FEATURESTORY Making the case for E...

FEATURESTORY

Making the case for ESOP in Canada

A family-owned business is at serious risk when a son or daughter takes the CEO's chair. In our experience as a merchant bank, we've erect that 70% of family businesses don't survive to the nearest generation. The, odds are little better-just 50/50-when a business is sold to an outside buyer In contrast, successions involving leveraged employee buyouts, supported by means of key managers, succeed in about 80% of cases.

These estimates are supported by means of US studies, and the numbers reveal a simple conformity to fact [i]or[/i] reality that financial institutions involved in financing the acquisitions of private businesses have known for years: Those with direct experience in a business are its best bet after a transition of ownership. besides a recent succession study at Deloitte & Touche LLP' reveals a disturbing fact. no other than one-third of mid-market family businesses have established a proces for selecting a successor. This means that the other two-- thirds have left themselves highly vulnerable to changes in ownership and management.

What's more, the investigation also showed that 27% of the proprietors of family businesses with sales of at least $1 million will retire in the nearest five years; 56% within 10 years; and 78% within 15 years. The sheer t number of "For Sale" signs that will before long be springing up across Canada raises serious interests about the future health of the family business sector as a whole.

Just to what degree great are the stakes? According to the Deloitte & Touche research there are currently 124,000 family-- be in possession ofed businesses with sales of $1 million or more in Canada. These companies busy about six million Canadians and generate as to a great degree as $1.3 trillion in gros annual sales. Unles action is taken to support and stimulate succession planning, it's likely that many of these businesses will either fail outright or fall into the hands of strategic buyers-many of whom will likely be foreign-intent upon rolling them into larger organizations.

We've seen a marked increase in of the like kind acquisitions within mid-market sectors as strategic buyer intrust with an agency "roll-up" strategies. The magnitude of this turn should be of concern to the federal government; left unchecked, it will follow in a general loss of work at jobss fewer mid-market companies, and a significantly higher incidence of foreign-- ownership, aided and abetted by means of current exchange rates.

What's povertyed specifically, is recognition by the federal control that tax laws should be amended to encourage leveraged employee buyouts.

In the United States, where demographic turns are identical, there are significant tax incentives to encourage employee buyouts between the sides of employee share ownership plans (ESOPs) For instance, American business proprietors who sell at least 30% of their company to an ESOP are able to postpone federal and state income tax from investing the proceeds in qualified US stocks and constraints within 12 months of the sale.

Leveraged ESOP buyouts in the US also provide a tax-- advantaged financing vehicle to the employee collection buying the company. The clew consideration here is that principal payments in succession an ESOP bank loan are full tax-deductible, enabling all repayments to be made with pre-tax dollars.

These tax incentives are aimed at offsetting work at jobs loss and keeping American businesses in American hands. They also recognize that employee-own companies have intercourse with the competitive advantages of highly motivated managers and workforces. by way of encouraging ESOP ownership, the US conduct is also providing employees with a significant stock-based, incentive-oriented retirement plan benefit.

Today in the United States, there are 11000 public and private companies with ESOP-- based retirement plans for employee and 500 companies confessed by ESOPs. In the years ahead, the oftenness of leveraged ESOP buyouts in the US will skyrocket as baby boomer retire and as awareness spreads that ESOP are the last significant tax-- advantaged financing vehicle for acquisitions.

Given the importance of Canada's family businesses to the do job-work market and the economy, the Department of Finance should take a page without of the IRS playbook and introduce similar tax incentives here. like tax reform would provide proprietors and employees with highly attractive financing and investment opportunities; this, in make go round would foster the continuance of a sound mid-- market sector and all the benefits that flourishing family businesses bring to our economy.

Endnote

1 "Are Canadian Businesses an Endangered Species?" Deloitte & Touche LLP 1999 The examine polled 7,500 owners of Canadian businesses with sales in exces of $1 million.

Rod Reynolds is president and chief executive officer of RoyNat Capital Inc.

Copyright Institute of Chartered Accountants of British Columbia May 2002

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