Tuesday, March 20, 2012

BV Benefit #5 - Internal Transfer of a Business

According to recent studies on the business succession market in Canada, between approximately 30% and 40% of business owners surveyed are expecting to transfer the business internally to other shareholders, management, employees or a family member. [1] 

A valuation prepared by an independent business valuator (perhaps annually in accordance with a shareholder agreement) is highly recommended and very beneficial for purposes of transferring business ownership internally.

In order to ensure a smooth internal ownership transfer, it is extremely important for all parties involved to agree on the current fair market value of the business.   The current fair market value can be used to set the price for the transaction in situations where the purchaser (i.e. shareholder, management, employee or family member) acquires the departing shareholder’s shares or in situations involving share redemptions by the company.

In his best-selling book on protecting family wealth, "Every Family’s Business", Tom Deans suggests that all business owners should arrange for an updated annual valuation of the business.   In fact, one of Tom’s 12 steps in his annual checklist for family businesses (referred to as the Wealth Protection Blueprint) states that business owners should:
"… arrange for an updated valuation of the business and calculate whether there is appropriate insurance in place to ensure that estate taxes will not impair the ability of the company to function in the event of the owner’s death."
Tom then discusses the implications of not obtaining a valuation prior to an internal transfer.   There can be serious repercussions to the business and to family members if the company is transferred to the next generation for an amount that is less than or greater than the actual fair market value of the business, particularly when the transaction was financed with debt.

Not only can a business valuation be used to set the price for an internal transfer or buyout of a departing shareholder’s shares but it is clearly a prudent tool for contingency planning to help protect the business and the business owner’s family in the event of the owner’s untimely death.

Next week we turn our attention to the benefits of a business share valuation for purposes of tax and estate planning.

1.   Source: "Quantitative Study of the Business Succession Market in Canada, RBC and CICA/RBC Business Monitor (Q1 2010).

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