Posts made in February 2017

Key reasons to grow your company and build scale

Gary Miller

The Denver Post  BUSINESS

A new strategic plan can set even an old company on a high-growth trajectory.

By Gary Miller / GEM STRATEGY MANAGEMENT | February 19, 2017 at 12:01 am

I recently visited the owner of a family business whose revenue growth had stalled over the past three years and his earnings had declined as well. Facing significant financial pressure from increased operating expenses and cost of goods, the decline of his net income was projected to accelerate over the next two years. He was discouraged. He asked us to help him stabilize the company so he and his family could maintain their lifestyle.

In analyzing his company’s operations, we focused on five areas:

  1. Reducing expenses,
  2.  Improving cash flow,
  3. Analyzing the company’s strengths, weaknesses, opportunities and threats (SWOTs),
  4.  Assessing the company’s competitive position, and
  5. Developing strategies for growing the company.

After completing the company review, we sat down with him to discuss our findings. He was pleased with our in-depth analysis but reluctant to embrace new strategies. He feared that investing in new growth strategies, if not handled correctly, would further erode both cash and earnings. He wanted to play it safe and just stabilize the company so he and his family could live off the current earnings, even though they were shrinking annually.

We pointed out that a so-called safe strategy was neither safe nor a long-term solution. While his company was stalling, his competitors were stealing his customers. After several discussions, he asked us to show him that taking a chance on growing his company was safer than maintaining his current status.

The most important reason to grow a company is to create significant enterprise value (Enterprise Value, or EV, is a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization.) to broaden the range of exit strategies for shareholders. The higher the EV, the more alternatives shareholders have for monetizing their investments.

Here are 10 additional reasons to grow a company.

  1. Market power: This gives large companies opportunities to establish larger geographic footprints to increase penetration. Expanding a geographic footprint builds scale and provides significant benefits to large companies. It drives credibility among all stakeholders, creates preferential treatment among suppliers and momentum to accelerate growth, stability to weather economic downturns, cost savings for company operations, competitive advantage, and financial strength to compete against larger competitors.
  2.  Inventory power: This provides opportunities to purchase through       master contracting with bulk purchasing and forward contracting that locks in costs of materials, labor and suppliers. A large company can employ just-in-time inventory strategies to increase efficiency and decrease waste by receiving goods only as they are needed in the production process. These strategies reduce inventory costs, improve cash flow and increase margins.
  3. Recruiting power: This gives large organizations greater access to higher-quality talent. Typically, higher-quality talent translates into more larger and higher-caliber clients. A company’s size creates the perceptions of success and, as a result, professional growth and opportunities for career advancement to its employees.
  4. Marketing power: This allows companies to command lower advertising rates due to media volume discounts in major traditional media. More media coverage provides more reach to the company’s target audiences, clients, and the investor community. It improves corporate image, reputation, brand name recognition and increases the brand power. Marketing power gives flexibility in developing new products and services to meet customers’ changing demands. It also offers opportunities for first mover advantage, which allows a company to be first in the market to capture share before other competitors can enter the market.
  5. Negotiating power: This helps organizations attract, recruit and retain higher-caliber clients. Large corporations, generally, have less client turnover and more new client acquisitions. Generally, the cost of attracting new clients is lower for large companies.
  6. Cost reduction power: This provides larger organizations to scale to optimum efficiencies. Operating expenses can be reduced. Policies, practice,s and procedures can be standardized to reduce management inefficiencies. Cost reduction power allows large corporations to substitute technology for labor intensive tasks.
  7. Technology power: This provides the ability to leverage hardware and software technologies to maximize growth, operations, earnings and competitive advantage. Technology power gives opportunities to create intellectual property as a result of developing new proprietary processes and software.
  8. Synergy power: This creates opportunities to meet customer needs through other related enterprises. It offers a holistic approach with a comprehensive portfolio of products and services that can touch clients multiple times throughout customer life cycles. Therefore, building repeat business is easier. It also creates strong brand loyalty and elongates customer life cycles.
  9. Competitive advantage power: This allows a company to scale operations, which leads to critical mass. Critical mass is the point at which the company no longer requires outside investment — of money, resources, or human capital — to continue being viable, to continue growing by itself. This leverage can accelerate growth, earnings, cost reductions, operations excellence and a solid, safe and secure work environment. Competitive advantage raises the barriers to market entry from potential newcomers and pressures smaller competitors who are not performing well.
  10. Earning power: This allows large-scale organizations to earn more for all stakeholders because scale and critical mass can produce increased growth, synergies, and resources at lower costs. Therefore, margins are increased and earnings are improved while operating expense rates are lower. More earnings produce financial stability, flexibility and the ability to take advantage of investment and acquisition opportunities.

Finally, a major benefit for larger corporations is that its bottom lines are larger, providing increased shareholder value. While the firm maximizes its profits, investors can maximize their returns.

After building a compelling case for growing his company, we persuaded the owner to re-examine his company’s strategic plan. He has set a new course for growth to increase his company’s enterprise value and expand his exit plan alternatives.

Gary Miller / GEM Strategy Management

Gary Miller is the CEO of GEM Strategy Management, Inc., an M&A consulting firm, advising middle-market private business owners prepare to raise capital, sell their businesses or buy companies. He is a sought-after business consultant and speaker on M&A issues, strategic business planning, business valuations, exit planning, what buyers are looking for in acquisitions and how to prepare for due diligence. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.

 

 

Watch out –The IRS is looking at tax returns when owners sell their companies

M & A Source the BRIDGE

POSTED: February 9, 2017

Home from a long cruise, Bob and Marge stopped by the post office to pick up their mail. One letter stood out — a notice from the IRS stating that it had disallowed a tax deduction of $547,400 from the couple’s 2015 personal tax return. In addition to owing back taxes on the disallowed amount, they also owed penalties and interest. An IRS audit that began eight months earlier examining the sale of their business had led to this devastating news.

How could this happen?
In the fall of 2015, Bob had sold his business for $23 million in a cash and stock sale to a publicly traded company. During the transaction process, Bob received a binding Letter of Intent (LOI) from the purchaser.  After negotiating some of the fine points of the terms and conditions, Bob signed the LOI. Followed by the successful due diligence review, the sale closed.

Once Bob had signed the LOI, he and Marge began seriously thinking about what they were going to do with the money from the sale. Bob called his accountant and his family practice attorney, who had advised him for years, to discuss their options. Bob and Marge did not have a financial advisor as Bob had always managed their investment portfolio himself.

Bob’s attorney advised him to establish a Charitable Remainder Trust (CRT). Making a donation to the CRT, could help reduce income taxes and estate taxes, avoid capital gains taxes on the donation and receive income from the trust for the next 20 years. They were thrilled and decided to donate 10 percent of the $23 million from the sale to their alma mater. Bob donated 230,000 shares of stock to the trust with a cost basis of $1 per share or $230,000. The publicly traded company’s shares were valued at $10 per share or $2.3 million.  Therefore, Bob would reduce his taxable estate by $2.07 million ($2.3 million – $230,000 = $2.07 million). Also, Bob avoided paying the capital gains tax of 23.8 percent on the appreciation of the donated stock. Bob and Marge elected to receive 7 percent of the earnings from the $2.3 million trust generating about $161,000 of taxable income per year for the next 20 years – a win-win for all.

But, the IRS disallowed most of the tax savings from the CRT, because Bob had not started his financial planning soon enough.  He established the CRT after he had received the LOI from the purchaser instead of establishing his estate plan well in advance of the sale of his company.  The IRS held that the CRT had violated the Anticipatory Assignment of Income Doctrine which was adjudicated in 1930 by the Supreme Court to limit tax evasion. Establishing the CRT after he had signed a binding LOI gave the appearance to the IRS that the CRT was nothing more than a scheme to evade taxes.

What should Bob and Marge have done to prevent the IRS problem?
First, Bob should have started his business exit planning including estate planning as early as possible before the sale of his company. Many wealth planning experts recommend that planning should begin from one to five years before the sale of the company.

Second, had Bob hired an Registered Investment Advisor (RIA) early in the exit planning process, the advisor would have examined Bob and Marge’s entire financial picture, assessing Bob’s and Marge’s goals. That would have been the time to establish the CRT and a Donor Advised Fund, (a charitable giving vehicle sponsored by a public charity that allows the donor to make a contribution to that charity and be eligible for an immediate tax deduction), to reduce income taxes and to achieve one of Bob’s and Marge’s goals of supporting their alma mater.

“Bob should have started his planning at least six months in advance of receiving the LOI. Anything less could spell trouble with the IRS,” said Shelley Ford, a financial advisor with Morgan Stanley Wealth Management, shelley.ford@morganstanley.com.

She continued, “Bob should have engaged key advisors including an exit-planning M&A consultant, a trust and estate planning attorney, a transaction attorney to guide the negotiations of the transaction and corporate and personal tax advisors to give expert advice on how and when to establish their estate plans in anticipation of Bob selling his company.

Scott Fleming, regional president – Rocky Mountain region, BNY Mellon Wealth Management, scott.fleming@bnhymellon.comagreed.  “Wealth planning should begin as early as possible, with a team of experts to examine all of the available income and estate tax savings strategies, to avoid what happened to Bob and Marge. Fleming said, “Had they started their planning early enough, they could have examined a number of income and estate planning strategies in order to meet their personal goals and at the same time avoid/defer income and estate taxes.”

Fleming continued, “Strategies often examined are a Grantor Retained Annuity Trust, a Grantor Retained Interest Trust, a Grantor Retained Unit Trust, an Intentionally Defective Grantor Trust, Irrevocable Life Insurance Trust, Charitable Lead Trust and potentially a Family Limited Partnership”.

Unfortunately, Bob made a number of mistakes that could have been avoided had he sought professional advice stated above. And while his attorney and accountant tried to give good advice, they were not experts in the field of estate planning and wealth preservation. Bob and Marge paid the price for not hiring experts.

Gary Miller is the CEO of GEM Strategy Management, Inc., an M&A business consulting firm, advising middle-market private business owners on how to sell their businesses for the highest valuation, buy companies and sourcing capital for growth and expansion. He is a sought-after business consultant and speaker on M&A issues, strategic business planning, business valuations, exit planning, what buyers are looking for in acquisitions and how to prepare for due diligence. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.