Why you must invest in your business, and the tax credits that can help

The U.S. isn’t a low wage nation. We have to make things and serve people better, smarter, faster and with more skill. Therefore, business owners are always working to improve their offering for customers. What equipment or methodology will technologically put you ahead of the curve?

The good news is that a few helpful tax credits have been made permanent or extended out several years, says Floyd Trouten, tax partner at BDO USA, LLP. Now, you won’t have to wait until the end of the year to plan your investments, worrying whether or not you can get the credit.

“That’s a heck of a way to run your business, especially with long-term investments that can costs hundreds of thousands of dollars,” Trouten says.

Smart Business spoke with Trouten about long-range planning and investment, as well as tax provisions that help offset these costs.

Why do U.S. manufacturers, distributors and service providers need to invest in themselves?

The U.S. dollar is high against a lot of currency right now, so it costs more to buy our finished goods. We have to ensure that we’re more efficient — better and faster — to stay attractive. At the same time, foreign companies can sell their goods cheaper because a dollar buys more finished product in the European Union or South America.

As another example, China now faces dumping duties on coiled steel. As a result, they’ll probably send more completed parts, which won’t have duties. Before, the Chinese might ship the steel and your company would convert and sell it to the user. Now, the Chinese are going to say, ‘OK, I’ll just make the part and sell it to the direct user.’

Having state-of-the-art equipment and the ability to find niches with expanded offerings is critical in today’s market.

What do companies need to know about the R&D tax credit?

The R&D credit for growing research and development has been made permanent, after 14 separate extensions. Employers can better plan and take more risk because the government is venturing with them.

The R&D credit applies to more than just product improvements or testing. It can be used for sales, general and administrative costs, as long as it’s continual improvement.

There are two calculation methods. The simplified method requires three years of data for a 14 percent credit. The full credit is 20 percent and requires five years of data. If you’ve incurred time from your engineers, line employees and management on a new product, you can do an R&D study to ensure you’re picking up all costs, in order to maximize the credit.

Also, if you’re a small company, typically $5 million in revenue or less, you have the option to use up to $250,000 of the credit to offset what you pay in Social Security and Medicare taxes.

How has bonus depreciation and Section 179 changed?

With bonus depreciation, in the initial year of service you can write off 50 percent of an asset. The bonus now extends through 2019. Employers will get 50 percent through 2017, and then it goes down to 40 percent in 2018 and 30 percent in 2019. This is particularly useful for employers with capital-intensive equipment needs.

A subset of this, Section 179 allows a company to expense up to $500,000 in the initial service year, as long as it’s not putting in more than $2 million in fixed assets. This has been made permanent and it will adjust for inflation. Also, companies can now expense off-the-shelf software under Section 179, rather than amortize it.

So, if you buy equipment, you could get a tax deduction, whether it’s 50 percent bonus depreciation or Section 179 immediately, even though you’re still paying the bank and the asset will benefit you for years to come.

Are there other tax credits that might apply?

There are additional credits, but one to consider is the Work Opportunity Tax Credit (WOTC). The WOTC or other similar programs, found on federal, state and local levels, are designed to help those who face barriers to employment, such as veterans, disabled, people on government assistance, etc. There’s a lot of paperwork and detail that you need to pay attention to, but it is something to think about if you have a talent shortage, whether you’re a manufacturer or restaurateur.

Insights Accounting & Consulting is brought to you by BDO USA, LLP

Stricter ACA enforcement will require attention to costs, detail

Affordable Care Act (ACA) regulatory requirements will continue to roll out in the coming years. Accompanying these changes will be greater enforcement of those rules, leaving noncompliant employers to face significant penalties.

Smart Business spoke with Ted Ginsburg, CPA, J.D., a principal at Skoda Minotti, about what employers can expect and strategies to lower costs and avoid penalties.

What should companies keep an eye on in the coming years regarding the ACA?

There may be new regulations coming out regarding certain classes of employees and situations — for instance, defining who can be classified as a seasonal employee.

While it’s not likely to transpire until 2018, the IRS will start to assess an excise tax for failure to provide the right amount of insurance to employees. If an employer is penalized for not providing appropriate coverage to employees, employers will have two months to respond. If they don’t, the IRS will come after them.

The IRS has made clear that the 1095 series of forms will continue to be used, and that the forms will be due Jan 31, 2017. There will be no extensions, so forms must be completed and submitted on time.

What can employers do to stay compliant with the ACA while reducing the costs associated with compliance?

One option to reduce the cost of providing health insurance coverage while staying in compliance with the ACA is to become self-insured, which suits companies with 200 or more employees. Programs are being marketed that would allow smaller employers to pursue this strategy. That move could save employers 30 percent annually on the cost of health insurance.

Employers could also better estimate how much they can charge employees for insurance premiums and still meet ACA affordability guidelines. Explore various policy alternatives such as Health Savings Accounts. Examine the plan and plan design to see if cost savings can be uncovered. Take into account both the amount that the company must pay in total for the coverage as well as the amount that the employee could be forced to pay while meeting the ACA standards.

Those that had an unpleasant experience preparing 1095 forms in 2015 should be looking at ways to make the experience better. The forms are not difficult to prepare, but many employers had trouble getting the necessary data out of their payroll system to complete the process.

What can employers expect in terms of enforcement of ACA regulations?

The IRS is starting enforcement actions for failure to file or inadequate filings. And employers that fail to give employees their required 1095 form will be penalized $250 for each form that’s not sent out.

When it comes to policing employers, the IRS is looking to the 1095 series of forms for clues. The IRS can easily check if an employer has completed that filing, so penalties for noncompliance can and will be doled out. The Department of Labor (DOL) may also help with enforcement. If, for instance, a disgruntled employee files a complaint for whatever reason with the DOL, it will likely ask if a 1095 was filed on the employee’s behalf. If not, the DOL will alert the IRS.

What should employers know about the “Cadillac tax”?

Employers trigger a 40 percent excise or Cadillac tax when the actuarial value of an employee’s health coverage exceeds a certain dollar level — the tax is on the benefit above that level. It won’t be imposed until 2020.

The level of benefit that triggers the Cadillac tax is relatively low but is indexed for overall inflation. Most collectively bargained plans will be subject to it as will most employer plans. Employers, then, need to think about how they can provide less of a benefit to employees and still remain in compliance with the ACA guidelines. Employers should be proactive here. In the collective bargaining sector, some employers are reducing the offered health benefit and giving employees a pay raise in exchange for accepting a lower level of benefits.

The Cadillac tax is a major funding source for the ACA and will be used to pay for the subsidies provided through the exchanges, so the government doesn’t want to give that up.

Most employers hold their open enrollment periods during the September through November time period. Employers should work with a trusted adviser prior to that time to examine changes in program design, employee contribution levels and the preparation of the 1095 forms.

Insights Accounting & Consulting is brought to you by Skoda Minotti

A quality of earnings report can be a valuable tool when selling your business

Quality of earnings reports are independent reports that are generally associated with the sale or acquisition of a business. While quality of earnings due diligence occurs more frequently on the buy side of transactions, they can be very effective for owners looking to sell their business.

Business owners may be taking a big risk by not completing a quality of earnings report in advance of any effort to sell their company, says Richard Snyder, CPA, Director of Audit & Accounting at Kreischer Miller.

“Discovering surprises once the due diligence phase begins can put the seller at a significant disadvantage in the negotiation process and can often result in adjustments to the sale price, the inclusion of an earn-out to protect the buyer or may lead to the transaction being terminated altogether,” Snyder says.

“Moreover, the process of selling a business is very time consuming, can be a distraction from day-to-day operations and can be very stressful on owners and senior management.”

The intent behind a quality of earnings review is to create an objective document that determines the accuracy and quality of historical earnings and assets, as well as the sustainability of earnings in the future.

Smart Business spoke with Snyder about the value of this report when considering the sale of your company.

What does a quality of earnings report include?
A quality of earnings report is usually prepared by an independent professional as part of the due diligence phase in an acquisition. It typically includes a summary of EBITDA before adjustments, with management and due diligence adjustments, and adjusted for capital expenditures; identification of debt and debt-like items; and a summary of seller changes and their impact to revenue and expenses.

In addition, reports include a breakdown of revenue by categories and customers; historical revenue and operating expense analysis and trends; balance sheet and working capital analysis; and identification of one-time or non-recurring expenses. Reports also include key observations noted during the due diligence assignment, a review of revenue recognition policies, and a review of federal, state and local tax filings.

What are the advantages to completing a quality of earnings report in advance of a transaction?
There are several reasons why completing this report is beneficial to a potential seller. It can allow the seller to objectively assess and evaluate the condition of the business, as well as understand issues that may come up during a buyer’s due diligence process.

This allows the seller to be in a better position to discuss potential issues with a prospective acquirer if they arise. Completing the report also identifies non-recurring items and other issues that could impact the sale price of the business and minimizes potential surprises when the buyer completes its due diligence review. When performed well in advance of an anticipated exit, owners will have time to correct or change identified issues and concerns.

When you understand the components of a quality of earnings review and are equipped to answer the majority of the questions that may come from a potential buyer, you put yourself as the seller in a stronger position to manage the due diligence phase of the transaction. You are also better able to limit or anticipate the number of changes the buyer may propose.

How do you know when it’s the right time to request a quality of earnings report?
Determining when is the right time to have a quality of earnings report completed is a matter of judgement. Owners and management need to consider the need for the report and the potential timeframe for the sale of the business.

Owners and management should consult with their professional advisors (i.e. accountant, attorney or consultant) to discuss the advantages and benefits to performing a quality of earnings report prior to the sale of a business.

In most instances, an owner should consider this type of due diligence about a year to two years from the time the business is anticipated to be available for sale. This will give the owner and management the necessary time to make any recommended changes or adjustments as a result of the due diligence. ●

Insights Accounting & Consulting is brought to you by Kreischer Miller

Mitigate cyberthreats by testing your network for vulnerabilities

Cybersecurity has become a necessity for every business, regardless of size or industry. A hack that results in loss of client information could result in fines or jail time if it was a protected class of information — as is the case with medical records — and the company did little to protect it. Even if unprotected information was lost, a breach of any customer data could mean irreparable damage to a company’s reputation.

“In many cases, basic controls such as firewalls do a reasonably good job of keeping the bad guys out,” says Joe Compton, CISSP, CISA, QSA, CICP, a principal at Skoda Minotti. “What many companies don’t protect is the data leaving its network perimeter. Viruses can get past sophisticated protective software through social engineering attacks that are delivered via email from a recognized sender. Clicking an innocuous link from a seemingly trusted source could cause a major breach. That’s why it’s necessary to understand the unique risks that face your company and implement controls designed to protect it where it’s most vulnerable.”

Smart Business spoke with Compton about finding and eliminating weak points in company systems that could otherwise leave companies exposed to cyberattacks.

What liabilities might a breached company face as a result of its inability to keep data secure?

A company’s liability varies based primarily on the type of information lost and the steps the company took to prevent a breach. There are significant monetary fines and possible jail time for a breach of health care information if a company failed to take reasonable steps to protect that data. In banking, regulators could close a bank if IT controls were deemed missing or inadequate to protect nonpublic customer information.

Businesses that handle unregulated information and are breached risk a damaged reputation. They can survive such a breach, but rebuilding consumer confidence can be complicated and expensive.

What is a compliance framework in the context of cybersecurity and when is it necessary or prudent for a company to establish one?

A control framework provides an outline of safeguards to consider implementing in specific areas to mitigate risk and secure information that’s vulnerable to a company. Some are industry specific, such as Payment Card Industry Data Security Standards for merchants, Health Information Trust Alliance CSF for health care entities and the International Standards ISO/IEC 27001 framework for information technology.

Industry and type of information stored aside, companies should take these basic steps to learn more about their risks:

  • Understand what information they posses and classify it — who internally can see what information, what should be restricted and why.
  • Figure out where that information lives — on workstations, in the cloud, and/or on a server or servers in the office.
  • Determine what information is critical to day-to-day operations.

These are the first steps in deciding what controls are best suited to protect company information.

How can companies know that the cybersecurity measures they’ve implemented are adequate?

It starts with a risk assessment. This inventories items such as hardware, software and data, and explores the risks and threats around those based on day-to-day business operations.

A vulnerability assessment is used to test those inventory items for weaknesses so that the control structure around them can be improved. Once the control structure is implemented or enhanced, a penetration test is conducted to see if a security engineer can break through the new controls.

Security is maintained through a cycle of risk assessment and updating the control framework to address the risks identified. It’s a process companies will want to repeat at least annually.

There’s no such thing as perfection when it comes to cybersecurity, but there are steps companies can take to significantly reduce the risk of having their systems compromised. Control frameworks show a company took reasonable steps to protect customer information and reduce threats. While companies can’t ensure a breach will never happen, they must do all they can to protect their sensitive information.

Insights Accounting & Consulting is brought to you by Skoda Minotti

Steps for positioning your company for growth or succession

What are your plans for your company and yourself? Do you know where and how you want to grow your organization? If you want to turn your company into a $25 million business in the next three to five years, you have to plan that out — you can’t just snap your fingers and get there, says Ross Vozar, CPA, managing director of Transaction Advisory Services at BDO USA, LLP. Or, if you’re 55 years old and you want to retire in five or 10 years, do you know what will happen to your company or how you’ll afford to stop working?

“Planning is the most important piece. If you don’t have a plan, your concept won’t get anywhere,” Vozar says.

Smart Business spoke with Vozar about how business owners can position their company for future growth or succession.

What kind of planning needs to take place?

First, you need to have a development plan. What is it that you want to do? What are your goals for the next three, five or 10 years? What is it going to take to get there? What type of commitment will it take? What kind of mindset do you need for how you spend your time?

Then, you have to look at your people. Do they have the right skill sets or background to get you where you want to go? These can be hard questions, especially for family-owned businesses. You have to honestly determine if your current management team is capable of taking your concept to the next level, or perhaps the business needs fresh ideas from a new employee.

A lot of first-generation businesses need to be asking these tough questions now, especially if you plan on taking on a private equity partner to get you to your goals. If you’re an entrepreneur who founded the company but you don’t want to spend the time or don’t have the skills to position it for growth, you need to develop a succession plan or find ways to bring in the right expertise.

Once you have the right development plan and people in place, you likely will need some financing to reach your goals, and a financing plan. Traditional bank financing is often the least expensive option, but depending on the size of your business, lending standards have become more restrictive and many banks are wary of working with small businesses. Fortunately, there are a lot of creative financing options that are now available, from crowdfunding to private equity ownership.

You need to find a partner to have a long-term relationship with. When you’re evaluating potential deals, the intangibles are important. It may not come down to the highest offer, as a personality conflict can easily derail your plan. Do you want a hands-off partner, or do you need guidance and expertise to achieve your goals? Do you plan to retire in five years; do you need the private equity company to help you grow the company so you can do that?

You’ll also need advisers to help you build an aggressive, but achievable financial forecast. Private equity investors typically want to see that your company has already shown success.

This seems pretty straightforward. Where do business owners run into problems?

Most business owners are just too busy. They spend 100 hours a week on their business, servicing customers, so this kind of planning becomes an afterthought. Before they know it, they’ve taken a business from zero to X number of sales, and then they start asking, ‘OK, what’s next?’

The options are limitless, but it takes a commitment of time and money. It’s critical to have advisers at your side. When you’re going into growth mode, you’ll be dealing with a level of sophistication that may go beyond your expertise. Advisers cost you money upfront, but they will pay off in the end.

You can’t rush this process. It’s all about upfront planning. A lot of business owners are embracing having their accountant come in and help clean up the financial statements. Accountants can find the skeletons in the closet that will matter to a buyer, and then coach you through the story behind that. For example, you lost a $1 million client, but that account was very low-margin and now allows you to have the capacity for more profitable business. Not having control of the process from all aspects is a transaction risk that you don’t want to take. It can be a deal killer that doesn’t allow you to reach your goals.

Insights Accounting & Consulting is brought to you by BDO USA, LLP

A look inside the elements of an effective audit committee

The primary purpose of an audit committee is to monitor an entity’s risk and to provide oversight of the entity’s financial reporting, the audit process, the system of internal controls and compliance with laws and regulations, says Maxine G. Romano, CPA, Director of Audit & Accounting at Kreischer Miller.

“While audit committees are not required for all business entities, and for many not-for-profit organizations they are not always practical, those who use one, or plan to form one, should understand the role and responsibilities that the committee must undertake to ensure its effectiveness,” Romano says.

Smart Business spoke with Romano about key characteristics of audit committee members and how audit committees allow companies to function effectively.

What characteristics are important for members of an audit committee?
Members must be independent of the entity in both fact and appearance. The Sarbanes-Oxley Act of 2002 imposed stricter independence requirements for public companies, but generally committee members should not be an officer of the entity or employed by the entity; they must act independent of management as well as independent with their personal, philanthropic and political relationships.

Members should possess the following skills:

■  Competence in accounting and finances – Best practice recommends at least one member of the committee possess financial expertise. Ideally, potential members should have past experience in finance and accounting, as well as specific industry knowledge.

■   A substantial understanding of the operations of the entity or organization – Members must be familiar with how the operations will be reflected and disclosed in the entity’s financial statements.

■   An understanding of generally accepted accounting principles, as well as professional auditing standards – Be able to identify risks associated with the entity/organization’s accounting transactions and financial statements.

■   An understanding of the Committee of Sponsoring Organization’s (COSO) internal control framework – Committee members must evaluate the entity’s internal control and the effectiveness of those controls.

■   An understanding of the role of the auditors – Committee members must be able to review the results of the audit, ask relevant questions and communicate concerns or observations. They must be transparent and be willing to make tough decisions.

■   High integrity and ethical standards – The accounting treatments of many transactions are open to interpretation and require assumptions and professional judgement. Members must act in the entity/organization’s best interest.

■   Good communication skills – Be able to have open dialogue with fellow committee members, management and external auditors.

What are some key points to consider when establishing the function of an audit committee?

■   You need a written policy/charter that describes the duties of the audit committee and includes the committee’s purpose and a description of its duties and responsibilities.

■   Assign or elect an audit committee chair, a position critical to keeping topics and meetings on point and have a process in place to educate committee members on their responsibilities.

■   Establish meeting dates well in advance to allow time to address issues or concerns prior to reporting to the board. Prioritize and understand the topics that are most important for the committee to address.

■   Develop succession plans for all committee members, but in particular the committee chair.

■   Promote open lines of communication with all company stakeholders.

■   Have a process in place to ensure that any financial/audit risks identified by management are communicated to the audit committee immediately.

Adopting and maintaining an audit committee is recognized as a best practice for most business entities and organizations. Entities with a strong audit committee benefit from the oversight, knowledge and direction it can provide.

Insights Accounting & Consulting is brought to you by Kreischer Miller

Use inbound marketing to become a trusted source of information

To successfully market and sell your products and/or services, your business must be “at the ready” at your target audience’s convenience. The perpetual search by prospective customers for relevant information suggests that buyers want to get better educated before making a purchasing decision. This approach to buying has created a need for companies to take a more consultative and interactive approach to their web marketing.

“Unfortunately, most sellers in the B2B space are not marketing in a way that matches customer behavior or needs,” says Jonathan Ebenstein, partner, Strategic Marketing Services, Skoda Minotti. “Many companies have websites that aren’t leveraging best web practices. Rather than being an educational resource to help guide prospective customers through the buying process, while at the same time serving as an interactive selling tool for their business, most B2B websites are simply cyber brochures with static content that’s been unchanged for years.”

Smart Business spoke with Ebenstein about best practices for B2B marketers.

In what ways can companies attract visitors to their site?

Attracting site traffic starts with search engine optimizing a company’s website. This is done so that anyone searching for keywords related to a given company’s products or services will find that company’s website at the top of their search results. In order to ensure that your website comes up in search it is essential that you create and post thought leadership content, such as blogs, white papers, how-to guides and e-books. This material helps educate an audience so they are better, smarter buyers while at the same time positions your company as a credible expert.

Best practice dictates adding new content on average once a week, but it’s better to publish a blog once a month that’s relevant to your prospects needs than post updates every day that don’t position you as the expert.

You should also be utilizing social media. Once content has been developed, leverage as many distribution channels as is feasible to promote it, such as LinkedIn, Twitter, Facebook and YouTube.

How can companies convert visitors into leads?

Create call-to-action (CTA) buttons and place them strategically throughout your website and other e-communications. CTAs promote special offers or premium content such as a how-to guides, white papers or e-books. A CTA will direct users to a website landing page, where in exchange for their contact information and answers to a few simple questions, they can download the premium content. In the end, they get the information they seek and you get a qualified lead.

Another lead converting best practice is to include contact forms on all website subpages for visitors to fill out and connect with a company representative. You never know at what point a visitor will want to reach out.

What are some best practices for qualifying leads?

Lead scoring is a great way to qualify leads. The process starts when a visitor fills out an online form on a landing page in order to download premium content such as an e-book or white paper. Online forms should always request some basic information such as the person’s name, company and email address. It should also include a couple of simple questions to learn more about the prospect and where they are in the buying cycle. Questions to ask could include company size, their biggest challenge or timing to purchase. Upon submission, each answer is given a lead score — the higher the total score the hotter a lead is.

How should manufacturers take advantage of inbound marketing?

B2B suppliers need to get to prospective buyers when they are performing their initial due diligence. This is when they are most impressionable because they are still figuring out their needs, forming their opinions and creating the technical specifications for an eventual request for quote or proposal. Since most due diligence is completed via the web, the B2B supplier that positions themselves as the educational resource for these buyers will not only increase their chances of making the buyers short list, but will be positioned as one of the favorites.

Insights Accounting & Consulting is brought to you by Skoda Minotti

Cybersecurity testing is a must for businesses of all sizes

The notion that your company is not at risk of a cyberattack because you have nothing of value for a hacker to take is a flawed argument that fails to take into account what most hackers are really after, says Sassan Hejazi, Director of the Technology Solutions Group at Kreischer Miller.

“Most hackers are just looking for quick cash,” Hejazi says. “They’ll take $3,000; $5,000; or $10,000 – whatever they can get their hands on. In most cases, your local FBI office will tell you to just pay it and then go back and secure your system.”

It’s also unlikely that the perpetrator will ever be brought to justice, especially if the hacker is from another country.

“These criminals are shielding themselves through multiple layers of identity,” Hejazi says. “And their favorite method to get money is digital currency such as bitcoin. Traceability is nearly impossible. Law enforcement is not going to aggregate all these crimes, so they get away with it. To them, it’s easy money.”

Fortunately, there are cybersecurity practices that can reduce your risk of being the next victim.

Smart Business spoke with Hejazi about the value of vulnerability and penetration testing and how it can protect your business.

Why don’t companies do more to protect against cybercrime?
Middle-market companies typically have had limited resources to protect their networks and systems against attack. But the good news is that the prevalence of these attacks has led to more companies entering the cybersecurity market.

There are now tools available that five years ago were very expensive and required extensive resources. Many of these tools are now cloud-based, allowing companies to buy a slice of that service and get great value for their purchase. Cybersecurity has become much more cost-effective for the masses.

What is vulnerability testing?
A vulnerability assessment is a review of all your IT systems to identify potential weaknesses. This includes your servers, your work stations, your telecommunication and phone systems and your network. It involves hiring an independent third-party with expertise in cybersecurity to do a deep-dive review of your systems, similar to an audit.

Every system has vulnerabilities. This assessment develops a document that identifies those weaknesses and the risks associated with them. If you don’t know where you’re weak, you can’t address the problem.

Once those vulnerabilities are identified, the next step is to determine the risk level you can tolerate. You can’t protect against everything, so you come up with a risk plan. What are the things that you should do that are common sense, cost-effective and represent good business management practices?

If you come up with a list of 15 items, you might decide to tackle the first seven items on the list. Even if you can’t cover all 15 items right away, at least you’ve started that process of looking at your security footprint and building remediation into your budget.

What is penetration testing?
The next step is leveraging your IT resources, either internally or externally, to fix those weak spots. Once that’s done, you need to know if your fixes will be able to stand up to potential cyberattacks.

Penetration testing, also known as pen testing, involves someone acting as a hacker who tries to infiltrate your system. That infiltration takes two forms. Your hard systems are your firewalls and your security monitoring systems. Are your devices properly configured? Are your systems updated?

The other part is your soft systems. Social engineering is when the behavior of your employees is tested. The “hacker” will send suspicious emails or direct employees to do things that they should not do and see how they respond. Employees need to be trained to avoid practices that put your data and your systems at risk.

How important is continuous education?
Protecting against cybercrime is an ongoing process and employees need to be participating in training sessions on a regular basis to learn about different cybersecurity topics. It’s about changing behavior and creating a culture in which cybersecurity is always at the forefront for your team. It’s not going to eliminate the risk, but it can reduce the probability of a cyberattack. ●

Insights Accounting & Consulting is brought to you by Kreischer Miller

Why sellers should know the value of their company before an M&A event

There is a broad spectrum of concerns first-time sellers have as they approach an M&A event. Sellers wring their hands over the future of their employees and the legacy of the business, but it’s the sale price that can be tough to accept.

“It’s very common that sellers think their business is more valuable than what buyers will pay for it,” says Sean R. Saari, a partner at Skoda Minotti. “Business owners invest so much of their time and money into their business that their estimate of its value is often inflated, and that can create challenges during a sale event.”

Smart Business spoke with Saari about the importance of an accurate valuation in the M&A process.

What common misconceptions do sellers have regarding their company’s value?

It’s not uncommon that sellers, being so focused on running their business, aren’t familiar with the valuation process. It’s more than just applying a multiple to EBITDA. It takes time and careful analysis of the company’s historical and projected financials to determine what multiples are appropriate to apply to that particular business in that specific industry. The end result may look simple, but it takes skill and experience to make sure the valuation assumptions are reliable.

Another common misconception is sellers believing they can retain the accounts receivable of their business without an adjustment to the purchase price. What they don’t realize is that the offered purchase price typically assumes that a level of working capital will be delivered with the business that allows its operation to continue uninterrupted. If the accounts receivable balance is not acquired, the buyer has to make up for the cash flow shortfall during that collection period by investing more of their own money, and is rarely willing to do so without a corresponding reduction in the purchase price.

What are the differences between enterprise value and equity value?

Equity value is the value of the ownership interest in the company or the pre-tax proceeds an owner gets in the event of a sale.

Enterprise value represents the value of the company as a whole, regardless of how it’s financed. Enterprise value equals the equity value plus the interest-bearing debt minus cash. Many times investment bankers talk in terms of enterprise value.

It’s common for manufacturers to fund working capital or fixed asset investments with debt, so there can be times when equity value and enterprise value differ significantly. Therefore, it is very important that sellers understand whether the values being discussed are equity values or enterprise values so that they can appropriately estimate their proceeds from a sale.

What are the differences between financial and strategic buyers?

Broadly, financial buyers aren’t operating in the industry of the business they intend to purchase. They’re buying for a stand-alone investment.

Strategic buyers are often competitors in the same industry as the company they’re seeking to buy. They view the purchase as a growth opportunity. They may be willing to pay more for a business because they could potentially unlock synergies by combining the companies.

Whether pursuing a sale to a financial or strategic buyer, there’s a benefit to having the right advisers to protect and manage the flow of the seller’s confidential information throughout the marketing process. For example, there is more perceived risk with strategic buyers since information regarding customers, vendors, pricing and personnel may be shared. These risks are limited if the marketing process is managed correctly.

What are the factors that drive differences in value between buyers and sellers?

A disconnect is created if there is a difference in:

  • The expected future cash flows.
  • The perceived risk and required rate of return for the investment.

The value of any potential synergies and whether the buyer is willing to pay for some portion of those potential benefits may also drive differences in value.

Sellers know their business better than anyone else, but they’re only one side of the equation. Considering both the buyer’s and seller’s perspectives offers a more accurate picture of the company’s value.

Insights Accounting & Consulting is brought to you by Skoda Minotti

How to read current private equity trends, as a business owner

Investment professionals say: Don’t try to time the market, because you’re reacting to what has already happened. The same holds true for a business owner.

“We often see business owners who aren’t truly prepared to take their business to market, but they want to get it out there quickly to try to capitalize on what they see as a good market trend,” says Scott McRill, a partner in Transaction Advisory Services at BDO USA, LLP.

Private equity is a great alternative for business owners who want to exit their company, so it is important to keep an eye on industry trends, he says, especially if you’ve paid attention and prepared your company for the process along the way.

“The trends are a great indication of what a business owner might expect, but you can have wildly different opinions and results among different private equity firms,” McRill says. “These are good barometers, but don’t assume everything is going to follow this path. The standard deviation among individual deals can be sizable.”

Smart Business spoke with McRill about what he’s seeing with private equity and his advice for business owners as a result of these trends.

Trend 1: Family offices are fueling investments, competition

Family office investing in private equity has been around for some time and is not going away. A recent BDO study found that of the fund managers surveyed, 64 percent were raising new funds and 42 percent of those receive the majority of their financial commitments from family offices. (See infographic below) This investment pace is driven by skittishness about the stock market’s performance and confidence in private equity.

At the same time, some family offices have grown frustrated by their returns as limited partner investors. These groups have started investing directly in companies, creating more competition in the sector.

The biggest advantage of family offices is they don’t need to follow the typical model of holding on investment for five to seven years. If a family office finds a great company that’s producing cash flow, it may hold on to it for decades. This is appealing to many business owners who don’t like the idea of selling their business to private equity, knowing it will likely be sold again in a relatively short period of time.

Trend 2: Valuations peaking

The deal market has generally been a seller’s market for several years. Valuations have been high for sellers with a quality business. Valuations seem to be softening a little, and the shift from a sellers’ market to a buyers’ market may be coming soon.

Trend 3: Increased sell-side due diligence

The trend over the past 18 to 24 months toward an increasing occurrence of seller-side diligence is expected to continue into the foreseeable future. This kind of diligence — sellers pay for advisory services to ensure their company is ready for sale and that the numbers will stand up to buyer diligence before they take it to market — has been common in Europe, but it now has caught on in the U.S.

A decade ago, advisory services on the sell-side were seldom performed, except for large corporations carving out a division. Today, sell-side work can be 65 to 70 percent of a transaction advisory firm’s practice.

Private equity firms and investment bankers have pushed for this shift. They don’t want to invest time trying to get a deal done to later find out the numbers aren’t what they thought. Sell-side due diligence tightens up the range of value, improves the success rate of completed transactions and increases the deal’s speed.

So, what’s your takeaway for business owners in this environment?

No matter what the economics and deal market is like, you want to plan early and spend time tightening up your policies and procedures to get the business ready for buyer scrutiny. Too many business owners scrape by for years, and then decide they want to sell when there’s infrastructure missing and the records aren’t clean. Value gets lost when that happens.

If you’re thinking about selling in the next couple of years, act now to line up good accountants, an M&A attorney, etc. Although valuations may be about to start coming down, trying to race to market before being prepared will likely result in erosion of value in the long run.

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