Michael Scrivens always knew that the family business was a good opportunity for his kids. It’s passed through his family for four generations – all the way back to the 1930s. Witnessing multiple transitions in their insurance business has given him perspective on passing the torch.
One thing he knew right away: When the kids finish university, they will need to have three to five years’ experience doing something else, ”so they can bring some experience and a different perspective to the table should they decide to eventually get into the family business.”
But the biggest lesson he’s learned is that a successful business transition doesn’t start two or five years in advance. “It should be 10 to 15 years ahead of the game,” he said. “The newer generation has to be involved in the business-planning exercise; when you sit down and do a business plan they have to be involved and get the nuances of how things are run.”
Mr. Scrivens’s story is the exception rather than the rule. According to a new HSBC report released last month, around two-thirds of business owners have yet to create a succession or exit plan. The survey, which was conducted by Ipsos and included about 1,800 entrepreneurs across 10 markets, found that many business owners avoided succession planning because it felt daunting or time-consuming.
But avoiding it can be costly – the drama that arises from handing over a family business isn’t limited to fictional multinational enterprises on TV shows such as Succession. As more than 60 per cent of family enterprises are set to change ownership in the next 10 years, according to data from Family Enterprise Canada, they’ll need to develop a succession plan well in advance to maximize financial returns while minimizing family drama.
“With a succession plan you’re thinking about what are your possible options – is the plan to sell the business? Is the plan to sell the intellectual capital or the client list?” said Tony Maiorino, vice-president, director and head of family office services at RBC Wealth Management. “It’s really about saying, if something were to happen to me yesterday, who’s reaching out to my customers and suppliers, who are the individuals stepping into the leadership role?”
For a growing number of business owners, the answer is not necessarily family. Just under half of family business owners in Canada plan to pass on management and/or ownership to the next generation.
“If the kids take over, they may have to take on debt. Business owners who sell to their kids [may] receive a slightly smaller part of the proceeds than selling to a third party – you can maximize how much you get, and selling to children can be more tricky and bring less proceeds to the seller,” Mr. Maiorino said.
Passing on a business means selling or transferring assets or shares of the company. And there’s a number of vehicles to do this, from using trusts to estate freezing, to probate strategies – all with different tax implications.
A secondary will could minimize probate fees at the provincial level, which could be relatively high in provinces such as Ontario and British Columbia, said Mark A. Feigenbaum, partner at KPMG LLP Family Office.
Though this process avoids the 1.5-per-cent probate fee, there could still be income-tax implications in a transfer at death. For example, the latter can be avoided through estate freezing.
Estate freezing can capture the value of the company at a certain point and the rest of the growth would go to the kids. “When the company is worth $1-million, we can stop that growth. … The parent, they would have to pay capital gains on that million but the remaining growth goes to the children,” Mr. Feigenbaum said.
This strategy can be particularly important given the changes to capital-gains tax implemented last year, with the inclusion rate increasing from 50 per cent to 66.7 per cent.
When a family transfers shares of a business, the availability of the capital-gains exemption and the ability to shelter the capital-gains tax will depend on whether the corporation is a qualifying small-business corporation, which generally means that it earns active business income rather than passive income, said Sabina Mexis, a tax lawyer at Mills & Mills.
If you have a business that earns passive income – from a real estate business, for example – the sale of shares of that corporation cannot be sheltered with the capital-gains exemption, she said.
Tax planners can work with corporations to remove non-qualifying assets such as investments and help restructure shareholdings to ensure the operating company qualifies for the capital-gains exemption.
Another key consideration is creditor protection. “When shares are transferred, they become property of the transferee. If there’s concern of creditors of the transferee potentially being able to seize upon those assets, it’s best not to transfer the shares,” Ms. Mexis said.
The bottom line: Pro-active planning ensures you control the future of your business – and how much you leave behind for the next generation.
“At the end of the day, your business will transition,” Mr. Maiorino said, “but will it be voluntarily or non-voluntarily?”