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I am working with several clients who are cash challenged at this time of year.  We are carefully reviewing the P&L on a regular basis to identify any opportunity to reduce costs and conserve cash.  

Cash management is so critical to the operation of any business.  The proper use of cash will provide a business owner with some real advantages in the marketplace.  It gives the businesses that manage cash well the opportunity to:

•         Survive unexpected loss

•         Adapt to unexpected change

•         Take advantage of unexpected opportunity

In managing cash flow I ask my clients to prepare 90 day cash forecast to determine the needs for borrowing and capital expenditure.  This forecast is based on a projection of the current income statement by month for the next three months.  Additions to the net income are for noncash expenses such as depreciation.  Common reductions in cash should be recognized for cash outlays used to purchase fixed assets, repay debt, pay dividends and reductions in vendors payable.

 Some questions your controller or CFO should be able to help you answer include:

•         Facilities.  Buy or lease?

•         Working capital.  How large & how do I manage it?

•         How much debt should my business have?

•         How much cash should my business have?

•         Am I meeting my financial goals?

A simple cash flow model is a necessary tool to help get you started in your business.

I’ve been spending some time lately analyzing gross profit $’s and margin %’s.  It’s interesting, because even if it’s trending in a relatively flat line, you may not be seeing the whole picture from 30,000 feet.  Whether you see your gross margin increasing, decreasing, or holding steady, you may want to do a little research to determine if the results are truly what they should be.  The issue is that there could be hidden risks or opportunities in there. 

If you’re selling 4 products, for example, you may find that one of them has been getting more expensive to produce while another has gotten more cost efficient.  And if you were to review them individually, you may opt to increase your pricing to your customers on the product that currently provides a lower individual return.

You may also find that you’re not selling as much of the more profitable product than you used to, because the pricing is no longer competitive.  Maybe your competitors have been tracking the improvements in cost to produce and passing a portion of the savings on to their customers.

What if you need to reconsider your product mix, and your marketing spend on each product line in order to achieve desired returns on your marketing dollars?  What if one of your vendors raised their unit prices without notifying you?

Without an understanding of the “numbers behind the numbers”, you’re operating your business in a bit of a dark room.

Taking the time to understand the financial statements supporting your business will equip you to make better decisions whether your goal is to grow your current company organically, or grow through acquisition.  It will help you to determine the best time to invest in new equipment, hire staff, request a loan from your bank, or reach out to investors for additional working capital.

Do you know where you make your money?  Do you know which of your products and services are most profitable and which are marginal or even lose money?  If you think you know this (and you should!), are you sure your data is accurate?  When was the last time you updated or reviewed your product cost information or your job routings and bills of material?  Are you making bad decisions because of faulty data?  Although some businesses may offer “loss leaders” for competitive reasons, this must be done consciously and not very often if you wish to stay in business.

I worked for a turnaround company that had a severely deteriorating gross margin, was hemorrhaging cash, and had been put into the workout group by their bank who was threatening to force them into bankruptcy.  We needed more gross margin quickly.  The first thing we did was to sample some of the higher volume products to ascertain the quality of the cost data.  We found some problems and fixed the costs as quickly as possible.  Next, we analyzed all the products and services the company offered, sorting the offerings by gross margin percent and gross margin dollars.  For goods and services below our gross margin target, we developed a “losers list.”  The losers list was comprised of those products and services with an insufficient margin and which were not “loss leaders,” consciously decided.  We agreed the losers had only three possible dispositions- increase the selling price, decrease the cost, or drop the product.  Utilizing this discipline, we were able to increase the earnings of the company nearly 400% in less than two years.  This increased profitability dramatically improved our bank relationship and allowed us to invest in new product development, further improving our competitive position.   

Although this is basic blocking and tackling, the number of companies not doing this is absolutely incredible.  Analyzing your losers list could result not only in increased profitability but should also lead to additional strategic opportunities.  If you cannot make a product profitably, perhaps you should de-emphasize or eliminate that product line.  Alternatively, if you have certain products that command a high margin in the marketplace, you should consider expansion into those areas.  What competitive advantages do you have that result in good margins and how might we further exploit those advantages and opportunities?

Do you believe your margins? 

Have you reviewed your losers lately? 

Transfer Options: Beyond the Outright Sale

It’s nice to have options.  Haven’t we all heard that before?  It’s something many business owners would probably say and sigh with relief when they realize that ‘selling’ a business isn’t the only way to exit that business. In this article, we’ll dispel this myth and talk about the many options available to exiting business owners.

Today, a large number of Baby Boomer business owners face the challenge of meeting their retirement needs with illiquid wealth tied to their privately-held businesses.  According to an NFO WorldGroup study performed in 2002, the number of business owners planning to retire was expected to increase from 50,000 per year in 2001 to 750,000 per year by 2009.  Now, more than ever, it is crucial for owners to become educated about their options.

There are primarily seven (7) different options by which a business owner can transfer the interests in a privately-held business:

·       Employees

·       Charity

·       Family

·       Co-Owners

·       Outsiders (owner retires)

·       Outsiders (owner stays)

·       Initial Public Offering

Employees & Family

Liquidity is the primary concern when considering a transfer of a business to employees or family.  One might naturally believe that these individuals don’t have the financial wherewithal to buy out the owner.  Whether or not this is the case, it doesn’t have to limit the succession planning process. Take a look at the following options:

ESOPs Provide Tax Benefits

An owner may transfer shares to employees, through an Employee Stock Ownership Plan (ESOP) without the employees ever contributing any money to the owner’s exit strategy.  Their liquidity simply isn’t a factor.  Furthermore, since 1974, Congress has supported ESOPs by way of tax incentives.  These incentives make an ESOP an attractive Exit Vehicle for an owner–even if the owner has no true desire to help their employees.

Estate Planning Within an Exit Strategy

Regardless of their liquidity, family members can in fact play a key role in an owner’s business exit.  If an owner has provided for his financial needs independent of the business, he can gift shares of the Company to family members.  Over a long enough period of time, these gifting programs can coordinate with an estate plan to manage estate taxation.  In addition, transfers to family members can occur in a fast growing business through a Grantor Retained Annuity Trust.  These powerful estate planning tools can provide significant tax savings to the exiting owner.

A Leveraged Buyout Option

Employees and Family Members can also utilize the existing assets of the Company to construct a Leveraged Buyout of the owner’s interest.  In this scenario, the Company takes on more debt and therefore more risk to accomplish the transfer.  If the employees and family members are willing to assume this risk, the owner can make out quite nicely.

Co-Owner Transfers

The existence of more than one owner creates yet another option.  This ownership structure often comes with a Shareholders agreement.  The Agreement dictates the terms by which one owner may purchase the interest(s) of the other owner(s).  These interests often have a pre-determined Value.  A co-owner transfer makes for a clear-cut transaction, as long as the pre-determined Value meets the exiting owner’s Goals. 

Outsiders

Outside Buyers will generally pay the highest price to an exiting business owner.  The higher up front Value takes into account all possible synergies of the deal (i.e. economies of scale provided by the Buyer, back office savings, cross-selling opportunities, etc.).  Most often in this scenario, the owner will sell to a competitor and leave the business entirely.

What about the owner who wants to sell to an outsider without completely leaving the business?  Good news—this owner has yet another option.  With the intention of using Capital and Management to improve the operation, a Private Equity Group can buy or invest in the Company. This is an attractive option for the owner who wants to keep a hand in the business since The Private Equity Group often asks the owner to ‘stay on’ and run the business.  Both cash and shares are offered to motivate the owner, thereby meeting his financial goals and allowing him to keep his ‘job’.  This option can present the best of all worlds.

IPO

Larger companies, those worth $100mm or more, can offer their shares in an Initial Public Offering.  This type of transaction allows the ‘general public’ to purchase ownership in the Company.  In turn, the Company accesses ‘public capital’ and its shares trade on a public exchange.  When considering this option, an owner must assess the public company costs.  The business will need to spend the time and money to report to its shareholders, which can sometimes lead to a short-term mindset.  Nonetheless, this option can provide the owner with a high level of liquidity.

Conclusion

Isn’t it nice to have options?  It isn’t necessary for a business owner to simply ‘sell’ the business and walk away cold turkey, unless of course, that’s what he wants.  After examining our brief discussion of transfer options, an owner can begin to ask questions that will lead to an Exit Strategy that meets his or her personal Goals.

According to the Association of Certified Fraud Examiners (ACFE), businesses lose an average of 6% of revenue each year to fraud, totaling some $3 trillion lost globally every year.  ACFE believes fraud could account for as much as one-third of the business failures in the United States.  Embezzlement is the number one financial crime and has been for the past thirty years, according to the FBI.  The average embezzlement lasts 18 months and results in a business loss of $160,000.  25% of all losses are for more than a million dollars.

As a business owner or CEO, you cannot afford to ignore fraud, it happens all the time to good people and otherwise astute business owners and operators.  Smaller companies are generally more vulnerable because they tend to have fewer internal controls.  Preventing fraud is much better and easier than detecting it.  Embezzlers are generally tough to catch; most are caught by accident or because of an anonymous tip from another employee or person.

There are certain actions you can take to prevent fraud.  First, this is a crime of opportunity. You need to have good internal controls in place to discourage fraud.  You should have well-designed internal controls to ensure segregation of asset custody and recordkeeping.  For example, if a person is responsible for cash deposits, they should not also be in charge of keeping your accounts receivable records.  Payroll check distribution, timekeeping, and employee master file maintenance should be done by different people.  You never want to put someone in a position where they can both perpetrate and conceal fraud.

 Common areas of fraud include paying fraudulent expenses, bid-rigging, kickbacks, false sales, false vendor invoices, accounts receivable “lapping”, and check tampering.

There are some things you should do to deter fraud: 

1.      Set the tone at the top.  Dishonesty should not be tolerated and you should have a zero tolerance policy about it.

2.      Develop the right controls and business practices and make sure they’re followed.

3.      Make sure different people are responsible for asset custody and recordkeeping.  Keep banking and cash separate from accounts receivable and keep procurement separate from accounts payable.  Have someone other than the check preparer sign and approve all disbursements.

4.      Insist everyone take vacations.  Many frauds are accidentally discovered when a perpetrator is away.  Consider periodic job rotations.

Know that a normal CPA audit or book review is not designed to detect fraud and the engagement letter will explicitly state that exclusion.  In any event, you should have a professional help evaluate your internal controls and business practices.  An ounce of prevention is worth pounds of cure!  Consider hiring a financial watchdog or make arrangements with a professional to come in periodically so potential thieves know someone is watching.

Your intuition is rarely wrong, take steps to protect yourself from fraud. 

Got fraud? You need to know!

What does a CFO do and how can a part-time CFO serve the needs of a business owner?

Many of the day-to-day responsibilities of a full-time CFO are executive management responsibilities that overlap with the other executives in the company.  Any great team has outstanding role players that can also fulfill the other roles as needed.  However, the specific financial discipline and skills a CFO brings to the table are specialized and can distract other executives from their roles in running a business.  Even a CEO or business owner that had been the CFO needs to have another financial executive assume the CFO role to keep the CEO or business owner focused on growing the business.

A listing of our firm's CFO Services is available elsewhere on our firm's website.  I will describe each of these services in subsequent entries, but want to summarize the services and our approach here.

The foundation for CFO services is timely and accurate financial statements.  Without this foundation, all other financial data and any business decisions made will be based on old or incorrect data.  Many business owners have a good sense of their business and make decisions based on their "gut," which is fine for their personal risk tolerance level.  However, once a company has a banking relationship, the owner's gut is generally not sufficient, although their other financial resources may be.  You will have a better relationship with your bank with good internal financial statements and they will be more likely to support your requests.

The financial skills a CFO may be best known for include Financial & Strategic Planning, Cash Flow Projections, Profit Improvement, Expense Reduction, Working Capital Improvement, and Gross Profit Optimization.  These skills and activities are crucial to the livelihood of any business.  A CFO fills the gap between the business owner and the Controller or Accountant that prepares the books and records.  A business owner often likes to work in the financial details to stay in touch with the financials, however this takes time away from growing the business or family activities, and the business can often begin to lose momentum which causes the owner to dive even further into the details to fix the problem.  This is the problem described in our firm's book The Danger Zone.  By keeping the CEO focused on "finding" activities instead of "minding" ones, the company can profitably Increase Sales.

Finally, every business owner will eventually leave their business.  The coming years will see many baby-boomers want to exit or sell their businesses and retire.  The current economic cycle has deferred many retirements.  When the market does recover, more businesses will come on the market to be sold, which will further depress prices for exiting business owners.  Our Finding The Exit program will help to define the goals, activities, and options for exiting the business, which may not necessarily mean selling the business.

In a recent blog post, Scott Medintz of The New York Times said, “Small-business owners should cultivate a relationship with a local banker — ideally, long before they need a loan — and treat that relationship as a long-term partnership.” <http://ow.ly/2d4ZJ>

This is excellent advice! Most business owners know that, second only to “Cash is King,” the most important rule of business is, “Borrow money when you don’t need it.” Having a relationship with your local banker is an excellent way to position yourself and your business to do so.

So what do you do if you haven’t done this? Many small business owners treat bankers like the enemy, rather than a friend. How do you get started? One way is through your B2B CFO^®. As senior financial executives with an average of over 25 years experience, they have arranged countless loans and lines of credit. They have the expertise to gather and present the information the way a banker likes and needs to have it. They can help you get your financial house in order, not only from a record keeping and financial statement perspective, but also actually getting much better sales, gross margins, profits and especially cash flow. It’s that cash flow to which the banker looks for repayment!

As an example, earlier in my career, I helped start-up a de novo community bank in rural Ohio. Working with the prospective bank president, we developed the business plan and financial projections, wrote the charter application, got approved, published the prospectus, sold the stock, bought a piece of land, built a building, hired the staff and opened the bank. I served on their Board of Directors for years before moving from the area. It was one of the most heart warming and satisfying experiences of my business career, as that small community really needed a local bank! But the point is, when I meet with a banker, I know what the banker’s thinking. What that means to my client is that they don’t have to guess or try to figure it out. I’m there for them.

In addition, I already have relationships with many local bankers. I can help decide which bank or banks you should know and make the introductions. This frees you up to work on growing your business!

Exiting Your Business Successfully:
What You Need To Know

If you are like most business owners, you have devoted an immeasurable amount of work and resources into growing your company. With all that you have invested, doesn’t it make sense to plan an exit from that business that protects the wealth you have accumulated in it? After all, exiting your business will certainly be one of the most important financial events of your life. The first step is to understand that an exit is not simply the sale of your business. Rather, it is a process that may occur over many years and selling your business is just one of many options available to you. Designing your exit strategy will take time, planning, and forethought but will allow you to reap the greatest reward for your years of hard work.

EXIT PLANNING EXPERTS

What is an Exit Plan?

An exit plan outlines your options as a business owner for transition of your business in the most wealth-protective way. This plan takes into account all factors related to your personal life, your business, the timing you would like for the exit, as well as potential successors or buyers.

The most obvious exit option to most business owners is the sale of the business to another buyer, perhaps someone in the same industry. It is important to know that less than 20% of businesses successfully sell to an outside buyer. What if you are one of the majority, and selling your business is not an option, do you know what exit choices are?

Ten Things a CEO Should Remember About Succession Planning

by Kevin Kennedy
 

You can read several books or my white paper about “succession.” The purpose of this article simply is to differentiate “exit planning” and “succession” and outline the    main points for a CEO to think about with succession planning.

In the simplest terms:

• Exit Plan focuses on monetizing the trapped illiquid wealth in a private business.
• Succession Plan focuses on a company successfully performing without its present owner/CEO.

An exit plan is a customized written plan that monetizes a business, meets the owner’s personal and financial goals, protects his or her wealth, and moves the owner into his or her next stage of life. 

A succession plan provides a customized written plan that focuses on the human side of a business. Succession replaces the owner by moving the chosen performers to a professional level of management and into leadership. This requires time, training and stretching the team.

A succession plan may take several months to write and several years to execute. Depending on the readiness of a company’s management and the type of exit and current payout, a succession plan may last from three to 10 years. On the other hand, if the business is systematized and has clean financials and mature management is in place, the company could be “sale ready” in less than a year.

Ten Things a CEO Should Remember About Succession Planning:

1.     The Owner’s Mindset:

The succession process does not begin until the CEO can begin to see him/herself outside the business, has a flexible date and a written plan. This stewardship will lay the groundwork for a successful transfer, the CEO’s legacy and the company’s future. Francis Hesselbein said: “Successful transition is the last act of a great leader.”

2.     Complete Your Exit Plan—Update Legal Agreements:

A large part of the exit plan is income replacement for the owner. The owner’s exit plan should be a process so the owner can see him/herself as financially independent or the owner will never be able to separate from the business. Legal agreements should be updated to protect the business and the owner’s estate during this process.

3.     Establish a Clear Direction and Focus:

The beginning of the succession process is a time to revisit the strategic plan, vision and mission. This process will be an exercise for the management team to establish their roles, work as a team and have a stake in the plan for the company’s future. It will be the management team’s responsibility to engage the company in this plan, communicate the plan and be held responsible for the plan’s implementation.

4.     The Odds are Against Your Success:

A Family Firm Institute study reveals how difficult it is for small businesses to succeed over generations and business cycles.

·       Seventy percent of companies fail to transfer into the second generation.

·       Ninety percent of companies fail to transfer into the third generation.

The CEO cannot take this lightly. If you fail to plan, you plan to fail.

5.     Develop Management Succession:

Management succession is more that the replacement of talent; it is the development of talent. This is a time for the new team to re-examine and improve performance of the company’s systems in a process of continuous improvement for the company’s profitability. The new management team should lead this process and education effort for the entire company.

6.     Develop Leadership Succession:

Traditionally, you have strong managers who drive the company and meet deadlines and corporate goals. They must now rise to a higher level of leadership, set a corporate direction and build consensus. How do you change their behavior, build self-awareness and still maintain their spirit?

This change is accomplished through the light of self-awareness, acceptance of the      truth, peer evaluation, experience and personal coaching. There are many processes and proven exercise to move them to the next level.

7.     Understand Emotional Intelligence:

Most of us recognize IQ (Intelligence Quotient) from an educational system that weights this measurement. Now researchers use EQ (Emotional Quotient) or Emotional Intelligence as a measurement, and studies have found it is the key ingredient for leaders and millionaires.

The book Emotional Intelligence considers non-cognitive skills more important than IQ in the workplace. The author, Mr. Daniel Goleman, states that emotional intelligence is reflected in behavior from self-awareness, [how one?] uses gut feeling, self-control of emotions, empathy, and the ability to inspire and influence others.

8.     Time is Your Best Friend With Education:

Succession and behavioral change take time, and the sooner you start training, the better your results will be. There are three parts to this training: education, coaching and stretching. You will spend about 30 percent of your time with education and coaching. The key is to leave 70 percent of your time for the stretching process. This is where managers are field-tested, apply their learning, make mistakes, adapt and mature.

9.     Coaching the New CEO:

Every CEO must realize his or her role with the new successor is to make sure the next CEO is prepared to lead the company. Meet and decide collectively the process, time line and curriculum. Remember, this process is all about the new CEO, not you. Your role is to teach, coach and insure the company’s future. The new CEO’s management and leadership style likely will differ in some way from your style. Let the new CEO find his or her own path unless you see a disaster in the making.

10.  The Lame Duck and Letting Go:

For each CEO, the succession process is different but the same. You will feel like a lame duck, it will be more emotional that you thought it would be and you must focus on life outside the business.

Eventually your phone will stop ringing, managers will bypass you and move directly to the new CEO, and you will be out of the loop. The good news is the process is working as it was designed to and you have succeeded where most CEOs fail. Congratulations, and welcome to the lame duck club.

For additional free educational information, go to Kevin's website, www.beaconexitplanning.com, for my 24-page succession white paper and newsletter archive.

Kevin Kennedy is the President of Beacon Exit, LLC. The content of this article is based on his personal experience successfully exiting his 63-year-old roofing company, the transfer to the company’s third succession team and his

training. The information is not intended to be legal, accounting, insurance or tax advice. Please contact your licensed business advisers for specific advice. Beacon is a process consultant that provides written plans and support programs to private business owners for succession and exiting their businesses. For more information, visit www.beaconexitplanning.com