Preparing Your Company For Sale
Demographics are changing across our country and Canadian business owners, like the rest of us, are aging. For many entrepreneurs, the sale of their business is how a great portion of their retirement will be funded. And planning for that stage of your entrepreneurial journey may require more forward-thinking.
“From a business valuation perspective, preparation for a sale can take place at any time,” shares Michael Riseley of Holmes CPAs and Tax Advisors. “That being said, the preparation for a business sale is made much easier and can result in a better sale price if it is done at least between 3-5 years in advance of a potential transaction.” For Canadian business owners, it means shifting the conversation to transition and sale of your business well in advance of your retirement goals. Some of the advantages of preparing at this earlier stage? Giving the business owner time to improve its financial position to make it more attractive to potential buyers. This could include improving the Company’s margins on sales, improving its operating expenses to be in line or greater than industry averages, ‘cleaning up’ the business’ balance sheet, and keeping track of potential discretionary or personal expenses that would be subject to normalization.
Aside from the valuation of the business, early planning allows for implementing tax-efficient strategies. “You want to ensure the business is organized in a way to assist in implementing tax planning strategies which may require extracting assets in advance of the sale that shareholder doesn’t want to include in the sale of the business,” says Matt Holmes of Holmes CPA’s and Tax Advisors. There are tax-efficient ways of extracting excess cash or investments from the business, but Holmes says this should occur no less than 2-3 years prior to a sale. “Planning could also be undertaken to multiply the possible use of a family’s capital gain exemptions through either including additional shareholders or a family trust, says Holmes. “But this type of planning should be performed well in advance of a possible sale.”
What are some of the common roadblocks preventing early-stage planning for the preparation of the sale of your business? A common one is understanding its value and having a proper business valuation completed. While Riseley reminds us every business is unique and that the business valuation process can differ slightly from business to business, it typically includes the following:
A review of the Company’s financial statements for the past five years and its latest corporate tax return;
A meeting with the business owner(s) or key personnel to discuss the nature of the business;
A tour of the business’ facilities; and
Research into the business’ industry and outlook moving forward.
The above leads to the preparation of a report which is reviewed with the business owner(s) in draft form before being finalized and provided to the owner(s) for their use in a business transaction.
How are the numbers crunched for the valuation process? Michael Riseley explains. “Business valuations attribute a value to a business or business interest based on the net cash flows generated by its operations,” he says. “The future net cash flows of the business are determined based on either historical normalized cash flows (based on accountant-prepared financial statements) or prospective discounted cash flows (based on management-prepared forecasts) depending on which is the best indicator of operational performance moving forward.” Once future net cash flows are determined, a multiple is then applied to determine the enterprise value of the business. This multiple is based on a number of factors including the risks associated with the individual business or industry within it operates and the rate of return that would be expected on a similar investment. “Once the enterprise value is determined, the business's debts and redundant assets are then deducted and added to this value respectively to arrive at the value of the business’ shares.” The value arrived at through this process usually acts as a starting point for determining the initial asking price for the shares of the business and is typically adjusted for specific circumstances including the nature of the potential buyer and the negotiating position of the business owner in a transaction.
Completion of the valuation of the shares then allows for tax planning strategies to be developed by considering tax minimizing strategies including the use of capital gains exemptions or RRSPs or Personal Pension Plans (PPP’s). “There are many other strategies that may be involved to help minimize tax on a sale,” says Holmes. “We often look for more opportunities to defer tax in these cases, which again may include the use of RRSPs and personal pension plans. There may be other opportunities to allow vendors to claim deductions for other compensation arrangements.”
One of the most important factors in preparing for sale? To engage your professional team and start these conversations early in your business planning cycle. In addition to the advisors at Holmes CPA, this professional team could include:
A corporate lawyer (knowledgeable and experienced in business transactions)
Real estate or equipment appraisers
Real estate agent
“You want a professional team around you that is experienced and also holds similar values to you as a seller,” Riseley shares. “With those attributes in place, the business owner can feel comfort through the valuation and sale.”
Holmes CPAs and Tax Advisors specializes in tax and transaction advisory services and also provides business valuation services.