Succession planning: 3 exit strategies for your business

Turning the page is never easy. It is, however, a reality facing more Canadian entrepreneurs. 61.5% of owners of Canadian small and medium-sized businesses are aged 50 or older, nearly double the proportion of the overall workforce, according to Statistics Canada and Innovation, Science and Economic Development Canada. And the proportion of those Canadian entrepreneurs is growing. In 2017, a BDC study indicated that 59% of them were 50 or older.

50 years old or older

Are there fewer entrepreneurs than before?

A recent BDC study found out that Canada has 100,000 fewer entrepreneurs than in 2002. Only 1.3 individuals out of 1,000 are starting new businesses compared with 3 out of 1,000 20 years ago. That means there are less than half as many individuals making the leap to entrepreneurship.

New entrepreneurs are generally between their late 20s and early 40s. However, the aging of the Canadian population will likely impact the creation of new businesses in the coming years, as that portion of the population shrinks and the 55+ age group grows.

The study also pointed out three main reasons for entrepreneurs deciding to exit their businesses:

• retirement
• personal or family reasons
• financial difficulties 

According to a report by the Canadian Federation of Independent Business (CFIB), 75% of business owners cite retirement as the reason for leaving their businesses.

Canadian businesses are set to change hands

More than three-quarters of small business owners plan to exit their businesses by 2033, according to the CFIB report.

More than $2 trillion in business assets could be at play between 2023 and 2033, with so many small business owners planning to leave behind their business activities.

Why should you have an exit strategy?

Anyone who operates a business will likely reach a point when they feel they must leave the business. This could mean retirement, selling the business or closing it down.

These are considered exit strategies, and every business should have one. Yet exit strategies and succession planning are rare among small businesses, largely because most small business owners focus on starting and building their businesses but not on leaving them.

An exit strategy requires that you take two important steps:

1. A personal soul-searching and information gathering, to come up with a vision for both the business and yourself.
2. Once you have identified an exit, begin planning and executing what it will take to achieve it. Because exiting a business involves many steps, this process must begin early. Advisors usually suggest that an exit strategy begin at least two years before your departure.

What are some common exit methods?

A homeowner putting a house up for sale normally wants to realize the highest possible return. It’s the same for entrepreneurs. They plan to sell their business, typically their biggest asset, for maximum return. Choosing the best option for your needs and retirement choices is essential.

When it comes to how owners intend to exit their businesses, the CFIB report indicates that:

• about 1 entrepreneur out of 4 (24%) will sell to a family member
• about 1 entrepreneur out of 4 (23%) will sell to their employees
• about 1 entrepreneur out of 2 (49%) will sell to a buyer with no personal connection the company

The first step in your process should be to decide which option best suits your needs. Here are three common exit strategies for entrepreneurs who want to sell or pass on their business.

1. Pass the business on to a successor 

In this case, the successor can be a family member or a manager in the company.

The first step when choosing this option is to establish the ideal profile for your successor. Next, identify and evaluate potential candidates using fair, measurable criteria. You may also need to train them to manage the business successfully. This could take time, depending on the complexity of the business.

2. Transfer ownership through a management or employee buyout

Here, the management team or a group of employees pool resources to acquire all or a part of the company. This is one of the best options for owners who don't have a candidate for succession or who want to preserve the corporate culture of the business.

These cases usually require legal processes, such as an arrangement of share.

3. Sell the business to a third party

There are several options for business owners who are looking to sell their small business.

• Initial Public Offering (IPO)—The sale and/or issuance of shares in a private company on a public stock exchange.
• Private equity—The sale and/or issuance of shares to a financial investor.
• Sale to another business—The sale and/or issuance of shares to another operating company. This is a good option for shareholders looking for a clean exit and the highest possible value.

Before making a final decision, make sure the type of transition you choose aligns with your retirement choices.

Your preparations need to lead to a maximizing on your return. Simply making cosmetic changes to your business at the last minute and putting it on the market for sale often results in a reduced return.

A sale usually requires a long strategic management process that produces evidence of growth potential and makes the business more attractive to potential buyers. In addition, likely buyers should be identified ahead of time, and alliances or overtures made before the actual event.

Another version of selling a business involves simply closing it and selling a client list to a competitor.

Where is the best place to sell your business?

Different platforms may suit different types of businesses, industries, and buyers. It is highly recommended to work with an experienced outside advisor who will help you with the sales process.

General factors to consider when choosing where to sell:

Size and value of your business

Larger and more valuable businesses may attract serious and qualified buyers through specialized marketplaces or through an investment banker.

Smaller and less valuable businesses may find more interest on general platforms, through direct contacts or through business brokers.

Intermediaries such as business brokers and investment bankers have access to a large network of buyers. They can approach them on your behalf or help you navigate the sale process.

Type and industry of your business

Some platforms may cater to specific types of businesses or industries, such as e-commerce, franchising or manufacturing. These platforms may have more relevant and targeted buyers, as well as more expertise and resources to help you sell your business.

Cost and convenience

Platforms and intermediaries may charge different fees and commissions for listing and selling your business, as well as offer different levels of service and support. You should compare the costs and benefits. Chose something that fits your budget and expectations.

New buyers prefer a strong, stable business

It’s also important to note that more buyers are most likely looking to purchase stable rather than growing businesses.

Before considering a sale, it’s best to ensure the business is strong and profitable. Very few buyers, no matter their size or risk appetite, buy declining or unprofitable businesses. Companies that need to be turned around before they can be profitable will be much more difficult to sell.

Select a good team of professionals to help you navigate through the succession planning process and communicate often and clearly with all the stakeholders.

How much tax do you pay when you sell a business in Canada?

The amount of tax you will pay depends on how you sell it, how much profit you make from the sale and your business structure. Fiscally, there are two main methods of selling a business: an asset sale and a share sale.

Asset sale

In an asset sale, you sell some or all the assets of your business.

Those assets can include:

• equipment
• inventory
• contracts
• list of clients

However, you do keep the legal entity of your business until you close its doors.

In an asset sale, you pay capital gains tax on the difference between the selling price and the adjusted cost base of the assets. Fifty percent of the capital gain is included in your taxable income, which is then taxed at your marginal tax rate. Marginal tax rates vary by province and income level.

For example, if you sell an asset for $100,000 and your adjusted cost base is $50,000, your capital gain is $50,000. Only half of that, or $25,000, is added to your taxable income. If your marginal tax rate is 30%, you will pay $7,500 in tax on the capital gain.

Share sale

In a share sale, you sell the shares of your corporation, which transfers the ownership and liabilities of the business to the buyer.

In a share sale, you also pay capital gains tax on the difference between the selling price and the adjusted cost base of the shares. However, you may be eligible for the lifetime capital gains deduction (LCGE). It allows you to exempt up to a certain amount of capital gains from tax if you sell shares of a qualified small business corporation (QSBC). The LCGE limit for QSBC shares is $923,460 in 2023. This amount is indexed to inflation and increases annually.

In addition to capital gains tax, you may also have to collect and remit GST/HST on the sale of your business, depending on the type of assets or shares you sell and whether you are registered for the tax. Generally, the sale of shares is exempt from GST/HST. The sale of assets, however, is taxable unless the assets are sold as part of a going concern.

You should consult a tax professional regarding your specific situation.

Next step

Discover how to prepare your exit strategy, boost the value of your business and finance your sale by downloading the free BDC guide, Selling Your Business.