Business and investment advice for a wealthy Vancouver couple

Client profile

Vancouver-based couple owns multiple businesses and holding companies but needs advice on restructuring, as well as guidance on long-term estate and financial planning.

*These are hypothetical clients. Any resemblance to real persons, living or dead, is purely coincidental.

The situation

Vancouverites Teresa Lin and Lyla Wong* (45 and 47, respectively) have started a series of businesses in the 20 years they’ve been together. And, because they’re not always related businesses (their empire spans everything from import/export to software development and specialty retail), they have a series of holding and operating companies grouping business lines that are, at least, similar.

Since 1994, Teresa and Lyla have started six businesses and placed them in three holdcos. One holds technology ventures (two software developers—one specializes in list-management systems for medium-sized publishers, and another that develops computer-aided design software for engineering firms—and a failing web security firm that the two have discussed shutting down due to low sales).

The second is dedicated to retail businesses (it holds a high-end men’s shaving goods retailer with locations in Vancouver, Calgary, Edmonton and Toronto and a group of mid-priced jewelry shops with eight locations in western provinces).

The third is keyed to import-export, and currently holds a Vancouver-based Asian specialty foods importer.

Also, Lyla and Teresa each started their own companies before they met, and each maintains separate and whole ownership. Each company—Lyla owns a group of three fashion boutiques, and Teresa a Hong Kong-based electronics exporter—has its own opco, but has never been shifted into any of the holdcos.

Their net worth, exclusive of a $2-million restored Arts and Crafts bungalow near Trout Lake Park, is $45 million. Most of it is tied up in their businesses, but Teresa and Lyla both have rudimentary, largely neglected investment portfolios, which consist of balanced mutual funds and GICs purchased through the bank branch where they have business accounts. They realize it’s time to revamp, expand and consolidate their investments with a dedicated advisor.

The couple has adopted one daughter, Cara, who at 14 has already shown keen business acumen and a head for finance. Teresa’s 38-year-old sister, Emily, has provided accounting services to all their businesses (even the ones that are separately owned) for 12 years.

She is currently on salary, but Lyla and Teresa have thought about bringing her into the partnership. Emily’s spent the last few years earning an MBA, and understands the businesses’ operations intimately. However, these discussions have never been formalized. Lyla is estranged from her four siblings. Neither partner has health issues, but the pair think they’ve over-segregated their businesses and want to clean things up before bringing Emily, and ultimately their daughter, into the family businesses.

Succession planning: the big picture

Jennifer Poon

Director, Advanced Planning – Wealth, Sun Life Financial, discusses how you can help business owners create their succession plan. Read More

The experts

Ian Black

RFP, TEP, financial advisor, Macdonald Shymko & Co. Ltd., Vancouver, B.C.

Adam Dlin

lawyer, M&A, private equity, business law, Mogan Daniels Slager LLP, Vancouver, B.C.

Michael Sileika

CA, CBV, partner, Valuation and Litigation Support Services, MNP LLP, Vancouver, B.C.

Pretend you want to sell

AD: With a business of any maturity or sophistication, I like to tackle it as if you’re trying to get it ready for a liquidity event, like a sale or IPO. Even if this isn’t on the horizon, and may never be, it’s a good way to view how things ought to be structured.

MS: I agree. The message I always give clients is to run your business as though you’re preparing to sell. The advantage this couple has is that they’re both relatively young. If they start now, they can take their time, reorganize effectively and still meet their long-term goals.

AD: I’ve seen people begin restructuring later than they should, and as a result it was much more complicated and costly than it had to be. To get clients to plan early, I like to employ not so much scare tactics, but anecdotes. So I give specific examples, and put a dollar figure on delayed planning. I find that gets their attention. The other approach I sometimes use is to say, “If you don’t believe me, talk to this person” (see “Anecdotes spur action”).

Teresa and Lyla have a holding company for each line of business, and that’s appropriate. The question is, would it make sense to have a single holding company above those three holdcos that owns all three entities fully, and which in turn is owned by Teresa and Lyla?

That would probably be desirable if they intend to own everything together. But it becomes problematic if their intention is to own any of the existing businesses separately. I don’t get the sense that’s their intention. It’s critical that there be a shareholders’ agreement. It would deal with the existing operation and governance of the businesses, and things like what happens in the event of death or disability.

The main problem is there are two businesses outside the holdco structure. So, you have three separate lines of business—technology, retail and import-export—with their own holdcos, but then two other companies, both individually owned, that aren’t under any of the holdcos. These two businesses, if not competing, are in the same categories—retail and import-export—as businesses under the holdcos. If you were trying to monetize the business, it would be cleaner and simpler if everything were siloed within a single holding company, since presumably a buyer would want to purchase all the companies in the same line of business.

Life goals and valuation

MS: How they plan to be involved in their businesses impacts valuation. The first thing I would do is have a conversation with them on where they want to be in 10, 15, 20 years. Do they want to spend the next 15 years expanding their portfolio of businesses, or do they want to start winding down now?

They could create a situation where they’re earning passive income as shareholders, and Emily takes on a wider role with operations. That would allow them to take a three-month European vacation, for instance, knowing that the businesses are being managed. I would also determine if they are passionate about any of these businesses, or if they just stumbled into some of them. There’s a pretty wide range, so it’s tough to stay focused. They could divest one line of business and keep the others, for instance.

The value and saleability of the businesses depends on whether they are asset- or goodwill-based businesses. In a goodwill-based business, success is largely dependent on the owners themselves and the relationships they have with clients. For example, the import-export business may rely on specific relationships. The question is whether they can transfer those relationships to, say, a general manager.

It all comes down to the notion of whether they can take that three-month European vacation. If the electronics exporter is Teresa Electronics Exporter Inc., and she has all the relationships, no one is going to buy it. So, she has to think about how she can transfer those relationships, or structure the business so that people don’t care if she’s there.

Potential buyers can fairly easily assess data about accounts receivable, accounts payable and quality of inventory, but it’s more difficult to gauge quality of management and how much the business relies on relationships. A buyer would want to interview some of the owners’ clients. If they say they love doing business with Teresa and she’s the only person they want to deal with, you start to put your radar up.

Generally, owners should be open about giving client names to potential buyers. On the flip side, any time a company’s going through a transaction, clients get a little anxious. So you don’t want to scare off clients, especially if there’s a chance the transaction may not close.

AD: I agree. As a buyer, you want to do legal and financial due diligence, but also business due diligence, and an element of that would be trying to access key customers, suppliers, employees and management.

But, on the sell side, that gets me nervous. I don’t particularly like it when word gets out that a potential transaction is underway, especially when it hasn’t closed or isn’t close to closing. That can obviously have adverse effects on the business. And who’s left holding the bag if there’s a negative consequence? The seller.

Typically, as a seller, you don’t want employees to find out about a transaction until the day of closing. And we would be very nervous about access to customers. It’s a fine balance, because you’re right, Michael: if you restrict access, you’ve got this red flag that goes up. There are two ways to address this issue. First, it’s very common in acquisitions to have key management stick around for a three-year period, for instance. Often they’ll be required to sign employment agreements specifically directed at transitioning relationships and connections. The other way the issue’s addressed is by conditioning a significant portion of the purchase price on performance of the business after closing.

MS: A contingent payment. You’ll have a base payment for the business, and then you’ll have a payment that’s contingent on meeting operational or financial goals.

AD: Typically, the financial metrics are based on bottom-line numbers, such as EBITDA; sometimes it will be based on revenues or some other metric, depending on the industry.

Also, if the seller says there are 10 key customers and they won’t be affected by the transaction, or by her no longer being directly involved in the business, we’ll make her put this in writing. And, to the extent it’s incorrect, there would be some recourse, at least theoretically, under the purchase agreement.

MS: A major consideration for the buyer will be risks to future cash flow. Effectively, when you buy a business, you’re buying the right to participate in its future profitability. If you look at an Asian specialty food importer, it may be a competitive market in Vancouver, and your profitability can be fairly well forecasted. But a mid-priced jewelry store, or a men’s shaving goods retailer? There’s less certainty around their future revenue streams. A stable revenue stream would command a higher valuation, whereas something that isn’t as predictable would sell for less.

Investing for retirement

IB: For retirement, I like to have multiple sources of income for clients, rather than just saying everything is going to be saved in the holdco.

There still should be an RRSP, a TFSA, and other investment accounts that are completely removed from their business operations in case there’s a scorched-earth-type scenario with the business. Say one of them gets a disability and her involvement in the business was required to maintain its value: I would want to have some of their wealth removed from the business beforehand.

Still, given most of their revenue is generated within companies, it wouldn’t make sense to be drawing $1 million in salary a year. They would probably keep it within the corporate structure to maintain tax deferral.

Entrepreneurs have a significant amount of risk in their businesses, so I often see them with lower-risk portfolios. Others have higher-risk portfolios—it’s just their personality. I would suggest being more cautious with a lower-risk, more diversified portfolio. It probably would not have a significant private-equity component.

They’re in their 40s and they’ve accumulated a net worth of $45 million, so they’re probably set for life. If they plan to spend a million dollars a year, then they might be in trouble. But, typically, even very wealthy clients don’t spend that much.

I wouldn’t have them in 80% fixed income, because then you’re taking a lot of risk from not taking very much risk. You’re just going to get beat up by taxes and inflation. So, I would think about 50% to 60% of the portfolio would be in equity ETFs, diversified globally. We would rebalance about four times a year.

We would also include Mortgage Investment Corporations (MICs). They’re a little higher risk, but you can get 5% to 7% yield.

You have to do your homework on the MIC, asking: Who are they lending to and is it the first or second mortgage? In some cases, we bring a group of clients together and do syndicated mortgages in the Lower Mainland.

I would also look at preferred shares as part of the fixed-income side of the portfolio.

Depending on how they’re held, it might be more tax-efficient to have dividend income from preferred shares, as opposed to interest income.

Once their daughter Cara is 18, they’ll be able to split some income out to her, either immediately or in the future, through a discretionary trust. The trust would also offer some protection to any shares Cara gets in the corporate reorganization. If she has direct ownership, then gets married at 19 or 20, those assets could be attacked by a divorcing spouse. The trust allows her to benefit from the wealth without having direct ownership.

Anecdotes spur action

Entrepreneurs are often so busy with day-to-day operations that they fail to act promptly on the planning needed to meet their broader objectives.

Such procrastination can carry a hefty price tag. Adam Dlin, a lawyer at Mogan Daniels Slager LLP, helps clients see the cost of delayed planning with eye-popping anecdotes like this one.

Five years ago, a client asked him to assist with a corporate reorganization. One of the goals was to make the business more saleable. “The existing structure was unwieldy, complex, tax-inefficient and otherwise very messy. We knew that the field of potential buyers would be very limited with that structure.”

He proceeded with the reorganization but, as that was going on, the client was exploring a sale. “It was too early, because the reorganization had not been completed. And, even when it was completed, we would not have consolidated financials or the benefit of any other historical performance under the new structure,” says Dlin. Still, the client entertained offers, and one serious buyer was willing to pay just under $100 million.

“Ultimately, the deal died,” Dlin notes, “primarily because the buyer could not get comfortable with the financial due diligence.” After a few years under the new structure, the client again brought the company to market. It sold, but for less than $50 million.

“The message here is, while the client recognized the need to reorganize and plan, had he done so even earlier he likely would have realized much higher value. He lost the opportunity to realize more value when market conditions were obviously more favourable.”

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Succession planning: the big picture

By Jennifer Poon, Director, Advanced Planning – Wealth, Sun Life Financial

In this scenario, there are a number of issues that I can see. And while ultimately Teresa and Lyla’s main goal is to address their needs for a succession plan, they need to consider taking a step back to look at the big picture.

As mentioned, they are currently working without an advisor. Finding a team of trusted advisors (legal, tax, financial, investment, etc.) would be their first step. When they have the correct team in place with a financial advisor that can see the overarching plan, they can start to put the pieces together — looking at their holdings along with their finances.

The next part would be to address their succession concerns. And in order to identify the plans for their companies, they need to evaluate various considerations. This includes their successors, a buy-sell agreement and stock appreciation rights. Let’s take a more in-depth look at these.

Separate businesses: where to start?

The first step would be to understand what would happen to their separate businesses if one or both of them should die. The couple isn’t married, so there are specific legal aspects to consider. However, getting away from the family law discussion, we need to address their organizational structure and what makes sense for them. Given the scope and the number of businesses they own, the couple should consider the following:

• How involved are each of them with each business? Is there a key management person(s) with each business? Who manages the operations when they are away?
• What is the current reporting structure? If they don’t have a formal reporting structure, then they need to start there.

Like most entrepreneurs, I suspect they are very hands-on and may not have professional management. Figuring out these answers may help them delegate some of their duties and focus on strategic directions. This will also help them figure out what role Emily should play — key management or shareholder.

It’s understandable that they would like to keep the businesses in the family. In fact, 51% of Canadian business owners plan to pass their business down to the next generation¹. And only 16% of family businesses have a discussed and documented succession plan in place². If Teresa or Lyla were to die, then who would manage their businesses? Do they have a plan in place and are they familiar with each other’s businesses? Teresa and Lyla need to evaluate these questions, especially considering the fact that their daughter is still a minor. And while Teresa’s sister may provide accounting, is she qualified as a professional manager?

Selecting a successor and future management is key, but it goes beyond a “want.” They need to consider the fact that their daughter might not be interested in running these operations, and Emily might not be qualified. When selecting a successor (family or non-family) they need to identify the key positions and roles, look at a replacement plan, evaluate promotability, discuss training and development needs, and a strategy to have the right person in place. And in this case, with such a wide variety of operations they should consider whether they will sell any of the holdcos or opcos to a third party, or create an overarching holdco — having each one of them as a joint owner.

A buy-sell agreement

While both Teresa and Lyla seem to be concerned with their businesses if one or both of them were to die, there are other considerations here. A business succession plan includes more than just death, but also a serious illness or disability, and planning for the unexpected is the only way to protect the long-term financial health of their businesses.

The role of a buy-sell agreement offers important protection to both the owners and the business. The agreement, which can be a separate agreement or part of an overall shareholders’ agreement, sets out the conditions in which an owner has the right to buy the ownership share of another owner. In this case, if Teresa or Lyla were no longer willing or able to act as an owner over one or more of their businesses, the person (or people) they’ve identified as the successor(s) would be able to buy out their shares.

Stock appreciation rights

If Teresa and Lyla feel that Emily is still the correct person to manage their businesses and be a partial owner in the companies, then they may wish to explore the option for stock appreciation rights. In this case, they would have the option to reward Emily with a “bonus” over time, and would instead offer this through stocks, rather than cash.

As they develop their succession plan, the key to all of this is having an advisor that can assist them with these decisions.

Read: Life insurance transfers and taxes – part 2

Read: Explaining the new estate information return – who’s accountable? What’s required?

Read: Come to terms with your business owner clients

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¹ When asked what changes they anticipated to their business in the next five years. PwC, Creating a lasting legacy, The Canadian supplement to the 2012/13 PwC Global Family Business Survey, 2013.

² PwC, Up close and professional: the family factor, Global Family Business Survey, 2014.