Sold!
Getting the best after-tax price for your business

If you’ve ever sold a house, you know how involved the transaction can be before either party signs on the dotted line. As the vendor, your ultimate goal is attracting the highest price – while minimizing your tax bill. Now imagine instead of your home, you’re selling your business. Suddenly you’re facing a myriad of issues you may never have expected.

Know the basics

• Asset sale vs. share sale. The first step towards preparing your business for sale is determining how your business is structured. In Canada, corporations are owned by shareholders, and are tax-paying entities that must file their own tax returns. Different liability and tax implications exist for sole proprietorships and partnerships.
  
  As each of these business structures possesses unique characteristics, the vendor and purchaser should understand the tax consequences associated with each type of sale at the onset of the deal.

• Negotiating the deal. Understanding what purchasers are looking for is important in establishing a price for your business and negotiating the deal. According to Jeff Llewellyn, director of mergers and acquisitions with Tamarack Capital Advisors, purchasers generally want to acquire assets, not shares. There are a couple of key reasons for this.
  
  “If someone purchases the assets rather than the shares, they’ll have a higher cost on the assets that can potentially be deducted for tax purposes. If they purchase shares, they can’t deduct any of the shares’ purchase price - and they end up inheriting the existing tax cost of assets owned by the company.”
  
  Jeff adds that when a purchaser buys the shares of your company, he or she also inherits any of the company’s potential liabilities, regardless of whether those liabilities are known at the time of purchase. As a vendor, you can use the tax consequences associated with an asset sale and the equivalent net proceeds on a share sale as part of the negotiation strategy.
  
  Determine what the proceeds on an asset sale need to be to leave you in the same after-tax position, and proceed from there. A purchaser can potentially pay less for the shares of the company and still leave you in a better after-tax position, resulting in a win-win for both parties.

• The packaging. As a small business corporation, shedding redundant assets that aren’t part of your business operations is another key step in preparing your business for a share sale. These assets could be in the form of real estate holdings, excess cash, investments not to be sold with the company, or semi-personal assets you would like to keep, such as vehicles.
  
  In the case of real estate holdings, Jeff advises taking a strategic approach to shedding your assets. If your company owns real estate, consider transferring it to a separate holding company.
  
  “Transferring the real estate to a holding company can make it easier for potential buyers to acquire your company, since the cost will be lower if they don’t have to acquire the real estate.”
  
  Jeff adds that having the real estate in a company separate from your operations is generally a good idea regardless of whether the business is sold, as it can protect the real estate from risks associated with the business operations.
  
  “Selling your business without the real estate can be particularly helpful, as it expands the list of potential buyers to include parties who previously may not have been able to secure sufficient financing.”
  
  You can then lease the property to the purchaser on a commercial basis, which can provide you with an ongoing income stream as well as potential appreciation in the value of the property.
  
  Remember that when removing assets from your company, you should be wary of potential tax issues that need to be addressed to avoid negative tax consequences. Proper professional advice is mandatory for these types of transactions.

• Accessing the capital gains deduction. One reason vendors prefer selling shares versus assets is the possibility of significant tax deductions. For example, in Alberta, businesses that qualify for capital gains deductions on the shares of a small business corporation may have access to a potential tax savings of up to $146,000.
  
  As the vendor, it’s vital you know up front whether you can use the deduction. To figure this out, Jeff suggests conducting a review to determine whether the company’s shares qualify for the capital gains deduction and whether shareholders have access to it.
  
  Your business advisor should complete a thorough review of your personal tax history, which is a mandatory step in the process to ensure nothing in your tax history would preclude access to the capital gains deduction. Previous use of the capital gains deduction, cumulative net investment losses and previous allowable business investment loss claims could restrict your access to the deduction.
  
  Detailed rules related to the definition of “qualified small business corporation share” also need to be addressed to determine whether the shares will qualify. In some cases, you may be able to take steps to make the company qualify prior to a sale.

• Planning ahead. Agreeing on the value of your business may be a source of contention between you and the potential buyer. In this case, you have a number of options.
  
  Jeff illustrates his point:  “As the vendor, you may think that based on future earning capacity, your company should be worth ‘x’ amount of money. If a purchaser isn’t convinced your company can actually generate that level of earnings, they may agree to pay your price, but only on the condition your earnings reach those levels.”
  
  This type of arrangement is referred to as an “earn-out” and can be a good way to structure a sale in which some disagreement exists about the future earnings, and thus the value of the business.
  
  From a tax perspective, earn-outs need to be structured carefully to help ensure payments are treated as part of the share selling price, not as regular income to the vendor.
  
  To achieve capital gains treatment on the earn-out component, the transaction should be structured as a “reverse earn-out.” A reverse earn-out is set up so the selling price in the purchase and sale agreement is set at the maximum possible, assuming the earnings levels will be achieved.
  
  If earnings post-acquisition aren’t what the vendor thought they would be, the selling price is reduced based on a formula to match the actual earnings of the company during that period. 

When preparing a business for sale, Jeff asserts that a qualified advisor can help ensure tax considerations are examined and structured properly throughout each stage of the transaction.

“The more prepared you are during the planning and structuring of the deal, the greater your chances for a smooth, tax-effective transaction.”

For more information, contact Jeff Llewellyn, Director of Mergers and Acquisitions with Tamarack Capital Advisors Limited at 1.888.314.1011 or your local MNP advisor. Tamarack is the corporate finance subsidiary of Meyers Norris Penny LLP.

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