Kristen Hampshire

Wednesday, 25 June 2008 20:00

The economy: what next?

Last year, public companies had the worst fourth quarter in a decade. Banks and insurance companies had the worst quarter in 35 years.

The only way to go at this point is up, if you ask some economists, including Dr. Robert Froehlich, vice chairman, DWS Scudder, a division of Deutsche Bank Group. During a May economic summit in the Detroit region, he responded to issues ranging from the effects of lower interest rates to the economic stimulus package.

Reflecting on Froehlich’s talk and his message that there are good thing to come, Craig Johnson, president and CEO of Franklin Bank in Southfield, Mich., addresses what business owners can expect as we enter the second half of 2008 and see through the presidential election in the fall.

“There are positive indicators that as interest rates begin to positively impact the economy, consumer spending and consumer confidence will increase, and that’s good for business, regardless of what business you are in,” Johnson says.

In your opinion, are we officially in a recession?

From a micro perspective, when you examine the economy in southeast Michigan, it’s hard to argue that we are not in a recession. However, plenty of economists across the board report that, nationally, we are not going into a full-blown recession. Rather, we are experiencing a downturn caused by the mortgage issues and the resulting drops in home values. Overall, the economy has grown and continues to grow, just at a slower pace. That’s the big picture.

But here at home, we feel pain from the blows that the auto industry has taken in the last year. A look at consumer confidence and business performance in the last two quarters supports the ‘downturn’ theory, and most would say that, yes, we in this region are in a recession. But that will change. The good news is that interest rate cuts and the economic stimulus package will improve the economy as we look forward to late 2008 and 2009.

What will interest rate cuts do for the economy and businesses?

Historically, positive effects from interest rate cuts take 12 to 18 months to make an impact on the economy. We have seen this pattern in the past, and there is no reason to expect that now will be any different. In the last four months, the Federal Reserve has cut interest rates by 325 bases points. But we cannot expect to reap the economic rewards of these cuts overnight. In time, consumer confidence will improve with these lower rates, and people will take advantage of them by investing in real estate and growing their businesses. Low rates please consumers, a happy consumer spends and businesses reap the rewards. Every player is linked — every industry and every economic piece of the puzzle, from the stock market to real estate to manufacturing.

Will the economic stimulus package jump-start the economy as expected?

Many economists are projecting that Americans who receive economic stimulus checks will spend the majority of the rebate, which represents only a small portion of their disposable incomes. But consider this: If someone mails you a check for $600, will you spend only that amount? Will you purchase a big-screen television for $599, or might you decide that this ‘gift’ justifies spending more — since that $600 was a freebie, after all?

While one segment of the population will use that stimulus check to buy groceries, pay down debt and manage regular household expenditures, the other camp will consider it a jumpstart to a purchase that costs far more than the amount distributed in the check.

The economic stimulus package could have a much greater impact on the economy than what initially was estimated. This will positively impact the economy in the next 90 to 120 days, during the period when checks are mailed and subsequently cashed and spent. This will inevitably benefit manufacturers, retailers and other service providers who will attract happy consumers that have newly inflated pocketbooks.

What should business owners do now to prepare for a possible upturn?

Begin to plan today for that time, and meet with financial advisers to discuss what moves you want to make with your business when the lending environment improves, consumer confidence increases and the economy perks up. Rather than planning ahead 90 days as you may be accustomed to doing, look out further — think six months, 12 months down the road. Involve your banker in strategic plans so when the time comes to seek funding, everyone is on the same page. Bear in mind that by planning ahead and starting these discussions now, you’ll stay ahead of the curve as competition sits on the fence.

CRAIG JOHNSON is president and CEO of Franklin Bank, Southfield, Mich. Reach him at or (248) 386-9860.

Monday, 26 May 2008 20:00

Mine your business

What do your customers cost you? If your business mirrors the 80-20 rule, where 80 percent of your business comes from 20 percent of your customer base, is that other 80 percent of customers worth keeping?

As business owners focus on top-line growth, they often lose sight of the profitability each customer brings to their business. A few service-intensive, time-consuming customers can chip away total company profits if you aren’t careful, says William Rymer, director of the Business Advisory Group at Kreischer Miller, Horsham, Pa.

“A lot of organizations lose sight of the true cost when they are expanding their product lines or when they expand their offerings to meet customer requests,” he says.

Smart Business learned more from Rymer about analyzing whether customers are profit bearers or burdens.

How do companies fall into a cycle of unprofitable revenue?

It happens innocently, usually to please a significant customer or in an effort to expand products or services in the marketplace. Say a big-time customer asks you to package a product differently. He wants your widgets in six-packs, another customer orders them in twos, and a third customer wants a case of 24. You must alter your product line slightly, and you’ll need to create new packaging for each request. This essentially means three different products, tripling the complexity of your labor and production line. You might have figured that the only added cost is the differential in raw packaging costs. But this type of expansion also requires an increase in inventory levels to support those customers. Over time, you whittle away the profit margin you once made with those customers.

The same scenario can play out in the service sector. You create a new branch office to cater to a large client in a new territory. You add a new service to the mix at the request of a customer, which leads to additional labor costs and overhead expenses, such as rent. In a quest to please, you destroy profit and increase risk by expanding your cost structure.

The question you must ask yourself is: Are you recouping the incurred costs of production and other back-end expenses that add up as you tweak, invent and roll out products and services to please those customers?

How can management limit the liability any given customer puts on a company?

The deeper the relationships you have with your customer base, the less likely you will be replaced by competition. So it makes sense to want to cater to customers. But you must understand the cost behind the service or products you offer them. You need to track profitability by customer and product line. You need to capture back-end costs, whether shipping procedures, customer service or production. Do you have systems in place to measure all of your costs? If so, when a customer requests something special, you will know what areas of the business will be more stressed and how much it will truly cost you to please this customer. Then, ask yourself how important this customer is in the overall picture of your business.

How can a business owner use this information to ‘find money’ that can be reinvested?

Separate your customer list and your products or services. In what products or services do you want to invest? Clearly, you want to go after the ones that provide the highest returns, especially if you have limited access to capital. And with today’s banking environment and tight credit markets, access to capital is an issue for most businesses. Your goal is to maximize your investment in the products and services — and customers — that deliver the highest return on investment. Here’s how that can play out for your business. If you eliminate less profitable products, services and customers — skim off the bottom 20 percent — you free up dollars to invest in higher-margin business. This decreases exposure to excess inventory and allows you to invest more funds into the right parts of your business. By trimming ‘flat’ or cost-prohibitive products, services and customers, you essentially ‘find money’ within the organization to invest in growth without having to approach external sources. Also, it’s important to note that most banks will ask if you raised capital within your organization before you approached them for funding.

How else can a business look for capital within the organization?

Evaluate your accounts receivables to determine customers’ pay habits. If a customer pays you 75 days after invoicing, you are essentially extending a line of credit and tying up capital that could be reinvested in the business. Also, consider your overhead costs. Can each branch or facility function independently as a successful profit center without leaching profits from the overall business? If the answer is no, it’s time to reconsider your multilocation infrastructure. Lastly, review your vendor relationships. Are you able to obtain longer payment terms that help to retain cash within your company?

Put everything else on the table for review. Ask yourself: How can we run more efficiently? Can we invest less capital if we have fewer manufacturing assets? If we reduce inventory, can we invest more into core products? The process of evaluating customers, products and services and rating their profitability in your overall business is ongoing.

WILLIAM RYMER is director of the Business Advisory Group at Kreischer Miller, Horsham, Pa. Reach him at or (215) 441-4600.

Monday, 26 May 2008 20:00

Say it in print

Employees at Franklin Bank are in the know, thanks to The Inspire, a monthly newsletter posted on the company intranet. The six- to eight-page e-publication contains high-quality pictures, news briefs on employee accomplishments, kudos to top performers and information on the bank’s new customers and latest endeavors.

“The cornerstone of an internal newsletter is employee recognition,” says Craig Johnson, president and CEO, Franklin Bank, Southfield, Mich. “Second, a newsletter should highlight company news, whether financial information, mergers and acquisitions, initiatives — all those things. An internal newsletter is an effective open forum.”

Customers also pick up printed copies of The Inspire to learn more about Franklin Bank’s company culture, Johnson adds.

Smart Business asked Johnson how an internal newsletter can function, what content to include and how to get started.

How does an internal newsletter benefit the company and its employees?

An internal newsletter can improve employee morale and let staff know that they are on ‘the inside.’ With this forum in place, employees know they won’t have to read about a significant company event in their local newspaper first. Internal newsletters encourage employees to participate in the process, to bring forward their ideas, join committees and get involved in initiatives. Over time, employees really take ownership of their publication. They get to know their co-workers better and learn how different departments in the company function. This communication format is one more way to strengthen employees’ commitment to your company. Also, in printed format, the tool is valuable for recruitment.

What should the newsletter include?

Just because you produce an internal newsletter does not mean employees will read it. Your employees are not the captive audience you may expect. You must include compelling content that is relevant, interesting and written in a voice that keeps people’s attention. In other words, avoid dryly regurgitating last month’s numbers or plopping in overpolished material from your PR or HR departments.

This newsletter should speak to employees in a casual tone, addressing milestones and achievements of co-workers and also sharing important company news. It’s important to strike this balance. For instance, you may print a list of top department performers, include an employee profile in each issue, and list birthdays and anniversaries — information employees really look forward to reading. But your staff also wants to know about benefit plan changes, new customers, continuing education opportunities, new branches or offices opened and the latest company initiatives. Mix ‘light’ announcements with business news. And address subjects that may be uncomfortable. Employees need to know the bad news, too.

How should sensitive business information be communicated in an internal newsletter?

Management must be willing to share the good and the bad. This can be difficult, particularly for closely held companies, but communicating ups and downs helps build employee trust. You want your staff to know that they can depend on the internal newsletter as a reliable source for company news — not just fluff. That said, you should be careful how you couch unfavorable financial news or other sensitive topics. Communicate in clear language, avoid clouding the message with marketing messages — remember, you’re talking to ‘your team.’ Leave employees feeling secure about their roles in the business and informed about the reality. Also, you can count on the fact that employees will share their internal newsletter with outsiders. Only print what you want others to know. And don’t criticize your competition.

How do you manage the review process?

Managers need to commit to deadlines and recognize that regular, predictable publishing of the newsletter is critical. You should include quality photographs, print it on nice paper stock and take care to design a visually appealing newsletter. How you present the information is almost as important as what you say. If the publication is written by your employees, be careful not to police the content. You’ll want to review it before publishing. Set aside the time to do so, and show those who work hard on your newsletter that their efforts are a priority to you.

When is it a good idea to hire an outside firm to produce the newsletter?

Producing an internal newsletter is time-consuming and, depending on the frequency and sophistication of the articles and design, you may wish to outsource the project. You can hire writers/consultants to produce the newsletter, but be sure to appoint a person in-house who will serve as the liaison. If you produce the newsletter in-house, give employees the freedom to produce the publication and understand that the responsibility is on top of their regular duties.

CRAIG JOHNSON is president and CEO of Franklin Bank in Southfield, Mich. Reach him at or (248) 386-9860.

Monday, 26 May 2008 20:00

Good moves for hard times

Lately, headlines don’t paint a pretty picture of the banking industry. Financial institutions are attempting to shy away from funding previously announced transactions and taking significant write-downs on balance sheets to reflect diminished values of loan portfolios, and — in many cases — there’s less lending capacity for loans, as banks are attempting to build up reserves.

Still, strong companies in a position to grow can set themselves up for continued success by assessing strategic and financial options.

“In times like this, the strong get stronger,” says Steven S. Goykhberg, MBA, CBA, associate director, corporate finance for SS&G Financial Services, Inc. “The best-prepared business owners are knowledgeable; they know what is going on in their marketplaces, and as opportunities to gain market share or to grow through acquisitions present themselves, they take advantage.”

Smart Business spoke with Goykhberg about today’s lending environment and what you can do to stay ahead of the game.

How is commercial banking responding to financial stresses caused by consumer sub-prime lending and an uncertain economy?

In the last six months, the news has been populated with stories about significant deals collapsing because of problems obtaining financing. There have been situations where consortiums of banks, committing to finance a large transaction, have backed down, citing changes in economic conditions as the cause. They are not readily lending money to private equity firms that power many of these major transactions. In the past, depending on collateral, we saw senior lenders extending credit up to four times adjusted EBITDA (earnings before interest, taxes, depreciation and amortization).

Today, lenders generally are not considering the notion of air ball (debt without sufficient collateral), and borrowers are forced to bring more equity to the table. This is part of the trickle-down effect from securitization, which is the process of packaging cash-flow-producing assets into securities, commonly called asset-backed securities (ABS), and selling them to investors. The vast majority of the recent credit crunch was caused by ABS backed by alt-A loans, loans made to subprime mortgage borrowers. Now, financial institutions are taking write-downs on their balance sheets to reflect the diminished value of such securities.

All this considered, banks are more cautious in their lending practices. We are starting to see a significant slowdown in higher-dollar transactions — $100 million-plus enterprise value deals, representing the market value of all security holders, debt holders, preferred shareholders and common equity holders — which in turn is affecting $5 million to $100 million enterprise value deals.

Will current market conditions prohibit access to capital?

If you are a solid company with a proven business model and a track record of financial performance, you will have opportunities to access capital from banks to continue to grow your business. During tough economic times, stay with the bank with which you have built a long-term relationship. Even if the financial institution next door offers you a lower rate, the last thing you should do is jump ship. Your long-term banker, who has seen your business through ups and downs, is more likely to extend your credit. In fact, if your business is strong, now is the time to gain market share or consider acquisitions that will put you in an even better competitive position once the economy upturns.

What strategies will help successful companies take advantage of today’s marketplace?

In times like this, you should consider ways to grow market share. First, you can acquire a competitor or a company with services and/or products that complement your own. This can be a company located either in your immediate area or in an area where you want to extend your reach. If a competitor who has a great portfolio of products or services is struggling, now is the time to discuss a potential acquisition with your financial adviser.

On the other hand, if you have no interest in acquiring a competitor but still want to increase market share, you need to strategize ways to encourage consumers to buy your product rather than the competition’s. The most obvious way to do this is to slightly lower your price but, generally speaking, this will only work if you sell a commodity product.

These are two basic strategic ways of building muscle during times when the weak get weaker. The point is to always be thinking ahead. What can you do to grow even if the rest of the market is at a standstill? How will you use this time to push ahead?

How can you balance being aggressive in tough times and just getting the job done?

The natural tendency for businesses during tough economic times is to maintain the status quo. Keep your nose to the grindstone, concentrate on your core competencies and keep quality high so that you maintain longtime customers and preserve the integrity of your brand. However, while ‘playing defense,’ you must also take an offensive position and always be thinking, ‘what’s next?’ Your trusted advisers will help direct you, and you should rely on your CPA, attorney and banker to provide third-party insight into what moves will make your business even stronger, no matter what the headlines say.

STEVEN S. GOYKHBERG, MBA, CBA, is an associate director of corporate finance at SS&G Financial Services, Inc. ( Reach him at (330) 668-9696 or

Friday, 25 April 2008 20:00

Engage the right firm

Accountants can do so much more for a business than crunch numbers — if you select the right firm. Ideally, you’ll choose an accounting firm that complements your business, addresses your needs and rounds out your internal skill sets by offering value-added services.

“At the end of the day, you can look at your accounting, tax and consulting fees as overhead or as an investment,” says Stephen Christian, Managing Director, Kreischer Miller, Horsham, Pa. “We view it as an investment. It is important to engage a firm that will advance your cause and make you a better company, as opposed to just preparing financial statements and tax returns on a timely basis,” he says.

Smart Business discussed with Christian the significance of using the right accounting firm and how to select the best one for your business.

Is one kind of accounting firm better than another?

We can break accounting firms down into three general categories. There are large, international firms that are compliance-oriented, process-driven and tend to work with large Fortune 1000 corporations. At the other end of the spectrum are smaller, local accounting firms that generally are more tax-focused. Somewhere in the middle are regional firms, like ours, which provide the skill set of national firms and the entrepreneurial slant of smaller firms. All three types of firms serve their customers well. Your choice will depend on your needs and expectations. Do you want a firm that simply meets your compliance needs, or are you interested in more of a consulting relationship? There is no right or wrong answer. You must determine your needs, then figure out the best fit.

How does a business owner decide what type of accounting firm to use?

Almost all accounting firms prepare tax returns, and most can help with your financial statement needs. What else is important to you? Are you seeking a low-cost firm, or do you want to work with an accountant who provides more value-added services?

Are you comfortable with several different associates with specific skill sets handling your account, or do you prefer to work with one person? Will you rely on your accountant as a balanced, financial voice as you grow your business? Or, do you simply want someone to crunch the numbers and prepare financial reports? You need to be honest with yourself as you determine what you truly value in a relationship with an accountant. Make a list of your needs and expectations before you begin your search.

How does management identify a potential firm?

Start by talking to your lender at the bank. He or she can point you to reputable accounting firms that do the type of work your business will require. Ask your attorney and other business peers for referrals. What firms do they use, and are they satisfied with the service? As you collect names of potential firms, study their Web sites and get a feel for their company culture and areas of specialty. What services do they offer? From there, narrow down your list to several and invite them to your business for an interview.

When selecting a firm, how do you determine the right fit for your business?

Every company is different — every business owner has his or her own nuances and style. Accountant candidates should want to spend time getting to know your business, your industry, your company structure and you, personally. Take them on a tour of your facility and introduce them to other key employees. Help the accountants understand who you are. Chances are, you will connect with one of the candidates you interview. But be sure to ask them some of these questions: How do you envision the capabilities of your firm meeting my needs? How much contact will I have with senior management in the firm? What is your attitude toward professional development for your associates? (You want to know that they are constantly learning so they can bring more to the table for your business.)

Try to determine from your conversations whether the personalities of the representatives are compatible with your team’s. Is the culture at the firm similar to yours? Finally, be sure to ask for references. When you contact a reference, ask him or her: Why are you a better company today for using this firm?

What value can you expect by working with the right firm?

The ideal firm will care about your company’s success. It will serve as a solution provider and offer facts and benchmarking information that will help you better understand your business. Along with your financial statements, the firm will deliver statistics from the best-run companies in your area so you can compare your performance. As you run your business day to day, you often don’t have time to stop and ask the simple question, ‘How am I doing?’ Ultimately, your accountant can help you answer that question and direct you to solutions so you can grow and prosper.

STEPHEN CHRISTIAN is the Managing Director at Kreischer Miller in Horsham, Pa. Reach him at or (215) 441-4600.

Friday, 25 April 2008 20:00

International business

In our global economy, competition isn’t just around the corner — it’s across the map. Business owners can tap new customers, vendors and markets that exist beyond our U.S. borders. While many Michigan companies are accustomed to doing business with Canada, the strong industrial activity taking place in Asia cannot be ignored. Doing business overseas is a proactive and, in many cases, necessary growth strategy for businesses.

“As manufacturers and other types of businesses seek new business partners, they look toward China and India, which are two of the fastest-growing economies in the world,” says Craig Johnson, president and CEO, Franklin Bank in Southfield, Mich.

But just as customs are different in every country, so are currency and payment processes. How do you know you can trust a company you’ve never worked with overseas? A bank can serve as an intermediary. By taking full advantage of a bank’s international services, you can increase the security of conducting business in China and other countries and also perform smooth monetary transactions so you can earn repeat business from those foreign customers.

Smart Business discussed with Johnson a bank’s role in your business’s international affairs.

How might a company learn about overseas business opportunities and new markets to tap?

Local trade organizations are a great place to start. Network with other peers in your industry and find out where they are seeking new partners overseas. You may find out about vendor opportunities, customers seeking your products or services, or simply learn more background on how overseas transactions take place. In the greater Detroit area, Automation Alley can provide information and support for businesses related to the automotive industry who are interested in crossing borders. Also, connect with the local office of the International Trade Administration and U.S. Department of Commerce to learn about trade events or interact with an advisory committee.

When starting a relationship with an overseas partner, what securities measures should a business owner here take?

When you conduct business for the first time with an overseas partner, there is naturally mistrust between both parties. How do you know you’ll get paid? What if the goods are never shipped? International collection services go beyond wire transfers and exchanging currency, whereby the bank actually serves as a collection agency of sorts. With collections services, the bank manages the payment process. Documents such as the invoice, packing list, document of title and customs information are sent directly to the bank. The financial institution then presents these documents to you for payment, and then wires your money overseas. This prevents you from having to work through a new international customer’s payables and receivables system. Both parties can rest assured that a trusted mediator is facilitating the payment transactions.

What if a business owner wants more security with overseas transactions?

International letters of credit are similar to collections services, but the bank acts as an importer on behalf of your business. Letters of credit guarantee payment to overseas customers or vendors. The financial institution provides ‘full faith and credit’ and assumes liability for the payment transaction. While a letter of credit does not replace insurance on products, it does protect your collections process. Letters of credit create a tracking process whereby payments are made at certain trigger points, such as when goods arrive in the United States. A letter-of-credit arrangement is a good way to begin a relationship with a new international vendor. As you develop a rapport with that overseas partner, you may feel more comfortable reverting to a traditional transaction method — doing business on ‘normal terms,’ if you will.

What basic services do banks offer to make international business more convenient?

Exchange services allow you to buy and sell foreign currency notes. If you travel overseas to do business, your bank will exchange currency for you before and after trips. Wire transfers are a seamless way to transfer money in foreign currencies. Also, your bank can sell you a foreign draft, which are checks payable in the country of the vendor.

How can banks help business owners do their due diligence on their international business?

The sooner you discuss any business plans with your banker, including expansion into international markets, the more value he or she can bring to you as an adviser. Once you have identified a prospective business to partner with overseas, you begin checking references. Your bank can help with this by finding out more about the company, its bank, the way it processes payment and its overall financial health. Above all this, your bank can help coordinate payment terms and complete transactions in a secure way.

CRAIG JOHNSON is president and CEO of Franklin Bank in Southfield, Mich. Reach him at or (248) 386-9860.

Sunday, 24 February 2008 19:00

Reward top talent

These days, top executive candidates seek more from potential employers than a salary and bonus.

“In today’s work force, it is extremely difficult to find and retain top executive talent,” says Tyler Ridgeway, director of the Human Capital Resources Group at Kreischer Miller, Horsham, Pa. “As a business owner, you must ask, ‘How can I make it more attractive to work here without risking the financial success of my company?’”

Phantom stock is an alternative vehicle to traditional stock options, restricted stock or similar deferred compensation programs. The monetary incentive is real, and it’s a key retention tool for midsize companies.

Smart Business discussed with Ridgeway how phantom stock works and when these plans are a smart fit for a business.

What is phantom stock, and what employer might offer this benefit?

Phantom stock is a benefit plan that gives selected employees, usually senior management, the advantages of stock ownership without actually giving them company stock. The employee receives ‘fake’ stock that mimics the price movement of the company’s actual stock. The employee earns a bonus equal to the increased value of the company’s shares, but the employer does not have to pay out stock. The plan works like this: Say you decide to reward your top-performing CFO with a phantom stock plan. You implement a plan that promises to pay the CFO a bonus every five years that is equal to the increase of the equity of your company. As an owner, you retain the value of your company and please shareholders by not diluting their ownership rights. Remember, you’re not transferring actual stock to reward your CFO. You’re paying a cash bonus that is equivalent to the stock value increase. Phantom stock is treated as ordinary income, like any other cash bonus.

What advantages do employers enjoy by offering phantom stock as an incentive?

While large and publicly owned companies offer benefits, such as stock options, medium-sized businesses are not necessarily able to offer options. This may be because of prohibitive regulatory requirements or burdensome implementation costs. Either way, some businesses seek an alternative to traditional benefits — they still want to offer an incentive to recruit and retain top executives. Perhaps this describes your business. You see that there are employees who are critical to your operation: a CFO, lead engineer, director of sales. Their efforts drive the success and, therefore, revenue of your company. To reward their performance and entice them to stay, you can give them phantom stock. You pay them a reward equal to the increase in value of your company over a given time period. Phantom stock is a way for you to share equity with employees without sharing the equity itself.

How do employees prosper?

Employees are paid based on the company’s performance, which is motivating because their hard work and contribution to the company’s success do not go unnoticed. They feel more tied in to the company and that what they do on a daily basis really matters. And it does. As the company grows, employees who are rewarded phantom stock make more money. This incentive is in addition to salary, health insurance and other fringe benefits, like automobiles. Phantom stock adds to the appeal of a recruitment package, and the promise of eventually earning phantom stock will encourage workers to stay on board. Shareholders also prosper because employee interests become aligned with their own.

Does phantom stock have certain limitations? Are there businesses that should not offer this incentive?

If you are considering selling or merging your business in a couple of years, you may rethink phantom stock. A potential buyer will see that you have promised to pay phantom stock, which is essentially tied-up cash. Limitations on phantom stock are mainly associated with administering the plan. Phantom stock must be carefully modeled by a professional who understands the program and the governing tax law, which includes Section 409(A) of the IRS code.

What steps are necessary before implementing a phantom stock program?

First, ask yourself why you want to implement a phantom stock program. If it’s because you want to share the economic value of the business and reward key managers for success and performance without diluting the value of the company, then you’re on the right track. Second, remember that these plans must only benefit a select group of management employees, otherwise it might make it an ERISA plan. Third, decide which key managers are performance-drivers — whom do you consider critical to your future success? These should be your candidates.

Finally, you must determine the value of your business and quantify the financial impact of the company. Many business owners misjudge the value of their own businesses. At this point, enlist the aid of a tax and accounting consultant who is also well-versed in phantom stock and the tax law surrounding these programs. A program must be modeled so it complies with the Section 409(a) IRS code that governs phantom stock plans.

TYLER RIDGEWAY is director of the Human Capital Resources Group at Kreischer Miller, Horsham, Pa. Reach him at (215) 441-4600 or

Sunday, 24 February 2008 19:00

What’s your worth?

Whether you’re selling your business or doing estate and gift tax planning, you may need to know what your company is worth. Business valuations take into consideration the economic and industry outlook, the investing public’s confidence, your financial performance, assets and market value, and more.

“There is not one universal formula used to value a company,” says Elaine Rockwell, CPA/ABV, CVA, associate director in the business valuation and litigation consulting services group at SS&G Financial Services, Inc.

There are guidelines that should be considered, however. The same ruling that valuation practitioners relied on 50 years ago still applies today: Revenue Ruling 59-60. By considering eight factors, you can understand the risks, opportunities and market conditions in determining a value estimate.

Smart Business spoke with Rockwell about business valuations and how the pieces all come together.

Are all companies valued the same way?

Companies are different, so valuations are different. There are three general approaches to value a business: the asset, income and market approach. The asset approach is generally based on this equation: assets - liabilities = value. The value of assets, such as property, plant and equipment, may need to be adjusted to reflect current fair market value. This approach is commonly used in asset-intensive businesses, small businesses and professional practices where there is little or no goodwill. An asset approach does not consider goodwill and other intangible values, therefore, it is less appropriate when valuing an operating company.

The income approach mainly depends on the present value of future cash flow, often based on historical financial statements adjusted for the nonrecurring, non-operating, and non-market value of income and expenses. The issues to consider are how much income/cash flow your company generates and whether your expenses are reasonable and comparable to the industry.

The market approach compares your company to a similar publicly traded company. This method is generally more appropriate for larger businesses. Finding a ‘match’ is critical for generating an accurate valuation.

What is needed to prepare for a valuation?

Valuators generally want to review five years of historical financial statements and tax returns. They’ll look at whether there are stockholder agreements in place or buy-sell agreements, leases or loans, among other information. You’ll produce a lot of records during the valuation process, and you’ll answer questions about your operation, competition, industry and history. That is where Revenue Ruling 59-60 comes in.

What are the eight factors?

  1. Nature and history of the company: What products and services are generated, and how has this changed over time? What are the assets, both operating and investment, capital structure, management, etc.?

  2. Economic outlook: How are your competitors performing, and what is your ability to compete given the current and prospective economic and industry conditions?

  3. Book value of stock and financial condition: This refers to the balance sheet and income statements. How much debt do you have? What is your capital structure?

  4. Earning capacity: How much net income is available for dividends? What percentage of income is reinvested in the company? Earning capacity is a prediction of the future.

  5. Dividend paying capacity: This looks at what dividends could be paid. This factor is less important when valuing the controlling interest of the company because the ‘controller’ can decide what the dividends will be.

  6. Goodwill of the company: An intangible asset resulting from name, reputation, customer loyalty, etc. It’s generally based on the excess of net earnings over and above a fair return on the net tangible assets.

  7. Sales of company stock: Transfers between unrelated shareholders are generally good indications of value. This precludes transactions between a father/owner selling stock to his son at less than fair market value, which is not at arm’s length.

  8. Market approach: The IRS considers this the best method of valuing a company because it shows what the investing public thinks the company is worth based on actively traded stock. However, this is usually the most difficult approach since all businesses can’t be compared to publicly traded companies because of size, multiple divisions, international operations and other reasons.

Is there an ‘expiration date’ on valuations?

There are many factors that play into valuations, with the key indicators being economic and industry conditions and the investing public’s confidence, which are constantly changing. Economic and industry conditions, such as changing interest rates, inflation, unemployment, the market and competition, can have a dramatic effect on value. For this reason, a valuation performed several years ago is most likely not accurate today. If a valuation is prepared for estate and gift tax purposes, the IRS may consider any valuation older than six months to be stale. Although Revenue Ruling 59-60 is still the foundation of business valuations, it is important that your valuator also considers rapidly changing case law, IRS Statements of Position, valuation standards, evolving techniques and tax ramifications. Read your valuation to make sure what’s important to you is adequately addressed. If you were parting with your own money, would you be interested in buying the company?

ELAINE ROCKWELL, CPA/ABV, CVA, is an associate director in the business valuation and litigation consulting services group at SS&G Financial Services, Inc. Reach her at (440) 248-8787 or

Tuesday, 29 January 2008 19:00

After the exit

At some point, every owner leaves his or her business, voluntarily or otherwise. After building a company and dedicating your best years to ensuring its success, you will eventually step back and exit. At that time, you want to receive the maximum return to accomplish personal, financial, income and estate-planning goals.

“If you’ve given yourself time and executed all of your planning steps, you can exit on your terms versus being forced or rushed into an exit, which ultimately will prevent you from accomplishing what you want,” says Joel J. Guth, an advisor in the Citi Family Office at Smith Barney, a division of Citigroup Global Markets.

In previous issues, Smart Business spoke with Guth about exit planning and the steps necessary to ensure a successful exit. Here, he summarizes the process and addresses what’s next after the sale is complete.

What are some consequences of not setting objectives and carefully planning for an exit?

Mainly, you could feel seller’s remorse. You walk out and realize, ‘I’ve got nothing to do with my time. I shouldn’t have sold the business. It wasn’t about the money. This is my passion in life.’ Or, you sell the company and realize that you can’t maintain the lifestyle you did when you were running the business. Also, you may underachieve during the next 15 to 20 years in what was capable from the standpoint of returns, gifting, estate planning and so on. You must take time to define your objectives before exiting the business. Otherwise, at the end of the game, you will regret that there was so much more you could have accomplished but didn’t.

What steps must owners follow before they even think about selling?

Timing is the key here, and many owners work backward when exiting. They have a deal on the table, then they set objectives, figure out how much money they need to sustain their lifestyles and what to do with liquid assets. You should work through the exit planning process first, and then structure a deal that will accomplish your objectives. Some steps to guide you through exit planning include: set personal and business objectives; determine the business value and price; preserve, protect and promote value; sell to a third party or transfer to an insider; create a contingency plan for your business; and establish a wealth preservation plan.

After the sale, is the owner truly ‘retired’?

The way to think about an exit is that you are really transferring from one business to another. Your first business may have been manufacturing. Then, you were managing assets that were tied up in the company. Once you monetize those assets into liquidity, your investment still requires careful management. You take on the role of being the CIO of a liquid pot of assets. You are in charge of an investment company rather than a manufacturing company.

What struggles do owners face when they become CIO of their liquid assets?

When you make that transition, you’re forced into a role where you’re less experienced. You may have been running a manufacturing company that sold products all over the world. Maybe you were the industry leader, and there was nothing about that business you didn’t know. But once you sell that business for several million dollars, you are now in the investment business. You do not have near the knowledge in stocks, bonds, hedge funds and municipal bonds as you did in manufacturing. There is a learning curve.

What steps can help an owner manage this ‘new business’ successfully?

Take the same approach as you did when running your company. Write a business plan for how you’ll manage your investments. Establish clear goals and objectives, and devise tangible measurements to gauge your successes. Partner with people who can help you learn as you transition into this new role, which is one you’ll maintain for the rest of your life. Enlist in a proactive accountant — someone who is used to dealing with wealthy families. Find an attorney that is in tune with tax and estate issues and a reputable wealth management advisor. By aligning a team of professionals who can work together, you can accomplish the goals you set as you were planning your exit from the business.

Citi Family Office is a business of Citigroup Inc., and it provides clients with access to a broad array of bank and non-bank products and services through various subsidiaries of Citigroup Inc.

Citi Family Office is not registered as a broker-dealer or as an investment advisor. Brokerage services and/or investment advice are available to Citi Family Office clients through Citigroup Global Markets Inc., member SIPC, and Citicorp Investment Services, member NASD/SIPC. All references to Citi Family Office Financial Professionals refer to employees of Citibank, NA, Citigroup Global Markets Inc. and/or Citicorp Investment Services. Some of these employees are registered representatives of either Smith Barney, a division of Citigroup Global Markets Inc., or Citicorp Investment Services that have qualified to service Citi Family Office clients.

Citigroup Global Markets Inc., Citicorp Investment Services, and Citibank, NA are affiliated companies under the common control of Citigroup Inc.

JOEL J. GUTH is an advisor in the Citi Family Office at Smith Barney, a division of Citigroup Global Markets. Reach him at or (614) 460-2633.

Tuesday, 29 January 2008 19:00

Is your project feasible?

The worst thing that can happen during a construction project is to run out of money before your project is complete. In the banking industry, this is referred to as the project being “upside-down” — the result of unforeseen cost overruns, resulting in a lack of funds to cover project costs.

All this can be avoided by performing a feasibility study before going to the bank for commercial real estate financing. This important exercise, along with a detailed construction budget, specifications and construction plans, assures your banker that the project is viable.

“No borrower should enter into a construction project not knowing what the bottom-line numbers are going to be,” says Dave Simko, vice president, commercial real estate, Huntington Bank, Akron.

Feasibility tests and planning are critical to understanding whether the venture is a wise undertaking. “You want to be sure the project makes good economic sense,” he adds.

Smart Business spoke with Simko about various commercial real estate loans and how you can help streamline the underwriting process.

When does a developer/business need a commercial real estate loan versus a business loan for project financing?

A commercial real estate loan is appropriate for large projects, generally $5 million or more, which usually involve more complex requirements. Smaller transactions are often handled through a business-banking lender. As far as commercial real estate/construction loans, those are used to build shopping centers, office buildings or residential developments. Commercial real estate lending requires unique underwriting, structure, approval and administrative processes as it relates to acquisition, construction and development loans.

How do the three types of commercial real estate loans differ?

Acquisition loans include the purchase of raw land or owner-occupied and investment properties with existing improvements. They also may include funds identified for renovation. It is advisable to have a building condition analysis completed prior to closing an acquisition loan. This analysis is separate from the property appraisal and environmental Phase 1 study and describes building conditions, identifies deficiencies and includes a budget for immediate and long-term corrective actions.

Construction loans include funds identified for construction, whether new construction, expansion or renovation. References to loan amounts are for construction costs only and do not include acquisition costs, soft costs and finance [interest] costs.

Finally, a development loan provides infrastructure improvements to raw land for future development, such as in residential neighborhood developments. This would include bringing all the utilities [i.e. water, sewer and gas] to the project site as well as the construction of streets. Usually, this type of loan is done in conjunction with an acquisition loan. Commonly referred to in the industry as an ‘A&D Loan.’

What is the most important document a borrower can provide to a banker?

The biggest risk any bank takes when granting commercial real estate construction financing is ensuring that there are adequate funds to complete the project. To prevent projects from potentially becoming ‘upside-down,’ you must do your due diligence. This process starts with a feasibility study. This gives the borrower, the contractor and the bank an overall indication as to the viability of a project. The study will take into account location, area demographics, if there are similar projects in the general area, potential lease-up and the projected revenue stream. This should be the first step the borrower takes when considering a project.

Feasibility studies can range from a few pages long to a book-length document, depending on the size and complexity of the construction project. You can’t afford to cut corners. By doing your research and drawing a realistic conclusion of a project’s bottom line, you can avoid potential pitfalls that may jeopardize your project.

What issues do banks confront in commercial real estate construction lending?

Invariably there always seems to be some sort of cost overrun with any project. Sometimes it is because of unforeseen circumstances, changes in building code requirements or changes to the project itself. This becomes an issue when your construction budget did not allow for those contingencies or miscellaneous items, or the percentage allowed for such line items was insufficient. Those percentages usually range between 3 to 10 percent of construction costs depending, again, on the size of the project.

The key is to partner with a banker who can assist and educate you during the lending process. Banks can provide contacts for real estate research firms and construction consultants who can assemble feasibility studies. Don’t leave any stone unturned when you are going through the budgeting process. Your project’s success depends on your preparation.

DAVE SIMKO is vice president, commercial real estate for Huntington Bank in Akron, Ohio. Reach him at or (330) 835-9552.