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Many business owners establish their corporate structure when their business first starts and rarely give it another thought after that. At the time, that structure was commensurate with the size of the business, the number of shareholders, and the objectives up for discussion.
After a few years, the business is not the same as it was on day one. The business is expanding, new partners have been added, and the firm might be involved in more than one type of business. But the corporate structure remains the same in most cases.
The difference between where a business is and where it needs to be in the legal sense is what makes it easier or harder when tax time comes, creates an unnecessary exposing risk of assets, and makes it easier or more difficult for succession or sale. Business owners fill that void through a corporate reorganization.
What Is Corporate Reorganization?
Corporate reorganization is a planned change to a company’s legal, ownership and/or operational structure. It may include establishing a holding company, changing share classes, transferring assets from one related company to another or setting up a family trust for succession.
Its aim is not to alter the day-to-day operations of the business. It is to ensure that the business structure behind the company is compliant with the tax position, asset protection, and ownership and control. This is not a negative process, but a positive planning one if done properly.
Here are seven signs it may be time to take a closer look at yours:
1. Business Has Grown Significantly
Too often, a small owner-operated business builds a structure that is inadequate to meet the demands of a growing business with a growing revenue, staff or retained earnings.
While profits are generated in an operating company, assets or investment they remain tied up in the operating company’s risks, including legal actions, creditor claims and contractual disputes, rather than being separated from the day-to-day risks.
Inaction leaves essential retained earnings susceptible for no reason. Surplus cash and investments can be placed in a different company via a holding company structure, which helps to shield the investment and can enhance the overall tax efficiency of a business.
2. New Shareholders or Business Partners Have Joined
A change in ownership of a company, whether through a new partner, investor or key employee shareholder, will alter the ownership and business structure of the company. One or two founders’ ownership may not work for various roles, contribution levels or exit expectations.
Disagreements regarding dividends, voting control, or future buyouts become much more likely without a proper share reorganization. A restructured share class can separate voting control from shareholders’ economic interests, ensuring shares are allocated according to each shareholder’s actual economic participation.
3. Business Now Operates Multiple Lines or Divisions
Many companies expand in new products, new services or even new businesses, all under one roof.
Having unrelated business lines within one corporation can have a direct impact on the other lines of business due to risk. If a business line is in trouble, it can endanger the assets and cash flow of the whole business.
Simplification of the company into separate segments, or lines of business, allows the risk to be separated and can lead to more transparent reporting for lenders, investors, and prospective purchasers.
4. Tax Inefficiencies Are Becoming Noticeable
Often, as business expands, the tax base expands more than is anticipated. Owners might see an increased need to pay more in corporate taxes, not realize they have the opportunity to split the income with family members, or struggle to access the tax efficiency of the lifetime capital gains exemption.
Unfortunately, these inefficiencies accumulate over time, and real dollars are lost from the business unnecessarily. A reorganization, including via a holding company and/or a carefully designed family trust, can enhance tax flexibility and allow more value to remain in the business.
5. Succession or Estate Planning Is on the Horizon
Entrepreneurs who wish to transfer their business to their children or key employees must have the correct structure in place to enable the smooth transfer without incurring an excessive tax liability.
When an individual dies, they are generally deemed to have disposed of their capital property, including shares in a private corporation, at fair market value immediately before death. This may trigger capital gains tax on the increase in share value. An estate freeze helps manage this exposure by locking in the current value of the owner’s shares, while allowing future business growth to accrue to the next generation. This can help limit the capital gains tax exposure associated with the owner’s estate and support a more tax-efficient succession plan.
6. Sale, Partial Sale or Investment is Being Considered
Corporate structure is carefully studied by buyers, investors and lenders in the due diligence phase. If the business holds and uses personal assets or has a real estate investment or unrelated business, it can create challenges or delay in the transaction.
Separating the company’s operating assets or business into a separate entity before a sale may make the company more attractive to potential buyers and help preserve eligibility for the lifetime capital gains exemption on qualifying shares. However, this restructuring alone does not guarantee eligibility. The applicable asset-use and 24-month ownership requirements must also be satisfied.
7. Liability or Asset Protection Concerns Are Growing
The more contracts, employees, or riskier activities a business enters, the more it is going to be exposed to lawsuits and creditor claims.
When there is operational risk, valuable assets that stay in the same operating corporation are also at risk. If the operating company is involved in legal proceedings, faced with creditors’ claims, or experiencing financial issues, cash reserves, investments or real estate held in the company could be at risk. This separation places a legal, though not absolute, separation between the operating risk and the value of the business that has been built up.
Common Corporate Reorganization Strategies
There are a number of tools that are seen several times in these scenarios, and most of the Canadian business owners have heard of these terms without understanding what they are and how they fit together.
Holding Companies: Separate accumulated value and passive investments from the operating business.
Share Reorganizations: Create new classes of shares for various reasons, such as estate freezing.
Estate Freezes: Freezing a business at the owner’s current value to benefit the next generation.
Family Trusts: Facilitate succession planning and, in appropriate situations, access the lifetime capital gains exemption in the hands of the family.
Asset Transfers: Transfer particular assets to and from related companies on a tax-deferred basis.
Corporate Simplification: Closes or consolidates inactive companies to streamline administration and decrease administrative burden.
Each of these tools is dependent on the unique circumstances of the business. A reorganization may work for one firm but not for another, and reorganizing should always be done on a firm-by-firm basis, based on individual tax and legal advice.
Reviewing Your Structure Is a Planning Decision, Not a Reaction
A corporate reorganization is best implemented as a proactive measure, rather than a reactive one that is required when growth, a new partner, or a pending sale brings it up. Companies that review their organizational structure at regular intervals and in conjunction with their ongoing tax and succession planning are less likely to have expensive rearrangements to make later in the year.
How Faber LLP Can Help
Faber LLP is committed to assisting business owners in Alberta and Western Canada with their corporate structures and the ways in which they can become more efficient, and also in the design of reorganizations to ensure they are the right structure for the business going forward, not just in the past. With our team, you’ll get a combined corporate tax planning, estate and succession planning, and business advisory experience perspective, so all recommendations reflect a thorough understanding of your business, not just one tax rule over another. We can help you develop a plan that protects the growth you’ve achieved and prepares the business for future growth if your structure hasn’t evolved with your growth. Make the first call to begin the discussion.