This is part two of a two-part series on the state and viability of Canada’s business-owner landscape. Read part one.
What’s next for your business?
If you haven’t posed that question to your client with a small or medium-sized business, don’t put it off any longer.
That’s because it’s never too early to think about transition planning, says Sean Foran, managing director of Business Transition Planning with CIBC Wealth Management. “Things that drive a business for transition also drive the value of a business for sale and ongoing viability. So […] considering transition and how a business would succeed is something [clients] should start thinking about the day [they] start the business.”
To get the ball rolling, Foran suggests you ask clients if they have a plan to maximize the value of their businesses on exit and, if they don’t, if they’d like to know their transition options.
Impartiality is key, he says, noting the goal isn’t to “steer them to a certain outcome” but to help clients consider the needs and resources of their businesses, as well as the pros and cons of keeping or selling.
Read: Where millennials leave other business owners in the dust
Business needs should be considered ahead of the needs of family members and shareholders, says Foran, who says part of business transition planning is getting clients to confront tough issues.
“We often get business owners to start identifying the attributes of the successful leader who can take the business forward, […] and see whether there’s anyone within the family or existing employee base who has the right stuff,” he says.
To encourage objectivity during that process, Foran recommends that a client rate her business’s financial resources on a scale of 0 to 5 (lowest to highest). “Businesses need constant reinvestment to thrive,” says Foran. “If [clients] can’t score at least 3.5 out of 5 on the resourcefulness around finances, then typically something has to give.”
Next, using the same scale, the client can rate her business’s human resources — particularly senior management. “A hallmark of successful businesses is their ability to adapt to change, and that requires effective leadership,” says Foran. “Again, on a scale of 0 to 5, how well resourced are companies when it comes to human capital and the senior leadership team who can motivate employees to adapt to change?”
Finally, the same scale can be used to rate the client’s emotional engagement with her business, which Foran describes as how energetically the client springs out of bed every day to drive the business. If the score isn’t at least 3.5, “perhaps the owner should step aside and let somebody else come in who’s more energized about dealing with the opportunities the business represents.”
Face tough choices
Foran also helps clients consider keep or sell options, of which there are three each.
The first two “keep” options are grooming an owner-operator or choosing an owner-investor. With the former, clients prepare a successor to fill their shoes and run the business as they have. With the latter, the business stays in the family but outside management is hired. “After the death of mom and dad, presumably the next generation steps into [their] shoes and manages the manager,” says Foran.
The third “keep” option is a hybrid arrangement, where some family members both drive the business and own shares, while other members only own shares — depending on their respective interests.
Read: Salary or dividends: Which is better for business owners?
Though the hybrid option could be a recipe for conflict, “there are ways to achieve some compromise so [family members] can all get along and appreciate both the needs of the business for reinvestment as well as the needs of the family for cash,” says Foran.
For selling, the options are a management buyout; a sale to a strategic business in the same industry, typically with the client staying on; or a sale to a private equity firm. With the last option, Foran says, “We’re seeing now the emergence of family offices, [which] also are financial buyers but often have different time horizons than the typical private equity firm that would look to exit between five and seven years.”
Build a support team
Detailed transition planning isn’t easy, so Foran suggests clients work with transition planning experts as well as financial and tax planning experts. For example, at least two years are required to plan a tax-efficient business transition if shares need to be reorganized and extended to other family members — though proposed tax measures affecting the lifetime capital gains exemption must be taken into account.
Read: How proposed tax changes target income sprinkling
Finally, clients must engage their families and key employees in the process. “Senior employees […] often have better insights as to how the business can be driven [and] what the key performance indicators are,” says Foran. “Failure to enlist them about the future viability of the business is a big mistake.”
Ultimately, transition planning is important because it provides stability for your business-owning clients and their families, says Foran. Not to mention, it helps ensure Canada’s small and medium-sized businesses – which employ so many Canadians — continue to thrive.
“Considering all this in advance is something that will keep value in the family, in the business, and preserve it for the next generation,” Foran concludes.
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