Succession planning is vital for a smooth transfer of business assets, benefiting the owners, the business, and Canada’s economy. With Canada’s aging population and the retirement of baby boomers, this has become increasingly important. Poorly managed transitions can lead to undervalued sales, closures, job losses, and economic instability. McFarlane Transition Advisory outlines the importance of succession planning and prepares small and medium-sized businesses for a successful exit.
Over the next decade, more than $2 trillion in business assets are expected to change hands, marking the start of the largest transition in Canadian small business ownership in history. With aging baby boomers leading this shift, approximately 76% of small business owners plan to exit their businesses in the next 10 years—that’s three out of four businesses. This unprecedented change is unlikely to happen again. As this transformation accelerates, it’s crucial for business owners to prepare now or risk being left behind in a rapidly evolving buyer’s market.
(Source: Canadian Federation of Independent Business, “Succession Tsunami – Preparing for a decade of small business transitions in Canada”, https://www.cfib-fcei.ca/en/research-economic-analysis/succession-tsunami-preparing-for-a-decade-of-small-business-transitions, January 2023.)
Retirement is the leading reason for small business transitions. Surprisingly, only 1 in 10 small business owners have a formal succession plan in place.
Addressing these obstacles is key to ensuring a smooth and successful transition of your business.
Conduct a Self-Assessment of Your Business
A potential buyer will want to evaluate the risk associated with achieving future cash flows. As part of your succession planning, it’s wise to assess both the quantitative and qualitative factors buyers typically consider when evaluating a business. The self-assessment will help you identify and address any perceived weaknesses, making your business more attractive and reducing potential concerns.
Start Planning Early and be Adaptable as Different Scenarios Unfold
Business transitions can be in the form of a transition to other family members, an employee group or a sale to a 3rd party. For example, professional practices are commonly sold to partners or associates, larger group practices, or consolidators. A well-crafted succession plan should consider all potential pathways to ensure the owner’s goals are fully realized. Larger group practices often offer the highest value during a transition by leveraging operational synergies, providing ongoing compensation to selling professionals who wish to remain involved, and offering equity upside opportunities that can be structured to defer income taxes as part of a well-developed strategic plan.
Determine the Value of Your Business Using an Income or Market-Based Approach
An income-based approach values a business based on normalized earnings or cash flow, adjusting for non-recurring expenses and management compensation. This cash flow is either capitalized (historical performance) or discounted (future projections), with rates reflecting the risk of achieving future cash flow. For instance, a 20% capitalization rate equals a 5X multiple.
Market-based approaches require obtaining information on comparable companies and past transactions to determine the implied multiple of earnings before interest, taxes, depreciation, and amortization (“EBITDA”). However, the difficulty in obtaining relevant and comparable information can lead to inaccurate valuations. Professional business valuators, however, tend to use market-based approaches to test their conclusions using an income-based approach.
Select Factors That Influence Multiples
(Source: Canadian Institute of Chartered Business Valuators)
Reduce Reliance on Current Ownership
To reduce reliance on a key or key group of owners, focus on transitioning personal goodwill into commercial or saleable goodwill. This involves building strong brand recognition, standardizing and documenting processes and essentially making the owner redundant. By emphasizing the value of the business itself—such as its reputation, systems, and team—rather than the personal relationships of a single owner, the business becomes more scalable, sustainable, and attractive to potential buyers.
Determine What is Being Sold
When selling your business, consider after-tax proceeds and whether to sell shares or business assets, as tax implications are significantly different. Selling shares may qualify for the Lifetime Capital Gains Exemption (LCGE), allowing up to $1.25 million in tax-free gains in 2025 if conditions are met. Advanced planning is key to ensure the 90/50 criteria is met. Given tax exemptions can come and planning early can make a huge difference in the after tax “in your jeans” cash from a sale of shares. The tax benefits, time value for money, and reduced risk often favor selling sooner than later.
Monitor and Assess Your Succession Plan
In today’s dynamic economy, it’s crucial to monitor KPIs and address areas of perceived risk in your business. Despite the benefits of succession planning, fewer than 10% of Canadian small business owners have a formal plan. Professionals such as CPAs, Chartered Business Valuators, lawyers, and succession experts can provide valuable guidance.
About McFarlane Transition Advisors
We help entrepreneurs and business owners maximize their company’s value in preparation of a sale or other business transition. Our expert transition team has the industry leading experience that you need and a national reputation that you can trust.