By John Liston
John Liston is a Certified Exit Planning Advisor(CEPA) with Newcastle West Partners with offices in Edmonton and Chicago. He has lived in three and worked in all 10 provinces of this great country.
Owning a business is not for the faint of heart and if you think getting into business is hard, try getting out of one!
Privately held small businesses are a vital component of the Canadian economy. As of December 2021, there were 1.19 million small businesses in Canada, or 98.1 per cent of all employer businesses in the country.
Small businesses employed 8.2 million people, or 67.7 percent of the total private labour force as of 2021, according to a report by Statistics Canada.
However, small businesses face various challenges, such as limited resources, lack of access to capital, and intense competition.
In Canada, the definition of a small business can vary depending on the industry, but in general it is considered a business with fewer than 100 employees. This number can range from one to 500 employees, depending on the sector and the specific program or initiative. And the term “small business” is a misnomer — these companies should be referred to as “vital businesses.”
Many vital business owners in Canada are baby boomers nearing retirement age, and as they retire, they will need to either sell their businesses or transfer ownership to family members or employees. Many of these business owners are not adequately prepared for this transition, leading to the closure of many businesses.
According to a survey by the Canadian Federation of Independent Businesses, only 10 percent of vital business owners have a transition plan in place. Yet 76 percent of Canada’s business owners plan to exit their business within the next decade, meaning more than $2 trillion worth of business assets could change hands during this period.
Having a transition plan in place can help ensure the business continues to operate smoothly after the owner’s departure. However, according to the Exit Planning Institute, 70 to 80 percent of businesses put on the market do not sell. Only 30 percent of all family-owned businesses survive into the second generation; only 12 percent survive into the third generation; and only three percent operate at the fourth generation and beyond.
To ensure the future of vital privately held businesses in Canada, several solutions can be implemented, such as providing education and resources to owners on how to create a transition plan. The government could also offer tax incentives to encourage vital business owners to invest in technology and marketing, helping them remain competitive.
Another solution is to promote entrepreneurship by making easier the creation and sustainability of new vital businesses. It is said that if you own your own business, you get to work half-days: which 12 hours do you want to work?
An example of such help is the very useful federal Scientific Research & Experimental Development tax credit program, which should be simplified to reduce the hours or costs associated with applying for it. Small business owners tell us that the biggest challenges are the complex eligibility criteria, documentation requirements, administrative burden, understanding the intricacies of the SR&ED program, and delays in receiving funding. Turning our entrepreneurs into administrators defeats the purpose.
There is an incredible technology tsunami sweeping across Canada, with business incubators and accelerators being driven from the grassroots. More funding through our federal regional diversification programs, while making access simple and easy, will allow the creators to create. For example, started in Edmonton, and now across the western provinces, Startup TNT is driving huge growth in connecting entrepreneurs with funding. More support for programs like this would be a great investment.
Integrate exit strategy with business strategy
It is important to move business owners to a more concrete version of an exit plan, something to be documented and communicated to all relevant stakeholders. The exit strategy needs to be integrated into the business strategy and internalized, a method for operating the business on a day-to-day basis.
Every 90 days a business owner should be asking themselves: Do we grow or exit? An education and outreach program to business owners (and family) is crucial to allow a business owner to understand and evaluate all available options.
It is highly unlikely that in the next 10 years, there will be enough capital to enable the number of acquisitions by private equity firms or strategic buyers preferred by business owners. As such, owners will need to take a more serious look at internal transition options — employee-owned, management buyouts and family transitions — or be forced to substantially discount the sale of the business to a third party.
The 2023 federal budget proposed changes to the tax act to facilitate Employee-Owned Trusts (EOTs). In an EOT the capital gains reserve is extended to 10 years (instead of five years) for sales of shares of a qualifying business to an EOT. This means only 10 percent of the gain on deferred proceeds must be brought into income annually, mirroring some the tax incentives available in employee stock ownership plans in the U.S.
As proud Canadians, we would like to see fewer foreign purchases of our companies and the associated talent, IP, and resources. Canada has invested heavily in supporting businesses and we would like to see planning include preparation of the next wave of purchasers. We have a responsibility to prepare the seller and the buyer so that Canada retains its strength. The best solution is to support any and all sources of capital for these buyers so that we don’t over-regulate capital sources to the point where foreign buyers have advantage.
Finally, it is important that the exit plan and estate plan be considered two sides of the same coin. It essential to look beyond the financial aspects of the planning process to encompass the personal aspects of post-transition life for the business owner.
Far too many business leaders do not have a clear plan for this period of their life. When asked why more entrepreneurs don’t properly plan for exiting their business, often the reason is that they have not been able to answer the question: “What do I do next?”
It is crucial to address all the challenges faced by owners during the transition period. This can be achieved by providing education and resources to small business owners, offering tax incentives, promoting entrepreneurship, and integrating the exit plan into the business strategy.
Thank you to vital business owners that drive our economy! Let’s keep the entrepreneurial spirit alive by helping them transition their business and reap what they have sown.