As the sponsor of a retirement plan, CEOs are helping their employees achieve a secure financial future. Sponsoring a plan, however, also means that you, or someone you appoint, will be responsible for making important decisions about the plan’s management.
The Employee Retirement Income Security Act (ERISA) requires that those responsible for managing retirement plans, referred to as fiduciaries, carry out their responsibilities prudently and solely in the interest of the plan’s participants and beneficiaries. Among other duties, fiduciaries have a responsibility to ensure that the services provided to their plan are necessary and that the cost of those services is reasonable.
“With more companies offering defined contribution plans rather than the traditional pension plans and given that the future of Social Security is hazy, there’s both a legal and moral obligation to make certain that the company’s 401(k) plan is managed prudently,” says Roy Rader, manager for audit and business advisory services for Haskell & White LLP.
Smart Business spoke with Rader about what CEOs should know concerning the responsibilities of 401(k) plan sponsorship.
What steps can CEOs take to evaluate plan fees and expenses?
Oversight of the plan’s costs is getting harder to do because many of the plan administration fees are not fully visible to the plan participants. Many CEOs, especially in smaller companies, also serve as trustees or fiduciaries of the 401(k) plans. Therefore, in that capacity, you should first ask for full disclosure of all plan fees and administrative costs.
Second, monitor what you are charged via monthly statements and audits to make certain that the plan is compliant. You can certainly shop various firms to see if what you are being charged is in line with market comparables. Before you seek bids or estimates, establish your requirements. You will need to know how much of the work will be done in-house and what duties will be required of an outside administrator. This will help you compare service plans and the proposed fees.
In addition, ask each prospective provider to be specific about which services are covered for the estimated fees and which are not. To help in gathering information and making comparisons, you may want to use the same format to review the pricing for each prospective provider. The U.S. Department of Labor Web site is a very good reference tool that can help you know what fees will be charged and what is reasonable and customary.
What other responsibilities rest with the plan fiduciary?
The fiduciary is held to certain standards of conduct and certain responsibilities including:
- Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them
- Carrying out all duties prudently
- Following the plan documents (unless inconsistent with ERISA)
- Diversifying plan investments
The bottom line is that, following Enron, plan administrators have greater responsibility to educate their employees about how to manage a defined contribution plan and to make certain that they provide a wide array of investment choices for their employees. Also, if company stock is offered as an investment option in the plan, make sure to stress the importance of diversification through educating the employees about how to choose investments that will fit their risk tolerance and future financial and retirement needs.
What education should fiduciaries provide to plan participants?
Many firms are hiring outside consultants to conduct seminars, and they are providing employees with access to Web sites that offer plan information and help employees figure out how much they’ll need to retire. These same sites provide a long-term forecasting tool that can show expected returns by investment type as well as historical trends. Employees can become more comfortable with their own risk tolerance and how to plan for their financial needs at retirement.
Are 401(k) plan audits required?
All 401(k) plans are required to file a form 5500 annual return/report with the federal government. An audit is required once a plan elects to file as a ‘large plan’ after reaching 100 participants at the beginning of the year. A copy of the auditor’s report must be attached to the form 5500 filing. The information reported under the 5500 is distributed to all of the various governmental agencies that oversee pension plans, including the Department of Labor and the IRS, as well as the public and the plan participants. There are penalties for failing to file required reports and provide required information to participants.
What penalties can be levied against a fiduciary for failing to meet the administrative responsibilities of 401(k) plan management?
Fiduciaries who do not follow these principles of conduct may be personally liable to restore any losses to the plan or to restore any profits made through improper use of plan assets. With so much riding on the success of these plans, it behooves all executives to make certain that their firms are fully compliant with their fiduciary responsibilities.
ROY RADER is the manager for audit and business advisory services for Haskell & White LLP. Reach him at firstname.lastname@example.org or (949) 450-6315.
The pace of layoffs has slowed and, in a recent study conducted by Watson Wyatt Worldwide, 55 percent of employers said major job cuts were over. Although news of a stabilizing economy is good, it may heighten the challenge of motivating and retaining employees, because more than half of surveyed employers said they intend to increase cost-cutting measures through 2009 and beyond. The recession has necessitated short-term savings tactics like reduced bonuses and salaries or wage freezes, yet it has done little to allay experts’ predictions of long-term labor shortages. The answer is to make sure that every penny spent enhances the company’s employment value proposition.
“A company entices and retains employees through its value proposition,” says Yana Plotkin, CCP, senior compensation consultant for Watson Wyatt Worldwide. “Historically, turnover has increased during periods of recovery, so now’s the perfect time to look at everything that contributes to the employee work experience to make sure it is creating the ultimate value.”
Smart Business spoke with Plotkin about the best ways to motivate and retain employees by recalibrating your company’s employment value proposition and redesigning incentive programs.
What is an employment value proposition and how can it be rebalanced to achieve maximum return?
Every company has an employment value proposition, but few know what it is, how to customize it or how to communicate it to employees. Compensation, benefits, the company’s work environment, brand and culture all contribute to the total experience of working for a company, and its value is determined by the company’s employees. First, employers should assess the desires of their critical work force — those employees they must keep — then customize programs and align funding so expenditures deliver their intended impact. For example, a younger work force might be willing to get by on 10 percent less salary because they value investments in training and development, whereas a more mature work force might affix greater value to continued pension contributions and 401(k) matches. One size does not fit all when it comes to value creation. The key is to focus on what is most valuable to the most critical people that a company needs to retain in order to survive and succeed.
How can employers motivate and retain employees with reduced salary budgets?
Our survey shows that companies have budgeted only 1.5 percent for salary increases in 2009, yet as late as May of last year, executives said that retention of key employees was still their No. 1 concern. Rather than mandating no salary increases or small merit increases across the board, top performers or those in critical jobs should receive larger raises. Scarce engineers or rainmakers in professional firms are much harder to replace, and differentiation in rewards and recognition is a key principal to retaining high performers in difficult times by communicating to the most talented workers that the company values them.
How should incentive programs be recalibrated?
This area is particularly challenging because companies with pay-for-performance plans may find that those goals currently are unattainable, which will only demotivate employees. Consider these
? Review your company’s long-term goals and projections to make sure you continue rewarding employees for the right behaviors during the downturn, but perhaps with smaller awards. Now may be a good time to lower performance thresholds to energize and motivate employees, while raising the performance levels leading to maximum payouts in order to protect shareholders and owners from paying windfall bonuses resulting from a recovering economy.
? If your company needs to preserve cash, consider paying bonuses in stock or a combination of cash and deferred stock or stock options. This tactic increases retention and takes advantage of the depressed stock values while aligning employees’ interests with the company’s long-term strategies, ultimately creating a return for shareholders.
Might other incentives also enhance value for employees?
Many companies budget as much as 1 percent of annual salaries for employee recognition, yet few managers even know the funds exist, what to reward for, or that they have the discretion to use those tools to motivate and retain key employees. Look for unutilized funding sources to grant top performers spot bonuses, gift certificates or other recognition so they know they are appreciated during difficult times, and continue funding training and development programs so your company is positioned to optimize business opportunities during the rebound. Keep in mind that, at some point, the market will change and employees will once again be in the driver’s seat. How they are treated now may make all the difference in whether they choose to stay or go once the economy turns.
Yana Plotkin, CCP, is a senior compensation consultant for Watson Wyatt Worldwide. Reach her at Yana.Plotkin@watsonwyatt.com or (415) 733-4212.
They say one man’s trash is another man’s treasure. So as big players in the orthopedics device industry, such as Johnson & Johnson, migrated away from rehabilitation and regeneration products, like knee braces, in favor of higher margin surgical implants, Les Cross, president and CEO of DJO Inc., swooped in and acquired the unwanted divisions.
Don’t look now, but Cross has built a pretty substantial business from the accumulated discards. In the past few years, DJO, which had 2007 sales of $492 million, has more than doubled its size and product offerings, primarily through picking through those unwanted pieces via mergers and acquisitions.
“A lot of the big companies view these products as low end,” Cross says. “The industry has been highly fragmented, with many entrepreneurial inventors choosing to move on after developing a couple of products. It’s not a very exciting industry, growing about 3 to 5 percent a year. All of these factors have made M&A a desirable growth strategy.”
But quick expansion by a midtier company through acquisitions can be risky, especially when you factor in DJO’s major merger in November 2007 with $450 million ReAble Therapeutics Inc. After all, without effective assimilation of newly acquired businesses, CEOs can quickly accumulate corporate debt while losing customers, revenue and sometimes even their jobs. But with five transactions under his belt, Cross has learned how to buy companies without breaking them by executing effective M&A assimilation plans that capitalize on all the possible synergies resulting from the deal. His process begins with figuring out what his company can do with the acquisition, handling the personnel transition and then maximizing the cost reductions that can come from bringing businesses together.
Understand what you’re getting into
Before making an acquisition, Cross says it’s critical for CEOs to honestly evaluate their management team’s ability to handle an acquisition and take on the extra work. Few companies have the luxury of a dedicated assimilation team, similar to the one at General Electric, and inexperienced, overtaxed managers will often neglect their day-to-day business responsibilities and fall victim to Cross’ assimilation failure scenario.
“Honestly evaluate your team because most CEOs don’t have capable managers just waiting on the bench,” he says. “Either strengthen your team or find consultants you trust to help with the assimilation.”
Next, CEOs should set a straightforward assimilation plan and timetable and then monitor the results. Cross writes a one-page strategic plan, because brevity makes it easier to communicate the plan’s goals and track the results. Then, he meets with his executive team each Monday to keep his finger on the pulse of DJO. He also spends a great deal of time communicating.
“The CEO’s job is to structure and consistently deliver the message outlining the priorities and the goals during the assimilation period,” he says. “Also remember that you need to communicate with all the stakeholders. Good communication creates line-of-sight between the CEO’s goals and the employees, which keeps everyone focused on the outcome.”
No matter how much experience and expertise a CEO might possess in executing post-M&A assimilation plans, even the most finely crafted strategies don’t always go as expected. Since the merger with ReAble, both DJO’s president and vice president of sales have resigned, causing Cross to wear multiple hats while searching for replacements. He says honesty is the best way for CEOs to deal with bumps in the assimilation road before setting a course correction.
“We wouldn’t buy a company unless we could see a clear path of what we were going to do with it, but we also make some assumptions in the process that may not be correct,” Cross says. “When that happens, face the truth, because you’ve got to know what’s truly happening. If you’re falling behind your timetable and there’s a flaw in the assimilation plan, admit it and then set a course correction with urgency. Do it today.”
Take charge of the personnel transition
“Assuming the due diligence has been done correctly, I believe most mergers fail for one of two reasons: either the cultures of the merging companies fight each other, or everyone focuses on systems integration and they forget how to run the business,” Cross says. “Beginning with day one following an acquisition, you have to protect the quality of the product and the service first.”
Cross breaks out post-M&A synergistic opportunities into two categories: cost-saving opportunities and increased revenue opportunities. He uses different strategies to exploit each opportunity, while simultaneously minimizing the top two perils he credits with producing assimilation failures. In some cases, he gets a bonus, because the strategy results in long-term cost savings and market share gains.
Take his post-acquisition human capital strategy as an example. Cross favors terminating most of the people in the acquired company because downsizing achieves cost reductions and eliminates the risk of clashing cultures. But he doesn’t release the staff immediately, so customer relationships and revenue streams are not only preserved but also expanded through sales of enhanced product lines.
“The key is to protect the customer base, so aside from the sales force, everything else pretty much goes away,” Cross says. “When you try to bring the cultures together, everyone ends up working in silos, and there’s a lot of resistance and internal competition. The risk to the strategy is in the planning, because the business must continue during the transition period.”
Many CEOs fear telling acquired employees they’re going to be laid off because productivity, morale and customer relationships may suffer during the critical transition period. Cross advocates open dialogues with the soon-to-be released workers and gives them plenty of notice about when their positions will be eliminated.
“I use an open, honest and fair approach with the people who are part of the acquired company,” Cross says. “They normally remain on the payroll for one year and know that at the end of that time their positions will be eliminated. My experience is that people respond well when they are treated fairly. While they may be sad that they’re leaving, they have plenty of time to adjust.”
Cross offers retention bonuses to workers who stay through the transition period as well as severance packages, because the incentive plans assure that most of the staff will remain in their roles and the business will run smoothly. In addition, retaining the work force of the acquired company for a year gives DJO’s management team the necessary time to transition operational functions so they don’t get derailed by Cross’ second reason for assimilation failure: focusing on systems integration and forgetting how to run the business.
Cross advocates one exception to his policy of terminating all acquired workers: He keeps the acquired company’s sales force. Building increased revenue through cross-selling opportunities and driving sales force productivity is the goal behind every DJO acquisition. To optimize the marketplace synergies and retain market share and customers, Cross says it’s vital to retain the sales force. But leading salespeople is often like herding cats, so Cross creates a marketing and retention strategy aimed at the sales team as part of his assimilation plan.
“You have to quickly win the hearts and minds of the inherited sales force, so they stay focused on the customers,” Cross says. “It can be tricky because sometimes the merger results in reduced sales territories, since you’re adding more sales staff. To get them on board with the changes, it’s important to emphasize the upside. For example, we’ve given our salespeople a continuous flow of new products, so they have a lot more stuff to sell. This industry is only growing 3 to 5 percent per year, but we’ve been able to translate that into double-digit compounded growth, and that’s a reason to stay.”
Cross counts on his VP of sales to do most of the heavy lifting when it comes to winning the hearts and minds of the salespeople, but he also crafts and delivers personal messages to the group because their retention and performance dramatically impact the return from the acquisition investment.
“In the past, I don’t think I personally invested myself enough in the process from the beginning,” Cross says. “As a result, I think our sales force and our customers were more confused about the transition than they needed to be.”
Take advantage of cost reductions
Besides the savings from a reduction in head count, Cross assumes he will find manufacturing cost-saving synergies because he relocates the acquired company’s manufacturing process to DJO’s plant in Mexico. But he doesn’t necessarily assume that DJO’s manufacturing process is superior. The goal is to improve or maintain product quality by adopting the best manufacturing process, even if the decision doesn’t result in immediate cost savings.
“We are Toyota junkies, so we believe in lean manufacturing, and we have one of the top 10 manufacturing plants in North America,” Cross says. “If we believe we have a better way to manufacture the acquired product, we’ll shut down the other plant and begin manufacturing the product in Mexico immediately. If we find the other company has a unique manufacturing method, we’ll build up inventory while the DJO operations team works to transition the process. Our goal is better, cheaper and faster — but it has to be better.”
Cross allows his operations team to make the manufacturing process assessment and the recommendation, and even if he can’t garner all the anticipated savings immediately, he says DJO’s continuous improvement process will eventually ferret out manufacturing process savings.
Manufacturing synergies are easy to spot according to Cross, while savings from cost of goods synergies are harder to predict. Often supplies are secured through long-term fixed price contracts, and current inventories must be depleted before new pricing can be secured using greater expenditures as a negotiating tool.
“Cost of goods synergies are tricky to forecast,” Cross says. “I would discount your estimates. In other words, if you planned on $10 million in savings, I’d expect more like $7 million to $8 million.”
The result of this careful process at DJO has brought substantial growth. After the company charged to $492 million in sales in 2007, its recent merger helped grow it again in ’08, as it pushed past $733 million in its first three quarters, with a realistic shot at $1 billion. That success makes DJO an industry leader within the orthopedic device marketplace, a $6.7 billion industry based on 2006 estimates.
Going through all the steps can be a bit tedious at times, but Cross has learned that sticking with it is worth it — and a successful destination requires that you take measured paces.
“I think, in some cases, I pushed change too quickly with the ReAble merger, and I’ve learned from that and taken responsibility for the mistakes,” Cross says. “But I’ve learned that being a CEO is a marathon, not a sprint. So I remain calm and take a long-term view to get through the assimilation process.”
HOW TO REACH: DJO Inc., (760) 727-1280 or www.DJOglobal.com
When George W. Haligowski was offeredthe opportunity to serve as CEO ofImperial Capital Bancorp Inc. in 1992, itcame with a catch: The board wanted a 100percent return on its investment.
There was also the slight problem of thecompany having $100 million of its $400million in assets impaired, potential FDICaction was looming, and it was in the middle of the savings and loan crisis.
Haligowski knew he couldn’t control themacro events going on at the time, so theasking price seemed too high. He countered by offering a 50 percent return inthree years. If he failed to hit the numbers,the board could fire him. The board agreed.Haligowski was a crafty risk-taker, as thatgamble with the board paid off for bothparties. Following an IPO in 1996, hebought out the owners, giving them the 100percent return they originally requested,and then he set to work to turn the organization around.
To move forward, the chairman, president and CEO identified a niche opportunity, supported that niche and maintained patience throughout the process.
“The company was trying to be a lot ofthings to a lot of different people,”Haligowski says. “I think it just took afresh assessment from an outsider, andmy first thought was, ‘There’s no way wecan do all these things well. It’s a gambleto put all your eggs in one basket, butsometimes you just have to do it.’”
Find a niche
Haligowski says he had a competitiveadvantage entering the CEO role as abusiness manager with significant salesexperience, because he viewed opportunities through the eyes of a marketer,not a banker. After making initial overhead reductions of 35 to 40 percent andeliminating the thrift’s commercialbanking services, resources weresparse. Generating new revenue was theonly road to growth and profitability,but the larger competition was formidable. After assessing the competition,Haligowski found a weakness in theenemy’s front line, and simultaneously,the bank’s niche market and a newgrowth strategy were born.
“Nobody has a crystal ball,” Haligowskisays. “I completed a thorough opportunity analysis by being involved in the marketplace and not sitting behind the desk.The bank had limited resources, and wecouldn’t really compete against the bigger commercial banks. It was a classicDavid versus Goliath situation.”
He identified an underserved market inthe commercial lending space, writingloans for real estate entrepreneurs, andhe saw an opportunity to exploit theniche through better sales techniques.
Haligowski concluded that many banking industry lending officers were reallyorder takers in disguise, and they wereleaving midsized commercial loanopportunities on the table. He took a riskand dedicated 25 percent of the bank’sresources toward the niche lending market composed of entrepreneurial ventures, such as multifamily real estate andconstruction loans ranging from$250,000 to $7 million. He attacked themarket with financially motivated salesrepresentatives, who outmuscled andouthustled the competition.
“To exploit a niche, you survey theadvancing army and look for breachesin the line,” Haligowski says. “Thenyou test the market to see if it’s receptive to your pricing and service. Whenyou see that it’s yielding, you want topower into the market and run as fastas you can. Timing is critical when youhave limited resources. We’re a smallcommercial bank; our advantage isthat we can move quickly. We’re like aPT boat: We can zig and zag becausewe are nimble and we can turn on adime, but we’re not an aircraft carrier,so we can’t survive the Battle ofMidway.”
Support the niche
With a new niche focus, Haligowskithen worked to change the company’sstructure and culture in order to support loan origination activities, loanservicing and the unique lending needsof the entrepreneurial borrower.
As part of the cultural shift,Haligowski made the bank’s managersowners by giving them stock in thecompany. He also empowered thecompany’s loan officers by givingthem creative license to structureloans in nontraditional ways to meetthe needs of borrowers who are oftenrepositioning a property. The notion ofentrepreneurs working with entrepreneurs was a hit in the market, and thebank grabbed market share from itslarger, less flexible competitors.
“I consider my managers to be mypartners, not my subordinates,”Haligowski says. “I think an ownershipstructure is preferable for an entrepreneurial culture because you can pushpeople differently when they have astake in the outcome.”
Giving key managers ownership andproviding the bank’s sales staff withincentives has enabled ICB to achievehigh rates of organic growth whileavoiding the need to take on largeamounts of debt from acquisitions.Not only has this driven the company’sstock price and dividend, but it’s setthe bank apart from its larger commercial peers, who often rely on mergers and acquisitions as a growth strategy.
In 2000, ICB re-entered the commercial banking arena. The 2002 acquisition of Asahi Bank of California provided ICB with the operating systemsit needed to operate commercially, soit could subsequently offer commercial borrowers a complete package of banking services. Asahi didn’t have branches, so the acquisition gave ICB the opportunity to increase revenue, without adding brick-and-mortar overhead. Haligowski stayedwith his successful niche market strategy and expandedeastward, eventually opening 19 new loan originationoffices across the country.
ICB made another acquisition in 2002, launching itsentertainment finance division. The division providesbanking, advisory and collection services to the entertainment industry. The division follows suit with Haligowski’sniche market strategy, because its focus is financing independent films, some of which scored home runs at the boxoffice, like “My Big Fat Greek Wedding” and “Monster.”
Aside from their strategic value, Haligowski made theacquisitions when the price was right. When he shops foracquisitions, Haligowski is first and foremost a bargainhunter. He says it’s important to look at acquisitions carefully before moving forward, and he always asks if he personally would pay two to three times the book value for abusiness.
“There has to be a really compelling reason to make anacquisition, like you’re getting a really good deal or you’readding to your core competencies,” he says. “Otherwise,you’re just diluting shareholder value. I’ve never reallyunderstood paying for good will. I don’t understand how itworks.”
Given the recent trends in the banking industry,Haligowski and his team may need those Midway-like battle survival skills. Over the last four years, other banks followed ICB into the midsize commercial lending space,some offering lower rates and less stringent lending qualifications. Then the bottom fell out of the market completely, and demand dropped by nearly 75 percent. Whencompetitors launch a niche market invasion, Haligowskisays the best survival tactic is often to hunker downbecause competitors aren’t often dedicated to the spacelong term, and then commence a hybrid marketing strategy to protect some of your market share.
“It’s a misnomer that being a niche player limits growth,”Haligowski says. “You select a niche market because it’ssignificantly underpenetrated and because you have a limited share of the available market. So you can mitigate riskand continue to grow by expanding your share.”
Despite having opport unities to increase market sharethrough better execution, Haligowski says that the last 12months have been challenging and that the underservedcommercial loan market all but evaporated during 2007.He says that just as timing is vital when gaining an initialfoothold in a niche market, it’s equally important whenwaiting out a down period.
“You don’t want to go surfing when the surf isn’t up,”Haligowski says. “You have to right-size your resourcesand wait for the next wave of opportunity. The otherchoice you have is to meet the price competition head-onby writing some loans at lower rates, and then outsourcethe risk to a third party. I think a hybrid solution is thebest answer, because you’ve got your entire structurededicated to the niche market, and it will eventuallyreturn.”
Under his hybrid solution, Haligowski has continued topush his sales team toward increased market share in thecommercial loan market, and then selectively meets pricing competition while carefully scrutinizing the split of thebank’s loan portfolio. In addition, he incentivizes his salesteam toward cross-selling by selling existing borrowersancillary banking services.
During the recent difficult times, Haligowski hasremained close to the bank’s employees. He provides thema monthly status report, and he personally visits customers to thank them for their business and also visitstroubled properties the bank has financed. Haligowskicautions CEOs not to overreact to market changes and tostay the course if they want to be successful in niche markets.
“We have our entire company and the culture set to support the commercial loan market,” Haligowski says. “It’s ahighly fragile system built on trust, so to undermine thatwould destroy the very underpinnings that make the entirething work. You have to spend more time in the field during difficult times and let people know you are committedto staying the course. You have to support people andmanage their perceptions when things are tough becausethat’s when they need reassurance the most.”
Although the bank has suspended its dividend for theremainder of 2008, it has remained profitable thus far. Asa demonstration of his confidence and his penchant for risk-taking, Haligowski purchased more than 100,000 ICBshares on the open market so far this year, making him thebank’s largest individual, noninstitutional shareholder.Since buying the company and repositioning it as an entrepreneurial niche player, he has grown the bank’s assets to$3.6 billion last year, up from $3.4 billion in 2006.
“I think you just have to make a judgment about the bestway to go,” Haligowski says. “You can get everybodyinvolved in the decision, but the only way the employeeswill follow a leader is if you are clear in your position.Sometimes, you just have to take a gamble and set a strategy, but don’t take it lightly, because if you’re wrong, youcan lose your job.”
HOW TO REACH: Imperial Capital Bancorp Inc., (888) 551-4852 or www.icbancorp.com
Half of all business mergers and acquisitions fail because things just don’t turn out as executives planned.
Acquisition value is often based upon a business’s past performance, and many executives rely on in-house personnel to conduct historical financial analysis only to be surprised later because the past isn’t always indicative of future earnings. An acquired company may not sustain growth if market conditions change, key employees leave or the company’s expense levels are too high compared to industry norms. An external financial due diligence review will uncover many of these hidden risks so executives can appropriately determine the acquired company’s true value.
“In M&A transactions, often what is not discovered through due diligence or unknown items are what really come back to bite you after the deal is done,” says Pat Ross, audit partner with Haskell & White LLP. “While earn outs or other contingency payments are designed to mitigate this risk, they can’t remedy the distraction of executives who have to deal with post-acquisition problems. Why not have a clear picture upfront, so you know exactly what you are buying?”
Smart Business spoke with Ross about the value of professional due diligence and the areas that produce the most frequent post-M&A surprises.
How can financial due diligence project future earnings quality?
It’s vital to understand how the target company earns its profit to know if that will continue. Sometimes a highly profitable division may have been sold or a competitor may have gained the upper hand in the marketplace with new technology. If margins or revenues will be impacted in the future, you won’t know that by looking at past or current financial statements, which are typically backward looking. Executives also need to know if the target has a consistent, stable customer base or if there have been one-time large orders that will not repeat, or non-operational gains. It’s important for the due diligence team to assess the marketplace and the target’s position to know if the acquisition price is right.
What are potential SG&A surprises?
Perhaps the owner of the target company didn’t take a salary for a year while he readied the company for a potential sale, or maybe the current staff is paid above or below the going market rate. These are situations that can cause big problems when new owners need to hire additional staff or are forced to offer substantial salary increases to mitigate turnover. You also want to know if there have been any extraordinary expenses, like lawsuit settlements, and whether those are likely to recur and how the target company’s expenses compare against industry benchmarks. How the company performs against its peers in all categories is an important predictor of future success.
How can human capital influence M&A success?
It’s important to understand if the target company’s financial performance is driven by a few key personnel. If so, they will need to be retained, and the due diligence team can assess current management in order to understand the relationship between it and the company’s future profit prospects. For example, items assessed can include: When and how are commissions paid to the sales staff members? Is the bonus schedule competitive? Might they woo away key customers if they go to work for a competitor? These are some of the questions that should be asked and understood before making an offer.
What are some hidden risks?
Back taxes, IRS liens and EEO lawsuits can be disruptive or even catastrophic if CEOs have to deal with them after the acquisition; a solid external due diligence review can uncover the potential of any of these events occurring. Also, be certain that you’re getting clear title to the assets you’ll be buying, the company has effective accounting controls and processes in place and the business has been adequately insured. The likelihood of a lawsuit or claim surfacing after the acquisition increases if the business hasn’t practiced sound management or risk management fundamentals in the past.
What constitutes an external financial due diligence review?
The due diligence professional will sit down with management in the preliminary stages to gain an understanding of the proposed deal, including the upside and potential downside, then he or she can calibrate the due diligence procedures to assess the potential risks in a variety of financial and nonfinancial areas. A customized plan will be prepared to perform investigative procedures around those risks and determine if there are real or perceived risks and any potential mitigating factors. The key here is to understand if the deal is likely to look just as attractive in a few years as it does today.
PAT ROSS is an audit partner for Haskell & White LLP. Reach him at (949) 450-6362 or PRoss@hwcpa.com.
Do you think employees leave your company for better pay or more robust benefits? If you answered yes to that question, then you aren’t alone. According to the “2008 Global Strategic Rewards Survey” conducted by Watson Wyatt Worldwide, work-place stress is one of the top reasons employees say they leave organizations, but stress doesn’t even register as one of the top five reasons employers cite as causes of employee resignations. The survey demonstrates that organizations applying an integrated approach to reward and manage talent have an advantage in attracting, engaging and retaining the talent they need to succeed in their markets and outperform peers.
“Some of the myths that employers subscribe to are the reasons why employees come and go,” says Laurie Bienstock, U.S. practice director for Strategic Rewards for Watson Wyatt Worldwide. “Once they understand the impact of stress in the workplace, employers can reshape their employee value proposition and take steps to attract and retain top performers.”
Smart Business spoke with Bienstock about reducing workplace stress.
What are the top causes of workplace stress cited by employees?
According to the survey, employees are most stressed about the day-to-day challenges associated with their jobs, more specifically the increasing expectation to do more with less. Here’s what employees mentioned as the most frequent causes of stress:
- Job definition Unclear or unrealistic performance expectations cause stress, along with unrealistic workloads, inadequate training and poorly defined work processes.
- Work group environment A lack of teamwork and/or a lack of staff to perform their job duties create workplace stress.
- Supervisor Employees were split about how supervisors contribute to work-place stress. Low performers said their supervisor was a cause of workplace stress whereas top performers more frequently cited poorly defined work processes, not their supervisor, as a reason for stress.
In times of economic uncertainty, it’s even more important to ensure employees are engaged and have the resources needed to do their work. If organizations are forced to reduce their work force, they must be careful not to expect the employees left behind to do the jobs of those who have left this creates excessive stress and may impact retention, particularly as the economy rebounds.
What actions have organizations taken to combat stress and which are most effective?
Organizations report taking these steps, with some being more effective than others:
- Strengthen performance management. Clarifying job definition and defining realistic performance expectations through their performance management systems is viewed as highly effective in reducing stress, according to more than half of the survey participants.
- Improve management communication. While many companies have instituted more frequent management communication around corporate goals and the company’s performance, the tactic was not reported as highly effective in reducing stress.
- Re-engineer job processes. Re-engineering work flow and processes was highly effective in reducing stress.
- Improve training. More than half of the surveyed companies increased the availability of employee training, but training was cited as one of the least effective methodologies for combating stress.
- Flexible work schedules. While almost 60 percent of organizations indicate they are making it possible for employees to have a healthy, comfortable balance between work and personal lives, only 50 percent of employees agree. Flexible scheduling is the most common tool employers are using to facilitate work-life balance, with work-at-home/remote policy and adjusted staffing levels common around the world, as well.
Why is an integrated approach to rewards and talent management effective in reducing stress?
An integrated approach ensures that the programs and processes in place at your organization align with your business strategy as well as the needs of your current and future work force. This includes creating and living up to a compelling employee value proposition. By implementing a holistic approach to rewards and talent management that drives business results, aligns pay with performance, promotes healthy work-life balance and integrates employee learning and succession planning, employers drive employee engagement (which reduces stress) and achieve higher productivity.
Are there other benefits for employers?
Employers benefit from other soft cost reductions as a result of lower employee turnover such as decreased recruiting and retraining costs and sustained productivity levels. According to the survey, companies that take an integrated approach to reward and manage talent are less likely to experience problems attracting critical-skill employees (20 percent less likely) and top-performing employees (25 percent less likely); have less trouble trouble retaining critical-skill employees (33 percent less likely) and top-performing employees (18 percent less likely); and are 18 percent more likely to be among the top financially performing organizations.
LAURIE BIENSTOCK is the U.S. practice director for Strategic Rewards for Watson Wyatt Worldwide. Reach her at (415) 733-4311 or email@example.com.
But the achievement is even more astounding when you consider that AMN Healthcare is in an industry composed of hundreds of competitors that has evolved from infancy to adulthood in record time. While the industry continues to eke out organic growth, its maturing status encourages consolidation, so larger competitors are making acquisitions and nipping at AMN Healthcare’s heels.
Nowakowski’s secret for maintaining the lead is never looking back in the rearview mirror at the competition and always striving to be the pace car that others must follow.
“To maintain an industry leadership role, you have to be constantly looking forward, earn the business every day, make long-term investments and take chances with people,” Nowakowski says.
She likes to offer people career opportunities because, at one time, she was given that all-important first chance to prove her abilities before she had all the requisite experience, and she grew through the process. Nowakowski also differs from many of her peers in that she was promoted to the CEO position from within the organization. Starting as the company’s first chief financial officer in 1990, she later became division president, then company president and finally CEO in 2005. Now, she’s the leader of a NYSE-traded company that generated $1.16 billion in revenue in 2007.
Under Nowakowski’s leadership, AMN Healthcare has grown by increasing its service offerings and global recruiting strategy, and in addition to driving organic growth, the company made five of its eight acquisitions under her leadership. Today, AMN Healthcare operates under 12 distinct brands as a way to recruit the highly coveted nurses, physicians and allied health professionals it places on contract assignments.
Create brand diversity
Nowakowski joined what was called American Mobile Nurses in 1990, a growing privately held provider of travel nurses. Clients were beginning to express an interest in contract allied health professionals, and the industry was growing by expanding the contingent work force concept to other health care disciplines. The following year, the company grew organically by launching a mobile therapist division, and in 1998, the company launched the AMN Healthcare name. The expansion phase has continued including overseas nurse recruitment and the more recent acquisitions of MHA Group, a provider of temporary physicians and physician direct-placement services, and Pharmacy Choice, which provides temporary and direct placement of pharmacists.
“Clients were asking for contract physicians,” Nowakowski says. “The key is to listen to them, anticipate the market, and then get into the space quickly. Otherwise, someone else will offer the service. To be an industry leader, you have to be a single-source service provider to clients or else you give a competitor an opening.”
Today, AMN Healthcare provides a full range of staffing services under a multibrand recruiting model. While there’s an increased cost and a few challenges associated with executing the strategy, each brand attracts a different group of health care professionals, so there’s value in retaining the inventory of health care professionals and the placement team who garners relationships with the contingent workers, following an acquisition. Sometimes, there are multiple suitors for health care staffing firms, so how the CEO handles the transaction and the integration of the brands often dictates success in maintaining the brand identity and retaining the work force.
“The key to managing multiple brands and keeping them intact is to respect each organization’s differences,” Nowakowski says. “You can’t expect to change everything overnight, and you shouldn’t change everything. You should author the integration plan before the acquisition closes and involve the key leadership of the prospective acquisition in the assimilation strategy. The process builds trust and eliminates surprises. Agree upfront which functions and decision-making processes will be consolidated and which will remain autonomous.”
Agreeing about the future operating model as part of the due-diligence process keeps the acquisition from unraveling once the investment is made. Each AMN Healthcare brand has its own president and its own profit and loss statement, which ensures operating independence, and the structure appeals to selling entrepreneurs. Nowakowski favors integrating back-office functions, like accounting and risk management, while providing new acquisitions with tools that enable growth, such as improved Web sites and technology capabilities.
“Each brand has its own operating plan, which is approved by the board,” Nowakowski says. “Of course, we’re looking for them to fit in to the long-term company goals and cohesiveness around things like pricing and the types of disciplines they are providing, but they have a great deal of autonomy in how they conduct business. That maintains the brand’s independence and its ability to appeal to a different segment of the contingent work force.”
Put people first
While people are a vital component in the success of most businesses, in the staffing industry, the key is the quality of the workers placed on assignment. In addition, clients rely on the expertise of recruiters to make critical placement decisions. With people dictating the company’s success at every turn, relationship prowess and execution consistency not only sustain the AMN Healthcare operating model, they directly impact the company’s industry leadership position. Because AMN Healthcare must compete for acquisitions, contingent workers, recruiters and clients, Nowakowski is adept at handling people and leading the way with her talents.
“We were vying to acquire MHA Group and closing the transaction was a critical step for our organization because having physician placement capabilities was vital to becoming a full-service provider,” Nowakowski says. “There were several times during the negotiations when the deal was off the table. I think what finally helped move the process forward, is that I envisioned the deal through the eyes of the other party. The contract included a post-acquisition earn-out bonus for the owners, if certain results were achieved. They were concerned they wouldn’t earn the minimum bonus, so I finally agreed to a guarantee. I think, sometimes, you have to put your ego aside when things get off course and come back to what makes a good partnership, which is trust.”
Each brand has its own sales force, so it’s important to keep the business development team focused on winning the battle against outside competitors, not merely diluting revenue generation by competing for the same business against other AMN Healthcare representatives. Clients can also be confused when multiple brands are offered under a single company umbrella a reason why many executives often favor brand consolidation following acquisitions. Nowakowski relies on her people management skills to build a cohesive team focused on taking down the company’s outside competitors not each other.
“I think it’s important to discuss how the sales teams will work together as part of the acquisition discussions and involve the managers and the sales teams in the strategy,” Nowakowski says. “We use a cross-selling model, and the sales teams’ incentives are aligned, which encourages the representatives to help their counterparts. They visit the client in teams, presenting our offerings only under the AMN Healthcare brand. Going to the client as a unified team creates trust between the sales groups and message uniformity with the client.”
Building and developing an internal staff has been vital to executing the company’s growth plan, which includes competing for the attention of the more than 2 million nurses in the U.S., who have their choice of jobs. Nowakowski says the company went from 800 associates to 2,000 seemingly overnight, in part because staff chose to remain with the company after acquisitions but also because she delivers on her promise of providing career opportunities to up-and-comers. Last year, 40 percent of the company’s promotions were awarded to internal staff in accordance with Nowakowski’s belief that talented personnel should be given the opportunity to spread their wings.
“I moved one consultant from Deloitte over our payroll and billing system, and he created the entire infrastructure that pays and bills our 7,000 assigned clinicians every other week,” Nowakowski says. “I gave him the opportunity to run our allied health division, even though he had no sales experience, because I was so impressed with his work. Sometimes, passion and commitment can make up for a lack of experience.”
In addition, having the staff and resources to assimilate acquisitions effectively and continually assessing the adequacy of the company’s infrastructure to sustain growth is something she reviews every day because both are vital to maintaining the lead.
“You can’t effectively integrate an acquisition with staff who can only dedicate themselves to the task part time,” Nowakowski says. “It’s a full-time job to do the job correctly and to make sure people are working together cohesively. CEOs should evaluate their staff and infrastructure before attempting an acquisition to make certain there are enough capable resources to assure a seamless transition.”
Investment in continuous improvement
When staffing industry customers procure services, they have many options, so customers must be satisfied or else they will defect to a competitor, and there’s certainly no room for error when contracting health care personnel care for patients. Nowakowski says that continuous improvement and continuous investment go hand in hand, because error reduction and client retention allow CEOs to reduce overhead and rework costs, which frees up investment funds.
“Quality and continuous improvement are the fabric of the organization,” Nowakowski says. “To create a culture of continuous improvement, CEOs have to constantly talk about the importance of quality, monitor metrics and quality ratings, and provide staff with incentives that support the quality mission.”
To demonstrate her commitment to quality, Nowakowski explains each of her decisions to the company’s staff by illustrating how her choice supports her commitment to quality, especially when her decision supports quality but not increased revenue. For example, Nowakowski says she could lower the selection criteria for contingent staff, enabling recruiters to fill more requisitions, but that would send the wrong message about the importance of quality to the team.
In addition, AMN Healthcare conducts anonymous quality surveys among client and contingent professionals and Nowakowski monitors those results along with data that measures the company’s basic deliverables, such as the percentage of filled orders, completed assignments and order cancellations.
She also uses feedback from client and contingent worker focus groups to craft the company’s investment strategy. AMN Healthcare maintains 20 different Web sites geared toward the recruitment and professional education of each brand’s contingent workers. The company’s latest investment, supported by focus group feedback, enhances each site’s social networking capabilities, creating a portal that will get into the lives of the health care professionals.
The concept and the investment decision were partly influenced by industry leaders outside of staffing. Nowakowski says she learns from observing what leaders do in all industries to keep their companies in the lead.
“We watch Nike and Google and bring some of their best practices to the table here,” Nowakowski says. “I think CEOs can learn a great deal from looking outside their own company and industry for ideas and what keeps them ahead of the competition.”
Under Nowakowski’s leadership philosophy, there’s no doubt that growth requires capable people and ongoing business investment, but she says those things are even more important if the CEO wants to maintain an industry leadership position, which is garnered through a blend of organic and acquired growth.
“While I think long-term investment is vital to sustaining growth, so is remaining steadfast with your values,” Nowakowski says. “As time goes on, strategies will evolve, but a commitment to respecting the individual, quality and continuous improvement are the things that keep companies at the top of their game over the long haul.”
HOW TO REACH: AMN Healthcare Services Inc., (866) 871-8519 or www.amnhealthcare.com
The debate over whether real estate acquisition transactions should be valued as business combinations should have ended after the implementation of Financial Accounting Standards No. 141 (FAS 141). Now a new change in the accounting standards will modify accounting for investment property acquisitions.
Although FAS 141 was enacted in 2001, some accountants were continuing to value acquired real estate as land and buildings and not recognizing intangible assets acquired during real estate acquisition transactions. In December 2007, the Financial Accounting Standards Board issued Financial Accounting Standard No. 141 (revised), FAS 141R, which replaced FAS 141, but retains the fundamental basis of the original standard. Its adoption is also significant because it represents progress toward two additional initiatives: the gradual migration toward a single set of international accounting standards and the need for greater accuracy and a standard presentation of financial reporting.
“Executives who invest in rental real estate properties should become familiar with the new accounting standard now,” says Paul Louis, CPA, audit manager for the Audit and Business Advisory Services Group at Haskell & White LLP. “FAS 141R changes accounting and reporting requirements for real estate acquisitions in fiscal years beginning on or after Dec. 15, 2008. It will require measuring and recognizing the acquired business at its full fair value as of the acquisition date.”
Smart Business spoke with Louis regarding what CEOs should know about the change in standards under FAS 141R.
Are real estate acquisitions considered business combinations?
Yes, but the definition applies, with some exceptions, to acquisitions of rental commercial or office property with tenants in place, not vacant land or owner-occupied property. Companies are not only purchasing the land and building, but they are purchasing the entire business. As part of the transaction, the buyer obtains control over the real estate and becomes responsible for all of its activities. In that respect, the acquirer’s balance sheet will more accurately capture the fair value of the assets acquired and assumed liabilities as of the acquisition date than it would using a traditional approach.
How does FAS 141R impact the treatment of acquisition costs?
This is one of the biggest changes under FAS 141R. Direct professional fees related to the acquisition, such as consulting fees or due diligence costs, can no longer be capitalized or used as part of the real estate acquisition cost. Now, those fees must be completely expensed in the period in which they occur. This change gives a real-time presentation for the fair value of the acquired assets and assumed liabilities as well as the expenses. This will impact the profitability of the acquiring company in the acquisition year as well as the years immediately preceding and following the acquisition.
How does FAS 141R change the allocation of tangible and intangible assets?
Tangible assets include land, building, site improvements and tenant improvements. Intangible assets include the value of existing leases (including the value of those leases that are above or below existing market rates), customer relationships, leasing commissions and legal and marketing costs. FAS 141R retains the guidance of FAS 141 for identifying and recognizing intangible assets. The value of all acquired assets and assumed liabilities should be based on fair value. The value of the existing leases and the materiality of those leases are some of the major components for the determination of intangible assets value. The acquired tangible and intangible assets and any assumed liabilities can be valued using one of these approaches or a combination: sales comparison, income approach or cost approach valuation.
What other changes should CEOs expect from FAS 141R?
Expect to provide greater transparency and disclosure to the financial statements’ user. The users will often be lenders or investors, who will benefit from greater standardization so they can compare expenses and values across similar transactions. The auditor will test the reasonableness of the assumptions used by valuation and appraisal specialists in setting the property’s fair value.
How can CEOs prepare for the change?
Begin addressing the changes with team members who are involved with real estate acquisitions and the members of the accounting department who prepare your company’s financial statements. Run financial models as part of the due diligence process to understand how the new standards will impact your company’s profitability as you consider new deals. Be sure to identify all the costs, including all the depreciation and amortization of tangible and intangible assets, respectively. Watch for updates and check with your accountant for more information.
Lastly, remember FAS 141R applies to acquisitions made on or after the beginning of the first annual reporting period beginning on or after Dec. 15, 2008. So for companies that have a fiscal year-end of Dec. 31, this new FAS statement is applicable for acquisitions made on or after Jan. 1, 2009; and early adoption of the standard is prohibited.
PAUL LOUIS, CPA, is an audit manager for the Audit and Business Advisory Services Group at Haskell & White LLP. Reach him at (949) 450-6237 or firstname.lastname@example.org.
All businesses will be affected by AB 32, known as the California Global Warming Solutions Act of 2006, especially with rising electricity and fuel prices. The only unknown is the extent of the fiscal impact and whether efficiencies will offset the increased costs. AB 32 is considered to be the most aggressive mandatory global warming program in the world, so the earlier CEOs develop an understanding of it, the better off they will be.
It is possible to forecast AB 32’s final emission-cutting strategy by reviewing the 2007 ARB (Air Resources Board) draft recommendations, according to John J. Lormon, partner and chair of the Environmental, Land Use and Governmental Affairs Practice Group with Procopio, Cory, Hargreaves & Savitch LLP.
“California intends to publish its final scoping plan to reduce greenhouse gas emissions (GGE) through regulations, market mechanisms and other actions by Jan. 1, 2009,” Lormon says. “CEOs should pay attention because the first draft of the scoping plan was released in June 2008, and the final strategy will be adopted by the end of 2010. The law includes fines up to $1 million for corporations and criminal sanctions of up to one year in jail for individual offenders.”
Smart Business spoke with Lormon about the likely final regulations under AB 32 and what CEOs should do to prepare.
What areas are targeted by AB 32?
AB 32 targets a return to 1990 emissions levels by 2020 (as much as a 30 percent reduction from what the 2020 emissions would otherwise be). There are many AB 32 effects, including the following: increases in electricity, fuel, construction and manufacturing cost; land use and forestry conservation impacts; and consumer lifestyle changes.
What were the early recommendations, and how will they impact energy and fuel?
Electrical utilities must triple their investment in renewable energy sources, and automobile manufacturers will have to produce more efficient light duty vehicles (if the U.S. EPA grants California a waiver), which may cost more to buy but should cost less to operate. Buildings, both new and retrofitted, will have to be more energy efficient, so property and leasehold acquisitions must consider these requirements and costs.
Regulations similar to those required for vehicle smog checks will apply to mobile air conditioning units and make it illegal to self-repair a motor vehicle air conditioning unit. Tire pressure monitoring system will be installed in all vehicles sold in California to increase mileage and reduce emissions.
What recommendations apply to manufacturers?
Appliance manufacturers will be impacted by regulations both directly and through their supply chains. Reduction of ozone-depleting substances used in consumer products will require reformulation of everything from cleaning products to paint and other coating materials; perfluorocarbons emissions in semiconductor manufacturing will be reduced or phased out. Regulation of the cement industry will impact all aspects of the building industry and its customers.
Are there any other recommendations that will impact businesses?
The Governor's Office of Planning and Research (OPR) issued a new technical advisory on the California Environmental Quality Act (CEQA) and Climate Change. All projects subject to CEQA review must consider significant effects caused by GGE. California's clean car standards, goods movement measures, low-carbon fuel requirements and movement of water (which uses 20 percent of the electricity in the state) will all be subject to GGE regulation and price increases.
What should CEOs do to prepare?
Educate yourself. The effects of AB 32 will be significant and broad. AB 32 will change permit and recordkeeping requirements and purchasing decisions and practices; corporate disclosure requirements will be expanded to include GGE; due diligence in mergers and acquisitions will change, as will budget and financial planning. Risk analysis for D&O and CGL insurance should be reviewed for appropriate coverage. CEOs should set up AB 32 news alerts to track new developments and attend science, law and policy workshops to stay informed. The EPA Climate Change Business Guide can be found at: www.epa.gov/partners.
Document baseline emissions. On Jan. 1, 2008, certain large California emission sources were required to report their 1990 baseline emissions. Early action to reduce emissions is great, but to get credit for early action, inventory and document your company’s emission baseline before making improvements or purchasing new equipment.
Take advantage of emerging opportunities. AB 32 will use market-based mechanisms like a cap-and-trade program, where companies can sell emission credits at a market price. So if your company converts its vehicles to natural gas, for instance, you’ll have available credits you can use or sell. Also, new regulation frequently opens the door for new products, services and investments, but CEOs need to be educated to spot these new opportunities.
JOHN J. LORMON is a partner and chair of the Environmental, Land Use and Governmental Affairs Practice Group at Procopio, Cory, Hargreaves & Savitch LLP. Reach him at email@example.com or (619) 515-3217.
Executives are frequently diligent and detailed negotiators when consummating a real estate purchase contract or long-term lease. But even the most thorough owners and tenants do not pay enough attention during the next phase, when construction or tenant improvement contracts need review and approval. Many of these contracts begin as boilerplate documents created by construction-related associations and, unless they are meticulously reviewed and modified, owners may forfeit savings opportunities, sustain cost overruns and assume financial liability for the contractor’s debts.
“Almost invariably, the contract presented to the owner by the contractor is missing fundamental provisions required by law or good construction practices to protect the owner against preventable risks,” says Katherine M. Knudsen, a construction litigation attorney with Procopio, Cory, Hargreaves & Savitch LLP. “If the contract does not provide adequate protection, the owner’s financial liability can quickly grow to hundreds of thousands of dollars due to delays, the contractor’s failure to pay its subcontractors or other situations. To avoid or limit financial loss or liability, owners should address and allocate these risks in the contract.”
Smart Business spoke with Knudsen about how to avoid the hidden pitfalls in construction agreements.
What is the first step in negotiating a construction agreement?
Before contract negotiations begin, owners should check with the California Contractors State License Board to verify the contractor’s history and to make certain the contractor has an active license. Also, an owner should verify that the contractor has adequate insurance coverage, including comprehensive general liability and workers’ compensation, preferably from an A-rated carrier, and verify the contractor’s ability to obtain payment and performance bonds. Further, the owner should check references and investigate the contractor’s qualifications and experience. Next, have a construction attorney review the contract to protect the owner’s interests and to make certain the scope of work, the compensation and the schedule for performance are all spelled out in detail. It is imperative that the contract include a construction schedule identifying completion dates for each phase of the project so the contractor is held to a timeline.
What else should be included in a contract?
Contractors should be required to provide a schedule of values or a budget for the project to help ensure that the contractor stays within the contract price and to guard against overpayment. Further, the contract should provide that the owner may withhold 5 to 10 percent from each progress payment until the work is fully completed and inspected and the time for subcontractors and suppliers to record mechanics’ liens has expired. The contract should also have a clause providing the owner the right to receive timely audits, a full accounting for the project and documentation of expenses if the contractor is being paid based on the cost of the work.
Are indemnification clauses and lien waivers important?
Owners should make certain the contract contains an indemnification clause stating that if the contractor fails to pay its subcontractors or suppliers, fails to keep the property free from liens, or causes injury or damage to persons or property, then the contractor shall indemnify the owner for all claims, lawsuits, losses, attorneys’ fees and costs. In addition, the contract should also contain language requiring the contractor and its sub-contractors and suppliers to execute conditional and unconditional lien waivers and releases before receiving progress payments and final payment, making it less likely that any mechanic’s liens or stop notices will be filed against the property.
How can construction delays be prevented?
The owner may consider including a ‘no damages for delay’ clause to help safeguard against a delay claim the contractor may assert if the project is not completed within the agreed-upon completion time. On the flip side, the owner may want to consider the inclusion of a liquidated damages clause entitling the recovery or withholding of a set amount for each day the project completion is delayed beyond the date set forth in the contract due to the contractor’s fault.
What bonds should be required?
The general contractor should be required to carry payment and/or performance bonds on the project, although the premium for such bonding is customarily borne by the owner. Even with a competent, adequately capitalized contractor and a well-drafted contract, unforeseeable difficulties may arise on a project. Payment and performance bonds offer additional protection to the owner. Generally, a performance bond ensures that the construction of the project will be completed if the contractor is unable to do so and a payment bond ensures that the subcon-tractors and suppliers will be paid if the contractor fails to pay them.
These recommendations are just a fraction of what owners should include in construction contracts. The main thing to remember is that ‘contract due diligence’ should not end when the lease or purchase agreement is signed.
KATHERINE M. KNUDSEN is a construction litigation attorney with Procopio, Cory, Hargreaves & Savitch LLP. Reach her at (619) 515-3206 or firstname.lastname@example.org.