The employee benefit procurement process, sometimes called marketing, has changed little over the past 25 years. This continues to frustrate many organizations looking for transparency, and potential cost savings, when procuring life, disability stop loss, dental, vision or pharmacy benefit management coverage.
Formal Requests for Proposals (RFP) may travel by email, but the underlying process is the same; insurance carriers simply send an image of the paper proposal that they would have dropped off years prior. The interpretation, presentation and, most importantly, negotiations haven’t changed, says Matthew R. Huttlin, vice president in the Employee Benefits Division at ECBM.
Almost a decade ago, a major insurance scandal in New York uncovered bid-rigging and anti-competitive activity within the opaque procurement process.
“The industry agreed to reform and become more transparent, which they did to some extent, but procurement activity remains a bit of a ‘black box’ process that continues today,” Huttlin says.
Smart Business spoke with Huttlin about the future of employee benefits procurement — a reverse auction.
What problems still exist today?
The process is clearly still antiquated and fraught with opportunities for mistakes. Business owners often negotiate without solid documentation. Broker/consultants, as well as their clients, continue to see proposal mistakes, missed deadlines, inaccurate proposals and presentation revisions.
Also, insurance carriers market to their strengths, as opposed to conforming to client requirements, which may lead to misinformation, more work, mistakes and increased costs.
How can business owners better obtain employee benefit coverage lines?
An online version of a reverse auction, or Dutch auction, cuts to the heart of the problem by introducing technology to the process while maintaining the business owner’s control of the outcome. This type of auction works opposite of a normal auction — instead of bidding up the price of an item, the auction bids the price down.
What are the benefits of this method?
This process is:
- Prescriptive — RFPs are standardized, specifying the client requirements. Carriers respond using pre-determined plan specifications.
- Efficient — Carriers get complete, consistent data on which to act with agreed upon timelines.
- Transparent — Clients receive documentation on every step from the initial offers to the final pricing.
- Effective — The online system delivers the RFP to more markets, garnering more accurate quotes that are immediately posted for analysis.
How exactly does this reverse auction work?
There are four phases to the procurement. In the RFP development/submission phase, the RFP is placed on a secure website under a standardized format and peer reviewed to ensure accuracy. Once released, carriers are notified to go to the website to obtain all of the relevant information to prepare their proposal.
During the technical evaluation/initial-pricing phase, carriers post proposals into the system for evaluation. The broker/consultant reviews the vendor confirmations and deviations to the requested scope of services, confirming plan design features, alternatives and administrative capabilities. The carrier also posts its initial pricing.
Then, all carriers receive feedback as to their ranking by their initial pricing in the financial evaluation/secondary-pricing phase. Actual rates aren’t shared. Over the course of a set period, usually two days, carriers can revise their pricing offers. Every time a new offer is submitted, all carriers are notified of the new ranking order.
Once the financial evaluation is complete, clients review the detailed results in the evaluation/selection phase. This review can include finalist presentations, site visits, etc. The client maintains full control over the selection process. Business owners aren’t required to select the lowest bid, but rather the carrier that best fits their requirements.
This high-tech approach is an efficient and effective way to handle procurement that provides accurate, transparent and documented results while driving prices down in a timely fashion. ●
For more information about risk management, visit ECBM's blog.
Insights Risk Management is brought to you by ECBM
If you have three qualified job candidates with equal experience who interviewed well, how do you choose? Ask yourself how the new hire will fit in — will they enhance or disrupt your current team? The culture is critical anytime there is a personnel change, whether hiring, promoting or planning for succession.
“If you put a tiger in a group of lambs, what’s going to happen?” says Ricci M. Victorio, CSP, CPCC, ACC, managing partner at Mosaic Family Business Center. “Tigers need to prowl on their own. They aren’t usually good team players.”
Smart Business spoke with Victorio about the importance of “casting” people in the right roles to magnify their strengths.
What’s key to know about personality traits?
There are five basic traits most personality assessment tools use to define how people naturally perform. Each trait has two opposite styles with a midline where people are more flexible or adaptable. They are:
- Dominance. Is the person more control-oriented, competitive and ambitious; or a team player who prefers collaboration?
- Communication. Is the person more persuasive and energized by people; or reserved, preferring one-on-one conversation?
- Procedural. Is the person more process-driven, organized and a good listener who needs time to make decisions; or flexible, creative and enjoys spontaneity?
- Organization. Is the person more detail-oriented, wanting things done correctly; or strategic, big picture and concept-oriented?
- Logic. Is the person more analytical, or intuitive when making decisions?
It’s interesting to note that leadership styles are determined by whichever trait is the highest. Many corporations recast CEOs depending on the stage of growth. A start-up could need an innovative, confident leader to make swift decisions and take calculated risks, while a more mature company might need a road builder or process-oriented leader to maintain the business.
How useful are personality assessments?
The surveys measure self-perception — how people see themselves and how they perceive the expectations of others. When hiring, you can’t rely solely on this feedback; it’s just one part of your vetting process. Also, results are dynamic and change as people evolve and their environment changes.
Personality assessments help create a baseline for understanding who we are and what we are experiencing. For example, in a demanding sales environment, you can increase success by looking for high communicators who are energized by personal interaction and adaptable. They need to be go-getters who can think on their feet and close the deal. Most assessments provide questions that offer greater insight during the interview.
What are signs your workforce isn’t gelling?
If you hire a high-dominant, low-extrovert manager to lead a collaborative team that is accustomed to brainstorming, the indirect ‘teller’ style of the new manager will be perceived as unfriendly and bossy. Team members will feel less valued, become disenfranchised and frustrated, leading to increased tension, absences or resignations. It is important to consider the desired behavioral attributes each position requires for optimum results, such as having outgoing, creative problem-solvers in people-oriented positions, and detail and process-orientated caretakers for more analytical roles.
How can you better understand your own behavior and management style?
Self-awareness is the first step in self-management. If you know you tend to make decisions hastily, never make an important decision without sleeping on it.
You also might struggle without knowing why you are feeling drained, stressed or anxious. In one case, an executive was proud of her open-door policy, but was feeling unsatisfied. She learned that it was causing her significant energy drain. She discovered that as a process-oriented, reserved communicator, it was more energizing to limit open-door interruptions to certain times.
Every personality is valuable and dynamic. It’s a matter of finding the right role that suits who you are and being able to adapt successfully to the world around you. ●
Insights Wealth Management & Finance is brought to you by Mosaic Financial Partners Inc.
Private equity firms use capital, usually committed by large institutions, to invest in different companies. Often their investments are riskier companies at the start-up stage, so the returns can be quite large if these businesses become successful.
Recently, a sub-category of private equity, listed private equities (LPEs), traded on the stock exchange, are gaining popularity in the U.S.
“Until now, the whole section of private equity, from a small investor’s point of view, wasn’t accessible. With this emerging trend of LPEs, every investor, including the smaller players or individual investors, can invest a portion of their wealth into private equity and get that exposure,” says Sinan Goktan, Ph.D., assistant professor of finance in the College of Business and Economics at California State University, East Bay.
Smart Business spoke with Goktan about how LPEs work, and the performances of companies backed by LPEs versus traditional private equity firms.
Why are LPEs growing?
When anyone is able to purchase shares in an LPE firm, gaining exposure to the private equity market, investors can further diversify their financial portfolios. This new asset class is drawing capital into the private equity market from a new investor group and the flow of capital is continuous (since the firm is listed), unlike the traditional private equity capital that has a typical investment horizon of eight to 10 years. Eventually, a traditional private equity fund needs to be exited and new capital needs to be raised, which can be costly. The appeal of access to public markets as a continuous source of capital is leading more private equity firms, especially the larger ones, to list themselves. At the same time, LPE investments are more flexible and liquid than unlisted private equity.
Although LPEs are more established in European financial markets, particularly London, some big U.S. firms are Blackstone, KKR and The Carlyle Group.
How are LPEs different than unlisted private equity firms?
Both private equity types function similarly, except in how they raise capital. However, research with my co-authors Volkan Muslu and Erdem Ucar has shown that there’s a difference in how the companies they invest in perform in the long run.
When LPE-backed companies go public, they are more conservative and reliable in how they report earnings before and after the initial public offering (IPO) year. They also are timelier with recognizing losses. LPEs are subject to greater scrutiny by the SEC due to being listed in an exchange. Our results may be attributed to the higher reporting requirements of LPEs spilling over to the companies they are backing.
More reliable numbers mean more control and less risk for the investor. Traditionally, with unlisted private equity, potential new investors didn’t know much about private equity-backed companies’ progress until the IPO. The relatively timely and accurate financial information revealed by LPE firms has an impact in financial markets.
How else does the type of private equity backing affect an IPO?
Looking at the example of Facebook, if there’s lack of information, analysts will come up with wildly different price estimates. Because of their nature and the greater information content with the LPE-backed companies, the first day’s pricing is more accurate, which creates a lower initial return. Since companies revisit the financial markets repeatedly, they need to earn the trust of investors by providing accurate information in a timely manner to generate price stability.
What does your research suggest about increased disclosure requirements?
With passage of the Dodd-Frank Act, even unlisted private equity firms must file information with the SEC. Recent evidence suggests that investigators also are more likely to approach small private equity firms to ask for more information about their investments. Thus, the more opaque the private equity firm, the more information is required. Ultimately, the general trend is that investors are increasingly seeking more financial information before committing capital. Companies will either choose to reveal better quality information themselves, or the SEC will probably require them to reveal more information as needed. ●
Sinan Goktan, Ph.D., is an assistant professor of finance in the College of Business and Economics at California State University, East Bay. He teaches finance in the MBA Program. Reach him at (510) 885-3797 or firstname.lastname@example.org.
Insights Executive Education is brought to you by California State University, East Bay
Merchant services affect the majority of companies — more than 90 percent of online purchases use credit cards.
“If you’re not sure if merchant services is the right fit for your company, think about what your competitors are doing. If you don’t accept cards today, then prospective customers may be going to other businesses,” says Jan Mitrovich, manager for Treasury Management and Merchant Services at California Bank & Trust.
Smart Business spoke with Mitrovich about how to understand merchant processing services and costs, and when to talk to your banker about new solutions.
How do you know if your company is using merchant services correctly?
Every company should consider where it’s doing business and how it’s transacting with customers. Examine whether you are effectively leveraging all your channels for sales opportunities. You may have a storefront that does terminal credit card processing. However, other payment options, including Web-based and e-commerce, may be worth considering.
How much of you sales efforts need to be in the field, such as industry shows? A mobile solution can extend your customer outreach while providing convenience to your customers.
The merchant services environment is continually changing. There are varying degrees of complexity, from processing basic transactions through a card reader, to merchants that need multiple payment channels, gift and loyalty card programs, check verification services and more. Your merchant partner can help you better understand your options and select the right solutions for your business.
What’s important to know when getting a merchant account?
The processing transaction fee can turn off businesses, but they must consider the value proposition of expanding their customer base by accepting more transactions.
Depending upon the transaction type and how it is processed, fees will vary, which gets confusing. Merchant processors also don’t always present the statement information and pricing in the same fashion. It’s common for business owners to think a quoted rate is the all-in cost.
Be aware of hidden fees. For example, only some organizations do pass through pricing for the interchange fees. A discount rate doesn’t necessarily compare apples-to-apples, so a more important question is, ‘What is the cost of the service?’
You also need to understand and educate your employees on the associated responsibilities and risks as a merchant processor, such as protecting customers’ sensitive data. Validation of payment card industry compliance is an important step to ensure credit card data is being protected. Data breach coverage can protect merchants from the cost associated with a data breach, which can easily run $35,000 or more.
What additional factors help determine which provider is the best fit?
One differentiator is customer service. Banks typically have a higher level of customer service, like 24/7 call support, than independent sales organizations.
You also need to consider whether to lease or buy equipment. The industry is moving toward chip-enabled cards that will require companies to change equipment during the next few years. Take the time to understand your options and pricing structure, as well as if any equipment is proprietary.
Finally, cut-off times for transactions and settlements can be a game changer. Settlement time frames differ, anywhere from next day to 30 days, depending upon the vendor. If you want to improve cash flow, in some cases, you can process transactions up to midnight with next-day availability of those funds.
How should you review current services?
Take the time to review your merchant statements and pricing. If your business model or activity levels have changed, talk with your merchant representative. New services or tools may be available that can create processing efficiencies for your business. For example, card-present transactions are generally lower risk and thus cost less to process, while manually keyed transactions cost more. You could make internal changes to reduce the volume of keyed entry transactions or possibly process transactions through a lower-cost channel. ●
Jan Mitrovich is manager of Treasury Management and Merchant Services at California Bank & Trust.
Insights Banking & Finance is brought to you by California Bank & Trust
For-profit organizations use the theory of profit to strategize and lead. However, not-for-profits, like Woodbury University, operate under the theories of constraints and strength.
“With the theory of constraints, the idea is to review past performances, coupled with ongoing and future goals or expectations, to identify areas that may delay or stop you from reaching goals,” says Kenneth Jones, vice president for finance and administration and CFO at Woodbury University.
That goes along with the theory of strength, which relies on engaging your total community, including your customers, to help develop your strategic plan, he says. Stakeholders help you achieve your vision.
Smart Business spoke with Jones about putting customers first to build strong loyalty and enhance your value.
What can for-profit businesses learn from the theory of strength when strategizing?
All organizations, for-profit or not-for-profit, need a strategy map that defines their mission, values and where they are headed. However, it’s important to include all stakeholders in the process of inception, implementation and assessment.
The corporate world often develops a strategy map through modeling and the experience of employees, but they don’t look at the No. 1 objective, the customer. A customer’s perspective and feedback is essential. If you don’t involve them, you’re not going to see what they see and you’re not going to react to the environment as readily.
In the education world, we have to understand our customers, the students, to do an effective job and provide a better service. As educators get older, our students stay the same age, so educators must change teaching methods as needed. Educators need to scan the environment of each new class, keeping the same core while adapting the delivery.
In the corporate world, you can create efficiencies with your basic business practice, distribution center, administrative center, etc., but you absolutely need to have a focus on your customers and get them involved.
Beyond understanding customers, how can you help clients become part of your community?
If you have value in your company, people want to share what they have to help enhance that value. By including key vendors, clients or customers in your mission and strategic plan, you show them the value of their input. When you deliver the outcome, they see that their opinions matter. They are not an offset of the community, but part of it.
As part of the community, you want to take care of all your stakeholders. For example, when the Cal Grants were cut in 2012 and scholarships for low-income students were reduced, we knew how hard it would be for our students to succeed, so Woodbury issued vouchers to make up the difference.
As another example, Woodbury has a lot of first-generation college students on financial aid. We can reach out and ask for input on how to make everything more affordable, making students part of the process. This in turns leads to former students wanting to give back. They could start a scholarship, set up a writing center or help with counseling services. You can’t build loyalty when you create an environment where you absorb the profit and customers take the loss. Stick to your word and show customers the quality they subscribed to.
Under the theory of constraints, how do not-for-profits do more with fewer resources?
One high-level constraint may be affordability. From an administrative perspective, we can accomplish that by investing in technology to shorten our operating processes, increase automated processes and eliminate processing constraints, thereby reducing the processing cost of material and labor.
The purpose isn’t just to create revenue or improve the bottom line. You want to create efficiencies, and then redirect resources elsewhere by investing in areas of strength.
Also, you don’t want to acquire something that is a constraint on your operations right away, just because you want to diversify your product line. For example, we wouldn’t bring in a dentistry school at Woodbury just because we can acquire it. It has to fit within the strategic map of the institution. Bring in something that you’re strong at, which will be a prototype for the next development. ●
Insights Executive Education is brought to you by Woodbury University
Most employers are distant from their workers’ compensation claims and thus leave money on the table when it comes to premium savings.
Good claims management starts at the beginning. As a claim progresses, there will be fewer opportunities to positively affect the outcome. It has to be an ongoing process, says Kimaili “Ken” Davis, ARM, assistant vice president at Momentous Insurance Brokerage, Inc. Employers need to be sure that the adjuster is aware of the mechanics of the injury and affected body parts. There are milestones that can change the path of a claim. Be sure that a claim goes in the right direction.
“Employers may think someone else will take care of it, whether it be the adjuster and/or insurance broker,” he says. “Yes, a good broker is going to have a knowledgeable claim professional monitoring the claims, but it’s best to take a team approach, where the adjuster, employer and broker are working together.”
Smart Business spoke with Davis about creating a culture of safety and attention to claims to give you a competitive advantage.
How does California’s workers’ compensation compare to nearby states?
California laws tend to (unfairly) favor employees when it comes to claims, so it’s important for employers to stay involved. In California, an employee can fail to follow the rules and still receive a positive outcome. In other states, the rules are enforced equally, meaning that both the employee and employer must play by the rules. I’ve seen cases before the appeals board where an employee has missed more than one hearing without good reason and has not been penalized. In other states, this conduct would negatively impact their claim.
What’s the best way to manage individual claims to decrease costs?
Employers need to manage their employees. If you create an environment where people want to come to work, claims will be resolved quicker and for less money.
After an accident or incident, don’t just investigate what happened, look at what caused the injury and ways to prevent future injuries. Also, have human resources and/or the supervisor keep in contact with the injured employee on a regular basis. Ideally, you want an injured employee to feel like part of the team, and have a desire to get back to work and resolve the claim promptly.
An important concern is getting employees back to work as soon as possible. If employees cannot work full duties, see if they can return to modified or alternate work. It will be up to the treating doctor to release them to light duties. Communicate with employees and the treating doctor on a regular basis. The sooner employees are back to work, the less claims dollars will be paid. The result can be a lower premium over time. Further, studies have shown when injured employees return to work within 30 days of the date of injury, there’s a better chance for a full recovery.
Are there certain claims employers should monitor more closely?
Litigated cases are important to monitor, as well as those claims where medical conditions complicate recovery, such as diabetes or obesity. The California Workers’ Compensation Institute found that in claims where obesity exists, a claim averages 81.3 percent more paid losses and experienced 80 percent more lost time. The American Medical Association recently reclassified obesity as a treatable disease, which may increase claim costs.
In addition, closely watch cases where doctors prescribe prescription drugs such as opioids. If an employee becomes addicted, you will likely incur the costs of a detox program.
What’s important to know about your experience modification (ex mod) factor?
An employer’s ex mod factor is determined by a formula that compares claims dollars to audited payroll on a rolling three-year policy basis. When actual losses are less than expected losses, the employer has a lower ex mod and thus lower premiums. Ex mods are calculated based on data valued as of six months following policy expiration. The best thing you can do for your ex mod is to not have claims. Create a culture of safety.
Ultimately, workers’ compensation claims are about people. You can best manage costs by going beyond monitoring the claims process to understanding employee concerns. ●
Insights Business Insurance is brought to you by Momentous Insurance Brokerage, Inc.
Owners of family or middle-market businesses invest a tremendous amount of time and energy — sometimes their entire adult lives — building a successful business. Yet they often spend little time working on their succession plan.
“The business world is littered with second and third generations that don’t succeed in continuing the business,” says Jay Silverstein, principal in the Wealth Services Group at Moss Adams LLP. “One of the big reasons is that there wasn’t a well thought-out succession plan.”
Smart Business spoke with Silverstein about why it’s important to implement and continually monitor a succession plan.
Does every business need a succession plan?
Any business owner needs a succession plan. But the plan may differ for a business in the start-up and growth mode where the owner is not looking to exit the business compared to a mature business with an owner looking to retire in the near future.
In earlier growth stages, a succession plan is a contingency that allows the business to sustain itself if something catastrophic happens. In many cases, banks that lend to closely held companies require this type of management succession planning. They want to know the business will continue to be profitable and be able to pay off the loan if you’re not around.
Where should you start?
You need to identify and prioritize your goals and objectives in three separate areas: personal, business and family.
You and your advisers should complete a personal financial plan to understand your post-transition cash flow needs, and the likely sources of that cash. Do you need to sell the business or have you accumulated outside assets? This is important for an owner who must figure out how to increase the business’s value to be able to retire, as well as someone whose net worth is higher than his or her need. If a sale will generate more cash than you’d need, estate and gift planning decisions should be made prior to a liquidity event to help minimize tax obligations.
Consider what you want to happen to the business. Will it continue as a family legacy or do you want to sell it? These decisions help determine an appropriate exit strategy and limit your succession planning options.
Finally, what do you want for your family? With a family business, what do you deem to be fair and equitable in terms of transitioning to the next generation?
What else do you need to address with a family-owned business?
If the goal is to preserve the business into future generations and your objective is to be fair and equitable to all, it’s critical to work through a detailed succession plan well in advance. Is it possible to get business assets to the heirs who are involved in the business, and equivalent assets to those who aren’t? If not, you must strive to create an ownership structure that doesn’t drive a wedge between your heirs.
Do your heirs even want to run the family business? If they are already involved, take an independent look at whether they have the attributes and skills to take over. If so, they still may need additional training under a management development plan.
What common mistakes do you see?
With family businesses, some people gift ownership to their heirs before implementing a succession plan. Then, brothers and sisters who are never going to work in the business are wondering when they can turn their ownership into cash. You also don’t want to have heirs come to work in the business without clear rules of entry and how to move up in the company.
If you’re going to sell, you may think you don’t need succession planning. However, you still must examine what sale price you need and your estate tax situation, so you can deal with income tax structure issues and improve the company’s value.
You need to dedicate enough time, enough in advance, to meet goals and objectives. Succession planning doesn’t give you an immediate ROI and there’s no guarantee of success, but it gives a far better opportunity of preserving what you’ve created.
Jay Silverstein is a principal in the Wealth Services Group at Moss Adams LLP. Reach him at (707) 535-4115 or email@example.com.
Insights Accounting & Consulting is brought to you by Moss Adams LLP
The U.S. is very much a national economy — even small businesses aren’t restricted to their hometown communities. Many companies don’t know that certain activities give rise to filing requirements for income, payroll and/or sales taxes in other states.
At the same time, it’s no secret that states are having trouble making ends meet, so they are using creative ways to find companies doing business from out of state.
“States essentially are looking to find new sources of tax revenue, without increasing taxes on the folks in their own state. It’s really easy to tax the people who don’t vote for you,” says Brad Greenberg, a director of tax in SS&G’s Chicago office.
Smart Business spoke with Greenberg about being proactive with your state tax filing requirements.
How would a business know if it had a filing requirement in another state?
There are more than 11,000 taxing jurisdictions in the U.S., whether states, cities or counties. With state and local tax filing requirements, the keyword is nexus — a minimum physical connection, often through sales or delivery trucks, attending a trade show or having contractors service a machine you sold.
If you make sales to a state, you probably have a responsibility to remit sales tax. However, if your activities are restricted to sales, you may not need to pay income tax. Payroll taxes are more black and white — if you have an employee based out of another state, you’ll have a payroll tax requirement.
If your employees are working on a project in another state, depending on the length of time and that state’s tax requirements, you may need to withhold state income taxes. Rules are so varied that Congress introduced legislation for a 30-day minimum rule. In addition, some states use a concept known as economic nexus to determine filing requirements, such as Ohio’s commercial activities tax, or if you sell $500,000 or more to California, even over the Internet.
What are states doing to find businesses?
States are cross-referencing taxpayer information from various departments to generate lists of companies that are remitting payroll taxes, but aren’t remitting sales or income tax.
Then, states send out letters. One is an audit or assessment that says ‘you’ve been doing business in our state. We think you should be filing sales and/or income tax returns.’ Any business receiving this letter needs a professional to investigate whether or not a filing requirement existed. If one does, you must file returns; if there isn’t, the adviser can help explain why filing requirements don’t exist.
The other kind of letter is a nexus questionnaire, which asks about your business activities. Don’t ever try to fill out one of these yourself. They are written to create more taxpayers for that state. Tax professionals can help ensure you answer the questionnaire completely and accurately, truly reflecting your business activities, without leading the state to believe there is a filing requirement.
Why is it helpful to be proactive?
You want to sit down with your tax adviser and take a close look at your multi-state activities to recognize any issues. If you happen to be doing business in a state where you potentially owe tax, there are mechanisms to minimize your liability, interest and penalties. Your accountant can ask the state for a voluntary disclosure agreement. If you voluntarily come forward, you’ll likely have a shorter look-back period, and in many cases forgiveness of penalty.
What if the business provides services?
A professional services firm can perform work for out-of-state clients on site or virtually. The income tax filing requirements depend on whether the states in which you perform the work, and where your customers are located, apportion income based on where you provide the service (‘cost-of-performance’ method) or where the customer realizes the benefit of the service (‘market’ method). So it’s important to keep good records with respect to where employees are working on each client engagement. The rules are complex and differ from state to state.
You don’t want to be subject to the hassle of audits or filing back tax returns, or to face penalties and interest. An accountant with a strong background in state and local tax can help manage these risks. ●
Insights Accounting & Consulting is brought to you by SS&G
Business succession often fails because business owners failed to plan, not because of a failure of the plan itself. But once a succession plan is established, it requires periodic review because tax laws change, goals change, dreams change and outcomes change.
“Often I find a business, particularly when it’s closely held, is one of the biggest assets of a family. So you’ve got to treat it that way,” says Rick Applegate, President of First Commonwealth Financial Advisors. “People get so close to their business that they forget, or fail to, look at it objectively.”
Smart Business spoke with Applegate about what to consider with business succession.
Why do business transfers to another generation often fail?
Assuring continuity is vital, but it doesn’t always mean that a second generation can assure success. A business succession strategy needs to take into account the business owner, the buyer, key employees and, most importantly, the clients.
Many times, owners of a closely held family business want to be ‘fair’ to all their children. So, a sibling who hasn’t been involved gets an interest equal to that of the sibling who has worked in the company for many years. Fairness has nothing to do with a successful business succession. Work out some other way, such as taking out a life insurance policy on yourself to benefit the uninvolved son or daughter.
How does a defensible business valuation help?
Understand what you’re trying to do — are you selling to family members, on the open market or to internal employees? One of the first things a buyer wants to know is the cost, so you need a supportable valuation to put a price on the business.
Even if you’re not selling, a business valuation is helpful. If the company hasn’t been properly valued at your death, the IRS will value it as highly as possible to collect more tax when your estate executioners sell or transfer the business.
It’s important to bring in appropriate professionals like attorneys, tax accountants, financial planners, etc. People who are closely vested in their business almost always think it’s worth more than it is. Professionals can help guide you to a reasonable valuation, including picking the best methodology.
What else should you take into account?
You need to think about who would be interested in buying your business. It might be difficult to sell in the open market. Family members could be disinterested. So, employees may be an option. Employee stock ownership plans have tremendous tax benefits to the prospective seller. Today’s low interest rates also easily allow a stock transfer with a bank loan. Again, qualified professionals can help with sale contract language and other matters.
In addition, you might not have the option of active, thoughtful selling. Plans must weigh what happens if there’s financial hardship, injury, disability or even death. Business succession planning should go hand-in-hand with your estate planning.
When family members are under duress, you don’t want them scrambling with business operations or estate matters. Leaving the business to your uninvolved spouse may be a terrible position to put him or her in. And it can hurt the value if they end up having a liquidation sale.
Use the plan to put your successors in the best position. Ask who is key to the continued success of the business. Do you need to give key employees part ownership or incentives to stay?
How can the right financing help with the plan’s execution?
There are different ways to sell a business. Prospective owners often utilize life insurance purchased under an agreement of sale because it makes the outcome a known entity. This is particularly useful when the buyer is paying through installments. If the business owner dies in the transition period, the life insurance awards funds to pay for the remainder of the company.
There are a lot of details to wrap up with business succession. Even after a sale, the right parties must be notified so previous owners or survivors aren’t liable for the unemployment tax filings, tax returns, business credit cards, etc. With help from experienced professionals, your plan can anticipate and respond to ensure the business continues after you’re gone. ●
Insights Wealth Management is brought to you by First Commonwealth Bank
When property owners start new construction or a building addition, they should insure against certain risks, such as fire, theft, vandalism, earthquake or flood.
“Most commercial property policies exclude property under construction. That is why it is important to obtain a builder’s risk policy,” says Carla Cave, assistant vice president at Momentous Insurance Brokerage, Inc. “This coverage should be put into place before the project starts and before any material is in transit to the site.”
Smart Business spoke with Cave about what you need to know about builder’s risk policies.
How does insurance coverage during construction work?
Builder’s risk is coverage for property under construction, which can include building materials, supplies, foundations, site preparation, temporary structures (e.g. scaffolding) and soft costs. Soft costs are general contractor’s administrative costs, permit fees, insurance, state taxes and fees, loan interest, etc.
If adding to an existing building, make sure the existing structure is included in the total insured costs on the policy.
You can occasionally add a course of construction endorsement to your homeowner’s policy if the cost is nominal — approximately 10 percent of the dwelling value. It also depends on the kind of construction.
If your company is leasing a location and intends to do improvements and betterments, a builder’s risk policy would be needed. The building owner will ask for proof of coverage if the tenant is contractually responsible for such improvements.
What if you don’t have coverage when construction starts?
Then it’s much harder to get the policy — and sometimes a little more expensive. The carrier might inspect the site to see how far you are, and may put on exclusions.
Who buys the coverage? What does it cost?
It depends. The general contractor, property owner or custom builder could buy the coverage. If the general contractor puts the policy into place, coverage should include the property owner as an additional named insured. However, the owner has no control over the policy, even though the contractor will pass along the cost to the owner.
Insurance carriers underwrite the general contractor, typically asking for three years of claims history. If you don’t have a general contractor or have one that poses an issue, carriers might surcharge the policy.
The cost depends on the scope of work or budget. For example, a $1.3 million home had $2.2 million of renovations, totaling $3.5 million insured value, generating a premium of $12,500. Premiums can increase during the policy if changes are made to the original plans, the renovation uncovers problems or if the project is delayed.
What are some important items to check on your builder’s risk policy?
If increasing the square footage of an original structure, add the existing structure to the policy. Make sure the structure is valued at replacement cost value, not actual cash value. An actual cash value policy factors in depreciation, which could be detrimental if a loss occurs.
Check that your soft cost limit is sufficient, and padded enough to account for problems. If something happens to delay or set back the project, all the project fees will increase.
The transit limit on the policy needs to be adequate, especially if it’s a large project. For example, a high-end office building in Beverly Hills may have granite, copper and high-end fixtures, which all must be transported. You don’t want a $200,000 limit when $500,000 worth of materials are on the road.
Permits will be required to build or renovate per city/county requirements. This is why ordinance or law coverage needs to be included. If a one-year project is vandalized or burns down after six months of construction, the ordinance and laws may have changed.
Off-premises coverage is needed for building materials that may be stored at a warehouse or staging area. Review this limit to make sure it is adequate.
Earthquake and flood can occasionally be included in the builder’s risk policy. If not, it’s recommended that you purchase a separate policy. ●
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