BUSINESS SUCCESSION PLAN – HOW THE ADVANTAGE MAY BE GIVEN TO THE CHILD KEEPING THE BUSINESS

I’m writing this article as over my career as a Business Valuator and Professional Accountant I have seen business succession plans where the intent of the plan was to be fair to all family members, however, the plan fell short of this objective.?

A bit of background information on how a Parent may transfer the business over to a Child in a succession plan while trying to minimize the financial burden to that Child.?

The Parent decides that a point in time he or she would like to transfer control and growth of their business to their children.? One of the critical pieces of information required to do this is a proper independent business valuation.

A strategy in a business success plan is that the Parent exchanges their voting shares for non- voting fixed value special shares.?? The Parent essentially takes back through a different class of non-voting shares the value of the business at the point in time he or she wishes to transfer the business over to their children.? The value taken back by the Parent is paid to the Parent by the business out of future profits and forms part of the Parent’s estate and typically assists in funding the Parent’s retirement.?? The Child 1 taking over the business would then subscribe for voting/controlling shares at a nominal amount say $1, therefore not financially burdensome to the Child 1. ?

An alternative strategy among others, would be an outright sale of the parent’s shares to Child 1 or Child 1’s holding corporation.? With recent Federal budget changes this strategy has certain advantages including the utilization of the parent’s life time capital gains exemption, preferred capital gains tax rate to the parent, utilizing the 10-year capital gain reserve and possibly tax deferred payments by the child to the parent. ?

You should consult with your tax advisor as to the best strategy given your circumstances.

The above strategies are only fair to all family members including children who do not participate in the business, if and only if a proper business valuation is completed. ?The reason being is that only a fair value taken back by the Parent will make their estate whole. ??

Let us break down the strategy, say you have a family business, Child 1 participates in the business and wants to take over the business when the Parents are ready to retire.?? Child 2 has no interest in the business as they have their own career.??

A typical initial step for the family when contemplating a succession plan would be to contact their Accountant.? The Accountant may recommend a strategy similar to the one discussed above.

The question is who prepares the business valuation for the business transfer? This is a very important question because if the business is valued too low then the value taken back by the Parent is below fair market value.?? What are the implications? Well, the first is that Canada Revenue Agency may impose significant tax penalties on the transactions. The second, which, is most often overlooked, is that the Parent’s estate is not made whole.? You might be saying, “Who cares” the benefit of the lower value for the business was given to Child 1.?? What about Child 2?? Remember the Parent’s objectives was to be fair to all family members.? Child 2 participates equally in the estate of the Parents through their Will.

I have often seen that the Accountant recommends that his or her firm prepare the business valuation internally.? Let us look closer at this recommendation.? The Parents have typically paid significant annual and recurring accounting, tax and consulting fees to the Accountant to take care of the business’ reporting requirements.?? When Child 1 takes over the business, they have the option of keeping the Parents’ Accountant as their Advisor or transiting to a new Advisor. ?The Accountant and the Accounting Firm certainly wants to keep the business as it may form a significant component of the Firm’s annual revenue.? Child 1 would certainly benefit from a lower business valuation at the point of transfer from the Parent.? There would be less money having to be paid out of future profits by the business to the Parent’s estate after Child 1 takes over.? The difference retained by Child 1.???

So, I ask you is the Accountant or the Accounting Firm the best Advisor to provide a value of the business at the point of transfer from the Parent to Child 1?? Is the Accountant or Accounting Firm independent enough both in fact and appearance?? I would argue not, if you truly want to be fair to all family members.

The problem that I see on a regular basis is that certain Accountants recommend that their Firm can prepare the business valuation internally.? Even though the Accounting Firm may not be independent in fact and appearance.? The Accounting Firm is motivated to keep the annual and recurring accounting, tax and consulting revenue after Child 1 takes over the business.?

Further, not all Accountants possess the required credentials and experience to prepare the business valuation, such as a Chartered Business Valuator (“CBV”) designation through the CBV Institute or an accreditation through the American Society of Appraisers.

There are sufficient independent and qualified Business Valuators in the Canadian market place to ensure the objectives of a fair and independent business valuation for a succession plan.?

Typically, the succession plan is completed in isolation of Child 2.? I would suggest that even though Child 2 is not taking over the business, that he or she participates in the plan, as their interest lies in a fair allocation of business value to the Parents’ estate.?

All Stakeholders in the succession plan should ensure the Business Valuator is qualified and independent in both fact and appearance. You should understand and assess the Business Valuator’s past and future business and personal relationships with all Stakeholders.

Feelings of worth can flourish only in an atmosphere where individual differences are appreciated, mistakes are tolerated, communication is open, and rules are flexible -- the kind of atmosphere that is found in a nurturing family.?????

Virginia Satir

?Andrea Pontoni holds an Honours Bachelor of Commerce Degree, is a Chartered Professional Accountant (CPA), Chartered Accountant (CA), Chartered Business Valuator (CBV) with the Canadian Institute of Chartered Business Valuators, Accredited Senior Appraiser (ASA) in business valuations with the American Society of Appraisers and Certified in Financial Forensics (CFF) with CPA Canada and the American Institute of Certified Public Accountants.? Andrea has also completed the three parts Chartered Professional Accountants of Canada’s in-depth tax specialty program.? Andrea has over 30 years of experience with 17 of those years at two National Firms where he held senior positions including that of a partner.? His practice includes providing advice on business valuation, succession and estate planning, personal and corporate taxation, economic loss quantifications, financial investigations, accounting advice, financial forecasts, business planning and corporate finance matters to clients varying in size and industry. For more information on his background visit his website at www.pontonifinancialsolutions.com .? He can be reached at 519-890-6288 or by email at [email protected] .