Whether your business is new, or generations old, it’s never too early to start thinking about your exit strategy. After all, even if you love what you do, you probably don’t want to do it forever. Jeff Halpern, Business Succession Planner with TD Wealth, joins Kim Parlee to dispel four common myths about business succession.
Jeff, it's always great to have you with us. Tell me why you think it's important for someone to think about an exit strategy even if they don't plan on passing on and selling on their business for a really long time.
- Thanks very much for having me today, Kim. Well, the truth is that any form of exit planning takes time. If you're planning to sell the business, it takes time to prepare the business to optimize the value. And if you're planning to transfer the business within the family, it takes time to decide who you're going to transfer the business to and to groom them in readiness in order to take over the business. Either which way, it takes time.
- Yep. OK. So let's talk about some of the things you need to think about because I know there's lots of myths around this as well. And the first myth you have is that if someone, the business owner, decides they want to transfer the business to the kids, they're not going to have any money for the retirement. That's not true?
- That's absolutely false, Kim. There are so many different ways that a parent who's transferring the business to a child can ensure that they still have funds. Even if they finance their children, they can remain a shareholder of the business and collect both salary and dividends while they're retired. So they can still be taking money out of the business, even if they transfer the business ownership and the gross shares to their children.
- OK. And option number one, I know, is sale of the shares at market value, getting into the technical details here. And option number two is a benevolent sale of shares.
- Sure. If the child is able to pay for the purchase, the child can go to the bank, like TD, and TD can lend them the money to buy the shares from the parent. And that way the parent has that big pot of money to actually have a comfortable retirement. But if that's not possible, which is traditionally more often than not because the children typically don't have the money, the parent can do what's called an estate freeze, Kim.
- So let's talk a bit about some of the other myths out there. And I'll let people know if they want more details, get in touch. Every situation is individual. The second myth that you talk about is if I'm transferring the business to my kids, I don't need a valuation. You're saying that is false.
- That is false, Kim, because in our view, it's important to have a professionally prepared valuation in order that the rest of the family feels that they've been treated fairly with regard to the price paid by the family member taking over the business. So it's for transparency and family harmony that it's in the best interest of the family.
Besides that, CRA may want to see the valuation, Kim, to determine that the seller of the shares has actually recorded the sale at fair market value because unfortunately, our Income Tax Act says that if you sell things for an undervalue, you're deemed to have received fair market value proceeds. So it's in everyone's best interest to have a valuation.
- OK. So you've got the valuation done. Here's another myth for you. If you have what we call bickering owners, that means that the business is doomed. It's not going to work. So if you've got kids who don't get along, this might be a bad idea.
- Not at all, Kim, because we also recommend that in advance of transferring the shares to the children, who will then become the shareholders of the business, it's very important to create what's called the shareholders' agreement. And the shareholders' agreement is the rule book for what happens in the eventualities that have to be thought of in advance. OK, it includes what happens if someone dies? What happens if there's a dispute? What happens if someone wants to retire or somebody is getting divorced, or someone has a disability?
The shareholders' agreement can speak to all of those potential eventualities to make sure that there is a well-thought out outcome that is going to happen to avoid litigation. And besides that, it's also useful to have life insurance put in place early on such that in the event of the premature death of any of the shareholders, that the widow of the deceased sibling does not have to be in business with their other sibling because that might lead to some disharmony, so to speak. So having life insurance in place to provide the buy-sell funding in the event of an untimely death is also very prudent.
- I've only got about a minute left here, Jeff, but I know this is a really interesting one as well. And this is a myth that if you have an estate and you have four kids, you need to divide the business four ways. And you're saying that is not the case.
- That's right, Kim. We've worked with hundreds of families that transfer the businesses within the family group. And the truth is, whoever is taking over the business, Kim, has business risk. And that risk does not come without a price. And so when it comes to equal, equal is not the same as fair. And every family has to evaluate what is fair for the children rather than what is equal for the children.
- And just maybe a bit on that, too. You've seen that work, right? You know that sometimes children can get a lump sum. Other kids can get part of the business. And you have to work out what makes sense.
- Well, there is a concept called estate equalization, Kim. And what we do when we apply that principle is we look at what the family owns in terms of different assets and asset classes. And then we decide what is the most logical assets to leave to the different children based on their interests and their circumstances. So in some cases, we strip out the business real estate. We can create that in a separate structure for certain children who aren't taking over the business. And then that real estate can be leased back to the child who was actually operating the business to create a rental income stream.
In other cases, when there is a shortfall of assets to leave to the children who are not coming into the business, we look at life insurance as a great way of doing estate equalization, where the life insurance can create a pot of money to leave to the children who are not coming into the business. And the business can then go to the child who is most suited to take it over.