Ensure business owners plan ahead

Businesses are more likely to survive if owners plan ahead. This real-life story explains why.

Karen, 56, started Staywell Corp, a health services business, 23 years ago. Her son John, 27, and daughter Beth, 24, have worked in the business since graduating from university.

Karen recently contracted a life-threatening virus leaving her paralyzed and unable to work. She hadn’t developed a strong senior management team, and Karen hadn’t documented much of the business knowledge.

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With the help of a few loyal employees, Karen’s children kept things together for several months, hoping in vain that their mother would quickly return to work.

Karen and her family never discussed what would happen in case of a tragic event, so John and Beth were completely unprepared for the responsibility resulting from their mother’s lengthy absence. After six months of declining sales, John and Beth realized it was necessary to sell the business.

The value received for Karen’s shares was substantially less than it should have been, as much of the intellectual capital was tied up with her. The proceeds still resulted in a taxable capital gain to Karen of $1.2 million, thereby costing her family $110,000 in capital gains taxes.

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After the sale, John and Beth left the company; only one has since found new employment. Karen’s disability insurance, a fraction of her former CEO’s salary, means the family is struggling financially, as Karen needs full-time nursing care, and the after-tax proceeds were used to pay down debt.

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How could this family have experienced a better outcome?

• Succession Planning – Karen could have developed a strong and capable management team and delegated as much responsibility as possible to the team, with the objective of making herself redundant to day-to-day operations.
• Insurance Planning – At least bi-annually, Karen’s advisors should have reviewed her life and disability policies to provide adequate coverage in case of death, illness, or disability. Insurance strategies can often include funding the premiums using corporate assets in certain situations. This planning also involves the preparation and updating of proper wills and powers of attorney.
• Tax Planning – A proper corporate structure also might have allowed Karen to multiply the Capital Gains Exemption on the sale of Staywell Corp’s shares, possibly eliminating all of the $110,000 of capital gains tax.
• Exit Planning – Karen should have been developing and communicating her plans for the business, so that the key stakeholders (her family and senior management) would know and understand Karen’s wishes and how to execute them in case of disability or sudden death.
• Financial Planning – a solid financial plan could have established family assets in addition to the business investment, making the group less reliant on Staywell Corp for support. Debts could have been managed to maximize interest deductibility.

Jordan Gould, CPA, CA, is a partner at Richter LLP in Toronto.