decide which option best suits your needs.
1. Pass the business on to a successor
In this case, the successor can be a family member or a manager in the company.
| Pros | Cons |
|---|---|
| Reduces third-party involvement | Not all successors are easy to train |
| Allows you to maintain involvement and influence in the operations | Potential for conflicts at work and/or in the family |
This requires identifying likely candidates and then training them to manage the business successfully. This could involve some time, depending on the complexity of the business.
The first step when choosing this option is to establish the ideal profile for your successor. Next, identify and evaluate potential candidates using fair, measurable criteria. You my also need to train them to manage the business successfully. This could take time, depending on the complexity of the business.
If you intend to transfer your business to a family member, it's important to ensure your family is fully aware of your plans and has a chance to voice concerns and interest in the business.
One of the most obvious advantages of opting for a family transfer as an exit strategy is that your family will benefit from your business legacy. As well, family members who are already involved in your business may require less coaching.
2. Transfer ownership through a management or employee buyout
Here, the management team, or a group of employees, pools resources to acquire all or a part of the company. This is one of the best options for owners who don't have a candidate for succession or who want to preserve the corporate culture of the business.
| Pros | Cons |
|---|---|
| Limits the need for due diligence. | Management often has limited access to capital and this could affect the price and the terms. |
| Rewards management for their long-term support of the business. | A vendor take-back is likely (seller loans part of purchase price to buyers). |
| A failed purchase attempt can affect business morale and performance. |
These cases usually require legal processes, such as an arrangement of share.
Often this is the first option for owners if they do not have a candidate for succession and are concerned with continuing the corporate culture. Usually in these cases there are legal processes, such as arrangement of shares, that must be taken care of first.
The sale of a company to its management team has several advantages for entrepreneurs.
Notably, it can ensure uninterrupted continuity because the new owners already have experience with the company. For this reason, your company is more likely to keep its existing clients and business partners.
3. Sell the business to a third party
There are several options for business owners who are looking to sell their small business.
- Initial Public Offering (IPO). The sale and/or issuance of shares in a private company on a public stock exchange.
- Private equity. The sale and/or issuance of shares to a financial investor.
- Sale to another business. The sale and/or issuance of shares to another operating company. This is a good option for shareholders looking for a clean exit and the highest possible value.
Before making a final decision, make sure the type of transition you choose aligns with your retirement choices. Your preparations need to lead to a maximizing on your return. Simply making cosmetic changes to your business at the last minute and putting it on the market for sale often results in a reduced return.
A sale usually requires a long strategic management process that produces evidence of growth potential and makes the business more attractive to potential buyers. In addition, likely buyers should be identified ahead of time, and alliances or overtures made before the actual event.
Takeover or phased exit
This often occurs when an owner wants to leave a business but does not completely exit. It is a way to transfer a business slowly to a new owner who is still being trained. The new owner becomes a de facto partner, buying a stake in the business; the stake grows as the partner takes on increasing managerial responsibility.
How to assure you get the best price for your business
Whether you're passing the company to a family member, your management team or selling it to outside buyers, keep in mind that you will need a business valuation that establishes a fair value for your business.
Putting a dollar value on a business takes time, and you will need to have a specialist who can look at your assets, liabilities and goodwill with an objective eye.
There are a few things you’ll need to have potential buyers recognize the full value of your business:
- Prepare supporting material
Smart buyers will certainly delve into your business’s financial and operational history. So, you should be armed with accurate figures and supporting material to help you negotiate the price you're looking for.
Company owners should keep in mind that the value of a business is not just based on financial statements. The number of customers you have, for example, could also be a determining factor. - Plan ahead
Succession planning should begin at least 18 to 24 months before your desired exit. Succession planning takes time because of complex issues such as business valuation, legal and tax considerations, family matters and the coaching of successors.
The earlier you start, the more time you will have to take an objective look at your company and prepare for the transition. - Know where to sell your business
Different platforms may suit different types of businesses, industries, and buyers. It is highly recommended to work with an experienced outside advisor who will help you with the sales process.
General factors to consider when choosing where to sell
- Type and industry of your business
Some platforms may cater to specific types of businesses or industries, such as e-commerce, franchising or manufacturing. These platforms may have more relevant and targeted buyers, as well as more expertise and resources to help you sell your business. - Cost and convenience
Platforms and intermediaries may charge different fees and commissions for listing and selling your business, as well as offer different levels of service and support. You should compare the costs and benefits. Choose something that fits your budget and expectations.
New buyers prefer a strong, stable business
It’s also important to note that more buyers are most likely looking to purchase stable rather than growing businesses.
Before considering a sale, it’s best to ensure the business is strong and profitable. Very few buyers, no matter their size or risk appetite, buy declining or unprofitable businesses. Companies that need to be turned around before they can be profitable will be much more difficult to sell.
Select a good team of professionals to help you navigate through the succession planning process and communicate often and clearly with all the stakeholders.
How much tax do you pay when you sell a business in Canada?
The amount of tax you will pay depends on how you sell it, how much profit you make from the sale and your business structure. Fiscally, there are two main methods of selling a business: an asset sale and a share sale.
Asset sale
In an asset sale, you sell some or all the assets of your business.
Those assets can include:
- equipment
- inventory
- contracts
- client list
However, you do keep the legal entity of your business until you close its doors.
In an asset sale, you pay capital gains tax on the difference between the selling price and the adjusted cost base of the assets. Fifty percent of the capital gain is included in your taxable income, which is then taxed at your marginal tax rate. Marginal tax rates vary by province and income level.
For example, if you sell an asset for $100,000 and your adjusted cost base is $50,000, your capital gain is $50,000. Only half of that, or $25,000, is added to your taxable income. If your marginal tax rate is 30%, you will pay $7,500 in tax on the capital gain.
Share sale
In a share sale, you sell the shares of your corporation, which transfers the ownership and liabilities of the business to the buyer.
In a share sale, you also pay capital gains tax on the difference between the selling price and the adjusted cost base of the shares. However, you may be eligible for the lifetime capital gains exemption (LCGE). It allows you to exempt up to a certain amount of capital gains from tax if you sell shares of a qualified small business corporation (QSBC). The LCGE limit for QSBC shares is $1.25 million for dispositions that occur on or after June 25, 2024 until December 31, 2025, with indexation to resume in 2026.
In addition to capital gains tax, you may also have to collect and remit GST/HST on the sale of your business, depending on the type of assets or shares you sell and whether you are registered for the tax. Generally, the sale of shares is exempt from GST/HST. The sale of assets, however, is taxable unless the assets are sold as part of a going concern.
You should consult a tax professional regarding your specific situation.
Next step
Learn more about how to develop your succession by downloading the free BDC guide, Preparing your Exit Plan.