Given Canada’s rapidly aging population, it is anticipated that many small and mid-size business owners will be retiring in the next 10 to 15 years.
Because many privately held business owners view their business as their primary source of wealth for retirement or estate purposes, appropriate succession planning is a vital part of retirement planning. Without proper consideration of business succession strategies and options, business owners might be forced to sell at a discount, encounter unfavourable tax implications, hand over their businesses to inappropriate successors or even face the possibility of having to close their companies.
An increasingly popular exit strategy for business succession planning is to provide for an opportunity for the existing managers or key employees to buy all, or part, of the business, a process that is often called a “management buyout.”
A management buyout may help achieve the continuity of the personnel and operations of the business and provide a significant opportunity for business owners, financial sponsors and entrepreneurial management.
That being said, not all businesses are well suited for management buyouts.
When considering whether this is appropriate for you or your client’s business, it is important to consider whether the existing management team or employees are ready to take on the risk of ownership and whether there are suitable candidates who have the necessary skills and experience to operate the business successfully. Not to mention issues around how the acquisition of the business will be financed.
A key issue to consider when planning and implementing a management buyout is financing, which will often influence the structuring of any management buyout.
Because it may prove difficult for the management buyer to finance the purchase price on closing, the financing for the purchase price may come from a mixture of personal funds, external lenders and the exiting business owner.
It might include stock option plans, a financed purchase or a buyout over time. In addition, it’s common for management buyouts to occur over a longer time period than a sale to an outside party and the owner’s exit in many cases is over a period of as many as five years. As well, in many cases the management buyout is earn-out based.
Other important factors to consider when planning and structuring a management buyout include:
•whether the acquisition will be mandatory or optional;
•the price to be paid for the departing owner’s interest;
•the impact of seller-provided financing;
•ensuring that financing can be obtained by the management buyer on reasonable terms; and
•if there is a buyout over time, ensuring that the exiting owner has security in place for the unpaid portion of the purchase price, whether in the form of personal guarantees, share pledges or security against the assets of the business.
In addition, management buyouts may provide tax-planning opportunities when determining strategies and structures. Depending on the circumstances, tax advisers may consider and suggest a variety of techniques to defer taxes and ensure the seller’s entitlement to the $800,000 lifetime capital gains exemption.
These recommendations may involve the establishment and use of an employee stock option plan, the incorporation of holding companies, the establishment of trusts and the implementation of an estate freeze where management will be buying out the owner over time.
Because management buyouts can be particularly complex to structure, when considering a management buyout it’s important to solicit input and advice from professionals, such as legal advisers, accountants and financial advisers, internal stakeholders in the business such as key managers and employees and finally successors, if they have already been chosen.
A properly considered and structured management buyout plan will deal with the legal transfer of the business ownership, consider the tax implications of the disposal of the exiting owner’s interest, set a timetable for retirement of the outgoing owner or owners and the sale of their interest and help ensure the future financial stability of the business. •
Michael Posnikoff ([email protected]) and Chris Speakman ([email protected]) are partners in Bull Housser’s Business Law Group.
