Business Transitions

If Congress Does Not Act, Tax Increases are on the Way

2010-07-16T10:27:00.000-07:00

On July 14th, 2010, approximately 30 legislative days before the fall elections and less than six months before significant portions of the tax code expire, the Senate Finance Committee held the first substantive hearing on the implications of allowing the Bush tax cuts to expire.

The tone of the majority of the witnesses and comments by the Chairman suggest this hearing was designed to anticipate higher rates next year. Most of the Bush tax cuts enacted in 2001 and 2003 went to middle- and low-income Americans, not the rich. So the pending tax hike is going to impact regular families in a very real and harmful way. With just 30 days of legislative session left before the elections, even a well intentioned effort to extend those tax policies may fall short.

Also, the hearing demonstrated the lack of a plan for what happens beyond 2010. Even if Congress extends some or all of the 2001 and 2003 tax cuts, something more comprehensive is needed.

Senators Jon Kyl (R-AZ) and Blanche Lincoln (D-AR) yesterday evening introduced an amendment to make permanent changes to the estate tax. The estate tax is not in effect in 2010 but unless action is taken will return in 2011 with a top rate of 55 percent and an exclusion of $1 million (in 2009 the exclusion was $3.5 million). We may go from a system that taxed the sale of assets at low capital gains rates or allowed the carryover of basis on inherited assets to one where the capital gains rates will raise, the exclusion be reduced, and the allowance of a carryover basis restricted. Conceivably this could be one of the largest tax consequences in United States history.

The Lincoln-Kyl proposal is designed to mitigate this harm and uncertainty by making permanent a middle ground on taxing estates. Key provisions in the bill include: reducing the top estate tax rate to 35 percent; increasing the exclusion from $1 million to $3.5 million; and allowing the estates of deceased taxpayers to choose between no estate tax and limited carryover basis or the provisions included in this plan for 2010.

Missing from the proposal are any revenue increases or spending cuts to offset the revenue loss of the lower rates and higher exclusion. The selective pay-go rules adopted by Congress earlier this year would have allowed Congress to extend 2009 estate tax without offsets (which was not done), but any reduction in the estate tax beyond that would have to be offset or face a 60-vote Budget Act point of order. This problem appears to be unresolved.

The question now is whether there is enough time in the legislative calendar for this or any other proposal to be adopted. The most likely outcome is that no proposals will pass. The result will be significant tax increases for business owners.

Do You Care What the Supply Curve is for Your Market?

2010-04-11T15:33:00.000-07:00

In the last email we discussed that the supply and demand curves create an equilibrium market price for a product. Understanding the demand curve for the market for your business can be beneficial with respect to making decisions about price, production, and understanding consumer satisfaction. Trying to understand the supply curve helps focus on decisions our market competitors may make.

Unlike the demand curve, which moves inversely to price, the supply curve moves directly with price (as price goes up, the production of the product increases).
This reflects the willingness of producers to produce more products as long as the consumer is willing to buy at a price that is greater than the cost to produce. In a market place where prices is high because consumers cannot find all the product they want, competitors will be attracted to the market to increase the supply.

When we try to construct a supply curve for a market, we are trying to understand what choice is now available to the consumer and what that choice might be in the immediate future. These are important determinations in the strategic planning for a business. Critical to this inquiry are two factors. Is the market one which is difficult to enter? Is our product different from other products, by brand identification or quality, that its utility to consumers cannot be easily duplicated?

In a market with history, we will know what the equilibrium price is – that is the current price. By constructing demand and supply curves on a graph, we attempt to portray with an objective numbering scheme our perceptions and forecasts about the market. Next time we will talk more about this and putting production information into the analysis.

Do You Care What the Demand Curve is for Your Market?

2010-01-29T17:34:00.000-08:00

Economic theory tells us that supply and demand create an equilibrium market price for a certain product. There is a benefit for an owner-manager of a business to understand the demand curve for the market for that business. Understanding the demand curve can help with price decisions, production decisions, and documenting consumer decisions (enabling effective response to changes in consumer interests).

When we try to construct a demand curve for a market, by necessity we are defining a market and then seeking to understand the value equation of the consumer. These are very worthwhile and rewarding things to do. We are trying to determine at what price the consumer will buy more or less of our product or services. To do this we must obtain from the consumer information about the effect of price on a decision to buy. Generally we know the higher the price, the less likely the purchase of additional units.

If we obtain the consumer information by survey, we may find various responses from consumers which may be listed in spreadsheet columns. The sample responses can be used to derive information about the amount consumers would purchase at certain prices. Usually these responses become columns of information on a spreadsheet (price and quantity) which then can be used to create a graph (price on the y axis and quantity on the x axis). In a market which is highly competitive and the products very similar, the demand curve will tend to be flat (parallel to the x axis) because price will be a determinative factor and production will be increased until the marginal cost of the last unit produced equals the revenue produced by that unit. On the other hand where unit is very differentiated from other units by quality or design, the demand for a particular unit will be much less affected by price and the demand curve will tend to be vertical (parallel to the y axis of the graph). In this type of market, price will be increased until production is at the point where the marginal cost of the last unit produced equals the revenue produced by that unit. The slope of the demand curve generally will indicate whether we sell many units at a lower price (high competition), fewer units at a higher price (differentiated products), or something in between.

Once you have developed a demand curve for the market, there are a number of different ways to use this information and the graphical portrayal of the information to analyze and make critical business decisions. More about that next time.

Repeal of the Estate Tax?

2010-01-20T15:43:00.000-08:00

In 2001 Congress passed a law that imposed a ten-year schedule. The law gradually reduced the estate tax until 2010, when the estate tax would disappear. But the law then provided that in 2011 the estate tax would be again in place at a very high rate ($1 million exemption and a maximum rate of 55 percent when in 2009 the exemption was $3.5 million and the maximum rate 45 percent). It is safe to say that most people thought Congress would act before now. In fact the prevailing assumption was that Congress would extend the 2009 estate tax into 2010 and enact a long-term approach to estate tax this year.

Most estate planners and most business succession plans have been based on the assumption that there would always be an estate tax. The cardinal rule of business succession has been to not own a business at death. The burdens imposed upon heirs by the process of valuing and paying taxes on a business interest meant that owners have been motivated to sell business interests or engage in gifting programs they might not have otherwise done.

If Congress acts in 2010 and attempts to make the legislation retroactive, it will be challenged but the precedent is there for this type of tax legislation to be retroactive and valid. In U.S. v. Carlton, 512 U.S. 26 (1994) the Supreme Court upheld a retroactive application of tax law. It is unlikely that Congressional action in 2010 reinstating some form of estate tax as of the beginning of the year would be ruled invalid.

In spite of the uncertainty created by the failure of Congress to act, it still is a good idea to assume that the estate tax will be a part of the tax and business succession planning scenario and that dying owning a business interest still will be a very expensive mistake.

Why Do Owner-Managed Businesses Fail to Plan?

2010-01-12T17:24:00.001-08:00

Lack of planning causes a variety of problems for owner-managed businesses. Business owners manage from bank account balances and then wonder why they have cash flow problems. Owners jump into a project, forgetting about marketing for the time being, and then wonder what happened to sales when the project completes. Owners initiate the business by wearing all hats, causing the business to succeed with hard work and a variety of talents, do not delegate and train, and then wonder why they have no time and their business has no value without their participation. These are just of few examples of many well-recognized problems resulting from the failure to plan.

The number of owner-managed businesses in this country and the difficulty of these businesses sustaining a long-term existence indicate the need for strategic planning to be utilized by these businesses. Businesses that engage in strategic planning have a much better success rate – both for the current owners and for the heirs of those owners.

So if the need and benefit are so clear, what is it about strategic planning that makes it so difficult for the owner-manager to practice? There are a number of suspects: the failure to prioritize and schedule time for planning, the inability to poll and communicate with the business group (owners, managers, and employees) to produce a wise plan, the fear of losing control (perhaps the most prevalent reason owner-managers do not train and delegate), and the managerial skill to execute the plan through effective monitoring and employee review. These and other critical issues can be addressed to make the valuable strategic planning process accessible and of use to owner-managed businesses.

It happens one owner at a time. You know the owner is getting it when the owner responds to a crisis by saying: “I need to review the plan to see why we did not anticipate this and then revise the plan” instead of saying “I am the only one who can save this situation, and I need to get to work.”

Managing Professionals

2010-01-06T11:36:00.000-08:00

In my experience, the question of when a business needs to pay for expert professional advice (accountants, lawyers, and consultants) often is not the subject of structure and policy, but it should be.

Professionals generally get paid by the hour or fix a fee for a project and respond to requests. This places a burden on the client, as the initiating party, to handle the relationship in a thoughtful and efficient way. This, of course relates to the resources available to pay the professional and the nature of the tasks the professional is asked to perform.

There are tasks which require certain professionals to be involved (tax returns and court cases). There are certain issues on which a business needs expert guidance. You may not know what all these tasks and issues are, but you will know most of them. Even if there are times when you will have to receive advice on what requires an expert’s opinion or action, you should control the relationship.

It will be less expensive for you if the professional is familiar with your business and the concerns it generates. Rejoice if a lawyer you are dealing with wants to know more about your business without charging you for that time. Similarly be pleased if your accountant makes suggestions for which payment is not expected. The more you interact with your professional advisors, the less time (fees) you will spend on giving the professional facts about your business, but as with any other cost the doctrine of diminishing marginal utility applies to more and more frequent levels of interaction.

For any given decision involving expert advice, the professional should identify to you the information you need to know to make your business decision according to your values and business acumen. Professionals are paid to advise, but beware of the professional who gives advice broader than their area of expertise. For example, lawyers advising you should not be telling you what decision to make, but informing you of the consequences that will occur depending on your decision. Therefore, it is misleading and unwise to engage a lawyer to provide specific legal advice and then ask for general business advice.

You should have a written fee agreement for all work done by professionals. You should understand the fees and costs associated with what you are asking before the service is performed, and if there is a change the professional should give you notice of that change immediately. You should expect the professional to be accessible by responding to your communications quickly and by having time to discuss important matters with you. You should be billed promptly and accurately for services with no surprises. Such a billing deserves immediate attention and prompt payment.

Create a thoughtful structure for asking for and receiving professional work and advice. Keep track of what you like and do not like about the various relationships. Learn from your experiences and change your structure. It is incumbent upon you to effectively manage your business relationships with professional advisors.

Shared Leadership

2009-12-09T13:51:00.001-08:00

Good policy development is based upon wise decisions. Wise decisions evolve from a process which includes polling a group of diversely informed individuals. While the decision must be made by a person with authority, leadership has been historically conceived around an individual decision-maker and that individual’s relationship to subordinates or followers. The leadership field has focused its attention on the behaviors, mindsets, and actions of the leader in a team or organization, which has traditionally been hierarchical.

Shared leadership concepts can enhance and make more effective the process of policy development and the process of making wise decisions. The fastest growing organizational unit is the team, specifically cross-functional teams. What distinguishes these groups from traditional organizational forms is often the absence of hierarchical authority. Leadership is not determined by positions of authority, but rather by an individual’s capacity to influence peers, and by the needs of the team in any given moment. Each member of the team brings unique perspectives, knowledge, and capabilities to the team. For each there are moments when background characteristics provide a platform for leadership and decision-making. Much thought should be given as to how the authority to make a decision can help and not hinder a shared-leadership organization.

For an excellent treatment of this subject see Shared Leadership, Craig L. Pearce and Jay A. Conger, Editors, All those Years Ago: The Historical Underpinnings of Shared Leadership, Craig L. Pearce and Jay A. Conger, Sage Publications, 2003.

Budgeting

2009-11-11T07:32:00.000-08:00

A budget is an important part of the business plan for an owner-managed business and is the detailed planning for how funds are to be allocated in the business. Once the strategic (long-term) part of the business plan is in place, the budget deals with the distribution of cash to execute the plan.

Putting the budget in place will show where the strategic plan is realistic and where it is not realistic. It will help answer the concern of whether the goals of the strategic plan can be reached. The budget will also help with the choice of what methods will bring you closest to reaching the goals of the strategic plan.

The budget will be a projection of the income statement for the business. Comparing the budget to experience will give you the opportunity to examine why there is a difference. Answering questions about the difference will make the next budget more realistic and more effective.

Also the owner-manager should be asking am I getting enough from the business? As a manager you should receive compensation for the management and other services you render to the company? As an owner, you should receive a return on your investment in the business. The budget should plan for this compensation and return on investment.

Effective budgeting requires adequate accounting information to allow comparison of your forecast budget with experience. After you budget a profit and loss statement projection, you will be interested in receiving an accurate profit and loss statement in a similar format on a frequent basis.

In analyzing the budget look at the chart of accounts and determine what accounts are fixed costs and what accounts are variable costs. Variable costs usually change with sales. Sometimes variable costs rise unreasonably because variable costs are not managed effectively. Variable costs that are rising when sales are falling must be carefully examined. Review and question the arrangement for fixed cost circumstances, the costs may not be as fixed as was first assumed.

The budget is a tool that will help you understand why things did not go as planned.

Health Insurance Premiums

2009-11-05T08:28:00.001-08:00

In an article for the National Center for Policy Analysis (http://www.ncpa.org/pub/ba642) Daniel Wityk states: “Since 1999, the cost of employer-provided health insurance has risen 120 percent, or four time faster than prices generally . . . small businesses face higher than average costs.” Wityk points to two causes for the higher than average costs for small business: first, insurance premiums for small businesses are 18 percent greater than those paid by large companies, and second, administrative costs run up to 25 percent of the cost of premiums for small business health plans compared to 10 percent for large businesses.

Large businesses self insure and are governed by federal law where small business must use small-group health policies subject to state regulation. The Employee Retirement Income Security Act of 1974 (ERISA) exempts self-funded employer plans from state regulations. In self-funded plans, the firm pays employees' medical bills and a third party processes claims. Large employers (and trade unions) do not face costly state mandates, but do enjoy economies of scale. Therefore, their costs are lower.

Given the fact that reform is on the way, but will not change things in the immediate future, what are the best tactics for the owner-managed business?

First, do not hesitate to delegate the fact finding and research aspects of this task. Having someone else, besides the owner-manager, understand the issues of health care is an advantage.

Second, understand the effect of the group of which your insurance is currently a part and the effect of state regulation on that group. While your insurance broker may feel that the best choices have been made, make sure you understand what other group and state regulation options there may be given your business configuration. You may belong to a trade or professional group who offers some meaningful programs or resources.

Third, understand what co-pay and deductible options are available. Other benefit plans may be able to compensate for having higher deductibles. Make sure you understand what cafeteria plans and medical health care savings plans have to offer.

Fourth, do not hesitate to use an insurance broker, but make it clear that this will not be a relationship purchase or renewal. You will want hard work and creative thought to obtain the most efficient health care package available. You will reserve the option and have every right not to select the health care plan offered by a broker.

Fifth, involve your employees to properly consider that effect certain decisions on coverage will have on their lives and their work attitude. Do not delegate the authority to make a decision, but make an effort to inform your employees and determine their opinions before you make your decision.

Sixth, start at least 90 days before renewal. Make your decision with enough time so that any change necessary can be accomplished.

Please comment or post with your own health insurance experiences and issues.

Estate Taxes

2009-10-27T11:51:00.000-07:00

Estate tax is due nine months after death. If a business owner dies owning the business, the business value is taxed as a part of the owner’s estate. A cardinal rule of estate planning is to avoid having a client die owning a business. From an estate tax point of view it is better to gift a business interest to heirs (often at substantial discounted value over time for a very low tax cost) than transfer a business at death.

Under the current estate tax law, following one year of repeal in 2010, the estate tax rate in 2011 will be 55% with $1 million in an estate exempted.

Ways and Means Committee Chairman Charles Rangel (D-NY) has announced that he intends to move separate legislation making permanent the 2009 estate tax rules: an exemption amount of $3.5 million and top tax rate of 45%.

Representative Shelley Berkley (D-NV) has introduced a bipartisan compromise estate tax bill that would begin with 2009 parameters and then phase in increases in the exemption and reductions in the rate. Under H.R. 3905, each year from 2010 through 2019, the estate tax applicable exclusion amount would increase by $150,000 and the top rate would decrease by 1 percent. The exemption would start at $3.5 million in 2009, and by 2019, the exemption and rate would be $5 million and 35 percent.

See the National Federation of Independent Business (NFIB) statement on H.R. 3905 (http://www.nfib.com/tabid/732/Default.aspx?cmsid=50097).

H.R. 3905 would be better than the current 2009 estate tax law (an exemption amount of $3.5 million and top tax rate of 45%) and prevent a reversion to an exemption amount of $1 million and top tax rate of 55% in 2011. Meanwhile, don’t depend on having a repeal of the estate tax starting in 2010.

Survival Checklist

2009-10-21T13:48:00.000-07:00

Owner-managed businesses are able to react quickly to economic downturns and find new opportunities when larger businesses can falter. Here is a survival checklist for a closely-held businesses and its owner-manager:

1. Review and revise the business plan. If you do not have a plan, create one. If you do have a plan, review it to see how things have changed for the long-term or strategic view and for the operational or execution portion of the plan. One of the very best planning activities is to ask: “Why didn’t things go as in the plan?”

2. Maintain a planning group for the business. Whether you call this group an advisory board, a power circle, or the happy hour bunch, this is a group of colleagues and advisors who can provide well-considered, written judgments for your review on the planning issues you need to decide.

3. Monitor and understand the market for your product or services. Communicate directly with clients or customers to understand their desires and needs. Monitor their satisfaction with your products or services. Develop resources to analyze the market and stay ahead of your customers to anticipate where their desires and needs may change, especially with respect to technological changes. Many times a downturn provides an opportunity to diversify.

4. Do not curtail marketing and business development activities. Business development and sales activities should be a constant whether business is good or bad. This activity is an important part of understanding the market and knowing when to make moves to diversify or serve new customer bases.

5. Think about incentive compensation. Reward employees who are productive or who find new sources of revenue by paying those employees a reasonable percentage of the additional funds realized by the business. Bonuses tend to be taken out of owner’s profit. True incentive payments should come from increased revenue generated by employee efficiency or productivity.

6. Manage cash flow. Your accounting should produce on an accurate and reliable basis the following: income statement (profit and loss) and balance sheet reports monthly, all payroll and related requirements (creating checks and filing compliance reports), billing and invoice functions with accounts payable and accounts receivable reporting on a daily basis, a cash flow report (containing bank balance, cash on hand or cash balance information, and a six-month cash projection) and other management reports such as inventory reports necessary for management purposes. Stay in touch with slow and late paying accounts. If you manage from a bank account balance especially in periods of economic decline, you will be constantly surprised and sort of cash.

7. Manage variable costs. Monitor variable costs through effective and accurate reporting. Employees should know that mistakes causing increased variable costs will be recognized. Provide incentives for employees who minimize variable costs.

8. As you manage, use milestones. Change is not instituted the way an on-off switch is toggled. The process of reaching a goal is accomplished through transition from one milestone to the next, a logical sequence of steps, each anticipated and monitored as part of progressing to the identified goal. When a milestone is missed, the plan needs to be reviewed and revised.

In a Crisis?

2009-10-14T10:28:00.000-07:00

Change is good, but difficult to accomplish. The bottom line is that the change accomplished has to be something that improves your business and makes the next potential crisis less likely or not as severe. If you have been through crisis but are not yet planning effectively, take that as a sign that a different approach might be required. Work with someone of knowledge and experience who can help you change your business and get a different result. Often effective planning and execution of the plan can improve business performance by making existing resources more effective and instilling clearer goals and incentives for business team members. If you are not planning effectively now, get some help and accomplish improved performance of your business. The next crisis may be one you avoid.In a crisis we all have regrets. We can look back and see what might have made a difference, but we are where we are and we need to get through it. In a crisis it is tough to plan and we react to survive. But we also need to ask, how did we get here? What could we have done differently? Crisis situations often help us understand what we need to do to avoid the next crisis.

After the crisis it is easy to forget. The urgency is gone and the post mortem epiphanies forgotten. As a result often there is no execution on the perception of lessons learned and no change to the business. That is recognized in the regrets experienced during the next crisis. And so it goes, round and round.

One way to break this circle is to write down what is learned from a crisis - the concerns and perceptions. Answer in writing the questions about what could have been done better and more wisely. Documenting what is learned from mistakes can be the best way to plan. When that learning is documented, a plan can be drafted and executed to change the result. This is long-term planning and it can be very effective for the success of your business.

If 60 Hours a Week is not Enough, What Will 70 Do?

2009-10-07T10:07:00.000-07:00

You complain about the time you have to spend at your business. No one else can get the job done. But you have great pride in the job that does get done. In fact your business is you personified and is the source of a great deal of satisfaction to you. At the same time it is all very scary. If you don't bring your A game every day, things don't get done, and the money does not come in. How much more time do you have to give the business?

Is there any doubt that someday you will not be able to spend this time at your business? Is there any way to tell when that might be? If you were not at your business so much, what would happen? If you are always there, how do you know what will happen?

If you were managing not doing, would you have to spend so much time at your business? Think about how that might work. Could you find someone else as good as you to train? Even if you found the talent, the attitude would not be there. Deep down – you would not really like having someone else around who could do the job the way you do. Could there be some ways to arrange your tasks so others could complete them. You are starting to plan. Write it down. Share the writing with colleagues. Revise the writing and start testing your assumptions. You are beginning to execute your plan.

Most owners are so wrapped up with the immediate projects of their business, they do not plan. The primary thing an owner needs to plan is the transition of the business from the owner performing the tasks of the business to managing the employees who perform the tasks of the business. Then the owner needs to become less of a manager so that the owner is not an integral part of the business. This is difficult but rewarding. Not only will it make your business more valuable, think of the time you will save.

Your business does not need more of your time, it needs more of your planning.

Making Wise Decisions

2009-09-30T13:55:00.000-07:00

The number one mistake of the Top Five Mistakes Preventing Business Owners From Realizing Maximum Value is the failure to implement a system of making wise decisions both in the business and family arenas. This process – the system of making and documenting wise decisions – is called planning.

To make the best decision-making process in the business succession planning process, a small group of diversely informed individuals should aggregate their judgments. This process of decision-making should include the elements of diversity, independence, and decentralization. Is this group the owners? Can the meeting be the way the judgments are aggregated?

This inquiry can be best answered by an examination of what occurs at most owners’ meetings. Generally there is a dominant or majority owner, who will preside at the meeting. There may or may not be a written agenda, but the dominant owner will control the topics discussed. The purpose of the meeting will be stated to make a decision on a certain topic. This topic will be discussed at the meeting with the dominant owner’s opinion stated. There may be discussion and dissent but at some point the dominant owner will state something like, “I think we are all on the same page,” and the meeting will conclude. Some might call this consensus decision-making, in that at the end of the meeting no expressed opposition existed to the action taken. It is often the case that the dominant owner used the meeting not as a part of the decision-making process, but to communicate the decision that the dominant owner had already made unilaterally. The danger of making a decision at a meeting is that the polling of the hopefully diverse, independent and decentralized individuals may be flawed. To say it another way, the means by which information is received from the group members may be influenced by the method of collection of information – the meeting environment.

At a meeting a number of dynamics are present. Participants in a meeting are affected by the appearance of other parties, their placement in the room, their physical state at the time of the meaning, their own personality traits (for example, being extroverted or introverted), and their individual skill in orally articulating thoughts on a subject. Individuals do not have the same capacity to absorb oral information, and the failure to document thoughts in a written format often indicates a less than thorough thinking process.

In certain circumstances, a meeting is appropriately used as a formal method of polling – the vote counting process. In the business ownership setting, if the plan is not fully supported by all of the owners, its viability will be in question. This suggests that in the business succession planning procedure polling (aggregating judgments) should be done informally and outside any meeting.

Ignoring for a moment the concerns of the meeting format, the compelling question is what process can be envisioned for the owners’ group to make the best decisions possible? The constituency of the group is fixed to the owners. With this group it is necessary to stress that the factors of diversity, independence, and decentralization are valued. A reporter can carefully poll this group to encourage diverse, independent, and unique thoughts on the decision to be made, and document these thoughts in writing. Before any meeting occurs a summary of the thinking should be circulated to all owners. This summary need not attribute the thinking or make a conclusion about the thoughts expressed. The owners should be encouraged to discuss the summary with the other owners and begin to formulate their own positions in accordance with their values and the information derived from the other owners.

From this summary and the discussions, a draft plan document can be created. After this document has been reviewed, the areas of disagreement among the owners will be understood. At this point, a direct group discussion may be helpful, and the proper forum for this discussion may be a meeting. This meeting will be a critical, and probably difficult, conversation, and the skills each owner develops in having critical conversations will be helpful in the conduct of the meeting.

The succession plan may be viewed as a series of decisions. These decisions are best made by the owners exhibiting diversity, independence, and decentralization and articulating solutions to planning problems in accordance with each owner’s personal values. If each owner has taken the time to define and articulate that owner’s personal values and then applies those values to determine solutions to planning problems in writing, and then applies the principles of critical conversations to engage the other owners in dialogue concerning their solutions, the best decisions will be made to create the succession plan.

The well advised family-owned business has two areas of governance, one for the business and one for the family. For example, the family might have a family council and the business might have a holding company. The boundaries for these areas of governance need to be established and respected. The governance of the business must involve appropriate selection of personnel based on merit (not relationship to the family) and the culture of the company. The strategic and operating plans for the business must deal with the culture of the business and the process of authority and delegation. As appropriately selected managers come into the business, the planning cycle (analysis, written plan including actions, implementation, and analysis) should continue and involve these new managers. Frequently the issues of control, delegation, and trust are at the forefront. The creation of a written plan containing wise decisions evolved from polling a group of diversely informed individuals (including those new managers) is the best way to deal with these issues.

2009-09-25T09:12:00.001-07:00

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No Succession Plan

2009-09-22T17:03:00.000-07:00

A succession plan consists of a contingency plan (plan for a crisis brought on by the sudden absence of an owner or critical executive of the business) and a transition plan (long-term plan for the change that will occur in the ownership and management of the business). It is a mistake for a business owner wishing to have maximum value from a business to be without a succession plan.

Here are foreseeable situations that could occur at any time:

1. The owner of the business dies. Who controls the business? What does the owner know that no one else knows? If there has been no preparation to prepare the business for sale and no one involved with the business is in a position to purchase the business, should the business be liquidated? How can the survivors obtain value from the business?

2. A critical executive of the business dies or becomes disabled. What does the executive know that no one else knows? Does the executive have sole authority to do certain things that must be done? How long will it take to find an effective replacement?

3. The founder and owner-manager of the business suddenly cannot participate in the business. Who steps in to fill the void and at what cost to their existing duties? Where the owner is a manager, all the concerns of 1 and 2 apply. Is there someone else trained and available to manage in the void? Who controls the business?

Obviously there are many other situations that could also be detrimental even with planning, but will certainly be worse without it. There are not plug-ins available. A succession plan is not drafted and implemented quickly or easily.

Maximum value will not be received from a business that does not have planning in place for foreseeable future events.

Purposes and Uses of the Business Plan

2009-09-15T15:25:00.000-07:00

The business plan should define what the business will look like in three to five years. In that time the business should be functioning without the owner’s critical involvement, stable in cash flow, and making a profit. That status will define certain business goals stated in the business plan and the progress toward those goals marked by milestones also established by the plan.

When the definition of the business in three to five years is clear, it is possible and imperative to establish that the market for the services or products of the business will support that definition. Often this is a critical area where independent expertise and advice can be helpful in establishing whether the definition of the business in three to five years is realistic or wishful thinking. If it is realistic, then the market will support the projected growth of the business. The documentation of this should be in the business plan.

This timeline established by the business plan will suggest any number of questions. Will the business have adequate capital to accomplish the contemplated growth? How many employees will be needed to run the company? How consistent will the cash flow of the business be? Will the working capital requirements of the business be in proportion to growth or will there be other factors changing working capital requirements? What are the governance issues raised? Will the organization of the business have to change to accomplish the growth? How many offices will the business require? Will the business become a national business or a world business? These and other relevant questions should be stated and answered in the business plan.

The questions and projections will also impact thinking about business entity and tax choices. These issues and resultant decisions should be in the business plan.

The table of contents of a business plan should have the following sections: executive summary, company, services or products, market analysis, implementation, management, and financial. The executive summary, written last and read first, will summarize the business plan coherently and succinctly. The company section should describe the business entity to be used and the governance of that entity from a legal perspective. The services or products of the company should be described with their relevance to certain markets. The market analysis should show in an objective and authoritative manner that a market exists for the current production and the projected production of the company. The implementation of the plan should be described in sufficient detail to demonstrate that the contemplated plan can be executed and include milestones to measure the progress of the plan. The management positions both as to job descriptions and personnel should be described in detail. The financial section will contain projections of future financial experience including initial funding, cash flow, profit and loss, and working capital.

The business plan should be dynamic – constantly referred to and constantly revised. The question at each milestone should be: why did it not go as projected in the business plan?

Manage to Sell

2009-09-08T10:14:00.000-07:00

When you offer an item for sale, you clean it up and make the item look as good as possible. You now do the things that before seemed not to be important, such as cleaning or deferred maintenance. Of course this is not good management – it would have been better to constantly keep the item clean or not to defer maintenance. I understand something like not detailing a car you commute in everyday, but then spending the extra money on cleaning to help sell the car. But that same reasoning does not work for not changing the oil. Deferring maintenance frequently causes problems later. When a crisis occurs, it is the items subjected to deferred maintenance that malfunction and cause the crisis level to increase.

As the owner-manager of a business, it is a good practice to ask: “If I were thinking of buying this business, what would keep me from closing?” “What if there were a crisis and I had to sell the business?”

A potential sophisticated buyer doing a diligence review of the business will investigate business entity status (including minutes of meetings and decisions as well as compliance with entity registration requirements), owner agreements (including management agreements, buy-sell agreements, and voting agreements), regulatory matters (including having in place necessary permits, licenses, and other filings), facilities (including all leases and use agreements), employment issues (including compliance with Fair Labor Standards Act categories, employee manual, employment agreements, confidentiality agreements, noncompete agreements, personnel files, compensation histories, and benefits plans with related records), the balance sheet (including inventory of assets, documentation of title, records of encumbrances, and intellectual property), insurance (including nature of coverage and evaluation of risks not insured), financial (including accounting, loan agreements, and management reports), tax (including federal income tax, state income tax, use or sales tax, and other taxes such as property tax), environmental status (including past surveys done and consent decrees), and legal issues (including existing and contemplated contracts.

After the diligence investigation, and most important for the buyer, is the projected operation of the business after closing. Will the buyer have to keep the services of the owner to have the business operate properly after the sale? If so, the buyer will pay less for the business.

Manage the business for sale for maximum value by working on creating non-owner management so owner-managers are not essential to the business and completing in a timely fashion the management functions of maintaining the business. Conduct your own diligence investigation on a regular basis. This is managing for the sale. Oh, and by the way, there is nothing that says you have to sell, just because you manage for the sale.

Why Delegate?

2009-09-02T10:55:00.000-07:00

Let's start with the axioms:

Value (cash) is obtained from a business when it is transferred.

The cycle from the entrepreneur beginning the business to establishing a stable business capable of generating maximum value to the owner is the transition from an owner who is a doer (essential) to an owner who is a manager (replaceable).

To get maximum value, the owner-manager cannot be an essential part of the business when it transfers.

An owner-manager of a business must be able to delegate or the owner-manager will not receive maximum value for the business interest when it transfers.

Transfer of a business could occur at any time upon the occurrence of certain contingencies (such as the death of the owner-manager).

A test question for the owner-manager: what do you do in a crisis? Do you say, “I have to get more involved;” or do you say, “I have to review what my employees are doing.” If you are not delegating, the first answer will be your answer.

If you are not delegating, the reason is control. Delegation scares owner-managers (usually entrepreneurs – the primary doers) because they have not learned how to measure performance and review employees. The reality is that learning how to measure performance and review employees is not easy, but it is a skill set that most entrepreneurs can learn with desire and application. The fear of losing control keeps owner-managers from learning how to measure performance and review employees.

To start delegating, make a list of everything business-related that you do in a month. After that month try to assign the tasks you do to others. Your primary task as a chief executive officer should be to eliminate all tasks except those related to management. Essentially those tasks will be to perform and enforce the business plan, measure performance, and perform employee reviews. You will accomplish control when you effectively measure performance and perform reviews. In fact, you will have more control than you did when your idea of solving a problem was to do it yourself.

Top Five Mistakes Preventing Business Owners From Realizing Maximum Value

2009-08-24T09:02:00.000-07:00

Here are my top five mistakes preventing business owners from realizing the maximum value from their businesses.

Mistake Five: Not delegating. Owners who do not delegate complain of spending too much time at their business without results. Frequently these owners also complain about the difficulty of finding capable employees. Most owners are really good at something when they start their businesses. If they don't transition from being doers to managers, their businesses do not grow and they burn out. When times are tough, these owners lay off employees and do even more of the work themselves. Years later they wonder why there business has not grown.

Mistake Four: Not preparing the business for sale as it is managed. Businesses managed with shortcut techniques, which delay system upgrades and maintenance cannot readily be remodeled. Businesses with dysfunctional accounting or inadequate legal maintenance are marketable only at a severe discount.

Mistake Three: Not having a written business plan. The essence of the business plan is accurate market information which identifies reasonable business revenue goals. These goals should be the basis for the operation plan of the business formed by the executive officers. If these goals are not in place, the business will have no direction, and growth will be serendipitous. The plan goals should include having the business sold within five years.

Mistake Two: Not having a succession plan, which includes provisions for a sudden absence of an executive officer (contingency plan) and a long-term plan (transition plan) addressing transition of the ownership of the business. In an owner-managed business, this is the provision for executive succession. The presence of a succession system for the executive leadership of a company will enforce its stability and capability.

Mistake One: Failure to implement a system of making wise decisions both in the business and family arenas. Wise leaders understand the importance of establishing a decision-making process and making the decision-making process transparent, ongoing, and accessible to the stakeholders. Where no process of decision-making is in place, stakeholders complain about “being in the dark” and about being surprised at decisions being made. Another symptom is no written record of decisions which have been made.

What are some other common mistakes? Let me know by commenting.

Who Reviews the CEO?

2009-08-21T15:36:00.000-07:00

In the corporate model, the shareholders (owners of the business) elect the board of directors. The board of directors do strategic planning involving succession planning and exit strategy as well as set policy (including performance goals and mileposts) and appoint the executives. The executives execute policy (marketing plan and operating plan) to meet the mileposts and goals set forth in the strategic planning adopted by the board of directors. The executives (especially the chief executive officer) report to the board of directors and are reviewed based on their ability to meet the mileposts and goals of business operation set by the board of directors.

This is a tried and true model. It works. But what about the owner-managed business, when all these different roles, such as owner, director and CEO, may be all one person. The entity may not even be a corporation but a limited liability company or something else. It is pretty incestuous. It can be like reporting to a mirror.

We all need to report to someone. There is a reason why we have teachers, coaches, and direct reports (managers). Most managers feel that at least an annual review is essential to keep an employee on track. What does the owner-director-chief executive officer of an owner-managed business have in the way of a review? Perhaps there is a spouse or a family member who is involved, but there are usually difficulties with the influence of other non-business issues and problems.

At the very least, the owner-managed business organization, even if it is a limited liability company, should have something like a board of directors to which the chief executive officer reports, even if the chief executive officer owns all of the company. It can be an advisory board if need be, but the essential act is the chief executive explaining what goals were met or not met and why not. It is an essential and humbling exercise. (Humility being one of the least recognized and most important aspects of leadership.) If it is helpful to have your employees report and review, shouldn't you as the owner-director-chief executive officer also report on your performance and be reviewed?

Milestones

2009-08-14T17:00:00.000-07:00

I cannot think of milestones without thinking of Miles Davis. In 1959 with Kind of Blue, a studio album from the Miles Davis sextet (pianists Bill Evans and Wynton Kelly, drummer Jimmy Cobb, bassist Paul Chambers, and saxophonists John Coltrane and Julian "Cannonball" Adderley), Davis moved from hard bop (jazz improvisations based on chords) to modality (improvisation based on a scale and creating melodies within the scale).

Kind of Blue arguably is the best-selling jazz record of all time and has been critically acclaimed as well as cited by composers of all genres as one of the most influential albums of all time. Roughly a year before Kind of Blue, Davis recorded (with a quintet since Bill Evans joined the group just before Kind of Blue) an album called Milestones. That album featured modal experimentations which led to the establishment of the concept of modality in Kind of Blue.

Davis could not have changed and thereby progressed as a jazz artist without going through a transition. What is true for artists is also true for businesses. In the aptly named Milestones album Davis is experimenting, developing, and preparing for a change. Change is essential for successful businesses - it must be envisioned with planning, identified with a goal, and accomplished by the reaching of milestones along the way. Change is not instituted the way an on-off switch is toggled. The process of change is accomplished through transition from one milestone to the next, a logical sequence of steps, each anticipated and monitored as part of progressing to the identified goal.

Execution

2009-08-11T17:52:00.000-07:00

If you create a business plan and it is all there in writing, what happens next? Assume you let your executives read the plan, they understand what you want, and they tell you they like it, does it happen? We all know the answer: the plan does not happen without effort all the way around. That effort is called execution.

There is a book on the subject, which I recommend, called Execution The Discipline of Getting Things Done by Larry Bossidy and Ram Charan. Although I like the book, my terminology is somewhat different.

The business plan must be realistic and set clear goals. The executives must honor the goals and the strategy of the plan by establishing methods of measuring performance and milestones for noting and marking progress to the goals. The employees who are making accomplishments must be recognized and rewarded. There must be a flexible enough environment, open to change, to allow adjustments to be made. The most important adjustment is that the right people must be in the right positions to accomplish the goals of the plan. The most important task of the executive is to have the right people in the right jobs at the right time.

If we promote employees to the level of their incompetence or place employees based on something other than merit, the business plan will not be successfully executed. To make these decisions, we must have accurate and immediate information about employee performance. Note there is nothing here about owners or executives accomplishing tasks – that should not be in the plan and it is not part of the execution of the plan.

Creating a Business Plan

2009-08-07T09:01:00.000-07:00

Often business owners create a business plan because someone (perhaps a lender or an investor) ask for one. The better reason to create a business plan is to chart a course for your business and to be able to ask a very important question (revealed to the careful reader below).

It will enrich you to create a business plan, but how do you create a business plan?

The term “business plan” in my experience often refers to an operational plan – how the business intends to meet the goals set forth in a strategic (long-term) plan. On the other hand, “business plan” could clearly include both kinds of planning (strategic and operational). It is important to think about and create (in writing) both.

The owners of a business, reflecting upon their own values and goals, should communicate and plan, setting forth a written strategic plan to be followed by the business. This plan should include issues relating to ownership transition and leadership or executive succession. The executives or managers of the business (who may also be all or in part owners) should create an operating plan to accomplish the goals of the strategic plan. Generally, the strategic plan is reviewed and revised annually, but I have seen it done successfully on a quarterly basis. The operating plan will be impacted by any change in the strategic plan and should be immediately revised accordingly. Aside from that, other dynamic factors concerning effective operation of the business may force changes in the operating plan on a more frequent basis.

The best place to start is at the end – the end of the planning cycle. I recommend something five years or less. Envision the business you could sell to a third party (non-owner) for the highest reasonable amount. (Understand that to obtain the highest possible value for the business at this point of sale some years down the road a selling owner cannot be an integral part of the business.) Then work backwards. What would the business be doing the fourth year to get to the apex in the fifth year, the third year to the fourth, and so forth? If the market will not support the five year plan from the beginning to the end, something needs to be changed. Therefore, the market analysis becomes the reality check for the projected business status at the end of the planning cycle. The beginning question should be: “How can I develop a business I can sell for top dollar in five years?” In five years you do not have to sell, but you will develop a better business if you have that goal.

There are a number of ways to construct plans from questionnaires and software; there is nothing wrong with adding structure and detail in that way. Do the marketing and conceptual work first to know if you can go where you want. After you have established this perspective, the details can fall into place. This is not to say that the details are unimportant – they can make you or break you – but they must be within a frame that is realistic and defined.

The purpose of doing a business plan is that it gives you the ability to ask a very important question: “Why didn’t things go as in the business plan?” Answering that question is a valuable business analysis tool. Of course, the plan is the prerequisite to having the analysis tool.

Inadvertent Partnerships

2009-08-04T10:11:00.000-07:00

Walter obtained a lease on valuable property which could be developed for office and retail use. Walter, lacking the funds to develop the property borrowed money from Sam, delivering a promissory note for the amount loaned but told Sam that he would share the profits of the endeavor with him equally. The development was successful, but Walter merely paid the note to Sam and refused to give Sam an accounting of the financial experience of the development. Sam, though he used poor judgment in not documenting the formation of the partnership in writing, can recover his share of the development proceeds if he can prove that Walter made the statement to share the proceeds.

A partnership is the only business entity that can be formed by oral agreement. The parties do not have to have the intention of forming a partnership; they merely have to agree to share the profits and losses of an enterprise. Most states have adopted some form of the Uniform Partnership Act which states: “The association of two or more persons to carry on as co-owners of a business for profit forms a partnership, whether or not the persons intend to form a partnership.”

If a partnership is formed, including inadvertently, without a written agreement between the partners, then in the event of a conflict about what the parties agreed, state law provides the partnership agreement. The terms of the default partnership agreement provided by state law are often a surprise to the partners.

What if a creditor agrees to wait for payment until some transaction occurs? Is a partnership formed? If an entity is formed for the purpose of carrying on business, but additional promises are made based on what would happen if certain goals are reached, is a partnership formed? Two knowledgeable entrepreneurs have a discussion over a beer about how they would plan and conduct a certain business built around an opportunity of which they were both aware; when one starts such a business successfully; can the other claim a partnership was formed?

There is only one defense to the inadvertent partnership. Make sure all business agreements are in writing. Do not act in recognition of an oral agreement until it has been documented in writing.