If you’ve tried to obtain or increase bank financing lately for your business, and been turned down, you’re not alone. The “word on the street” is that bankers’ lending criteria continue to be stringent. So what can you do to improve your chances? Obtain the assistance of a CPA who knows how the process works.

“Through including a CPA firm in the relationship between your bank and business, you can increase your chances of success and reduce the frustrations of the application process,” says Jeff Hipshman, partner, HMWC CPAs & Business Advisors in Tustin.

“Your CPA can also work with you throughout every phase of the process to help solve your company’s needs and meet your objectives,” says Curtis Campbell, a partner at HMWC CPAs & Business Advisors.

Smart Business spoke with Hipshman and Campbell to learn more about how business owners can benefit from the assistance of a CPA firm in securing bank financing, whether the economy is in a recession or going strong.

What is the role of financial statement reporting?

Accounting firms prepare financial statements for businesses, which are typically required by lenders and investors. Bankers analyze your company’s ‘capacity’ to repay a loan from these financial statements. This is one of the criteria that bankers use in evaluating debt repayment ability (the others commonly referred to as character, capital, collateral and conditions).

Your balance sheet and income statement, when accurate, provide a testimony over the years as to your ability to manage the business. Cash flow can be evaluated from your financial statements so that the banker can analyze your debt repayment. Collateral is demonstrated on the balance sheet and, along with notes, UCC filings and other documents, will provide the banker with key information. Your company’s equity is also an essential element that is critical for evaluation of debt repayment. It is important, therefore, to select a CPA firm that understands your business and can prepare financial statements meeting the highest quality standards.

My company should ask for the highest amount possible, right?

One of the easiest ways to let a banker know that you don’t really understand the lending process is to ask for an unreasonably high loan amount. This happens all too often, for example, when a business owner will ask for a $500,000 line of credit based on $300,000 in assets and minimal profitability. A CPA can help you to evaluate your needs and ask for the appropriate amount based on a banker’s perception of your company’s debt capacity. Your CPA can also project the cash flow cycle that your company may experience under a variety of scenarios. You will then have a better idea of your needs for outside financing.

What type of financing should we seek?

Your CPA can help to determine whether your business needs an operating capital line of credit or a loan or lease for a fixed asset. Sometimes this isn’t too clear to the business owner, who may only see that there isn’t enough internal cash flow to satisfy needs. An accountant can also do various analyses to compare costs of different financing options and your ability to repay each in a timely manner.

Are there options beyond traditional commercial bankers?

The typical business owner has a higher opinion of the company’s ability to repay a loan than does a banker. Bankers have regulatory and internal lending policies that limit their ability to extend credit. For example, banks tend to frown upon a company that has not shown consistent profitability or is highly leveraged in assets to liabilities. They also have other financial ratio criteria that must be met, may stipulate certain collateral, and might even have internal policies regarding lending to specific industries.

As such, your business may not qualify for traditional bank financing. An accountant who is experienced with such matters can help steer you toward other types of financing. While such financing might be more expensive, it may also be more useful in meeting your cash flow or expansion requirements.

Do we need a business plan?

The banking business, from a lending perspective, is all about managing risk. They lend a significant amount of money for a relatively low return, so bankers need to be convinced that your company is a good credit risk. They need to know why you want the money, how you are going to use it and how you will repay it. Your business plan should help the banker to start putting together the pieces of this picture. An effective business plan portrays your company’s objectives, management team, marketing strategy, operational structure and financial history and projections.

Accountants who have prepared business plans will know when one is needed and what should be in it. Count on your CPA to help you prepare the information needed to provide appropriate answers to a lender’s questions.

Jeff Hipshman and Curtis Campbell are partners at HMWC CPAs & Business Advisors (www.hmwccpa.com) in Tustin. Contact them at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s services.

Published in Orange County

Does your company have an effective plan for executive succession? Do you have a plan for current employees to step into key positions? Do you have an objective process to identify and develop future leadership? These issues alone point out the need for succession planning.

According to the U.S. Small Business Administration, only 30 percent of family-run companies succeed into the second generation, while only 15 percent survive to the third generation. A key reason, according to many experts is the lack of an orderly succession plan. Creating a succession plan can help ensure that your company will continue into the next generation and beyond.

“A succession plan is a tool to help a business to be prepared for the transition of management and ownership,” says Jeff Hipshman, partner, HMWC CPAs & Business Advisors in Tustin. “Succession planning not only helps ensure the ongoing prosperity of your business but also protects family members and reduces turmoil in the event of unexpected circumstances.”

Smart Business spoke with Hipshman about several key aspects of succession planning.

What should a succession plan include?

For maximum effectiveness, your plan should address a number of issues, including management, ownership, legal concerns, expansion plans, product development, finances and taxes. The plan should reflect both the needs of your business as well as your personal interests and goals. To ensure a continuity of business goals and strategies, consider which aspects of the plan should be prepared in conjunction with your successor(s).

This process may point out the need for an appropriately structured buy/sell agreement. Buy/sell agreements protect the business, the business owners and their families if one of them can no longer work. Without a buy/sell agreement, an owner’s family would own his or her share of the business if he or she passed away. They could participate in the profits without contributing to them. A buy/sell agreement solves that problem as well as other issues. Work with your CPA and attorney to develop a buy-sell agreement.

When should the plan be prepared?

It is typically best to begin creating your succession plan while you are healthy and fully involved in running your company, perhaps no later than your mid-50s to early 60s. However, starting at an earlier age will allow time to further prepare your children or others for leadership transition.

How should a successor be chosen?

One of the toughest decisions to make when creating a succession plan is whether you’ll give ownership to your children or sell the business. Be sure that your successor possesses the appropriate education, skills, professional experience and management abilities necessary to preserve and grow your business. Key characteristics to look for in a potential successor include motivational and conflict resolution skills and the ability to communicate ideas, as well as a vision for the company that’s in line with yours. Keep in mind that, as your business evolves, your successor may need a different set of skills than you possess.

What about sell versus transfer issues?

If your children will take over, you need to decide whether you’ll transfer your ownership interests during your life or at death and plan for any gift or estate tax liability, which could be sizable. If you choose to sell, you can sell to an outsider or to employees. If you choose the latter, you may want to consider setting up an employee stock ownership plan.

Once you’ve decided who will own your business, your plan should detail how the ownership transfer will take place. For instance, how will the successor purchase company assets or stock? In some cases, insurance policies provide funding for the purchase. The succession plan should include a timeline of when company property or management tasks will be transferred to your successor. Your retirement income could be significantly impacted by these decisions.

What should your role be after succession?

The answer to this question is personal and varies with every owner. Consider how involved you wish to be with your business as you age.  There are numerous issues to address, a few of which include: Do you want to work full-time or in a part-time capacity? At what age do you want to retire?  Do you want to be involved in day-to-day business issues after stepping down as leader, or just strategic matters? Where do you want to live after retirement? Will you be relocating away from the business?

Jeff Hipshman is a partner at HMWC CPAs & Business Advisors (www.hmwccpa.com), one of Orange County’s largest local accounting firms. Contact him at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s services.

Published in Orange County

Few functions in a business can bring a company to its knees like malfunctioning accounting software. The ability to track invoices and payables, handle cost accounting, prepare payroll and monitor cash flow is absolutely crucial for day-to-day operations.

“If your accounting system is inadequate, or too slow and cumbersome, several steps should be taken prior to purchasing a new system,” says Gerry Herter, a partner and head of the Information Technology practice at HMWC CPAs & Business Advisors in Tustin. “Take the time to identify the benefits of a new accounting program, along with the disadvantages involved in implementing the system.”

Smart Business spoke with Herter about some of the considerations involved in selecting and implementing a new accounting system.

Why is having the right accounting software so important?

Many businesses are constantly battling with their accounting system to get the information needed. Multiple confusing steps are often required to enter and extract certain data that is specific to their projects or customers. Generic accounting programs may be simple to set up, but can be too limiting; whereas advanced accounting software and industry-specific software can be much more beneficial, but at the same time more challenging to implement and use effectively.

Why are businesses often hampered by their accounting software?

Here’s a typical scenario. A new business is well into its first year before the importance of having a complete accounting system becomes apparent. Then, dealing with tight cash flow, the owner picks a cheap, off-the-shelf package, believing the claims that this software will fulfill every imaginable expectation, with no prior accounting knowledge, little effort and minimal computing horsepower.

A few months later, bank statements are stacked up unreconciled, cash in the bank drops as invoicing falls behind, and vendors call for payment while the company struggles to get checks to print on the ‘do-it-all’ accounting software. Finally the owner realizes help is needed and hires a bookkeeper. Now months behind, the bookkeeper has to learn the system, cure the ‘bugs,’ and catch up, all while trying to stay on top of current business. At this point, many businesses fail, not having the tools needed to address or even recognize symptoms of urgent cash flow issues.

Suppose the business survives this initial phase, then what can be expected?

The owner recognizes that the effort to save money in acquiring the software and hiring the bookkeeper have cost much more, intensifying the resulting difficulties. A degreed accountant is brought in to replace the bookkeeper. The owner shows the accountant some jerry-rigged schedules scratched out on a columnar pad that have been hurriedly put together to make sense of the minimal data produced by the basic software. The accountant reproduces the schedules using a computerized spreadsheet that exports the data from the accounting system, rearranging it into more meaningful information. The owner, for once, feels more hopeful. As the days go by, more requests are given to the accountant to devise expanded spreadsheets, providing additional analysis to help in managing the business.

The business owner’s problems are solved, right?

For a while, the upgraded and timelier data help the owner to turn the corner and move ahead. But soon, several new challenges arise. For example, (1) the computerized spreadsheets become more complicated and errors in formulas and calculations creep in, creating inaccuracies leading to bad decisions; (2) new versions of the software are announced, requiring extensive rewrites of the spreadsheets to maintain compatibility; or (3) the accountant departs leaving no one who understands how the spreadsheets work.

What could the owner have done differently to avoid these problems?

In a growing business, there will always be new challenges and not enough money to do all that may be desired. However, the owner was right to recognize that success in this area requires both the right kind of accounting software and properly skilled personnel to implement and operate the system. Depending on resources and conditions, the owner can pursue a process to acquire appropriate, industry-specific software or a more affordable cloud-based application. Also, qualified accounting personnel can be hired to carry out the search and implementation of the system, or outside consultants may be utilized.

In the current example, the company is at the point where an advanced industry-specific application should be considered. With his experience developing the spreadsheets, the company’s internal accountant may be well positioned to assist the owner in the search process. The important thing in this area is to not try to save money in the short run by cutting corners that may jeopardize the longer-term future of the business.

Gerry Herter is a partner at HMWC CPAs & Business Advisors (www.hmwccpa.com), one of Orange County’s largest local accounting firms. Contact him at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s services.

Published in Orange County

Businesses carry various types of insurance in order to provide protection from liabilities and reduce risks. Since coverage for certain types of risks is expensive or difficult to obtain, many business owners simply choose to not obtain this insurance.

Is there a better option?

“An innovative technique to address business risk is through a captive insurance company,” says Curtis Campbell, a partner at HMWC CPAs & Business Advisors in Tustin. “It is a great tool to consider for the insurance coverage and can provide additional tax, estate and asset planning benefits as well. We’ve found this to be very useful for many small and medium-sized businesses.”

Smart Business spoke with Campbell about how a captive insurance company can benefit Orange County businesses.

What is a ‘captive’?

A captive insurance company, or captive, typically refers to an insurance company that provides insurance to and is controlled by its owners. Its purpose is to provide insurance coverage for some or all of its owners’ risk. In the closely held business environment, it is most commonly used to write insurance policies for risks that are currently not insured at all by the owners. However, it can also create policies to replace existing coverages if the economics make sense.

How does it work?

A captive is a separate corporation established for the exclusive purpose of writing property and casualty insurance. It is a fully licensed insurance company under the jurisdiction of the Insurance Commissioner within the state it is established. As such, the captive must adhere to certain requirements to be respected, such as proper risk sharing, risk distribution and underwriting guidelines for the determination of the annual premium amounts. A wide variety of risks can be covered including workers’ compensation, liability, earthquake, mold, loss of a major client, etc.

Each year, the captive issues a policy, or multiple policies depending on the need of the operating business, in exchange for annual premiums. The operating business deducts the insurance premiums as a business expense and the captive records the premiums as income. However, the captive does not pay tax on the first $1.2 million of premiums received each year if a Section 831(b) election has been made. This election allows for some very unique planning opportunities not normally available.

What are the potential benefits a captive owner may realize?

Given the right fact pattern, there are many possible benefits. First the operating business can improve its cash flow by pre-funding potential future risks with pre-tax dollars. This saves on income taxes and provides peace of mind that some of the company’s risks are being addressed.

Second, if the captive is properly managed and experiences a positive claims history, it could generate annual profits for its owners, providing a secondary income source.

Third, the ownership of the captive is very flexible. Since it is a C corporation, it can be owned by any type of entity such as a trust or a partnership, or by relatives or business associates of the operating company. This flexibility adds some potential estate and asset protection planning possibilities to the mix.

What about some of the potential drawbacks?

As with most business decisions, there are things to consider before coming to a conclusion. First, set-up costs and annual operating costs need to be evaluated. Factors that impact the cost structure are the State of Jurisdiction in which you incorporate, the number of insurance policies written, the types of coverages involved and the number and types of captive owners.

Second, whenever you create a new business entity it can add complexity to your world.

Third, the IRS could change the rules down the road. These potential drawbacks may be mitigated by aligning yourself with qualified professionals who are knowledgeable in this area and who can guide and support you through the complexities and potential rule changes.

Who should consider a captive?

Generally, any profitable closely held business with at least $500,000 per year of discretionary income, current uninsured business risk and a desire to improve its bottom line should consider a captive. In the right situation, a properly established and well-run captive can accomplish the goals of many business owners, including reduced income taxes, better risk management, and the ability to take advantage of estate and asset planning opportunities.

This article is for general information purposes only and should not be construed as a professional opinion on any specific facts or circumstances. The tax advice contained in this article is not intended to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person.

Curtis Campbell is a partner at HMWC CPAs & Business Advisors (www.hmwccpa.com), one of Orange County’s largest local accounting firms. Contact him at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s services.

Published in Orange County

Tax planning is often thought of solely as a year-end activity. While there are a number of tax minimization moves that can be made within the last 60 days of the year, it is typically a mistake to wait until then to do all of your strategic tax planning. For businesses in particular, numerous tax planning techniques cannot be effectively implemented without proper planning and implementation that require a longer timeframe.

“One of the key aspects of our tax department’s services is tax planning, helping our clients to look ahead and consider strategic moves that can minimize their tax exposure,” says Curtis Campbell, partner, HMWC CPAs & Business Advisors in Tustin. “Several of these strategies require a careful tax analysis, as well as business planning, so we typically work closely with clients to help them plan and execute each step.”

Smart Business spoke with Campbell about some of the midyear tax planning techniques that he offers his clients.

What are some of the tax breaks available for hiring workers?

The Work Opportunity Tax Credit is a federal tax credit incentive Congress provides to private-sector businesses for hiring individuals from target groups who have consistently faced significant barriers to employment. The main objective of this program is to enable the targeted employees to gradually move from economic dependency into self-sufficiency as they earn a steady income and become contributing taxpayers, while the participating employers are compensated by being able to reduce their federal income tax liability. It is available through Aug. 31, 2011.

If you own a business, consider hiring your children. As the business owner, you can deduct their pay, and other tax benefits may apply. They can earn as much as $5,800 (the 2011 standard deduction for a single taxpayer) and pay zero federal income tax. They can earn an additional $5,000 without paying current tax if they contribute it to a traditional IRA. They must perform actual work and be paid in line with what you’d pay nonfamily employees for the same work.

Are there opportunities with employee benefits?

Due to the economy, employers are continuing to evaluate their benefits and compensation programs to get the most ‘bang for the buck.’ For example, small employers (generally those with 100 or fewer employees) that create a qualified deferred compensation plans may be eligible for a $500 credit per year for three years. The credit is limited to 50 percent of qualified startup costs. Some fringe benefits, such as group term-life insurance (up to $50,000), health insurance, parking (up to $230 per month) and employee discounts, aren’t included in employee income, yet the employer still receives a deduction and typically avoids payroll tax, as well.

Should employers take action now on the health care act?

The Patient Protection and Affordable Care Act was a sweeping overhaul of the U.S. health care system. Starting last year, the act provides many small businesses a new tax credit for purchasing group health coverage. If you aren’t providing health care coverage, this tax credit might make doing so more affordable. For tax years 2011 to 2013, the maximum credit is 35 percent of the premiums paid by the employer. To get the credit, the employer must contribute at least 50 percent of the total premium or of a benchmark premium. The full credit is available for employers with 10 or fewer full-time equivalent employees (FTEs) and average annual wages of less than $25,000. Partial credits are available on a sliding scale to businesses with fewer than 25 FTEs and average annual wages of less than $50,000.

What about tax planning for capital expenditures?

The Tax Relief Act of 2010 and The Jobs Act of 2010 had some positive changes affecting Section 179. The deduction limit was increased to $500,000 and the total amount of equipment that can be purchased was increased to $2 million. Business owners can use the Section 179 election to deduct (rather than depreciate over a number of years) the cost of purchasing such things as new equipment, furniture and off-the-shelf computer software. You can claim the election only to offset net income but not to reduce it below zero. There are other limitations, so check with your tax advisor.

In lieu of electing Section 179 deductions, a taxpayer could consider taking ‘bonus depreciation’ on new assets acquired during 2011. Bonus depreciation has no dollar amount limitations and can credit a net operating loss.

Are there any special incentives for manufacturers?

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the Federal Research and Development Tax Credit through Dec. 31, 2011. This credit, which is generally equal to a portion of qualified research expenses, continues to be the best tax incentive for manufacturers. It’s complicated to calculate, but savings can be substantial, so consult your tax advisor. Also, the Domestic Production Activity Deduction provides businesses that have ‘qualified production activities’ with a deduction of 9 percent of the net income arising from these activities based in the United States. Calculating the deduction can be complex, depending on the nature of the business activity.

This article is for general information purposes only and should not be construed as a professional opinion on any specific facts or circumstances. The tax advice contained in this article is not intended to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person.

Curtis Campbell is a partner at HMWC CPAs & Business Advisors (www.hmwccpa.com), one of Orange County’s largest local accounting firms. Contact him at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s services.

Published in Orange County

For anyone concerned about estate taxes, for almost a decade it was known that 2010 was set to be a key year. After much deliberation in Congress, on December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Tax Act).  The Act provides a two-year acquittal from the expiration of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).

“Many of our clients have invested a lifetime in building a business and personal wealth. They feel that they have every right to transfer as much of those assets as possible to their heirs,” says Jeff Hipshman, partner, HMWC CPAs & Business Advisors in Tustin. “Of concern to estate planners, the expiration of these Bush-era tax acts would have resulted in substantial increases in income, estate, gift and generation-skipping transfer taxes. Fortunately, the passage of the 2010 Tax Act has offered a temporary reprieve of a potential massive increase in such taxation.”

Smart Business spoke with Hipshman about the 2010 Tax Act’s changes to federal estate, gift and generation-skipping taxes.

What is the status of the estate tax?

Effective January 1, 2010, the estate tax exemption amount is $5 million per person (or $10 million per married couple) and there is a maximum tax rate of 35 percent on estate transfers above the exemption amount. Also, beneficiaries of an estate are entitled to receive a ‘step up’ in the basis of the inherited property, meaning that regardless of what the decedent paid for the property, the heirs will inherit the property at the fair market value at the date of death. Looking forward, the estate tax exemption in 2011 continues at $5 million per person and $10 million for married couples. For 2012, the same exemption amounts are in effect but are indexed for inflation. Transferred assets in excess of the exemption amount will still be taxed at 35 percent.

On an estate planning note, if an individual passed away in 2010, the executor of the estate can decide to ‘opt out’ of the 2010 estate tax laws. If the executor chooses to opt out, the deceased individual’s assets will not be subject to an estate tax but the tax basis of the assets will be subject to the modified basis rules. In particular, for estates over $5 million, the executor may want to opt out but will need to evaluate the income tax aspects of subjecting the estate to the carryover basis rules. This is a fairly complicated decision and should be reviewed with a tax accountant and estate planning attorney.

How does ‘portability’ apply?

A significant aspect of the 2010 Tax Act is offering ‘portability’ of the federal estate tax exemption between married couples for the 2011 and 2012 tax years. Portability means that if the first spouse dies and doesn’t use up all of his or her federal exemption from estate taxes (i.e., $5 million), then the amount of the exemption that the deceased spouse didn’t use (e.g., $1.5 million) will be transferred to the surviving spouse’s exemption, so that he or she can use the deceased spouse’s unused exemption plus his or her own exemption (e.g., for a total of $6.5 million) when the surviving spouse later dies. To do so, an estate tax return must be filed at the time of the first spouse’s death.

What about gift taxes?

For 2010, the gift tax exemption continued at $1 million per person, while the gift tax rate remained at 35 percent. For 2011 and 2012, the lifetime gift tax exemption is $5 million for an individual and $10 million for a married couple (indexed for inflation in 2012). As with estate taxes, gifts in excess of the lifetime exemption are taxed at 35 percent. The gift tax exemption is also portable.

What are the generation-skipping tax levels?

For 2011 and 2012, the generation-skipping tax (GST) exemption amount is $5 million for an individual and $10 million for a married couple (indexed for inflation in 2012) and the tax rate on amounts over the exemption are 35 percent. This allows for tax planning opportunities over the next two years, such as gifts to grantor retained annuity trusts (GRATs) and charitable lead trusts (CLTs). However, portability of a spouse’s unused exemption was not extended for the GST exemption in the 2010 Tax Act, so if a married couple wishes to utilize GST tax planning, a trust should be created upon the first spouse’s death to take advantage of the exemption.

What about beyond 2012?

Estate planning is a continuous process. Personal situations change, such as marriage, divorce, death, wealth, etc. Further, Congress will be reviewing these laws and must address them prior to 2013, so estate planning must consider any tax law changes.

We believe that clients should regularly review their estate planning objectives, beneficiary designations, tax ramifications and other specifics of their individualized estate plan. Business owners and wealthy individuals typically desire to provide for their children and future generations, as well as to take steps to perpetuate their goals, dreams and values. At HMWC CPAs & Business Advisors, our goal in estate planning is to help clients achieve their goals in preserving, protecting and transferring their wealth.

This article is for general information purposes only and should not be construed as a professional opinion on any specific facts or circumstances. The tax advice contained in this article is not intended to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person. Professional advice should be consulted with regard to specific application of the information on a case-by-case basis.

Jeff Hipshman is a partner at HMWC CPAs & Business Advisors (www.hmwccpa.com), one of Orange County’s largest local accounting firms. Contact him at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s estate planning services.

Published in Orange County
Thursday, 31 March 2011 21:01

The multiple uses of business valuations

Is a business valuation needed when you aren’t planning to sell your business? What factors determine a company’s value? What do you need to know before hiring a valuation professional? These are some of the common questions that business owners pose when the issue of a valuation is raised. Since 2011 is expected by some economists to see an increase in mergers and acquisitions activity, it is a good time to review the role of business valuations.

“Valuations are useful in such circumstances as mergers and acquisitions, due diligence by a lender, succession planning, estate planning and complying with government regulations,” says Jeff Hipshman, partner, HMWC CPAs & Business Advisors in Tustin. “Even if none of these trigger events are happening now, it still can be beneficial to have a valuation. A business valuation can impart insights into a company’s strengths and weaknesses, as well as provide a road map for increasing its value. Understanding what adds value to your company can help you in future business decisions, such as timing the sale of your business for the maximum selling price.”

Smart Business spoke with Hipshman about some of the typical questions that business owners ask about business valuations.

Why is a valuation needed?

Valuations can be helpful in many situations, including some you may not have even thought about:

  • You want to buy or sell a business.
  • You are divorcing.
  • You use gifts as a tax strategy in your estate plan.
  • You are liquidating your business.
  • You are the executor of an estate.
  • You are setting up a buy-sell agreement.
  • You are seeking business financing.
  • You are doing strategic planning.
  • You require a fairness opinion.
  • You need to comply with certain FASB standards.
  • You are converting your C corporation to an S corporation.

What methods do valuators commonly use?

The business is first analyzed and then a valuation method is selected based on the analysis, the interest being valued and the purpose of the valuation. Your financial statements are a starting point when setting a value for your company. But important information will be missed if the analysis relies solely on the financial statements. Valuators select their valuation methods based on their analysis and all other facts and circumstances.

Typically, a valuator considers one primary method to derive the asset’s value, and one or two others to serve as checks or supports of that value. The process of valuing a business is necessarily somewhat subjective. Valuation professionals may vary in their estimates. In using the various methods, even the same valuator may come up with several estimates.

Here are some of the most common valuation methods:

  • Income approach. This approach capitalizes the company’s expected income or cash flow stream by determining the rate of return on investment required by a potential investor, and it sets the value at the amount appropriate to generate that rate of return. This method is often used in conjunction with a discounted cash flow analysis to estimate the present value of the future stream of net cash flows generated by the business.
  • Market approach. This approach gathers data from acquisitions of similar businesses or from the stock prices of comparable publicly traded companies. The valuator adjusts the data to account for differences between the subject company and comparable firms. An adequate number of comparable companies are necessary to produce credible results.
  • Asset-based approach, also called adjusted book value method. This approach requires establishing the value of all assets and liabilities as a method of valuing the entire business. This method is often used when a business’s earnings and cash flow don’t materially contribute to its value. The identification and valuation of intangible assets is the most challenging aspect of this method.

To ensure a quality valuation, be sure to hire an independent valuator who knows the ins and outs of your company and industry.

What makes some businesses worth more than others?

Many factors affect your company’s value. In addition to financial factors (e.g., profitability, revenue sources, cash flow, current debt and equity), some of the key factors affecting value include:

  • Economy: Economic conditions, especially costs of materials and availability of capital, can profoundly affect a company’s continued profitability.
  • Industry: A particular industry’s economic outlook can have an impact on the value of a business. In addition, markets and channels of distribution as well as changes in production technology can greatly affect a company’s future potential and have a major impact on value.
  • Competition: The number and nature of current and potential competitors and their ease of entry into a company’s market can profoundly affect a company’s success.
  • Regulations: From a valuation standpoint, compliance requirements and restrictions to market entry may be particularly important. Also, current or anticipated zoning and licensing restrictions can substantially affect price.
  • Market position: Reputation, pricing policies and diversification of customer base all significantly affect a company’s ability to generate earnings.
  • Intangibles: An established name and reputation, a customer base, a skilled work force and many others are what increase the value of a business above its tangible assets’ fair market value. They can greatly increase a company’s profitability.
  • Internal controls. The functioning of accounting and operational controls affects risk. If internal controls are faulty, financial and other data could be as well.

Jeff Hipshman is a partner at HMWC CPAs & Business Advisors (www.hmwccpa.com), one of Orange County’s largest local accounting firms. Contact him at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s business valuation services.

Published in Orange County
Tuesday, 01 March 2011 16:33

The fundamentals of a successful merger

Even as the economy shows some signs of life, many companies continue to struggle to survive. Sometimes a merger can actually be an effective resolution to their problems. A merger is a mutual decision of two companies to combine and become one entity, generally as two “equals.” Through structural and operational changes, the combined enterprise can cut costs and increase profits, improving the combined enterprise’s value for both groups of shareholders. An acquisition, on the other hand, typically involves the purchase of a smaller company by a much larger one, with the acquiring company’s management team usually running the operation.

“For those companies considering a merger, there are several factors that need to work together to make it successful,” says Curtis Campbell, partner, HMWC CPAs & Business Advisors in Tustin. “Merging companies immediately gain access to a larger customer base and greater clout in negotiating with vendors. Plus, overhead usually drops and the two companies are often able to pool capital resources. We typically advise clients in pre-merger financial projections, tax planning and due diligence, as well as post-merger accounting, tax and consulting services.”

Smart Business spoke with Campbell about some of the key issues to be considered in mergers.

What are major issues to consider prior to a merger?

Identifying and pursuing a merger opportunity is likely to take several months. While operational, sales and marketing issues often drive the initial excitement, the hard facts of a merger are that financial issues ultimately determine whether it will be viable. Therefore, you may find it helpful to hire a CPA as you attempt to answer these and other questions, such as:

• Can you agree upon the value of each company?

• How can it be structured to minimize taxes for ownership?

• What are the primary financial benefits driving the need for a merger?

• How do compensation levels compare?

You should also do thorough due diligence on all aspects of the other company (i.e., financial, operational, human resources, and sales and marketing). In some industries, it is important to give serious consideration to legal and regulatory requirements that can impact the potential merger.

How will valuation and ownership be determined?

More than any other issues, these concerns are the primary ‘deal breakers.’ In any merger, the combined entity considers the value of each entity prior to the merger, even when owners may say ‘we’re about the same.’ Sometimes an owner may have a ‘number in mind’ that his or her company is worth, which may be very unrealistic, and this breaks the deal. An independent business valuation professional can provide a resolution through developing an appraisal of each company, which can be from asset, income and market approaches.

When the value is agreed upon, the initial ownership percentages can be derived, allowing owners to decide whether they want to infuse additional cash (or other assets) in order to increase their ownership percentage. Of course, other factors are typically considered, such as paying a premium to those owners who ‘own the relationship’ with major customers. These are all part of the pre-merger negotiations that are fundamental to a successful merger.

How can the transaction be structured tax effectively?

Taxes play a role not only in personal income tax (i.e., capital gains) but also in corporate income tax. The tax structure of a merger is very important and can have a dramatic impact on the post-merger cash flow of a company. Your CPA can make a big difference in helping to decide upon and execute a favorable structure for after-tax cash flow. With the right situation, certain strategies can even have immediate results and lead to better profits and cash flow, even during poor economic times.

Are differing management styles a concern?

With multiple owners, they need to recognize that they may have less autonomy and less influence in a larger company. If your goals for the company and your approach to customers are significantly different from those of your partners, you’re probably headed for disagreements and frustration. Work ethics may differ — one executive may regularly put in extra hours, while another stays only as long as required. All of these problems can be mitigated through diligent pre-merger exploration and negotiation.

What about employee issues?

Some of the greatest benefits of a merger come from integrating operational routines and then eliminating redundant positions. You won’t need two CFOs or two presidents, so someone has to go or be reassigned to another position that is needed and allows the person to be productive. Job security, along with duties and compensation, are key issues for most employees in a merger. If your line employees react negatively to the new environment, you may initially experience increased turnover as well.

From a camaraderie standpoint, it is important to encourage a sense of unity and team spirit. Under the merged company structure, it is important to have clearly defined managerial roles to prevent employees from falling back to old reporting relationships and allegiances. The combined companies should also implement standard policies and procedures for all aspects of operations.

Curtis Campbell is a partner at HMWC CPAs & Business Advisors, one of Orange County’s largest local accounting firms. Contact him at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s services.

Published in Orange County

You’ve trimmed all the visible fat from your operations and improved efficiency as much as you can. Yet your bottom line still isn’t where you want it to be. So now you’re thinking about diversifying into a new market or product to improve your bottom line. Not a bad idea. Done right, diversification can be a lifesaver. Done wrong, however, it can be, at the very least, a letdown and, at the very worst, a quick path to disaster.

“Business owners diversify for many reasons, such as to gain a competitive advantage, minimize risks from concentrating too heavily on a particular market, or as a method to adapt to customers’ needs,” says Steve Williams, managing partner at HMWC CPAs & Business Advisors in Tustin. “Branching out to new lines of business, markets and suppliers may seem like a good idea, but, without a careful strategy, adequate resources and realistic expectations, it could turn out to be a bad one. We help our clients to be successful from the initial stages.”

Smart Business spoke with Williams about the best path to diversification.

What are some typical strategies for diversifying?

Diversification can take on many forms. You can take advantage of new market opportunities through introduction of a product developed through research and development. You may want to expand a product or service line to gain additional customers. Another alternative is to take on an entirely new area of business through a merger or acquisition.

Sometimes it makes sense to buy another company for economies of scale, reduced supply-line costs or other economic reasons. One type of diversification is horizontal integration, which involves expansion into the same industry and/or a similar product area. For instance, a vehicle dealership could buy another dealership.

Another type of diversification is vertical integration, in which a company moves into a different level of the supply chain. Usually each subsidiary, owned by the parent company, combines together to form a more efficient and cost-effective supply chain. For example, a manufacturing company might purchase a distributor or retailer. Some businesses use vertical integration strategies to eliminate the middleman — such as wholesalers and retailers — and keep the profits in-house.

These diversification strategies typically require significant capital expenditures. In most cases, you’ll have to pay (i.e., acquisition costs, time, operational changes and other resources) before you can reap the benefits, which may take time to materialize.

What are some easier, less-costly strategies?

There are several less-expensive methods to enhance your product lines and service offerings and provide the best value for your customers while maximizing your business’s growth over time. Some strategies to consider:

  • Ramp up sales. If you don’t have an outside sales team, consider hiring salespeople (or contracting with independent sales reps) to prospect for customers. Your distribution channels, which are in contact with a diverse customer base, can also be instrumental in finding new business.
  • Add the extras. You can compete nationally and globally by offering value-added services to your customers. For instance, don’t just sell a product; offer a complete package that includes warranties, preventive maintenance contracts, educational and training offerings, and any other services that will make the product more attractive.
  • Know your customer. Get to know your customers’ businesses and the changes they’re making, such as an increase in production capacity or new packaging for a product. Offer to support their new business goals by customizing products, services and other offerings to fit their needs. This will convey your value to them, help develop a new business opportunity and keep your customers satisfied.
  • Seek smaller fish. Many companies rely heavily on large-volume customers who make up a significant portion of their sales base. Consider diversifying your customer base to lessen the impact should a major customer decide to depart.

Is a business plan needed?

Adding successful products or services, for example, isn’t as simple as just buying equipment and finding building space. Develop a business plan that encompasses goals, production, human resources, financial and marketing issues. Goals, for example, may include increasing sales, gaining a broader product line, and having greater control over quality and delivery. Make sure that the plan identifies important details, such as capital costs, incurring additional debt, time commitment to manage the new product line, etc. Calculate the potential profitability by projecting an income statement that considers all the additional revenue and expense (both fixed and variable costs) factors. Consider how your projected balance sheet and income statement might affect relationships with banks or investors. These are just some of the issues that should be addressed in your business plan.

What about ‘barriers to entry’?

When you expand into new markets, there are ‘barriers to entry,’ which can include capital investment costs, branding, government regulations, taxes and permits, unions, heavily entrenched competitors and a wide array of other factors. For example, when you look to get into new markets you’ll likely be up against many established relationships, so you’ll need to identify solid reasons for customers to jump ship.

Barriers to entry should be fully analyzed, especially the financial factors, before committing to a diversification plan. Consider your company’s strengths (such as a highly skilled work force or any specialized equipment you can bring to the table) as well as its weaknesses (i.e., poor cash flow at the moment). Be objective, honest and realistic in this assessment.

Steve Williams, CPA, is the managing partner of HMWC CPAs & Business Advisors (www.hmwccpa.com) in Tustin. He also heads the firm’s Healthcare Practice and has served healthcare clients for more than 25 years. He can be reached at (714) 505-9000.

Published in Orange County