If you have been considering selling your business, or any other asset that will generate a handsome long-term capital gain, Consider this – compliments of Janas Associates, an investment banking partner of ours:
“The Biden Administration has indicated a plan to increase taxes. For Long-Term Capital Gains (“LTCG”), the proposal is to increase the rate from 20% to 39.6%. New rates are unlikely to apply through the end of 2021 and possibly into the first quarter of 2022. Income tax laws are generally not retroactive. Under current tax law, the federal tax for each $10.0 million of LTCG on sale of your business will be $2,000,000. Under the proposed new rate, the federal LTCG tax would be $3,960,000, reducing the net cash to owners at transaction closing of $1,960,000 per $10.0 million of LTCG.”
That’s a pretty big chunk of any gain you might achieve on the sale. Regardless of what you might think of the tax policies of former President Trump or President Biden, it would be wise to avoid a hit of that size if possible. While it’s not a certainty that the proposed rate increase will pass as proposed, you might be wise to avoid the risk if you’re in a position to take your profit this year. If you’re ready to sell and you need to understand the process and ensure you have a solid team of advisors, think about this:
Virtually any sale of a a business takes the better part of a year from decision to close, and that’s if everything is in great shape. If not – and for most privately owned companies the answer is usually “not” – the timeframe could already be too short. If your balance sheet needs a cleanup, if your path to a sale is unclear, if you don’t know what should be fixed and what won’t much matter, I suggest you call us today. Or you could take your chances. It could all work out just fine. Or not. We are Your CFO for Rent.
As 2020’s challenges resulted in a significant drop in M&A activity, deal flow is expected to pick up big time in 2021 and 2022 because of the suppressed workings of supply and demand. There’s a lot of money on the sidelines waiting to be put to work. There are a lot of business owners who were close to the decision to sell in 2019 – remember our earlier articles on the demographics of business owners – and are now very ready to retire. So my question: If this is going to be a seller’s market for the next year or two (or three?), how can you drive the value of your company so that you get the best possible price, even in the face of other business owners equally anxious to sell? Remember, a seller’s market means the average prices paid for good businesses could be higher than any time in the past decade. In our research, here are the key factors that we favor to drive value:
1. Asset Quality: Are the assets that the business depends on of good quality and long life so as to avoid the need to recapitalize the business in the near future? This applies to physical assets – equipment, facilities, etc. – but also intellectual property, the secret sauce that drove your success to this point.
2. Human Capital: Do your people have the skills and tenure to keep the business growing? Is the morale of the team strong enough to ensure retention when you’re no longer there?
3. Depth and Quality of Management: How good is the leadership team you will leave behind? Can they run and build the business without you? Do they have the knowledge of your processes, the relationships with your customers and suppliers, and the leadership abilities to carry on without you?
4. Financial Performance: Is the company’s history of profitability appealing to the next owner? Not just in admiring the profits you created, but in recognizing the presence of trends that will continue to deliver positive top and bottom line results into the future.
5. Scalability: Is it clear the business model can be scaled up without a major retrofit? Is the market there? Is what you sell valuable enough to have appeal to that market into the future so that the business has an inherent ability to grow and a market that will continue to want what it has to offer?
6. And finally, Risk: Is there inherent risk in your business that could negate the value of some of those factors above? Are you in bricks and mortar retail as ecommerce takes a greater and greater market share in the years ahead? Is it particularly susceptible to visible trends that exist today – climate change, consumer tastes, international competition, etc.?
That’s my list. If you have some thoughts on what else should be on the list, or removed, I’d love to hear from you. And let me know if we can help. We are Your CFO for Rent©.
Do you really have enough cash? Let me be more specific: Do you really have enough cash for some unexpected horrific event in your industry? Hertz Corporation, a household name for decades to business travelers, filed for Chapter 11 bankruptcy last year when the travel industry collapsed. They were already short of cash in an attempted turnaround of their business when the pandemic hit, and they had nowhere to turn. What about your business? Can you say with certainty that you will not face a sudden, unanticipated event that would suddenly cause your revenue to drop by 40, 50, or 75% or more? Such events, even for a few months, can easily cause the death of a company if they don’t have the resources to see it through. For example:
- You operate a chain of restaurants and two of the units in your chain are hit with shooting incidents from unknown (and uncaught) shooters, causing regular customers to stay away fearing the unit they favor will be next.
- You manufacture parts for an airplane that has just crashed for no known reason – sorry, Boeing – and orders for those parts, which make up 50% of your business, stop cold. The FAA will likely take a year or more to clear the fix.
- You’re a SaaS business or web services company and a wave of hugely successful hacks from some bad actor has suddenly made internet connectivity unsafe for virtually every one of your customers. So they sign off for 6 months or more until they’re convinced it has blown over.
Whether you’re the company’s CFO, or its CEO, or a member of its Board of Directors, it’s your responsibility. And the only thing you have reasonable ability to control is access to the one commodity that can tide your company over – cash. That doesn’t mean your company needs to have a closet full of money sitting collecting dust, i.e., .02% interest. It simply means you need to have a way of accessing enough cash to pay the company’s fixed costs for an extended period of time. How much is that? That all depends. One thing is sure: If you don’t know what your fixed costs are, if you don’t have access to a bank credit line or easily accessible cash reserves or saleable investments, or if your lifestyle demands that you take most of the cash home every quarter as ownership distributions, then how much doesn’t matter because you won’t have it. This is where your finance team comes in. They need to provide the answers to these key questions:
- How much money do we need to have each month if our revenue goes to zero?
- How much money can we access quickly to cover that number, and for how long will it last?
- If the answer isn’t good enough, what are the recommendations to make it better?
If you think it can’t happen to you, let me introduce you to the (former) CEO of Hertz.
FOR CA EMPLOYERS ONLY – NOT FINANCE RELATED BUT IMPORTANT IF YOU HAVE ONSITE EMPLOYEES
An alert compliments of Greenberg Glusker:
The California Department of Fair Employment and Housing (“DFEH”) has updated its COVID-19 guidance (effective 3/4/21, replacing its previous version from 7/24/20).
Use Caution If You Are Considering Making Vaccines Mandatory
The DFEH now says employers may require employees to receive a Food and Drug Administration (FDA)-approved vaccination. We suspect that many employers will be misled by this guidance because many COVID vaccines are available and being administered to many people. The new guidance relates only to FDA-approved vaccines. Currently available COVID vaccines are not FDA-approved; they have only received emergency use authorization (“EUA”) at this time.
In the job of managing a company, the owner/CEO has many tools available to help decide when a department is functioning effectively or not. Some are easier to use than others. Managing the sales department may be among the easiest, because you have sales numbers to use, sales vs. quota, sales vs. prior period, sales of most profitable products, etc. Production departments can be monitored by the percentage of goods produced timely, labor and overhead rates, etc. But what about your administrative functions, and in particular Accounting? OK, you eventually got your monthly P&L statement. Is that it?
We recently got a survey report commissioned by Airbase, an expense software management company, that attempted to create some benchmarks by asking nearly 800 US-based companies of various sizes what they do to get their accounting jobs done. The results, while not earth-shattering insights, are useful as a way to develop some metrics for your company. For purposes of this post, I’ll focus on companies that reported total headcount of 100 or less, representing 98% of the businesses in this country. Here are a few highlights:
- Nearly 2/3 of these companies realized the need for improving processes by adding new systems and techniques to reduce manual operations. Does your accounting leader regularly look at the possibilities in this area? Best single path to improving productivity, in my view.
- Half of these companies said they need to improve their control over budgeting – meaning get them to work better for what they’re intended, which is to focus spending. How’s your budget process working for you? Do you even have one?
- 75% of these companies don’t have a CFO, while the other 25% outsource their CFO support. For companies with less than 100 employees perhaps not having a full-time CFO to oversee their financial affairs is understandable, but not having any CFO support at all when there are many fractional CFO resources out there does not make sense to me. Yeah, I genuinely believe we’re the best, but we’re certainly not the only resource out there. What’s that about anyway?
- The vast majority of these firms use QuickBooks for accounting, despite its limitations beyond basic accounting, perhaps related to the complaints about the amount of time spent in manual processes. The reality is that basic accounting software can’t handle very much beyond the basics. If you manufacture anything and your books are on basic software like QuickBooks, you’re going to either have lots of manual processes or poor visibility into the financial side of your business.
To that we would add one fundamental metric. Your monthly financial report should be ARTistic, that is: Accurate within reason, Relevant, meaning formatted to your needs and level of understanding, and Timely, which means you can count on it being on your desk within X workdays after the end of the prior accounting period.
We are Your CFO for Rent®.
To all who made a well thought out plan for 2020: sorry about that, glad you’re still there. To all who despaired of any ability to create a plan for 2021, this blog’s for you.
We have three big reasons for developing annual plans (for this article, think both written plans and budgets):
- to properly and thoughtfully allocate our limited resources to best use,
- to be prepared to take advantage of opportunities that present themselves to us, and
- to be prepared for any bad things that might come along and hurt the business.
I think you can agree with me that avoiding any effort to plan would be a risky idea and inconsistent with effectively managing your company. The problem is doing it in an environment where the unknowns are larger than normal, the length of undesirable events can’t be predicted – yes, even into 2021 – and your resources have been strained just to stay viable and safe, not to mention visible to your market. So how to begin? Centage, a maker of financial analysis software, presented a short list of reasons to not only do a budget but develop what-if scenarios to attempt to avoid being blindsided by what you don’t know. I liked it, so decided to share their thoughts. Here’s the cliff notes version:
Be Prepared. One of the primary reasons companies create what-if planning scenarios is to be prepared to adjust to a variety of unknown situations. It can also prepare you for any situation or potential change in the market. Foreseeing how these changes will have an impact on your business will give you an advantage over your competition, as you can adjust your business accordingly. Think Blockbuster vs. Netflix.
Manage Risks. Managing risk isn’t just about knowing when and what changes to make should something bad happen. It’s also about thinking and planning for various possibilities to see if your internal systems can handle a situation, or if operational changes need to be made. Think of this what-if planning like a stress test for your financial health. Think Lehman Brothers in 2008.
Identify Key Business Drivers. Similar to KPIs, knowing what these are is always a good idea, from planning the future to assessing the past. As you start to work these interest-drivers into your planning, some will emerge as the most meaningful to you and therefore also to the company’s success. Measuring them, trending them, paying attention to them is essential to success for any business.
Understand the Effects of Big Business Decisions. Big business decisions are both frightening and ubiquitous for a company’s leaders. While a what-if scenario won’t make you a fortune teller, it can make clear what the business could look like after the success or failure of a given decision. This information can then arm you to make informed, data driven decisions.
Let me know if we can help. We are Your CFO for Rent.
A long-time friend, Jim Blasingame, who is a well-known radio commentator, business writer and small business expert has recently written a thoughtful article making the case that the soon-to-be-considered $15 national minimum wage is a bad idea, and he gives 10 pretty compelling reasons to back up his position. (Read his article here)
Jim’s well reasoned argument tells us that it will hurt small businesses in most of the country, and ultimately hurt more workers than it helps. His argument may not have much sway on the low income worker who is working two jobs trying to support a family on $7 or $8 an hour, but if that worker’s employer can find a way to eliminate that job as a response to the wage hike, how does that help? When it all plays out, who wins and who loses?
What do you think? I’m curious to know how you feel about that issue, as it will soon be front and center in the news. If you will, send me a YES (it’s a good idea) or NO (it’s a bad idea) and tell me why you think so, and I’ll publish the results of my very unscientific survey here. AND THE RESULTS OF MY VERY UNSCIENTIFIC SURVEY ARE: 58% IN FAVOR, 42% OPPOSED.
A business writer once published an article that an exit plan can also be referred to as a succession plan. Sorry, folks, but that’s just not true. They’re very different strategies intended to accomplish very different objectives, and the actions that a business owner will take to implement a succession plan will be very different from those intended primarily to achieve an exit at the highest possible price.
Let me explain.
First, a more accurate definition of the terms:
A succession plan is one in which the owner wants to turn over the running of the company to either family members or members of the internal management team. It can involve complete or only partial change in ownership. Typically the involvement of the owner doesn’t suddenly stop cold.
An exit plan, by contrast, is just that – a planned exit from all responsibilities of running the company AND a divestiture of the owner’s ownership interest as well. While it’s true that some exits involve the owner remaining partially involved for some period of time, this is almost always designed to maximize the purchase price or ensure that any contingent elements of the purchase price are resolved to mutual satisfaction.
It’s true that both plans will have some elements in common. But there are important differences. For example, remember that a succession involves passing the company to people who already have knowledge of the company, often in-depth knowledge, while an exit involves a sale to (probably) strangers. So, let’s briefly clarify some of the major differences.
Some of the unique elements of a succession plan:
- Where children are the preferred choices, an assessment of their willingness and ability to step in, with or without parental involvement
- Where the management team will be the successors, an assessment of the their preparedness for taking on that role
- A plan for providing training/coaching to fill important gaps in knowledge or experience
- Decisions about any equity consideration that might accompany the transfer of responsibility
Some of the unique elements of an exit plan, by contrast:
- Definition of discrete actions that should be taken to increase the enterprise value of the company, and then the “sub-plan” to implement as many of them as possible
- A dry run due diligence review to help prepare for the real one when the first prospective buyer’s Letter of Intent (LOI) shows up, along with their CPAs and lawyers.
- Engagement of an M&A attorney and an investment banker to support the process, handle the legal issues and create an environment that will earn the best selling price.
Admittedly this is a short and incomplete list of differences, but I hope you get the point. While a decision to move forward with a succession will involve much less complex planning than a sale and exit, neither is a walk in the park. Recognize which direction you want to go, pull together your team to lay out the plan, and don’t confuse succession with outright exit.
We have a long-term client that manufactures custom products for their customers. One of those customers contributes over 80% of the company’s annual revenues, a situation that has been in place for years. We call that “concentration,” a condition that is usually seen as a serious business risk, because losing such a customer can make huge dent in revenues and thus profits, perhaps even causing the failure of the business. Add to that a condition that all those products are made to the design requirements of the customer, who also own the designs and the exclusive right to decide who can use those products.
How can you possibly look at such a business as anything but a disaster waiting to happen? How can that be a positive attribute of this company if, for example, the owner wanted to sell it and retire? Technology evolving as it is today, so much manufacturing production is now done in Asia at much lower cost, and access to alternative suppliers for most everything is easier today than ever before. Our client’s (former) CPA told them over 20 years ago that they should sell it and run, because everything was ultimately going to be made in China.
So how come they’re still around? How come they’ve experienced some of the most profitable years in the history of the company over those same 20 years? How is it that their huge customer hasn’t gone away for any of the reasons outlined above? The answer lies in managing that concentration and managing the relationship. Here’s how this company is doing it:
- Many of their products require very precise quality standards, that they manage and adhere to scrupulously. Very high quality consistently delivered. Strong cost accounting controls.
- Most of their products require a steep learning curve to manufacture correctly, something not easy to duplicate (remember all those stories about manufacturing going overseas and then coming back again? This is one reason for that).
- Because their products often go into equipment with a long service life, some of their products have been made and delivered for years without changes, making the manufacturing process easier over time as familiarity lowers production costs, learning curve, etc.
- They have consistently been responsive to their customers’ shifting production needs, often shuffling scheduling to help their customer meet JIT requirements, thus lowering the customer’s need to keep large inventories on hand.
- As a result of all that, their customers’ buyers keep coming back because it’s easier to go to a supplier that you know will perform than to go through the pain of finding and training another supplier and living through their learning curve.
Is this the kind of company you would try to build from the start. Not likely. But if you have one, or inherit one, perhaps there is real lemonade that can come from your lemon(s). You build on your strengths, fix your weaknesses, and tout your company as a success story whose revenue is amazingly predictable and predictably profitable. Any buyers out there?
The Private Directors Association (PDA) put on a really good virtual session this week on the subject of evaluating the directors of a privately owned company. Their thoughts and ideas apply more broadly than the topic might suggest – they are applicable to advisory boards, nonprofit boards, and even public company boards (although the complexity goes up steeply for those boards). So in keeping with my ideal audience, that will be the last time I mention public company boards. But for the rest of you who are not involved in those boards that will not be named, the highlights of the presentation (colored somewhat from my own board experiences) are these:
- While evaluation of board member performance is not widely conducted now, the trend is on the rise, mostly due to performance pressure caused by today’s dynamic economy and the trends toward addressing diversity and inclusion (the buzzword being “D&I”)
- Any assessment of individual directors needs to be carried out with complete confidentiality to preserve the working relationship of the board, the feelings of individual directors (yes, they have some too), and the ability to take appropriate action without incurring legal risks along the way. That means discussions between the Chair/CEO and the affected director on a 1-on-1 basis.
- By contrast, a problem director situation that is not corrected – by performance adjustment or removal – creates an environment in which the faith in board judgment is damaged, or as one presenter said “you lose the credibility to lead.”
- One of the key obstacles to effective board evaluation is balancing the need for board member collegiality vs. the need to deal with a problem or conflict.
- Key tools that have proven useful for board member evaluation include:
- Surveys of individual board members that are constructed to help a director evaluate their own performance as well as solicit their concerns about other board members,
- A governance committee whose job includes working with the CEO or Board chair to create and implement a grading system to guide the process based on the goals of the organization, and
- The availability of outside consulting firms that specialize in helping companies create the infrastructure for such a process, and even to conduct the evaluations as na independent third party.
- A periodic Board refresh, as they called it, gives an organization a reason to clean house periodically without pointing fingers. I’ve found that term limits for all board members is a clear way to accomplish this; and really good board members can be asked to stay on key committees, be re-appointed a year or so later, etc. We’ve done this very effectively on nonprofit boards I’ve served on.
For those of you who are directors and want to be better, for those who would like to become board directors, and for advisors to private or nonprofit boards, you might think about PDA membership, as there are now 2 local chapters, Orange County and Los Angeles. Call me if you want more details.