The Practicalities of Passing the Torch
Toronto Star – Thursday, October 13, 2005 – Page J10
Owners set to exit but few have plan
Don't force family to sell your legacy
After 26 years of running the industrial adhesives manufacturing plant started by his father in 1949, Randolph Paisley isn't quite ready to pass the torch to the next generation – although his adult son is involved in the business and is being groomed to take it over some day.
But with the help of Aron Pervin, president of Pervin Family Business Advisors Inc., and the Canadian Association of Family Enterprise, Paisley has begun to take steps. As company president he's developing an effective transition strategy for Paisley Products of Canada Inc., which is Scarborough-based and employs 42 people.
"Our business succession plans are not fully formed, but the business is being run in parallel as a professionally managed organization – which could be sold to interested parties – and as a family enterprise, with a strong successor being mentored and groomed to lead," says Paisley. "In the event that the successor chose to follow a different path, the company would not be adrift."
Paisley's advance planning puts him in a minority among small business owners, concedes Catherine Swift, president of the Canadian Federation of Independent Business, which surveyed more than 4,000 of its members recently on their plans for exiting the business upon death or retirement.
With aging baby boomers set to trigger yet another demographic wave as they retire, the issue is looming. According to a recent Canadian Imperial Bank of Commerce study, one-fifth of small business owners – more than 500,000 individuals – are expected to retire in the next five years. Yet, few have planned for the inevitable ownership and management transfer of their business assets, which the bank estimates to be worth $1.2 trillion.
"Only 7 per cent of small- and medium-sized business owners have a formal succession plan, and yet 70 per cent plan to exit the business within 10 years – that's worrisome, to put it mildly," says Swift, whose organization is developing a succession checklist in partnership with the Canadian Institute of Chartered Accountants. The check-list will be posted on the federation's website, www.cfib.ca, by February, she says.
Paisley believes good succession planning is vital. He has taken out ample life insurance to ensure his family could pay for such things as transfer taxes and shareholder buyouts, if he were to die before retiring.
There doesn't appear to be any official tracking of the success rate of generation-to-generation family businesses in Canada. But according to the Family Firm Institute in the US., only 30 per cent of all family-owned businesses survive into the second generation, and only 12 per cent will still be viable into the third generation, says Paisley, who received the figures recently from Andrew Pigott, the president of the Canadian Association of Family Enterprise.
"It doesn't necessarily mean the businesses fail, but they are broken up or diminished or diluted or sold off," he says.
Even if there are no heirs apparent to take over a family business, a transition plan is vital to avoid leaving the family in a "distress sale" position, which could seriously reduce its market value, warns Grant Robinson, a partner with the Guelph-based accounting firm Robinson, Robinson & Company LLP, and advocacy chair for the Upper Canada chapter of the Canadian Association of Family Enterprise.
If a family-run business loses its founder, with no proven management team running the enterprise, "the best you can get is the book value," says Robinson, adding family members may be forced to sell a business to meet obligations caused by the 25 per cent transfer taxes. As well, banks may pull loans and suppliers and customers may withdraw their business if they are not confident plans have been set in place for the company to continue as before.
Perry Muhlbier, an associate partner with accounting firm KPMG's enterprise practice, agrees that most forced sales of businesses don't get top dollar.
"People need to think on a day-to-day basis, 'How can I add value to my business so it is ready for sale?'"
Perhaps a bigger issue is how to avoid family conflict and distress, if relations are left to manage the transition on their own. "People don't like to plan for succession," says Robinson. "It's tied into a fear of mortality – it smacks of planning your own funeral."
Instead, they should look at it as passing along their legacy, he says.
Keys to an easier succession
A good succession plan considers these issues: tax and legal matters, income needs of the owner in retirement, a successor selection process, the mechanics for selling the business, successor financing, future roles of key members, a timetable, a process for resolving disputes and a process to monitor the success of the transition. The key elements are:
- Separation of ownership issues from management issues.
- A parallel plan for professional management, even if there is a family successor, in case the successor finds they are unsuited or loses interest.
- A governance structure to shift decision-making from the owner to the next generation.
- A shareholders' agreement, which is a rulebook about how business decisions will be made.
- Adequate life insurance coverage to make sure transfer taxes get paid and any shareholders wanting out can be bought out.
- Small businesses should ensure they are structured to qualify for the $500,000 life-time capital gains exemption, offered to businesses with taxable earnings less than $200,000. The CFIB is lobbying to increase this exemption to $800,000.
- In some cases, an estate freeze is used to fix the value of an enterprise before succession takes place, with any increase in value going into a trust fund, for instance. This powerful instrument is often used to reduce the amount of transfer tax owed upon succession.
- Plans may be developed for successor financing options.
– BETH MARLIN