Succession Planning the Co-operative Way
By Kristen Wittman
The question of how best to structure business succession from one generation to the next is often answered with tax planning in an effort to reduce the impact of the taxes arising on transfer between generations. Unfortunately, that narrow focus risks neglecting the long-term needs of the business and the next generation of business owner and the community in which the business operates.
The changing legal landscape
Bill C-208 – An Act to amend the Income Tax Act (transfer of small business or family farm or fishing corporation) – received Royal Assent in 2021, changing federal income tax laws that seem to be designed to encourage more inter-generational transfers between family members.
But what if the family is not the best successor for the business? Or, if the next generation is the right buyer, what if the transfer saddles the new generation with a long-term obligation to pay out the previous generation at high rates of interest? Or what if the only seeming solution is to sell to a buyer that has no interest in keeping the business in the community?
Changes that have been implemented to the provincial legislation governing co-operatives in some jurisdictions should encourage consideration of the co-operative as a vehicle to enhance a succession plan. Co-operatives in most jurisdictions in Canada can now have passive investors (shareholders who are not necessarily members) or more than one membership group (multi-stakeholder cooperatives).
A co-operative? But how?
A co-operative can be formed by key employees for instance, and the co-op can acquire the ownership of the operating entity. If that entity is a corporation, in some jurisdictions the corporation can then be wound up into the co-operative, making it the operating entity.
The beauty of this or similar structures is the spread of risk across a group of owners who have equal say in the strategic planning of the business, rather than limiting that risk (and control) to a small (family) group that may not be well-equipped to handle it or may have returns on investment as their sole focus.
A critical difference between traditional business structures and co-operatives rests in the governance.
Governance and control
In a co-op, every member has an equal say, regardless of the capital contributed or at risk (the one member- one vote principle). Severing the connection between capital and control is a distinctive quality of the cooperative. That may sound like a bad thing in a business that has been closely held through its growth phases, but if it is correctly understood, it is the key to long-term success.
Most businesses have hit their stride when the time comes to look at succession, and do not need private capital to assist with growth. Rather, the business, being established, can secure the capital it needs from lenders, and needs the energy of its executive to drive it forward.
When that executive is empowered with membership control and recognizes its purpose as providing value to its non-shareholder stakeholders (consumers, employees, suppliers, the environment within which it operates), the business can move into a new and more responsible phase. Growth for growth’s sake ceases to be the driving force; the business shifts its focus away from providing ROI at all costs and the risks associated with that singular objective.
The rubber hits the road
Take, for example, a manufacturing firm, owned by a family consisting of the founding parents, with four children only one of whom is actively involved in the business. The family can achieve a tax-efficient extraction of its capital by selling the shares of the corporation to a group of employees who have formed a worker co-operative. That co-operative’s purpose is no longer the generation of profit for a small group of owners (although it does not have to exclude that purpose). Now, the purpose of the business is to generate work for the employees. This shift in focus allows the business to sustain itself within the community where it operates and where its employees live.
What if the founding business owner wants to remain active, or defer some of the tax bite for a while (if not all the capital gain realized on the sale can be sheltered from tax)?
The co-operative can issue a form of investment share to the founding shareholder, potentially as a tax-deferred rollover. Of course, any tax planning needs to be carefully examined by a qualified professional to ensure compliance with current tax laws. While shares in the co-op do not necessarily equate to membership, they do potentially provide the shareholder with a voice, albeit small, as non-member shareholders can be permitted to vote up to 20 per cent of the Board of Directors.
Success through successful succession
Of course, succession is only successful when the people involved are focussed and committed to see the succession through. That said, saddling a business with a cookie-cutter solution that worked well once can mean that no matter how good the talent, the result will be the ultimate demise of the business, either in the form of insolvency or absorption by a larger conglomerate that has no interest in maintaining jobs or a head office in the original community.
A good succession plan is one that considers the sustainability of the business far beyond the initial transfer and beyond the needs of the initial owners. Saving tax on the transfer of the business should be only one of many considerations.
The key driver might be the likelihood of success of the business once transferred. An equally important factor should be ensuring the sustainability of the business in its original location, feeding the economy that once fed it into existence.
Kristen Wittman is a partner practicing in the corporate commercial department at Taylor McCaffrey LLP, a full-service law firm. Kristen’s practice is specifically focused on cooperatives. Kristen is also a director of the Canadian Cooperative Investment Fund.