B2B CFO^® (602) 296-6888

ESOP’s may be used as a means to allow shareholders with management responsibilities in a closely held company to gradually sell and ease out of the business (exit strategy) over a number of years and reward employees with a benefit tied to corporate performance (i.e. - stock value increases).

Implementing and administering ESOP’s are very complex and can wreak havoc if not properly structured. ESOP’s are not for the faint of heart and before pursuing down this road owner(s) should clearly understand the benefits and pitfalls of an ESOP and look at other alternatives carefully.  ESOP’s are qualified (i.e. tax qualified) defined contribution employee benefit plans that primarily invest in the stock of the employer. If a company performs poorly the value of its stock falls and so does the employee’s retirement account value.  There are DOL, IRS and fiduciary rules that MUST be adhered to throughout the entire lifecycle of the ESOP that can be onerous to the owners especially if the ESOP fails or cannot be sustained.  ESOP’s can be costly to form and maintain!

ESOP’s are not for companies that are volatile or subject to major swings in profits. Commodity product companies typically are not good candidates. Employer contributions are usually required annually, and if not paid the ESOP Trust may fall into default on its obligation to the company unless provisions provide otherwise. Finally, ESOP’s almost always leverage the company (leveraged buyout). That’s just one more thing to worry about with bankers. There are also the GAAP accounting rules which are confusing at best.

However, a properly structured ESOP has many benefits for owners wishing to exit the business and for employees committed to staying on for the long haul.  ESOP’s allow the selling shareholder to sell stock to the employees via an ESOP Trust.  In the simplest of terms, the ESOP Trust is obligated to pay the selling shareholder for the value of the stock sold to the ESOP Trust, which holds the stock for employees until employees retire and cash out.  Employees vest in their account overtime. Therefore they must stay with the company to benefit. This is one of the main selling points of an ESOP, employee retention. The proceeds of the stock sold by the selling shareholder usually is tax deferred (section 1042), essentially indefinitely as long as certain IRS rules are adhered to.

The company is allowed to deduct dividends paid and any contributions (required) made into the plan providing a nice tax shelter. The tax savings may be sufficient to payout the selling shareholder over time.

Determining whether an ESOP is right for your company requires careful investigation by experienced ESOP and accounting professionals.  Setting up an ESOP may take from three to nine months and can be costly.

If you need assistance with ESOP’s or finding qualified ESOP professionals please contact me at 480.403.1483

Many companies develop strategic and operational plans only to have their value dissipate due lack of accountability.  Creating an accountable organization is an ongoing continuous process. 

“Accountability is a concept with several meanings. It is often used synonymously with responsibility, answerabilityand other terms associated with the expectation of account-giving. In leadership roles, accountability is the acknowledgment and assumption of responsibility for actions, products, decisions, and policies including the administration, governance, and implementation within the scope of the role or employment position and encompassing the obligation to report, explain and be answerable for resulting consequences.” (Wikipedia).

The owner is accountable to a number of stakeholders of the company, individuals or companies that may not have an ownership interest but have an interest in the success of the company.  Stakeholders include vendors, bankers, and employees as well as the customers who depend upon the product or services.  The managers need to be accountable for the promises and performance of the company against plans and projections.  To be held accountable, stakeholders must be able to compare actual performance to the promises made, comprehend how performance differed between the promise and the actual, and communicate changes to future performance that the company will implement from that point.

“Comparing” requires timely generation of financial statements and any other standards used as Key Performance Indicators (KPI’s). “Timely” means that they are produced after period end so that management can affect the next operating period.  “Period End” because some measures might have weekly timelines, some monthly and still others quarterly.  In the restaurant industry, nightly P&L’s are generated to monitor performance.  Financials generated the middle of the following month can’t be used to affect performance in that month.  To compare, the goals and indicators need to be side by side for easy comparison.  Without this specificity, you have only set up potholes for failure.

“Comprehending” means understanding the root cause of differences.  Changes in sales, the product mix of the sales, staffing – all of these impact the differences between the budget or forecast and the actual performance.  Often times increases in sales are not accompanied by comparable increases in profitability, so understanding why the bottom line is better, or worse, is important in changing behaviors later.  9 times as much time should be spent on analyzing the results as is spent preparing the comparison data.  Since timeliness is important to affecting current behavior, having your CFO prepare the data quickly and efficiently is key to driving organizational change.

With the crystal clear expectations set from the beginning, Accountability means going public.   Communicating is publicly acknowledging both the successes and the failures of performance, creating a system of notification and dialogue regarding results.  Communicating results requires dialogue to confirm that the message was transmitted and questions have been resolved.  Most importantly, Management must communicate an action plan to change behaviors to continue or to improve performance in the next period.  Invite feedback – look for people who are actually doing the work to reflect on their performance, their feedback may contradict the numbers, and add context or provide explanations that numbers alone can’t provide.  Most importantly communication provides connection – enabling people to connect their performance to the overall performance of the company.  Communication occurs verbally and visually –signs, graphs or pictures help to reinforce the message.

Preparation, Execution and Accountability – the three most important aspects of your 2010 plan.  Your CFO is a valuable resource in developing the plan, providing actionable goals to enhance execution and providing the comparisons and analysis for holding individuals accountable.  All companies need a CFO, most don’t need one full time.  With your B2BCFO, you have a seasoned professional available when you need a CFO.

If you are fortunate enough to find that your business has moved back into a growth phase or you are beginning to see accelerated growth in early 2010, congratulations.  This is good news and could signal a reduction of the impact of the recession on your bottom line.  It also means you’ve got to keep a close eye on your bank account. 

Increases in revenue are good, but if not monitored carefully, the improvement to your bottom line may be less than you anticipated.  Please find a few scenarios below to consider:

• Revenue is increasing, but not as fast as unit sales – you may need to review the profitability of your individual products to ensure that you are focusing the right amount of attention on each product.  If you’re seeing movement in low end merchandise, consider motivating your sales force with stronger incentives around growth in your higher profit product lines
• Gross revenue is up, but gross margin isn’t – is it time to review your vendor pricing and put some components up for bid?  Have you seen an increase in vendor control over pricing, necessitating a review of end consumer pricing?  Are you experiencing an increase in unit costs associated with volume reduction in 2009?
• Revenue and Gross Margin have increased, but profits remain stagnant – Have you reviewed your staffing to ensure that the number of employees make sense, and their salaries are competitive?  Have you seen contractual increases in facilities expenses?  Are accruals appropriate, or is their a possibility you’re building up some balances on the balance sheet?  Do you have adequate internal controls established to minimize the potential for employee theft?

Even if all is well on the income statement, you may want to take a closer look at your balance sheet.  Some items to consider include:

·         Cash – Do you have enough cash to sustain the growth?  In other words, if sales continue to accelerate and you need to hire additional employees, or purchase components for manufacturing or goods for resale, will you be able to meet demand?

·         Accounts Receivable – Are you collecting quickly enough?  Are there vendors that aren’t paying you in accordance with your terms?  Is customer billing prepared and distributed in a timely manner?

·         Accounts Payable – Do you pay your vendors on terms, or “as soon as the bill arrives”?  While it’s important to maintain your credit rating, there is no real need to pay an invoice until it’s actually due (unless you receive a discount for early payment).

Taking the time to understand these items may save you from a lot of headaches down the road.  In addition, if you are still looking at a future cash shortfall in spite of your attention to these details, the time to start seeking a line of credit is now.

The centerpiece of the bill, a top administration priority, is a tax credit designed to encourage hiring.

Companies that bring on employees who have been out of work at least 60 days would not have to pay their 6.2% share of federal payroll taxes for the rest of the year. If the worker is still on the books in a year, the business owner would receive an additional $1,000 tax credit.

Is this enough to encourage small business job growth?  Some argue that firms won't hire unless there is a real need regardless of the incentives.

(Excerpts from the Wall Street Journal)

Large companies employ top executives in sales, operations and finance.  They provide the strategies and management expertise required to bring in customers, competitively produce the firm's products or services and provide the financial management and planning required to maximize the firm's profitability and growth.

Small and mid-market companies also employ top sales and operations executives, but not financial executives.  The majority have bookkeepers or controllers who process financial transactions and generate financial reports. But, they cannot provide the financial strategies or offer the level of financial sophistication, problem solving, and strategic financial management these companies need to maximize profitability and growth.

Companies without a CFO are at a disadvantage.  Many small and mid-market firms have sophisticated operations and complex cost and financial challenges like large companies.  They need the expertise of a senior financial executive… but not full time. Nor can they afford the cost of a full time CFO.  These firms often seek financial advice from their CPA firms who provide tax, reporting, and general financial guidance but do not have the corporate experience and specialized skills that CFOs excel in.

B2B CFO^® provides CFO services on an affordable, part time or as needed basis and is the largest CFO firm in the U.S. focusing on small and mid-market companies.  With over 145 partners in 39 states, B2B CFO^® provides small and mid-market companies with the financial management they need to prosper.

What are the benefits a B2B CFO^® partner brings to small and mid-market companies?  Cash, profitability, and growth:

In Summary, a B2B CFO^® partner,

• Allow Start-ups, small, and mid-market companies the advantage of a CFO.
• Help drive revenue and profitability that far exceeds the cost of their services.
• Help reduce "administrivia" so Owners/CEOs can focus on leading their companies.
• Help Companies without a CFO gain significant competitive advantage and improve profitability.

CASH. WE HELP YOU GET IT.^TM

How Can They Help Your Company?

The preparation of timely and accurate financial statements is critical to the success or failure of a business. The Chief Executive Officer, owner, partner or a member of the senior management team of a business must review the financial statements and have a good understanding of them. Visualize a funnel, with all the daily activities and costs of a business - sales, production, distribution, advertising, promotion, warehousing, engineering, research, accounting and administration - dropped into the top of this funnel, with timely and accurate financial statements coming out the bottom of it. Each and every internal and external stakeholder in the business - owner, shareholders, partners, management, employees, suppliers, landlord, bankers, legal counsel, consultants, leasing companies, federal and state tax agencies, credit agencies, potential buyers and/or sellers of the company - all depend upon and have a vested interest in the issuance of timely and accurate financial statements, the review of the financial statements and an understanding of the financial statements.

The preparation of timely and accurate financial statements creates confidence, credibility, reliability and business awareness of the owner and senior management in the eyes of bankers and other financial institutions and investors who provide cash and working capital to the business. Bankers and other financial institutions are more apt to provide the necessary cash and working capital when they have confidence the owners and senior management know what's happening in the business. The greater the level of confidence bankers and other financial institutions have in timely and accurate financial statements, the easier and faster it is to obtain the necessary cash and working capital at attractive interest rates, with satisfactory covenants, terms and conditions and the easier it is to increase cash and working capital as the business grows. This is especially valid when the business experiences ups and downs during the various economic cycles of the domestic and worldwide economy.

The internal review of financial statements and especially management's understanding of the financial statements are critical elements in making proper strategic and operating decisions regarding the business. Timely and accurate financial statements provide key financial ratios and trends, in comparison with previous months and years and in comparison with industry peers. The understanding and analysis of these factors provide owners and management with the ability to anticipate cash and working capital needs before events occur in the business. There is nothing worse to owners and management than to find themselves with inadequate cash and working capital to grow the business when an opportunity is presented to it. Understanding financial statements, financial ratios, inter-relationships among the various business functions - sales, production, warehousing and inventory control, engineering and accounting - is the key to a successful business. It enables the business to better budget the future and not find itself in the difficult and sometimes insurmountable situation of having no cash nor working capital to fulfill its objectives and insufficient or no time to explore options to obtain cash and working capital.

Timely and accurate financial statements understood by owners and management, enable them to look at "what if" scenarios. What is the impact on cash, working capital and profits if the business grows 15%, 20%, 25%, 50%? What is the impact on cash, working capital, expenses and profits if greater promotional programs are offered to customers? What is the impact if the business expands distribution domestically and internationally? What is the impact if the business introduces new products?

The preparation of timely and accurate financial statements and the analysis and understanding of financial statements empower the owner and management to significantly control the business's direction and destiny on its own terms and conditions and achieve its long-term goals.

A B2B CFO^® partner can help your business prepare timely and accurate financial statements and understand their impact on your business.  

What is the difference between a good CFO and a great CFO?  Maybe we should start with some basics…what does a CFO do anyway?  Typically, these responsibilities fall into three general categories:

Accounting – Oversight of the Controller function.  Typically the controller is responsible for the accuracy of the reporting of financial information; in other words, accounting and accounting personnel.  This function tends to focus on activities that are in the past as well as protecting the assets of the company.

Treasury – investment of money, liquidity, minimizing the risk that the company faces, bank relationships and managing the capital structure of the company all fall under this function.

Economic Strategy and Forecasting – A CFO should be able to identify areas that provide the greatest opportunities for the company as well as those products or activities which are least profitable for the company.  With this data, the company can begin to make adjustments to help maximize profitability.

In the long run, the most important thing that a CFO does is help their companies see into the future.  When a company can see the direction that it is headed there is usually time to make alterations so that a different outcome can be achieved, if necessary.  I believe the ability to see into the future is one of the most important aspects that any CFO can provide. 

 As a W2 CFO, one of my bosses would tell me, “Mike, you’re the policeman.  You know what is supposed to happen.  Your job is to make sure it does.”   To do that, the company needed to have a couple of key items.   First, the company needed to develop a business model.  Depending on the complexity of the business and number of business sku’s, this could be a big undertaking.  Fewer sku’s or product families simplify this process. 

I’ve written earlier about budgeting for balance sheet items.  The implications for the business are enormous.  When you include balance sheet items, you begin to develop a process that allows you to forecast the effect of changes to assets and liabilities on the entire organization.  Forecasting the balance for cash, accounts receivable or the line of credit won’t be perfectly precise.  Instead, the focus should be on the general direction of those items.  This model should be able to provide answers like will there be enough cash for what we intend to do.  How much availability will we have on our line of credit?  Will inventory and accounts receivable be able to support our line of credit?  These are critical questions.  Knowing that you will be short of a key resource provides the opportunity to make adjustments.  That knowledge creates tremendous freedom.

A KPMG study conducted in 2000 determined that only 17% of Mergers and Acquisitions examined created a substantial return and, even more discouraging, 53% destroyed value. Validating these findings, a six year study by Business Week showed that 61% destroyed value that existed prior to the acquisition.

Which is why Warren Buffett, in a recent shareholder letter said, “Don’t ask the barber if you need a haircut”.   It was his thinly veiled dig at Wall Street bankers and the perverse incentive system for corporate “advice” on mergers and acquisitions — namely that bankers are paid only if a deal is completed. Given how the incentives work…you will get a haircut.  Buffett, of course, is no stranger to deals and he’s got an idea for companies that think they need counsel: reward one advising bank if the deal goes through, and another if it doesn’t. 

So…what are the implications for smaller companies?

For most business owners the most significant M&A deal they do will be the sale of their company.  There are 20 million companies with employees under 1,000, and about 70% are expected to change hands in the next 10 to 15 years.  But only about 20% of companies will actually complete a successful sale.  Many owners begin their Exit Plan by speaking with a Business Broker or M&A advisor – transactional advisors who only get paid for a sale.  So, it’s no surprise that they are advised to get the haircut.

A better way to begin an Exit Strategy plan is to discover your own goals, personal circumstances, and needs which can depend on how you treat your business – as an investment or as a lifestyle, whether you have developed independent retirement funds, what your family and estate tax situation is.  After a review of these factors, you can then evaluate some Exit options – which might include Private Equity, Management buy-outs, ESOPs, and even strategic gifting – as well as a Sale.

Once this review is complete, you can now pick an advisory team.  If a sale is indicated then it will be time to employ a value enhancement process to maximize sale proceeds, and to engage with a reputable M&A company.  Other advisors will include experts in legal, estate, and tax matters.  For a full discussion of Exit Strategy Planning, contact a B2B CFO® partner.  David Kirkup – 404 348 0326 and dkirkup@b2bcfo.com

When an organization conducts its strategic planning cycle, close attention is paid to the sales plan, budgets and the elements of the cost of goods sold.  Organizations look at the controllable costs – Material, Supplies, Labor, etc.  But when it comes to benefit costs, the concept of “Planning” seems to be counter intuitive.  Most organizations consider them almost uncontrollable and either “grit the teeth and bear it” response to premium increases imposed by the insurance companies or carving out benefit levels or value and cost shifting to the employees to save the increase, getting  the same or less for more.  But are these really sensible reactions for an expense that is typically the third largest expense after materials and labor? A Strategic Benefit Plan will significantly capitate or reduce total premiums paid without affecting coverages and needs to be a part of every company’s strategic and operational planning cycle. 

The first step to establishing a Strategic Benefit Plan is to realize that a company can significantly affect premium costs.  Just this change in mindset alone is a significant difference in approach.  Just as we plan our revenue targets for the next three to five years, sit down and plan what costs the company can absorb and still meet its performance targets.  Document the average per employee cost targets for each of the planning years.  Remember the SMART goal acronym and apply it to these targets.

Just as you would do a SWOT analysis on sales growth targets, you now need to do a similar analysis on the risk pools that cause premium growth.  What are the factors that had led to your historic premium growth?  Over the next 3-5 years, what other factors may affect the employee pool?  What about the dependant pool?  Age, demographics and other risk factors need to be considered.  If you plan growth in your employee pool,  how will your company control (within the law) the potential risk factors that you may hire into your current pool?  Document your approach and findings to support that change in strategy.   This is especially important for groups smaller than 100, where utilization reports can be hard to extract from the insurer.  

Controlling the costs of your existing pool of employees requires a pool of funds without increasing the overall costs of your current health care plan.  The best way to develop that pool of funds is to move to a high deductible plan from your current plan with a Health Reimbursement Account (HRA) component.  For a 100 employee plan with a $500 can cost an average of $10K per employee per year or $1,000,000 in premium per year.  Moving the deductible to $2,000 can reduce the overall premium 20%, or $200K.  So that there is no affect on the employee, your HRA will reimburse employees for the $1,500 difference between the old deductible and the new deductible, or a maximum risk of $150K.  The minimum net savings is $50K.  But since most employees rarely hit their deductible, most of the $150K is saved per year – about $125K.

This is where the work stops for most companies.  They take the total savings of $175K to the bottom line and congratulate themselves.  But the savings are a one-off.  The next year, premiums will increase 20% and the steady drum beat of growth continues.  A strategy puts into place a plan that affects the long term growth rate of the target.  Your strategy needs to affect the Weaknesses and Threats of your risk pool.  Like any other risk, your need to assess your exposure to those weaknesses and threats.  The best way of doing so is to have your employees take a “Health Assessment” – an annual battery of tests which can tell you how your overall population fares for cholesterol, blood pressure, etc.  Your insurance agent should be working with you to assemble those tests based on your SWOT analysis.  These targeted assessments, along with your utilization reports can reveal the overall population risks your company experiences.  Once the exposure risks of the overall population are understood, you and your agent then tailor your wellness programs to address those specific risks.  For example, if your employee population is overweight but non-smoking, your wellness program will stress weight loss, not smoking cessation.

Progressivity is important in any strategic plan – all goals shouldn’t be achievable in the first year - so the access to the HRA reimbursement is adjusted from year to year.  Key to the strategic plan is making the source of the risk factor progressively accountable for the long term cost controls.  For example to be able to access all $1,500 the second year, the employee must be enrolled in a wellness program that addresses the risk factors of the employee population.  In the third year your company could add a requirement that the dependants have a Health Assessment.  As your company expands the pool of participants in the Assessment program and adjusts the parameters of the wellness program, the annual premium costs will level off as the number and size of the claims are reduced.  You and your agent should be actively managing the wellness program and progressivity each year to address changes to the assessed risks of the employee pool   to protect the value that the company is able to offer.

Does this work?  In case after case, annual premium increases level off after the third year of implementing a Strategic Health Care plan.  This occurs in both union and non-union environments, office and blue collar.  It is estimated that for every dollar spent in targeted, actively managed wellness programs, three dollars is saved in claims and premium costs.

Bending the cost curve requires an active health care strategic plan.  Understanding that you can plan your healthcare costs by knowing and targeting your risk exposure is the first step.  Create a pool of savings that can be used to incent your employees to participate in the strategy – they need to have some skin in the game.  Create annual targets based on participation in the wellness program, increasing their rewards based on their – and their dependants – participation.  Actively manage the wellness program to respond to the risks of the population – the risks will change over time by age of the employee base and through addition of new employees, birth of dependants, etc.  Implement your strategic health plan and eliminate increases in your premium expenses.

Here we are in our second consecutive year of a challenging economic environment that spans almost every industry.  Every day we are reminded of this with still high unemployment rates, less than hoped for corporate financial results, bankruptcies and foreclosures, low consumer confidence, etc.  With this news constantly put before us, I frequently hear from business colleagues that it isn’t possible to succeed in this environment.  However, the one commonality with all of these is that business owners generally cannot control them in the sense of the larger economy. 

Instead of crawling into a cave and hiding, a better alternative is to focus on the things that we can control in our businesses.  There are many things we cannot control, some of the larger macroeconomic issues listed above are among them.  What then can we control?  To name just a few, we can control new product development, marketing, internal costs, operational efficiency, reliance on debt to run businesses and the amount of time and money we invest in growth (i.e., resource allocation).

To illustrate a more positive approach, I provide the example of one of my clients.  Their industry was down about 25% in 2009 and the business was definitely feeling the downturn early in the year.  During the 1^st quarter, a key competitor went out of business and liquidated.  Instead of sitting on their heels and letting the poor economic environment hold them back, the owner and his team sprung into action.  Together we were able to quickly put together a financial projection for the business.  Based on the projection, the client decided to hire the competitor’s top salesperson, a key customer service rep and a technical expert.  We also worked with the client’s bank, presented the financial plan, and were able to increase the line of credit to support the several million dollar increase in business.  By the end of 2009, instead of being down 25% and having real struggles, the business was up 7% for the year and had increased market share in a very competitive space.  Already this year, my client is expanding their warehouse and office space in anticipation of future growth.

The lesson here is that prudent risk even in the face of economic uncertainty can provide the impetus for excellent financial performance.  Here are some thoughts that come to mind when I think of ways to be more aggressive in this shaky world we are in right now.

·         Invest in new equipment that will reduce manufacturing cost and increase gross margin.  The financial tools to use to help with this decision are a return on investment and discounted cash flow analysis.

·         Develop or acquire a new product / service that brings unique value to your market or provides access to a previously untapped market.  The financial tools here are similar but in this case, I would also suggest a pro forma P&L.

·         Advertise your product, rebuild your website or add the ability for customers to purchase from your website to stimulate new sales.  Similar financial tools can help bring facts to this decision.

Let’s not allow what we’re hearing in the media and from the government cause us to stifle our businesses.  There remains a tremendous amount of opportunity in every marketplace.  Taking advantage of these opportunities now requires a more analytical approach followed by a good plan of execution.  A plan is only that, a plan.  However, a well thought out plan with good financial projections can lead to a more certain and acceptable outcome.

Wishing you success in 2010!