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Business Adviser

When the economic crystal ball is cloudy

By Dennis Fortnum
Canadian Managing Partner,
KPMG Enterprise

How easy it would be to have a better early warning system that could help business owners navigate important decisions during prolonged economic uncertainty. Entrepreneurs are the economic canaries in the coal mine. They are the first to feel constraints when there is an economic downturn and they are the first to turn more optimistic when conditions improve. That’s why KPMG Enterprise joins with Ivey to tap into the experiences and insights of QuantumShift ™ Fellows semi-annually.

Entrepreneurs signal better times ahead

As bad economic news trickles in day after day – with some of the flow more torrent than trickle – it’s wise to remember that the economy is a marathon, and like any of the world’s great races, some years the average finishing time is slower than others.

But every year there’s a healthy group of runners who set a personal best. They are the pacesetters of tomorrow.

Similarly, it’s hard-charging Canadian entrepreneurs who are setting personal growth bests with their businesses, even as many larger organizations seem to be running in molasses. They have a very different view – a much more growth-oriented view – of the near future than the CEOs of larger and more entrenched Canadian companies, and that difference may be a signal of better times ahead.

The entrepreneurs in this case are 320 graduates of QuantumShift – the Richard Ivey School of Business/KPMG Enterprise leadership program, who lead companies with average revenues of about $25 million and an annual growth rate of 25 per cent. The C-Suite respondents are 160 executives from ROB 1000 companies in the manufacturing, service and resource sectors.

The biggest difference between the two groups is that almost one-third more Canadian entrepreneurs expect to be hiring than their C-level compatriots. The numbers come from the Ivey Entrepreneurs Index, which found that 81 per cent of the high-energy entrepreneurs it surveyed are planning to hire more employees over the next year, compared with only 56 per cent of executives in the quarterly C-Suite survey.

Like the entrepreneurs, the CEOs are a confident lot. Nearly all of them expect their revenues to increase in the next year. The entrepreneurs are a little less sanguine about the prospect for growth of the Canadian economy overall, with only two-thirds expecting it. In comparison, three-quarters of the C-suiters foresee economic growth over the next year.

More entrepreneurs anticipate they will bolster their balance sheets with external financing – 44 per cent—compared with just 29 per cent of the C-Suite executives who think they will seek additional funding.

But the differences in their plans to hire more employees is more than statistically interesting. It is a bellwether for economic recovery. It’s a signal that, just as Peter Drucker observed more than 25 years ago, “the entrepreneur always searches for change, responds to it, and exploits it as an opportunity.”

For Canada, this ability to exploit change is more important than ever. We lost 54,000 jobs in October and Finance Minister Jim Flaherty recently said that, in light of global economic turmoil, GDP growth projections for the country have been revised downward. Among the many fears dotting the U.S. economic landscape is the realization that despite GDP growth, slow though it has been, job growth is not keeping pace.

As Peter Morici, former chief economist at the U.S. International Trade Commission, recently wrote: “Anecdotal reports indicate that businesses are cutting back. They don't expect a recession but are gearing for persistent subpar growth in the United States, slower growth in Asia and virtually no growth in Europe. Reflecting this assessment, companies …. have announced plans to cut costs further, even as they meet modestly growing demand. That means lower head counts, which could start a negative feedback cycle.”

Not the Ivey entrepreneurs. They’re bolstering their work forces.

“These Canadian entrepreneurs are consistently confident in their ability to grow their businesses,” explains Stewart Thornhill, executive director of the Pierre L. Morrisette Institute for Entrepreneurship at the Ivey business school. “They believe they can sustain success, even if overall economic conditions deteriorate.”

Entrepreneurs have the ability to see, understand and take advantage of evolving markets, says global strategist Mona Pearl. They are able to think differently, use insights, see what others don’t, envision what doesn’t yet exist, and identify opportunity when it’s ripe. These, she says, are the prized qualities of today’s entrepreneur.

The QuantumShift entrepreneurs achieve steady, high growth rates because their focus goes beyond the immediate future. They monitor their business models and re-engineer them when necessary to keep their companies sustainable and to build them over the longer term.

That’s exciting news, even if only as a tonic to other gloomy scenarios. But I’m sure it’s more than that. Working with these entrepreneurs I have learned to never underestimate their ability to make things happen, and that is reason for optimism.

Special to The Globe and Mail, published with permissions

Capital, Growth and Financing in the current market

By Neil Blair
Partner, KPMG Enterprise/Toronto

Tim Prince
Senior Manager, KPMG Enterprise/Toronto

Despite recent market turbulence, Canada’s transaction environment remains strong with Canadian dealmakers confident that activity will remain healthy. While markets fluctuate as conflicting economic indicators have investors bullish one day and bearish the next, fundamentals still point to transaction activity.

On the buy-side, dealmakers point to a number of positive signs. Notwithstanding the constantly changing economic landscape, both at home and internationally, company balance sheets are much healthier than they were a few years ago with many companies sitting on significant cash piles. Additionally, the lending market is operating much more efficiently with a return to liquidity in the banking sector and more appetite from less traditional lenders to provide innovative products such as high yield debt. Equity investors are also back and many have a requirement to deploy capital before fund expiration which is driving activity.

The sell-side is no different with numerous positive indicators pointing to M&A activity. Companies are starting to target growth and this often leads to a focus on core activities and raising capital for acquisitions. Dealmakers expect this to result in a number of companies undertaking non-core disposals of assets and business units. Private Equity investors are also feeling the pressure to realize investments and return capital to their LPs. This is especially important for those private equity groups looking to raise a new fund in the next 18 months. Additionally, the long awaited boom in transaction activity among ‘baby boomers’ as they look to exit private enterprises is building momentum as the appeal of retirement increases and the opportunity to realize value returns.

While these indicators exist across North America, Canada is particularly well positioned for activity given its relatively strong economic performance. In fact, many commentators believe that there has never been a better time for Canadian companies to transact.

From a sellers perspective, Canadian purchasers tend to have weathered the economic downturn better and are starting to look to consolidate market share. Additionally, Canada is attracting significantly more investment from international companies. While the headlines focus on the mega deals in the resources space, there has been and is expected to be significant activity across a broad range of sectors. Much of this activity can be attributed to companies viewing Canada as a stable yet growing economy where the acquisition of a good business can bring a combination of geographic growth and world class expertise to their operations. The activity is not limited to companies though, with US private equity particularly active north of the border. While the US economy remains somewhat uncertain, there have been a large number of US equity houses shopping for companies in Canada.

Canadian private companies and investors are also in a strong position to drive growth through acquisition. In addition to many Canadian private companies being in better shape than their International competitors, the Canadian dollar is strong, giving Canadian private companies a relative pricing advantage when acquiring cross-border. While internationally there are opportunities, the domestic market is equally likely to provide opportunities given the reasons outlined above.

While the signs point to activity, the process to realize value still takes time and significant expertise. No doubt there is a lot of capital in the market and there is a will to invest but the pain over the last few years is not yet a memory. Investors are cautious and top valuations are only evident for exceptional companies and strong growth stories. That being said, value can be created for both buyers and sellers through detailed preparation and structuring on the sell-side and thorough due diligence and integration planning on the buy-side – now may be the time to capitalize on the opportunities.

Ready to sell your business? Plan ahead to reduce your tax bill

By Serena Lefort
Partner, KPMG Enterprise/Toronto

Sooner or later most entrepreneurs will consider selling their business, whether it’s because they’re ready to retire or they just want to move on to new challenges. If you’re thinking about selling your business, whatever the reasons, you’ll want to keep the tax implications in mind as you negotiate the sale with your purchaser. Careful planning can significantly increase the amount of your sale proceeds that wind up in your pocket after taxes are paid.

When you’re selling your incorporated business, there are two general approaches that you can take—you can sell your shares of the corporation, or the corporation can sell the assets of the business.

If you sell your shares
If you sell your shares of the business, the difference between your cost of the shares and the amount you receive will generally be considered a capital gain for tax purposes. At the top marginal tax rate (on income that falls into the top federal tax bracket), you will generally pay between about 20% and 24% tax on a capital gain, depending on your province.

Every individual is entitled to a lifetime capital gains exemption of up to $750,000 on qualified small business corporation shares. Generally, your shares qualify if at least 90% of the assets are used in carrying on an active business in Canada and more than 50% have been used in this way in the past two years. If your spouse also owns shares in the corporation, you can effectively double the available exemption. If your children also own shares, directly or through the use of a family trust, the number of exemptions available potentially increases.

If the company sells assets
If your company sells assets, the company will pay corporate tax on the taxable income that may arise on the sale. Taxable income includes recaptured capital cost allowance on the sale of depreciable assets, capital gains on other capital properties and gains on the sale of goodwill. Once taxes are paid, then the company distributes the after-tax proceeds to the shareholders in the form of a taxable dividend. You may also receive amounts that you won’t have pay tax on, such as capital dividends (the tax-free portion of the corporation’s capital gain or gain on goodwill) and repayment of any shareholder loans you made to the corporation.

The overall tax rate of selling your company’s assets and distributing the money really depends on a number of things including whether the distributions are entitled to the preferential “eligible” dividend tax credit rate, if your company has tax losses and the types of gains inside the company.

To the extent that you don’t need all the proceeds immediately, because corporate tax rates are generally lower than individual tax rates, a significant deferral of tax can be achieved with an asset sale.

For the purchaser, the purchase of assets (for example goodwill) typically creates future tax deductions that reduce the purchasers future tax burden – which is not the case if the purchaser buys your shares. Depending on the asset mix in your company, it may be mutually beneficial for your company and your purchaser to agree to an asset sale.

After the assets are sold, you may choose to wind up the corporation or reinvest in another business or portfolio investments.

These are only a few of the issues you’ll need to think about. Because the tax consequences of selling a business are complicated, detailed professional advice can help ensure all the tax implications are carefully considered. Proper planning can help minimize the tax you’ll have to pay, leaving more money in your pockets to help you embark on your next big adventure.

Business Adviser is published by KPMG Enterprise™ specifically for owners and executives of private companies. KPMG Enterprise is devoted exclusively to serving the needs of private companies in Canada. For further information about how KPMG Enterprise can help private companies, visit kpmg.ca/enterprise.