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The ins and outs of selling shares

Most of you know that when you sell your company, whether it is an alarm, integration, fire or guard company, the sale will either be a sale of assets or shares and that each is a completely different sale process and agreement. Talk to your accountant to understand the difference.

Some of you will know as well that as a Canadian citizen/taxpayer you each ( including your partner in life) have access to a one-time capital gains allowance that now totals $890,000 towards the sale of the shares of a Privately Controlled Canadian Corporation (PCCC).

If you own your company, it is likely that it is a PCCC but it may not qualify for the capital gains exemption. There are very strict rules in place governing which PCCCs qualify to give their owners access to the capital gains exemption if and when the shares are sold. Here are the key rules:

• When you sell the shares of your PCCC, 90 per cent of the fair market value (FMV) of the assets in the company at the time must be “active” and being used in the business. Goodwill, which is often the largest asset in the business, can count as being an active asset.
• The shares of the PCCC being sold have to be held or owned by the persons claiming the tax allowance throughout the 24 months immediately prior to selling.
• Finally, throughout the 24 months immediately preceding the sale, more than 50 per cent of the FMV of the PCCC’s assets must be assets active being used in the business. This is the trickiest of all the rules.

It is imperative that anybody who is considering a sale of shares of their company to access this one time capital gains exemption talk to their accountant well before starting the sale process. It is very easy to be offside on one of the three rules stated above. Often a company has to “purify” their balance sheet to rid themselves of passive assets like excess cash and then have to wait for two years before selling.

There is very good reason to take the extra steps to make sure your company qualifies. $890,000 of tax free purchase price for each shareholder is a huge win which makes selling shares a very attractive option. To put this into perspective I have calculated that for a seller selling a block of say 1,500 alarm accounts generating $50,000 of RMR, a buyer would have to pay a multiple of 43X in an asset deal to equate to a share deal at 37X. There is not room to spell out what gets taxed in each type of deal but suffice to say this gives you some guideline.

However the facts on the ground are that now many of the bigger buyers of alarm accounts in Canada will not buy the shares of the company that hold the accounts. Not only does this often mean a smaller return to owners from the sale of their monitored accounts but selling that alarm company may be the only chance that the owner gets to use his or her capital gains exemption. It therefore goes to waste.

What are the reasons given by these buyers who will not buy shares? Many will not give you a reason or the person you interact with in doing the deal simply does not know. I have heard a series of silly reasons.

Firstly, there is the tall tale that the buyer is worried about buying undisclosed liabilities in buying the shares. Frankly, this is nonsense. Share sales are done every day in Canada in all kinds of industries, including the security industry, without any liability concerns. Moreover, it is easy to insert clauses in any share purchase agreement and take a small, short term holdback to deal with undisclosed liabilities.

It is true that most times doing a share deal is slightly more complicated, time-consuming and expensive to do than doing an asset deal. The operative word is slightly. It is not nearly as  complicated, time-consuming and expensive as many of the bigger buyers of alarm accounts will tell you.

There are some guidelines to go by when considering a share deal. The deal does need to be big enough to justify the extra time and expense in doing it. I tell my alarm clients that they have to have at least 1,000 accounts and 1,500 would be even better.

Secondly, I like the process of taking all the other assets and liabilities out of the company before selling it. The buyer just buys the goodwill or accounts.

Thirdly, don’t balk if the buyer inserts a small, short term holdback into the deal to cover any possible undisclosed liabilities. We are talking amounts like $25,000-$50,000 being held for three to six months.

Finally, sellers of shares have to realize that in some or most cases you will get a smaller upfront price (but a higher tax home amount after tax). This is primarily because buyers of shares cannot write the purchase price off after unlike with asset deals.

The Canadian alarm industry would better off if more buyers were prepared to buy shares.

Victor Harding is the principal of Harding Security Services (victor@hardingsecurity.ca).