You are the owner-manager. You have thought about the continuation of your company. You have arrived at the conclusion that a family succession is the most appropriate solution for you. You have spoken with your family members. You have spoken with everyone concerned.

It is now time to move deeper into the succession process and equip yourself with an action plan.

In terms of the transfer of ownership, these are the elements that will help you establish the action plan.

1. Settle fairness and ownership issues

Putting in place a family succession raises the question of fairness among the family members. How do you fairly settle the family estate? Will those who will not work in the company also have an interest? Are they interested in becoming shareholders?

These questions must clarified. The division of ownership must take into consideration the risks assumed by those who work in the company and their investment, both personal and financial, in the company. In addition, the presence of inactive shareholders (PDF), meaning owners of the company that are not implicated in its management, can give rise to a special dynamic that deserves particular attention. Remember that equality is not necessarily synonymous with fairness, and that an equal division or remuneration might give rise to an imbalance.

What about your children’s spouses? Will you decide to limit ownership of the company to your children only, excluding their spouses?

Fairly dividing ownership has important consequences on both the company’s financial health and growth and on harmony within the family. Opt for transparency. Meaningful discussions in the family council (PDF) will be useful to help settle these issues. Discussions with professionals and with people you trust who have experience in these matters or who have gone through similar situations might also be of assistance.

2. Determine the fair market value of the company

Since the family business is part of the family estate, it is import that all the family members are aware of its fair market value. For tax reason, you will also need to know the fair market value of the company, whether you give it to your successor or you sell it.

The valuation should begin with a thorough diagnostic of the company. If you have developed a strategic plan, you will have already completed a large part of this task. If not, remember that the diagnostic must be financial, which means it should allow the determination of whether the company is profitable and solvent, and it should also allow the identification of the company’s strengths and weakness in all areas: human resources, production, marketing, information systems, etc.

The diagnostic will prompt you to make changes to improve the company’s position. It will also lead to the valuation. If the valuation (PDF) is partly based on the historical performance of the company, it absolutely should address the company’s capacity for future gains.

The diagnostic and valuation of companies are specialized domains that require a particular expertise. Seek the assistance of an expert in the domain. The involvement of people outside the company will lend credibility to the results obtained.

3. Decide on the type of transfer you want

You must now think about the type of transfer you would like to adopt. Would you like to give the company to the next generation? Will you be able to do it? Would you rather sell the company to your successor? At what price? If yes, how do you expect to be paid? Immediately? Over several years?

Before making your decision, you should consider two things:

1. Your financial situation and
2. Fairness toward the other members of the family

In terms of the first point, it is important to make sure you have adequate resources for your retirement. This also applies to the capacity of your successor to do the job. You will not be able to disengage from managing the company, to let the successor do his own thing, if your financial security depends on his daily actions. It is important that you are ensured a comfortable retirement. The assistance of a financial planner could be very useful to take stock of your current financial position and determine your future needs. It is important to note that the price you sell at does not have to be the maximum of the fair market value of the company.

In terms of the second point, the sale of the company at its fair market value only to the family members working in the company might be a solution to the question of fairness among the family members. Obviously, the financial capacity of the buyers should also be taken into consideration.

4. Determine the optimal tax strategy

There are important tax consequences to handing over or selling a company. Pursuant to the Income Tax Act Canada, regardless of the vehicle, there is a disposition of a company, and where there is a disposition there is a capital gain, which might imply a tax liability at the end of the day. What can be done to minimize the tax bill when the company is transferred?

From the outset you should understand that these questions are very complex. Consequently, it is important to call on experts – chartered accountants, tax specialists, legal advisors – in the area of business succession. Mistakes in this area can turn out to be very costly.

Meanwhile, understand that tax planning should adapt to what you want to do and not the other way around. In other words, if you decided to transfer ownership to all the members of the family, you should not change your mind for tax considerations. A good tax specialist will find an optimal way to implement this plan within the existing legal framework.

Having said this, consider several scenarios to choose from. For example:

• Would it be better to sell the assets or shares? Or to adopt a combination of the two? To sell the operating company and the management company? The tax implications of each of these strategies are very different.
• Are there actions to take ahead of time, for example purifying the company (by removing certain assets)?
• Should you sell the entire company to the successor, or should you retain some assets?
• Should you use the estate freeze technique? If yes, with what conditions?
• Should you make use of a family trust? If you are at the early stages of the process and you have not identified a successor, and you are not certain of the terms of dividing the ownership, it might be best to use a family trust.

A detailed examination of each of these scenarios and their financial, tax, and legal consequences will allow you to make the best choice. In some cases, you will probably be able to make arrangements to be in a position to pay the taxes that will come later.

It is paramount that you really understand the structure of the transaction and the consequences of your choice on you and your successor’s future positions. Your specialist should clearly explain to you what he is doing and why he is doing it.

5. Proceed to the analysis of different models for financing the transfer of ownership

The financing package, which combines several sources of financing, is a crucial dimension of a company transfer. Based on the company as it is, the financing package must satisfy the future needs of the retiree, address the family’s questions, and satisfy the needs of the new team of owners to be able to continue growing the company. A judicious choice should take all of these points into consideration.

To make a choice, establish scenarios that will allow the verification of the company’s capacity to meet its financial obligations. Do not forget to take into account the strategic plan and the future projects contained in it. If the financing package results in too much debt, the future capacity of the company will be limited.

In examining the scenarios, you will be in a position to identify the cornerstones of the ideal financing package: the split between debt financing and equity financing, the percentage of shares purchased immediately, the timeline for the purchase of outstanding shares, the nature of contractual debt (e.g., guaranteed loan, subordinate debt, debentures, line of credit), and the nature of the equity (e.g., preferred shares, common shares).

Because circumstances and needs differ from one company to the next, financial institutions have made a vast array of products (PDF) available to entrepreneurs and their successors that address the special circumstances of many situations.

Check with your banker. He knows your company, backs its value and will be able to create various scenarios thanks to his knowledge of the products.

After having settled on the ideal scenario, it will be necessary to negotiate. Even if your successor is buying the company and you are retiring, you will probably be a stakeholder in the financing package. Help the successor negotiate. You surely have more experience than the successor on this front. You also have some credibility with your banker or other financial partners that you know. You should also be ready for a due diligence review. This is important, even in a family succession. Besides, the stakeholders in the financing will require it. It is also the time to introduce your successor to these people so that they can get to know him and begin to trust him.

6. Implement the appropriate legal structures and finalize the transaction

Implementing the strategy for transfer ownership requires putting in place appropriate legal structures, particularly to maximize the transaction from a tax perspective. This could mean, for example, creating a management company or a new share class, or even creating a new operating company altogether. If there are several shareholders, a shareholders agreement will also be required, even if all the shareholders are in the same family. Finally, you should sign the sales contract, including the representation and guarantee clauses, which will allow the transaction to be closed.

7. Consult with professionals

To be able to complete the transfer of ownership following standard procedures, there is no room for improvisation. Consult with specialists, chartered accountants, legal advisors, bankers, venture capitalists, and strategic planning specialists who will be able to guide you and provide you with good advice in the critical moments.

Most of all, be wary of packaged solutions from an expert who claims to do it all himself. Skilful people know how to work as a team and rely on one another.