You plan on taking over the family business and you have talked about it with the owner-manager. He is inclined to consider you as his successor.

It is now time to establish an action plan.

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

1. Clarify the terms of distributing the ownership of the family business

The family business is part of a family’s estate. Given this, the terms of distributing the ownership of the business is a family issue, even if the management of the company is passed on to only one family member.

It is therefore very important to be aware of the conditions under which ownership will be distributed. Will you be the only owner of the business? Will there be several owners? If yes, will the ownership be divided equally? On some other basis?

It is essential to really understand the issues associated with dividing ownership. The presence of inactive shareholders (PDF) who are not implicated in management, can give rise to a special dynamic that deserves particular attention.

The terms of the division of ownership should be discussed among the people concerned. An equal distribution is not necessarily synonymous with a fair distribution. Be creative and share your opinions and ideas with the owner-manager. Different share classes according to the type of involvement in management might be an interesting solution in certain situations. Callable and puttable shares might be useful in other situations.

Make sure that the discussions on this subject are frank and open, and that all the individuals concerned have the chance to share their point of view.

2. Determine the fair market value of the company

You must determine the fair market value of the company. This step cannot be avoided, regardless of whether the company is given to you or you have to buy it. Establishing the fair market value will be necessary for tax reasons, for the financiers, if they are involved, and also for the other inheritors to establish the value of what is handed down when ownership is divided.

The valuation should begin with a thorough diagnostic of the company. The diagnostic must be financial, which means it should determine whether the company is profitable and solvent. It should also lead to the identification of the company’s strengths and weaknesses not only in the area of its finances, but in other areas: human resources, production, marketing, information systems, etc. The diagnostic will be useful in the context of the valuation and will also be useful in guiding you in determining any actions you should take. There is a link between this and the successor training plan (PDF) that you will have to draw up. What skills do you need to develop further to meet the future needs of the company?

In terms of the actual evaluation (PDF), if it is partly based on the diagnostic, which is itself based on historical results, the valuation should absolutely address the company’s future earnings potential.

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. And do not hesitate to ask questions and discuss the results that your are given. A good specialist can communicate in simple terms what he has done and the grounds for his conclusions. It is important that you really understand the diagnostic of the company and the determinants of its value. A good understanding of all this is a contributing factor to successfully moving forward.

3. Discuss what kind of model and the pace you would like for the ownership transfer

In order to plan how everything will progress, you should understand the nature of the compensation which will be required for the company to become yours. In other words, will the current owner(s) give you the company or will they require compensation in exchange for the assets or shares that will become yours?

Among the many factors that come into consideration on this point, there are:

1. the financial position of the person retiring,
2. the financial position of the successor and the company and
3. equity, in terms of the other members of the family.

In terms of the first point, you should understand that it is essential to ensure that the person leaving the company has an adequate financial position. If that is not the case, it will be difficult for that person to truly remove himself from management. In terms of the third point, the payment (or promise of payment) of financial compensation at the time of the ownership transfer can serve to equalize the positions of the other family members.

4. Determine, with the owner-manager, the optimal tax strategy given the circumstances

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 and that it is important to call on experts in the area to help: chartered accountants, tax experts, legal advisors with experience in business succession.

Meanwhile, you should consider that choices made to minimize the tax bill should adapt to your original plan. For example, the decisions on how to divide ownership should not be modified for tax reasons; rather the tax strategy should be adapted to the choices made regarding division of ownership.

Having said this, several scenarios should be considered in choosing the optimal strategy:

1. Would it be better to buy assets or shares? Or to adopt a combination of the two? The tax implications of each of these strategies are very different.
2. Should you buy all the assets or only a portion and leave the ownership of some with the outgoing owner-manager?
3. Should the estate freeze technique be used? If yes, with what conditions?

A detailed examination of each of these scenarios and their financial, tax, and legal consequences will allow you to make the best choice that takes into account the wishes of the outgoing owner-manger and the next generation. It is of utmost importance, as a successor, to have a good understanding of the structure of the transaction and the consequences this choice will have on your personal situation and the situation of the company.

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

The financing of the transfer should not be ignored. It is a crucial aspect of the process. A financing package must be found that will ensure the right balance between the financial needs of the person who is retiring, the financial means of the person or people taking over the business, and the financial needs of the company.

In order to make a sound decision, you should:

1. Take an inventory of the various sources of funds available. This includes:
   • your personal means and, if you have any, those of your partners
   • the financial means of the person retiring (What are his plans? How much will be needed and when?)
   • the different sources of financing presently available on the market to finance this kind of transaction
2. Draw up scenarios that will allow you to determine your capacity (and the capacity of the company) to meet the financial obligations associated with each of the scenarios. In creating the scenarios, do not forget to take into consideration the company’s future plans. If the company’s borrowing capacity is completely maxed out in the purchase by the next generation, its growth and its ability to compete will both be affected. This is why financial institutions have made available to entrepreneurs and their successors a vast array of products (PDF) that can be adapted to the particular needs of many situations.
3. Armed with these scenarios, you will be in a position to identify the key points of an ideal financing package: distribution between debt and equity financing; percentage of shares purchased upfront; timeline for the purchase of remaining shares; the nature of contractual debt (secured debt, subordinated debt, line of credit, etc.) and the repayment timeline; the kind of equity (preferred shares, common shares).

This way you will be able to make a clear choice and begin negotiations with various financiers. Do not forget that a good financial partner can not only offer his products, but can also put you in touch with other financial institutions that are likely to participate in the financing package.

Keep in mind that your project is unique and even though some clauses are inevitable, many can be negotiated. Assert your point of view and seek assistance if necessary.

6. Proceed to the due diligence review

Even if you are acquiring a family business, the due diligence review cannot be avoided. Before becoming the owner, you should really understand the company you are buying. This review will allow you to answer many questions such as: Are there aspects of the financial position of the company that you missed? What about legal issues? Do you know all the contracts and relationships the company has? What are the consequences of having them? Do they have an effect of the value of the company? What is the company’s situation in terms of the tax authorities? And in terms of environmental responsibilities? There are so many areas to look at that an in-depth review is necessary.

It should also be noted that, regardless, the stakeholders in the financing of the transaction will also perform their own due diligence before fully committing to the project.

7. Identify the legal steps to take to put into place the transfer strategy and finalize the transaction

Implementing the ownership transfer strategy requires putting in place appropriate legal structures. This could mean, for example, creating a management company or a new class of shares.

Legal advisors will make sure the transaction has all the contracts and legal documents required. Among others, a solid shareholder agreement is essential when the ownership is shared among many people.
You will also have to sign the sales contract, including the representation and guarantee clauses. This is the contract that leads to closing the transaction.

As with the tax aspects, make sure you really understand the legal implications of all the structures, documents, and contracts that are involved in the transaction. A good legal advisor should be able to clearly explain them.

8. Do not hesitate to call on experts to assist you

To be able to complete the transfer of ownership following industry standards, there is no room for improvisation. As mentioned several times already, 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 that takes into consideration the particularities of you situation.

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.