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Survival of Family Owned Businesses Depends on Good Preparation

The sad reality is that only about one-third of small business’s survive into the second generation. – Are you prepared?

As a business owner, you have worked hard and tirelessly to get your business to where it is today. But the sad reality is that only about one-third of small business’s survive into the second generation. Experts agree that the thorn in the side of family-owned businesses stems from a lack of preparation – on everything from succession planning to taxes and ensuring wills are up-to-date.

Here are some of the most common financial planning problems blamed on bad or even no preparation:

1. The Business isn’t organized properly

Sometimes the company has been set up as a full proprietorship when it should be a corporation and even when it has been set up as a corporation, it’s not structured properly. It may be best to structure the corporation with different classes of shares depending on who the owners are.

2. The founding generation is almost totally concerned about sustaining the business by reinvesting profits and wealth into the company at the expense of not looking after the own needs.

In the end that may mean the original owners have quite a bit of wealth, but then find it difficult to translate this into a sustaining cash flow after the reach retirement. The challenge comes to a head when the founders want to retire and hand over the reins to the second generation but discover they can’t monetize their investment. The owners could sell their stake to their adult children who are taking over the business, but chances are they don’t have the capital to buy it from them. Unless the founders are looking at a sale to a third party, there’s no monetization, and the business passes between generations in almost a cashless transaction.

3. Owners not needing to spend everything they make, but take it out of the corporation via salary or dividend

The problem here is that the owners than pay higher personal taxes on that money rather than leaving it in the business and pay a much lower small business tax of 15.5%. A benefit of leaving the money in the business is that you can pay a dividend to your children when they turn 18. In Canada, no income tax is paid on the first $40,000-or-so for anyone who has no other income, like a student, if that money comes from a dividend from a small company. This can be used to fund a child’s education. Instead of using money that you have taken out of the corporation and paid 50% tax on, you can use money that you have taken out of the corporation and only paid 15.5% tax on.

4. The owners decide to borrow money from the corporation.

There are many times in the growth of a company when the owners may need to borrow money, and some owners may think it’s to their benefit to borrow from within the corporation rather than go to a bank, but there are a lot of rules about shareholder loans and they are abused. For the most part, if you decide to take money out of your corporation you have to pay it back the year after you took it out.

5. No succession plans are in place and the goals and future plans of the company are not in sync when the next generation takes over.

Nine out of 10 business owners lack business continuity instructions for the family or the employees. Who is going to make financial decisions or accounting decisions or how to change the directors if the owner becomes incapacitated or dies? Literally 8.5 out of 10 businesses have no plan. Succession planning is so important it should be addressed by founders a minimum of five years before they want to retire.

6. The Owners don’t have updated wills that deal with their business.

Often business owners have one will for their personal wealth and a second will for their business. Most of the time, the shares of a privately held company can avoid probate, which can vary among provinces.

7. Bringing in family and friends who are not really capable of doing the job.

It’s may be difficult to say no to a family member or the adult child of a close friend. But having the wrong individuals making decisions that negatively impact your business, especially during a time of transition, puts the company at a great deal of risk.

8. The founders don’t address how to fund the taxes that will arise then they die.

When the founders die and want to pass on the business to the next generation, the tax department considers those shares to be a deemed disposition. There are those who are proactive and have purchased life insurance to cover the cost of this inheritance tax, as long as they do so when they are young and healthy and don’t wait until they are well on in age. The worst case scenario is that eh business has to be liquidated to pay for the taxes.

9. The families can’t adapt to constant change.

There are many disruptors out there, whether they come from technology, government regulations, new competition or the inability of the company to keep fresh and in front of customers. To help the next generation, ensure you work with them to be current in terms of educating yourself and your key employees.

10. The owners have worked hard to build their company and insist the next generation take over.

It is important to be open and continue communicating with the “next generation” to ensure they are also on board with this succession plan. It is also pertinent to keep other avenues of succession open such as selling the business to someone outside of the family or hiring a professional management company to take over the firm in the event the next generation is not interested in taking over the family business.

ProPath Insurance works with numerous small family owned business and along with a specialized lawyer, helps develop plans and protection strategies to help mitigate many of these risks. If you would like to set up a review meeting with us , please do not hesitate to call Glenn Davis, Managing Partner at 647-367-9475 Ext 1 or via email at: We also have an alignment with a boutique law firm that specializes in small family owned businesses that we would happy to refer to you.