You have probably heard the advice “don’t put all of your eggs in one basket”.
We see a lot of businesses that suffer from the eggs in one basket syndrome. Like the phrase suggests, this can result in greater risk and cost them in the long run.
For families in business, this can describe a couple of situations. One is that all of the family’s wealth is tied up in their business and they have not diversified some of their wealth away from the business (in a tax efficient way). Another is where most of the family’s assets, including assets not directly used in the business, are owned by the corporation that also owns and operates the business.
It is not unusual to see a situation where a business structure has not changed from when it was first set up, after 10, 20 or even 30 years or more in business. The business has grown and evolved over the years, additional assets have been acquired, circumstances have changed and the wealth has grown. Notwithstanding, no one has paid much attention to whether the business structure and ownership still makes sense for the business and the family.
A common situation is where commercial real estate, investments and/or cash (excess to working capital requirements) have been acquired or left to accumulate in the operating company. They are all in the same basket as the business.
Here are some of the ramifications:
- Those non-business assets are exposed to the risks of the business. Should the business suffer a financial downturn or failure, those assets could be lost to the creditors of the business.
- The shareholders may not be able to use the capital gains exemption, with a potential tax cost to each of them of $170,000 or more. The capital gains exemption is only available for shares of a corporation that uses 90% of its assets in carrying on an active business. The non-business assets could throw that offside.
- The business owner may have plans to some day sell the business but retain the commercial real estate where the business is carried on and lease it to the business. That is difficult to do when the business and the real estate are owned by the same entity. It won’t happen without potentially significant tax cost.
- Estate planning can be challenging with this inflexible structure. In many cases the founders intend that the business be left to certain family members (who take an active role in the business) and leave the non-business assets to other family members. This is almost impossible to do (at least in a tax efficient way) when everything is in one basket.
- Where a family has more than one business, the succession of those businesses to the next generation can be more complicated if they are held in one corporation. Having them owned in separate corporations can provide greater flexibility as to future management and ownership among family members.
It is important for a business family to make sure that their business and corporate structure continues to make sense and takes advantage of opportunities. It involves a careful review of the current situation and structure, taking into account the family’s objectives.
Things can be restructured, and often in a very tax efficient way. In a recent case, we were able to move the commercial real estate, investments and excess cash to a new “wealth accumulation company” for the patriarch of a family business, without triggering tax on the assets. What’s more, the structure will allow him to move the excess profits of the business into his wealth accumulation company on a regular basis very efficiently. He now has the opportunity to better protect those assets and further diversify his wealth away from the business by pursuing other investments. He also has greater flexibility in his estate plan, accommodating his desire to ultimately leave the business to one of his children and equalize things with his other children using his wealth accumulation company.
Note that any possible restructuring involving the next generation becomes much more complex and more expensive (costs and taxes) if both of the parents are no longer in control of the corporation. Therefore, it is very important that the business structure be reviewed regularly and certainly before mom and dad have given up control (whether intentionally or as a result of their death).