Turning Success into Failure

Turning Success into Failure

Selling your business in mid-career (say in your mid-forties) can either be a blessing or a curse.

Like many private equity sales, the founder wasn’t able to take advantage of the tax free capital gains exemption ($883,384 in 2020), since the purchaser wanted to buy assets instead of shares. This is standard practice when a sophisticated purchaser buys a business run by a private corporation. In essence the purchaser is seeking protection from the proverbial “skeletons in the closet”.

While there was some tax to pay, the underlying assets of the company were sold and resulted in significant capital gains. One half of those capital gains were converted into a qualifying capital dividend account, which meant that the shareholder(s) could remove the dividends (carefully) from the CDA account and avoid tax.

As a part of the deal, the founder was kept on salary to work through the transition.

Here is where the deal began to unwind. The founder believed that she had won the lottery and spent all of the cash before the capital dividends could properly withdrawn. This resulted in a taxable overdraft in the shareholder loan, one third of which was taxable.

She was unconcerned since her salary was much higher than what she had paid herself, and she could easily afford to pay the tax based upon her new salary – until they fired her. Immediately after the two year term in her contract was up, she was let go.

Then she began looking for a similar role as a manager in a technology company. However, it is much harder to find a senior managerial role than it would be to find a technical role (operations, engineering – even accounting). Now with no salary and no comparable job prospects, she was unable to pay the tax that she owed.