How to Prepare Your Business for Sale
Selling a business is often one of the largest financial transactions a business owner will complete. Yet many owners spend years building their company and only start planning for the sale when a buyer appears.
That can be costly.
Preparing a business for sale is not simply about finding a buyer and negotiating a price. The preparation process should improve the value of the business, reduce risks identified during due diligence, create a smoother transaction, and ultimately maximize the amount you keep after tax.
For many Canadian owner-managed businesses, the best preparation begins two or more years before a potential sale. This is particularly important where the owner wants to preserve access to tax planning opportunities such as the Lifetime Capital Gains Exemption (LCGE). The qualification rules for Qualified Small Business Corporation (QSBC) shares include conditions that look back over the 24 months before the sale.
Here are the key areas business owners should address.
Start With Your Personal and Financial Objectives
Before deciding how to sell the business, determine what you want the sale to accomplish.
Consider questions such as:
- When would you ideally like to exit?
- Do you want to retire completely or remain involved for a transition period?
- Would you consider selling to management, employees or family members?
- What minimum after-tax proceeds do you need?
- Are you prepared to provide vendor financing?
- Is maximizing price more important than closing quickly?
- Would you prefer to sell the entire company or retain an ownership interest?
These decisions can affect the valuation, buyer selection, transaction structure and tax planning.
The important number is ultimately not just the sale price, but the after-tax proceeds available to you after the transaction.
This is why tax planning should ideally begin before the business is marketed—not after a letter of intent has already established the structure of the transaction. Doane Grant Thornton notes that once negotiations are advanced or an LOI has been signed, some planning opportunities may already be difficult or impossible to implement.
Understand What Your Business Is Actually Worth
Owners often have an idea of what their business should be worth, but buyers generally value businesses based on financial performance, risk and expected future cash flow.
Depending on the industry, valuation may be based on factors such as:
- normalized EBITDA or cash flow;
- recurring or contracted revenue;
- revenue and profit growth;
- customer concentration;
- strength of the management team;
- intellectual property;
- competitive advantages;
- industry outlook;
- working capital requirements; and
- comparable transactions or valuation multiples.
Obtaining a preliminary valuation or pricing analysis well before a sale can be extremely useful.
If your expected value is $5 million but the current market value is closer to $3.5 million, finding this out three years before selling gives you an opportunity to improve the business. Finding it out after receiving your first offer does not.
Clean Up Your Financial Reporting
One of the first things a sophisticated buyer will examine is your financial information.
Ideally, you should have several years of reliable financial statements supported by consistent accounting records.
Before selling, review areas such as:
Revenue recognition
Revenue should be recorded consistently and supported by contracts, invoices and other documentation.
Personal or discretionary expenses
Owner-managed companies often pay certain discretionary or owner-specific expenses. These may eventually be presented as EBITDA adjustments, but the adjustments must be reasonable and supportable.
Non-recurring expenses
Legal settlements, unusual repairs, restructuring costs or one-time professional fees may also require normalization.
Related-party transactions
Management fees, rents, salaries and other transactions involving shareholders or related companies should be properly documented and preferably conducted on reasonable commercial terms.
Balance-sheet accounts
Old receivables, obsolete inventory, unreconciled accounts, shareholder loans and unsupported balances should be resolved.
A buyer will often calculate normalized EBITDA, removing legitimate expenses or revenues that are not expected to continue after the acquisition.
Having credible support for these adjustments can directly affect valuation. For example, at a 5x EBITDA multiple, proving that $100,000 of expenses are genuinely non-recurring could theoretically support $500,000 of additional enterprise value.
Make the Business Less Dependent on You
A business that cannot operate without its owner is harder to sell.
Buyers want to purchase a functioning business—not simply the owner’s job.
Consider gradually transferring responsibilities to management and documenting key processes, including:
- customer relationships;
- sales and pricing;
- purchasing;
- banking;
- payroll;
- financial reporting;
- employee management;
- supplier relationships;
- quality control; and
- regulatory compliance.
Developing a capable management team and clear reporting structure can materially reduce buyer risk.
This is particularly important when the owner holds most of the key customer relationships or institutional knowledge.
Improve the Quality—not Just the Amount—of Earnings
Two companies earning $1 million of EBITDA may receive very different valuations.
Buyers generally place greater value on earnings that are predictable and sustainable.
Areas worth improving before a sale include:
- recurring versus one-time revenue;
- customer retention;
- long-term contracts;
- customer concentration;
- gross margins;
- employee retention;
- supplier concentration;
- operating systems;
- scalability; and
- documented sales pipelines.
For example, if one customer represents 45% of revenue, the buyer may view the business as materially riskier than a business with a diversified customer base.
Preparing for sale therefore means improving both profitability and the quality of the underlying business.
Tax Planning Before the Sale
Operational improvements can increase the price. Tax planning can determine how much of that price ultimately stays with the owner.
The following areas should generally be reviewed well before a transaction.
Determine Whether a Share Sale or Asset Sale Makes Sense
For an incorporated business, transactions are commonly structured as either a share sale or an asset sale.
Share Sale
The shareholder sells the shares of the corporation to the buyer.
From the seller’s perspective, a qualifying share sale can be particularly attractive because the gain may be eligible for the Lifetime Capital Gains Exemption if the shares qualify as QSBC shares.
The buyer, however, inherits the corporation together with its historical liabilities and generally does not receive a new tax cost for the underlying business assets, because a change in ownership of corporate shares does not change the tax values of the assets owned by the corporation.
Asset Sale
The corporation sells individual assets such as equipment, inventory, customer relationships and goodwill.
Buyers may prefer an asset purchase because they can select the assets and liabilities they want to acquire and, depending on the assets, obtain increased tax cost for future deductions.
For the seller, an asset sale can result in tax inside the corporation followed by additional tax when the remaining cash is distributed to shareholders.
Neither structure is automatically better. The purchase price and transaction structure should be evaluated together on an after-tax basis.
In some transactions, a hybrid structure may also be negotiated.
Protect Your Eligibility for the Lifetime Capital Gains Exemption
The LCGE can provide significant tax savings when an individual sells shares that qualify as Qualified Small Business Corporation shares.
However, qualification is not automatic.
Among other requirements, CRA’s QSBC rules contain both:
- an asset test at the time the shares are sold; and
- a separate test covering the preceding 24-month period.
During the relevant 24-month period, more than 50% of the fair market value of the corporation’s assets generally must meet specified active-business requirements, while a stricter asset test applies at the time of sale.
This makes early planning critical.
Investment portfolios, excess cash, shareholder advances, real estate not used in the active business and other passive assets can potentially interfere with qualification.
Please read the “LCGE and QSBC qualification requirements” blog for more details.
Consider Whether the Company Needs to Be “Purified”
A company may accumulate significant cash and investments over many years.
While that may be financially desirable, holding too many passive assets inside the operating company can potentially jeopardize QSBC status.
Purification refers broadly to planning undertaken to remove or reorganize assets that are not required in the active business.
Depending on the circumstances, planning could involve:
- paying liabilities;
- distributing eligible amounts;
- repaying shareholder loans;
- transferring excess assets within a corporate group;
- moving investments to a holding company; or
- completing a broader corporate reorganization.
These transactions must be structured carefully. Tax provisions including the intercorporate dividend and anti-avoidance rules can apply.
Please refer to the “corporate purification strategies” Blog for purification steps n strategies.
Review Your Corporate and Ownership Structure Before a Buyer Appears
If a sale is still several years away, there may be opportunities to restructure the company.
Depending on the owner’s circumstances, planning might include:
- establishing a holding company;
- completing an estate freeze;
- reorganizing share classes;
- introducing family members or a family trust where appropriate;
- transferring business assets between corporations;
- separating business operations from real estate or investments; or
- reorganizing multiple businesses before a sale.
These strategies may facilitate succession planning, creditor protection, future growth and tax planning.
However, reorganizing immediately before selling can create significant tax complications. Many strategies work best when implemented years rather than weeks before a transaction.
- Review Tax Attributes Before Negotiating the Deal
Before entering negotiations, prepare a detailed tax profile of the business and its shareholders.
Review items such as:
- adjusted cost base (ACB) of shares;
- paid-up capital (PUC);
- shareholder loans;
- capital dividend account (CDA);
- refundable tax balances;
- tax loss carryforwards;
- depreciable asset balances;
- tax cost of goodwill and other intangible property;
- unused tax credits;
- previous reorganizations; and
- the shareholder’s remaining LCGE availability.
These balances can affect both the structure and economics of a transaction.
For example, legitimate repayment of an amount actually owing to a shareholder may have very different tax consequences from extracting the same amount as a dividend.
Identifying these opportunities after the purchase agreement has been negotiated is often too late.
Conduct Your Own Tax Due Diligence Before the Buyer Does
In a share purchase, the buyer acquires the corporation’s history along with the business.
Expect the buyer’s advisors to review areas such as:
- corporate income tax returns;
- GST/HST filings;
- provincial sales taxes;
- payroll remittances;
- employee versus contractor classifications;
- shareholder transactions;
- related-party transactions;
- outstanding CRA audits or objections;
- tax elections;
- corporate reorganizations; and
- unusual historical transactions.
Undisclosed tax exposures can reduce the purchase price, increase holdbacks or escrow requirements, result in broader indemnities, or cause a transaction to fail altogether.
Don’t Ignore the Tax Terms in the Purchase Agreement
Tax planning continues after the price has been negotiated.
The way consideration is structured can affect when and how the seller is taxed.
Deferred payments
Where sale proceeds are collected over several years, a seller may, subject to applicable conditions, be able to use a capital gains reserve to recognize part of the gain over more than one taxation year.
Earn-outs
Part of the purchase price may depend on future revenue, EBITDA or another performance measure.
Earn-outs require careful tax drafting because different structures can produce different tax consequences.
Restrictive covenants
Payments relating to non-competition or similar agreements can be subject to specific tax rules and should be addressed when the agreement is being drafted—not afterward.
Allocation of an asset purchase price
If assets are being sold, the allocation of the purchase price among inventory, equipment, goodwill and other assets can have different consequences for both buyer and seller. CRA notes that where prices are allocated to individual assets in an agreement, those allocations should be reasonable and the purchaser’s and vendor’s treatment should correspond.
GST/HST
Certain sales of a business or part of a business may qualify for a joint election under section 167 of the Excise Tax Act so that GST/HST does not apply to qualifying property transferred in the transaction. Generally, the buyer must acquire all or substantially all—generally at least 90%—of the property reasonably necessary to carry on the business, together with the other applicable requirements.
These issues should be reviewed by the tax advisor and transaction lawyer before the purchase agreement is finalized.
Prepare for Buyer Due Diligence
A well-organized seller creates confidence.
Before going to market, consider creating a package containing:
Financial and tax
- three to five years of financial statements;
- current interim financial statements;
- corporate tax returns;
- GST/HST and PST information;
- budgets and forecasts;
- normalized EBITDA calculations;
- accounts receivable and payable aging;
- inventory reports; and
- details of debt and leases.
Corporate and legal
- articles and corporate records;
- shareholder agreements;
- material contracts;
- financing agreements;
- leases;
- insurance policies;
- licences and permits;
- litigation information; and
- intellectual-property documentation.
Employees
- employment agreements;
- compensation information;
- vacation and benefit obligations;
- contractor agreements; and
- information regarding key employees.
Commercial
- customer concentration;
- major customer contracts;
- supplier agreements;
- sales pipeline;
- recurring revenue statistics; and
- operational KPIs.
Build Your Transaction Team Early
A business sale usually requires several advisors working together:
CPA / Tax Advisor – financial preparation, normalized earnings, tax structuring, due diligence and after-tax modelling.
M&A Advisor or Business Broker – positioning the business, identifying buyers and managing the sale process.
Business Valuator – providing valuation analysis where required.
Transaction Lawyer – negotiating the LOI and purchase agreement and addressing legal risks.
Investment and Estate Advisors – planning for the proceeds after closing.
Ideally, these advisors should coordinate before a buyer dictates the transaction structure.
A Practical Timeline for Preparing Your Business for Sale
Two or more years before sale
- Establish your exit objectives.
- Obtain a preliminary valuation.
- Review QSBC and LCGE eligibility.
- Begin purification if required.
- Review the corporate structure.
- Reduce dependence on the owner.
- Improve profitability and recurring revenue.
- Address customer and supplier concentration.
- Clean up accounting and tax records.
12–24 months before sale
- Track normalized EBITDA.
- Strengthen management.
- Document systems and processes.
- Resolve tax and legal issues.
- Review material contracts.
- Prepare forecasts.
- Review shareholder and corporate tax attributes.
- Update the valuation.
6–12 months before going to market
- Complete seller-side financial and tax due diligence.
- Build the data room.
- Prepare the information memorandum.
- Identify potential buyers.
- Determine your preferred transaction structure.
- Model the after-tax proceeds under alternative offers.
During negotiations
Before signing an LOI, understand the implications of:
- share versus asset sale;
- purchase price;
- working capital;
- debt assumptions;
- earn-outs;
- vendor financing;
- holdbacks;
- representations and warranties;
- indemnities;
- transition services; and
- tax structure.
A higher headline purchase price does not necessarily produce the highest amount in your pocket.
The Bottom Line
Preparing a company for sale should be treated as a business project—not an event that begins when someone makes an offer.
A well-prepared company can be easier to value, easier to finance, easier for a buyer to understand and less likely to encounter surprises during due diligence. Just as importantly, starting early gives the owner time to implement tax planning that may no longer be available once negotiations are underway.
For many Canadian business owners, the right question is therefore not:
“How much can I sell my business for?”
It is:
“How can I maximize the value of my business and the after-tax amount I ultimately keep?”
At Finsight CPA, we work with business owners through the acquisition and sale process, including financial analysis, transaction structuring, tax planning, due diligence and evaluating the after-tax impact of alternative deal structures.
If you are considering selling your business—even if the potential sale is still several years away—early planning can give you significantly more options.
References and Further Reading
Canada Revenue Agency