Structuring your business for sale
There comes a time in most entrepreneurs’ lives when they’re ready to sell their company—whether to build another business, pursue a different career path, retire or start building their legacy.
A 2021 BDC survey shows one in four Canadian entrepreneurs were looking to sell or close their business within five years.
For some business owners, the pandemic has been a time to reflect on their futures and make a change.
Regardless of what’s driving the decision to sell, entrepreneurs think about the structure of their business well in advance of any transaction.
The right structure can smooth out the sale process and maximize the after-tax proceeds for the business owner, says Mark Chan, a vice-president of wealth planning at Gluskin Sheff.
“Selling a business can be a very long and complicated process, so it’s important to plan well ahead of time to minimize any disruptions and make it suitable for you: the business owner,” Chan says.
One major consideration is whether to structure the business as a share sale or an asset sale, each with different tax implications.
A share sale is when the individual business owner(s) sell their shares to the buyer(s), including the company’s assets and liabilities.
Sellers generally prefer share sales because of the favourable capital gains treatment. Based on current Canadian tax laws, only 50% of the capital gains are taxable. The sellers may also be able to shelter some or all of the capital gain with the Lifetime Capital Gains Exemption (LCGE) if the shares qualify as Qualified Small Business Corporation (QSBC) shares. In 2022, the LCGE for QSBC shares was $913,630 and is indexed annually for inflation. Assuming a top individual marginal tax rate of 50%, claiming the maximum exemption would generate tax savings of approximately $228,000 for the shareholder.
It’s a very large tax benefit that business owners can receive if they execute a share sale,
Still, he says sellers should plan a few years before a potential sale because the process can take time – and there are certain requirements the shares must meet to qualify for the LCGE in the 24-month period immediately preceding a sale. For more information about the LCGE and those requirements, please review the enclosed publication.
Sellers may also wish to consider an estate freeze strategy that could allow for multiplication of the LCGE. An estate freeze is a strategy allowing the shareholder to freeze their ownership in the business at its current value and transfer future growth to other parties, such as family members. By allowing other family members to hold shares of the corporation, they could potentially use each of their LCGE on a share sale. For more information about estate freezes, please review the enclosed publication.
In an asset sale, the company sells some or all of its business assets (such as property, equipment, technology and intellectual property), but the sellers retain ownership of the corporation as a legal entity. Buyers may often prefer an asset sale so that they can pick and choose which specific business assets to acquire and will be able to increase the tax cost of the purchased assets to the current market value that should result in tax savings in the future.
In addition, buyers will often prefer an asset sale to lessen the risk of inheriting unexpected liabilities that would arise with acquiring the existing legal entity of the operating business.
With an asset sale, sellers can’t claim their available LCGE, which often makes it less attractive, Chan says.
The sellers may also experience a double tax hit in an asset sale. First, there’s corporate tax the corporation pays on the gains realized on the asset sale; then personal taxes are paid on the net proceeds distributed as dividends to the shareholders at their individual marginal tax rate. If there is a gain on the sale assets, a portion of the dividend can be paid as a tax-free capital dividend.
“Sellers need to be mindful of that extra tax treatment in an asset sale,” Chan says.
There are other advanced planning strategies that may be available, such as a hybrid approach that encompasses the sale of shares allowing the vendor to claim the LCGE (if eligible) and the sale of the business assets that allows the purchaser to claim a higher cost base for those assets. These advanced strategies are beyond the scope of this article and should be discussed with professional advisors to ensure relevance and suitability.
How your advisor can ensure the sale fits your financial plan
Chan recommends that business owners work with their professional advisors to help tailor the best sale structure to satisfy their broader career, financial, retirement and estate planning goals.
For instance, some business owners sell their companies but remain active in the business for a few years before retiring. Some may also decide to retain a minority interest.
“These decisions often play a big part in the best way to structure a sale,” Chan says.
“Having a conversation with financial and legal advisors and taking these factors into account can be key to ensuring the business owners get the best value from the transaction that also meets their personal and professional needs and wants.”