Business Owners’ Exit Options

[cs_content][cs_section parallax=”false” style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/05/Content-Detail-News.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text]Business Owners’ Exit Options

Business owners planning for retirement may have a greater range of exit options available to them than they realize. If they truly are ready to “let go” and cash in on the fruits of their success, then an outright sale of the business usually is the preferred route.

However, some owners may wish to give their key managers the opportunity to take over the business, but are concerned that these employees don’t have the capital to match the price available from outside buyers. In fact, under certain circumstances, existing management can be the best buyers.

Finally, some business owners are not yet ready to spend their remaining days at the beach! After decades of building the value of their business, they cannot bear to let go entirely. This attitude is consistent with the entrepreneurial personality. Such people prefer to remain in control, but just want to take some money “off the table” for personal security.

A creative, well-structured financing package can address this array of exit options.

Competitive “Auction” Sale

There are two types of third-party buyers for businesses: strategic buyers and financial buyers.

Strategic buyers are companies in the same or related businesses that recognize the value of an add-on acquisition that provides economic synergies to their existing enterprise. For example, incremental business volume to a strategic buyer often can be added without duplicating infrastructure costs that already are in place, thereby yielding more to the bottom line. For this reason, experienced investment bankers/sell-side brokers always target strategic buyers first when they market a business for sale. Simply put, strategic buyers usually pay a higher price.

One cautionary note when dealing with a potential strategic buyer is the risk of revealing confidential customer information to a competitor. This concern can be addressed up front with a confidentiality agreement, but it is important to limit revealing the most sensitive information until there is a binding agreement between the parties.

Financial buyers are a different target. These are private investment funds seeking acquisitions in which they can build value over a five- to seven-year investment horizon. The price they are willing to pay is driven purely by the economics of their investment returns.

Sometimes these funds already have existing portfolio companies in the same industry that are seeking a strategic add-on. This is the “platform” on which they intend to build an industry concentration that they believe has attractive potential. In this sense, the private equity buyer is making a strategic investment and likely is very knowledgeable about the business owner’s industry. The supply of private equity funds today far exceeds the supply of good investment targets, so these financial buyers are ideal targets when running a competitive auction sale.

Management Buyout

Some business owners feel an understandable obligation to give their management team a succession opportunity, even though these key employees may have little capital of their own. After all, these are the people who helped to make the owner rich! The owner also may realize that if the business is sold to a strategic buyer with management already in place, some of the company’s key people probably will lose their jobs.

However, there also are self-serving reasons beyond gratitude and kind-heartedness for why owners should consider their key executives. The truth is that some business sales cannot take place without the eager participation of lead management. Moreover, successful management teams often can be the most competitive buyers. There are two paths to a management buyout, each with contrasting risks and opportunities.

Private Equity Partner – Private equity funds nationwide are eager to partner with proven management teams in the acquisition of their businesses. If the key managers have a good track record and a vision for further growth and profitability, they can be an absolute magnet for investment capital!

The private equity fund will take care of all necessary capital raising – including their own equity, senior bank borrowings and anything else needed to fully fund the purchase price, expansion capital and working capital going forward. The management team will not be required to guaranty any borrowings. They will receive a “carried” minority ownership interest, often with the right to earn more based on performance, as well as employment agreements.

The management team also will be under persistent pressure from the investor to increase value through growth, additional profitability and add-on acquisitions. If successful, management shareholders can make a lot of money upon the private equity firm’s exit – through either private or public sale five to seven years later. However, as controlling shareholder, the private equity firm determines the exit schedule and terms, not management.

Leveraged Buyout – An alternative form of management buyout is the classic leveraged buyout, where the assets and cash flow of the target company are used to raise the maximum debt possible to buy out the controlling shareholder. The total funds needed to cover the purchase price and working capital usually cannot be raised with bank debt alone. Additional funds may be raised in the form of “mezzanine” financing – that is, long-term debt that is subordinated (junior) to the senior bank debt and accordingly is viewed by the bank as underlying “capital.”

Mezzanine financing is available through specialized funds of all sizes, beginning at $1 million and up. It’s a complex form of financing that, due to its subordination features, is quite expensive and should be used only as a supplement to less costly bank debt. A primer on this form of financing is available through the link below:

http://lrnathanassoc.com/funding_sources/index.html

A seller’s note taken back by the owner may be negotiated as a means of boosting the price further, but this obligation likely will need to be subordinated to both the bank and mezzanine debt. This non-cash portion of the selling price, sometimes cynically referred to as a “hope note,” might be secured by the acquiring management’s new ownership shares. If the total financing in a leveraged buyout is structured properly, the management team should end up with a controlling ownership position. However, in the absence of their significant equity contribution, the key managers likely will be expected to personally guaranty the senior bank portion of the debt.

Shareholder Recapitalization

Business owners who have built successful companies over many years, but are not yet ready to relinquish control, might wish to take some money “off the table” for personal financial security. A well-structured leveraged recapitalization can enable owners to put cash into their personal bank accounts and preserve the outright sale opportunity for another day.

A leveraged recap cannot rely solely on bank financing. Banks are reluctant to see corporate borrowings withdrawn for personal use. Moreover, bank loans usually require the personal guaranty of the majority shareholder, which would be inconsistent with the owner’s objective of

diversifying personal risk. The use of long-term subordinated mezzanine debt as a supplement to bank financing is a recognized and appropriate way to monetize ownership value. Moreover, banks view mezzanine loans as junior capital that strengthens the balance sheet. Mezzanine funds will not restrict working capital and usually do not require a personal guaranty.

Conclusion

Business owners have a range of choices as they consider retirement, winding down, or monetizing their ownership value and preserving the option of an outright sale for another day. They may choose to sell to a strategic buyer, which has the potential to yield the highest price, or to a financial buyer. They might consider selling to their deserving management team in partnership with a private equity investment fund, or through a leveraged buyout. Finally, they might elect a partial cash-out through a shareholder recapitalization.

Whatever their choice, a well-structured financing package that is customized to fit individual objectives can expand the range of realistic options available to controlling shareholders seeking an exit. However, each situation is different, with its own personalities, issues and conflicting priorities. The good news is that abundant capital is available in today’s market to facilitate the optimal solution for each case.

About the Author

Larry Nathan is president of L. R. Nathan Associates (www.lrnathanassoc.com), an investment banking and business advisory firm that has been advising middle market companies throughout the Northeast since 1980, helping to finance their growth, strategic acquisitions, management buyouts, shareholder recaps and turnaround plans.

Link to PDF[/cs_text][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]

Mastering Cash Management

[cs_content][cs_section parallax=”false” style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/05/Content-Detail-News.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text]Mastering Cash Management
Effective Cash Flow Strategies for Growing Companies

If you have been fortunate enough to hit that sweet spot wherein, through hard work, instinct, timing and opportunity, you find yourself at the helm of a thriving, profitable business, you have already achieved what many others have only dreamed of.

Yet, once you have realized your vision and created a successful business, the prospect of what it will take to remain on top can be daunting.

So, what makes one company the pinnacle of success and another the failed execution of an otherwise brilliant plan? Although the answer might surprise you, history has demonstrated that ineffective cash management has been the nemesis of many an entrepreneur. The old adage “cash is king” is as true today as it was the first time it was ever uttered.

That’s why we created, with the help of seasoned business managers, investors and lenders, a guide to effective cash management. Download “Mastering Cash Management: Effective Cash Flow Strategies for Growing Companies,” and you’ll find tips on:

  • The fundamentals of cash management
  • How to put together a cash flow statement
  • How to accurately forecast cash flow
  • How to manage growth
  • How to manage accounts receiveable and accounts payable
  • How to raise funds to fuel growth
  • How to invest idle cash balances
  • and more

Link to PDF[/cs_text][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]

Customer Loyalty: Delight Them with Your Product, Amaze Them with Your Solutions

[cs_content][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/05/Content-Detail-News.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text]Customer Loyalty: Delight Them with Your Product, Amaze Them with Your Solutions
How to take customers from satisfied to loyal and grow your business

employees in office

Whether you are selling business-to-consumer (B2C) or business-to-business (B2B), retaining customers for your product or service should get as much attention as winning over new ones. According to HubSpot.com, it is your delighted customers who will refer new business to you. Securing new business through existing clientele is, in fact, more cost effective than always searching for new prospects. Campaigns to win new customers require about five times (sometimes even 20 times, depending on the industry) the investment than those to build loyalty.

“Campaigns to win new customers require five to 20 times the investment than those to build loyalty.”  Click to tweet.

Don’t assume loyalty
In most cases, even in B2B, it is not that difficult for customers to switch to new sources. Moreover, when they do switch, they are apt to share their story with others, especially if they switched because they were dissatisfied. A dissatisfied customer spreads the word faster than a satisfied one.

For many customers, however, it is easier to remain with their existing suppliers than to make a change; just don’t confuse this inertia with loyalty. Even if something doesn’t go dramatically wrong, a competitor with an attractive pitch can overcome this inertia once the honeymoon phase comes to an end.

Satisfied vs. loyal
In B2C especially, competitors with coupons, loyalty discounts, “points” programs and other tactics to attract new customers vie on a daily – if not hourly – basis to overcome the inertia of customers and win them over to their side. This is a tactic you most likely are employing, as well, if you are B2C. Plenty of loyalty-and-reward systems out there can help you expand your customer database. By rewarding customers for staying “loyal,” you give them a good reason to come back every single time, and in return you get reports, customer data and analytics. In B2B, these loyalty platforms may not be as feasible, or as effective, but it doesn’t matter. Loyalty cards that build points toward special pricing, QR codes for scanning by smartphones, tokens that can be traded for discounts and the like are a good idea, but they don’t get to the heart of what drives customer loyalty.

If a product or service meets specification consistently, customers are satisfied with the buy. To get from satisfied to loyal, however, there is a stretch; you need to do more. Full-blown loyalty is driven by small things that can be difficult to measure. These small things build up, for good or for bad.

Focus on the user
Actual loyalty is driven by relationships that you build between your team and the customer. Even in B2B, when sourcing is often driven by approved-supplier lists, purchase orders, and long-term budget and capital planning, there is still a person behind every decision to buy – a person in a visible position in the organization who has a stake in the outcome of the buy. It might be a CEO, CFO, CIO or a purchasing manager, but someone in your customer’s organization is concerned that every user experiences the value of the product or service.

“Actual loyalty is driven by relationships that you build between your team and the customer.”  Click to tweet.

Bear in mind that whether you are B2C or B2B, you are ultimately selling individual-to-individual. You need to demonstrate that you understand your customers as individuals, and then make yourself indispensable to those individuals. It is difficult to fire somebody you like, especially when you not only like them but you like the job they are doing for you.

How to build the one-to-one relationship
There is always a period after a customer buys when the relationship is in a honeymoon phase – when the customer is excited about their decision and the benefits they expect to see. Use that momentum to ensure they actually use your product or service, and use it in the way that will make them the most successful. Active use that drives results is the first step to making your company a fixture in their organization.

Tools are available to measure individual user activity and the enthusiasm behind it. For example, the Net Promoter Score measures people’s responses and their likelihood to recommend a product or service on a scale of 1 to 10. There are many other tools, as well. Whichever tools you use, measuring is a basic tenet of all good marketing campaigns. The traditional areas of measurement, in addition to customer satisfaction, include attrition rates, revenue targets, up- or cross-selling, the number of customer saves and the number of customer programs completed.

However, measuring is just the start. To build a relationship, you must go beyond the transaction. You must communicate with the people you sell to. If you survey your customers, if you ask for their feedback, if you use loyalty programs to collect data from them, you are making a commitment. After a customer invests time giving you information that enables you to measure his or her satisfaction, to complete the commitment, you need to share the results of your measuring with your customer.

Sell solutions, not features  Click to tweet.
In today’s markets, customers are struggling with complexity on a near daily basis. Your B2B customers may be dealing with constant regulation changes; your B2C customers are dealing with more personal issues. All are trying to find a solution to a problem, and each time they show a potential interest in a product or service, they are thinking about a pain of some kind or a problem they are having, and they are looking to make their lives easier. The more you can offer your company’s product or service as a utility that minimizes their pain, the more delighted your customers will be.

“The more you can offer your company’s product or service as a utility that minimizes pain, the more delighted your customers will be.”

To do this, share what you know. Use blogs, white papers, webinars and face-to-face or telephone conversations – or, if possible, a combination of all of the above – to reflect back to your customer what you have learned about their problem, and how your product or service provides the exact solution they need. The organization that constantly measures customer experience but does not share its findings with customers is doing only half the job, and the half it is not doing is the part that risks leaving loyalty on the table.

When you tell your customer how much you have learned about their challenges and what you know you can do to solve them, you set yourself up as more than a seller of features. You become a trusted adviser: “Here is data that shows how individuals in your exact situation have benefited from this exact solution. Based on this data, we have built our product and services specifically to provide you with these benefits, too.”

Ultimately, you must have a product or service that provides a unique and amazing experience to your customers. Acquire top talent to manage the development of your product and service offerings. Recruit front-line employees who serve as the helpful and intelligent face of your business to customers. Remember, however, the strong correlation between customer loyalty and how likely an individual is to recommend your organization. These recommendations are rooted in the customer’s perception of you as the only one they trust to understand and solve their problems. Then you will measure your growth not just in revenue and market share, but also in terms of increasing the number of problems you are solving for your loyal customers.

NOTE: Special thanks to those who shared their insights for this article:

Link to PDF[/cs_text][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]

Why Outsourcing HR May Be the Smartest Decision Your Business Makes

[cs_content][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/Content-Detail-Paper.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text]Benefits of HR Outsourcing – Why it May be a Smart Decision
applicants sitting waiting for interview

HR may sound boring, but it’s important. Learn how venture-backed small businesses can benefit from doing it right.

According to a Harvard Business School study, as many as 75 percent of startups fail. Essentially, the companies in the study couldn’t generate a profit in order to pay back their investors. As many business owners know, being profitable is not just about creating a successful product or solution and selling it, but also sorting out how to efficiently and effectively manage day-to-day operations, like human resources (HR), within a budget, which in turn affects the bottom line.

Developing a value proposition, gaining traction in the market and trying to make sense of the overall business model is tough. Having the right people on your team eases these challenges. Although HR can be difficult for businesses of any size, the growing complexity of managing HR processes today presents a significant challenge for small companies starting out – in particular, because these companies have fewer resources.

Scope and Complexity of HR

HR is not only about hiring and firing. It’s also about offering benefits that attract and help retain workers, such as healthcare benefits, retirement plans and workers’ compensation insurance; procuring time, expense and payroll management tools that keep employees paid and happy; and complying with employment law. HR has become even more complicated in the past 20 years due to regulatory compliance issues like the Affordable Care Act and the Lily Ledbetter Act. Noncompliance with these acts can cost companies dearly in expensive legal fees and penalties.

“Noncompliance with the Affordable Care Act and the Lily Ledbetter Act can cost companies dearly in legal fees and penalties.” Click to tweet.

Options for Managing HR

Employers can try to manage HR themselves, but such internal HR handling distracts from managing core business matters. Employers, particularly those with limited resources, find it hard to keep apprised of the latest HR laws when their attention is needed elsewhere. Although hiring someone full-time in-house is an option, it may not be cost effective for a small company.

To minimize the challenges posed by HR management, startups can turn to HR outsourcing companies. HR outsourcing companies can take care of services such as payroll administration, employee benefits, and HR management like recruiting, hiring and firing. They also provide risk management tools in connection with compliance, legal and related risks such as workers’ compensation, employee practices liability insurance and company policies. In addition to providing more time to address issues outside HR, outsourcing HR helps employers stay current with state and federal regulations and reduces the risk of employee litigation. At its best, HR outsourcing organizations operate as a strategic and aligned business partner with the company, which in turn allows the company to better plan for future growth.

Here are some numbers to consider. According to a Small Business Administration study, the average small business owner spends 25+ percent of his or her time handling employee-related paperwork. This average can increase to a staggering 35-45 percent if the tasks include recruitment, hiring and training of new employees. HR outsourcing companies save business owners time by taking on this burdensome responsibility, while helping them remain compliant.

Even better, outsourcing HR can save companies money. For example, HR outsourcing companies are often able to offer their customers healthcare discounts of roughly 2 to 5 percent. Savings can jump even higher when HR outsourcing companies bundle a variety of HR services (e.g., healthcare, payroll and staffing) for customers.

“HR outsourcing companies are often able to offer their customers healthcare discounts of roughly 2 to 5 percent.” Click to tweet.

Types of HR Outsourcing Providers

If a startup company decides to make the move to an HR outsourcing provider, it’s important to know that such providers come in a few varieties. Some offer comprehensive packages, while others allow you to pick and choose what you need. Most fall into these four basic categories:

  • Professional employer organization (PEO): assumes full responsibility of human resources administration, essentially becoming a partner of the company. It becomes a co-employer of a company’s workers. Employer responsibilities are shared or allocated between the company and the PEO. This includes legal requirements for employers and responsibilities for hiring, firing and financial compensation. As full-service providers, they often provide services like on-call consulting, sending consultants who will come in to train staff or even settle a dispute.
  • Business process outsourcing (BPO) organization: encompasses outsourcing in all fields, not just HR. BPOs either put in new technology or apply existing technology in a new way to improve processes. A BPO makes sure a company’s HR system is supported by the latest technologies, such as self-service access and HR data warehousing.
  • Application service provider (ASP): hosts software on the Web and rents it to users. This includes both packaged and customized software to manage payroll, benefits, etc.

Keep in mind that even while using outsourced HR, it’s possible to maintain some of the HR in-house. A company might choose to keep hiring in-house while outsourcing payroll or expense management, if it suits the company’s needs.

HR presents a complex set of challenges to businesses, especially to small and growing ones. There is no one-size-fits-all approach to outsourcing HR, so a company should be sure to research its choice carefully. Not only will such a company’s employees be thankful, but its investors will too, when they see the potential cost effectiveness of HR outsourcing and the ability of the company’s internal team to concentrate on managing the core business.

(See related TriNet white paper.)

About the Author

Peter DembrowskiPeter Dembrowski is a regional vice president of sales at TriNet in New York. TriNet is a strategic partner to small businesses for HR, benefits, payroll, employment law compliance and risk reduction. With more than 15 years of experience, Peter has assisted a wide range of companies with their HR needs. He has worked with technology, venture capital, accounting, financial and other professional services firms. You can contact Peter at Peter.Dembrowski@trinet.com.

 

Link to PDF[/cs_text][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]

Employment Agreements: Who Needs Them? When Should a Startup Company Have Them?

[cs_content][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/05/Content-Detail-News.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text class=”cs-ta-left”]Startup Employment Agreements: When Should a Company Have Them?

job interview

Companies whether long established or just starting up—are not required to offer a written employment agreement to any employee they hire or currently employ. In some cases, however, it may make sense to have a written employment agreement signed by an employee. Below are some general considerations, good and bad, that a company, particularly a startup, should think about before using an employment agreement.

A startup company may find it useful and in its best interests to have an employment agreement in order to exercise a degree of control over an employee’s ability to leave. For example, a company that is spending a significant amount of time and money on recruiting, interviewing, hiring and training a new employee might want to consider an employment agreement. Such an agreement may lock an employee in place for a specific period of time or, at the very least, require the employee to provide a specific amount of notice prior to leaving. Although a company cannot force an employee to remain employed, having an employment agreement may keep the employee from voluntarily walking away, especially if there is a penalty for doing so.

An employment agreement can set performance standards and grounds for termination. With those spelled out, a company may find it easier to hold an employee accountable and terminate an employee should that employee fail to live up to the company’s standards.

A startup may want to take affirmative steps to attract and retain an employee with specialized knowledge or technical skills applicable to critical company functions; particularly since replacing such employees may prove difficult. Rewarding an employee with nonfungible skills by providing secure employment over a certain time period may help ensure that the employee remains with the company, and provide a competitive advantage over rival companies.

“Rewarding an employee with nonfungible skills by providing secure employment over a certain time period may help ensure that the employee remains with the company, and provide a competitive advantage over rival companies.”  Click to tweet.

An employment agreement may limit an employee’s ability to disclose proprietary information or seek employment with a competitor through certain confidentiality provisions or restrictive covenants. These may include confidentiality, nondisclosure, noncompetition and nonsolicitation clauses. Since the nature of each position is different, an agreement may not need to include all four clauses, or any of them at all. Each position should be examined separately to determine which covenants are appropriate. To be enforceable, the restrictive covenants must be reasonably limited in time and/or geographic area.

However, a company does not need to have an employment agreement with an employee to limit the employee’s ability to disclose confidential information or compete against the company. A company may require employees to sign confidentiality, nondisclosure, noncompetition and nonsolicitation agreements without having a written agreement for employment in place.

A startup company should bear in mind, however, that an employment agreement will also bind the company to certain obligations and limit its rights with respect to the employee. For example, if the company decides that it needs to close part, or all, of its business, or if it decides that reorganization is required, the company may want to end the terms of an employment agreement early. Generally, such early termination comes with a penalty. Indeed, depending on the terms of the employment agreement, such early termination may be a breach of contract. To avoid such penalty, a company may have to renegotiate an employment agreement, which may result in less-favorable terms for the company.

Similarly, if an employment agreement provides specific benefits to an employee, such as health insurance, life insurance, disability payments, membership to a health club, or retirement benefits, a company cannot unilaterally stop providing such benefits even if the company is facing financial difficulties. In such a case, the company will have to renegotiate with the employee, who may not agree to the reduced benefits.

“…if an employment agreement provides specific benefits to an employee, such as health insurance, life insurance, disability payments, membership to a health club, or retirement benefits, a company cannot unilaterally stop providing such benefits even if the company is facing financial difficulties.”  Click to tweet.

Lastly, while having agreement terms that clearly define grounds for terminating an employee may make it easier for the company to hold the employee accountable, such terms may also limit the company’s ability to simply part ways with the employee if the relationship sours or for any other reason. The company likely could terminate the employee without penalty only if he or she engaged in conduct warranting such termination as set forth in the agreement. Any other termination would typically require the company to pay a pre-negotiated severance amount to the employee.

In considering the above recommendations, remember that these are meant as general guidance; each case will present its own unique set of circumstances. Thus, we recommend that you get some input from an employment lawyer prior to drafting and offering a written agreement to an employee.

About the Author 

Jarad LucanJarad Lucan is an associate with the law firm Shipman & Goodwin. He practices labor and employment law on behalf of both public- and private-sector clients. Additionally, Jarad advises employers and provides training on a broad range of personnel-related matters, such as disciplinary issues, termination and separation issues, reasonable accommodations, and personnel policies and practices. You can contact Jarad, who is based in Shipman & Goodwin’s Hartford office, at jlucan@goodwin.com.

 

 

Link to PDF[/cs_text][/cs_column][/cs_row][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”] [/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]

The Ins and Outs of In-Licensing

[cs_content][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/05/Content-Detail-News.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text]The Ins and Outs of In-Licensing – What is In-Licensing?

In the research, development and design of new products, an increasing number of startups are turning to “in-licensing” technology from universities and other institutions as a means of getting products to market quicker while reducing both risk and cost in the early stages of development.

Rapid progress in product development also allows for financing opportunities beyond what is possible for most technology startups. An increase in capital, in turn, can help support more aggressive development of novel technologies (both internally and by way of additional in-licensing arrangements).

While in-licensing can result in a successful “marriage” between licensor and licensee, it’s important for the parties to recognize that – just like in any marriage! – they often come to the table with different (and at times conflicting) experiences, incentives and goals. Therefore, a better understanding of key issues involved in structuring and negotiating the in-licensing arrangement will help the parties better establish a clear framework for a mutually beneficial relationship.

Drilling Down

As with any strategic transaction, in-licensing arrangements are typically more successful when both parties enter the relationship well-informed and with eyes wide open. Identifying risks and other “red flags” through the due diligence process – and working together in addressing and trying to resolve those issues – will go a long way in ensuring that the parties start the relationship off on the right foot.

In addition to general business and economic considerations, a licensee will want to drill down on certain technical and legal matters in determining the value of a prospective in-license arrangement, including the following:

  • What is the track record of the licensor and its development team in supporting successful commercialization of technology?
  • Have all members of the licensor’s development team and other personnel duly assigned all rights to the technology to the licensor?
  • Will the licensee have access to key members of the licensor’s development team? Are they willing to provide the licensee with information regarding their development efforts?
  • Are there any existing research and development, joint venture or other arrangements restricting the licensor’s use or license of the technology? Do any third parties hold patents or other rights that could block the use of the technology the licensee proposes to in-license?
  • What do the licensor’s patents and patent applications actually cover? Will the licensor (or the licensee, if associated rights are granted) be able to effectively prevent others from competing with the licensee?
  • Are there any regulatory considerations that should be disclosed? What is the risk the licensee will not get regulatory approval for products containing the technology? Has the technology the licensee intends on in-licensing already been used in an approved product?

Bridging the Value Gap

Generally speaking, the more likely it is that the product containing the technology will be commercially successful, the more favorable the financial terms will be to the licensor. A number of factors need to be considered in assessing the likelihood of success, including existing and prospective competition, expected demand for the product, the need for additional capital/investment and the nature of any required regulatory approvals.

“The more likely it is that the product containing the technology will be commercially successful, the more favorable the financial terms will be to the licensor.”  Click to tweet.

The following are among the most common financial features of an in-license arrangement:

  • Upfront Payment
    • Paid to the licensor upon or shortly after signing the definitive license agreement
    • Often treated as an advance on royalties
    • Typically expected in situations where the technology is well-developed (resulting in less risk to the licensee)
  • Milestone Payments
    • May include payments due upon events such as the licensee obtaining financing, the successful completion of clinical trials, the product receiving regulatory approval and/or some other mutually agreeable milestones
    • Allow the licensee to extend payments over the term of the license as the product achieves commercial or other success
  • Royalty Payments
    • Typically expressed as a flat rate per unit sold or a percentage of sales/profits
    • Often a difficult point of negotiation
    • “Customarily” ranging from 3% to 8% of sales
    • Often subject to adjustment over the term of the license upon the occurrence of certain “trigger events” (e.g., an increase in the sale price of the product, an increase in  licensee’s costs in supporting the product, the expiration or invalidity of the patent(s) covering the licensed technology, etc.)

It should be noted that licensors and licensees often have different notions of what it means for a product to be a “success” when considering commercial and other milestones. For example, a large pharmaceutical company may establish certain commercial thresholds before advancing a new compound into the final stages of clinical development (e.g., projected annual revenue of at least $200 million). These thresholds may be much higher than those that a startup or emerging company may look to establish in determining “success.”

“Licensors and licensees often have different notions of what it means for a product to be a ‘success’ when considering commercial and other milestones.”  Click to tweet.

Furthermore, as the primary focus for an early-stage company is typically enterprise value (rather than revenue), a successful clinical trial (or achievement of some other “non-commercial” milestone) may be of more relative value to the early-stage company than it is to the larger company that is more concerned about its bottom line and share price.

To negotiate successfully, it is important for each party to recognize the other party’s goals and incentives and find a way to “bridge the gap” between the values placed on the technology and the product at the various stages of the in-licensing transaction.

Papering the Deal

The definitive license agreement should accurately reflect the commercial terms as agreed upon by the parties, with appropriate representations, warranties, covenants and conditions to account for the results of due diligence and allocation of risk between the parties.

The scope of the license and the definition of licensed rights and technology are arguably the most “material” provisions of the agreement. The licensee will want to ensure that the license includes all rights it needs – both now and in anticipation of future growth – to produce and sell the products. The licensor will want to ensure that the scope of the license is not overly expansive (potentially resulting in an inadvertent grant of rights to technology or other intellectual property [IP] that is not necessary for the production of the products or violation of the terms of an existing agreement it has in place with a third party).

As the licensor owns and may continue to develop the licensed technology, it is important for the licensee to ensure that the scope of the in-license extends to all new technology/IP that is derived from the original. The licensee may also create new IP based on the licensed technology (i.e., derivative works), and while it is common for the licensee to maintain ownership rights in this new IP, the licensor may be granted rights or a “grant-back” with respect to this technology.

As with other commercial agreements, termination rights will typically arise upon breach of the in-license agreement by either party. In addition, both parties will want the right to terminate the relationship in the event regulatory approval is not obtained or obtainable within a predetermined period or upon the occurrence of any other event that makes the commercialization of the product containing the technology impracticable.

Express Licenses

In an effort to support local entrepreneurs and startups (many of whom lack the time and resources to negotiate the terms of a “customary” in-license), a recent and growing trend among universities is to offer “express licenses” – a predefined template license designed for startups with a rapid and streamlined review process. The associated license fees are typically deferred (or substituted with a convertible note), and while the terms of these licenses are not subject to negotiation, a startup can get access to technology within a relatively short period (often as little as 30 days).

About the Author

David SchafferDavid Schaffer is a corporate partner with the law firm of Wiggin and Dana LLP and a member of the firm’s Emerging Companies and Private Equity Practice Group. He counsels foreign and domestic clients in a broad range of corporate and commercial matters, including licensing and distribution arrangements, mergers and acquisitions, debt and equity financings, joint ventures and other strategic transactions. David is based out of Wiggin and Dana’s Stamford and New York offices. You can contact him at dschaffer@wiggin.com.

 

 

Link to PDF[/cs_text][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]

Budgeting and Financial Statements for Startups

[cs_content][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/05/Content-Detail-News.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text]Budgeting and Financial Statements & Financial Plans for Startups

In addition to the hundreds of other things you must think about when starting your business (e.g., facilities, equipment, personnel, permits and sales), you must consider a financial plan (budget) for the business and a way to measure financial performance (financial statements) against the budget on a periodic basis. Once your company has been financed through either debt or equity, you can expect that your investors will require (1) an annual, board-approved budget, (2) quarterly (or more frequent) statements showing a comparison of the budget to actual results and (3) quarterly (or more frequent) financial statements based on generally accepted accounting principles (GAAP). You can also expect a requirement that your annual financial statements be audited by an independent certified public accounting firm.

BUDGETING – A THREE-STEP PROCESS

1) Develop goals – The most effective budget is one that starts with the corporate goals of your organization, and your budget is a tool to understand the financial consequences of your operational plan. The corporate goals of organizations will vary greatly among industries and may include sales goals (for manufacturing and distribution companies), billable hours (for professional service providers) and scientific goals (for biotechnology companies). Goals should be developed by the management team and/or CEO and be focused on creating value for your shareholders.

2) Determine resources, make estimates and assumptions – Significant thought is necessary to plan what resources are necessary to reach your goals. For example, a new product launch requires assumptions and estimates around pricing, units sold, cost of goods sold, additional marketing costs, sales force requirements and more. If your corporate goals involve research and development of new products, it is important to consider head count, equipment and facility needs. Other considerations may include a public offering of your equity, which requires estimates and assumptions around legal costs, auditor fees, printing fees and more. When developing estimates for these items, don’t be shy about reaching out to your network to get these estimates.

3) Compile the results – The last part of the budgeting exercise is to compile the results from steps 1 and 2 and produce, in Excel, an operating budget and a capital budget. The compilation will provide a financial picture for your organization based on the goals for the coming year. The complexity or simplicity of this compilation will depend on the complexity or simplicity of your operations. Your operating budget should include logical cost centers that will correspond, at some level, to your organizational chart. The exhibit is a hypothetical example of this compilation.

Expect the budgeting process to be iterative – you will likely need to revisit these three steps several times prior to submitting the documents to your board of directors for approval.

FINANCIAL STATEMENT PREPARATION

Financial statements, the basics – Four financial statements are outlined under GAAP: a balance sheet, statement of operations, statement of cash flows and statement of changes in stockholders’ equity. Plus, a set of footnotes accompany the financial statements. You can get an idea of what is included in a set of financial statements by looking at any public company’s Securities and Exchange Commission (SEC) filings through EDGAR on www.sec.gov. The balance sheet is as of a point in time and outlines the company’s assets, liabilities and stockholders’ equity. The three other statements (operations, cash flow and changes in stockholders’ equity) are for a period of time, typically a three-month period and a 12-month period.

Under GAAP, financial statements are required to be prepared on an accrual basis and not a cash basis, which requires a bit of training. In general, expenses are recorded when incurred, not paid, and revenue is recognized when earned, not received. GAAP also requires the capitalization of fixed assets (e.g., equipment, buildings and so on) and requires that they be depreciated over their useful life. If you do these three things – (1) record revenue when earned, (2) record expenses when incurred and (3) capitalize and depreciate fixed assets – you are on your way to producing GAAP financial statements for your investors.

Financial statements, the complex – GAAP requires other items that are best left to certified public accountants (CPAs), including accounting for stock-based compensation, income taxes and derivative financial instruments (e.g., warrants, puts rights, call rights and so on), which may be embedded into your financing documents. You should strive to get agreement with your investors that these items will be reflected not in your quarterly statements but rather in your annual statements. Likewise, you should plan to provide footnotes to the financial statements on an annual basis, not a quarterly basis. These actions will save you significant time and expense while still allowing your investors to adequately track your financial performance.

Budget to actual – Once you have finished your financial statements, you can make a comparison to your operating budget and capital budget. You should share these results with your board of directors at your regularly scheduled meetings. The exhibit includes an example of a hypothetical budget to actual.

Accounting and budgeting software – Several types of accounting and budgeting software are available, all with different levels of complexity. QuickBooks should meet your needs as a startup, as it has the ability to assist with bill payment, invoicing, fixed asset tracking and preparation of financial statements. Once an organization becomes more complex, with decentralized operations, it may be time to turn to more sophisticated material requirements planning (MRP) software packages, but a discussion of these packages is outside of the scope of this article.

About the Author 

Sean Cassidy

Sean Cassidy is the chief financial officer of Arvinas, a biopharmaceutical company located in New Haven, Connecticut. He was previously chief financial officer or controller of three other Connecticut-based bioscience companies. Sean is a CPA and spent over nine years in the audit practice at Deloitte in the Hartford office. You can contact him at sean.cassidy@arvinas.com.

 

 

Link to PDF[/cs_text][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]

The Importance of Estate Planning for the Closely Held Company

[cs_content][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/05/Content-Detail-News.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text]Estate & Succession Planning for the Closely Held Company

Why is estate planning so important for the closely held company? Let’s consider two scenarios:

Scenario 1
You start a business that is doing less than $1,000,000 in sales in its first year, but you know you are onto something valuable. The company sales over the next 30 years grow to $200,000,000 and generate over $10,000,000 in free annual cash flow.

You initiated estate planning when you were young. At the time you turned the company over to the next generation, just prior to your death, the value of your estate was below the level at which it would be subject to estate taxes.

Scenario 2
The facts are identical to scenario 1 above, but you did not undertake estate planning until the company was more mature.

Your children are struggling with a $40,000,000 estate tax, and they may have to sell the business to pay the estate tax.

In scenario 2, how can your children avoid the estate tax without losing control of the company?

We will assume that you have elected the provisions of Subchapter S of the Internal Revenue Code and that your company is an S Corp for income tax purposes, or it is operating as a limited liability company. Either way, you are paying only one level of tax. You definitely do not want to be a C Corp, which is taxed under Subchapter C of the Internal Revenue Code and thus is subject to two levels of tax. The company pays one level of tax on its net income, and you pay another level of tax on distributions to you from the company.

Back to how to accomplish the estate tax savings…

Reorganize the stock structure of your company to Class A Voting and Class B Non-Voting Stock! 

First, you reorganize the structure of your company so that it has two classes of stock. One is a Class A Voting stock, which represents 1% of the equity of the company, and the second is a Class B Non-Voting stock, which represents 99% of the equity of the company. The shares must be identical except for the voting rights. Otherwise, you’ll breach the two classes of stock rule that is applicable to S Corps. For whatever reason, the IRS chooses to treat two classes of stock as “one class” of stock if the only difference between them is voting rights.

Note – Although I am writing this article on the assumption that you have an S Corp, the same principles, with minor variations, are applicable to limited liability companies.

Second, you exchange all of your shares of the common stock of the company that you currently own for all of the Class A Voting and the Class B Non-Voting shares. You keep the Class A Voting shares and use the Class B Non-Voting shares to reduce your estate through gifting.

Gift-Giving Plan 

Third, you start an annual gifting program of the Class B Non-Voting shares to members of your family. If your children are minors, you’ll use a minor’s trust to obtain the benefit of the $14,000 annual gift tax exclusion for each of your children.

Discounting 

Fourth, you use the benefit of “discounting.”

What is discounting?

If a company goes to Wall Street to obtain an investor, the investor will not be willing to pay the full value for the company’s Class B Non-Voting shares because he or she will not be able to either sell the shares on a market (thus, it is an illiquid investment) or control the investment.

Let’s say that the company is worth $20,000,000 and it wants to sell 20% of its shares for $4,000,000. The investor will insist upon a discount, say 25%, because his or her shares will be illiquid and he or she will not be in control of the company.  Thus, the investor will be willing to invest $3,000,000 for a 20% interest in the company for the risks he or she is taking.

This is called “discounting,” and tax attorneys have been using it successfully for years in family-held businesses. Yes, the IRS does not like the concept and has argued the point in court, but the courts have held that the gift tax laws say that the fair market value of a gift is the standard that the statute requires be used for gifts, family included.

Translate this concept of “discounting” into a family situation, and a 25% discount means that each annual $14,000 gift is actually valued at $18,666.

Over a period of years, when your company is young and far less valuable than it will become, you can transfer a substantial amount of equity on a tax-free basis.

So far so good for your company when you start early. But what if you didn’t start early, and the company has grown so that the annual gift-giving plan has some value but you need more to spare your children the “big taxes” problem that arises in scenario 2 above?

The Grantor Trust      

What is a grantor trust?

A grantor trust is a trust that you create and in which you retain sufficient powers so that the income of the trust is taxable to you, but the ownership of the assets in the trust belongs to your children.

The Internal Revenue Code provides that if you retain the power to borrow from the trust without adequate interest or security, or you retain the right to substitute property of equal value in the trust, the trust is a grantor trust. If your spouse is an income beneficiary of the trust, the trust is also a grantor trust.

How does this help? The answer is two-fold:

First, you will sell all or some of your Class B Non-Voting shares to the trust for either a private annuity or an installment note.

Second, you will be paying the income taxes on the income in the trust even though the assets of the trust belong to your spouse and/or children. In essence, the amount of the tax you pay on income of the trust is a tax-free gift.

Installment Note vs. Private Annuity       

Which do you choose?

When selling your Class B Non-Voting shares for an installment note or private annuity, be aware that the concepts and tax consequences for each are different.

The Installment Note 

The sale for an installment note is a freezing technique. You have the estate taxes covered for the value of your company now, but don’t want to increase the value of your estate. In essence, you want to freeze its value.

Because the sale of your Class B Non-Voting stock is to a grantor trust, the IRS treats the sale as a sale to yourself, and there is no recognizable gain on the sale. The IRS treats the sale as if you took assets from one pocket and put them into another pocket.

Thus, you have no capital gains taxes to pay, and in turn, the payments you receive from the trust on the installment note are without tax consequences.

You die 10 years later. The balance of the installment note is included in your estate, but the appreciation on the shares during the 10-year period escapes any estate taxes.

The Private Annuity     

The private annuity will eliminate the value of the stock from your estate on day one. Because a private annuity ends upon your death, it has no value upon your death, so the full value is excluded from your estate.

However, if you live to age 120, your trust will have to continue to pay the annuity for the rest of your life.

Life Insurance 

Life insurance can be a very valuable tool if it is purchased by an irrevocable life insurance trust.

If you have an estate plan, and you want to insure the taxes that are payable until your plan has achieved the tax consequences you want, life insurance may be a very good purchase.

Many whole-life policies can generate sufficient cash buildup over a 10- or 12-year period, which permits you to fund the projected estate taxes during the 10- or 12-year period the plan is active. After that period, you cash the policy in for its cash surrender value, which can be equal to all or a large part of your investment in the policy.

A Note on GRATs 

If you have done any estate planning and have been told to consider grantor retained annuity trusts (GRATs), we would advise against them in the current low-interest environment. An installment sale to a grantor trust has, in my opinion, more certainty and yields better results.

A Note of Caution 

I have discussed the concepts above only briefly. Be aware that there are also exceptions and technical rules that must be followed to ensure a successful outcome.

My advice – Seek competent legal and tax advice before proceeding!

Thanks for reading! Hope this helps!

About the Author

Joel KarpJoel Karp is founder of the law firm Karp & Langerman P.C., which serves as general counsel to closely held businesses, from startups to those doing $200 million in gross sales. You can contact Joel at jkarp@karp-langerman.com. He is based in the firm’s Milford, Connecticut, office.

Link to PDF

[/cs_text][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]

A Startup Blueprint for HR and Insurance

[cs_content][cs_section parallax=”false” style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/05/Content-Detail-News.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text]A Startup Blueprint for HR and Insurance

You’ve recruited, interviewed and identified the ideal professionals to fill open positions within your growing business. Job offers have been extended and accepted. Now what? Here are some mandatory actions you must take as an employer to satisfy the Internal Revenue Service (IRS), Social Security Administration (SSA) and federal government.

1) Obtain an Employer Identification Number (EIN) by applying with the IRS on its website, www.irs.gov, or by calling 1-800-829-4933.

2) Set Up Records for Withholding Taxes. There are three types of withholding taxes, which must be kept on file for at least four years.

  • Federal Income Tax Withholding (Form W-4), to be completed by the employee on or before the start date.
  • Federal Wage and Tax Statement (Form W-2), to be completed by the employer annually. Copy A of the W-2 must be sent to the SSA by the last day of February. Copies of the W-2 must be sent to employees by January 31.
  • State taxes. If you have an office in Connecticut or transact business within this state and are considered an employer for federal tax purposes, you must withhold Connecticut state tax.

3) Employee Eligibility Verification. Within three days of hiring, your new employees must complete Form I-9, a federal form used for verifying their identity and employment authorization. On the form, an employee must attest to his or her employment authorization. The employee must also present acceptable documents as proof of identity. The list of acceptable documents is found on the last page of Form I-9. As the employer, you must determine whether the document(s) appear to be genuine and record the document information on the form. You are required to maintain an I-9 file separate from other employee files, and keep a separate file of I-9 forms for employees who are no longer employed. These files must be maintained for three years from date of hire or one year post termination of employment, whichever is longer.

4) Register with Your State’s New Hire Reporting Program. All employers are required to report newly hired and rehired employees to a state directory within 20 days.

5) Obtain Worker’s Compensation Insurance. All businesses with employees are required to carry worker’s compensation insurance coverage. This can be done on a self-insured basis (rare for a startup and not recommended) or through the state’s worker’s compensation insurance program.

6) Posting of Required Notices. Employers are required to display federal and state employment-related posters that inform employees of their rights as well as employer responsibilities, such as minimum wage. Posters should be displayed in a place readily assessable to all employees.

7) Filing Your Payroll Taxes. Employers who pay wages that are subject to withholding for income, Social Security and Medicare taxes must file Form 041 with the IRS.

If these requirements seem overwhelming, a human resource consultant who specializes in this area can help you through the process. While it is exciting to begin building your staff, the complexity and related penalties for mistakes can be significant. Taking proactive measures can help avoid such risk.

Employee Benefits: Keep Your Company Competitive

Employee health and welfare benefits are a vital component of an organization’s total compensation package. Organizations should seek creative ideas when building their benefits packages to retain and attract the best talent, meet the needs of a diverse demographic and balance corporate objectives. Being cognizant of industry competition is also vital in positioning your company as an attractive place to work. Start with these steps to build your benefits package:

  • With an internal team, discuss your business’s major initiatives (corporate and benefits-related) for the year and document them in a formal work plan.
  • Consider the cost and design of those initiatives.
  • Conduct industry-specific benchmarking to compare your benefits with those offered by similar companies.
  • Design a customized benefits plan suited to your firm’s needs, budget and business dynamics.
  • Find a trusted partner to identify appropriate products and carriers and negotiate all applicable lines of coverage on your behalf.

As your organization grows, you may also need to consider implementing a system to help you manage and measure claims data. The majority of your claims will likely come from a minority of your population. Analyzing claims data and creating customized claims reports will allow you to measure risk in different areas, which will in turn allow you to mitigate catastrophic financial burdens.

Property and Casualty: Protect Your Assets

Once your employees are covered, you’ll need to think about obtaining property and casualty insurance. Contractual obligations between potential customers, suppliers, landlords or your bank requiring either liability or property coverage will determine the initial insurance. Here are items to consider:

Property coverage for computers, contents, furniture and fixtures.
Insurance requirements for leases.
Listing lenders on the property policy as loss payees.
Directors and officers (D&O) liability insurance for venture capital and private equity investors.
Errors and omissions (E&O) insurance.

The Affordable Care Act: How It Affects Employers

The Affordable Care Act (ACA) represents one of the largest overhauls of the American healthcare system since the passage of Medicare and Medicaid. The ACA has far-reaching implications for all employers, but the most significant impact is on employers with more than 50 full-time employees. For such employers, the ACA adds 3–5% to normal healthcare premiums.

There are numerous reporting requirements and tax obligations (listed below) associated with the ACA. Organizations should consider seeking assistance to ensure compliance.

Annual and Employee Retirement Income Security Act (ERISA) Notices and Reporting

COBRA Initial Rights Notice: Updated for HIX information

HIPAA Privacy Notice

HIPAA Special Enrollment Notice

Women’s Health and Cancer Rights Act

CHIPRA Notice

Market Place Notice

Summary of Benefits and Coverage

Creditable Coverage Medicare Part D Notice

Grandfathered Notice (if applicable)

Summary Plan Description

Annual 5500 (plans with 100 participants)

FMLA Federal and State Rules

Creditable Coverage Reminders, Notices and Disclosure Filing

Imputed Income for Group Term Life and Tax Choice Disability Plans

The 90-Day Enrollment Waiting Period Limitation

HRA and HSA Funding Limits

  • IRS Reporting Under ACA: Section 6055

Insurance companies or self-insured plans must report MEC plan information to:

  • IRS
  • Each individual enrolled in the MEC plan

Entities that must report:

  • Insurance companies – Form 1095B
  • Small self-insured plans not covered under 4980H – Form 1095B
  • Large self-insured plans – Form 1095C

Taxes and Fees

Patient-Centered Outcomes Research Trust Fund (PCORI) Tax

  • Effective 2013–2019
  • Insured plans: The insurance company will pay the $2 tax and pass back to plan sponsor.
  • Due every July 31 until 2018–2019

Reinsurance Fee

  • Effective 2014–2016
  • Applies to both insured and self-insured medical plans.
  • In 2014, the United States Department of Health and Human services set the amount at $5.25 per enrolled member per month, paid by the insurance company.

Health Insurance Tax (HIT) Industry Fee

  • Applies only to insured plans
  • Planned as a permanent tax
  • 2–2.5% in 2014, based on 2013 data
  • 3–4% thereafter

This document is a useful guide through the basic steps of mandatory reporting to federal agencies, building effective employee benefits packages and understanding the implications of the Affordable Care Act. However, due to the complexity of ever-changing regulations, you’ll also want to consult experts to ensure compliance and to better position your organization as a desired employer.

About the Author

Greg Fenn
Greg Fenn is a senior consultant at CBP. Greg has a passion for delivering a world-class client experience while driving efficiency and developing synergies among employees and vendors. He continually strives to understand what will make his clients successful, then, along with his team, collaboratively develops the long-term strategic vision for CBP. A veteran of the healthcare services arena, Greg focuses on strategic planning, client relationships, creating value-based processes, driving revenue and extending the overall business model through strategic partnerships. You can contact him at (800) 963-3771 or gfenn@cbp.com.

 

 

Link to PDF[/cs_text][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]

Exit and Succession Planning

[cs_content][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/05/Content-Detail-News.jpg” alt=”” link=”false” href=”#” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=””][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][cs_text]Exit and Succession Planning

For the entrepreneur business owner, succession and transition planning is not only a complex proposition but also a difficult challenge. Deciding who will succeed the current generation in running the business, while also maximizing and preserving the value of the company built over years, requires careful deliberation and forethought. For the business seller, this can be the transaction of a lifetime.

Selling or transferring a business is a complex process entailing a transition plan setting forth goals, priorities and strategies for success. Given the inherent challenges of the process, it is imperative for owners to identify a team of professional advisers familiar with legal, tax and risk management issues in order to review available choices and make the best decision.

Planning Process

Remember that the sale or transfer of a business is a process and not an event. This process, from planning to execution, can take anywhere from three to five years and entails four phases:

  • Pre-sale
  • Positioning for sale
  • Transaction phase
  • Wealth management

Pre-Sale

The first step in the process is the development of a succession plan establishing the personal retirement goals and cash-flow needs of the retiree owner. The plan should seek to minimize estate and gift taxes but must also provide liquidity to pay these taxes and provide financial independence to the surviving spouse and dependents. The plan should also take advantage of wealth transfer strategies such as gifts, trusts and family partnerships, which can be used during the owner’s lifetime to transfer assets to the family. Planning must also consider any children not involved in the business, to ensure equitable allocation of assets.

Determine the importance of continued family involvement in leadership and ownership of the company. Owners should have a candid discussion with key family members and work through the emotional and sensitive issues, establishing ground rules as to who will be involved and in what capacity, and identifying those who may not be involved in future management. This process has to be done early enough so that it becomes a planning conversation. This will greatly reduce the intense emotions often connected with business transitioning.

The outgoing owner must be committed to a transition timeline and, most importantly, must adhere to the planned departure date. This is critical to assuring the next generation of owner-managers, employees and customers that the founder’s exit is his or her decision and that the transition is a well-thought-out plan and not a reaction to a crisis.

As a retiring owner, you will want to identify a team of professional advisers to help facilitate transition planning and execution. Consulting experts in a variety of specialty areas will ensure that you derive the maximum value from the sale of your business. Make sure that the professionals you select are experienced and qualified to assist you with the transition.

Positioning for Sale

Positioning the business will bring out the “hidden value” to maximize the selling price. It is important to start this process early to be better prepared for the sale.

Make strategic and operating improvements to increase value in the areas of sales, marketing, pricing and innovation. Take a close look at the balance sheet for unnecessary assets; for example, identify any excess, slow-moving or obsolete inventory the purchaser will not want to buy. This leads to estimating the scrap value of such inventory, often to the detriment of the seller. With proper planning, it’s possible you can sell this inventory close to cost prior to the sale of the business.

Review fixed assets. What machinery and equipment are you carrying? Dispose of any assets no longer needed before the sale of the business. Again, you can likely realize more from liquidating those assets than from incorporating them into the deal for your business.

Clearing the balance sheet of any unproductive assets will optimize the return on investment from the buyer’s perspective, thereby maximizing the selling price. A clean balance sheet will also result in fewer items to negotiate.

Don’t overlook the income statement. Identify and adjust for benefits paid to the owner and family members. Review expense classifications carefully and be knowledgeable about unusual or extraordinary non-recurring items. This will result in a better snapshot of the business’s true value.

Review and restructure management to cull a team that is not dependent on the owner for business continuation. This will enable the acquirer to transition into the business while the existing management team effectively carries out the day-to-day operations.

Transaction

The selling process is complex and time consuming. The time invested in up-front planning will help realize the maximum value.

Have an audited financial statement prepared for at least the two years prior to sale. An audit will lend credibility to the financial information being used by the prospective buyer and shorten the due diligence timeline. This is also an opportunity to highlight achievements resulting from changes you implemented and will demonstrate a trend with “clean” financials.

Have a valuation prepared by qualified consultants. The valuation identifies the realistic market value of a business, and enables the owner to align his or her personal and financial goals through the sale. Remember that the valuation does not necessarily translate to the selling price. Much will depend on whether the buyer is a strategic acquirer, a private equity firm or an ESOP (employee stock ownership plan).

Determine the deal structure – is it an asset sale or corporate sale? The type of deal determines the tax consequences for both buyer and seller. This is where the parties need to compromise in order to maximize the tax benefit.

Wealth Management

Once the transaction is done, it’s time to step back, take a deep breath and assess what you have put in place.

Review your estate plan strategy to minimize estate and gift taxes. Address liquidity issues and how wealth should be distributed at death. Consider wealth transfer strategies, such as maximizing annual gifts and use of lifetime exemption, trusts and other tax-efficient mechanisms. Because these planning decisions involve complex questions of tax and law, it is best to work closely with your lawyer and certified public accountant, who can advise you. The better informed you are about the choices available, the better positioned you are to make the best decision.

Consider holding family retreats. Involve and educate family members regarding investing, philanthropy and financial responsibilities. History has shown that in transitioning wealth to the next generation, some families have prospered greatly, while others have seen their hard-earned assets evaporate. The main reason for this is not a lack of estate planning but a failure to prepare the next generation for stewardship.

Conclusion

Selling a business is the final chapter of your years of hard work to build a successful enterprise and recognize the benefits of your investment of blood, sweat, tears and cash. Therefore, proper planning and positioning will not only enhance the value of the business but will also help protect both you and your loved ones.

About the Author

Armand RossiArmand E. Rossi is a partner in the Tax & Business Services division of Marcum LLP’s New Haven, Connecticut, office. With more than 30 years of experience, he provides accounting, tax and consulting services to businesses, high-net-worth individuals and families. You can contact Armand at armand.rossi@marcumllp.com

Marcum LLP is one of the largest independent public accounting and advisory services firms in the United States, ranking 15th nationally. The firm has offices throughout the United States and in the Cayman Islands and China.

Link to PDF

[/cs_text][/cs_column][/cs_row][/cs_section][cs_section parallax=”false” separator_top_type=”none” separator_top_height=”50px” separator_top_angle_point=”50″ separator_bottom_type=”none” separator_bottom_height=”50px” separator_bottom_angle_point=”50″ class=”cs-ta-left” style=”margin: 0px;padding: 45px 0px;”][cs_row inner_container=”true” marginless_columns=”false” style=”margin: 0px auto;padding: 0px;”][cs_column fade=”false” fade_animation=”in” fade_animation_offset=”45px” fade_duration=”750″ type=”1/1″ style=”padding: 0px;”][x_image type=”none” src=”http://ctinnovations.com/wp-content/uploads/2017/04/backtocontentlibrary.png” alt=”back to content library” link=”true” href=”http://ctinnovations.com/access-content-library/” title=”” target=”” info=”none” info_place=”top” info_trigger=”hover” info_content=”” class=”back-image”][/cs_column][/cs_row][/cs_section][/cs_content]
Newer Posts
Older Posts