Back to Ins and outs of selling a business

Ins and outs of selling a business

March 04, 2007

Ellen Roseman

You’re an entrepreneur in your 50s or 60s, hoping to retire soon. Your children have no interest in joining the business.

Should you make plans to sell it? What is it worth, anyway?

Trevor Hood is a chartered business valuator. He’s trained to analyze the value of companies and give reports to use in succession planning.

“Often, businesses have these huge risks,” he says. “There’s too much reliance on a sole owner, customer or supplier.”

For example, an owner in his late 60s had a steady business that made $200,000 a year in profit. But last year, he barely broke even because he relied on a couple of customers, whose revenues had dropped off.

“He thinks the customers will come back, but this is too much risk for a potential buyer,” says Hood, a chartered accountant and vice-president of SB Partners LLP in Burlington.

Owners may have high expectations of what their businesses are worth, because of the reputation they have in their communities.

But prospective buyers won’t pay for personal goodwill.

“A lot of owners are so entangled in operations that their businesses would be nothing without them. It’s important to build infrastructure,” he says.

Infrastructure means putting written policies and procedures in place, so they’re not all embedded in the owner’s head.

It means hiring new managers or promoting employees to take over when the owner is no longer around — and putting contracts in place to ensure they will stay.

It means diversifying the base of customers and suppliers, since a business isn’t nearly as valuable when a key customer or supplier is lost.

Hood knows of another owner, just diagnosed with terminal cancer, who’s winding up his business. He hasn’t enough time to get it ready for a sale and find a buyer.

“Unlike the cosmetic touches a home seller may undertake in the weeks preceding the listing of a home, it takes more than a little touch-up or a coat of paint to sell a business,” says The Succession Planning Toolkit for Business Owners: Leveraging your Life’s Work, published by the Canadian Institute of Chartered Accountants.

“It takes a great deal of effort to prepare a business for sale. At the very least, you should plan on spending a year or two years on strengthening the business.”

The value of an operating business depends on the future profits and cash flow, says Farley Cohen, a chartered business valuator and managing director of Navigant Consulting in Toronto.

But a business could be worth more than its operations if it has valuable assets, such as a building in downtown Toronto. Owners need to find experts, such as real estate appraisers, to prepare for a sale.

Owners often seek help from other experts — such as lawyers, accountants, insurance brokers or financial planners — when getting ready for a transition.

“The biggest problem is when the owner does no planning and the family starts fighting,” Cohen says. “Some businesses are destroyed when the key shareholder dies.”

Here’s an important consideration when selling a business: Do you sell the assets or the shares?

The asset vs. share sale decision is complex, says the Succession Planning Toolkit, and tax issues usually play a significant role.

A sale of shares allows the business owner to use the $500,000 capital gains exemption. With a sale of assets, there’s no tax shelter.

It’s important to do some tax planning before a transfer of ownership to ensure the business shares qualify for the $500,000 exemption.

There are three conditions, says Hood:

  • The owner must have owned the shares for the previous 24 months before the sale.
  • The company must have 90 per cent of its assets invested in active business operations at the time of sale.
  • The company must have 50 per cent of its assets in active business operations for the 24 months preceding the sale.

    Purchasers of a business usually prefer to buy assets. There are tax advantages to doing so and they don’t inherit any lawsuits or unknown liabilities. Business sellers, however, prefer a share sale because of the $500,000 capital gains exemption.

    “You and the purchaser should compare the tax consequences of both a share and an asset sale transaction,” says the toolkit.

    “Often the choice will be made by negotiating the purchase price to make it attractive to one of the parties.”

    There shouldn’t be a lot of non-operating assets in a business, Hood says. Owners who have built up cash should take it out before a sale.

    Even better, owners should keep 90 per cent of their assets in active business operations all the time. If they die unexpectedly, this ensures their estate can take advantage of the $500,000 capital gains exemption.

    A chartered business valuator is often called in after the owner dies. Some owners, while still alive and looking ahead, may seek a business valuation for estate planning purposes.

    More complex than an appraisal, a valuation looks at the tangible and intangible assets of a business, as well as its cash flows. The cost starts at $5,000 to $10,000 and can go higher, especially if the report is used for litigation purposes.

    “A business valuation is often an important part of your succession plan, as it can be a critical factor in determining your overall strategy for your exit,” the toolkit advises business owners.

    “If you are selling your business, a professionally prepared valuation report assists you in determining a selling price, adds credibility to your marketing package and ansures a quicker, more effective business transfer.”

  • Next Sunday, we’ll look at how a power of attorney for finances can help avoid family disputes. And do you need a lawyer to prepare a will and power of attorney?

    Ellen Roseman’s column appears Wednesday, Saturday and Sunday. You can reach her by writing Business c/o Toronto Star, 1 Yonge St., Toronto M5E 1E6; by phone at 416-945-8687; by fax at 416-865-3630; or at by email.