If you own or operate a business, you know the challenges of keeping it growing and profitable. While in it for the long haul, entrepreneurs face considerable, and unique, financial risks.
That’s illustrated in a Statistics Canada study released in 2019 that looked at the survival of companies launched between 2001 and 2017. It found that, 10 years after their founding, 49% of firms with one or more employees in the goods-producing sector were still open; for service providers, the number was 44.8%.
With numbers like those, you can be forgiven for focusing entirely on your company’s health and relegating succession planning and valuation to the back burner. In fact, some entrepreneurs don’t feel they need a succession plan because they don’t plan to retire. According to some studies, as many as a third of small business owners have said they plan to hold on to the reins for as long as possible.
That can prove to be a dangerous position, because they’ll likely be forced to make a snap succession decision – if they get to make one at all. That can harm the business if it forces management to spend more time focusing on stabilizing the company’s leadership than on growth.
Below are some simple strategies that will help you develop a succession plan that gives you and your business the future you deserve.
Start with valuation and build from there
For an unbiased, outside view of your business’s valuation, consider hiring a chartered business valuator (CBV). The CBV Institute, the umbrella organization for the profession in Canada, has a searchable online registry that includes 168 CBVs in the Vancouver area.
Generally speaking, any estimate will be based on one or more of the following:
Comparable sales offer the most straightforward approach. As you would when selling your home, you’d base your estimate on similar properties (in this case businesses) that have recently sold. The drawbacks? As the Corporate Financial Institute says, it’s tough to find directly comparable businesses to yours, and there’s seldom enough other, similar information to generate a reliable estimate. Moreover, in fast-moving markets like today’s, comparisons can quickly become dated.
Earnings: Similar to a forward price-to-earnings ratio on a stock, this type of valuation looks at past earnings and projects them into the future. The valuator will then come up with a multiple of those profits based on a range of factors, including the business’s asset value, balance sheet and “goodwill” (intangible items such as customer loyalty and brand strength). According to the Business Development Bank of Canada (BDC), this multiple could range from three to six times earnings before interest, taxes, depreciation and amortization (EBITDA).
Asset-based models focus on the value of a company’s physical property. They can be useful if you’re considering shutting down your business, for example, and selling its assets separately. According to a recent report by Vancouver-based CBV Hugh G. Livingstone, it’s mainly useful for firms that consist mostly of their physical assets (or have little or no goodwill), such as real-estate holding companies.
Bear in mind, too, that there’s a subjective element to valuation: different estimators and methods will generate different figures. Still, the process will give you a starting point for the next item this article will discuss: building a succession plan.
How to ensure a smooth succession – emotionally and financially
The topic of succession could span many articles, but let’s assume you’ve ruled out selling to an outside buyer and will transition your business to a family member or current employee. According to the BDC, a family-business transition can take as long as a decade to complete. When you consider the emotional and financial matters at play, it’s easy to see why.
In the case of succession to a family member, let’s say a child, you’ll want to leave time to assess their interest in taking over, and their ability to do so. You’ll also want to allow time to smooth over any family politics that may be involved, say if you have multiple family members interested in the business. If things get tense, you may even need to bring in an outside party to help steer the discussion.
On the financial side, thanks to your business valuation, you now know your business’s value. This is critical for dealing with another succession issue: taxes. Because no matter who the next owner is, the transition counts as a sale to the Canada Revenue Agency.
As a result, gains on the sale are subject to capital gains tax. So if your business is incorporated and you sell it whole, rather than breaking it up and selling off its assets, 50% of your profit on the sale will be added to your income in the year the deal closes, meaning it will be taxed at your marginal tax rate, which is 53.5% for BC earners in the highest tax bracket (or with incomes above $227,091).
There’s a lifeline available, however: your business may qualify for the lifetime capital gains exemption, which lets you shelter all or part of your gain: the exemption was worth $892,218 in 2021. (For more on the exemption and whether your business qualifies, we recommend engaging a tax professional.)
The key? Get started, and get expert advice
As with many things in business (and in life), the key to a successful succession is to get started as early as possible. Your BlueShore Financial business advisor can work with you to help get plans for your business’s future off the ground. Contact us to make an appointment.
