June 2016 eNewsletter
Ask the Question - Have the Discussion
Larry Grypp, President of the Goering Center
Sometimes the truth hurts. But what can hurt even more is the fear that it might.
This is especially true when a family business founder or owner begins contemplating inviting their child to join the family enterprise – or perhaps be the leadership successor.
For all the content and guidance and even anecdotal case studies we can offer to family businesses at the Goering Center about the value of having clarity around next-generation succession, we have come to appreciate that for many families these conversations are hard – or imagined to be hard – to the point where they are avoided.
Why is that? In our experience, it’s because there seems to be so much at stake for both parties – and much of that is unsaid or imagined. If my parent asks if I want to be in the family business, does that mean they expect that of me? What if I say “yes,” but I realize they have serious reservations about it? If as the next generation I ask them, am I putting them in a bad spot or seeming pushy? Even if the answer is “yes,” is that the final answer or are there other conditions (and difficult choices and learnings) that might come with that? You can see the swirl of sentiments and hidden anxieties that this question can stir up on both generations.
In some cases, it may not be avoidance so much as either party just takes it for granted the other person “just knows.”
The consequence of that avoidance is enormous. Much more than a hard truth, not having the conversation can endanger legacy, squander family wealth and be a wordless wedge in family harmony. We recommend that a family business have a charter, and that charter ought to lay out the considerations or standards for family employment and promotions – but the first step in that process is clarity around intent.
Questions lead to clarity and clarity leads to commitment – in that order. Pushing through whatever awkwardness, casualness or fear stands in our way, having the dialogue early can clear the path for all family members to commit to the next steps.
Overtime Rule Changes Are Coming - Is Your Business Ready?
Kelly Schoening Holden, Dressman Benzinger LaVelle psc
The Department of Labor (DOL) has issued some proposed changes to the overtime regulations pursuant to the Fair Labor Standards Act. This is the first amendment since 2004 and if finalized, it will have significant impact on businesses.
The major change proposed is an increase to the salary level to qualify for exemption from overtime. The current level is $455 per week ($23,660 annually) and that would increase to $921 per week or $50,440 annually. Obviously, this is a significant increase that will have a substantial impact on who must be paid overtime. Additionally, the DOL proposes to automatically update the salary level on an annual basis for the first time ever. The DOL estimates that it would extend overtime protection to over 5 million workers, which means increased wages/costs to businesses.
There is also discussion to modify the duties test for white collar exemptions. The DOL is proposing a strict division of labor test requiring individuals to spend at least 50 percent of their working hours performing executive, administrative or professional duties. Another change is to the highly compensated individuals. The current salary level is $100,000 and the proposal is to increase it to $122,148.
The DOL sought comments last fall to the proposed changes and it is anyone’s guess as to how those comments will affect the final regulations. It has been reported the final regulations were submitted to the Office of Management and Budget (OMB) for printing and should be issued this summer. Businesses will have 60 days to comply with the new regulations, including reclassifying currently exempt employees into hourly.
If your business has an exempt employee who is below the $50,440 threshold, it is wise to evaluate that position to determine if it makes sense to raise the pay to keep the exemption or change the position to avoid excessive overtime costs.
Why You Should Value Your Business Today Even If You Are Not Selling
David Lingler, Cassady Schiller CPAs & Advisors
In the current economy, no one wants to spend money on something they don't need today. So why do you need an estimate of your company's value when you don't expect to leave for several years or have no plans of transferring any ownership?
Well, you don't need to know the value if you are certain that the value of your company is very small compared to what you will need upon sale or transfer.
Most owners, however, look to the value of their businesses as a major source of liquidity for their post-exit lives. The “intention” is to leave as soon as it is feasible rather than when you are completely burned out. Therefore, most of us need to know the value of our companies now so we can be smart about creating greater business value in as short a time as possible.
Knowing the value of your business today is critical whether you plan to leave your business tomorrow, or in many years because:
An estimate of value establishes your starting line and distance to the finish line.
An estimate of value tells you where your unique race to your exit begins. Your job, whether your company is worth $500,000 or $50 million, is to fill the gap between today's value (the starting line) and the value you need when you exit (the finish line). Based on today's value, your race to the finish may be shorter, longer, or perhaps much longer than you expect. Once you know how far you and your business need to travel, you can begin to create timelines and implement actions to foster growth in business value.
An estimate of value tests your exit objectives.
An estimate of value helps you to determine if your exit objectives are achievable. Let's assume that you decide that your finish line (financial objective) is to receive $7 million (after taxes) from the transfer of your business interest. You also want to complete your race in three years (timing objective). An estimate of value will tell you if the distance between today's value and the finish line is too great to reach in three years. If a growth rate is unrealistic for your business, you must either extend your timeline or lower your financial expectations.
An estimate of value provides important tax information.
First, an estimate of value gives you a basis for analyzing the tax consequences of exit path alternatives. Once you choose your path, the value estimate provides a basis for your tax-minimization efforts. Taxes can take a significant chunk out of a business sale price so the value of your company must usually exceed the amount of money you need to fund your post-exit life. The size of that excess depends on how you and your advisors design your exit, and exit design in turn begins with knowing starting value and the distance to your finish line.
An estimate of value gives owners a roadmap to increasing value.
When owners know how much value they need to create to meet their objectives, it helps them determine where they need to concentrate their time and effort. Instead of hoping to grow value, dedication to a goal enables many owners to exit sooner with the same amount of after-tax cash than owners who do little or no planning. Exit plan success all begins with a starting value.
An estimate of value provides an objective basis for incentive plans.
As you design incentive plans for key employees (such as stock purchase, stock bonus and non-qualified deferred compensation plans, long-term incentive plans, etc.) to motivate them to increase the value of your company (so you can successfully exit and provide golden handcuffs to those key employees) you must base these plans on an objective estimate of value. You and your employees need a current value (or starting line) and a methodology that you all can confidently rely on.
This is Not a Full-Blown Valuation!
Are you thinking, "How much is this going to cost me?" We are suggesting that you need an estimate of value to establish a benchmark, not the opinion of value (conclusion of value) which precedes your transfer of ownership and is used for estate and gift planning.
Estimate of Value
An estimate of value:
- Costs about half as much as a standard valuation opinion,
- Is the basis for the (later and complete) valuation, but…
- Lacks the supporting information contained in a full written opinion of value, and…
- Is used for planning only.
Failure to Value
On some level, we all recognize that we will leave our businesses someday. While you may not yet have a vision for the second half of your life, you do know that the exit from your company is likely to be the largest financial transaction of your life. Does it make sense to go into that transaction and into the second part of your life without an objective understanding of your company's value and how to maximize that value?
Principles for Avoiding Owner Compensation Pitfalls
Seth Morgan, MLA Companies
In closely held businesses, few tangible discussions are as emotional as compensation for owners, especially if those owners are family members.
Early in my experience as a business adviser, my client did what many do – equalize compensation for the owners. To be “fair,” each owner was compensated equally as each of them was working full time in the business and each held an “officer” title.
When we challenged them to reconsider their “fairness” principle, the CEO insisted that it worked, and it did for five more years. However, over time things changed and the “fairness” principle became a significant problem in their relationship. After two years of arguing, bickering, and dialogue, three of the four owners decided to exit the business altogether.
Our client failed to address owner compensation, and as a result, discontent festered – eventually severing the ownership group.
As executives, we focus significant time on the compensation of our people. We consider market rates, perform wage studies, meet with our staff and spend countless hours on compensation plans to help incentivize the behaviors we wish to encourage. Certainly, we can also spend a few minutes considering some wise principles for owner compensation.
What’s the Market?
Start by removing the name of “owner” from the position the owner fills. What would you pay anyone else to be the CEO, President, top sales person, or any other role an owner plays? Don’t place or keep an owner in a particular position, such as CEO, just because he or she is the owner. Ownership alone does not equal qualification for the job. We don’t pay employees if they fail to perform their duties, nor should an owner earn a salary because he or she holds a position they are ill-equipped to perform.
Likewise, consider the company paid perks for the owner in the same way. What business expenses would you pay for any other employee in the same position?
Answering these questions is the starting point for considering proper owner compensation, but it is not the end. There are plenty of ways to reward an owner for their investment and one very well may be a salary. But honesty about the market rate of that owner’s duties is key.
Return of Equity
Providing a regular stream of cashflow to the owner as a return of equity (distributions, withdrawals, dividends) may be wholly appropriate; but it should be above and beyond any consideration of the market rate of the services provided by the owner to that company. Don’t conflate the two.
However, here’s a caution. Depending on your business model and vision for the company, be careful not to distribute away too quickly the profits and cash earned by the business, even if it is the most tax advantaged treatment. A healthy equity balance is important for certain industry financing relationships and a possible sale in the future.
Consider Taxation Separately
Too many companies try to answer the tax question before they answer the questions above. Don’t get in the trap of organizing your business around tax planning (sorry CPAs). Organize your business around principles and policies that will allow your business to grow, thrive, and become sustainable. Once you answer the questions above, it is wholly appropriate then to meet with your CPA and discuss the various ways to accomplish the desired compensation. And it might even be that you mix up the form of compensation (salary versus expense reimbursement versus return of equity) for tax purposes. But you should always be able to answer with clarity the rationale behind the compensation for each and every owner.
Given the various tax and business ramifications, owner compensation can be tricky enough. Once you introduce the emotion of family members or partners, it becomes even more difficult. A dose of good business principles and discipline will pay great dividends in the future.
Intellectual Property Basics
Mark Musekamp, Keating Muething & Klekamp PLL
Intellectual property is a general term given to diverse categories of intangible assets which give rise to ownership and other related rights. Although most are familiar with this term and the categories of assets which it incorporates, few understand the importance of these assets to a business. Even among businesses that understand the value of these assets, few fully comprehend the measures necessary to preserve and grow the value of these assets. Like tangible assets, intangible assets require certain measures to protect and secure their value. As the importance of intangible assets continues to grow, business owners must understand the nature and extent of their rights in these assets. In an effort to provide a better understanding of these assets, this article will address three categories of intellectual property protection, the nature and scope of protection afforded by these categories, and the general procedures necessary to protect these categories of intellectual property.
Although there are three types of patents (utility, design, and plant), because they protect inventions, this article will focus on utility patents. In general, utility patents protect useful inventions that are novel and non-obvious. In order to secure rights in a patentable invention, an inventor may file a patent application with the United States Patent and Trademark Office (USPTO). Provided that the proposed invention meets the novel, non-obvious, and other statutory requirements, an applicant may receive a utility patent registration for its invention. A utility patent registration grants the holder the right to exclude others from making, using, selling, offering to sell, and importing the patented invention within or into the United States. Subject to several exceptions, a utility patent has a duration of 20 years from the filing date of the earliest application. Although enforcement of a utility patent (e.g. writing cease and desist letters, opposing the registration of other patent applications, and filing lawsuits) is not necessary to maintain its validity, enforcement may maximize any potential revenue that could arise through the holder’s exploitation of it. However, the patent holder must pay several renewal fees and abide by certain marking requirements to ensure the continued validity of the utility patent and any enforcement actions involving it.
Trademarks are source identifiers used to distinguish the goods and services of one party from those of another. Common examples of trademarks include words, phrases, logos, colors, sounds, and even packaging in some circumstances. The owner of a trademark may prevent others from using confusingly similar marks in connection with related goods and services and/or from creating a false impression that the subsequent user is associated or affiliated with the owner. Although a party can secure common law (i.e., unregistered) trademark rights simply by commercially using a particular mark in connection with goods or services, these rights will be limited to the territory in which the mark is used. Subject to several limitations, federal trademark registration secures these rights in all territories in the United States. To maintain the validity and strength of a trademark, the owner must continuously use its trademark, enforce its trademark against confusingly similar third party uses, and, if federally registered, pay the applicable maintenance fees. Provided that the owner properly maintains it, a trademark can be protected for an unlimited duration. Given that the strength of a particular trademark depends on the owner’s enforcement of the mark, the owner may want to engage a watch service to alert the owner of any newly filed trademark applications which could be confusingly similar to the owner’s mark.
Copyrights protect original works of creative authorship such as literature, photographs, drawings, designs, music, and motion pictures. A copyright arises as soon as a work is fixed in any tangible medium of expression, meaning that it is written, filmed, typed, or recorded. Although registration of a copyright is not necessary to confer ownership rights or exclusivity, federal registration confers significant benefits such as the right to sue in federal court and to receive statutory damages. Assuming the work is a work made for hire, the duration of a copyright is the shorter of 95 years after publication or 120 years after its creation. The most significant copyright issue for businesses is ensuring that it owns works created by its employees and independent contractors. Generally, a work created by an employee within the scope of his or her employment is a work made for hire and ownership automatically vests in the employer. Although the work of an independent contractor may sometimes be a work made for hire, this is not always the case. As a result, it is necessary to have a written agreement assigning ownership of the work to the party that commissioned it.
Although this article omits several categories of intellectual property, including trade secrets, it should provide the reader with the foundational knowledge necessary to seek out more information about these topics. As businesses continue to rely on intangible assets for a competitive advantage in the marketplace, the value of intellectual property will continue to increase.
Don’t Underestimate the Value of Corporate Culture
Rene Robichaud, The Malibu Group
As a CEO of two public companies each with revenues of approximately $1 billion, Rene Robichaud is well-sanctioned to discuss the importance of corporate culture.
Below, he elucidates on Peter Drucker’s assertion that “culture eats strategy for breakfast” in order to highlight the critical role of a healthy corporate culture in creating value.
Corporate culture is not easily defined. Most businesspeople know it when they see it in action, but how would you define the corporate culture of a company you are looking to acquire? Below is a simple culture framework in order to get started:
1. Define the company’s values: standards they will not dip below for any reason.
2. Define the company’s beliefs: ideas about how the business world works best.
3. List the company’s habits: regular activities and relationships that flow from their beliefs and values.
Overall, a healthy corporate culture is more stable than a smart strategy in a dynamic economy. In the M&A arena, there are several studies that show most acquisitions fail to create long-term wealth for the buyer because:
1. The acquirer paid too much.
2. The strategy of combining acquisitions with a “platform” company (the initial acquisition made by a private equity firm in a specific industry or investment type) meant to enhance revenues and control costs did not work.
3. The culture of the acquiree never meshed with the culture of the acquirer, resulting in the loss of key people, customers and value.
If the selling company’s management team can properly describe its successful culture, the acquirer’s integration process will have a higher probability of achieving the synergies that make a deal work. Considering this, you may want to go through this culture definition process if you are thinking of harvesting one of your divisions or companies in order to help the acquirer get more comfortable with the deal.