December 6, 2017 by Michael Barclay

Overcome succession challenges facing your family business

Canada's succession planning rules can make it less costly from a taxation standpoint to sell a family business to a third party than to a family member. However, this depends on how the deal is structured. Typically, when you transfer to a family member, there is some sort of discount and freeze on the shares. For instance, if parents take back preferential shares and the next generation buys common shares at a relatively nominal value, this turns the proceeds for parents into dividend income, as opposed to capital gains. If they use a capital gains exemption, the child ends up paying more tax, but if the parents want better tax treatment for the child, they can forego the capital gains exemption. There are tax disadvantages to both options, but the priority tends to be setting the next generation up to succeed.

The difference when selling to an independent third party is that you will likely be paid the full value of the property, whereas you usually are not when transferring to a child. In a sense, you’re giving them their inheritance early, providing the potential for stable employment and offering something of lasting value. With this in mind, there are other significant risks to consider when transferring a business to the next generation. Take the following advice and you will drastically improve your chances of succession success.

Make sure the next generation is committed

In recent years, we have seen more and more cases where the next generation simply doesn’t want to take over the family business. Even in cases where the next generation is ready to commit, delays in the transfer can cause them to consider other options and opportunities. We try to emphasize the importance of commitment to all parties involved. Sometimes it’s just a matter of giving the next generation a 20 percent stake in ownership, anchoring them more firmly to the business. Even if they’re not yet making all the decisions, they’re getting a piece of the pie that will tie them to the business.

Emphasize fair, not equal

There are often non-active siblings in the next generation that need to be considered when the business is transferred to a sibling. If one child works in the family business and others do not, efforts should be made to ensure that the non-active child is treated fairly. In most cases, the child who takes over the business has worked with the business for several years, contributing to its value. Rather than try to distribute everything equally, you should focus on fair distribution. You may have some life insurance policies or other assets you can use to equalize the estate settlement on your eventual passing, so maybe one child gets the business and the other gets the house and an RRSP account or investment account. In cases where there isn’t much else in the estate, it becomes a bit trickier, but you can issue free shares or preferred shares to the non-active child (with some rules and stipulations) to arrive at a more fair arrangement.

Don’t be afraid to spend money

Before spending money on succession, it is wise to do a cost-benefit analysis to determine if the investment in question is worthwhile, but don’t be afraid to invest in succession. Rather than attempting to do all the work yourself, you should bring in someone who can help define goals and expectations for everyone involved and monitor the roles and compensation of the various family members. There are also fees associated with developing a good shareholders’ agreement, but this is a wise investment and a good way to avoid conflict down the road.

Some final suggestions

Even if you don’t expect the next generation to compensate you for the full value of your business, it’s important to know what your company is worth. If you don’t have a proper valuation, you can suffer some negative consequences from the Canada Revenue Agency — if they challenge your tax deferral. As well, any time there’s a change in ownership, all parties involved should get their wills updated and consider any other updates that might be necessary in light of the transition.

Michael Barclay, CPA, CA, CFP, is a partner at Collins Barrow WCM LLP. He focuses on small and medium-sized owner managed businesses and works closely with them as their primary business advisor.

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Michael Barclay Michael Barclay
Morrisburg, Ontario
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