As Canada’s business landscape prepares for a generational shift, the importance of thoughtful succession planning cannot be overstated. With over 70% of Canadian businesses being family-owned and nearly half of business owners planning to exit within the next five years, billions of dollars in private business assets are poised to change hands. Yet only a fraction have a formal plan in place.
Below are key considerations for those preparing to pass the torch. Whether you’re selling to a third party, transitioning to family or employees, or winding down operations, the tax implications are too significant to ignore.
The Foundations of Succession Planning
Succession isn’t just a transaction – it’s a multi-year process that affects family dynamics, management, ownership, and legacy. A comprehensive plan should address:
- The future of the owner, family, and company,
- Accurate valuation of the business,
- Clear communication with successors,
- Defined transition timelines, and
- Early-stage tax and legal planning.
Early planning, ideally two to three years before a transition, is critical to unlock tax strategies and maximize value.
Exit Strategies and Their Tax Impact
1. Selling to a Third Party: Share vs. Asset Sale
This is one of the most pivotal decisions. From a tax perspective, sellers prefer share sales (to access the $1,250,000 lifetime capital gains exemption), while buyers prefer asset purchases (to get tax deductions and avoid liabilities).
Share Sale Benefits for Sellers:
- Access to Capital Gains Exemption (CGE).
- Simpler tax reporting.
- All liabilities transferred with the corporation.
Asset Sale Benefits for Buyers:
- Cost base bump-up for future deductions.
- Control over what is acquired.
- Avoidance of unknown liabilities.
Hybrid structures, such as selling shares of a newly formed “Newco” that holds the business assets, can meet both parties’ objectives.
Other Planning Tactics:
- Safe income strips via holding companies.
- Pre-sale capital dividend distributions.
- Purification of corporations to meet QSBC criteria.
- Capital gains exemption multiplication across family members.
2. Transferring to Family or Employees
Transferring ownership internally brings its own set of challenges. Beyond the numbers, issues like fairness vs. equality, family harmony, and leadership clarity are vital.
Key Planning Concepts:
- Estate Freeze: Locks in the value of the business for the current generation and allows future growth to accrue to children or trusts.
- Thaw and Re-Freeze: Allows flexibility in timing or choice of successors.
- Use of Trusts: Offers flexibility and creditor protection.
- Shareholder Agreements: Clarify buy-sell provisions, succession terms, and rights of active vs. inactive shareholders.
- Employee Buyouts: Typically require vendor take-back financing and a staged buy-in structure.
Fair vs. Equal:
Founders often try to treat children equally—but equal share ownership can be unfair to the active successor. Consider alternate methods of equalization, such as life insurance or non-business assets.
3. Liquidation or Wind-Down
When continuation or sale isn’t viable, winding down the business is the fallback. This involves:
- Selling assets (triggering potential capital gains and recapture),
- Distributing after-tax cash to shareholders (via PUC, CDA, RDTOH), and
- Maximizing tax-free elements like the Capital Dividend Account (CDA).
Final Thoughts
Succession planning is not just a financial exercise, but a legacy decision. Tax considerations should be embedded early in the planning process, not left until a deal is imminent.
Whether transitioning to family, employees, or selling externally, the path forward requires:
- Clarity on goals and values,
- Expert valuation and structuring,
- Strategic tax planning, and
- Open communication with all stakeholders.
Done well, succession can be a springboard to family harmony and financial security. Done poorly or neglected entirely, it risks dismantling decades of hard work. To talk further about your unique situation, please contact a Cardinal Point financial advisor.