June 2008: by Steven Krueger

Cash is king

The typical cycle of the owner-manager business includes a start up period, a growth cycle, eventual maturities, and finally the succession or exit from the business.

For most of us, the capital required to start our business included a variety of sources such as taking a larger mortgage on a house, personal savings, borrowing from friends and relatives, and commercial loans. The early years were almost always difficult and personal income sacrifices were necessary to keep operating. Seldom was there any excess cash.

For the minority of these "start ups" that succeeded, the first sign of success was a profitable year and even some tax to pay. As this situation improved, we typically would transition from a sole proprietor (or partnerships) to an incorporated structure to lower tax rates. Of course this left more money in the business to upgrade, expand, and progress. Even though the business was profitable, the business still needs the money.

The next phase for the successful business is maturity, a time that is characterized by excess cash and the ability to consider other investment opportunities.

Cash now is available and offers the opportunity to achieve even greater successes. It is also at this stage that a variety of planning opportunities arise.

For example, the first step might be a reorganization of the corporate structure that includes a holding company (HoldCo) where the assets, not used nor needed in the day-to-day operations, can be placed. There are two benefits. First, this removes the assets from the risk of creditors, and secondly, it will allow the operating company (OpCo) to qualify for the capital gains exemption. At the same time this starts to restrict the growth of value in the OpCo by transferring it to the HoldCo.

There are a variety of other ways that result in effective use of redundant cash such as Individual Pension Plans (IPP), corporate class equity investments, universal life contracts, many of which have been discussed in previous editions of this column.

The critical planning opportunity for the successful mature business organization is to look ahead to the eventual sale of the business and arrange its affairs accordingly.

The eventual sale of all business is not an easy task. Sometimes, the business owner becomes the victim of his own success. He (she) has been so effective that no one can afford to buy the company. More often there are other issues such as knowledge and experience requirements, change in industry or product, family conflict and retirement requirements.

In a perfect world, particularly for a family run enterprise, mom and dad have accumulated enough cash in their RRSP, IPP, investment account, and other non-operating business assets that they don't require immediate cash nor maximum sale price. Additionally, if they hold the real estate outside the operating company they can remain landlords and collect rent. If the affairs have been planned properly both could potentially qualify for the $750,000 capital gains exemption or dividends at reduced rates.

Getting the cash out of the business to provide retirement income and reduce future risk is a process that needs to be planned many years prior to the actual sale. To the extent that the retiring owners have stockpiled cash, isolated real estate holdings, diverted cash to pension plans and other similar strategies, the business becomes easier to sell due to the reduced value and the required need for an initiated sale price.

Too often the opposite situation occurs where almost 100 per cent of the assets owned by the prospective retirees are tied up in the business and the cash position is weak. This makes for a more difficult business succession plan and carries significantly increased risk.

It's important to have an efficient exit plan from the very early stages of the business cycle and to remember there will be many times when "Cash is King."

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About the author
Steven Krueger, CFP, is a Financial Planning Advisor with Assante Financial Management Ltd. He can be reached at 1-877-837-3377 or 682-2240, or click to email Steven Krueger.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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