Cash Reserves Help Your Business Weather the Storm

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by Michael Iverson

“Save it for a rainy day” is an old saying that still makes sense today. In good times, it’s smart to put aside something for the lean times that are sure to follow.

For a business owner, saving for a rainy day means building cash reserves. Liquidity is the lifeblood of any business, and a lack of liquidity is the cause of most business failures. Squirreling away cash during times of prosperity may, one day, save your business.

A cash reserve provides a business owner with the financial flexibility to continue operations during difficult times. In a sluggish economy, for example, a business may receive less cash from operations than anticipated. Customers who lose jobs are unable to pay their accounts on time. As a result, the business owner finds there’s simply not enough cash coming in to meet business expenses.

The owner can’t very well tell employees and vendors that they won’t be paid until customers pay their accounts, or he risks driving them away. A wise business owner wants to keep his employees and vendors happy, so he pays them on time. He usually does so by tapping into the cash reserve he established during good times.

Cash Reserve vs. Line of Credit

Business owners that have the foresight to build generous cash reserves are sometimes reluctant to tap those reserves. When difficult financial times arrive, a business owner shouldn’t feel any guilt about putting those reserves to use. The funds were saved with a specific purpose in mind—one day the business might not be able to generate adequate cash from operations.

When that day arrives, the question to ask is whether it’s best to dip into the cash reserve fund or make use of an available credit line. Usually, the conservative stance that led the owner to build cash reserves prevents him from taking on debt. But, there are circumstances when using the credit line makes sense. We recommend that you pose the question to your financial advisor.

When it’s considered best to use the cash reserve fund, the money will be put to good use. It will pay the salaries of your employees that have helped you achieve so much over the years. Hopefully, they will continue to be productive employees for years to come. This is a time for looking ahead. Make it a celebration of good business planning and loyal employees.

Opportunity Knocks

Cash reserves may also provide unexpected opportunities. Suppose a competitor of yours is highly leveraged. He has grown his business using borrowed money. He didn’t anticipate an economic downturn and never gave much thought to putting aside cash for a rainy day. What happens if his customers can’t pay their bills in a timely manner? He will have a tough time making payments on his business loans. If the problem is serious enough, he might be forced to liquidate the business. His customers could easily become new customers of yours. His employees might become your employees.

Not sure how to reserve some cash every month?  Contact Michael for advice on how to modify your current business financial model to weather future storms.

Does Your Business Have a Succession Plan in Place?

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by Michael Iverson

Have you met a business owner who is close to retirement age and wants to sell the business? His or her life’s work is tied up in it, and the owner is unsure whether a buyer can be found. Unfortunately, he or she never developed a plan to transfer ownership of the business.

According to a recent survey conducted by PNC Bank, only about one-third of small businesses in the U.S. have a succession plan in place. Without one, a business owner probably won’t attract what he or she considers to be a fair selling price. In all likelihood, the owner will sell the business at terms stacked in favor of the buyer. Should the business owner die without a succession plan in place, it might have disastrous consequences for his or her family, such as a forced sale of the business to pay estate taxes.

The business case for a succession plan is to make sure the owner can gradually withdraw from the business on his or her terms – at a fair price and on a preferred timetable. In this article we are going to focus on three key areas that need to be considered in your succession planning process: 

  1. Identifying a suitable buyer for the business.
  2. Allowing a long enough training period that assures a smooth transfer of ownership to the new owner.
  3. Preparing a financial plan for “cashing out” the owner without draining all of the business’s operating capital.

How to Identify the New Owner

Finding the right person to purchase your business need not be difficult, but it does require time and forethought. Trying to identify a buyer under time constraints is difficult, especially during an economic downturn. As part of your planning, write down periodically a list of possible buyers – even if you are not considering a sale just yet. The exercise is a good way to understand your options.

People familiar with your business are often the most likely buyers. Many business owners ultimately transfer ownership to existing business partners, a family member or a long-time employee. In any of these circumstances, there are benefits to the seller and the buyer(s), including:

  • The seller is likely to achieve a better price by selling to a party that knows the business.
  • The buyer(s) can negotiate a timetable that assures the seller will pass along valuable knowledge about running the business.
  • The resulting continuity of business will benefit employees and customers.

Do you know potential buyers of your business?  Go ahead and start making a list.

How to Plan a Smooth Transition

No matter who the prospective buyer may be, there are significant benefits to allowing a period of several years for a successful transfer of ownership, including:

  • The current owner can provide training to the prospective buyer.
  • The owner can also assess the strengths and weaknesses of the buyer, and spend the time necessary to address areas of weakness.
  • The prospective buyer can be introduced to customers and interact with them for an extended period – to minimize the risk of customer attrition.
  • A long transition period usually improves the financial stability of the business. And, the business’s tax accountants have a chance to plan for future tax liabilities.

A long time frame might not be warranted if the business is being sold to another company. In that case, a shorter period would be better to integrate. However, planning for the transition is still very important because the real work begins after the close of the sale.

How to Cash Out

As an owner transfers ownership of the business, he or she needs a plan for both a) funding retirement and b) leaving the business with the cash resources necessary to continue operations. In other words, writing him or herself a large check from the business’s bank account is not a solution.

Many partnerships put buy-sell agreements in place, which provide for the orderly exit of one partner. Deferred compensation plans can be established, which allow the owner to begin the transition to retirement while still collecting a salary. And, life insurance policies can be used to provide liquidity in case an owner dies before a transition is completed.

These are just a few of the considerations for any succession plan. The important thing to understand is this: not having a succession plan is a huge risk – not only to the business owner, but to his family and to the employees.

If your business doesn’t have a succession plan in place, get started today.  Let us know if we can help you by calling (404) 370-6147 or sending us an email.

Next time we will talk about what can create Transferrable Value. Without it, you don’t have a business to sell.

Are You Insuring Your Life and the Life of Your Business?

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by Duffy G. Elliott, CPA, CFP

As a business owner, you may not consider life insurance an integral part of your financial planning. However, life insurance is critical to an owner’s family, as well as the business, in the event of an unexpected death. In order to make sure both your family and your business are adequately protected, it’s important to purchase the
proper amount of life insurance coverage.

The amount of life insurance you need depends on your current net worth, the lifestyle you want to provide for your family, and ultimately, your personal desires. (see more detailed guidelines below).

For business owners, life insurance for the business is often referred to as “key man” or “key person” insurance. In this case the beneficiary of the policy is the business and not the owner’s family. The insurance is used to provide funds to help the business navigate through the change as a result of the loss of the owner. The funds may be used to buy out the owner’s family interest, find a replacement to lead the business, provide working capital to cushion any financial impact from the loss, or a combination of these options.

Key man life insurance is an important part of a business’ planning. Without it, all of the hard work by the owner and the sacrifices of the owner’s family could vanish.

A common rule of thumb is that you should purchase 5-7 times your annual income. Unfortunately, like most rules of thumb, this does not take into account individual circumstances and may leave you with an inadequate amount of insurance.

  1. First, you should consider how much your family will need every year, being sure to take into account the effects of inflation.
  2. Next, total your assets and other sources of family income. Be sure to include any benefits your family may be entitled to under any pension plans. If your spouse doesn’t work now, you need to consider if he/she would work if you died and how much he/she could earn. Don’t overlook social security survivors’ benefits available to your children under age 18 and to your spouse if he/she does not earn significant wages.
  3. Finally, determine how much life insurance you require. This will depend on how long your family will need this income, what rate of return can be earned on the insurance proceeds, and other factors.

Unfortunately, this is not a calculation that can be made only once. Since your needs will change over time, you should assess your insurance coverage periodically, especially if a major life event occurs.

To learn more about how life insurance plays an integral part of your business and personal financial planning, contact Duffy G. Elliott at Elliott & Associates Wealth Advisors at (770) 451-2446 or visit http://www.elliottandassoc.net/.

What Should A CEO’s Role Be?

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by Tim Fulton, Vistage Group Chair

I was asked recently to describe the role of the Chief Executive Officer (CEO) of an organization. As I considered the question I realized that there were at least six that came to mind. I am sure there are more. Here are the six roles of a CEO I described:

Casting Director

I believe that staffing a small business is much like casting a movie or a play. No matter how good a screenplay is, if the cast is not strong, the production will be a flop. Small businesses are the same way. You can have a dynamite business plan, but it’s the people who make it successful.

Jim Collins, author of Good To Great, said it best: “You must get the right people on the bus, wrong people off the bus, and the right people in the right seats.” This may be the most important role of the CEO.

Scorekeeper

I attended my son’s baseball game recently and encountered a very interesting (and frustrating) situation. The game started and it became apparent right away that nobody was operating the scoreboard. No record of balls & strikes, runs scored, or outs recorded. Initially, this did not seem to be a big deal. However, the game progressed, innings passed, & runs were scored. As spectators, we were totally in the dark. We didn’t know who was winning or losing, what stage the game was in (inning), or even what the batter’s count was. The players were just as ignorant about the status of the game as we were because they depended upon the scoreboard as much as we did. Where was the scorekeeper?

How many small businesses are run without a scorekeeper? I believe that there are many. Employees work hard, just like the baseball players, never knowing the results of their efforts. Just as it doesn’t make sense for the baseball scorekeeper to only keep score for himself, it also doesn’t make sense for the business owner to keep his own score and not share the results with his key stakeholders.

Designer

I often share the story of a sculling coach whose team was unable to win any races until he took the time to lift the racing boat out of the water and discovered that the boat had a fatal design flaw. I believe that it is the role of the CEO to oversee the design of his/her business and than make sure that periodically that design is reviewed to make sure it is still working.

Michael Gerber, author of the best-selling book The E Myth, suggests that while designing our business we should assume that it is the first of ten thousand (10,000) locations. What does that mean? I interpret that to say that we should seek out a design that can be replicated and one that ensures the highest level of consistency of performance. Gerber also suggests that we should design our business as if we were designing a game. The game has rules. There must be a way to win the game. The game must be fun. We shouldn’t design a game for our employees that we are not prepared to play ourselves.

Chief Fun Officer (CFO)

Have you ever seen a business that was having fun that wasn’t also very successful? I believe that the two go hand in hand and that ultimately the CEO is responsible for making that happen. Let me be clear: I do not believe that the CEO should do this at the expense of his ability to lead. The CEO does not need to also be the CEY…Chief Executive Yuckster; responsible for making everyone laugh.

The CEO should make sure that employees have the opportunity for fun as it contributes to their performance. Examples of this might be celebrations (birthdays, anniversaries, etc), toys in the workplace (ping-pong, foosball etc.), or just looking for opportunities to be light-hearted. Laughter or even a smile can do wonders in a high stress/high performance work environment.

Storyteller

Leadership guru and Vistage speaker, Don Scminke, shared a leadership model with one of my groups that really made sense to me and my members. He suggested that the results we seek from our employees are a direct result of their work behavior. Their behavior is driven by their beliefs. Their beliefs are a result of the “story”. What story you ask? Our story. The story of your business. There exists a story within every business. Sometimes more than one. The story might be a positive one, thus resulting in great organizational results. Or the story may one of doom and gloom, and hence, performance suffers.

I believe that the CEO is responsible for developing the right story for their business and then communicating that story at every opportunity. In fact, each CEO should have three stories to tell at any given moment: a story about the past, one about the current situation of the business, and maybe most importantly, a story about the future. Consider this, as a young child; how did we learn about life? Most of us did through stories. Not just stories from books, but also stories from our parents, our grandparents, and our friends. At an early age, those stories most certainly impacted our behavior and most likely still impact our lives as adults. Stories are very powerful communication tools…

Race Car Driver

I believe that so much of what a successful CEO does today is managing velocity. Customers want everything faster. The pace of business today is much quicker than ever before. Hence, the CEO needs to be able to accelerate his/her business accordingly. Vistage speaker Ole Carlsson suggests that “the CEO must have his hand on the gear shift at all times prepared to up shift or downshift at any given moment”.

Likewise, the CEO must know when to pull his car over for a quick pit stop when necessary. That’s time to fuel up (cash infusion), check the tires (employee performance reviews or 121 meetings) and check under the hood (planning meeting). One speaker said recently that “changing a business is like changing a flat tire on a car…doing 60 miles an hour”. Not even a racecar driver would attempt that feat.

What have I left out? I’m sure there are several more traditional CEO roles that you find yourself in at times. Which role are you most comfortable in? Which role are you most uncomfortable in? What role is most needed in your organization today? Sometimes it’s better to be asking the right questions than always looking for more answers.

Is a Clash Brewing in your Workplace? The Impact of Mixing Generation X and the Millennial Generation in the Workplace

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by Cynthia Miller of cindy.miller.atl.communications

As you watch the impact of the much-discussed generational mix on your company, pay particular attention to this: The most unsupervised generation in American history is starting to become the bosses of the most supervised generation in American history.

Generation X, the oldest of which were born in the late 1960s, is the next generation of corporate leadership. Independent from the time they were “latch-key children,” this demographic is moving into leadership vacancies created by the retirement of the Baby Boomers, now turning 60 at a rate of about 10,000 a day. Often described as a “cynical generation,” Generation X’s formative years were shaped by soaring divorce rates and two-income families, limiting the time they were physically in the presence of adults. They learned to do things themselves, at a young age, with little supervision.

Compare that upbringing to that of the Millennial generation, the oldest of which are now in their mid-20s. This generation saw a return to parenting, and has routinely sought out their parents for advice, encouragement and the creation of structure. Their time has been managed since they were toddlers, and praise was given out daily.

It’s the “Figure it out” generation up against the “How do I do it?” generation, and that’s bound to cause some friction in your company.

So what’s a CEO to do? Here are some ideas to help keep everyone focused on the business at hand:

  • Promote flexible work arrangements. One thing both Gen X and Millennial can agree on is a desire for flexibility. Mandatory face-time is out; results-based management is in. But flexibility doesn’t mean you’ve lost control of employees and the work required. Train your managers in the skills of goal-setting and performance evaluation. You’ll find productivity increases (along with the bottom line) when your staff feels ownership for meeting company goals.
  • Hone your employee communication strategy. Communication is critical to help the different generations understand the intricacies of a successful business. The standard employee newsletter may not be sufficient to a staff with expectations of immediate access to information. Personal communication skills, too, will play a vital role in keeping everyone focused on current business strategies and priorities.
  • Train the next generation of leaders. Gen X and Millennials are poised to sit in the driver’s seat of your business. Is your next generation of leadership up to the task? You’ll skip many frustrations — both for yourself and your managers — if you invest in leadership development to give your management team the tools they need to lead.

Harnessing the power of the generations will move your company to the next level of success.

Cynthia Miller is the principal of cindy.miller.atl communications, a company that specializes in communication strategy including crisis communication and media relations. Learn more at http://cindymilleratl.com/

Use Your Dashboard to Monitor Profitability

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by Michael Iverson

Believe it or not, it is possible to manage the financial side of your business in only a few minutes each week. With a good dashboard, you can quickly review the key drivers of the business to know how well you are doing.

Here are some metrics you might want on your dashboard. Let’s consider your Income Statement (aka, Statement of Profit & Loss, or P&L) and four profitability metrics that derive from the Income Statement:

  1. Price
  2. Gross Profit Margin
  3. EBITDA
  4. Net Profit

1.  Is the Price. . . Right?

As consumers, we know that Price represents the specific dollar amount a vendor charges for a given product or service. Business owners tend to think about Price differently. In the context of the Income Statement, Price represents the average dollar amount a business charges customers for a product or service sold during a reporting period (month, quarter, year, etc.). Because it is an average of all products and services sold, it might seem like a statistic that’s not particularly noteworthy. However, the statistic can be used for benchmarking – comparing the average price for the current reporting period against the average price for a prior period, for example.

Price is a variable component of Sales for the period, meaning it’s possible to increase or decrease the price and see the flow-through impact on bottom-line profits. In some instances, a price increase substantially improves the Net Profit of the business. In a price-sensitive environment, a price increase is rejected by some customers and sales volume may actually decline. When Price is a component of your dashboard, a quick glance provides some indication of customers’ price sensitivity for your products and services – which certainly is important for an owner to know because it has important implications for business profitability.

2.  Managing Gross Profit Margin

Gross Profit Margin is one of the most basic measurements of profitability. Sales less Cost of Goods Sold yields Gross Profit. Cost of Goods Sold includes direct costs of production, such as materials and production labor. The Gross Profit Margin is simply Gross Profit (GP) expressed as a percentage of sales. A business with sales of $50 million for the reporting period and a $25 million Cost of Goods Sold (CGS) has a 50 percent Gross Profit Margin (calculated as CGS/GP).

Gross Profit Margin is an important gauge of profitability. If a company does not generate adequate gross profit to cover its other operating costs, then it cannot become profitable. In addition, much like Price, it provides a good benchmark. It is especially useful when compared to other companies in the same industry. If a company’s Gross Profit Margin is significantly lower than those of competitors, the costs of its primary inputs (generally, material and production labor costs) may be too high and the company will have a tough time competing.

3.  EBITDA

EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA is a measure of profitability that goes a step beyond Gross Profit. EBITDA includes another layer of costs, which are typically classified as selling and administrative expenses (sometimes referred to as overhead costs). It excludes interest, taxes, depreciation and amortization, which are considered to be non-operating costs. EBITDA is a measure of profitability from operations and plays a role in the valuation of a company. Like most profitability measures, an upward trend over time is desirable.

4.  Net Profit – The Bottom Line

Net Profit is the final line of the Income Statement, hence the alias “The Bottom Line.”  In terms of accounting, regulatory compliance and most debt covenants, Net Profit (or Net Income) is the most complete measure of a company’s financial performance. It includes all the costs subtracted from sales. A growing Net Profit figure over a sustained period of time suggests that a business is managed effectively.

 

A dashboard with these income statement metrics can help you more efficiently manage and make decisions for your business. There can be other factors and income statement metrics that drive your business and we would be glad to discuss which ones make the most sense for you.  Contact us for a no-obligation assessment of your dashboard metrics.

Put Your Working Capital to Work in Understanding Your Financial Dashboard

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by Michael Iverson

I often remind clients to pay attention to their working capital levels, particularly in today’s economic environment, when banks have shown a reluctance to lend to small businesses. Business owners need to maintain liquidity, generate positive cash flow and – to the extent possible – prepare to fund growth internally. Working capital is critical to your financial dashboard, a tool we recommend you as a business owner use to monitor your financial health.

Understand Working Capital

Let’s begin by defining working capital. Simply stated, it is the difference between current assets and current liabilities. A common perception is that a profitable business always has adequate working capital; however, that is not necessarily true. Profitable businesses can, and do, experience capital crunches. Often, an effort to expand operations aggressively is the cause of a shortage of working capital.

Working capital is composed of primarily of Accounts Receivable, Inventory, and Accounts Payable. A business owner needs to consider changes to these short-term assets and liabilities in order to ensure the business generates adequate operating cash flow.

For example, an increase in Accounts Receivable might mean a business is falling behind its in collections. Sales offered on credit, a business is effectively making a non-interest bearing short-term loan to its customer. Collecting accounts promptly is important. An aged invoice that goes past its due date can have a negative effect on cash flow. The business used precious resources to bring a product to market and sell it, but until the account is collected those funds are unavailable.

For my clients that extend credit, I recommend a dashboard metric called Days Sales Outstanding (“DSO”). It measures the relationship between Accounts Receivable and Sales. When this metric spikes higher than a specified level, then collections are not keeping pace. A quick glance at the dashboard shows you the trend of the metric. Measuring and understanding the drivers of the metric can help you identify where to make changes.

For businesses with inventory, it’s important to make sure that inventory is not consuming capital unnecessarily. Is inventory getting sold on the schedule? As with aging Accounts Receivable, a buildup of inventory ties up your cash resources when it is not converted to cash on a timely basis. The Inventory Turnover Ratio is a dashboard metric that highlights this trend. When the ratio decreases, it can signal an upcoming cash flow problem.

Another balance sheet account in working capital is Accounts Payable. Accounts Payable is the opposite of Accounts Receivable, where your business has been extended a short-term interest free loan from your vendor. When a business slows down its vendor payments, it is conserving cash. A business will at times use this strategy when it is experiencing slower payments in Accounts Receivable. Days Payable Outstanding (“DPO”) is a metric that measures your payment cycle trend. Consider putting it on your dashboard. Measuring your DPO helps identify when you may be disbursing funds faster or slower than expected.

Working Capital Ratios

To recap, here are the Working Capital ratios that I recommend you measure:

  • Days Sales Outstanding
  • Inventory Turnover Rate
  • Days Payable Outstanding

If you don’t understand the relationship of these metrics on your operating cash flow, your business can quickly become a very profitable operation that is very quickly running out of cash.

Developing a financial dashboard helps you manage review key metrics to gain insights on making decisions for your business. Schedule a free consultation with our Numbers Coach, where we are glad to discuss metrics that make the most sense for your business.

Back to Banking Basics

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by Anne Moore Odell

Is that a ray of sunlight peeking through the economic clouds? Yes, banks are still lending to small businesses. True, loans aren’t as easy to secure as they were three years ago. But businesses that are willing to work to show their ability to repay lines of credit and loans are still getting financial support.

“Things are starting to loosen up,” says Mike Iverson, CEO of Trillium Financial. “Bankers are opening their doors again.”

Banks are getting back to the basics of lending. As a business owner, this means you need to re-familiarize yourself with these basics and make sure your business is ready to request that loan.

Sailing through the Five “Cs”

The “Five Cs” of business credit are more than a banking concept learned in business school. As banks pull back their lending reins, they are investing more time to learn about their clients’ businesses before lending.

“Banks are really looking at lending from a basic banking process,” explains Iverson. “They’re not going to take the same risks they were before. Banks are monitoring loans downstream. Before, some loans were unmonitored, but as businesses want to renew their loans, many banks want to see more information on a more regular basis. You’ll be hard pressed to see unmonitored loans of a million dollars anymore. Even much smaller loans are being monitored quarterly.”

With your business loan application in hand, the bank’s lending committee will examine how well your business can repay its loans according to five critical factors:

  1. Character. The lender is looking at you both as a business owner and a manager. Your character includes your personal financial history, reputation, and, importantly, your relationship with your lender.
  2. Collateral. Both business and personal collateral. More banks are asking for business owners and partners to sign personal guarantees so that loans are secured at an acceptable margin.
  3. Capacity. More than ever, banks require you to demonstrate your capacity to repay the loan. Although the recession has changed and often slowed down cash flow, lending committees must be convinced that your business has the liquidity and cash to repay on time.
  4. Capital. By supplying current, in-depth and correct financial information to your bank, a lender can understand that your business has the capital structure to survive and thrive in these tough economic times.
  5. Conditions. You also need to show that you understand the conditions of your industry, the economy and other factors that could impact your ability to repay the loan.

Communication is Key

Be upfront on your application and honest with your banker on where and when risk could occur. Communicate your business plans and clearly explain to your banker how you plan to use the borrowed funds. Once you have your secured your loan, keep the lines of communication open between yourself and your banker.

“If you have bad news you need to tell your banker ‘here is the issue, here is how I plan to address the issue,’” says Iverson. “If they get surprised, they get worried.”

Filling out a loan application and talking to your banker shouldn’t be an angst-filled experience. The irony is that when you don’t need a loan, when your cash flow and income are high, it is the best time to apply for one. “You get the loan, you use it, you pay it back it back, and you show the bank that you have the management and cash flow to do it,” adds Iverson.

Even in these tough times there are lenders ready to loan money to well-run businesses. Remember the five “Cs” and always communicate with your banker in good times and bad times.

Is Your Business M&A Ready?

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by Michael Iverson

Merger and acquisition (M&A) activity can be a key part your business strategy. Whether you seek business growth through acquisition or your business is the target of a buyout offer (solicited or unsolicited, you are a party to the M&A process. From that standpoint, it makes sense to understand what the process entails and how it might affect your business.

For the sake of simplicity, and because my clients are more often sellers rather than buyers, I will address the process from the seller’s side of the transaction. However, the same principles apply whether your role is that of buyer or seller.

Organization and Documentation

In a previous article, I discussed how to build transferable value into your business. If you desire to sell your business, you have to make sure its value is readily apparent and transferable to a prospective owner. Let’s review a couple of the tenets of transferability:

  1. Your business needs to have an organizational structure that will survive your departure from the business. Many business owners don’t have that kind of structure in place. When a business owner is an irreplaceable force in their organization, the business can lack transferability.
  2. Documenting your processes and training employees to follow them consistently adds transferable value to your business. It gives a prospective buyer a high degree of confidence that he or she can purchase the business and make a successful transition to ownership. To use a sports analogy, you are turning over your playbook to a new coach.

To bring together the two tenets above, let me point out most entrepreneurs are focused on the delivery and growth of their company and not on organizational structure and documentation – at least, not initially. Most emerging growth business owners are correctly focused on meeting customer needs and providing the products and services customers want. As a business matures, it’s important for the owner to recognize that organizational process and documentation are absolutely necessary. Without them, it is very difficult for an owner to extricate himself from the business.

Well-organized processes and documentation conveys to a potential buyer that:

  • the owner knows what he/she is doing,
  • the buyer can easily understand the business model, and
  • the transfer of knowledge to run the business can happen quickly, which makes a seller attractive.

If an owner is knowledgeable about business contracts, for example, it gives a buyer confidence. When employee files are complete and updated, it reflects the owner’s commitment to matters of compliance.

Letter of Intent

When buyer and seller reach agreement about general parameters of a sale – price, terms, a timetable for completion of the deal and the consequences if the deadline is not met – the particulars are set forth in a letter of intent. The document indicates that initial negotiations have been completed and both parties are committed to additional negotiations with the intention of completing a transaction. The letter of intent (“LOI”) typically includes language stating that information learned about the other party must be held in strict confidence in the event a transaction does not occur.

An LOI is followed by a phase called due diligence. During the due diligence period, the potential acquiring party takes a closer look at the target company. This is a time when organizational structure, process, and documentation can help seal the deal. On the other hand, if any of these is found lacking, the buyer might find reason to re-negotiate the deal. Tax returns reviewed may indicate possible obligations not earlier known to the buyer. Contracts reviewed might show significant uncertainties about vendor or customer relationships that might not be transferrable in the event of a transaction. The result can be a downward revision of the sales price.

Closing the Deal

Assuming nothing significant is uncovered during the due diligence phase, attorneys from each side will then compile a list of documents needed to close the deal. Typically all the documents must be signed by each shareholder of each company, either in person, electronically or by proxy.

When all parties to the deal have signed, the process of integrating the two operations begins. In my experience, that’s the hardest part. It includes a series of meetings, deadlines and assigned responsibilities designed to make the two become one. We will address the integration aspect of M&A in a future article.

If you have questions about M&A, or your company’s readiness, contact us. We are happy to assess your situation and make recommendations.

Are Those Contractors Really Employees?

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by Ned Lenhart

Over the years I’ve worked with many companies who use “contractors” to perform a lot of the work they do. Given the control these companies have over these so-called “independent contractors,” I’ve always been concerned that they are really “employees.”

On February 23, 2013, the U.S. Tax Court issued Kurek vs. Commissioner, T.C. Memo 2013-64 and held that a general contractor who used laborers to complete his work had improperly classified them as “independent contractors” and that they were really “employees.”

Even though the workers provided their own tools and set their own schedule, the general contractor set deadlines for the work and monitored their work on a daily basis. Further, he paid them on a weekly basis and had the ability to approve the quality of their work. The Tax Court held that these factors made these workers “employees” and not “contractors.”

The implications of this decision are extensive and include workers’ compensation insurance, unemployment insurance, FICA, and now healthcare coverage.

Over the years we have seen situations that are similar to this fact pattern, especially in the construction industry. If your company uses “subcontractors” or other laborers to complete projects, please review this ruling carefully and evaluate the potential consequences. The ruling could also have implications on state and federal income tax withholding rules. The penalties associated with these violations can be significant.

Ned Lenhart is President of Interstate Tax Strategies, a multi-state sales and use tax advisory firm based in Atlanta. To learn more about ITS, visit http://www.salestaxstrategies.com.

Preventing Employee Fraud

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by Michael Iverson

Small-business owners often talk about treating employees like family. They work hard to provide environments that support and nurture employees. The nurturing process involves increasing responsibilities over time. Owners want (and need) to trust their employees to exercise authority and help manage the business.

Occasionally, that trust is misplaced. In recent years, small businesses have been hit by a series of high-profile cases. For instance, the vice president of finance for a Midwestern headphone manufacturer is accused of embezzling more than $20 million over several years.

Physician practice embezzlement is on the rise too, according to the Medical Group Management Association. Three out of four physicians will suffer some financial loss from employee dishonesty during their careers.

No employer wants to dwell on the possibility of employee theft or embezzlement. On the other hand, few businesses can withstand the effects of a prolonged financial crime. Here are three reasonable steps you can take to protect your business:

  1. Make Vacation Mandatory

    2. Most financial crimes require constant attention, even diligence, on the part of the perpetrators. A policy of mandatory vacation time can deter employees from even considering any impropriety. Employees fear that any financial misdeeds will be detected during their absence.

    Make the mandatory vacation time commensurate with each employee’s level of responsibility. Don’t allow the vacation time to be taken one or two days at a time. Multi-week absences give a temporary contractor or employee a better chance of uncovering fraud—if it exists.

    Other employees, especially those with access to cash and high-value inventory, should also be required to take mandatory vacations. In addition to thwarting fraud, such vacations provide opportunities for employee cross-training.

  2. Segregate Duties

    3. Through appropriate segregation of duties, it’s possible for a business to remove most temptations to commit fraud. For example, the employee receiving cash should not be the person recording the cash receipts and making bank deposits. The employee receiving high-value inventory should not have any ability to adjust the accounting records pertaining to the inventory.

    The idea is to prevent any one individual from having enough responsibility to misappropriate assets and cover their tracks by altering related financial documents.

    By their very nature, certain work activities lend themselves to detecting potential crimes. For example, reconciling bank accounts often leads to questions about unusual wire transfers out of a bank account or unrecorded cash withdrawals.

    When the person who normally reconciles the bank accounts is on mandatory vacation, make sure his or her temporary replacement completes these reconciliations. Any items that cannot be explained should be brought to the attention of management immediately.

  3. Purchase Fraud-Inclusive Insurance

    4. Finally, business owners should be aware that commercial property insurance policies typically exclude from coverage any crime-related losses. It is possible to purchase a separate “fidelity insurance” policy that protects against the risks of employee theft and fraud.

    Often a policy requires a rider or notification for processes that could be potential fraud risks. If your business accepts credit cards over the phone make sure your business insurance covers for misuse of 3rd party credit cards. If you keep credit card records on file, how do you secure them from unauthorized use? Does your merchant agreement allow you to maintain credit card numbers on file? Some merchants will not allow you to keep credit cards on file without being what is referred to as “PCI compliant”.

    See the advice of your insurance agent or business risk manager to ensure you are adequately covered and in compliance.

If you have questions about preventing or determining employee fraud, contact us. We are happy to assess your situation and make recommendations.

Don’t Gamble on Employee Selection

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by Tim Fulton

Employee selection. No two words frighten small business owners more than these two.

Why is this? Maybe it’s because the selection process can be so time consuming. Maybe it’s because the process can be so costly. Maybe it’s because we are never quite sure we know how to select the right person for the position.

I believe that the main reason so many small business owners and managers dread the thought of hiring new personnel is that they have made bad decisions in the past and the thought of duplicating such decisions brings terror to their hearts.

Why is it that despite our good intentions, we still make bad decisions in selecting new employees?

The reason is simple. We usually base our decisions on the wrong set of information. This fact became very evident to me recently in talking to a small business owner. Bill had just about sworn off hiring any more new employees as a result of the horrible experiences he had experienced recently in trying to fill several vacant positions.

Predicting future performance

Bill had owned this small retail business for five years and had always struggled in hiring new employees. I asked Bill on what basis he made a hiring decision. His response included such common factors as appearance, communication skills, and past experience. He than shared with me that his most important factor in hiring a new employee was his ability to predict their future behavior and performance in that particular position.

I was glad to hear that Bill used such a criteria for hiring. Experts tell us predicting future performance is quite normal and a good practice in the selection process.

I than asked Bill on what basis he was able to predict such future performance. He responded that he would often times ask hypothetical questions such as, “If you were getting ready to close the store and a customer entered and demanded that you stay open for the next thirty minutes while she browsed for a future purchase, what would you do?”

Bill also suggested that he tried to determine applicant’s work attitudes and moral values during the interview. That information, he felt, was important in trying to predict future work habits.

Bill felt that despite getting great information asking such questions, for some reason many of his new hires did not perform the way he had imagined during the interview. In fact, several of his newly hired employees turned out just the opposite of what he had predicted during the selection process.

Hiring is Similar to College Football?

In talking to Bill, I also found out that he was a huge sports fan. He loved college football and confided to me that he was known to place a wager on one or two games a week. In fact, he bragged to me that he had earned enough money last year from betting on football games to pay for a recent week-long vacation to Florida for his family.

I asked Bill what he contributed his betting success to.

He responded that he had become very good at predicting the outcomes of games almost to the exact point spread. He was able to do this by studying each team’s past performance in close detail. He would watch replays of their last games. He would scrutinize their statistics. He would research how the teams had played under like circumstances in past years.

In simple terms, Bill had created a science of predicting football game outcomes by looking at past performance.

I asked Bill if it was possible to draw a parallel between predicting winning football teams and predicting the future behavior of a potential employee.

At first Bill had a confused look on his face. He was having a difficult time correlating the process of picking football game winners with the selection of productive employees. Slowly, a grin emerged on his face as he realized the connection between the two processes.

“Are you saying that I should pick my employees the same way that I pick my football games?” he asked.

“Absolutely.” I responded.

A New Approach to Hiring

All of a sudden Bill experienced a huge awakening. He considered that he would never bet on a football team just because the coach talked of winning such a game. He would never pick a team to win just because of their apparent work attitude or values. In picking his teams, he predicted future performance based on past behavior under similar circumstances. It had always worked. Why wouldn’t it work in selecting new employees?

Of course it would.

Not only will it work for Bill, but it will work for any business, large or small. Research has conclusively shown that the only way that we can accurately predict an employee’s future behavior is by looking at their past behavior under similar circumstances.

Why is this so? Because behavior can be measured, it can be evaluated, and it can be changed. To the contrary, attitude is difficult to measure, evaluate, or change. Which one would you want to use to predict future performance?

If an employee has a history of satisfying customers in similar situations as your workplace would require, you can bet that that same employee would continue at that same level of performance under your supervision. Likewise, if an applicant has had negative experiences in the past, you can rest assured that he or she will repeat that behavior in a future position.

So the formula is simple: we select employees on the basis of predicting their future performance as a result of their past behavior under similar circumstances. This formula has been tested many times in many different situations and has always provided the best means to acquiring great employees.

I received a call from Bill last week. He had hired his first new employee using this new philosophy and he was certain that this young lady was going to be a star employee. In fact, in just a week’s time she was setting a new standard for outstanding customer service for the other employees.

Bill was ecstatic. He couldn’t wait to hire his next employee. He is also enjoying football this fall. He is certain that this will be a profitable season.

Tim Fulton a business coach and CEO of Small Business Matters, a leader in small business coaching and development. Learn more at www.smallbusinessmattersonline.com.