Selling A Business with Jason Watt | E091
Tales from a recent exit.
On today's episode Jason Pereira is going to talk to Jason Watt. He recently was part of the sale of his family business. Today they will discuss the tales of what it's like to sell a family business. They will also discuss the ups and downs and unexpected turns that may be included in that.
Episode Highlights:
1.06: Watt trains financial planners and he was never a financial planner previously. He was in the military till 2006 then he entered the family business.
1.58: Watt says that they had a pretty good transition as far as family businesses go and in 2018, he became CEO of family business. There was no friction back and forth about control from the elder generation to the younger generation or any of that kind of stuff.
3.17: We made some mistakes in the sort of 2006 to 2010 era but like a lot of family businesses we made it work. But there wasn't enough sort of free cash flow in the business to be able to finance father's retirement, says Jason Watt.
4.33: The due diligence process must have alerted Jason Watt to issues and deficiencies that he had and that he needed to get cleaned up prior to any kind of sale, says Jason.
7.15: There was a very short meeting in January 2020 with local company Yardstick and Jason Watt talked price a little bit just to kind of get a feel for whether it would be enough money for them to consider a deal seriously and whether the price would be right for the buyer to make a deal work.
8.01: There was sort of a base price established in the letter of intent and there was an agreement that Jason Watt wouldn't talk to any other prospective buyers, and they are not going to disclose any of the confidential information they released to them about customers or business practices, says Jason Watt.
9.29: The effort involved in due diligence was surprising to Jason Watt. It was like having a part time job for the roughly three months that they were going through due to the diligence process.
12.37: The working capital is important to business as any talent they have or any equipment they have acquired because it is also a part of the factory process.
14.02: Jason Watt shares once the diligence is over, how long does this take before the purchasing party says, "We are good to move forward, and this is the price we are going to pay."
15.36: Jason Watt talks about the negotiation of the deal. What is the methodology of price negotiation, its timeline and how that goes?
16.17: Jason Watt had done some financial planning work for his folks and sort of retirement planning at least and he knew what negotiation had to look like and he had been very forthright for the same with their buyer.
18.38: Jason Watt doesn't have a big product liability concern or anything like that and in fact there was a sort of pro buyer reason for the share sale because there are a bunch of regulatory approvals that go along with business.
20.10: Jason Watt shares after the negotiations stage, how long does it take to come to the final contract.
21.37: Jason Watt had to undergo an exercise of a lot of force of 'will' to make the final deal happen. He had a couple of really difficult conversations and ultimately. They were able to get it to happen.
23.01: It took six and half months from negotiation to final conclusion and Jason Watt thinks that is a reasonable time frame. It should have closed a month earlier than that if they hadn't had that sort of shareholder reorg snag.
29.22: Jason Watt is very aware of the personal tax planning issues. He knows about lifetime capital gains exemption and the cumulative net investment loss and alternative minimum tax. He talks a lot about all of these things in clouds regularly. He understands how this works and yet he was so busy with the acquisition, and he didn't really think about his personal tax planning all that much, except to make sure that he was going to be able to use lifetime capital gains exception.
31.20: Jason Watt faced some complicated tax issues where his accountant helped him to resolve the issue.
32.59: The due diligence process is a two way as much as you should be, you know going through and providing a lot of information about your business, you should be learning about the business that's acquiring you, says Jason Watt.
3 Key Points:
If the parents are deeply entrenched within the business operation or the value relative to cash flow is not something that's going to work out over a reasonable amount of time then you do have to consider a third party, says Jason.
Working capital adjustment, shareholder loans and all similar things were things that Jason Watt wasn't as prepared to deal with because they were pretty good about sort of operational metrics.
Deal with specialist lawyers and people who have been there and understand the process well before.
Tweetable Quotes:
"When it came time to talk about their retirement meaningfully, we really had to look at a third-party acquirer." – Jason Watt
"You wouldn't sign the letter of intent if you are not seriously intending to proceed." - Jason Watt
"We couldn't really go to the staff and say broadly that we are selling the business because people get concerned about their jobs. They might disclose it to customers and that was a tricky thing to manage." – Jason Watt
"If you don't do massive purification and if someone comes to approach you for sale then it's off the table. It's not even an option." - Jason Pereira
"I did end up with, having to wipe out that senile balance, the cumulative investment loss balance, before I could use my capital gains exemption." – Jason Watt
"As long as you are earning income going forward at a reasonable level, you actually get that credit back." - Jason Pereira
"You have to be prepared that that due diligence process reveals something about the buyer that might not make you comfortable as well." – Jason Watt
Resources Mentioned:
Transcript;
Producer: Welcome to the Financial Planning for Canadian Business Owners Podcast. You will hear about industry insights with award-winning financial planner and entrepreneur, Jason Pereira. Through the interviews with different experts, with their stories and advice. you will learn how you can navigate the challenges of being an entrepreneur, plan for success, and make the most of your business and life. And now your host, Jason Pereira.
Jason Pereira: Hello and welcome. Today on the podcast, I have a friend and colleague, Jason Watt, who recently was part of the sale of his family business, and we thought it'd make a great idea to come on podcast, discuss the tales of what it's like to sell a family business, and the process and the ups and downs, and unexpected turns that may be included in that. So with that, here's my interview with Jason. Jason, thanks for taking the time.
Jason Watt: Thanks so much for having me on today, Jason. I'm looking forward to it.
Jason Pereira: My pleasure. The two Jason's podcast, this should be interesting. We should actually just brand that and start doing that. So Jason, tell us a little bit about who it is you are, and what it is you do.
Jason Watt: So I train financial planners, and I was never a financial planner myself previously. I was actually in the military before, came into the family business. When I left the Army in 2006. Started training to the life license qualification program, which is the base program for people to get their life insurance license. Kind of by accident, in 2009 I started teaching towards the CFP curriculum and really got into that pretty seriously about 2011 or '12. We wrote our own curriculum around the CFP in mid 2012 or '13, thereabouts, and while I was doing that, I gradually took on more and more responsibility at the family business, Business Career College, and I became CEO there in something like 2018.
Jason Watt: And one of the interesting things is that we had a pretty good transition as far as family businesses go. There was no friction back and forth about control from the elder generation to the younger generation or any of that kind of stuff, and I think that really helped with what follows, with the sale of the business that we're going to talk about today. And even though we never sat down and wrote out a plan, we did talk about it a fair bit, so the succession was something that I think happened pretty painlessly.
Jason Pereira: Yes, your company's been one that I've sent many people to get educated on the CFP in the past, so you do a wonderful job. And for those of you who want to understand some of the stuff that can be done in advance of this type of conversation, go back and listen to the episode I have with Tom Deans near the beginning of the podcast series about specifically how to prep and decide when it's time to do that sort of transition. Okay. So what facilitated the desire to sell? Were you approached about this? Did you basically think it was time as a company, as a family, to move on? How did it happen?
Jason Watt: Right. So my folks are at retirement age. They're now both in their late sixties, early seventies, and notably, my father's healthcare was starting, he was having some issues, and we all worked hard still. I work very hard, and I think they sort of work hard in their own ways now too, but we had to be realistic about their ability to retire, and we'd had some real financial struggles. We made some mistakes in the 2006 to 2010 era, stuff that honestly should have wiped out the business, but like a lot of family businesses, we made it work. But it really made it so that there just wasn't enough free cash flow in the business to be able to finance their retirement, and I didn't have enough assets to be able to buy them out for an amount that was going to be meaningful for them to retire.
Jason Watt: And when it came time to talk about their retirement meaningfully, we really had to look at a third party acquirer, and we hadn't honestly thought about this as a source of acquisition. It's one of these things where about 2015/16, we started to get our ducks in a row a little bit. We started to fix cash flow. We had good years. We had positive EBITDA. We had just a lot of the hallmarks, and we started talking about it internally, about the prospect of sale. And without going out and looking actively for acquirers, we had a couple people approach us in about 2016, '17, '18. We had a couple US private equity groups. We had our ultimate acquirer approach us in 2017, the first time around, and we couldn't make anything work then. Just our financials weren't strong enough to support an acquisition, but it was still a good foot in the door. It made it obvious that there was a conversation to be had there.
Jason Pereira: Also, the due diligence process must have alerted you to issues and deficiencies that you had, that you need to get cleaned up prior to any kind of sale.
Jason Watt: Exactly, right. And we didn't get into a formal due diligence at any point in that first round of let's say tire kicking, but you're exactly right in that we knew that we had to do some more cleanup. And some of that also revolved around we had a silent partner in the business. We brought on a financing partner when we were having our financial struggles in the late 2000s, and we were able to get some buy in from that silent partner with structuring things properly, and just thinking about the future of the business. So absolutely, we cleaned a bunch of stuff up. We had a lawsuit that was lingering that we got off the books, and just a bunch of stuff like that, that you're exactly right, that we identified as impediments to sale.
Jason Pereira: So this is not an uncommon story, especially if the business relies on the founding family members to stay in it. So I've seen many cases where over time, the parents retire out of the business, and then the cash flows into the business are sufficient to buy them out over time, which can work. But if the parents are still deeply entrenched within the business operationally, or the value relative to cash flow is just not something that's going to work out over a reasonable amount of time, then you do have to consider a third party, so it makes sense. That experience is not uncommon. So talk to me about you had the initial approach with the private equity firm, but when it came time to actually start selling, did you start marketing your firm? How did that work?
Jason Watt: No. Honestly, what happened here was kind of a surprise. So we did have these PE firms come to us, but we didn't end up ultimately selling to a PE firm. We sold to a local company actually just by I don't want to say coincidence, but they had come across us in their business development. It's an e-learning company based in Edmonton, it used to be called Yardstick. The original discussion with a company called Yardstick, which actually was doing some exam work in the financial planning or financial services space, doesn't anymore. There was some conflict of interest there. Just in early 2020, so January of 2020, the first workday of 2020, actually, I had a meeting scheduled with the principal of it was its first day as now We Know Training. So Yardstick rebranded, they did a little divestiture, and we know training as an e-learning company was left.
Jason Watt: And I had a meeting where I thought we were going to talk about a financial educators conference, having some sort of conference to get all financial educators in Canada together, and it turned out that it was an overture to look at the acquisition again. So this was January 2020, and we agreed that this is something we wanted to explore. In that very short meeting, we talked price a little bit, just to get a feel for whether it would be enough money for us to consider a deal seriously, and whether the price would be right for the buyer to make a deal work. And I think this was still the days of low interest rate environment, so we knew that it was a finance deal and I think that helped to make the deal work. So really, we signed a letter of intent. I want to say just within a couple days, a couple days before the whole COVID lockdown situation happened, we ended up
Jason Pereira: Good timing.
Jason Watt: ... Signing a letter of intent. Yes.
Jason Pereira: So that's how it came about. Let's talk about the process in itself. So the letter of intent is of course the first step once you've actually had these overtures. Typically, that's accompanied with or inclusive of a non-disclosure agreement, so you can start sharing information. Is that what happened there?
Jason Watt: Exactly that, yes. So there was a base price established in the letter of intent, and there was an agreement that we wouldn't talk to any other prospect of buyers during that time, non-disclosure back and forth. Sp they're not going to disclose any of the confidential information we released to them about customers or business practices or anything like that, and I have to be even careful in this conversation because there's still stuff around exact pricing in the non-disclosure agreement that I'm not privy to disclose. So exactly that.
Jason Watt: That locks in that we're serious about a deal, and really, my experience with this anyways is that once the letter of intent is signed, you wouldn't sign this if you're not seriously intending to proceed. And something we did with our letter of intent was we added a break fee, so we said, "Look, if you're just going to come and kick the tires," which I didn't think they were going to do, you never know, that they were going to pay a break fee. And of course, now this break fee thing is in the news with the whole Elon Musk Twitter thing.
Jason Pereira: Oh boy. Yeah. I bet he's going to cough that one on. Actually, a funny side note, first judge who heard this entire thing basically told them to grow up and get the deal done. Not in those words, but it was pretty amusing. So again, and this makes sense. The purpose of a break fee is basically that you're spending time and effort to give these people the financials to let them look inside the kimono, you did all this other stuff, and you're also taking time and opportunity away from basically looking for any other deals, so there's an opportunity cost and a direct labor cost. Is that about right?
Jason Watt: 100%. And the effort involved in due diligence was surprising to me. I knew it was going to be busy. I'm a regular listener to John Warrilow's Built To Sell podcast. I don't know if you listen or not, but it's excellent, and he talks to a lot of people who recently sold their businesses. They all talk about how much work due diligence is, and still, it was really like having a part-time job for the roughly three months that we were going through that due diligence process.
Jason Pereira: Fair enough. Okay. And it totally is, because the reality too is that the stuff that you need to sell your business and inform the discussion is not stuff that you necessarily have readily accessible. You're too busy operating the firm. So the financials are one thing, that's fine, but then they're going to want to know things like probably, especially in your kind of business, what is the recurrence of buyers? How many times do people buy one course and come back again? What other metrics were surprises to you, that basically came up as part of this?
Jason Watt: Well, that's a good question. So what metrics did we provide? We really provided a ton, and I guess the overall here was you're absolutely right. A big thing was concentration of customers, and this wasn't really a surprise, but I didn't necessarily have all the data myself at my fingertips. And one of the challenges, we had a staff member who's responsible for all that, but I couldn't tell him that we're prepping the business for sale. We couldn't really go to the staff and say broadly, "We're selling the business," because people would get concerned about their jobs, they might disclose it to customers, they might disclose it outside of the bounds of the NDA.
Jason Watt: So that was a tricky thing to manage, was pulling all of this information. I guess on the metrics side, there was some stuff that surprised me, and something you talked about on your podcast before. You talked about the interview with Tom Deans, but the other one that you have that's really good for this is your series on financial statements. Working capital adjustment, shareholder loans, all of this, these were things that I wasn't as prepared to deal with. We were pretty good about operational metrics, it was the shareholder and cap table metrics that were harder to get a handle on.
Jason Pereira: Yeah. And those are actually the ones, the shareholder loans, those have to be cleared up before any sale. No one wants to take over a business and simultaneously also owe money to the shareholder, so those have to be dealt with one way or another, and that's usually easy for most business owners to understand. The working capital conversation is one that, unfortunately, I find a lot of business owners have a hard time wrapping their heads around it because they just see it as an inventory, cash, all the stuff that it shows up there. But at the end of the day, and as I said in that podcast, it represents an investment in the company. I had this conversation with a friend of mine who's looking to sell recently, and basically, he's like, "Well, do I just take all the cash out of the business?"
Jason Pereira: I'm like, "No, because here's the thing. Imagine you own a lumber mill. You're just talking about taking the trees away. So someone bought the mill, but they can't generate the profit without the trees, so now they have to turn around and buy the trees. So you're asking someone to pay money for your business, and then simultaneously make an investment just for cash, or any other form of working capital. To me, if I'm a buyer I'm going to be like, "Oh. Is that how it's going to be? Great. Well, that cash investment just came off the price," because the working capital is as important to the business as any kind of talent that they have or any kind of equipment they have, because it's all part of the same factory process to basically make money happen.
Jason Watt: Yeah. And then the other thing that goes along with that is the repayment of the shareholder loans. And this was all very transparent, but I didn't understand it before we did the deal, this difference between the enterprise value and the price that the buyer pays, where we take the shareholder loan accounts all out of the business, and that goes towards the sale price for the business. It's just something I hadn't understood well before we did the deal, and it worked out all good. I don't want to sound like the buyer was in any way disingenuous. They were very, very generous with us, and really negotiated. There was no re-trading or anything like that. The deal was done very well, it's just understanding these mechanics becomes pretty complicated.
Jason Pereira: It can be. And it makes sense, because if you're paying at the share of loan, you're extracting some form of value out of the business, so you can't extract value out of the business and simultaneously ask for that value in the purchase price. There's a book that was written, it was an advisor I saw that was talking in the US at a previous conference. He actually wrote a book on exit planning called Your Baby's Not Pretty, which is exactly the first thing we like to talk about is I know you think your business is awesome, but if there's an endowment effect here, and if you were you were a third party buyer, you would find all the warts guaranteed, even though you don't see them. Okay, so those were surprised. So let's talk about once due diligence is over. And how long did this take before they said, "Okay, we're good to move forward, and this is the price we're willing to pay?"
Jason Watt: About three, three and a half months. Again, it was a well-managed process. The buyer had a proforma, so they sent us this very long Excel spreadsheet with tabs for financial, tabs for legal, tabs for HR, tabs for admin. And it was a matter of they had a SharePoint site set up where we just fed information back in, or I just fed information back into that SharePoint site, and then there was a second round of questions following that, and then a third round of questions following that. We had a lot of meetings in that time, tons of Teams meetings, just because they were a Teams user.
Jason Pereira: Don't get me started on Teams, but continue.
Jason Watt: I know, I know. I said that just to press your buttons. About three and a half months, and then we agreed in principle that we were going to make the deal happen. They liked what they saw in due diligence, there was no surprises there, no reason to change the price, so that was good for us as well. And we knew, I did know the ugly baby thing. I've never heard that specific thing before, but I did know that, that there were some warts. I knew we had concentration with one customer, I knew that there were some regulatory risks, so I was pretty aware of that because we had thought about sale, meaning fleet, beforehand, so I went into it I think eyes wide open, at least on the front of where the risks were in the business and that kind of thing.
Jason Pereira: Fair enough. And clearly, you dealt with an experienced buyer, because to have all that stuff set up and ready to go and understand the process. Inexperienced buyers can also be very difficult because you may have a buyer potentially, but have they ever done this before? Do they understand what due diligence is? Do they have a realistic understanding of what valuations are? And the answer to a lot of that is honestly, no. Until you've been down the road or you have experience with it, it's all just hearsay and guessing. So you get to that stage, due diligence is done. Talk to me about the negotiation of the deal. I know there's NDAs there, but how long did that process take to negotiate the price, the methodology, the timeline? How'd that go?
Jason Watt: So, because early on I had expressed what we were looking for, I knew for example that if we could do a share sale, that a share sale was going to work out much better for us, so I had indicated that early on. I had presented, because I had done some financial planning work for my folks, retirement planning at least, so I knew what that had to look like. And I had been very forthright with that with our buyer, and I know that's not always the best advice. Sometimes being the first to offer a financial position puts you at a disadvantage, but I knew what we needed. And because I provided that information, I think it helped the buyer to structure the deal well, or at least structure the deal in a way that he knew was going to work for us.
Jason Watt: So we were able to do a share sale, and it's ironic because I teach the lifetime capital gains exemption and I say in practice, a lot of times it becomes unavailable. Buyers prefer asset sales, people have too much passive stuff in their corporation. You were just telling me a story a minute ago about a corporation holding a boatload of passive assets, real estate in the case you were describing. So the lifetime capital gains exemption, I find you spend all this time teaching it, learning it when you're going through CFP curriculum, and then how many sellers can actually use it? So we were able to use it, which was nice, and it really takes a lot of pressure off in other ways.
Jason Pereira: Well, this is one of the things that I refer to as a lever in these negotiations. There's different parts and aspects of negotiation that could impact the price. Everybody focuses on price, but what about the terms? Is it share versus asset? Well, if it's with shares, then it's an after tax larger amount for the seller. So if it's not, then basically, that is less quote unquote liability for the buyer, but also should command a higher price because there's less liability in your tax benefit. And that goes in keeping with things like escrow amounts, how much is kept back and for how long, conditional performance of the business, what interest rates, if any, are charged.
Jason Pereira: These are all things that you negotiate all these other terms on the back end, but really, they impact the end number, which is what everybody thinks about the price. But the different levers can really move them around, and it's interesting. The share versus, you're right, we talk about this all the time. There's some buyers, most lawyers will tell you just never buy the shares, because they're looking at it from a liability standpoint. My response is always, "That's nice. We can indemnify to some degree," depending on the nature of the business, especially yours. No one's going to turn around and sue you for failure to deliver three years after taking a course, let's get realistic, whereas some businesses with very long-term contracts, that's a very real concern, so it makes sense.
Jason Watt: Yeah. We don't have a big product liability concern or anything like that. And in fact, there was a sort of pro-buyer reason for the share sale, because there's a bunch of regulatory approvals that go along with Business Career College. So they were certain that they were getting all those regulatory approvals with that share sale, and we did have to approach our various regulators around that too.
Jason Pereira: Fair enough. There are ways to take advantage of the exemption, even if you do an asset sale. In particular, if you've done a crystallization, you can do that, but again, you have to do that well in advance of the sale. We talk about that a lot, we've focused on that a lot, and I'd say the other thing, it must have been to your benefit. Did you have to do any sort of purification of the company prior to? And just so everybody knows, purification, there's a test that happens in order to qualify for this lifetime capital gains exemption that says that effectively, all of the asks of the business have to be used in operations.
Jason Pereira: You can't have a large rental property in there, or a bunch of investments. And the test for that is correct me if I'm wrong, it's basically at the time of sale, about 90% of the assets have to be employed in the business, and I think it's two years prior, at least 50% have to be. I just did a massive purification for a client just last month, because if you don't do this and someone comes to approach it for sale, well then, it's off the table. It's not even an option.
Jason Watt: You're exactly right. We didn't have to do it, but I was aware of those rules. Honestly, if we'd had the purification problem, then we probably would've had the assets to do everything internal, and I probably would've been buying my folks out with corporate assets.
Jason Pereira: Fair enough. Makes sense. So you basically get to the negotiation stage, how long did it take to come to the final contract?
Jason Watt: So this is where we ran into a little bit of a roadblock. I had mentioned that we had this silent partner before, so what it was, and I hope I don't disclose too much here, but I'm going to go anyway, my folks and I owned 49% of the business and our silent partner owned 49% of the business, and then there was one person, a person that we had both agreed on that owned the tiebreaker vote. And the silent partner came to me when this all became obvious. This ties into it was not a purification issue, but it was a tax planning issue, where he wanted to move some shares around, I think so that his partner could take advantage of lifetime capital gains exemption.
Jason Pereira: A little late for that, because there's a two-year provision. Anyway, fair enough.
Jason Watt: Well, I think there might have been some rectification there, essentially jumping into the time machine and redoing some documents. So because we had a unanimous shareholder argument in place that said you can't transact shares without everybody's agreement, he came to me and said, "I need your permission. I need to sign against the USA and say we can transact shares." I did that under the understanding that there was going to be really just a tax planning reorg on his side, and something that I wasn't anticipating happened there. I don't want to get into a ton of detail around it
Jason Pereira: Don't say to much. Fair enough.
Jason Watt: But it gave the buyer pause. The buyer said, "Well, hang on a second here. We're not now dealing with who we thought we were dealing with as far as the purchase of these shares." And I had to at this point really exercise a lot of force of will to make this happen. I had a couple of really difficult conversations, and ultimately, we were able to get it to happen, but I think it's a good warning. And it's exactly like you say, Jason. That stuff should have been done a couple years prior. We had talked about a possible sale of the business. Everybody should have had all their tax planning ducks in a row in 2017, the first time that we really looked at selling the business. So trying to get that tax planning sorted out and bringing in different parties than originally expected, it caused some issues.
Jason Pereira: Yeah. As I like to say when people start saying, unfortunately every advisor's had this. They've had the we try to go to a client, we tell them to get this stuff ready. They put it off, they put it off, they put it off, and then oh, lo and behold, an unexpected purchase option comes along and they're like, "Well, can't we go back and do it?" And the answer is unless you have a DeLorean, you're not going to go back and do it well. And frankly, in the vast majority of cases, no buyer's going to want to sit around and wait two years for you to get your act together. They're looking to buy because they're motivated, so it is what it is. So you ran to a snag there. So snag aside, how long did the process of negotiation and coming to that conclusion take?
Jason Watt: From the very first conversation, which was January 1st, until the deal closed was July 15th or 16th. I should know the date, but July 15th or 16th, so call it six and a half months, and I think that's a reasonable timeframe. It should have closed a month earlier than that. If we hadn't had that shareholder reorg snag, it would've been five and a half months. And the other thing with that whole reorganization snag is that then the lawyers had to review documents a second time, and that cost us a fair bit. My lawyer was great for this, super responsive, super quick, but of course bills you for it. He wasn't doing this for free.
Jason Pereira: Absolutely. And in fairness that, it's a lot. It's usually a ton of documentation to do. It's not just a general shareholder, it's just not just a sale. There's the guarantees, there's oftentimes employment contracts for key people who are staying on, so there is a lot to be done. It can really get people in a huff over it. I would say the best advice I'll give on this is do not have the lawyers negotiate the sale. Don't get me wrong, you might run into a snag where there's a negotiation topic where the lawyers have to get on a call, but I literally have people say, "Well, I'll just have my lawyers negotiate this with their lawyers," and my response is, "Well, given the size of the sale, what percentage of the sale do you want going to the lawyers? Because at this point, it's going to be pretty significant." The last thing you want is someone charging those kinds of hours to just go over and negotiate a business that they're not intimate with. That's the reality of it.
Jason Watt: And certainly, we didn't do that. We negotiated, and there was an agent working for the buyer, but he knew what he was doing. And so he and I did the negotiation, and really my lawyer and accountant. And in fact, I dealt with two lawyers here to help make the transaction happen. One on the corporate side, and then I signed an employment contract that I also had reviewed. I feel like having a good team, we had that employment lawyer, we had the corporate lawyer and we had our accountant, all of whom were people we had dealt with previously, all of whom knew our business reasonably well, so that went well.
Jason Pereira: Yeah. This is a valuable lesson there, especially on the other side, is that there are people who can help you through this that aren't lawyers, who are more affordable. There are people who broker these deals or counsel on it, like financial planners and advisors like myself, who've through it before. I've coached many people through the process, and gotten to the point where we get the broad strokes done, and the lawyers come out for the fine strokes, and that can save you a bundle. It's also helpful because they tend to speak a non legalese. But one piece of advice here, and you kind of said it and you didn't really accent it, was the fact that you were dealing with specialist lawyers. You were dealing with a corporate lawyer, you were dealing with a employment lawyer.
Jason Pereira: You were dealing with people who knew what they were doing, and I find that's also one of the big obstacles is when someone uses their generalist lawyer, that goes wrong. I remember one deal was involved with that the lawyer was great at what they did, but it wasn't on M&A, to the point where a conference still had be set up between both lawyers, and he brought in a third lawyer to argue this point, and the third lawyer ended up agreeing with the opposite side's lawyer and disagreeing with him. So you think about the wasted money that was on behalf of the client, because you asked someone, you try to fit a square peg into a round hole, so that's a challenge. So I'd say, again, I said this many times before, deal with specialist lawyers and people who've been there and understand this process before. It'll save you a fortune.
Jason Watt: I did ask my lawyer that when we were entering, because I knew the lawyer. He was our corporate lawyer. He had done our shareholder documents and all that kind of stuff, and did our annual returns for years and years. And I had asked him, I said, "Am I best to deal with you for mergers and acquisitions? Do you have M&A experience, or is there somebody else that you should send me to?" We had that conversation point blank. I didn't assume that was something he was qualified in.
Jason Pereira: Also, I will say this much, this is why I do favor dealing with larger law firms. They may be more expensive on a per hour basis, but the reality is, just being able for that lawyer to turn to the tax person for an advanced question, or the labor person. Just being able to have that network right in the house is far more valuable than having one person figure it out themselves.
Jason Watt: Now, we were at a boutique firm, but a boutique firm that really only does corporate. And when it came time for the employment law thing, they didn't have somebody in house, but I knew somebody else that I had previously
Jason Pereira: Yeah. And that's more of a secondary, separate. It impacts it, but you've already agreed at that point to work there for how long and for how much, it's just a matter of making sure everything else is in order. Excellent. Okay. So you got the deal in principle, everything's ready to go. Talk to me about closing. How long did it take you to sign your life away?
Jason Watt: That was actually once we had everything done, the closing was pretty good. Money flowed exactly as it was supposed to, there was no delays around getting cash in hand. I think that the financing partner that our buyer used or the financing team our buyer used was really good on this front. They made sure that money was paid when it was supposed to. My purchase was I took a small amount of cash and then some equity in the buyer, my folks took 100% cash, and that cash, they took some upfront and then some paid monthly over I think it was three or five years now, but some timeframe like that. That's all gone exactly as expected. None of the money there was at risk, so it was all a set price, which allows us to use lifetime capital gains exemption for the whole thing, of course.
Jason Watt: No performance amount or anything like that, the only thing was that there was a small holdback, what I thought was a fair amount, to make sure that we capture its legal fees, waited for that final tax return to be filed, make sure we captured any taxes. And I was actually surprised, I thought that we were never going to see any of that whole back amount, and we ended up with a little bit of cash then too, which was a nice bit of good faith it just felt like, getting that unexpected cash against that whole back amount, because I honestly thought it was going to get all eaten up in legal and accounting fees.
Jason Pereira: Yeah. And I will say, this is also dealing with a good buyer, because I've seen deals where that hold back amount, guess what? It just doesn't get paid. It's like, "Go challenge me about it," unfortunately. So again, hopefully that never happens to people, and that it's a deal in good faith. So, deal's done. Talk to me about what surprised you along the way that we haven't covered? You know the textbook version of this, but what about the reality of it was a surprise or new to you?
Jason Watt: And I'm very aware of the personal tax planning issues around this. I talk about lifetime capital gains exemption, and the accumulative net investment loss, and alternative minimum tax. I talk about all of these things in class regularly, I understand how these work, and yet I was so busy with the acquisition, and I didn't really think about my personal tax planning all that much, except to make sure that I was going to be able to use lifetime capital gains exemption. But when it came time to file my tax return, lo and behold, because I had borrowed some money personally in the early days of the business, so I had a cumulative net investment loss, which I knew.
Jason Watt: I was aware that I had a cumulative net investment loss, and what that cumulative net investment loss does is it reduces your ability to use the lifetime capital gains exception. So it wasn't a big deal, but I had a little capital gain that I had to pay tax on because of my previous use of investment losses related to borrowing money. It's a super complicated issue, and I did end up with, again, having to wipe out that CNI balance, that cumulative net investment loss balance, before I could use my capital gains exemption. So it's funny, because I talk about it in class, I just never thought about it for myself, and there it was.
Jason Pereira: There we go.
Jason Watt: And it wasn't a huge thing, it was few thousand dollars, not anything material to the sale. And then the other one that again, caught me a little bit by surprise was alternative minimum tax, which of course is in the news so much now. But because really, I had a large capital gain mostly wiped out by the lifetime capital gains exemption relative to my income in that year, I did end up with some AMT payable. This is a financial planning one. I had made a big RSP contribution because I had the sale proceeds and I had nothing else to do with it really, so made a big fat RSP contribution. And my accountant worked with me here where really, we pushed most of that RSP contribution into the following tax year, because I had alternative minimum tax payable. So some complicated tax issues, where my accountant was a good help on this.
Jason Pereira: Yeah. And for those who don't understand this, the lifetime capital gains exemption, which is sitting at what's it at now, $900,000?
Jason Watt: $913,630, I think.
Jason Pereira: Eventually it'll hit at the $1 million and stop, but that is not a savings necessarily in the first year, because it triggers the alternative minimum tax. So you end up paying some tax on that, but that said, as long as you're earning income going forward at a reasonable level, you actually get that credit back. So it's usually over two years, roughly, depending on the situation. So you do get it, but you don't get it all upfront, and that often perturbs people. They're like, "I thought those was tax free." Well, it is, mostly.
Jason Watt: Eventually.
Jason Pereira: Eventually, we will basically do it. And at least there's some tax playing later on, for example, realizing investment gain returns are generating investment game returns in order to utilize that AMT amount, which can be tricky. And yes, they are very much talking about making AMT worse. Let's not go there. Not pleased about that. So as always, there's a difference between the theory and the practice. I always think back to I don't remember which book it was, it may have been When Genius Failed, when one of the traders turned to the academic and said, "You guys think you know a lot about trading this stuff, but you really have no idea how it works." And it's in theory, it works a certain way, and execution, well, you have to factor in a lot more that happens because we typically just summarize the top line and without the difficulties. Excellent. So thanks for sharing your journey, Jason. Anything else you want to share about what this was like?
Jason Watt: I think that the other thing that I didn't mention here, and you talked about it, finding a good buyer, but the due diligence process is a two-way street. That as much as you should be going through and providing a lot of information about your business, you should be learning about the business that's acquiring you. And I think it's good to have discussions about philosophy around things like employee hiring and firing, discussions around strategic planning, discussions around investment into the business.
Jason Watt: I think those are all big philosophical issues that a small business owner might take for granted that they have a certain perspective on, and the acquirer might not have the same perspective. So we had a lot of conversations about that kind of stuff in the acquisition. And I would really encourage people, and you even mention it, there's a sunk cost problem here where you think well, we're this far along in the deal. We can't turn it off now, but I think that you have to be prepared that the due diligence process reveals something about the buyer that might not make you comfortable as well.
Jason Pereira: Yeah. And I will sum this up as that's just advice for any relationship. And the reality is that unless you're a highly transactional business without any real relationship or intimacy to the consumer, and you're not staying on and maybe your employees aren't staying on, the reality is that once that trigger is pulled, you staying on, your customer staying on, and your employees staying on, that new entity becomes the reality for those people. And all too often, I've seen cases where people have basically sold a company who did a bunch of stuff that they were not happy with or that things that were were against their principles, or maybe took advantage of clients in the way they didn't see fit, or treated employees terribly, and in many cases, even where sellers left early because they didn't want to be there, and leaving a bunch of money on the table.
Jason Pereira: So any relationship is a two-way interview, quite honestly. Even with my own practice, I always refer to our introductory meetings as, "Look, this is a two-way interview. You're finding out what I'm doing, I'm finding out what you're looking for, and we're also finding out if we can work together." And I know many people will often say, "Well, I just want to sell for the highest dollar." Many people will say that sounds good in theory, in practice, just all this other baggage that comes with that you may not approve of. I actually had one case of a acquisition fall apart, largely because of the conduct and we'll call it shenanigans that we were seeing on the other side. It was like, "You know what? Better off just staying on our own." Excellent. Well, Jason, thank you so much for taking the time. Very much appreciate it.
Jason Watt: Thanks so much, Jason, and I always love your podcast. Thanks for doing the great work you're doing.
Jason Pereira: Appreciate it. So that was today's episode of Financial Planning for Canadian Business Owners. I hope you enjoyed that. As you know, this is not a weekly series right now, simply because I'm having trouble finding any content I haven't covered. If you have ideas for things that I have not covered, by all means, reach out, but this will be still be coming out and rolling out. I have not quit. As always, if you enjoyed this podcast, please leave a review on Apple Podcast, SoundCloud, Stitcher, or Spotify, or wherever it is you get your podcast. Until next time, take care.
Producer: This podcast was brought to you by Woodgate Financial, an award-winning financial planning firm catering to high-net-worth individuals, business owners, and their families. To learn more, go to woodgate.com. You can subscribe to this podcast on Apple Podcast, Stitcher, Google Play, and Spotify, or find more episodes at jasonperrera.ca. You can even ask Siri, Alexa, or Google Home to subscribe for you.