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.
I am a practicing family physician with two young children. My accountant mentioned the idea of incorporating my practice into a professional corporation. How does this work?
As a physician, you are generally permitted to create a physician corporation. The Ontario Business Corporations Act (OBCA) and the Regulated Health Professions Act govern physician corporations. Once incorporated, a Certificate of Authorization from the College of Physicians and Surgeons of Ontario (CPSO) is required for your professional corporation to practice medicine in Ontario.
There may be significant benefits to incorporation arising from income splitting through the payment of dividends to adult shareholders and the deferral of tax through retention of excess cash and investing in the corporation.
A professional corporation carries on the practice of medicine with you as both a shareholder and employee of your corporation. It is important to note that under the provisions of the OBCA, a professional corporation does not shield the shareholders from professional liability as acts of a professional corporation are deemed to be acts of the shareholders. Non-voting shareholders who are not members of the CPSO are exempted from any professional liability.
All voting shares of the corporation must be held by a member of the CPSO. Non-voting shares can be held by a parent, spouse or child (and minor children must have their shares held in trust). Professional corporations are only permitted to carry on the practice of the profession or activities that are related to or ancillary to the profession. Furthermore, a professional corporation is permitted to invest its surplus funds in passive investments.
A Lawyer with experience in incorporating professionals can help you set up your professional corporation such that your objectives may be realized.
“I’ve been told I need a Shareholder’s Agreement - do you have a standard agreement I can use” is something we hear with frequency. It reflects an understanding by the client that a Shareholder’s Agreement is a “good thing”, but without an understanding of what that good thing is. Generally the response of legal counsel to this question is that there is no such thing as a “standard” Shareholder’s Agreement, let’s meet and talk. So what is it about Shareholder’s Agreements that are so valuable and why isn’t there a standard form, like a real estate agreement?
At a high level of abstraction, a Shareholder’s Agreement is a document that expresses the expectations of shareholders in respect of a corporation through legal obligations and rights. The task of the Lawyer in preparing the Shareholder’s Agreement is threefold - discerning what the expectations are (and those expectations are often not fully formed) – providing counsel on the legal and tax implication on the various alternatives by which those expectations may be realized - and expressing those expectations in the form of contractual terms that bind the parties.
For example, shareholders in a narrowly held private corporation may have an expectation that on death the shares will be purchased. In the absence of a Shareholder’s Agreement, this expectation may not be realized. There is no statute or common law requiring or obligating a purchase. If the remaining shareholders are unwilling to agree to a purchase, the estate is left with the shares and a tax bill. Nothing of course prevents the parties from negotiating a purchase, but the relative bargaining power may have shifted in unpredictable ways, and planning opportunities, such as insurance funding, may have been missed. A Shareholder’s Agreement that addresses these expectations will reflect the parties prior expectations for fairness, and will create certainty. Legal counsel will discuss alternatives including the corporate purchase of the shares, purchase by the remaining shareholders, and hybrids including spousal rollovers, the tax implications under the alternatives to the estate and to the remaining shareholders, the use of insurance funding, payment terms, security and so forth.
In family held corporations, expectations for succession (how management is succeeded) and liquidation (how the shareholding interests are turned into cash) are particularly difficult and require unique and sometimes innovative solutions. A Shareholder’s Agreement is a valuable tool in estate planning for resolving how competing expectations for liquidation and succession are accommodated.
I want to become an entrepreneur and start a business. Should I incorporate now, or start as a sole proprietorship and delay incorporation to a later date?
The advisability of incorporation is dependent on the particular facts and personal preferences of the entrepreneur. The role of the Lawyer and other professional advisors is to help draw out the relevant facts and explore personal preferences to assist the entrepreneur in making the decision that is right for her. Some of the relevant factors include:
Risk. Is the proposed business inherently risky? The shield of limited liability that an incorporated entity provides to the entrepreneur is an important benefit (note that the shield from liability is not absolute);
Tax. A valuable attribute of an incorporated entity is the relatively low tax rate (approx. 16%) payable on the first $500,000 of net income. This allows a profitable incorporated entity to grow much quicker using internally generated working capital than a similarly sole proprietorship where a marginal tax rate in excess of 50% of profits may be payable. An exception is where the sole proprietor has other sources of income and it is anticipated that the new business will suffer losses in the start-up year(s) – it may be possible to set off the losses against the other income and thus reduce the overall tax burden;
Costs. Incorporation of the business at an early stage is less expensive than incorporation once the business is up and running. Once the business (sole proprietorship) is up and running it is generally necessary to use a “rollover” transaction to transfer the business from the sole proprietorship to the corporation.
Separate Existence. An incorporated entity has a legal existence separate and apart from the entrepreneur. This provides for a number of real and perceived benefits including (generally): broader alternatives for raising capital; easier salability of the business and possible availability of lifetime capital gains exemption to avoid tax on sale, continuous existence past the life of the entrepreneur, public perception of greater substance, and easier separation of personal and business dealings.