Special Feature

HNW Guide 2017

The high net-worth client sector is growing. Learn about the expectations and demographic characteristics of these clients, how to use teams to meet their needs in areas such as estate planning and what the future holds for advisors who choose to focus on this lucrative segment.

Estate planning is a top priority for business owners

By Jim Middlemiss | Mid-October 2017

High net-worth (HNW) owners of small and medium-sized private businesses play a dangerous game when they procrastinate and wait too long to put estate and succession plans in place.

In fact, Tom Zaks, vice president with RBC Dominion Securities Inc. in Mississauga, Ont., and a financial advisor who is licensed to sell both securities and insurance, observes that seeing clients come in who don't have proper planning in place is common. This is particularly worrisome, he adds, because, as a client, "what you don't know can hurt you."

Susan Fincher-Stoll, a lawyer with Harrison Pensa LLP in London Ont., says clients often ignore estate planning because it relates to their children and the business owner's mortality: "They don't want to deal with all the sensitivities."

Thus, you must take the lead and poke and prod your clients forward regarding estate and succession planning. When clients wait too long, Fincher-Stoll adds, they risk suffering a "health event" without having a plan in place or missing out on opportunities to shelter from taxes the results of their life work. "There are a lot of [difficult] situations in which you see people coming to you for the first time, which is surprising."

Wills are Job No. 1

Wills and powers of attorney should be put in place as soon as possible. Without these documents, your client's family will have to go through the time-consuming process of obtaining court-ordered powers to act for the client after he or she has become incapacitated.

Keeping the costs of estate administration down also is important. Once a business grows and becomes more complex, costs such as probate fees and other liabilities can add up and become an impediment to settling a deceased owner's personal estate. Fincher-Stoll recommends what she calls a "separate will" to deal only with the company's shares. If the shares are those of a closely held family corporation, the estate usually can avoid probation of this will, as there are unlikely to be objections to its terms.

In this scenario, only the will dealing with personal assets goes through probate, which ensures that the executor for the main will has authority to act. This makes directing financial services institutions to make distributions to beneficiaries, as directed by the terms of the will, easier for the executor.

The power of insurance

Another matter in which frenzied business owners often fall short is insurance. Zaks notes that the biggest mistakes business owners make include thinking about insurance after a health event and underestimating or minimizing the estimated tax bill related to the disposition of their estate. By then, dealing with these issues occurs too late.

Instead, these clients should proactively consider using whole and universal life policies to buttress other estate planning strategies. For example, insurance can be used to guarantee that a spouse or child receives a fixed amount, free of taxes, when the client dies. The death benefit also can be used to fund a charitable donation or to "equalize" an estate in which one child receives the business and another child receives cash.

Business succession planning

Many business owners assume their children will want to take over the company, says Stephen Kerr, partner and business lawyer with Fasken Martineau LLP in Toronto. However, the next generation often has no interest in doing so. Either that or the owner mistakenly assumes that "through the magic of osmosis, their kids will know how to run the business." The result is that selling to family members often leads to the business collapsing later.

When family members lack interest in taking over the business, a better alternative, Kerr says, is to sell to a third party, such as a competitor, a strategic buyer or a private-equity firm. However, preparing a business for sale is a two- to three-year process, Kerr says.

To maximize value, the owner must take four key steps:

1. Clean up the balance sheet. This includes stripping out personal expenses and ensuring that all the cash is accounted for, reaching back a couple of years in the financial statements. Kerr says buyers pay in multiples based on revenue. By not properly accounting for revenue and expenses, business owners hurt their asking price - not to mention running the risk of tax-evasion charges.

2. Develop a list of potential buyers. "Very few people even think about that," Kerr says. There is a very big difference between the process of selling to a strategic buyer and selling to a private-equity firm.

3. Avoid deals that will handcuff potential owners. Kerr cautions against entering into long-term deals shortly before selling the company. These deals will hinder potential buyers who may have their own supply chains and also will have an impact on synergies and valuations.

4. Seek advice from professionals regarding how to maximize the purchase price. "Nobody does that," Kerr says. "They don't want to spend the money." However, doing so can pay off handsomely in the long run.

Accounting for taxes

Regarding taxes, there is a dark cloud ahead for business owners. This past summer, the federal Liberal government proposed several tax changes that will impact estate planning for business owners significantly if the proposals become law. Matters under review include: income splitting, passive investments and converting income into capital gains.

"[The changes would] be detrimental for people," says Raj Juneja, partner and tax lawyer with Davies Ward Phillips and Vineberg LLP in Toronto. "Everyone is very, very worried."

The feds portray the proposals as an attempt to close loopholes for the wealthy, but most tax experts don't view them that way. "To a large extent, this is a fundamental shift in tax policy; it's not closing loopholes," Juneja says.

Fred Gallagher, an accountant at MNP LLP in Kitchener, Ont., adds: "Every single entrepreneur is affected in some way." Assuming that the proposals are implemented, expect a flurry of planning activity by year's end. Says Gallagher, "All the stuff you used to be able to do relatively easily, most of that is shut down."

© 2017 Investment Executive. All rights reserved.