Preserve and Protect Your Business On All Fronts

Today I would like to discuss four areas to preserve and protect business value:

Reducing Expenses
Minimizing Risk
Minimizing Taxes
Ensuring Business Continuity

Expenses
Most owners have, by now, taken action to eliminate non-essential expenses. These actions, or reactions to the faltering economy, typically include terminating or laying off employees, reviewing company financial information, eliminating “perks,” and reducing and/or eliminating employer contributions to 401(k) plans. If you would like more information about what other companies are doing to reduce expenses, please contact us.

After the initial round of expense reduction, there may be more you can do — even if you have resuscitated your company’s cash flow. Cost cutting increases gross margins, increases cash flow, and thus increases business value. Second-round cuts often include benchmarking expenses to industry standards to see if they vary significantly from industry norms. If they do, owners are asking the hard question, “Why?”

Another strategy is to subject employee costs to further scrutiny. For many businesses, labor constitutes a huge chunk of their budgets, but for all business owners, having a successful, motivated management team in place is critical to a successful exit. Because balancing these two is no easy task, many owners are conducting employee-by-employee reviews, are re-aligning salaries and incentive programs and evaluating whether their current employees are the best ones to meet today’s economic challenges.

Risk
Every company faces risk from both inside and outside its doors. Today’s economic climate, however, has increased the level of risk that many companies face from claims of discrimination by laid-off employees, employee fraud, or patent infringement by desperate competitors.

While many owners see their Property & Casualty (P&C) premiums as a great place to cut costs, they forget that their exposure to risk is heightened and their ability to absorb a claim (given their weakened financial state) is compromised. Consider meeting with your P&C firm to examine deductibles and coverage limits, but this year, ask questions about the strength of the insurer and its loss reduction programs.

Smart owners also are taking a close look at the financial condition of their suppliers and customers. Especially if owners have depended on a small number of suppliers, or if suppliers are in an especially hard-hit industry, owners are diversifying their supplier lists. They also are reviewing credit-granting policies, updating them as necessary and most importantly, adhering to them.

Many owners find themselves on the receiving end of “let’s talk about that line of credit” calls from their bankers. Others are pre-empting that call by creating written plans that show how their companies will respond to today’s challenges. They are sitting down with their bankers to examine those plans and often renegotiating the payment terms of their loans.

No discussion of risk is complete without considering the personal component: Do you have a plan to protect your personal assets? And, does that plan include ensuring that your family receives full value for your company if you do not live to sell or transfer it? Since each owner’s situation is unique, we encourage you to schedule a time for a frank conversation with your advisors about your family’s exposure to risk.

Taxes
Every new presidential administration brings with it new tax rules affecting your company. Under the Obama Administration, the rules governing the treatment of net operating losses have changed as have those related to the built-in gains assessed in conversion from a C to S corporation. If you haven’t already done so, take time to talk to your CPA about his or her ideas about how these (and other) new rules can reduce your personal and company’s tax liability.

Business Continuity
This last area of protecting your company during tough economic times is one that many owners overlook: business continuity. Is your business continuity plan appropriate for the current value of your company? Many owners created their plans when all they could foresee was growth. If that is your situation, we remind you that the disability or departure of a co-owner could have a devastating affect on your company. The departing shareholder will want his or her buy-out at the highest reasonable value — one the remaining shareholder may simply be unable to pay (given cash flow constraints) or, in this credit market, unable to finance.

Unless your business continuity plan specifically states that the value of the company will be its fair value — as determined by an impartial appraisal — on the date of the triggering event, one of you (the remaining or the departing shareholder) will be unfairly harmed and the other unfairly enriched. So, pull that business continuity agreement out of your bottom drawer and read it carefully.

Tough Times Crown Cash Flow As King

In the previous issues of this newsletter, we outlined two of the four areas where business owners who want to both survive in today’s economic climate and emerge from it poised for growth (or sale) can focus their energies. As you may recall, the areas we have already talked about are creating value and creating revenue. Today, we discuss the third area: quantifying cash flow.

As you consider ways to meet today’s economic challenges, a vital first step is to focus on company cash flow.

What do we mean by cash flow? The amount of cash left over after the company has paid its expenses. Common add backs to cash flow include:
• Excess Compensation
• Shareholder Distributions
• Owner Perks
• Retained Earnings Additions
• Depreciation and Amortization deductions

We recommend that you take a hard look at your company’s monthly cash flow statement. Do you really understand what it is telling you? Today every owner must become an expert in reading cash flow statements. If you are not as comfortable with your company’s financial statements as you are with your favorite novel, ask for help. Your CPA can quickly teach you to “read” or analyze your financial information so that you can quickly determine, on a monthly basis, your company’s cash flow.

Why is cash flow “king?”

Cash flow has always been hugely important in both running a successful company and in orchestrating its successful sale, but today cash flow is king. Why?

1. Cash flow is the lifeblood of a company. Owners must understand —and be able to measure —where cash comes from and where it goes. It is an accurate indicator of the financial health of your business. Unlike more subjective measures, it makes no assumptions and entertains no preconceptions.

2. For the reason stated above, cash flow is a critical component of what your bank wants to see. Unless you are able to accurately establish current cash flow, banks will be reluctant to grant or renew financing.

3. Quantifying exactly how the current economy has affected your company’s cash flow (as opposed to just revenue) provides a credible way for you to predict the impact of further expense reductions, strategies to improve revenues or strategies to improve gross margins. If you don’t know —at this moment —your company’s cash flow position, you cannot effectively manage your company and you can’t predict or project future cash flow.

4. The financial reason you are in business is to grow shareholder value. Shareholder value grows as cash flow increases.

5. In troubling times, employee fraud (such as embezzlement of company funds) tends to increase. The best way to detect fraud is to review cash flow/financial statements on no less than a monthly basis. We are assuming, of course, that your company is producing monthly financial statements. Anything less frequent than that and you run the risk of not reacting to something that “isn’t quite right” as quickly as you should, and not knowing where your business is or where it’s heading.

Once you’ve got a handle on current cash flow you need to create, based on today’s economic climate, a projection of future cash flow. Begin with an accurate picture of current cash flow. Then, create three projections: one for the best-case scenario, one for the worst and one for the likeliest scenario. All of those projections should include assumptions about:

• Customer Expectations/Policies
• Supplier Options
• Actions of your Competitors
• Profitability
• Pricing
• Product Lines
• Equipment Replacement

Keep in mind that your employees may not be able to create these projections. They may have their hands full managing the day-to-day issues. If that’s the case, seek the help of your CPA, or consider hiring someone on a temporary or project basis. These projections are simply too important to put off until next week, next month or next quarter.

Indecision: The WRONG Decision

“I haven’t decided what I ultimately want to do with my business, or when I want to exit, or how much money I’ll need, or whom to sell to, so how can I plan my exit? Besides, I don’t want to exit right now.” If you’ve said this, or thought it, you are not alone. Many business owners are either overwhelmed with the thought of exiting or are so busy fighting daily business fires that they think they cannot plan their exits.

Know that in your indecision, you are making a decision. As Winston Churchill observed, “I never worry about action, but only about inaction.” When you take a passive attitude toward the irrefutable fact that you will–one way or another–leave your business, you are deciding to settle for a least profitable exit for yourself and for your family.

If you are an owner who isn’t sure about what you want, or when you want to leave, why is it so important to decide to act today? Why can’t you wait?
Preparing and transferring a company for top dollar takes time—on average about 5 years. Most of those years will be spent preparing the business for the transfer. If you decide to sell to employees or children (two groups who rarely have any money), they’ll need that time to earn the money to pay you for your interest.

More time often equals greater reductions in risk. Time can be used to design and implement income tax-saving strategies, build value, strengthen your management team, begin a gradual transfer of ownership (not control) to key employees or children. If you wait too long, you probably won’t have time to implement these strategies and you’ll likely end up transferring your business on less-than-ideal terms.

The market does not operate on your schedule and may not be paying peak prices when you are ready to sell to an outside party. Witness the state of the M&A market in 2008 and 2009: activity is almost non-existent in many business sectors and down in almost all.

If leaving a company you’ve worked so hard to build and having little or nothing to show for it, is unacceptable to you, let’s look at a few of your options.

Wait for a buyer. According to Deloitte's Entrepreneurship UK: 2008 survey, 35 percent of business owners said they will wait for a third-party offer for their businesses. Owners in this group believe that one day a buyer will contact them, negotiate a sale, and that will be that. Well, this is a decision of sorts—but one that flies in the face of reality. While few businesses are being sold today, there will likely be a significant number of Baby Boomer business owners vying with you to sell their businesses when the M&A market recovers.

In a competitive buyer’s market, only the best-prepared businesses sell for top dollar. And the owners of those well-prepared businesses will be those who made the decision to act to prepare their company years ahead of the actual sale.

Liquidate. Liquidation is a common exit path for owners of companies whose cash flow is flat and has little probability of improving—absent the design and execution of a business/exit plan. If you find yourself in this group, we recommend that you meet with your tax and other advisors to do the planning necessary to create the most tax-efficient liquidation possible.

Decide to exit and plan accordingly. Start today and take the following steps:
1. Fix a departure date.
2. Determine your financial needs.
3. Decide whom you want to succeed you.
4. Have your business valued to see if: a) should you sell today; and/or b) it has the value necessary to meet your financial and other exit objectives.

Deciding to do something now to create the best possible exit path is not difficult. The failure to act, however, can potentially be fatal to a successful exit. The success of your business exit is simply too important to you (your family and your employees) to leave to chance. Why wait? Why decide not to decide?