Help a widow sell her business

Widow Jill Yohannes*, 58, has been managing her husband’s company since he died six years ago. Now, she’s considering retirement. Experts detail how to wind down the business, and deal with estate and tax challenges.

The situation

Bejan Yohannes died in a plane crash in 2008. His widow, Jillian, never missed him. She was planning to ask for a divorce before he died and refers to him as “the easiest 180 pounds I ever lost.”

Part of the reason she hasn’t missed him is because she barely knew him. Bejan devoted his life to a growing tubular steel importation firm in Prince Rupert, B.C.

Read: Tax consequences of selling a business

The firm, founded in 1975, brings in aviation and construction-grade steel components (originally from Japan but expanding to goods from Chinese mills in 1996). Bejan took advantage of a recession in the lumber sector to gain low 40-year leases on storage facilities adjacent to railway lines. This strategy, coinciding with his signing early import deals with Chinese steel mills, caused the business to double between 1996 and 2000. Annual receipts are $50 million; EBITDA is $3 million.

The firm employs three senior managers, five middle managers, 10 clerical staff and 25 yard labourers. None has equity in the firm. Chief expenses beyond labour costs are storage facility leases, rail shipping agreements, and real estate taxes on the company’s headquarters (a mortgage-free, 10,000-square-foot commercial office structure with 40 parking spaces valued at $375,000).

Jill let the company’s managers run the firm during the year it took to settle her husband’s affairs, and then took over the business in 2009. She’d gotten an MBA before dropping her career plans to have children—both kids are now pursuing their own careers in Vancouver with no plans to return to Prince Rupert and work in the business.

Jill held 50% of the firm’s shares and inherited Bejan’s half when he died. Despite suggestions from an estate lawyer, Bejan refused to include the children in the share plan drawn up in 1992, citing they were minors and that such matters were “only to be looked after by adults.”

Read: Avoid the (new) kiddie tax

Likewise, Jill was a joint tenant on the commercial building, as well as on the couple’s primary residence (a split-level, suburban ranch house valued at $240,000). Jill has a $5-million unregistered investment portfolio acquired through self-directed trading.

Her goal these past four years has been to manage the company, rather than grow it, and orders for construction steel spurred by strong condo construction have kept the books healthy.

Read: 5 reasons to use an advisor when selling a business

But Jill’s nearing 60 and realizes it’s time to draw up plans to pass the company to new owners. She’s had initial conversations with Victor, Bejan’s accountant since the company opened. His response has been simple: “Just put out a few feelers, see who bites and sell quickly.” That answer’s got her nervous.

The experts

Mark Groulx

president and founder of AIM Group Canada Ltd.

Peggy Gates-Hammond

director, Wealth Planning & Trust Services, BMO Harris Private Banking

Jeff Halpern

business succession advisor, TD Wealth, Wealth Advisory Services

Business sale

Mark Groulx: It’s irresponsible of the accountant to be so flippant. The company has a substantial enterprise value. To not formalize a process would minimize proceeds and could also increase risks inherent in the transaction.

So rather than just put out feelers, she should start interviewing M&A advisors.

Jeff Halpern: Yes, she must commission a business valuation. This will help her understand its value relative to other competitive businesses in the industry, and what metrics buyers would look at so she can get the maximum sale price.

Read: Help an ailing business owner

Then Jill must evaluate all options. There is no one single solution for succession. We’ll first meet with the family and ask if keeping the business in the family is a possibility, because a legacy is something that’s very hard to replace.

In Jill’s case, the children are not interested. If there were another shareholder or partner, we’d also look at selling to him. But again, we won’t since she’s the sole shareholder.

The third option is a management buyout. This structure is usually used if owners want to reward the loyalty of a management team by giving them the option to buy into the company.

MG: But it’s very rare you’re going to get anywhere near the cash consideration from a management buyout [that you would from an external sale]. This is because management have been employees all their lives, and don’t have a big pool of capital amongst themselves. So they’ll borrow money and pay out over time. If you just want to settle quickly and get the best price, this option might not work.

Peggy Gates-Hammond: Still, given the small number of employees in Jill’s management team, she risks losing some senior managers. So, she might take a little less money from a management buyout just to secure the senior team.

JH: If this option doesn’t work, we look at customers or suppliers, who are familiar with the business. If we still don’t have any buyers, then we go to competitors. Someone who knows your business and values it would be a logical party to deal with.

Read: Businesses selling assets need better strategy: EY

If at that point we still don’t have a buyer, we’ll consider private equity firms. Jill’s business has $50 million top line and $3 million bottom, so it’s desirable. A PE firm might be interested in buying into the company to consolidate it with similar ones it owns, or even to expand.

The last resort is to look to a third-party, unknown buyer.

Advisory boards can help

Advisory boards have a significant impact on a business’s financial performance. Yet only 6% of Canadian small- and medium-sized enterprises use one, finds a study from the Business Development Bank of Canada.

Almost 86% of entrepreneurs who do have an advisory board say it’s had an important impact on their business success. These companies saw their sales grow three times faster in the following three years.

“The benefits of having good quality, independent advice from well-respected, experienced individuals is clear, and we now have research to support it,” says Jean-René Halde, BDC’s president and CEO.

PGH: Have you ever seen a scenario where a buyer would want assets, not shares?

MG: Yes. The only reason there are so many share transactions in Canada is because of the small business capital gains exemption. Buyers prefer to buy assets because they limit their liability going forward. They’re not buying the history of the company—just the operations. So, yes, they prefer to buy assets, but usually there’s so much tax structuring in advance that, especially vendors in Canada, prefer to sell shares.

Read: What is my client’s company worth?

One issue she might face is that she hasn’t been growing the business—it’s been stagnant. But it’s also been steady, so that’s good. It’s a nice company and there are lots of buyers, both within the industry and outside, who’d be interested.

JH: To ensure the company remains desirable, it’s better to retain staff so it doesn’t fall apart as soon as they learn about the sale. Some business owners implement golden handcuffs. These include special compensation arrangements or a share of ownership to retain and reward staff, so they don’t leave and cause the business’s value to decline.

Investment options

PGH: A business sale is like winning a lottery. If you look at the statistics of how many lottery winners still have their money five years later, it’s not pretty. I often recommend clients take a cooling-off period—possibly as long as a year for a large transaction—before making big investment or spending decisions. For instance, maybe she wants to buy a boat, move to a foreign land, give money to her children or lock into an investment strategy. She should wait, and keep proceeds from the sale relatively liquid until that initial excitement has worn off.

In the meantime, she needs to protect her retirement income [and live within it] so she doesn’t run out of money. This may include changing her spending habits, and choosing tax-advantaged investments.

Read: How longevity impacts financial plans

If she has more capital than she needs, which is likely given her sizeable investment portfolio and what she’ll receive from the sale, she could give her adult children lump sums, or leave an inheritance.

Also, the commercial building is a great source of retirement income because she can earn rent, and leave it to her kids in her will.

JH: Jill’s still young, so annuities might be something we consider down the road. The longer an annuity stream has to last, the lower the income. So at her age, we’d still want to build her wealth tax effectively to create a capital base that would sustain her for the rest of her life.

Read: Create retirement stability for Gen X

Tax and estate considerations

PGH: Jill needs to properly structure the business to minimize the tax bite of the sale, and that needs to be done before identifying a purchaser. For instance, there may be an opportunity for her to sell shares and use that to enhance capital gains exemptions. Since she’ll likely sell within a few years, an estate freeze could make the tax on those proceeds more efficient. So while she’s undertaking that valuation process, she should also be consulting with a tax advisor to look at the company structure.

And she must make sure there are no passive assets, including cash that’s been built up in the company, that aren’t used in operations. Then she could consider using the capital gains exemption of her children if she wants to give them proceeds from the sale. She could issue new shares to them directly.

MG: Mind you, for the children to benefit from the small business capital gains exemption, they have to be shareholders for two years, don’t they?

PGH: The rule is that no one other than the kids can have owned the shares, so there are ways of achieving that. The shareholder and the shares have to qualify. For the shares to qualify, at the time of the sale, 90% of company assets have to be used in active business. And, for two years prior to the sale, 50% of the assets have to be used in active business. And, yes, no one other than the shareholder can have owned the shares for two years prior.

But the kids don’t seem to want the company, so she could benefit them through a family trust.

Read: How the Clintons use trusts to cut tax

JH: It’s common in wealthy families for parents to leave assets in a trust for children. In her situation, we know the kids are adults, so she might create an inter vivos trust.

That’s a formal method of remaining in control of the assets, while being able to do income splitting with the children, and their children as well. Also, she’ll be able to take advantage of the capital gains exemption, and can avoid probate costs since the funds are sitting in a trust.

PGH: I would definitely recommend testamentary trusts for her children. Notwithstanding that some of the tax benefits may be gone after the last budget, a testamentary trust still provides an added legal layer between household assets and inheritance. We don’t know much about the kids, but say she has a son who has credit issues and falls behind on bill payments. Any money that’s in the trust will be safeguarded from a third-party creditor.

Also, one underlying factor in Victor’s suggestion to sell quickly could be that Jill has health concerns. If that’s the case, she should have a financial power of attorney that can step in to her place as shareholder and make decisions about the company, including negotiating a sale if she’s unable to do so.

JH: Plus, there’s a fear her children might misuse assets if they’re deemed power of attorney. So appointing an independent fiduciary, like a big bank trust company, provides an avenue of protection. This prevents the kids from fighting over the money.

Read: Avoiding estate litigation

Also, she resides in British Columbia, and as of March 2014, the province became a multiple wills jurisdiction.

So, just like Ontario, those in B.C. will be able to have one will to govern the shares of a private company, and one to govern probatable assets.

This will save Jill a probate cost that is graduated to a maximum of 1.4% of the value of assets that go through her secondary will—$14,000 for every million dollars of asset value. However, a distinction in B.C. remains: the need to have two separate executors, one for each will.

PGH: And even though it doesn’t seem as if Jill has charitable intent, I’d point out she’d be able to mitigate some of her tax liability upon on death, or on her sale during her lifetime if she donates.

Final thoughts

PGH: Jill’s in a good position. She doesn’t have anyone dependent on her. So she’ll sell her company, and at death her assets, including investment portfolio, home, commercial building and shares in the company, will be deemed disposed.

Tax liability would come due at that point. So there needs to be cash to cover that, which I’m less concerned about since she has $5 million in her investment portfolio already.

MG: She needs to do a lot of preparation before she plans for a sale, including getting her documentation in order, as well as her historical financial statements and due diligence records. AER

*This is a hypothetical client. Any resemblance to real persons, living or dead, is purely coincidental.