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Why succession planning?

The biggest threat to the financial well-being of independent business
owners in the aggregate and road building industries can be summarized
in three words: No Succession Plan.

The biggest threat to the financial well-being of independent business owners in the aggregate and road building industries can be summarized in three words: No Succession Plan. A recent member survey by the Canadian Federation of Independent Business (CFIB) found that only a third of businesses have succession plans, most of which are unwritten and informal. Having no business succession plan is like building a road without your engineering reports. It wouldn’t happen, so it shouldn’t happen. You only have one chance to get it right when you sell or pass on your business.

What is a succession plan?
A succession plan is a plan of action that helps you better manage the outcome of your retirement. Many of our clients are in their 60s and will retire in the next 10 years. Some retire willingly and others are quite reluctant or are forced into retirement. Although it is not possible to control the event that requires clients to retire, it is possible to control the outcome of the retirement. Clients are counselled to follow an Integrated Transition Plan, which is outlined in Figure 1. At the learning phase, there is fear, uncertainty and procrastination. Information is provided to help owners move to the initiation and implementation phase where they are in control of the direction they want to take.

Why having a succession plan is vital
Every business owner is going to sell their baby eventually. The question is, “Will it be a voluntary sale where the entrepreneur is in control, or an involuntary sale where someone else is calling the shots?” In our experience, these are the only two options; the voluntary sale is the way everyone wants to proceed.

Another reason for having a succession plan is that the prospect of selling to a family member or a third party under conditions you control is much more appealing than being forced to sell because of having no plan or a weak plan that is further exacerbated by a poor economy, health issues or possibly even death.  When you sell your business, you have just one chance to earn the financial outcome you have worked your whole life for.

Tax implications 
Here is an example that is, sadly, very common in the industry. A business owner who has been growing his business at 15 per cent per year owns all of the shares of his company. He does have children working in the business. 

The tax can be reduced in this situation. One effective strategy is to fix the tax on the business at death through an estate freeze. From the date of the freeze, any further growth will be taxed in the hands of the common shareholders (usually the children) and the business owner will own the preferred voting shares. This makes it somewhat more palatable to the owner knowing that he doesn’t lose control. The known tax will have to be paid at death and we recommend, through our experts, an offsetting insurance policy. The company could pay this policy, making this transaction much easier to afford. This policy will provide the capital to redeem the preferred shares without having to sell assets from the company to satisfy the taxman. As a result, the tax is paid – at a greatly discounted rate. Many times an unforeseen death creates a tax event that is unmanageable for the business and forced asset sales are the only alternative. You are definitely not in control when this happens. Good planning will provide an easy transfer with the necessary liquidity to make it happen.

Strategies to benefit business owners
Owners are advised to start diversifying their assets now, by building wealth outside of their business. When the time comes to make your voluntary sale, having enough capital to fund your retirement outside of your business makes the transition that much easier. Knowing that the continued success of your business will not affect your personal retirement is a peace of mind event. If you sell your business to your children or to a third party and your retirement is dependent on the health of the business, you will not be able to just sit back and let it go. Your quality of life will still be determined by the company’s profitability, so it will not be easy to stay out of the kitchen when you were in charge for so many years, and when your livelihood depends on the business being successful. Investing for income is very different from running a business for income. It is wise to be familiar with this process well before it happens. The earlier you start to build a succession plan, the better. Starting to plan now, years before you want to leave the business is not only wise but in many ways is required. You will have the time to strengthen your balance sheet, carefully consider a successor or purchaser and have a process ready to follow for a smooth transition.

A good tax advisor adds value
A good tax advisor helps tremendously and our group works very closely with our clients’ advisors to help provide the best strategies for our clients.  One issue that came about as a result of a change in the tax rules three years ago, concerns bonusing down to qualify to be a small business enterprise. It used to be more beneficial to pay tax personally than corporately, hence the bonus. Now, the opposite it true. So instead of taking that bonus, you would do well to use money from the business to create a tax-efficient investment portfolio in a company Holdco. This creates prudent diversification and the portfolio is managed to reflect each individual’s capital requirements. The sooner this is put in place, the better.

Jim Sanderson is a certified financial planner and wealth manager at ScotiaMcLeod.