As our ongoing series on exiting your business demonstrates, the exiting process is more complicated and takes longer than many owners may realize. The upfront investment—in terms of both time and attention—in planning can yield significant returns in the end. This is perhaps most apparent when considering the tax implications of the decisions made during the exiting process. By understanding the implications of your choices throughout the process, you can avoid needless and costly headaches throughout. In this article, we outline some fundamental tax planning questions to answer at the outset of the process and provide an overview of some of the more impactful actions that can be taken as you ready your business for sale.
It may seem obvious, but the crucial first step in any sales process is determining exactly what’s up for sale. Even the simplest business is made up of many different components, each of which has value to a potential buyer. A bike shop with a single location in a small city could be carved up into different assets including inventory, brand, real estate, and so on. Once you define exactly what is being sold, you can begin to explore different strategies to manage your tax profile and get the most out of the final deal.
There are two primary options for selling a business: an asset sale and a share sale.
When a seller chooses to sell assets, they put some or all their assets up for sale but retain ownership of the corporation itself. In general, sellers face a greater tax liability on asset sales. First, the company may be required to pay corporate tax on accrued gains from the sale. Second, the shareholder may have further taxation on the distribution of the net proceeds at the seller’s personal tax rate.
A share sale is generally more favorable to sellers in terms of tax burden. First off, the proceeds of a share sale are taxed as a capital gain which benefit from a reduced inclusion rate as compared to regular income. Additionally, subject to certain conditions, the vendor(s) may benefit from the lifetime capital gains exemption afforded to qualified small business corporation (QSBC) shares. Where applicable, that could be up to $1.016 million (or $1.25M assuming the capital gains amendments that were deferred to 2026 are eventually passed into law).
Sellers looking to keep their business within the family should consider whether they would meet the requirements of the intergenerational business transfer rules or if there are steps they can take to meet that criteria before the time of the transfer. These rules allow certain family business transfers to be treated similarly to a third-party sale by allowing the sales to be taxed as capital gains instead of full taxable dividends.
When the average person thinks of a sale, they are likely thinking of a cash transaction. In a cash transaction the seller receives payment upon transfer of ownership. Sometimes this will include a holdback for a pre-defined period (often to determine final balance sheet figures or other potential deal matters).
There are, however, other forms of consideration that can drastically change the tax implications of a sale depending on the final structure of the deal.
Sometimes purchasers would like the vendor(s) to receive rollover consideration. For owners that don’t need to cash out completely, a rollover may offer significant advantages. A rollover sees the seller reinvest a portion of the proceeds back into the business without paying tax on the reinvested amount. This allows the seller to retain an interest in the business—and profit from future increases in value—and to defer a portion of their tax liability until they sell their remaining shares. This is often especially attractive when the company in question is being sold to a private equity firm, which will work to enhance the value of the business and sell at a higher price in the near term. It should be noted that the tax advantages of the rollover are only available when consideration includes shares in a Canadian company. Where a foreign buyer offers shares of a non-Canadian corporation as consideration, the tax deferral is unavailable. In such instances, there is other planning available, however the process is more complicated.
Sometimes the purchaser may fund a portion of the sale price as a promissory note. Unlike shares of the purchaser which can provide tax deferral, a vendor take-back note would trigger up-front taxation. In certain instances, a reserve may be claimed depending on the period for which the remainder of proceeds are received although limited to five years. Further consideration would need to be given to the terms of the debt (e.g., term length, interest rate, subordination, security) negotiated as part of the sale.
In an earnout, a portion of the proceeds are determined based on agreed business metrics post-acquisition. This is often meant to keep the seller involved in the business past the sale date to ensure continuity and ease the transition between owners. There is a risk that the proceeds of an earnout will be taxed as business income, especially in the case of an asset sale. With a sale of shares, there are ways to have earnout proceeds treated as capital gains if the earnout period is less than five years. In an asset sale, the planning is more complicated.
No matter which form of consideration is ultimately selected, the need to assess whether the seller wants to personally receive the proceeds upon closing or have proceeds received by a holding company. If they’re prepared to leave the proceeds of the sale in the company (or a holding company) as opposed to receiving it personally, they can take steps to defer their tax liabilities. If they want to receive the funds personally, then they’ll need to explore their options for capital gains exemptions more closely to limit their final tax bill.
The initial planning for a sale is about the seller determining what they need, what they want, and what they’re willing to accept. This is a good foundation to prepare for moving forward, but in the end, the buyer is going to have their own set of needs that will need to be managed. The sales process is stressful, moves quickly and requires addressing a wide variety of issues simultaneously. Having a grasp of some of the key issues you’ll confront and the strategies available to you will help minimize delays and get the deal done.
One of the most useful tools available to a seller is to look at their business through the buyer’s eyes by performing sell-side due diligence before the buyer undertakes their own process. This involves hiring a third party—independent of any existing service providers—to take a thorough look at the business and identify any elements that could be challenged by a buyer. Generally, the process will involve a quality of earnings and tax diligence review since those are generally the most significant areas of risk for a potential purchaser.
Undertaking due diligence in advance of the deal process enables the vendor to prepare for deal risks a buyer will call out during negotiations. It also offers an opportunity to either mitigate or eliminate any issues prior to being raised as impediments to the transaction. The purchaser will likely still conduct their own due diligence, but by having a report ready to go will mean that you’re in the driver’s seat instead of reacting to their concerns. In the end, this can help to secure a higher purchase price and speed up the deal.
As Mike Tyson once said, “everyone has a plan until they get punched in the mouth.” No matter what you’ve identified as your goals during the planning process, the specifics of the deal will evolve once you begin to negotiate and build a transaction. As that happens, it’s critical that you understand the after-tax net result of each change and what steps you can take to attain the greatest benefit to yourself. Each provision of a purchase agreement may have a material impact on the net proceeds you realize once the deal is done. While an advisor—whether an accountant, lawyer or wealth management professional—can provide guidance throughout the process and explain the effect of the options available to you, the decision remains yours. However you proceed, it’s important to give yourself the time you need to consider your options and make adjustments to your exit plans to maximize your results.
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