What Is Succession Planning?

If you've ever seen the TV series Succession, you know what can happen when business owners don't plan for their own departure. The company flounders or suffers a financial setback—including, potentially, a huge tax bill. Families can get torn apart and, in some cases, the business can fail or end up under someone else's control.

While the show does, of course, dramatize the challenges of succession planning, you don't have to look hard to find real-life stories that resemble what happened onscreen. Yet few business owners have taken steps to avoid a similar drama playing out in their own families.

Three-quarters of Canada's business owners say they plan to leave their company by 2032, according to research from the Canadian Federation of Independent Business (CFIB). That's less than a decade away, yet only 9% of business owners have a formal succession plan.

Here are some things you need to know about succession planning for the day when you want to—or have to—step away.

What is succession planning?

Succession planning is the process of getting ready to transfer ownership of a business to a new owner or, in the case of a family business, perhaps the next generation. A succession plan addresses key questions such as who will own the business, who will run it, how and when ownership will be transferred, and how to transfer it tax-efficiently.

Succession planning benefits business owners in a variety of ways. It helps to protect your legacy and the wealth you've accumulated over the course of your tenure, and it helps the business continue to thrive by ensuring a smooth transition that preserves customer trust and retains employees.

When should you start succession planning?

Ideally, succession planning happens early, even as early as when you set up the structure of your company. In Canada, the four main business structures are sole proprietorship, partnership, corporation, and co-operative. Your business structure will eventually influence your exit strategy. Typically, business owners either transfer the business to a family member, sell it to company managers or employees, or sell it to a third party.

Although a succession plan spells out how you're handing over control of your business, laying the groundwork can begin years in advance. At a minimum, allow 18 to 24 months for succession planning before your desired exit date, the Business Development Bank of Canada (BDC) recommends. Starting early allows you to document your process, develop leaders, clarify roles to avoid conflict, and structure the business to allow for a tax-efficient transfer of ownership.

How a business is taxed when transferred

The way a company changes hands has significant tax implications, so one of the most important questions a business owner faces is how to structure the sale.

For an incorporated company in Canada, there are three main options: selling shares, selling assets, and arranging a hybrid sale. Let's look at each one.

Sale of corporate shares

When you sell shares in an incorporated company, the ownership transfers to the buyer, who assumes all assets and liabilities. This arrangement can be tax-efficient for sellers, particularly if they qualify for the Canadian government's Lifetime Capital Gains Exemption (LCGE), which reduces the capital gains paid at the time of the sale. (Shares of publicly listed companies are not eligible.)

If your company is a family-run business, it's worth familiarizing yourself with Bill C-208, Canadian legislation aimed at making it easier to pass on corporate shares to the next generation. The bill enables sellers to transfer shares to family members and offset or eliminate capital gains through the LCGE. (More about the exemption below.)

If there's no family member or third-party buyer interested in taking over the company, another option is transferring shares to your employees through an Employee Share Ownership Plan (ESOP). Typically structured as an Employee Ownership Trust (EOT) that buys shares from the seller, this approach gives employees a greater stake in the company's future, while leaving a management team established in your succession plan to help ensure continuity and ongoing success. From a tax perspective, this option can also benefit the seller, since federal regulations offer up to $10 million in capital gains exemptions when shares are passed on through an EOT.

Sale of company assets

When a corporation sells only its assets, which can include things like intellectual property, equipment, or inventory, the seller retains the legally established corporation. Some buyers may favour this arrangement, since it means they avoid assuming any of the company's liabilities.

Selling assets rather than the full company can offer tax benefits, too, because at the time of purchase, the value of any acquired asset is adjusted to a fair market price for tax purposes. The buyer can then use the new, higher tax basis to claim greater depreciation or amortization expenses and reduce their taxable income.

Hybrid sale

Business owners can also choose to structure a sale that combines share and asset sales, usually to offer tax benefits to both the buyer and seller. In a hybrid sale, an owner might sell shares in order to benefit from the LCGE, but also sell specific assets that enable the buyer to benefit from cost-basis increases. Hybrid sales are more complex, so they typically require the support of tax professionals.

What is the Lifetime Capital Gains Exemption (LCGE)?

Normally, 50% of any capital gain you receive, outside of a registered account or the sale of a principal residence, is subject to tax at your marginal rate. To incentivize investment in small business, the Lifetime Capital Gains Exemption (LCGE) means you don't have to pay any tax on the first $1.25 million you earn when you sell your business. In practical terms, what it means is this: the taxable portion of a $2.5-million sale ($1.25 million) would be deemed tax-exempt under the LCGE, if you qualify.

Key things to know about the LCGE: It's a $1.25-million cumulative, lifetime limit that applies only to share sales, not asset sales. The LCGE limit is indexed annually to inflation.

Not all companies qualify for the LCGE. Unincorporated businesses aren't eligible, and other restrictions apply as well, so it's best to speak to an accountant or a financial advisor well in advance of an ownership transition to find out how to qualify.

How to create a succession plan

1. Identify potential successors—and talk to them. If you have someone in mind to take over the company, make sure they're aware of it, and find out if they're interested. If you can't identify a successor, now is the time to start looking.
2. Assemble a team of advisors. Seek assistance from legal, financial, and tax advisors early on. These might include your small-business bank account manager, wealth and estate planning managers, lawyers, and accountants.
3. Assess financial records and documents. Potential buyers will want to review comprehensive, up-to-date financial statements and accounting records (typically three to five years' worth), as well as relevant legal documents. Consider what other information a buyer might want to see, such as lists of suppliers, equipment, and customers and clients.
4. Obtain a company valuation. Your idea of what your company is worth may not reflect its current market value, so it's a good idea to hire a qualified appraiser or accountant. If their estimate doesn't reflect your expectations, consider ways to increase your company's value before you try to sell it.
5. Develop a timeline for the transition. Outline the process step by step and set realistic goals for reaching each milestone.
6. Create a plan for knowledge transfer. What will your company's next leaders need to know in order to succeed? Outline a road map for documenting processes, training, mentoring, onboarding, and other necessary steps.
7. Communicate your plan. Transitions that come as a surprise can unsettle employees—and your clients and customers. To ensure stability, make sure to communicate your succession plan.
8. Update your plan regularly. Key employees come and go, and family members' interests change. Review your plan regularly.

Start planning for your next act today

When you're running a business, it's easy to become consumed by the day-to-day operations. But if you've invested countless hours and dollars growing your business, it makes sense to spend time planning for its future success—and yours. A well-thought-out succession plan helps to ensure ongoing prosperity for your company and set the stage for a worry-free, tax-efficient departure.

Set yourself up for success with the right financial tools

Keep your bookkeeping immaculate with QuickBooks, and simplify your corporate tax filing with TurboTax Business. Our experts are here to help.

Get Started