Change of Ownership

A business is established under one of the following forms:

• A proprietorship has a low start-up cost, is in control of decision making, and pays income tax as individuals, as all profits go to the owner. The disadvantage is the personal liability for business debt, risk of a lack of continuity during illness, challenges in raising capital and no name protection for the business.
• A partnership is easy to establish, has similar low start-up costs, additional sources of capital from the partners, pays income tax as individuals, has limited regulation and a larger management base. However, it suffers from unlimited liability, shared decision making, challenges in raising additional capital, difficulty in finding suitable partners, risk of conflict between partners, risk of being legally bound without knowing, lack of continuity and no name protection for the business.
• A limited company is most often favoured due to its limited liability, possible tax savings, transferability of ownership, ongoing existence, ease of raising capital and name protection. However, it is more closely regulated, formation is most expensive, it requires extensive record keeping, has potential double taxation by company and shareholders, directors may be held liable, and it requires personal guarantees for debt of corporation. The type of structure you intend to form requires careful consideration and legal advice.
• A Co-operative is the least common form of business that is suitable to individuals wanting to pool resources to access common needs.

(Canada Business Network, 2015)

Small Business BC’s How to Choose the Right Business Structure describes the advantages and disadvantages of each business structure. The formation of the business you are buying is important to know, as is the formation of the new business that you will enter into.

The form the selling business takes does not preclude the new owner from changing the format. For example, an existing Proprietorship can be changed to a Partnership, or a Limited Company to one that is most suitable for the new business owner.

Next, you will focus on responsibilities that are assumed from the existing business.

Contract and Fiscal Responsibilities

When an existing business is purchased there are several relationships already in place. Existing customers, suppliers, employees and bankers know the business and will likely want to continue after the change in ownership. Building relations with the key partners will be an important task for the new buyer.

Examining customer commitments for either price or performance will help you understand the degree of formality. The use of purchase orders, payment by statement or invoice, and credit terms will need to be discussed.

Suppliers are also key to a successful enterprise. Knowing what relationship exists, volume discounts or annual volume rebates are important. The credit terms and history of payment to suppliers will be relevant as well. Pending price increases will impact future profit margins.

It is important to determine if any labour contracts are currently in place. Most small businesses are not likely to be under a Collective Agreement; however, confirmation is part of a due diligence process. The employees may have an expectation based on the current owner for a year-end bonus or regular annual increases. Discussions with the owner and perhaps the key employees would be prudent.

Look into the possibility of maintaining the same banking relationship that the current owner has as the bank will have good knowledge and experience with the company. On occasion the bank may have covenants in place that restricts the level of debt or the sale of assets in order to protect the bank’s investment. Disclosure of covenants should be discussed. Any monthly or quarterly reports to the bank need to be identified.

The relationship with the accounting firm is also relevant. Annual financial statements and tax returns for the past 3 years will shed valuable insight into the reported results.

Any indication by the seller that the statements reflect only part of the revenue should be a caution flag. Small business owners may not report all income for a variety of reasons. A wise buyer would need to be very cautious to avoid any liability related to misrepresenting business records.

Other regular reports to various levels of government, including Statistics Canada, should be reviewed. These mandatory reports need to be completed on a timely basis. The Canadian government generates many different reports based on data collected from businesses that are relied upon as factual, complete and representative.

Submission of payments for Canada Pension, Employment Insurance and Income Tax need to be current. You can find further information on Revenue Canada’s website.

Work Safe BC reports and benefit plans also need to be up to date.

Determining Value of People Resources

Most small businesses rely on the owner to do the Human Resources (HR) work. When assessing a potential business it is important to recognize any “key” employees. These are the ones that can continue the business with minimal supervision for a week-long period. Try to estimate the number of weeks of training required to move a person to the “key” role. Now look at the other employees and determine which “specialists” are in the company. The “specialist” may work alone and have little backup for vacation or sickness. Also, estimate the number of weeks of training to move a person into this role. The remaining employees may need an orientation period, basic training and close supervision typically lasting less than one week. When you total the training required to replace all the staff you will have an idea about the overall value of the people. Naturally, employees will not leave at the same time but rather over time, each one could be promoted or resign. Determining who would be the trainer is also useful as that individual would be operating with reduced productivity during training.

The level of education required for each position is important. Most businesses are looking to promote people within the company. By setting a high education standard for new hires the company can train and promote from within. Innovation can often be boosted with educated or experienced employees.

Acknowledging that employees are the most important resource in a business is very important. Nothing will be ordered, built, or shipped without an employee action. Business is simply not automated. The owner will have to develop special skills to manage the workers, to help them achieve outstanding results. The owner may err at times but an honest, open, engaged employer should be a pleasure to work with. Determine the present culture at the prospective business to provide insight into the success of the firm.

Financial Considerations

You will recognize the need for a Certified Professional Accountant (CPA) to review the audited financial statement of your business.  The CPA will be able to highlight trends in the business that you will want to know.  Often there may be an excellent explanation that needs to be discussed or there may be an opportunity for a new buyer to act on.

The following videos by Pacific Business Brokers help give an insight into financial and income tax issues:

What is EBITDA? What should you know about it?

Inventory and Business Value

Importance of Tax Planning When Selling or Preparing a Business to Sell

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Activity: Change of Ownership

Before continuing to the next section, take some time to examine the business structure for your business.

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