Are you planning to sell your business & retire in the next ten years? Selling a business is a complicated process, to be sure. There are a couple of things to start considering early.
According to a Canadian Federation of Business survey released in November of 2018 just over 60% of retiring Small to Medium Business Owners (“SMEs”) plan to use the proceeds from the sale of their business as a source of income when they retire.
The first item on the agenda is how to shelter your sale proceeds from the taxman. The marginal tax rate on income over $210,000 in BC is almost 50%. Without an effective strategy, the government’s share of the sale of your business could be almost as large as your share.
The Small Business Capital Gains Exemption is an obvious place to start sheltering your money. There are some qualifiers, the most critical of which are – there must be continuous ownership of the shares during the previous 24 months, it must be a Canadian-controlled company, and the majority of the assets must be used mainly for the active business. Tax laws are subject to change and you should discuss the specifics with a qualified tax accountant well before you sell and retire.
Another avenue for owners, like you, to consider is setting up an independent pension plan (“IPP”). Your company can make tax-deductible contributions to an IPP in advance of the sale of your business.
Building your own pension plan sets aside money for your retirement and it can reduce the sale price of the business for the buyer. If you start early enough it also may make qualifying for the Small Business Capital Gains Exemption easier.
Owners who are taking a salary are able to contribute more to an IPP than they would an RRSP. It allows for additional deductions, business-level deductions, and also saves on taxes.
There are three other advantages to consider with this strategy:
Owners can move existing RRSPs into their IPP, which are fully protected from creditors,
Fees paid to a financial adviser to manage the IPP can be deducted as a business expense, something that’s not allowed with a personal RRSP, and
The option for income splitting with an IPP starts at age 55, unlike with a registered retirement income fund (“RIF”), which starts at age 65.
Endowment Approach to Investing
Once established, investments within your IPP should be managed utilizing an “Endowment Approach”. An endowment is a type of investment portfolio designed for consistent withdrawals while protecting a base of invested capital. This approach is used by the Canada Pension Plan, universities, non-profit organizations, and churches.
Endowment portfolios are constructed on the principle of enhanced diversification which means they also invest in asset classes outside of the typical North American stock and bond markets. The goal is to prudently manage risk while providing consistent returns that can be taken out and used as income or reinvested in the growth of your asset base.
Typical asset classes are foreign equity, private equity, venture capital, absolute return strategies, and real assets. The diversified mix of asset classes targets more stable returns adjusted for volatility.
Below is a table of the growth performance of the North American large-cap stock markets for each of the first two decades of this century. While returns have been good for those that stayed the course, the path hasn’t been smooth – in other words, returns from equities are volatile.
Projecting out over the next ten years is difficult – valuations are high suggesting more muted returns and volatility reverting to the mean and moving higher. This is all the more reason that diversification and risk management will remain critical for meeting one’s investment goals.
With outcomes over the next ten years highly uncertain, an investment process following a properly executed endowment approach can provide peace of mind. This is important when you sell your business and retire.
Anchor Pacific Investment Management Corp. (“Anchor Pacific”) is a Vancouver, BC-based portfolio management firm, which leverages process, technology, and infrastructure to democratize the process of managing endowment and pension style investment portfolios to deliver innovative, high-touch, and transparent investment programs across the full spectrum of asset owners and investment consumers.