Articles & Presentations

Headed for a crash? 50 Leading indicators

By Bob Vanourek, Senior Consultant, GEM Strategy Management, Inc.

Posted March 6, 2017

Why is it that a corporate financial crash seems obvious in hindsight? The “Monday morning quarterbacks” cite the warning signs that were brewing. But why weren’t those signals heeded beforehand? Is your organization headed for a financial implosion?

Sometimes major external shifts cause a company to go under – shifts such as a major industry crisis or technology transformation. More frequently, a company implodes because of internal deficiencies that leaders ignore. But internally driven crashes don’t occur without emitting warning signs. These warning signs are not financial signals, such as revenue declines, shrinking margins, slowing inventory turns, deteriorating working capital ratios, and falling profits. Those metrics are lagging indicators.

Leading indicators are more important to watch because leaders can address them before the financials go south. What are some early warning signals of a potential crash? Based on my experience as a leader in eight industries and as the CEO of five very different companies, here’s my list of 50 red-flag indicators covering a wide variety of signals. I list 50 leading indicators because, even though some are louder warnings than others, all are important to understand the future of your business

You and some trusted colleagues can score your organization on these warning signals.

 50 Early Warning Signals of an Organizational Crash

Scoring system:

5 points = this happens often

3 points = this happens occasionally

1 point = we don’t have this problem

 

  1. Not holding people accountable for results.
  2. Not paying attention to how results are achieved (sometimes they are achieved unethically, leading to a future blowback).
  3. Tolerating abusive, egotistical superstars.
  4. Seeing complacency in people’s work.
  5. Sacrificing the long-term good for the short-term expedient.
  6. Neglecting integrity, cultural fit, and emotional intelligence in hiring and promotions.
  7. Failing to invest in developing people.
  8. Not listening to people.
  9. Lack of clarity in why the organization exists (is your organization’s purpose inspirational, or is it all about making money for you?).
  10.  Lack of commitment to mutually developed shared values to guide the behavior of people.
  11.  Leaders not flexing between the hard (steel) and soft (velvet) edges of leadership depending on the circumstances.
  12.  Excessively tight controls that stifle creativity.
  13.  Leaders being too easy-going because they want to be liked.
  14.  Excessive deference to the top leader(s).
  15.  Leaders making virtually all the decisions (not empowering others).
  16.  Failing to tap into the capabilities of people.
  17.  Weak, inadequate board of directors or advisors.
  18.  Constantly changing priorities
  19.  Poor communications and secrecy.
  20.  People operating in independent silos.
  21.  Insufficient understanding of how departments are interrelated.
  22.  Lack of discipline to execute well.
  23.  Lack of trust between people.
  24.  Treating people disrespectfully.
  25.  Leaders having favorites among people.
  26.  Excessive employee turnover.
  27.  Incidents of internal sabotage or theft.
  28.  Lack of rigorous, honest feedback from customers.
  29. Lack of rigorous, honest feedback from vendors.
  30. Lack of rigorous, honest feedback from employees.
  31.  Failure to cut unprofitable products or services.
  32.  Failure to understand new market trends.
  33.  Failure to invest in new products and services.
  34.  Excessive debt and interest expense.
  35.  Insufficient capital.
  36.  Lack of reasonable financial controls.
  37.  Excessive dependence on a single, or very few, customers.
  38.  Excessively high or low compensation and benefit levels.
  39.  Excessive travel and entertainment spending.
  40.  Owners taking excessive funds out of the business.
  41.  Leaders not knowledgeable of financial details.
  42.  Lack of rigorous financial planning and budgeting.
  43.  Exploiting vendors with excess pressure to lower costs.
  44.  Giving insufficient attention to local community needs and issues.
  45.  Insufficient policies, systems, and procedures to guide people’s work.
  46.  Poor quality products or services.
  47.  Unaddressed safety issues.
  48.  Excessive stress levels among people.
  49.  Constant surprises.
  50.  Leaders in denial about what’s really going on in their business.

To ensure you have an objective assessment, have one or two trusted colleagues also score your organization, even if they have to make some guesses at some answers. Assure them they will not be penalized for an honest assessment – you are trying to avoid a disastrous crash.

If your organization scored:

·         50-125 points: Congratulations, you are unlikely to crash and burn.

·         126-200 points: There could be trouble ahead. Some changes are needed.

·         201-250 points: Disaster looms.

Practical Applications:

Review and discuss any metrics with a 1 or 3 rating. Then you and your team can brainstorm solutions and prioritize action plans. You’ll unleash their creativity and heighten their engagement.

There is no reason for you to be blindsided by an organizational crash. Pay attention to the warning signs of leading indicators.

Bob Vanourek is a senior consultant with GEM Strategy Management and is the former CEO of five companies and a frequent speaker, consultant, and coach on organizational leadership. He is the co-author of the award-winning book, Triple Crown Leadership: Building Excellent, Ethical, and Enduring Organizations. Bob’s latest book is Leadership Wisdom: Lessons from Poetry, Prose, and Curious Verse http://tinyurl.com/zr2peng You can see Bob’s entire profile on http:gemstrategymanagement.com or reach him at 970.390.4441.

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.

Cyber-Attacks Put 60% of Small Companies Out of Business — Don’t Be Next

Axial FORUM |

By Gary Miller, GEM Strategy Management, Inc. | January 26, 2017

Gary Miller

Websites hacked. Corporate data leaked. Identities stolen. The threats are real and growing. Seventy-five percent of all organizations have experienced a data/cyber security breach in the past 12 months.

Take a small online retailer in the Midwest. It seemed like just another ordinary day when one of the company’s employees received an email with a link to a seemingly benign catalogue. Little did the company know that the simple click of an email link was about to threaten their entire business. After the employee clicked on the link, the system was infected with Crytowall. The malware affected the company’s accounting software, customer account files, including credit card numbers, social security numbers, customer names and addresses, among other information.

The accounting software and customer files did not live on the employee’s computer; it lived on the company’s network drive. That meant the malware was able to encrypt over 15,000 accounting and customer files. Soon a ransom demand followed. The cybercriminals demanded $50,000 to provide the decryption key for the files. With the virus proving impossible to remove without the loss of crucial company data, the company had no choice but to pay up. Unfortunately, the company’s backup systems had not been working for months. So it had no recourse for restoring its files.

After the ransom was paid, the cybercriminals gave the decryption key to the retailer. But when the company attempted to decrypt the files, the decryption key didn’t work. The company came to a standstill. The owner could not afford to pay to rebuild the network systems. The lack of sales and cashflows strangled the business. Six months later the company closed its doors. This small business learned about cybercrime the hard way.

The U.S. National Cyber Security Alliance found that 60% of small companies are unable to sustain their businesses over six months after a cybercrime attack. The financial burden and reputational issues of having your customer’s’ data compromised means you could go broke after just one attack. According to the Ponemon Institute, the average price for small businesses to clean up after their businesses have been hacked stands at $690,000. For middle market companies, the cost is over $1 million.

Recent events have proven that nobody is safe from the threat of cybercrime – not large corporations, small businesses, startups, government agencies, or even presidential candidates.

Small and mid-sized businesses are hit by 62% of all cyber-attacks, about 4,000 per day, according to IBM. Cybercriminals target small businesses because they are an easy, soft target to penetrate. They steal information to rob bank accounts via wire transfers, steal customers’ personal identity information, file for fraudulent tax refunds, and commit health insurance or Medicare fraud.

So what can you do besides pray and hope you’re not next?

  1. Remember, most cyber breaches happen because an employee does something that he/she aren’t supposed to do. They share a password or open something they shouldn’t have. Basic training can stop a majority of low-level threats. But coaching your employees on data protection is not enough. Business owners must establish data security protocols that every employee takes seriously.
  2. Create a business continuity and incident response planthat you can put into effect immediately once you know your systems have been compromised.
  3. Keep security software current.Having the latest security software, web browser, and operating systems is the best defenses against viruses, malware, and other online threats.
  4. Links in emails, tweets, posts, and online advertising are often how cybercriminals try to steal information. Even if you know the source, if something looks suspicious, delete it.
  5. Protect all devices that connect to the Internet.Smartphones, tablets, and other web-enabled devices need to be protected from viruses and malware in the same way as laptop and desktop computers.
  6. Plug-and-scan USBs and other external devices can be infected by viruses and malware. Use your security software to scan them.
  7. Small and medium businesses should consider cyber insurance.While premiums continue to rise, the cost of the insurance is small in comparison to the cost your business will pay for the necessary experts and consultants to restore your systems, or worse yet, the costs of going out of business altogether.
  8. Don’t delegate cybercrime prevention solely to your IT departmentand tell them “get on with it.” Embed these practices across all areas of your business.

Finally, consider encrypting your most sensitive files. Encrypting data is a process of converting data into a form, where it becomes unintelligible to any person without access to a key/password to decrypt the data.

Two forms of encryption that exist currently are hardware-based encryption and software-based encryption. Hardware encryption and decryption processes are executed by a dedicated processor on the hardware encrypted device. In software encryption, the resources of the device on which the software is installed are used for the encryption and decryption process of the data.

Robert Fleming, founder and president of Black Square Technologies, a Denver-based manufacturer of the Enigma hardware encryption device, states that “hardware encryption is much faster than software encryption” as well as more secure.  With hardware encryption, “Even if a company is hacked, and the bad guys capture your files, they cannot open any files that are encrypted,” says Fleming.

Today, small business owners have to assume they will be victims of cybercriminals. Cybercrime is now the world’s largest business running in the trillions of dollars. So far the bad guys are winning. Business owners have to do more than hope and pray that their businesses won’t be next.

 

5 Smart Ways to Boost Your Bottom Line

 

by

Bob Vanourek

Posted: 6-29-14

Times are tough. The “new normal” way of doing business requires smart thinking to protect, and even enhance, your profitability.

 

Here are five smart ways to boost your bottom line:

 

  1. Stop Doing Some Things. In tough times, a more radical focus is essential. So many activities creep into what you and your people do every day that you don’t even realize they are now unessential. Cut that waste-of-time meeting. Cease doing business with that never-satisfied customer. Flow chart some of your business processes such as your billing steps. (Just Google “flow chart a process.”) You are likely to find redundant, non-value-added work that you can eliminate.

 

  1. Vent Your Key Staff You can’t get financial stability in your business until you have psychological stability. Right now some of your staff, probably your best employees, are thinking about where they might go to work next, or what to do if the axe falls on them. Therefore, they are frozen in their work, their innovation, engagement, and their commitment. Stephen Covey famously said, “People can’t listen until they’ve been listened to.”

 

Gather your staff for a long meeting. Announce that “we have to get every issue out on the table.” Announce you’lll go around the room for each person to briefly name an issue for you to write down on flip chart pages. No long speeches. No defensive counters. There will be no retribution for anything that is said. It is a safe environment. People can pass if they wish, but you’ll go around the table until the whole group has passed three times in a row.

 

Be prepared to hear some tough issues, some likely about you. Then have the group prioritize the issues into A’s, B’s, and C’s, or into issues easy to resolve versus longer term challenges. If you’ve done this exercise well, you’ll now know some critical things you must do to enhance your financial performance.

 

  1. Unleash Some Tiger Teams You can’t do everything yourself, and you can’t afford to send people off for “training” in these tough times, so you need to spread the challenges around and unleash the leadership latent in some of your staff.

 

Ask for volunteers to lead some temporary Tiger Teams of other volunteers to attack and solve the A priorities (or easy-to-resolve issues) that were identified. Give them a one-page charter outlining the problem (or opportunity), the specific goal(s), the time frame involved, their authority and budget (if any), who they report to, and how they’ll communicate progress. The volunteers can be people outside the firm too. I was CEO of an organization that reduced 15% (!) of our purchased products costs by forming these teams with trusted vendors.

 

The best way to develop the leadership capabilities of others in your organization is to give them project assignments and to coach them along the way.

 

  1. Find Some Sanctuary You can’t think smartly and strategically when you are buried at the office and under great stress. Consistent with “stop doing some things,” you must get away on weekends, find the time to get away into a place to really relax (without your email and smart phone), or to just get 30 minutes a day to not be on high octane adrenaline.

 

  1. Make a Strategic Move Your competition is back on its heels. Coming out of your sanctuary, you may realize that now is the perfect time to buy out a weak competitor or enter a complimentary market with a new value proposition.

 

Boosting the bottom line by cutting customer services or across the board layoffs won’t help you these days. Be smart in how you boost your bottom line.

 

 

 

Bob Vanourek is a senior consulting for GEM Strategy Management and  the former CEO of five companies from a start-up to a $1 billion NYSE turnaround. Bob is a “turnaround specialist” working with boards of directors, CEO, senior management and leadership tems. He is an award winning co-author of, Triple Crown Leadership: Building Excellent, Ethical, and Enduring Organizations, a 2013 USA Best Book Awards Winner and Leadership Wisdom:  Lessons from Poetry, Prose, and Curious Verse. Bob writes for a number of publications including  Fast company, Financial Executives, & People and Strategy.

 

 

Watch Out — Avoiding IRS Penalties After a Business Sale

Gary Miller

Axial | FORUM

By Gary Miller, GEM Strategy Management, Inc. | January 5, 2017

Any investment banker, wealth manager, or exit planning consultant will tell you that advance preparation is key to a successful M&A transaction.

What they may not mention is that poor exit planning can lead to significant financial consequences for your family. The below scenario tells the story of Bob, a business owner who ended up losing more than half a million dollars thanks to an IRS audit after the sale of his business.

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, Bob and Marge 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 Did This Happen?

In the fall of 2014, Bob 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, both of whom 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). A CRT is an irrevocable trust that generates a potential income stream as the donor to the CRT, or other beneficiaries, with the remainder of the donated assets going to the donor’s charity). Making a donation to the CRT, could help Bob and Marge reduce personal income taxes and estates 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 total. The publicly traded company’s shares were valued at $10 per share or $2.3 million. Therefore, this enabled Bob to reduce his taxable estate by $2.07 million ($2.3 million – $230,000 = $2.07 million). Bob also 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.

The IRS Penalty        

In the fall of 2015, the IRS requested that Bob provide documentation surrounding  the CRT.  After the IRS review was completed, 8 months later,  Bob and Marge received the unwelcome letter from the IRS.

They had disallowed most of the tax savings from the CRT, because Bob had established the CRT after he had received the LOI from the purchaser. 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. Because Bob established the CRT after he had signed a binding LOI, the IRS assumed that the CRT was nothing more than a scheme to evade taxes.

What Should Bob Have Done Differently?

First, Bob should have started his business exit planning including estate planning as early as possible before the sale of his company. Though the law does not specify how long in advance an owner should begin his estate planning, many wealth planning experts recommend that planning should begin from one to five years before the sale of the company. “Bob should have started his planning at least six months in advance of receiving the LOI.  Anything less could spell trouble with the IRS,” says Shelley Ford, a financial advisor with Morgan Stanley Wealth Management.

Scott Fleming, regional president at BNY Mellon Wealth Management, agrees. “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. 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.”

Second, hiring a Registered Investment Advisor (RIA) early in the exit planning process would have given Bob and Marge the opportunity to assess their goals and establish the CRT well in advance. While his family attorney and accountant tried to give good advice, they were not experts in the field of estate planning and wealth preservation.

In addition to the CRT, an RIA may have also recommended 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.

Unfortunately, Bob made a number of mistakes that could have been avoided had he sought professional advice early in the process — and he paid the price for these missteps.

 

Earlier is better when planning a business exit

Gary Miller, GEM Strategy Management, Inc.

Albuquerque  JOURNAL

Earlier is better when planning business exit

By Gary Miller / Executive’s Desk

Monday, January 16th, 2017 at 12:02am

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 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 adviser, as Bob had always managed their investment portfolio himself.

Bob’s attorney advised him to establish a Charitable Remainder Trust. 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 a registered investment adviser early in the exit planning process, the adviser 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 adviser with Morgan Stanley Wealth Management (shelley.ford@morganstanley.com).

She continued, “Bob should have engaged key advisers, 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 advisers 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.com), agreed. “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 added, “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 the 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 can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.

 

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Management practices to avoid: A case study

The Denver Post | BUSINESS

By GARY MILLER / GEM STRATEGY MANAGEMENT |

January 15, 2017, at 12:49 am

Gary Miller

Over the holidays, I spent some time reflecting on both good and bad management practices among clients that I served last year. As I thought about management practices in general, I couldn’t help returning to one company that had engaged our firm to review its operations.

During the review, we found that our client had experienced very poor operating results in 2015, and 2016 was projected to be even worse. With missed revenue targets, negative earnings, high employee turnover, a lawsuit and demoralized shareholders, the company was close to imploding. One management practice stood out like a sore thumb: The company president was a bully. He suffered from what I call the “smartest guy in the room” syndrome.

For example, at a company customer review meeting, the president, in an accusatory tone, asked each account representative why he or she was not generating more sales. When the representatives explained their reasons and offered recommendations for closing more sales, the president dismissed their answers, calling them nonsense or unreasonable. He embarrassed the representatives with caustic remarks in front of their peers.

Staff members’ ideas were never good enough to be considered, much less implemented. He chastised employees for not being more aggressive about making their quotas. He appeared to be competing with them by boasting that he always met his sales quotas and never had any of the problems they described.

During our operations review, we interviewed a number of managers and employees. The president’s management practices were described as “abrasive,” “abusive,” “arrogant” and “condescending.” Many employees said they had put their resumes “out on the street” and were seeking other opportunities.

Bullying in the workplace usually starts at the top. In this case, other company officers tolerated the president’s management style. Bullying puts all employees, not just those who are being bullied directly, into a state of fear. As a result, it’s extremely difficult to be positive, creative or productive. Bullying is one of the most demotivating, demoralizing and debilitating of all management practices. It’s the quickest way to lose your most talented people and develop a reputation in the marketplace for having a ”poor work environment.”

After spending a good deal of time at the company’s offices, we also observed other poor management practices. Rarely did senior management treat employees as individuals or offer simple courtesies. Greeting staff members in the morning, asking about families and complimenting employees when they accomplish major tasks are easy interpersonal skills that help bond employees to their companies. It’s debilitating to employees to feel unappreciated – particularly when they believe they’ve done a particularly good job on a project or solved major problems for the company.

In our review, we also observed poor communication to employees and disorganization and indecision among management. Employees did not trust senior management. When it came to corporate values, management did not “walk the talk.”

It’s demoralizing for staff to see senior management spouting the rhetoric of corporate values but not practicing those values. Senior managers who fail to model appropriate behavior in the workplace or in their personal lives send a message of shallowness and phoniness.

When we provided our findings to the company’s board of directors, we recommended that the president be terminated. The culture of the company and its operations issues were beyond repair if he continued to lead the company. After discussing the report’s findings, the board asked us to provide details about what the new president will have to do to save the company.

The new president will face daunting morale challenges beyond the operations issues. The new president will have to:

  1. Build a new foundation – a core team that shares the company’s vision to drive accomplishment. Choosing the right person for each role will be critical so no one is saddled with constantly having to perform tasks that are not part of the employee’s responsibility. That can cause resentment.
  2. Forego coaching weaknesses and focus on leveraging strengths and passions of the new team.
  3. Manage without ego. Select a senior management team that can admit when operating systems are failing and be willing to change to improve. A feeling that “we are all in this together” must permeate the organization and is critical to inspiring motivation.

4 Select senior management that will own the operating systems from start to finish. Managers should be obsessed with the details, the metrics, and the numbers.

  1. Compliment staff members when they hit their goals. If goals are missed, work with each member to examine what he or she could have done better.
  2. Solicit genuine feedback from both management and staff. The president’s team members must be vocal and active participants in the company’s operations to eliminate inefficiencies and make improvements as the business grows.
  3. Set management and staff expectations. Accountability and responsibility are two of the most effective management practices any business can employ. Regular meetings – every week or two — will demonstrate management’s commitment to the goals, the operating priorities and the focus on people and processes.

A few weeks later, the board terminated the president, and the search for a new president is underway.

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.

 

 

 

Want to grow the company? There may be extra cash on the balance sheet

Gary Miller, GEM Strategy Management Inc. He writes a monthly column for The Denver Post

The Denver Post | BUSINESS

BY Gary Miller

GEM Stratetgy Management, Inc.

I am often asked by business owners how to generate cash — beyond their company’s immediate cash requirements — to make an acquisition, expand into new territories, hire additional staff or buy a new plant and equipment.

All of these growth scenarios take significant cash. Since many companies have existing debt, their borrowing capacity is often limited. Therefore, generating additional cash strengthens a company’s balance sheet and allows the company to increase its credit facility.

In today’s environment, lenders and sellers are vetting operating companies’ and buyers’ capacities to repay loans — particularly if an acquisition is structured with an earn-out or includes seller financing as part of the deal structure.

Generating additional cash, whenever an owner can, is important since a company’s cash requirements are generally extensive. The more cash the owner can bring to the table, the less the owner will have to borrow.

Before developing a strategic borrowing plan, I advise clients to first examine the full potential of resources within their own companies.

This examination is applicable to almost any cash need a company has, whether it is for an acquisition, for growth and expansion purposes or just for improving profits.

The most obvious place to look for internal cash generation is the current asset section of the company’s balance sheet.Advertisement The conversion of under-utilized assets to cash provides a triple bonus: It reduces the amount of the funds needed, it improves the balance sheet, thus improving debt coverage ratios, and it improves cash flow.

If an owner examines each element of his or her current assets, receivables can offer substantial opportunities for generating additional cash.

For example, if a company with $25 million of annual revenues shortens its average receivable collection period by only two days, it will produce almost $150,000 of additional cash.

Also, changing sales terms, or tightening credit standards, procedures and follow-up, often can improve the average collection period by as much as a week. If that $25 million company, for example, reduces its collection period by a week, then as much as $500,000 of interest-free cash can be added to the company coffers. Regardless of the company’s size, shortening the collection period to as few days as possible will generate significantly better cash flow and additional cash.

Analyzing inventory is another resource often overlooked. In addition to the obvious tactic of reducing gross inventory levels, there are often more subtle elements that can be explored. Three questions owners should ask themselves:

  • Are there product lines that contribute nominal amounts of sales but absorb significant inventory resources?
  • Are there inventory items that are in small demand but are required to produce low volume products with high margins?
  • Are there suppliers that can be induced to assume some inventory functions, even though it may require entering into annual supply contracts?

Finally, another place to find additional cash is examining the fixed asset accounts on the balance sheet.

In addition to the obvious tactic of outright disposition of assets (excess land, unused/underutilized equipment and similar items), there are opportunities to sell and then rent or lease back such items as vehicles, computers, plant and equipment. While these arrangements can be more costly than owning, it is worth examining them as another source of cash.

Since many of our clients are looking for acquisitions or to sell their companies, I advise those looking to buy companies to use these and other techniques to find “synergies” that can lower their acquisition costs and add cash to the acquired company’s operations.

All of these techniques should be examined during the due-diligence process of any acquisition or expansion.

After the owner has squeezed every last nickel out of the various balance sheet items, it’s time to develop a strategic borrowing plan.

Start with the owner’s cash flow statement. The historical cash flow of a company is the surest prediction of how much money can be borrowed solely on the strength of the company’s own resources.

Regardless of your needs for generating additional cash, whether it be for profit improvement, growth and expansion or acquisitions, a review of your asset utilization — particularly receivables, inventory and fixed assets — will provide opportunities to generate additional cash, improve the balance sheet and profit and loss statement, and lower borrowing needs.

 

 

 

An Acquisition Program May Be the Answer to Faster Growth

Gary Miller

By Gary Miller, CEO, GEM Strategy Management, Inc.

POSTED:  July 15, 2014

Slow growth is affecting many small and middle market companies causing owners to re-evaluate their growth plan strategies. Traditionally, business owners have depended on “organic” growth only, (growth coming from existing and newly acquired customers) as their primary sources of revenue. With higher taxes, more regulations and industries consolidating, business owners realize operating expenses are rising faster than new revenues.

Faced with this environment, smart business owners are developing acquisition programs to bolster revenue growth. Since most business owners have neither expertise nor experience in acquiring companies, they often hire a management consulting firm with M & An experience to assist them in developing a successful acquisition program. All successful programs require a combination of careful planning, savvy thinking, and well-executed tactics.

There are six critical steps to a successful acquisition program:

  1. Planning your acquisition program;
  2. Finding and approaching the right acquisition candidates;
  3. Conducting robust due diligence;
  4. Structuring the proposal;
  5. Preparing transaction documents and closing; and,
  6. Integrating the acquired company.

This article examines in depth the first step only of the six step acquisition process, “Planning Your Acquisition Program” (see The Denver Post, 6/22/2014 “Grow Faster with a Well-Planned Acquisition Program” for a description of all six steps.

Careful acquisition program planning includes:

  1. Determining the program goals:
  2. Selecting the strategy and rationale; and,
  3. Determining criteria and, matching criteria against available financial resources.

After careful examination of alternative methods for corporate growth — new product development, licensing arrangements, and joint ventures’ — it must be determined, whether acquiring another company is the most effective path to meet corporate growth objectives. An acquisition program should ameliorate strengths and/or eliminate weaknesses. Before embarking upon a program the company must spend time in serious self-examination to determine its own strengths and weaknesses and their capacity for supporting, financing and integrating a newly acquired company.

Establish Acquisition Goals

  1. Goals can include addressing these issues.
  • To fill a product/service line gap
  • To expand geographically while taking out a competitor
  • To upgrade infrastructure
  • To increase distribution channels
  • To improve the acquirers balance sheet
  • To acquire management talent and their customer base
  • However, the most important goal is any acquisition program is to add enterprise value and increase shareholder wealth.

Establish Acquisition Strategy and Criteria

Among others, an important strategic issue is the form of payment. The ramifications of using cash or stock must be examined against the possible benefits of using other forms of payment, such as notes, earn-outs, stock options, bonus clauses, and non-compete contracts. Flexibility in structuring the transaction will enhance the buyer’s negotiating position.

Criteria supporting the strategy should include the following:

  • Companies of interest
  • Financial requirements (balance sheet, cash flow, earnings history, ROI)
  • Minimum size
  • Market position (i.e. # 1, 2, 3, other) growth rate potential
  • Profitability trends
  • Margins
  • Competition
  • Regulatory environment
  • Labor/capital intensiveness
  • Stability/Risk
  • Management team depth and quality
  • Payback time period
  • Debt capacity
  • Synergy of combined operations
  • Product/Service offerings and quality
  • Brand and reputation
  • Cultural fit

Summary

Careful planning can significantly lower risk of failure. The path to rapid growth is littered with acquisition “road kill”. Most acquisition failures can be traced back to poor planning. However, that same research indicates that those companies that complete more deals than companies who do not, generate higher returns on investment, greater enterprise value, deliver stronger financial performance and create significantly more shareholder wealth.

Gary Miller is founder and CEO of GEM Strategy Management, Inc., an M&A management consulting firm focusing on strategic planning and growth strategies, mergers and acquisitions, value creation and exit strategies for business owners of middle market companies. For more information contact gmiller@gemstrategymanagement.com or 970.390.4441