What new Canadian entrepreneurs need to know about succession planning
By ATB Financial 11 August 2020 7 min read
“New Canadians tend to start businesses at a higher rate than Canadians businesses,” says Corinne Pohlmann, senior VP of national affairs at Canadian Federation of Small Businesses (CFIB). A recent study from Statistics Canada shows those businesses are fast growing job creators. Turns out, immigrant-owned, private, incorporated companies are 1.3 times as likely to be high-growth firms than businesses owned by Canadian-born entrepreneurs.
In the next 10 years, these immigrant entrepreneurs will be part of the 72 percent of businesses owners who are planning to exit their business and transfer $1.5 trillion in assets to the next generation, according to the CFIB. But they don’t have succession plans mapped out. A 2016 survey of Alberta business owners found only 21 per cent have formal plans in place.
“For new Canadian or immigrant entrepreneurs, over 80 per cent of a families’ wealth is tied up in the business,” says Amanda Vella, Senior Director, Business Advisory and Transition Consultant, Wealth Transfer at ATB. Without a succession plan in place, new Canadian entrepreneurs are putting this hard-earned wealth at risk. No plan means the entire business could be at risk too. Only 20 percent of business transitions happen when an owner wants or expects, she adds. The majority — about 80 per cent — are wound up because of an unexpected event, like a death, disability, dispute or divorce.
When should I start succession planning?
“As soon as possible,” says Vella. For busy new Canadian entrepreneurs, succession planning can feel like a luxury, but it’s critical to make time to develop a plan so you can provide clear leadership to employees, reduce your own stress, preserve the wealth built up in the business, and maximize the value from the transaction. Otherwise, if something unexpected happens and you are forced to sell, you risk getting lower offers because the business isn’t seen as valuable as it is.
“We recommend being in a “transition-ready state”, which means having a great management team supporting the owner, so the business isn’t overly reliant on him or her and also establishing good processes within the business, like documenting day-to-day practices to run the business and organizing customer, supplier and employee contracts. You can more easily enter a sale with these things in place,” she says.
Developing and implementing these things can take three to five years, says Pohlmann. For immigrant business owners starting to daydream of retired life, they need to prioritize succession planning. “Most entrepreneurs want to exit their business, so they can retire. Without a pension, selling a business becomes the way they fund their retirement.”
How much can I sell my business for?
“Most entrepreneurs tend to overvalue their businesses,” says Pohlmann, so a key part of the succession planning process is determining how much your business is worth. The CIFB survey found that 48 per cent of business owners say determining what their business is worth is one of the biggest challenges of succession planning.
Vella says this involves determining the “multiple” of your business, which is basically a metric used to calculate the sale price. As explored in our business transition guide, different industries use different multiples — like multiples of cash flow, revenue, or profit — but the most common is earnings before interest, taxes, depreciation and amortization (EBITDA).
While owners can have little control over the multiples in their industry, there are ways to polish up the business and reduce risk to potential buyers. The lower the risk to the buyer, the higher in the range of multiples an owner can expect. This is why it’s so important to start succession planning early and give yourself time to improve the value of your company.
A few ways to boost the value of a business include:
- Establish a sustainable management team: When an immigrant entrepreneur is so integral to the day-to-day operations of the business, this can be a red flag for potential buyers. They want assurance that a business can thrive in the absence of the owner.
- Cleaning up debt: Buyers consider company debt loads when determining the purchase price. If your business has a high debt capacity, this enables a buyer to borrow more cash against the company, which means they are likely to pay a higher price for it.
- Trim fat from the balance sheet: Remove personal items like vehicles, second homes or other fixed assets that won’t add value to a sales transaction.
- Update customer and supplier agreements: Having up-to-date contractual agreements provides reassurance that customers and suppliers will continue working with your company after the transfer of ownership.
Keeping it in the family
Whether a new Canadian or Canadian born, about twenty-five per cent of small business owners plan to sell or transfer the business to a family member, says Pohlmann. One area where she’s seen this get tricky is when the family isn’t aware of the plan. “An owner might want to sell the business to a family member, but they haven’t communicated that,” she says. Not only does this lead to potentially uncomfortable family conversations, it can extend timelines for an owner’s exit putting the company value at risk.
When a family member is interested in taking over the business, an entrepreneur must invest time in onboarding them into the business to ensure a smooth transition. The other critical piece is determining whether the family member will buy the business or if the business will be transferred and the financial tools needed for that transaction. For example, a shareholder loan can be issued so as the family member makes money in the business they can pay back the owner with interest attached to it, says Vella. It’s worth adding however, that having a family member lead the company that isn't ready can cause friction or departures of the management team jeopardizing the sustainability of the business. Having clear, transparent communication around readiness and the scope of responsibilities around running the business will be crucial in determining a successor’s readiness.
Selling outside the family
In cases where a family member is not an option for an immigrant entrepreneur’s exit from their business, there are other options such as selling to an employee or finding a third party to purchase.
Selling to employees — whether whole or in part — allows for a smoother transition of the business with minimal disruptions. When exploring this option, owners will need to consider if the purchasers would use outside funding to complete the sale, or if they are seeking a leveraged buyout where the sale is funded by using company assets as collateral. In these scenarios, a shareholder agreement is needed to protect everyone involved in the deal. The downside of selling to employees is often a lower value given the lack of a competitive process that can attract strategic buyers willing to pay a premium for the company.
Finding a third party to buy your business used to be much more complicated, says Pohlmann. “If word got out that you were selling the business, employees and suppliers would worry and that could impact the business. Often business would have to go to a consulting firm and pay them for a plan,” she says. Today, there are online options where owners can list their business for pre-vetted buyers to consider purchasing, like Succession Matching. The benefits of a third-party buyer include being able to completely exit the business and a higher rate of return.
Ensure the sale of your business is a success
Whether your family is taking over the business or you’re selling to another party, you want to ensure the sale goes as smoothly as possible. “About 75 per cent of business owners regret selling their business after one year,” says Vella. “They haven’t done a lot of after-business life planning. They found out that traditional retirement life isn’t as meaningful or impactful as they had anticipated.”
To avoid this, she says immigrant entrepreneurs who are succession planning should be thinking about what will provide meaning and significance in life beyond their family and lifestyle goals post sale, that may mean staying on as an advisor, doing charity work or sitting on a board of another business In addition, personal wealth, tax and estate planning is necessary too. “You want to make sure you’re financially sound, so you can enjoy retirement. Considering both of those sides — the personal and business — is what makes a transition through a succession plan successful,” she says.