Category Media Corner

Liquidity Alternatives

Liquidity Options for Privately Held Businesses

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In my previous article, Preparing for a liquidity event, I discussed how to prepare a business for a liquidity event. Proper preparation ensures a business is well‑positioned when unexpected events result in a need for liquidity.

What is a liquidity event?

A liquidity event is a transaction through which corporations and/or their controlling shareholders gain financial liquidity as a result of a sale or recapitalization of a business.

In order to ensure optimal outcomes for all shareholders and allow them to best meet their objectives it is recommended business owners consider a number of different types of liquidity alternatives.

Shareholder motivations for liquidity

The desire for a liquidity event may be motivated by one or more of the following personal and business circumstances:

  • Business owners may wish to “take some money off the table” and reduce personal financial risk by diversifying their assets.
  • Business owners may look to take a step back from the business to pursue other interests or retire.
  • Unexpected personal circumstances, such as a death, deteriorating health or divorce, may require the division of family assets.
  • A shareholder may elect to leave the business due to a challenging interpersonal situation resulting from mutual ownership with other individuals with different personalities.
  • Owners may encounter increased competition and margin compression, challenging future growth and possibly throwing into question the future viability of the business.

Liquidity alternatives

A liquidity event can take many forms,including:

  • Management/employee‑led buyouts: selling a company to its existing management or employees.
  • Recapitalizations and financial restructurings: infusing new capital into a company to facilitate growth and the partial buyout of existing shareholders.
  • Divestitures: selling a company to a strategic or financial investor that is external to the business.
  • Raising private capital: raising debt and/or equity capital to facilitate growth or ease liquidity constraints.

Characteristics of liquidity alternatives

Each of the transaction alternatives noted above has certain characteristics that make it a better option for addressing shareholder motivations and realizing shareholder objectives under a set of circumstances. Some of these characteristics include:

  • Confidentiality: increased ability to maintain a higher degree of confidentiality about the transaction process and the fact that existing shareholders are looking for a buyer or investor.
  • Speed: ability to be executed more rapidly due to the familiarity of the buyer/investor with the business and/or the fact that the required capital for the transaction is readily available.
  • Growth & upside: certain of the alternatives allow existing shareholders to continue to retain an interest in the company where they believe considerable future growth and upside potential exists. These alternatives involve partnering with seasoned investors with access to tangible resources, experience and knowledge not available to the existing management and shareholders.
  • Price: by their nature, some of the alternatives will be directed to a broader pool of potential buyers/investors and a more formal auction process will likely be undertaken. Broad auction processes that target strategic investors are typically considered optimal from the perspective of price maximization.
  • Use of proceeds: by design, certain of the alternatives will result in existing ownership being diluted, taking chips off the table and diversifying their personal assets. Other alternatives do not necessarily (immediately) allow for these options.
  • Ongoing ownership and management: certain of the alternatives result in existing ownership severing the relationship with the company immediately while others result in continued ownership and potentially holding management roles going forward. One needs to contemplate the various alternatives taking into consideration the shareholders’ comfort level with having additional/new stakeholders at the table.

Conclusion

We often find that shareholders desiring a liquidity event are fixated on a particular form of transaction. Given the range of transaction alternatives available, it behooves business owners to carefully consider all options so they can identify the type of transaction that allows them to best meet their personal and business objectives.

Informed decisions, optimized value

For more information:

Nathan Treitel
Managing Director – Valuation and Transaction Advisory
416.798.6916

NTreitel@segaladvisory.com

In Touch with Tax 2023-2024

A long time ago, in a northern land far, far away… the tax wars began. Tax matters became increasingly complex and overwhelming, but a hero emerged to provide hope and clarity. Armed with tax guidance and insights, Segal has come to the rescue with its 2023/24 edition of In Touch with Tax ⁠–⁠ Tax Wars: The Empire Strikes Back.

Building on its long-standing tradition, this year’s annual tax publication provides essential tax guidance and breaks down complicated matters into easy‑to‑read sections, with an entertaining twist. The theme of this year’s guide is “Movies.”

With its striking visuals and unmistakable movies-inspired flair, this resource is designed to inform (and entertain) on a range of tax planning and reporting matters ⁠–⁠ from capital gains to income‑splitting, incorporation and more.

Following on the heels of last year’s award‑winning Power of Partnership (POP!) edition, the new 2023/24 publication continues to be a testament to Segal’s commitment to helping clients plan for success beyond today.

Pushing play on success

For more information:

Preparing for a liquidity event

Ensuring a successful liquidity

Preparing for a liquidity event

A successful liquidity event involving a privately held business requires considerable preparation.

Even in circumstances where a sale is not imminent, much can be done to ensure the owners can capitalize on favourable market conditions or be prepared when they unexpectedly find an offer on the table.

Even if a liquidity event is not expected to occur for many years, the business owners will benefit from owning a company with reduced risk and better operating and financial performance.

The following outlines the main areas of focus for business owners contemplating a future liquidity event.

Understand your objectives

Undertake some honest introspection to understand your rationale for sale, desire to be involved in the business post‑transaction and the size of the nest egg you will need to finance your lifestyle post‑sale. These motivations and preferences can impact the type of transaction you may wish to pursue, the timing of sale and the type of buyers that you may approach.

Know the value of your business

Even if there are no plans for an imminent sale, it is important business owners have a reasonable estimate of their company’s value.

Armed with this knowledge, owners will be better positioned to evaluate unsolicited offers by potential investors. Additionally, regularly obtaining a realistic estimate of value serves as a tool to examine changes in value over time and is a means to target and track growth objectives.

Relying on a value based on pricing metrics (i.e. multiples) realized in transactions involving similar companies may lead to value expectations that are unrealistic in an open market transaction. It is worth retaining an experienced Certified Business Valuator to get an accurate and unbiased valuation based on the operational, financial and tangible and intangible assets specific to your business and industry.

Understand the value drivers

Along with a realistic estimate of value, it is important to understand the factors driving this value.

Value drivers consist of financial and non‑financial metrics and intangible attributes that are of importance to prospective purchasers. They are also the catalysts to increase the future value of a business prior to any liquidity event. Identifying value drivers will allow owners to focus on enhancing areas that are deficient, resulting in better financial performance, lower risk and, ultimately, a higher value.

Prepare the business for a liquidity event

Optimizing a liquidity event involves timing the transaction to coincide with favourable company and market conditions.

Much preparation can be done in the months and years leading up to a transaction to ensure owners are ready to capitalize on attractive market conditions, including the following:

  • Reducing key man risk through the development of a strong senior and mid‑level management team.
  • Reducing customer and supplier concentration.
  • Investing in maintenance and capital expenditures to ensure productive capital assets.
  • Improving financial systems and reporting capabilities.
  • Documenting business relationships with customers, suppliers, employees and related parties, as well as internal operating controls and governance protocols.
  • Obtaining resolution and greater clarity relating to contingent liabilities, and outstanding tax and litigation matters.
  • Cleansing the balance sheet of redundant assets.
  • Developing a growth plan based on sound business strategy and detailed financial assumptions.

Successfully implementing the above initiatives will increase profitability while reducing risk and costs to potential buyers, thereby increasing the attractiveness, marketability and ultimately the value of the company.

Consult with a transaction advisor

Liquidity events are unusual in the business lifecycle and therefore an area where management typically has limited experience. Given the significance of the process to the business owner, it is prudent to hire an advisor to ensure the outcome is maximized. Two of the areas in which advisors can provide value if consulted significantly in advance of a planned transaction include:

  • Advising on the purification of the balance sheet to ensure overall after‑tax proceeds are maximized for the business owner.
  • Advising on the optimal transaction structure (full sale, partial sale, management buy‑out, sale to family members, etc.) and a process that will yield the best outcomes in light of the business owner’s objectives.

However, even business owners with transaction experience can benefit from engaging a transaction advisor during/at the outset of the transaction process. These benefits include:

  • Signaling that the process will be professional, pragmatic and unemotional.
  • Allowing the transaction advisor to have the “difficult conversations” with potential acquirers, leaving existing owners who will often remain involved in the business and/or have a certain portion of their consideration deferred to a future date, out of the fray.
  • Outsourcing the responsibility for overseeing and managing the transaction process maximizes the efficient use of management’s time and enables them to focus on the day‑to‑day operations and growth of the business.

Secure a successful outcome

For more information:

Nathan Treitel
Managing Director – Valuation and Transaction Advisory
416.798.6916

NTreitel@segaladvisory.com

2024 Federal Budget Commentary

On April 16, 2024, the Canadian government introduced Budget 2024: Fairness for Every Generation.

Brief Highlights – Capital Gains

We want to highlight the most time sensitive issue – change in capital gains rates.

There has been talk of a change in capital gains rates for years. They have finally done it. The good news is that the new rules are not effective for gains before June 25, 2024. This means that any capital gain that occurs between today and June 24, 2024, will be under the current regime.

The following is a brief overview of the key tax measures.

Canadian transfer pricing compliance

Canadian contemporaneous documentation – Are you ready?

Canadian transfer pricing compliance
  • Are you a multinational group with international operations and intercompany cross‑border transactions?
  • Do you transact with your related entities on a regular basis?
  • Do you have a transfer pricing policy and pricing basis that is up to date and reflective of your business realities?
  • Has the pricing basis adopted on intercompany transactions been documented, and is it compliant with Canadian and international transfer pricing rules?

If you answer yes to any of these questions, then keep reading.

As year-end tax and accounting obligations approach, it is essential for multinational groups with international intercompany transactions to prepare contemporaneous transfer pricing documentation.

The Canada Income Tax Act (“the Act”) requires taxpayers to maintain specific documentation showing they have made reasonable efforts to determine and use arm’s length transfer prices or allocations. Assuming reasonable efforts to determine and use arm’s length prices were made, any adjustments by the Canada Revenue Agency (“the CRA”) will not be subject to penalties.

This is especially relevant for multinational groups with Canadian subsidiaries or Canadian‑headquartered multinational groups with reportable intercompany transactions of $1 million CDN or more in a financial year. Transaction amounts are based on a gross basis (not net of income and expenses), reportable on Form T106 (related party disclosure filed with annual corporate tax return).

While the Act does not specifically define contemporaneous, the CRA’s administrative guidance clarifies its position as:

“In light of the obligations set out in subsection 247(4), taxpayers will generally produce or obtain the required documentation at the time the transaction is entered into.”

and

“Taxpayers may, after a transaction has occurred but before the filing‑due date, recognize that the transfer price recorded for that particular transaction does not represent an arm’s length price.”

At a minimum, contemporaneous documentation must be completed within six months after the year‑end. Where taxpayers have such contemporaneous documentation prepared, they may respond “YES” to Question 7 on Form T106 (related party disclosure, shown below) which forms part of the Canadian T2 (annual corporate tax return).



Select Penalties for non‑compliance

Under section 247, if the terms or conditions of controlled transactions differ from those that would have been made between persons dealing at arm’s length, the CRA may adjust so the amounts paid reflect those that would have been paid between arm’s length persons. As such, the Act contains a penalty provision under subsection 247(3).

Subsection 247(3) of the Act imposes a penalty equal to 10% of the net result of certain adjustments calculated as follows:

  • The total of the transfer pricing income and capital adjustments (upward adjustments, whether there are reasonable efforts or not);

  • less:

  • The total of transfer pricing income and capital adjustments for which a taxpayer has made reasonable efforts to determine and use arm’s length transfer prices or allocations (upward adjustments for which there are reasonable efforts); and
  • The total of transfer pricing income and capital setoff adjustments for which a taxpayer has made reasonable efforts to determine and use arm’s length transfer prices or allocations (downward adjustments for which there are reasonable efforts).

If the documentation described in subsection 247(4) is not prepared, and/or obtained by the documentation‑due date, the taxpayer is deemed not to have made reasonable efforts for the purposes of the penalty in accordance with subsection 247(3) of the Act, therefore resulting in penalties should a transfer pricing adjustment be made by the CRA.


Segal’s Transfer Pricing team

Led by Partner & Practice Leader Avinash S. Tukrel, our team assists multinational groups with all aspects of the transfer pricing lifecycle, including policy and planning, implementation, compliance and documentation, as well as local country tax authority audit support.

If you have any questions, simply contact Avinash for a complimentary preliminary discussion to determine your next steps. Alternatively, you can contact your Segal advisor who will be happy to connect you with our Transfer Pricing team.

Proactively compliant, eliminating uncertainty

For more information:

Avinash S. Tukrel
Partner & Practice Leader – Transfer Pricing
416.774.2446

ATukrel@segalgcse.com