Estate Executors – How to Increase Your Protection and Minimize Your Risk

The executor of an estate with business interests should obtain an independent professional business valuation as support for the values used in the estate administration tax (“EAT”) filing, particularly in light of recent changes to EAT legislation and the potential for personal executor liability.

At the time of probating the will, EAT (previously known as “probate fees”) of 0.5% must be paid on the first $50,000 of estate assets and 1.5% on the value of the remaining assets. [1]  The estate representative (i.e. executor or trustee) has many responsibilities, including:

1. Filing an affidavit as to the estimated value of the estate; 
2. Remitting the EAT on the estimated value; and 
3. Providing an undertaking to file, within six months, a sworn statement of the total value of the estate, and to pay the balance of any additional tax owing (if any).

In 2011, the Ontario government amended the legislation to enhance the EAT compliance regime.  Beginning January 1, 2013, the Ontario Minister of Revenue will be afforded significant audit and verification functions including the right to conduct a review of the estate inventory and valuation provided by the executor.  If a greater estate value is determined, additional taxes can be assessed.  As a result, there will be much more pressure to verify the value of the assets disclosed in the EAT filing.

Penalties have been added to encourage compliance.  It will be an offence for an estate trustee to fail to make the required filing with the Minister of Revenue.  It will also be an offence for any person who makes, or assists in making, a false or misleading statement in connection with the estate trustee’s filing.  Offences are punishable by fine, by imprisonment or both.  The minimum fine will be $1,000.  The maximum fine will be twice the EAT payable.

An estate representative may be exposed to personal liability if the estate assets have been distributed before the Minister of Revenue issues a notice of assessment.  There is no ability to obtain a “clearance certificate” to protect the estate representative from personal liability.

In light of the responsibilities of the estate representative, the new audit measures, and the potential for personal liability, it will be critical for executors to be diligent in obtaining and documenting proper and accurate valuations of the deceased’s property for purposes of calculating the EAT.  Where the estate holds shares in privately held businesses, the benefits of obtaining an independent business valuation will far outweigh the costs to the estate and the risk to the executor of not having one prepared.

Contact us at jason@vspltd.ca or www.vspltd.ca for an independent business valuation if you want to minimize your risk and increase your protection as an estate executor.

[1]  source: www.attorneygeneral.jus.gov.on.ca

Business Valuations to Support Life Insurance Coverage

We were recently contacted by the Inspection Department of an independent service provider to the Canadian life and health insurance industry with respect to one of our clients.  They were gathering information to assist in the underwriting process and wanted independent evidence supporting the client’s claim as to the value of the business as part of their inspection process.  Our client asked us to provide a copy of the independent business valuation we had prepared for purposes of their estate planning and life insurance.  

We have been providing independent business valuations to help business owners determine an appropriate amount of coverage for many years.  This was the first time, however, that we were contacted by a representative of the insurance company.  It may be that independent business valuations are becoming a more formal part of the underwriting process.

Life insurance is often used for income replacement or to alleviate the burden of estate and probate taxes upon death.  However, when business owners use life insurance to fund a buyout or redemption of the shares of a deceased shareholder it is important to ensure that the death benefit will be adequate to:

1. Fund the buyout or redemption of the deceased shareholder’s shares (Buy/Sell Insurance); and
2. Ensure the continued survival of the business upon the loss of what may be a key person in the business (Key Person Insurance).

As a result, the life insurance coverage should at least cover the current value of the business and many business owners grossly overestimate or underestimate the value of their business.  An independent business valuation provides business owners with third party evidence for ensuring adequate life insurance coverage.  This in turn provides the shareholders with peace of mind that their families and their businesses are sufficiently protected.  

An independent business valuation is also helpful to the insurance advisor as it will help:

1. Manage and control the process in creating the application file - insurance companies and their risk advisors are increasingly requiring support for the amount of coverage requested; and
2. Solidify trust and cultivate the relationship with the client - providing the insured with third party evidence regarding the value of their business eliminates any pre-conceived notions the client may have with respect to being over sold or under estimated as far as coverage.  

The business valuation should also be updated periodically as the adequacy of the life insurance coverage should be reviewed in light of any growth or other changes to the business over the prior years.  Ideally, this process should be agreed to and formalized in the company’s shareholders agreement, which for many business owners, may not exist or may not have been updated for many years.

Life insurance is an integral part of estate and contingency planning for business owners.  If you are in the process of obtaining life insurance or reviewing your current coverage, contact us at jason@vspltd.ca or www.vspltd.ca to assist with your business valuation needs.

Supporting Valuations in Tax and Estate Planning

30% to 40% of business owners are planning to transfer their business internally to another shareholder, management, employees or family member. [1]  One option for those planning to transfer the business to the next generation over time is through an estate freeze.

In an estate freeze the business owner’s common shares are exchanged for preferred shares of equal value to the common shares.  New common shares are then issued by the company to the next generation family members.  This allows the business owner to “freeze” his/her unrealized gain in the corporation on a tax-deferred basis, with any future growth in value of the company accruing to the children.  As a result, the business owner can estimate and plan for the future tax liability, perhaps with life insurance.

Under an estate freeze the fair market value of the common shares must be established.  According to the CRA, the fair market value must be determined “by a fair and reasonable method”. [2]  If not, CRA will likely challenge the validity of the transaction alleging that a benefit had been received by a shareholder who acquired property from a corporation at less than fair market value.

In the event of a potential dispute with the CRA, price adjustment clauses (PACs) are sometimes used to retroactively adjust the fair market value to avoid the “conferral of benefit” problem.  Unfortunately, a PAC may not help if a fair and reasonable valuation attempt was not initially conducted.  

In Guilder News Co. (1963) Ltd. et. al. v. M.N.R., 73 DTC 5048 (FCA), the Court rejected the PAC as a basis for adjusting the price and eliminating the benefit on the grounds that the parties had not reasonably attempted in good faith to transact at fair market value.  Other recent case law involving PACs include St. Michael Trust Corp. v. Canada (2010 FCA 309, affirming Garron, 2009 TCC 450) and Krauss v. Canada (2010 FCA 284, affirming 2009 TCC 597).  Potential implications of not having a fair and reasonable valuation to the business owner include additional taxes, interest and penalties.

An independent valuation prepared by a qualified business valuator can provide a fair and reasonable basis for the fair market value used in an estate freeze, essentially acting as insurance for potential disputes with the CRA.  Inadequate fair market value assessments can give rise to unfortunate tax consequences as well as costly and time-consuming litigation, not only with the CRA but also with the advisors. 

Other tax and estate planning mechanisms involving the transfer of assets or shares to a related party could include business incorporations, corporate restructuring, share reorganizations or family trusts.  In order to take advantage of tax deferrals, these transfers typically must occur at fair market value.  You will be well served and protected by involving and retaining an independent business valuator to assist you with the fair market value determinations.

If you are considering an internal transfer, contact us at jason@vspltd.ca or www.vspltd.ca to assist with your business valuation needs.

1.  Sources: 2007 RBC Study - Quantitative Study of the Business Succession Market in Canada and CICA/RBC Business Monitor (Q1 2010).

2.  Source: CRA’s Interpretation Bulletin IT-169.

Business Valuation Helps Facilitate an 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 their business internally to other shareholders, management, employees or a family member.

If you are planning to one day sell your business to an internal party, an independent business valuation can be very beneficial for managing value expectations and ultimately facilitating the transfer of the business at a fair and reasonable price.

It is extremely important for all parties involved in an internal transfer to agree on the current fair market value of the business, to ensure a smooth ownership transfer.  The current fair market value can be used to set the price for the transaction in situations where the purchaser acquires the departing shareholder’s shares or 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.  One of the 12 steps in Tom’s 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.

An independent business valuation will help set a reasonable price, one that is fair to all parties, to facilitate the transfer of all or a portion of the equity to other shareholders, management, employees or a family member.  Having an independent expert business valuator explain the valuation process, approach and assumptions will help ensure that all parties are satisfied that a fair and reasonable deal was struck.

The business valuation can also be used for contingency planning to help protect the business and the business owner’s family in the event of an unplanned involuntary transfer due to death, disability, divorce, distress or disagreement.

If you are considering an internal transfer, contact us at jason@vspltd.ca or www.vspltd.ca to assist with your business valuation needs.

1.  Sources: 2007 RBC Study - Quantitative Study of the Business Succession Market in Canada and CICA/RBC Business Monitor (Q1 2010).

6 Ways a Business Valuation Prepares You for an External Sale

According to studies on business succession in Canada, more than one third of those surveyed are expecting to sell their business externally to a third party. [1]

"We should remember that good fortune often happens when opportunity meets with preparation."

― Thomas A. Edison

Business owners looking to sell their business to an external third party should take note.  There is tremendous opportunity to sell for a significant premium because many business owners are not properly preparing.  The preparation for this begins with a business valuation and solid value enhancement plan.  The good fortune comes in the form of a sale of the business for the maximum possible price.

  

For many business owners the sale of their business is a once in a lifetime event and, without proper education, many will either grossly overestimate or underestimate the value of their business.  If you plan to sell your business to an external party one day, obtaining an independent business valuation is an investment that will pay for itself many times over.  Here are 6 reasons why:

1. An independent valuation helps to manage the business owner’s pricing expectations which increases the likelihood of getting a deal done;

2. A professional valuation helps to justify the asking price and provides support for negotiating the price with a potential purchaser;

3. An independent valuation prepares the business owner for any unsolicited offers received from competitors or other industry participants;

4. The valuation process can help identify potential purchasers or purchaser categories;

5. The valuation process educates the business owner regarding “stand-alone value” and “synergistic value” and the notion that strategic purchasers are often willing to pay more than “stand-alone value”; and

6. A valuation ultimately helps the business owner maximize the sale price, ensuring no money is left on the table.

Many business owners looking to sell their businesses will not take advantage of opportunities in the current marketplace through proper planning, including a professional business valuation.  On the other hand, those that are prepared with a professional valuation and keen sense of market timing will vastly increase their odds of good fortune.

If you are considering an external sale, contact us at jason@vspltd.ca or www.vspltd.ca to start your preparations with an independent business valuation.

1.  Sources: 2007 RBC Study - Quantitative Study of the Business Succession Market in Canada and CICA/RBC Business Monitor (Q1 2010).

Business Valuation - Critical for Pre-Sale Planning

An independent professional business valuation is a critical element of pre-sale planning for business owners.  

Various studies indicate that between 60% and 75% of business owners will exit their businesses within the coming decade. [1]  Over $10 trillion in private wealth will change hands in North America over this time frame, the largest transfer of private wealth in history. [2]

There certainly is capital out there currently sidelined and looking for good investment opportunities.  If you have an attractive and salable business, and you are ready, now may be the time to put it on the market given that the increasing supply of businesses for sale over the coming decade will put downward pressure on sale prices.  Under these conditions buyers will only pay top dollar for the most attractive businesses and those that come to market unprepared will risk selling for a significant discount or face liquidation altogether.

Effective pre-sale planning must begin at least 3 years prior to sale and should begin with a business valuation.  A current valuation provides: 

1. An indication of what the business owner could reasonably expect to fetch on the open market (i.e. managing value expectations will increase your odds of getting a deal done); and

2. A benchmark for enhancing the value of the business prior to an actual sale.  

The business valuation process involves a careful assessment of the company’s risk profile and the key value drivers for the business.  A valuation conducted by a professional valuator will identify areas of weakness to focus on to increase the attractiveness of the business to a potential purchaser.  Beginning early enough allows time to implement the key value enhancement initiatives required to maximize the price that is ultimately received in a sale.  

All business owners will eventually exit their business.  The importance of pre-sale planning must not be overlooked.  In a Newport Partners survey of more than 100 Canadian business sellers, 62% recommended methodically pre-planning the sale of a business two to three years in advance.  Less than 25%, however, actually did so themselves.  Success can be achieved by learning from the mistakes of others.  

Pre-sale planning is especially vital in light of existing demographics and the expected increase in the supply of businesses that will be put up for sale over the coming decade.  The planning begins with a business valuation so there is a frame of reference for measuring the effectiveness of the pre-sale planning activities.  Without one business owners may never realize just how much money was left on the table.

Contact us at jason@vspltd.ca or www.vspltd.ca to start your pre-sale planning process with an independent business valuation.

1.  As per the Canadian Federation of Independent Business (CFIB) and the CICA/RBC Business Monitor (Q1 2010).

2.  Source: The $10 Trillion Opportunity, Richard Jackim & Perry Phillips, 2007.

8 Ways to Tell if You Are Building a Business or Just Have a Job

The ultimate test to determine if you own a valuable “business” or just have a “job” can be found in a simple question: would someone want to buy your company?  

Would your customers continue to do business with the company (and its new owners) after you are gone?  In other words, will the revenues and discretionary cash flows generated by the business continue after your departure?  This is a major issue for many smaller personal services businesses that have few, if any, employees and are very dependent on the owner(s) for generating business and performing specialized services.  

If you are planning to one day sell your business you should address this issue now to understand what, if anything, must be done to turn your “job” into a salable “business”.  Whether you want to sell next year or a decade from now, you must build an asset someone would buy – otherwise, you have a job, not a business. 

Here are eight ways to ensure you are building a salable business and not just doing a job:

1. A job requires that you show up at work to make money, whereas a business generates revenue whether you are there or not.

2. If your company is so reliant on a single customer that they can dictate how you deliver your product or service, your company is more like a job than a valuable business.

3. A job is a place where your personal reputation impacts your results, whereas a business is a place where the brand is more important than the personality of the founder(s).

4. A job requires you to use your personal experience and expertise to get a result, whereas a business is a place where a process – not a person – consistently produces a desirable result.

5. In a job, you get fired for taking too much vacation, whereas if you own a business, the more vacation you can take without impacting your company’s performance, the more valuable your business will be.

6. In a job, the harder you work, the more money you earn.  In a business, the smarter you work, the more money you earn.

7. In a job, you solve the problems. If you own a business, your employees solve the problems.

8. If the majority of your customers know your personal phone number, it’s likely you have a job, not a business.

If you are unsure as to the extent to which you own a valuable “business” or just have a “job”, you should get your Sellability Score.  Whether you are looking to sell now or in a decade, the Sellability Score assessment allows you to see your business as a potential buyer would see it and to identify areas to focus on continue building a salable business. 

Complete the Sellability Score questionnaire at www.sellabilityscore.com/vsp/jason-kwiatkowski and we will send you a summary report showing just how your business stacks up on the “job” versus “business” issue.