We are often asked:
The first question to ask, before asking any of the above questions is: What is my exit strategy? How do you plan to exit the current or planned business. You can sell shares. You can sell assets. You can sell to employees. You can transition to family members. Or you can simply wind down the business. Your chosen exit strategy impacts and brings clarity to all of the above issues.
The ideal time to ask yourself about an exit strategy is before you start your new business. As the Japanese proverb says: The best time to plant a tree is 20 years ago and the second best time is today. The second best time to plan your exit strategy is today.
Now let’s look at the impact your choice of exit strategy can have on some of the choices you make.
Do I incorporate or use another different structure? Incorporation provides a lot more options and flexibility if you plan to sell your business. You can sell shares or assets. In selling shares, you can sell all your shares at once or gradually over time. You can sell to one buyer or several buyers. Sole proprietorship has the advantage of significantly lower costs for both set up and ongoing operations. If you are planning to operate for a few years and then just sell off the assets and shut down the business incorporation may not be necessary.
Do I encourage my new employees or junior partners to become shareholders? If your exit strategy is to sell the business to the employees or junior partners then bring them on as shareholders. However, make sure that when the corporation is started there are different classes of shares available for employees or junior partners. If the exit strategy is to sell the entire business to a third party, having other shareholders such as employees or junior partners can complicate or even prevent the sale from taking place.
Does it make a difference how long I plan to operate the business? Yes. If you plan to grow the business and sell in five years or less than you can keep the structure fairly simple. If this business will be your career then the separate use of holding companies and operating companies is an effective asset protection and tax strategy.
I am thinking about buying a business condo or land for my business operations. How does my exit strategy affect this decision? If you envision selling the entire package to one buyer or passing it down to the next generation then it may make sense to have the property owned by the same corporation that operates the business. In most cases, it is much easier to sell the operating business as a separate transaction from the sale of the land. If the potential exit strategy may involve two different sales: the business and the land; use a separate corporation to hold the land. For many business owners, the exit strategy comes in two stages. First, sell the business and continue to hold the land as a source of rental income. In stage two, sell the land. Structure the business with this in mind from the outset and you will save thousands of dollars when it comes time to execute your strategy.
My exit strategy is transferring the business to the next generation. How does this affect what I do today? A corporate structure allows you flexibility to engage in tax planning and gradual transition of control and income. An estate freeze can be used to allow the next generation entry into the business without triggering immediate tax. Share ownership can be structured to allow continued control while passing on growth to the next generation or you can enjoy the income and growth while passing control onto the next generation. This involves the use of different classes of shares and can be incorporated into the share structure of the business when it is incorporated.
My business has been operating for several years and my exit strategy has changed. What can I do now? All of the above strategies can be implemented at any stage in the business lifecycle. Typically, it is more costly and time-consuming to implement a strategy after the business has been in operation. Potentially disastrous tax consequences can follow if the plan or restructuring is not done properly. With the use of professional advisors in both the accounting and legal fields you can still effectively implement your exit strategy. For example, you can roll the assets of a proprietorship into a corporation or you can completely reorganize the share structure of an existing corporation. The benefits must outweigh the cost or the strategy will not be implemented.
For more details on any of the above issues please contact us. We can help you with incorporation, buying or selling your business, unanimous shareholder agreements, succession planning and more. Ralph Colistro and Stan Galbraith both have extensive experience in this area.