The financial meltdown has caused many entrepreneurs to re-evaluate their retirement plans and wealth planning. Business owners face postponement, if not elimination, of retirement plans because of a decrease in the market valuation necessary to support those plans. Yet changing Canadian demographics may in the long-term have an even greater impact than the current recession for the small and medium sized enterprises.
Recessions come and go. Anyone in business more than twenty years has gone through at least one prior recession. When a recession first takes hold, it always seems that this one is the “worst” or the “big one” or “like the great depression”. Yet while there are failures, most businesses survive and within a few years recover with the rest of the economy and the retirement plan continues, perhaps slightly postponed. So what is different about demographics, and why might demographics pose an even larger threat to a succession, liquidity and wealth planning?
Demographics are about population characteristics. Canada’s is aging. The baby boom generation will complete its journey into retirement in the next ten to fifteen years. The generation after that is smaller, and the generation after that is smaller still. Records show that in 1921, one in twenty persons was over 65 years of age; by 2026 one in five persons in Canada will be over the age of 65. Virtually nothing can change this. A massive (and highly unlikely) baby boom will not change this.
The implication for the owner of a small or medium sized business is that there will be relatively more sellers, and fewer buyers, than there are today. Demographics dictate that this will get worse, not better, for the foreseeable future. The business owners that succeed with their retirement plans are those that plan for succession and liquidity now, and implement the plan well in advance of the day that they want to turn over the keys to the business and hit the golf links.
Frequently Asked Questions
I have a corporation the shares of which are held only by me and members of my immediate family. Do I really need to have annual minutes?
If your corporation is audited by the CRA and matters, such as the declaration of dividends, have not been formally documented by a written resolution of the directors or in annual minutes, the consequence can be severe. There are other risks that may be avoided by having minutes prepared annually. This is analogous to your dentist who encourages you to have good dental hygiene and periodic check-ups so that small problems do not become big problems. Practicing good corporate hygiene just makes good sense.
The minimum legal obligation of a corporation is to hold an annual meeting of shareholders to consider the financial statements, elect directors and to appoint (or dispense with the appointment of) the auditor. In practice, and as permitted by statute, narrowly held corporations often dispense with an annual meeting in favor of signed resolution of all of the shareholders. The failure to hold annual resolutions, or obtain written resolutions in lieu, can lead to legal action from disgruntled shareholders.
The practice of holding annual meetings (or resolutions in lieu) also tends to ensure that corporate matters requiring attention are addressed, such as share transfers, changes to directors, and address changes, which if left unaddressed could become significant problems.
An effective method of ensuring good “corporate hygiene” is for the corporation to instruct its accounting advisors to provide legal counsel with an annual letter of instructions to document applicable financial matters.
It is not uncommon that a new client brings us a minute book that has not been properly organized, or that has not been updated for many years. It is not a cause for embarrassment. We strongly encourage that the minute books be updated before an issue arises, such as a CRA audit.
I am negotiating to purchase a business and my business advisor has strongly suggested I structure the deal as an “asset purchase”. Why is this preferable?
There are two principal ways to structure the agreement of purchase and sale of a business: as an asset purchase or as a share purchase. An asset purchase is just that, a purchase of listed assets without taking on liabilities of the business. A share purchase, by contrast, is the purchase of the shares of the corporation that carries on the business and owns the assets. There are a number of considerations as to which form of purchase is preferable. In this article, we want to focus on why your advisor has strongly recommended an asset purchase.
Liability
A properly structured asset purchase agreement will allow you to purchase all of the desirable assets of the business you wish to acquire while leaving out the unwanted liabilities.
Your advisor has likely identified the business as one either by its nature or by the disclosure you’ve obtained in which there are significant potential liabilities that may be avoided through an asset purchase agreement. For example, if the owner of the business has been pocketing cash payments or using corporate assets for personal use, the business may be exposed to re-assessments and penalties by the Canada Revenue Agency. A purchase of shares would mean that you, through the purchased corporation, are exposed to those claims.
Exceptions
There are some exceptions to the avoidance of liability by an asset purchase. For instance, if the purchased business employed unionized labour, a collective agreement and any ongoing liabilities thereunder will follow the purchased business, even if structured as an asset purchase. Your legal counsel can assist you to identify and understand the relevant risks and how to avoid them where possible or otherwise obtain protection.
My husband and I are the sole shareholders and directors of an incorporated retail business. We have been quite successful and are generating cash excess to business requirements. We do not want to pay the cash out to ourselves now, and pay high rates of tax, but at the same time this cash is a significant part of a retirement fund. We have no creditors, other than trade creditors payable in the ordinary course. How do we protect this cash for our retirement?
You are asking a good question. In the event of an unexpected economic downturn or legal claim against your active business corporation, the excess cash generated in the business could be exposed to potential creditors. Once the liability is crystalized, it may be too late to take action that will protect the cash. You have also correctly identified that the simplest solution –payment of the cash out to yourselves – attracts undesirable tax consequences.
A cost efficient solution is the creation of a holding corporation. The holding corporation structure, when designed properly, allows excess money from your active business corporation to be paid by dividend to the holding corporation, tax free. The holding corporation is a separate legal entity, and is generally insulated from claims against your active business corporation.
Care is required that the desired tax treatment is achieved in the structuring of the holding corporation. There are other financial planning considerations, such as ensuring the availability of the lifetime capital gains exemption, which must be addressed by the new structure. This type of corporate structuring may also be implemented as part of a broader strategy for business succession and included as part of your estate planning.