If You Want to F*Ck Up Your Exit, Don't Read This
We come across numerous examples where CEOs have challenges leading up to the sale of their business – an emotional journey that often comes with any M&A transaction. Even if M&A is expected to be way off in the future, here are a couple of lessons we learned from these stories:
(1) DO YOUR HOMEWORK: doing your due diligence on a buyer before entering into exclusive diligence with them is critical. Just as buyers do their homework on you as the seller to really understand all the intricacies of your business, so should you.
Questions to keep in mind are;
· What’s the strategy behind the acquisition?
· Why does it fit?
· What are the intentions post deal?
· What other M&A deals have they done?
· Do they have the ability to pay for the acquisition?
(2) Providing the right type of information prior to LOI – it’s always difficult to know the level of detail to share pre-LOI and it’s always a balancing act. By sharing too little (of the right information) you risk the deal falling apart post LOI because the buyer doesn’t really know the intricacies of the business and sharing too much results in companies that don’t end up buying you having a lot of your confidential information.
(3) Trusting your gut – sometimes it isn’t the highest offer that you should be going with. There’s always a lot of other factors in M&A that you also need to get comfortable with including what’s the plan with the business going forward, which people is the buyer keeping, will there still be an office where the company was originally founded.
(4) Getting your house in order before it’s too late – in the early-stages, founders are often too busy to invest any time understanding tax planning strategies, until it’s too late. Here are some things to think about NOW to safeguard your financial future:
Income Splitting: dividing the income of a person who is in a high tax bracket (like a founder) to another person is in a lower tax bracket. In the case of a Startup, this means having some or all of the shares that were allocated to a founder issued instead to a low-income spouse, children, or other family members. However, the new tax changes definitely impact this as there is a test for contribution from that family member to the business – so definitely talk to a tax specialist before adopting any of these tax strategies.
Income splitting can be done either by having family members hold shares directly or by implementing a family trust, or holding shares through a holding company.
- Direct Ownership: this structure may be the simplest way to document share issuance and avoid unforeseen tax consequences. However, each family may act independently in matters like electing directors and determining whether to accept an offer to purchase shares – and this fragmentation of ownership can be challenging on the influence of a founder unless certain voting structures are used that minimizes non-founder votes.
- Family Trusts: one alternative to direct ownership of shares by a founder’s family members is to issue shares to a family trust. Unlike with direct ownership, beneficiaries of the trust don’t have direct access to the shares. Instead, the trustees of the trust, are registered as a shareholder of the company and have all the rights/responsibilities of any other shareholder. Capital gains and dividends received by the trust are then paid out are potentially subject to more favourable tax treatment (including the $866,912 capital gains exemption that can be used by each beneficiary of the trust – ie no tax on the first $866k per person).
- Holding Company: a holding company has the same advantages over direct ownership as a family trust would, but the costs of setting up and maintaining a holding company would generally be equal to or greater than those associated with a family trust. Also, the $800,000 exemption would not be available to the holding company on the sale of shares of the startup. Holding companies are normally used to move assets out of the operating company and protect them from any litigation or legal actions against the operating company.
(5) Minimizing very high legal fees – if the scope of the M&A assignment is not truly defined ahead of time, then legal fees can begin to accumulate. So knowing if there is any tax structuring, updating of minute books or other legal records, etc is important to figure out ahead of time. Also, if you ask for prices from several lawyers, taking the lowest bid might not be the best path – we saw a case recently where the co-founders picked a lawyer because they had a better price only for them to get a final bill that was double the quote!
(6) Selecting the right advisor – with the right advisor as your partner, you’ll be able to navigate all the above and get expert advice on the intricacies of M&A. In particular, finding the right buyer for your tech business, negotiating the best price and non-financial terms and guiding you through a very complex and time-consuming process so you can continue to run your business at the same time.
Disclaimer: “Sampford does not provide legal or tax advice and we highly encourage you to talk to legal representation and tax specialists before following any of the advice above.”
1 VentureBeyond - Tax Planning for Canadian Founders: by Dentons 2019