A Starting Point – Part 2 of 3
Business owners make a multitude of decisions every day, from the mundane to the big picture. Yet many leave their succession planning undone, with often difficult consequences for the business, and their families and communities.
Why do some people avoid the inevitable? Is there anything advisors can do to help them?
This is the second in a three-part series creating a baseline for succession planning discussions (see Business Succession Planning – Understanding Key Drivers and Putting the Pieces Together for parts 1 and 3 of the series). The goal is to give advisors a common framework and reference point for these discussions, so we can all better help individual business owners build their comprehensive succession plans.
The first post focused on the emotional background of succession planning. Many advisors focus on building the plan – the technical mechanics and components of the same. This makes sense, as it is what we are trained to do. But this focus only helps clients move ahead if they know what they want to achieve – if the business owner has already bought into the need for the plan. Understanding the emotional background, the familial and other life circumstances impacting the decision-making process, is critical for advisors wishing to help those owners who are not yet sure of what they want or need, who have not yet decided on how to move forward.
Once an advisor understands the owner's basic motivations, they can help put together a plan that drills down to these goals. But, before jumping to technical mechanics, it is important to take a step back and understand the options available.
A business owner has two overarching "levers" in a business: control and economic benefits. That is, the owner looks to either maintain control or receive economic benefits from their involvement in the business (or requires both aspects). It is important to delineate what each means, both at law and in practice, to understand the implications of succession planning and assist owners to see a path forward.
Control
Where businesses are structured as corporations, different levels of control are available. Definitions of legal corporate control are found in a variety of statutes, including federal, provincial and territorial corporate laws, the Income Tax Act1, and in applicable securities laws. The shareholders with legal control of a corporation are those that: (1) control at least 50% of the votes that may be cast to elect directors; and (2) have the power to appoint a majority of a corporation's board of directors.2
The foundation behind legal control is that directors have the legal responsibility to manage, or supervise the management of, the business and affairs of a corporation (unless otherwise modified by the corporation's articles, by-laws or a unanimous shareholder agreement).3 That is, if directors or their delegates are managing the business, the shareholders who can appoint those directors are, in fact, the ones who can control this management.
In practice, the real control of a corporation depends on the circumstances. Key individuals, whether directors or otherwise, can wield a high degree of influence that amounts to practical control of the business. Significant third-party contracts, like franchisee agreements or large customer or supplier relationships, can impose such onerous obligations that they amount to practical control as well.
Understanding legal and practical control in the business is key to beginning the succession planning discussion. It is important to understand the relationships and dynamics of the business to ascertain the level of control maintained by the business owner and their family. An owner who is heavily involved in the day-to-day life of the business may need to maintain legal and practical control for a prolonged period even when planning for their estate or business succession.
Economic Benefits
There are two economic benefits available to shareholders of a corporation at law: dividends and the right to receive the corporation's remaining property on dissolution.
A corporation must have at least one class of shares. Where there is only one such class, the shares must be entitled to vote at all meetings of shareholders and to certain of the above economic benefits. Under the CBCA, such class must receive both economic benefits above.4 Interestingly, the OBCA only requires that such class be entitled to receive the remaining property of the corporation on dissolution.5 Technically, under the OBCA, a corporation could be created without any shareholders entitled to receive dividends (though this makes it very difficult for shareholders to extract any value or return on their investment other than upon dissolution).
Practice and law are two different things here as well.
There are many practical economic benefits to dealing with a corporation beyond dividends and assets on dissolution, including: loans, guarantees, and other financial assistance, as well as a portion (or all) of the underlying value of the business in any other circumstance other than dissolution, like in a sale or estate freeze. Third parties can also receive economic benefits from dealing with the corporation, including by way of leasing property, engaging as employees or consultants, or otherwise selling products or services to the corporation.
The cornerstone of estate and succession planning for a business owner is to understand what economic benefits they and their family members are entitled to receive and how those same benefits will be allocated in their estate and/or upon their exit from the business (assuming such exit is before death). This requires an in-depth review not only of the current corporate financial information, but also the owner's current and future personal financial picture.
Part three in this series will outline a way of thinking about an owner's goals and motivations together with the options available to create a truly tailored plan.
Footnotes
1 Income Tax Act, R.S.C. 1985, c.1 (5th Supp.). Though the ITA does not contain a definition of the word "control", case law stipulates that the generic legal control test set out in various corporate statutes is the general standard unless otherwise provided. See, for example, Deans Knight Income Corp. v. Canada, 2023 SCC 16 at para 92.
2 See: Canada Business Corporations Act, R.S.C. 1985, c.C-44 ("CBCA"), s.1(3); Business Corporations Act (Ontario), R.S.O. 1990, C.B.16 ("OBCA"), s.1(5).
3 See: CBCA, s.102(1); OBCA, s.115(1).
4 CBCA, s.24(3).
5 OBCA, s.22(3).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
