Let’s not waste this one
Around the end of WWII, Winston Churchill said “Never let a good crisis go to waste”. Not to be crass, but Covid-19 presents an opportunity to take advantage of depressed business values – namely, with depressed values, non-arm’s length transfers can occur on a tax advantageous basis – and we think this opportunity will only last for a year or so.
Read on to see where CVTrustCo sees opportunities.
Our view on opportunities
To get us started, let’s begin with determining the amount of the opportunity, and then have a look at ways of using it.
What are things worth?
To get an idea as to the magnitude of this opportunity, we contacted Paul Woodhouse CPA, CA, CBV, Director of Valuations Services at Smythe LLP. In simple terms, Paul told us that they are valuing businesses based on their 3 to 4-year historical profits adjusted for a one-year deduction for anticipated lost profits. Generally, this assumes that business profitability will get back to normal in about a year, which is about the time frame commentators estimate for a vaccine.
Paul provides a simple example – assume your business earned $500,000 on average over the last four years and this year you are estimating a loss of $200,000 (i.e. a $700,000 shortfall due to temporary closures or a short-term fall off in demand). With Covid-19, your business, previously worth $2.0M (assuming a 4x multiple), may be worth $1.3M – calculated as 4 years times $500,000, less the $700,000 one-year shortfall.
How to capitalize on an opportunity?
Some possible ways to capitalize on a reduced value are discussed in general below. Detailed tax and legal advice is required as we have intentionally ignored the important technical bits such as minimum tax, the capital gains exemption, fraudulent conveyance, etc. – our goal is to introduce concepts and you can get specialized advice if you think there is a fit.
Re-freeze – Previously having done an estate freeze, you likely will have received preferred shares of your business at a fixed value representing their value at the time of the transaction. With reduced values, consider re-freezing at a lower value, say $1.3M (using Paul’s example). Once values return to normal, the family members that you re-froze to will benefit from the $700K shortfall reduction in value.
Skip a generation – As mentioned in our last blog, if you are re-freezing and your immediate children are cared for, consider the new growth shares being for the benefit of your grandchildren. Of course, their new shares will be held in a new trust. That $700K reduction in value would be a great start for the grandchildren and of course, more family members could be eligible for the capital gains exemption in the future.
Insurance – If you are re-freezing at a lower value consider the amount of life insurance you bought as part of your initial freeze. Your insurance specialist should be able to structure you into a more efficient product with the insurance dollars you are currently spending, or possibly reduce your premiums.
Use a Trust for Creditor Proofing – If you are over 65, transferring your business to a joint partner or alter-ego trust is typically done on a tax deferred basis. But if you are under 65, a transfer to a trust is likely taxable and requires some form of an estate freeze using preferred shares. This means you still have a creditor exposed asset – those new pref shares. With a reduced value, possibly multiple shareholders and a $800k plus capital gains exemption per shareholder, you may be able to transfer your business directly to a trust with little, or a palatable amount, of tax. As no preferred shares are required, creditor proofing may be achieved.
An independent trustee together with proper trust documentation and management will help in strengthening any creditor proofing structure.
Trying to be cost effective
The above concepts should not break the bank – if you are re-freezing, you likely have the desired share capital and valuation principals in place from the original freeze. And in terms of reviewing your insurance, this should be a win-win as you can re-deploy the savings back into your business or have a new more efficient insurance product.
Time is of the essence. Hopefully, Covid-19 will be behind us in a year and we can get back to whatever feels normal. Not sure how many more “spouse induced Covid haircuts” I can handle. Next quarter’s blog may be a whole new box of chocolates. Be safe, and be flexible with your team.