Many investment advisors have clients who are owners of privately held businesses.
Oftentimes, these are high-net-worth clients with substantial investments under management. And yet, the bulk of their net worth is tied up in the businesses they own. That being the case, it’s certainly in the advisor’s interest to provide any assistance possible should the entrepreneur consider selling his business.
Most entrepreneurs work not only to generate earnings for the current period but also to create equity in the business that will facilitate a future sale. Most businesses are sold for one of two reasons: Retirement (when the owners’ children aren’t interested in taking over the business) or changes in shareholder relationships (disputes, death and so forth).
Regardless of the reason for sale, there are numerous steps shareholders should take before the company is put up for sale. These fall into three time frames:
- Things to do well in advance of sale;
- Things to do a year or two before the sale;
- And things to do just prior to the sale.
Well in advance
There are many tax implications related to the sale of the business. Entrepreneurs should discuss the prospect of a sale with their accountants well in advance of the anticipated time frame to make sure the company and its ownership is structured to maximize after-tax proceeds.
Probably the most consistent benefit for any Canadian selling a business is the Small Business Capital Gains Tax exemption for the first $750,000 of proceeds resulting from the sale of shares of the business. This tax-free exemption can be attributable to any number of Canadian resident shareholders, provided they have been shareholders for at least two years and the company meets certain other tests.
If the owner decides to share the proceeds with his or her spouse or children as shareholders, each of them can receive $750,000 tax-free under this structure, assuming they meet the same tests. If the entrepreneur doesn’t want these shareholders to have access to the proceeds right away, their accountant or lawyer can set up family trusts to hold the proceeds with the entrepreneur as trustee.
Another seemingly obvious but surprisingly rare bit of preparation is to discuss the prospective sale with stakeholders. If you realize you may be selling in a few years’ time, don’t surprise your minority partners, your most senior management or your family.
More often than not the sale is a benefit to all involved. And, if you need unanimous shareholder approval for a sale, you’d better sort that out well in advance.
One to two years in advance
Numerous business owners in Canada seem to charge certain non-business expenses to their companies, thereby decreasing the amount of tax that they have to pay to the CRA. However, buyers will be looking at the profitability of the business as the primary measure of what they’ll be willing to pay.
Considering the purchase price of the business will usually be a multiple of pre-tax earnings (plus interest and depreciation), anyone thinking of selling their business in the next year or two should look to minimize these outside expenses and thereby decrease the uncomfortable discussions about how the earnings should be normalized. There are enough variables and issues to deal with in a transaction without having to squabble over that. Besides, the increased tax paid is well offset by the three to six times multiple you will make on the earnings.
Running a business is usually a hectic, all-consuming activity, which means corporate record-keeping can suffer. Clients planning on selling their businesses have to get their files and records in tip-top shape. If not, they’ll be penalized in the due-diligence process.
Legal documentation such as Articles of Incorporation, corporate minutes and much more will be required. Your client should involve his or her lawyer months in advance to make sure these documents are in order. Similarly, records related to accounting, tax, banking, human resources, health and safety, information systems, real estate and more need to be organized. Your client should be informed of this lengthy preparation process and should consider hiring a Transaction advisor at this point to help the entrepreneur get organized.
Prospective buyers will make investigations into products, customers, outstanding litigation, environmental issues and so forth. Anything available to document these matters is helpful in the sale process. It’s a time-consuming and tedious exercise, but it’s an essential part of preparation.
Buyers don’t like companies that are dependent on the owner to operate. A business owner should work to give the management team enough independence that they can run the show without the owner’s full-time involvement. Having good systems to automate the business as much as possible is helpful. Scheduling systems, reporting systems, enterprise resource planning, accounting and billing systems all add to the value of the business.
Assuming everything in bullets points one and two has been attended to, it’s time to start the process of selling the business. If the entrepreneur has not yet hired an advisor or agent to manage the sale, now is the time to do so.
This can’t be their lawyer or accountant. It needs to be someone who specializes in selling businesses. Few people sell their houses without an agent and selling a business is significantly more complicated. Preferably hire someone with a long track record, good references and knowledge of the industry in which the entrepreneur is working.
The advisor will work with the seller to assemble an extensive document called a Confidential Information Memorandum that summarizes all aspects of the business. He or she will also work with the business owner to put together a list of prospective buyers. After this, the company is ready to go to market.
Ideally, the timing of commencing the process would occur close to the company’s fiscal year-end or shortly thereafter. This allows prospective purchasers to have current financial information that’s easily accessible from the year-end financial statements. However, if the company has accurate financial reporting systems it probably is more important to schedule the sale process in the company’s less busy seasons—if there is any seasonality to the business.
A great deal of preparation must precede the start of any process to sell a business. Advisors can help clients considering such sales by informing them of these steps and introducing them to a reputed transaction advisory firm that can assist them during the sale process. Your reward will be the management of the proceeds of the sale.