Common myths about the transfer of business ownershipSeptember 15, 2022
A family business usually changes hands for one of three reasons: the owner is retiring, the owner has passed away, or the owner has decided to sell the business at some point before retirement. Whatever the occasion, misconceptions swirl about the business-transfer process. Here are six common myths—and the realities behind them.
Myth #1: Most Canadian entrepreneurs intend to keep their business in the family after they retire or die.
Reality: Only 31% intend to pass their business to the “next gen” or other family members.
The assumption that a majority of entrepreneurs want to keep the family business in the family holds true in Asia, the Middle East, and Africa. However, a major global survey from 2019 shows that only 33% of North American entrepreneurs have this intention—and in Canada, the figure is even lower. According to a 2018 IPC private wealth poll, 42% of small business owners in Canada said they would rather sell their business than pass it on to family members, while 27% said they plan to wind the business down on retirement. This makes Canadian family business owners the least likely in the world to intend to keep the business within the family.
Myth #2: Entrepreneurs planning to transfer their business should put the interests of the business before the interests of the family.
Reality: The interests of family members should be top priority during the transfer-planning process.
A recent Deloitte survey showed that 88% of entrepreneurs thought the interests of the business should come first. Many owners reason that by making sure the business thrives, which in turn provides family members with financial security, they are taking care of the family’s interests. But experts on multigenerational wealth management almost unanimously agree that the focus should be on the emotional and personal fulfillment of each family member—even when the owner’s main goal is wealth, not legacy. Research backs them up: when the transfer results in the failure of the business, 70% of the time it is because of family factors such as lack of trust and communication.
Myth #3: It takes only a couple of years to complete the transfer of business ownership, including the preparation period, the transfer itself, and the post-transfer adjustment period.
Reality: Completing the transfer of ownership of a family business takes 5-10 years, depending on the size and complexity of the company.
In one study, 5 out of 6 entrepreneurs thought they could complete a transition in two years or fewer. Experts say this dramatic underestimation is one reason that so many business owners fail to plan adequately for the transition.
Myth #4: If no one in the family wants to run the business, it will need to be sold outside the family or dissolved.
Reality: If family members are uninterested in running the business, there is a simple option for keeping it in the family: ownership and management can be separated, and the family can continue to own the company while non-family members manage it.
This is also viable option when the selected successor is weak but the incumbent is intent on keeping the business in the family (or letting a favourite non-family executive buy it). Weak successors can often be effectively offset by putting very strong people in supporting roles, including top management.
Myth #5: When assessing what a business is worth before its sale or transfer, a “guesstimate” is good enough—especially if the transfer is to family members.
Reality: It is important to get a fair-market–value assessment done by a Chartered Business Valuator (CBV) as part of the business valuation that you submit to the Canada Revenue Agency.
Using a CBV is not mandatory, but when other assessors are used, the CRA will often carry out its own valuation and levy taxes according to its own results. Cautionary tale: In a recent B.C. case, the submission of a “careless” one-page valuation by the business’s longtime accountant (a managing partner at a national accounting firm) resulted in a 10-year court case, an additional tax levy of nearly $280,000, and heavy legal costs for the estate.
Myth #6: A family business can be passed down to the next generation upon the death of a business owner without paying any estate tax on the shares.
Reality: There is no avoiding estate tax when passing down a business to the next generation. Life insurance is a viable way to protect a family by ensuring that the beneficiary has the financial means to pay the tax bill without having to liquidate other assets to take over the business.
Despite the wealth of many business owners and their families, their assets are often not liquid enough to pay the estate taxes in the event of a death. The value of the shares would be subject to capital-gains tax—at a rate of about 25%. The death benefit from permanent life insurance can help to finance these shares so that the business can be transferred to the next generation successfully.
For more on this topic, read TTSG’s whitepaper 7 Steps to Creating an Effective Family-Business Succession Plan.