Tips to increase the value of your business

May 14th, 2012 admin

Most business owners come to a time in their life when they think about selling. Some have very specific plans, such as when they reach a certain age, or when their business reaches a certain level of profitability. Others think about selling, but really have not formulated anything specific.

Whatever category you fall into, it is a good idea to make your business valuable to buyers. That’s because building value takes time, and the best time to do it is now so that you will be ready when you are actively exiting your business. Also, many of the things mentioned below are just good business practices, and well worth developing for now and the future.

Obviously, having a history of profitability and a clean balance sheet are essential in getting a good price for your business, but there are some other non-financial items that you might think about as well.

Diversity
Look at your customer base. Does one large customer account for 50% or more of your sales? If so, attracting a buyer willing to pay a good price is going to be more difficult. The concern is that after the deal is done, that customer might be lost. A buyer does not know what relationships you have with your current customers, so that buyer has no idea if he/she can maintain it.

There are certain exceptions of course, but many small customers are almost always advantageous to a few large ones.

Employees
Many companies live up to the ‘our employees are our most valuable asset’ slogan. After all, attracting and retaining good employees is a key ingredient to success even in these economic times of high employment. But be aware that a potential buyer might be a little apprehensive toward a business that relies too heavily on one or two key people.

Beware of “The Fiefdom Syndrome.” Some managers hoard knowledge in an attempt to give themselves job security. A buyer is buying a business, and while management expertise is important, portability of that expertise is a key factor for someone looking to buy your business.

With employees, as with customers, all your eggs should not be in one basket. If you have one key employee, who if not retained would cause the business to suffer greatly, you really should consider some way of reducing that risk.

Recurring sales and revenues
Not all sales are created equal. Someone looking to buy a software development company will be much more interested in service contract revenue than new license sales. Contract revenue is a sure thing. Even if your business revenue is not typically driven by contracts, you might consider generating more contract revenue by selling service and/or warranty contracts. This might create a liability, but the security of contractual revenue will make your business much less risky, and much more appealing to a potential buyer.

A Unique Core Differentiator (UDF)
This is a fancy way of saying you need to stand out from the crowd. Someone looking to buy as business is probably looking at several prospects. And in this economy, it has become a buyer’s market. So what sets you apart? For some businesses it might be as simple as product packaging. For other businesses, it is good old fashioned reputation. And for some, it might be a unique website or blog that gets a lot of traffic.

And speaking of websites, a dull template design will work against you if you are striving to develop a UDF. In this day and age, your website might be the first contact your business has with potential buyers. Why not show them you are not run of the mill?

Borrowing Potential
I am surprised by how many small businesses operate debt free. There is something to be said about not owing anything to a financial institution, but you should maintain a good relationship with your bank, and your bank should be eager to lend you money if you need it. Note that it is usually in the bank’s best interest to retain the relationship with the new owners, so an ability to borrow money can often easily be transferred from seller to buyer.

But even if third party financing is not part of the equation, a potential to borrow easily means your business is less risky.

Bottom line, it’s not always about the bottom line. You can probably calculate discounted cash flows and times earnings to ballpark a selling price, but if you want to get the true value from your business, try focusing on things that do not necessarily show up in the financial statements and analysis.

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Alternatives to 401K retirement plans

May 12th, 2012 admin

By: Steve A Porter, CPA, CMA

If you have looked at retirement plans for you and your employees, it’s a sure bet that you are familiar with 401K plans. Chances are you already have one. Since they were introduced in the 80’s, there has been a literal explosion of these type plans.

Although they are very popular, they are heavily regulated by the DOL, and sometimes the rules as mandated by the government do not allow you the flexibility you want in rewarding your top performers. The problem usually arises when the plan becomes ‘top heavy’, ie: highly compensated employees receive a greater share of benefit than allowed by the regulations.

Fortunately there are other options available, and one of the most common involves ‘carving out’ highly compensated employees and allowing them to participate in a ‘non-qualified’ style plan.

Other Options: Non-Qualified Plans

A non-qualified plan can replace the existing plan, or exist alongside it. Employees can participate in both plans if the employer allows it. In reviewing what’s out there for these type plans, I found they have increased in popularity in recent years, and they also are very varied and come in many forms. Note that the general recommendation (not necessarily a requirement) is that 15% of the employees be in this plan. It is not meant to be a general retirement fund for all employees. It is a special plan for management and/or upper-tier executives.

The two broad categories are Supplemental Executive Retirement Plans (SERPS) and Non Qualified Deferred Compensation (NQDC).

SERPS are usually in the form of defined benefit plans where the employer foots the bill for a retirement/life insurance payout. NQDCs are contribution plans where employees defer a portion of their salary, and employers provide matching contributions.

Top Hat Plans is the common term for these NQDC style plans. They are very popular because they can be designed and set up to look and feel like (to the participant, at least) a 401K plan. However, there are no testing requirements, no non-discrimination rules, no fiduciary responsibility on administrators, no annual filing, no audits, and they are very flexible as far as pre-funding and payouts are concerned. Also, there are no limits on contributions. Most employers do set limits, but the limit is determined by the employer, not the government.

The structure of the plan is very different from a 401K plan, however. The plan is “unfunded.” This term is misleading because it does not mean the plan has no funds, only that the participant has no specific claim to the fund assets other than that of a general creditor. The assets in the funds are essentially arrangements made by the employer to finance the payout. There is no requirement for this financing (pre-funding), but that lack of financial security adds significant risk to participants. Administrative fees are very high if you do not provide financing for the payout.

Essentially, the participant has a legally binding contract with the employer that he/she will be paid “X” amount of money on a certain date depending on certain events. The payout can be tied to contributions made by employer and employee and/or fund earnings. You can even have a vesting schedule as long as the employee understands he/she does not own anything other than promise by the employer backed up by a contractual obligation. Note that this contract is not administered or regulated by the DOL as in the case of a 401K plan. It is simply a standard contractual obligation bound by standard contract law.

The assets of the fund are owned by the employer. As such, they are vulnerable if the company files bankruptcy. Also, any earnings on the funds are taxable to the company. That’s why most companies use Company Owned Life Insurance (COLIs) as the pre-funding asset. Of course mutual funds and similar investments can be used.

To give employees a little more security, most of these plans use a “Rabbi Trust.” which acts to set aside the fund assets in a special type of trust. These trusts offer no protection from involuntary liquidations such as bankruptcy, however. Also, Rabbi Trusts are required if participants make pre-tax deferrals.

Probably the biggest negative aspect of these type funds is that the employer does not get a tax deduction for contributions to the fund since the company retains ownership and control of the contributions. These tax savings over the years are VERY significant. Forfeiting that tax deduction is costly, however, you do get to deduct employer contributions it when they become taxable to the employee, usually through payout.

These type funds do provide a very good tax shelter for participants, however. And a C-Corp actually has a small advantage over pass though entities since any earnings on the plan are not passed directly to the owner.

If you are interested in these style plans, I would recommend getting proposals from several companies. The big players like Principal or Fidelity can help you learn about these type plans, and offer you quotes and advice on getting set up.

Although these plans have very relaxed rules and are very flexible, they are complicated financial arrangements, and there are several “gotchas” if not done correctly.

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S-Corp owners: is your compensation reasonable?

May 9th, 2012 admin

By: Steve A. Porter, CPA, CMA

In a previous article, I discussed reasonable compensation and how it applied to owners of C-Corporations. With those type organizations, the issue is usually an owner compensation that is unreasonably high. In that situation, it could be construed that the compensation was actually a dividend, which would not deductable at the corporate level.

But most businesses, particularly small businesses are ‘pass-through’ type entities. These include S-Corps, LLCs, and sole proprietorships. The problem is not a compensation that is unreasonably high, but one that is unreasonably low.

If you own one of these pass through type entities, you probably are aware that you pay taxes on the businesses earnings even if you take no money from the business. You might pay yourself a salary, on which you pay taxes, or you might take a distribution from equity. This distribution has already been taxed to you since earnings are passed to you personal income tax return via a K1.

So why would the federal, state, and local tax folks care if your compensation was too low? It has to do with payroll taxes, or more specifically FICA, Medicare, FUTA, SUTA, and in some cases local occupational type taxes. These type taxes are levied on compensation, but usually not on distributions.

Let’s say your business earns a half million dollars. And let’s say you are taking an annual salary of $10,000.00. You get a K1 for the $500,000.00, which goes on your income tax return. Since your payroll taxes are applied to the ten grand, an not the $500 grand, you can congratulate yourself for making such a smart business decision, right?

Wrong, and beware! Unless you can show that the relatively low salary of $10K is reasonable, you could be challenged in an audit, and receive a substantial bill for back taxes relating to the payroll taxes mentioned above. Note that these taxes have some very harsh punitive penalties associated with them. OK, so maybe the idea of keeping payroll taxes low by paying your self a salary that is below the market value is not looking like such a good move.

To avoid this situation, the answer is simple: pay yourself a reasonable compensation. That begs the question: “how does one determine what is reasonable?”, a question for which the answer is not so simple.

The answer is not eimple because ‘reasonable’ is subjective. In many areas of tax law, there are specific rules for determining various amounts. There are safe harbors, there are online calculators, and there are schedules. But With ‘reasonableness’ of compensation, you are somewhat on your own.

While this gives the IRS some advantages in that they can challenge you from more than one angle, it actually works to the taxpayer’s advantage, since you can justify your claim of reasonableness using one or more criteria that people in business typically use. You can use simple things like hours worked, average salary for similar jobs in your industry, or you can use a return method such as commission or percent of profits.

It all begins by documenting your formula and criteria for paying yourself. If you do that, you are ahead of many small business owners in justifying your compensation to a tax auditor. You just want to make sure the formula and criteria used is, well, ….reasonable.


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15 Ways a Small Business Can Save Money

April 29th, 2012 admin

Editor’s note: Molly Cunningham, owner of the site ‘Business Administration Degree’ sent me a concise, ‘cut to the chase’ list of ways to cut cost and save money. I wanted to share if because these days, who doesn’t want to cut cost?

1. Switch your software. Open-source software costs much less than commercial products while offering the same, if not more, capabilities. You can also download freeware or limited versions of software for free on many sites like download.com.

2. Change your phone service. VoIP is a cheaper type of phone service that works through the internet. This is a popular choice for small businesses. Another option is a hosted PBX system like Virtual PBX, which requires no hardware or software to maintain. You could even do something as simple as reducing the number of phone lines to save on telecom costs.

3. Go green. Although it may cost you a little more at first to make the switch, using energy-efficient appliances can save you lots of money in the long run. From lighting to technology, there are many options. Even simple changes like making sure lights and equipment are turned off at night can make a big difference.

4. Use laptops. Believe it or not, laptops consume about 90 percent less energy than desktop computers. They are also much cheaper to buy and replace.

5. Get cheaper help. Hiring freelancers, consultants, and contractors means that you won’t have to pay for benefits. You may also consider hiring interns or college students for credit, which means you’ll have bright young employees working for little or no pay. If your business is particularly busy during a certain time of year, you may want to hire temps just for the busy period.

6. Buy used equipment. Used computers, copiers, and office furniture can be found on sites like Capasset.com and Craigslist.com. You can also get great deals at going-out-of-business sales, trade shows, and wholesale retailers.

7. Take advantage of social media. Using sites like Blogger, Twitter, Facebook, and YouTube can get the word out about your business for free. You can advertise your products, promote special offers, and offer tips. Using social media is also a great way to connect with current and potential customers. It’s also good to make sure your company can be found on Google Maps.

8. Know your community. There are many ways you can use your local community for low-cost advertising. Get to know the neighboring businesses and exchange business cards to display in your offices. Ask clients to tell others about your or write a review on your company’s website. Speak at a community meeting or hold free community events to reach out to new customers.

9. Re-evaluate insurance and policy costs. Ask your provider about umbrella policies, which can sometimes be cheaper. You may also consider raising your deductibles to lower your premiums.

10. Check your property taxes. Sometimes new businesses end up paying higher property taxes than other neighboring businesses. Go to city hall to find out what these other businesses are paying, then use this to negotiate a better rate with community authorities.

11. Don’t forget tax deductions. A number of costs can be deducted on your business taxes. You can deduct a portion of what you pay for rent or mortgage interest, utilities, various maintenance expenses, and even services such as cleaning and lawn care. Check the IRS website or speak with a knowledgeable tax advisor.

12. Outsource HR, payroll, and benefits. You can save a significant amount of time and money by handing administrative services over to another company. Working with a Professional Employer Organization (PEO) is an easy way to let someone else take care of administrative and legal responsibilities and reduce your company’s legal liability.

13. Join a trade association. You can get industry-specific information, advice, and sales opportunities that will make your business better. In addition, many associations offer competitive group insurance and bulk purchasing discounts to save its members money.

14. Use travel discounts. Travel can be a large expense for a small company. Look for discount airfare online, especially with regional and budget carriers. Discount car rental companies like Rent-A-Wreck of America offer used car rentals for cheap prices.

15. Don’t forget disaster-recovery planning. This is one area in which you should not look to cut corners. It’s far cheaper to plan for emergencies like fires and natural disasters than to take such a large risk that could ruin your business.

This article was submitted by Molly Cunningham. She has been in business her whole life and owns the site Business Administration Degree

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