When the news came out July 2 that the Affordable Care Act (ACA) employer mandate — the enforcement of the shared responsibility requirement — would be postponed until 2015, you may have felt relief. But for many large-group employers, it’s not so simple.
“This is not a reason to put your head back in the sand,” says Mark Haegele, director of sales and account management at HealthLink. “Keep your eyes open. See what’s going on. Run some cost benefit analyses of different scenarios of offering different levels of coverage, or not offering. The bulk of the health care reform law is still being implemented on Jan. 1, 2014.”
In fact, Haegele says in some instances it may make sense to follow the employer mandate now, as waiting until 2015 could cause certain problems downstream.
Smart Business spoke with Haegele about what this delay means for business owners and their employees.
What was delayed until January 2015?
The Obama administration announced a one-year delay of the requirement that insurance companies and employers report certain information about health insurance coverage offered to individuals and employees, as well as the employer mandate.
It doesn’t change anything relating to the community rating rules, the individual mandate, the $8 billion sector tax, etc. These provisions are causing employers to explore self-funding, and all are still in play for January.
In what scenario does waiting to follow the employer mandate in 2015 create problems?
Large employers — those with 50 or more employees, according to the legislation — with employees who work 30 to 39 hours who don’t receive insurance face a unique situation. These employers were expecting to either pay a penalty or the need to offer some form of coverage. Many contemplated offering minimum essential coverage plans, or skinny bones plans, that just cover prevention and wellness — no hospitalization.
Let’s say an employer has 300 employees who work 30 to 39 hours and receive no benefits, and with the delay the company doesn’t plan to offer any until 2015. These employees still must have insurance coverage to meet next year’s individual mandate.
Many also are eligible for sliding-scale subsidies on the new health care exchanges — those with an income level 400 percent or lower than the federal poverty level. In 2013, that qualifies any family of four with an annual income of less than $94,200, or $45,960 for an individual.
Fast forward to 2015, a portion of the 300 employees have gone on the exchange and gotten insurance with subsidies. Now, you want to provide pared-down benefits to avoid the employer mandate penalties, which basically strips the employees of their subsidy, possibly increasing their insurance costs and/or decreasing their coverage. This might make it worthwhile to price out minimum essential benefit plans for 2014. Otherwise, employees may believe you did this to them, causing retention problems.
What other concerns does the delay raise?
More Americans will be accessing federal subsidies for health insurance, but the Internal Revenue Service (IRS) won’t be collecting employer mandate penalty revenue, as originally projected. With less money coming in and more going out, it may impact the ACA’s sustainability.
Originally, the ACA required insurance companies and employers to send an informational return to, for example, the IRS. This was meant to help enforce the individual mandate by offering a secondary source about whether individuals are covered by health insurance. With the delay until 2015, there is no way to match up the employer informational returns with the individual tax returns, which may make the individual mandate more difficult to enforce.
So, what are some next steps for business owners?
In addition to considering whether it’s worth offering coverage even though the penalties won’t start until 2015, you still need to implement complicated procedures that measure how many hours variable employees work on average. Companies need to work on their approach even in 2013, as transitional relief going into 2015 is more unlikely after a one-year delay. You’ll want to get it right the first time.
Mark Haegele is director, sales and account management at HealthLink. Reach him at (314) 753-2100 or firstname.lastname@example.org.
Website: Visit www.healthlink.com/key_business_trends.asp to learn more about transparency and other key health care business trends.
Insights Health Care is brought to you by HealthLink
No matter what type or size of a business, health care tends to be one of the leading employer costs. Although the Affordable Care Act (ACA) was intended to reduce costs, businesses are finding themselves on the receiving end of double-digit rate increases each year.
“Because of these hefty increases, employers are searching for more creative ways to reduce costs, while ensuring their benefits package remains competitive in the employment sector,” says Mary Policky, assistant vice president at Momentous Insurance Brokerage, Inc.
Smart Business spoke with Policky about how to reduce or restructure health benefits offerings in tough times.
When should a company consider reducing or restructuring benefits?
First, they should review their policies at the beginning of each fiscal year to determine a budget dedicated to the employee benefit package.
Then, they should do a mid-year plan review, which is also a good time to re-educate employees on important benefits available to them, such as various types of preventative care, which may be covered at no cost to the employee.
Lastly, review policies near open enrollment. Typically, the carrier releases renewal rates 60 to 90 days prior to the plan expiration date. That’s the time to shop around and research opportunities with other carriers, as well as alternate plans with the current carrier.
What’s the first step to figuring out where to make cuts or restructure?
A key factor is determining how much you want to spend. The challenge is how to significantly reduce the premium without sending employees into a tailspin from extreme changes, such as increasing deductibles and copays, which inevitably raise financial concern. Additionally, it’s a good idea to conduct employee surveys to determine their areas of concern, such as office visit copays, in-network doctors, prescription drugs, etc.
It’s also beneficial to have your broker provide benchmark information to see where you are in the industry, and where your competition is. More and more, employees are seeing that medical benefits are a vital part of their total compensation package, and will often consider a reduction in salary if the company offers comprehensive plans.
Generally, what low-hanging fruit can businesses look at first?
In addition to the deductible and copays, they should review the provider network. A company with 30 employees enrolled in an HMO plan typically spends $18,000 per month. By changing to a limited network, the premium reduces to $13,000 a month — a 28 percent savings. You can use disruption reports to gauge how many current doctors are in a new limited network.
Many employers are moving toward consumer-driven plans, such as health savings accounts (HSA) or health reimbursement arrangements (HRA). These plans allow employers to give each employee a fixed dollar amount to choose how they want to spend it on medical expenses. These tax-advantaged plans result in a lower premium and less rich benefits. However, a portion of the premium cost savings can be given back to employees to use for deductibles/copays. Also, with cost decisions in the hands of employees, the onus is on them to make better health decisions.
But it’s not always about reducing benefits. Adding wellness or disease management programs help create a healthier workforce and reduce premium increases.
What’s the best way to communicate to employees?
Employers often underestimate the need for clear communication and making sure that employees truly understand their benefits. Make time for mid-year reviews, webinars, conference calls and/or payroll stuffers. If you must raise rates, inform employees as soon as possible. Also, inform employees how much of the increase the employer is absorbing. A great way to convey this is through benefits statements, which show the total cost of benefits, and how much the employer is contributing.
Health care reform is just one of the many reasons to have a broker help navigate constant changes in the marketplace and tailor a plan to fit the company’s needs.
Mary Policky is an assistant vice president at Momentous Insurance Brokerage, Inc. Reach her at (818) 574-0426 or email@example.com.
Blog: Get more information on employee benefits and other important insurance topics at www.momentousins.com/blog.
Insights Business Insurance is brought to you by Momentous Insurance Brokerage, Inc.
“America likes cheap gasoline,” says Sandra Dunphy, director of Energy Compliance Services at Weaver. “But as much as we want cheap gasoline, we also want clean gasoline and clean air — and they are not necessarily mutually exclusive.”
In the balancing act between the two, Renewable Identification Numbers (RINs), which are attached to gallons of renewable fuel as it is produced, have become very valuable to the oil companies required to own them.
“If you bought 1 million RINs on Jan. 1, it would have cost you about $70,000,” Dunphy says. “Today, that same purchase would cost about $1 million.”
Because there’s so much money in RINs, there’s also the potential for fraud. After a handful of fraud cases rocked the market, the Environmental Protection Agency (EPA) has stepped in with a solution — Quality Assurance Plans (QAPs).
Smart Business spoke with Dunphy about the EPA’s Renewable Fuel Standards program and how QAPs fit in.
How do RINs and the RFS program work?
Congress passed the Energy Independence and Security Act in 2007 to introduce fuels with lower greenhouse gas emissions, reduce dependence on foreign oil, and promote domestic agriculture and employment. This act spawned the EPA’s RFS regulations that encourage biofuels beyond corn ethanol — those made from non-food sources like used cooking oil, wood chips and algae.
Oil refiners and importers of gasoline or diesel are required to own a certain amount of RINs at year-end. The RFS requirements will increase annually from about 16.5 billion gallons in 2013 to about 36 billion gallons by 2022.
Why have RINs become so valuable?
We are hitting the blend wall. When this law passed, Congress anticipated that the volume of gas and diesel we consume would increase each year. But demand has fallen with fuel-efficient vehicles and fewer driving miles, and now there’s nowhere to put additional renewable fuel into the declining gas and diesel pool. Anticipating higher mandated renewable fuel volumes, and a possible shortage of RINs, many oil companies are buying RINs now to use in 2014 — 20 percent of RINs can be carried forward from one year to the next.
Why did the EPA create the QAP program?
Since 2011, a few RIN fraud cases have shaken the market’s foundation and made oil companies nervous about buying renewable fuel or RINs, after the EPA penalized oil companies who used fraudulent RINs for their annual compliance needs. As a result, many oil companies started buying only from the biggest renewable fuel producers who had the ability to replace bad RINs, and small fuel producers suffered.
The QAP program seeks to address the concerns of invalid RINs in the market and tries to level the playing field.
How does the QAP program validate RINs?
There are three options available to a domestic renewable fuel producer or importer with this program. The first option is to maintain the status quo, where oil companies do their own due diligence reviews.
Second, under the QAP-B program, the producer hires an auditor to audit its paperwork and conduct an engineering visit quarterly to ensure the energy and mass going into the plant are equivalent to the energy and mass going out. It reassures those buying the RINs that the producer is doing everything it is supposed to. The oil company has an affirmative defense against EPA penalties if they use a QAP-B RIN for compliance. They just might have to replace bad RINs if the producer cannot.
Another option is the QAP-A program. It’s the same as QAP-B, but the scrutiny is more ongoing. In addition, the auditor must hold an insurance policy. So, if a producer makes an invalid RIN and can’t replace it, the auditor is responsible.
What’s the timeline for the QAP?
The EPA has not issued the program’s final regulations. That is likely to happen in the third or fourth quarter of this year and become effective beginning in 2014. However, the EPA is encouraging producers to get started now. A renewable fuel producer’s purchasers will probably dictate what type of QAP the producer will need, if any.
Sandra Dunphy is director of Energy Compliance Services at Weaver. Reach her at (832) 320-3218 or firstname.lastname@example.org.
Follow up: Weaver has been pre-approved to perform U.S. EPA RFS Quality Assurance Plan audits. Contact Sandra Dunphy if you’re a domestic producer or importer of renewable fuel and would like to learn more.
Insights Accounting is brought to you by Weaver
Estate planning is more than just having documents. It needs to be tied to long-term intent and aligned with your goals. What works for one person may not work well for the next, and what worked 10 years ago may not work now.
Geoffrey M. Zimmerman, CFP® practitioner, senior client advisor at Mosaic Financial Partners Inc., says many treat their estate plan like a transaction, even though the moving parts may have changed.
“They may have a document that is doing things to them and to their beneficiaries, and not really working well for them,” he says. “That’s why it’s important to review the plan periodically. It might take a visit to your attorney and the cost of several hours of time to update it. But in terms of relieving the headache on a surviving spouse or beneficiaries, those can be dollars well spent.”
Smart Business spoke with Zimmerman about why your estate plan should be continually adjusted.
What recent changes make updating your estate plan important?
Although the estate tax exemption did not reset as many feared, there are new items to consider. Undistributed income from an irrevocable trust can reach the top federal income tax bracket of 39.6 percent plus the Medicare tax of 3.8 percent after only $11,950. Those trusts can also see capital gains rates increase from 15 to 20 percent. This might impact a surviving spouse with capital gains assets in a credit shelter trust (also called a bypass trust) and assets in a marital trust.
How could outdated plans create problems?
In 1996, a couple with a $3 million estate would typically use a bypass trust to allow both spouses to use their respective $600,000 exemption to non-spouse beneficiaries, effectively allowing $1.2 million to pass to heirs free of estate tax. The remaining $1.8 million — plus any additional growth — was taxed at the death of the surviving spouse at rates up to 55 percent. A common planning strategy at the death of the first spouse was to put growth assets into the trust, as there would be no estate taxes on those assets. Heirs would still pay capital gains taxes, but capital gains taxes were (and still are) lower than estate taxes.
Today, the estate tax exemption has increased to $5.25 million per person. In our example above, the surviving spouse’s estate of $2.4 million worth of property could more than double before reaching $5.25 million and triggering any estate taxes.
Also, with the new laws, there is a now a new feature called ‘portability,’ which allows the surviving spouse to use the deceased spouse’s unused exemption amount. So in theory, a surviving spouse could pass up to $10.5 million worth of assets to heirs free of estate tax without using a bypass trust.
Older trusts that call for the creation and funding of a bypass trust may incur other unintended consequences. For example, formulas that call for funding the bypass trust to the maximum amount available without triggering an estate tax could leave the surviving spouse at a disadvantage with little or no assets in the survivors trust. Subtrusts that contain highly restrictive conditions for distributions to the survivor can create further complications. Finally, estates that contain large amounts of illiquid assets that would need to be split between multiple trusts may also be problematic. Periodic reviews, including a flowchart to understand what assets are going where, may be particularly helpful.
Also, as mentioned earlier, undistributed income in the bypass trust can hit top tax rates at very low levels of income, whereas the surviving spouse may not reach top tax brackets until he or she reaches $400,000 in taxable income.
Does this mean subtrusts are no longer useful?
They are still useful in cases where control over the disposition of assets is important, such as preventing a surviving spouse from disinheriting children from a previous marriage. You must balance the need for control against the surviving spouse’s needs, and your goals for your non-spouse beneficiaries. The surviving spouse and beneficiaries may have different interests — income versus growth. Proper planning, which includes a good understanding of goals and motivations, can help improve the odds of a successful outcome.
Geoffrey M. Zimmerman, CFP® practitioner, senior client advisor, at Mosaic Financial Partners Inc. Reach him at (415) 788-1952 or Geoff@MosaicFP.com.
Zimmerman, CFP® practitioner and senior client advisor for Mosaic Financial Partners Inc. serves affluent individuals and families. A complimentary consultation is available upon request.
Insights Wealth Management & Finance is brought to you by Mosaic Financial Partners Inc.
A company’s liquidity and cash needs are like a river. The short-term immediate needs flow pretty fast as cash moves in and out of the business. But the further you go down in the water — down to cash that’s only needed for a rainy day — the slower it moves. In fact, it can be too idle.
“Often, there is this big pool of excess cash for the off chance they need liquidity,” says John Whiting, CFP, principal at Moss Adams Wealth Advisors. “But what they give up in that scenario, by keeping that money highly liquid, is less yield and return on those dollars. It can grow to be a fairly significant amount of money that potentially, year-after-year, is pooling up in unproductive ways.”
Smart Business spoke with Whiting about maximizing your business’s treasury management to make assets as productive as possible.
Why is treasury management critical?
Treasury management is the strategic management of a company’s working capital and excess liquidity. By maximizing this, given the specific business needs, the company is more competitive with better earning potential through properly deployed assets.
Today, businesses have accumulated a lot of cash and may not deploy those assets with the economic uncertainty. Even in this low-yield environment, companies that have built cash over the past three to five years could be getting an extra 20 to 30 basis points. And by deploying excess liquidity, you not only can get an extra return, but also, with low interest rates, can use working capital lines to address unexpected needs.
Why do treasury functions not get the same scrutiny as inventory control, capital budgeting and accounts receivable?
It can be an afterthought, as it may initially start so small it doesn’t feel like it warrants a lot of attention. Typically, a controller or CFO is charged with making sure the liquid assets are positioned, but there isn’t anything defining the objective.
What’s a better approach?
You need to be disciplined, looking out over the horizon and anticipating company cash needs to a better extent.
The business should have a written investment policy statement that defines expectations and is used to segment liquid assets into different buckets based on the time horizon for the business’s needs. The statement also would say exactly what investments are appropriate for each bucket, including the necessary credit quality.
Further, the investment policy statement should help set up controls to monitor risk.
How should the guidelines for how funds are invested be structured?
Start with assessing the risk and the needs of the company. Then, look at the next business cycle or more to see possible cash flow needs. You can time assets to ensure the liquidity is there when you need it.
Let’s say, a business is sitting on $10 million in liquid assets and is anticipating either an acquisition or significant capital improvements that might take $3 million or $4 million of that in 18 months or two years. Understanding that allows you to position the assets by buying municipal bonds or high-quality corporate fixed income that would mature three months before the assets might be needed. Now, you’re getting the best and highest yield possible, given that expected need.
What’s important to know about monitoring these treasury functions?
It’s important to understand the real return on investments by having a reporting mechanism, which then determines your success. For example, many CFOs or controllers use multiple financial institutions in order to mitigate risk. However, they need to aggregate all of the information to really assess and score the overall management process.
The cost of management is not terribly opaque, even with the effort to create more transparency. With fixed income, you need an understanding of who is negotiating on your behalf and how are they going about procuring that fixed income for you.
Half the battle is asking the questions and getting straight answers. An outside adviser is often the best management choice, but be sure to have an open discussion about the fee structure and associated costs. In fact, it can be a line item on your investment report because understanding the real cost of managing assets is key.
John Whiting, CFP® is a principal at Moss Adams Wealth Advisors. Reach him at (707) 535-4167 or email@example.com.
Insights Accounting & Consulting is brought to you by Moss Adams LLP.
Even in this recovering economy, businesses are trying to do more with less. While managing existing processes can enable flexibility for the ups and downs of business, incorporating software could alleviate pain points, improve productivity and save money.
“The big question is, ‘How do I improve what I do with my customers, my vendors or my employees?’” says Curtis Verhoff, systems integrations and applications manager at Blue Technologies. “Those are the big three, and every organization is like that — whether it’s somebody who sells widgets, provides professional services or is trying to find donors and support.”
Smart Business spoke with Verhoff about utilizing software to improve a range of business functions.
What are some examples of optimizing your software resources?
These software solutions often deal with enterprise content or customer relationship management, but they also can be transactional, such as helping handle invoices, statements, packing slips or the documents you use daily to communicate with customers. One business recently optimized its existing systems to reduce raw postage costs, saving anywhere from $4,000 to $5,000, or 20 percent, each month.
Two other organizations increased productivity by improving payment management. By adding to its software and adjusting existing systems, one company took better advantage of pricing discounts by paying vendors earlier. The other business tweaked the integration of its current system, getting its elite group of customers to pay on average five to seven days faster, which improved cash flow.
What can maximizing your software integration mean for your business?
In this economy, it’s critical to look at the level of success you’re having integrating your current software products. All businesses have to work harder to maintain their current customer loyalty, while trying to attract new customers. You must be more productive with the same or fewer employees.
Your competitors are already working to be productive and more customer friendly — you don’t want to be left behind. You need to provide advantages to your customers to separate yourself. Highlighting your software solutions through marketing can give your customers an indication of how it will make doing business with you more pleasant and reliable.
How can you discover if you have problems with existing software?
What complaints do you hear from your current staff about being more productive, servicing customers better or doing day-to-day activities more efficiently? Is each department running at peak efficiency? Where is your business not functioning at optimal capacity? If you’ve integrated certain solutions, then what’s the ROI and are you happy with that?
If you’re not hearing about problems, check with your managers. Some managers don’t take problems to the top until they reach critical mass.
Once you’ve spotted the pain, what’s next?
First, identify and pull together people to discuss the fine details of the problem. You don’t need to connect all the dots, just get a solid understanding. Develop a game plan that focuses on the most painful areas that, if resolved, can produce the biggest gain.
Many companies put together a laundry list, and then don’t move forward, fearing the cost and scope. However, if you prioritize the most critical items, you might be able to resolve the few problems that are causing most of the pain.
Then, reach out to a provider with the skills and abilities, as well as the offerings, to help you overcome your top challenges. It’s important for all parties to keep the larger list in mind because it could affect the software solution decision. Each resolution is a piece of the puzzle, and you want to avoid having to revisit it later once you’ve moved on.
Curtis Verhoff is a systems integrations and applications manager at Blue Technologies. Reach him at (216) 271-4800, ext. 2251 or cverhoff@BTOhio.com.
Save the date: Discover how your office technology can connect your business at our Aug. 20 Synergy Showcase. Meet us at the Q to see for yourself. Visit http://bit.ly/12PbQOd for details.
Insights Technology is brought to you by Blue Technologies
Many retirement plan sponsors don’t realize the significance of breaching their fiduciary responsibilities.
“Being a plan sponsor should not be taken lightly, and being a fiduciary especially should not be taken lightly. There can be, and have been, severe consequences for breach of fiduciary obligations,” says Rob Martin, ERPA, QPA, Senior Team Manager at Tegrit Group. “So, take them seriously and find sound professionals and service providers to guide you.”
Even though the company is sponsoring the plan, a fiduciary is a named individual. Therefore, with very egregious errors, the personal assets of the individual fiduciary could be at risk.
Smart Business spoke with Martin about handling fiduciary obligations.
What fiduciary obligations are retirement plan sponsors responsible for?
The fiduciary obligations are to look out for the best interests of the plan participants and to put their needs before any personal or employer needs. The plan sponsor must have a written investment policy statement that includes how the selection of fund offerings and service providers are made.
If one of the funds has a bad year, it doesn’t necessarily mean the sponsor didn’t do its job. As long as the process is in place to select that fund beforehand — a process that compares past history with benchmarks and other funds in that same category — then there will be no problems from a Department of Labor (DOL) standpoint.
What can happen if sponsors fail to meet their fiduciary obligations?
The DOL has made a point of emphasizing fiduciary obligations when it comes to auditing retirement plans. The DOL audits can occur randomly or if there’s been a complaint against the company.
If a DOL audit finds problems, the sponsor will need to correct them quickly. For egregious errors, the DOL will hold the fiduciary in violation and go through the legal system. Even if a fiduciary is found in good standing, it takes extra work and time, including possibly paying service providers, to find needed items.
Civil lawsuits are another danger if you’re not following DOL guidelines.
How should these obligations be managed?
One of the best places to find information is on the DOL’s Web page: Meeting Your Fiduciary Responsibility, www.dol.gov/ebsa/publications/fiduciaryresponsibility.html. Plan sponsors should call third-party investment administrators or investment advisors for further assistance.
Sponsors need to answer participant questions in a timely manner. Otherwise, participants may file a DOL complaint and/or lawsuit. Once a suit is filed, fiduciaries will have legal fees and face the consequences of the case’s outcome.
Plan sponsors should also have a default account, known as a Qualified Default Investment Alternative (QDIA). A QDIA protects the fiduciaries from participants who do not make an investment election or who fall short in making a full investment election.
What is the biggest hot button area to keep an eye on, as a fiduciary?
The hot button area right now is fees. Part of being a fiduciary is to provide the new fee disclosure notice to the participants. This started in 2012 and now must be provided annually or quarterly to the participants, depending on what’s being disclosed.
Another important fiduciary responsibility is making sure plans have reasonable plan expenses. The plan sponsor should have a process, as part of the investment policy statement, to examine service providers and see whether it pays reasonable plan expenses, by utilizing professionals who provide benchmarks for comparison.
Do late deposits remain a concern?
The DOL is still pursing this. These typically apply to making timely participant contributions and loan repayments — not employer contribution deposits. More specifically, for plans with fewer than 100 participants, the DOL considers timely to be within seven business days.
With all fiduciary obligations, the key is choosing professionals with a good understanding of the requirements, which can be investment advisors, third-party administrators or record keepers.
Rob Martin, ERPA, QPA is a Senior Team Manager at Tegrit Group. Reach him at (614) 458-2023 or firstname.lastname@example.org.
For additional retirement planning tips, visit Tegrit’s Advisor Resource Center at www.tegritgroup.com/arc.
Insights Retirement Planning Services is brought to you by Tegrit Group
Private equity firms use pools of capital that are raised from a variety of sources. This capital comes not only from wealthy individuals, but also from insurance companies (that pay retirement plans and annuities) and pension funds.
As a result, school teachers, police officers and others often have a portion of their retirement assets allocated to private equity, which bolsters the overall investment returns of the fiduciaries that run these funds. These higher returns are increasingly important in today’s low interest rate environment. Private equity firms use this capital to invest in all sorts of companies, creating jobs and economic growth along the way.
“Private equity firms are easily and inaccurately portrayed as corporate pirates,” says Jackie Hopkins, managing director, Sponsor Finance Group, at FirstMerit Bank.
“But these firms are willing to invest in businesses that need capital to grow as well as companies that might go bankrupt if not supported with new capital in exchange for ownership. In order to induce them to accept the risk of these investments, private equity firms need high returns. Sometimes the returns are very large. Sometimes the firms lose their investment. Either way, they provide critical capital that allows the economy to grow.”
Smart Business spoke with Hopkins, who lends to private equity firms, about how these serial entrepreneurs operate.
How does the private equity world work?
Private equity companies use pools of capital from investors, called limited partners. The general partner of the private equity firm is tasked with finding good investment opportunities to generate above average returns. The partner is usually paid operating expenses and a portion of the profits earned. In most cases, the general partner buys a controlling interest in a company with a leveraged buyout (LBO), and uses his or her expertise to improve revenue and profitability, such as helping a Midwest firm expand product sales internationally. After three to seven years, the company is typically resold.
What is a leveraged buyout?
In an LBO, an investor uses debt to finance a portion of the purchase price of a company. Depending on the underlying business risk of the transaction, the amount of debt can be very low or up to 65 percent of the purchase price. Using debt allows the investor to amplify his or her return. In addition, interest costs are deductible while equity capital is not, providing a built-in bias toward debt financing in the capital structure.
The debt to equity ratio changes depending on market conditions — today, the average equity investment for a middle market company is 40 to 45 percent in a LBO. For larger companies, it is usually less, because a bigger company can absorb more financial risk.
How is private equity financing different than traditional middle market bank loans?
Traditional middle market loans focus on the balance sheet —assets, inventory, receivables, equipment, real estate, etc. — so if the company is unable to service its debt out of earnings, the collateral can be sold to repay the debt.
Private equity financing tends to be enterprise value loans, looking at the company’s earnings before interest, taxes, depreciation and amortization (EBITDA). Financial institutions look at selling the entire company as an enterprise for a multiple of EBITDA. They consider how sustainable the EBITDA is to figure out how much debt the company can safely carry. So, if you think the average multiple of a middle market company is six times (that is, its total value is six times its most recent EBITDA), the bank might lend up to three times. The inherent risk is the possibility that EBITDA will decline or that the prospects for the company or the industry lead to a lower multiple. So to qualify for this type of enterprise loan, a company should have a sustainable level of EBITDA that is not too concentrated in terms of customers, products or suppliers, and is not prone to cyclical swings.
Jackie Hopkins is managing director of the Sponsor Finance Group at FirstMerit Bank. Reach her at (312) 429-3618 or email@example.com.
Website: Get information about FirstMerit’s Sponsor Finance Group services.
Insights Banking & Finance is brought to you by FirstMerit Bank
Performance-based compensation is the variable component of total compensation that may be paid to an individual, team or even companywide upon achieving some defined performance metric. For instance, when a salesperson is paid a commission for achieving a sales target, or an annual bonus is distributed after meeting a companywide goal.
“You need some form of performance-based compensation to keep top performers motivated and happy,” says Brian Berning, managing director at SS&G’s Cincinnati office. “They want to believe that they can make as much as they possibly can if they are able to achieve goals. And with a variable component, there’s rarely a ceiling on it.”
Smart Business spoke with Berning about using incentives to benefit both the employee and the company.
How do companies typically pick incentives for performance-based compensation plans?
It’s largely based on defining goals and setting performance benchmarks around them, which can be for an individual, team, companywide or any combination of the three. It’s important to understand that without consequences, positive and negative, it’s not a goal — it’s a wish. The best companies develop incentives with clear, objective and measurable goals, stating exactly how to successfully get to the target.
You also want to target the right people. A shop foreman of a manufacturing company can influence on-time delivery but shouldn’t be tied to goals for meeting sales initiatives.
Which incentives can be problematic?
Those that are difficult to explain, to measure or achieve are prime for failure. Remember you’re trying to reward results that are largely influenced by behaviors in connection with the company’s goals. So, if the incentive is tied to a behavior that the responsible party has no control over, or the performance measurement isn’t in alignment with meeting the desired goals, it simply won’t work. Employees must be able to understand it, measure it and achieve it.
Why is it important to avoid rushing in?
Look at various scenarios and test to make sure that they mathematically work — that they’re achieving your desired goals. There’s nothing more embarrassing than implementing a performance-based incentive structure that doesn’t work.
On a commission-based structure, for example, be careful when trying to reward certain behavior. If you sell two products, product A and product B, and you want to encourage additional product B sales, you may increase B’s commission. But if everyone is focused on selling product B, there could be a loss of sales in product A. It’s better to use minor awards or only change the commission structure minimally, enough to keep people conscious of it, but not enough for them to ignore product A.
So, talk to your staff and others, and make sure the plan is designed properly.
How can awarding equity in a private company be problematic?
There seems to be two situations that prompt a company to look at a plan like this.
1. Senior management thinks that by giving employees ownership, it is going to motivate results. But by giving stock, you haven’t tied that to goals. The award isn’t instantaneous; employees don’t have more cash. As an owner, how is an employee going to behave any differently?
2. The business uses this as a tool to recruit talent when cash flow is tight. It may work, but it can have consequences later if it doesn’t work out with that employee.
There are other options that look and feel like equity, such as contractual arrangements that don’t necessarily result in the award of true stock or units in a partnership.
What should management be doing to measure, review and adjust these plans?
Measure it frequently and pay promptly. Otherwise, people will lose interest in it.
When reviewing or adjusting the plan, that should be far less frequent. If you’re continuously tweaking your plan, you’re going to create confusion. If there’s some anomaly, fix it immediately, but if you’re making wholesale changes right away, you made a mistake and didn’t do your due diligence. A well-defined performance-based compensation plan provides employees with an upside they feel they can achieve that ultimately helps the company.
Brian Berning is managing director at the Cincinnati office of SS&G. Reach him at (513) 587-3270 or BBerning@SSandG.com.
Website: SS&G was named a top workplace in Northeast Ohio.
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Whether to buy or lease is a question real estate professionals hear from business owners all the time. It’s a difficult decision that’s based on several factors.
You should evaluate your needs, as well as your personal and business goals, with a qualified real estate consultant, says Joseph V. Barna, SIOR, principal at CRESCO Real Estate. Also, understand your motivation drivers — are you interested in the bottom-line cost of occupancy, long-term ownership, image or flexibility?
“You need to step back and look at where you’re at, where you want to go, and how important your personal goals on the ownership side are in order to understand the best manner in which to invest your money,” he says.
Smart Business spoke with Barna about what propels owners to buy or lease.
What drives owners to buy?
One example would be if you are in a specialized industry and you’re going to make a significant investment in the space’s infrastructure. You don’t want to be unable to come to terms on a down-the-road lease renewal or expansion and have to reinvest in another building.
Another scenario is that you don’t anticipate long-term future growth and the facility you identify is in a desirable location that meets your projected needs.
Many times, the deciding factor is whether you can buy a building, ‘right.’ If a building can be acquired in the lower range or below market value and/or combined with market-driven incentives, the opportunity is worth serious consideration.
Sometimes it comes back to pride of ownership. In Northeast Ohio, we are fortunate to have a wealth of successful entrepreneurs who want to own their real estate simply for pride or a desired image, even if they have to pay a premium for it.
Why do business owners decide to lease?
One reason would be that your space requirements could fluctuate, so you don’t want to be locked into a building. Often this can be market driven; your business grows when the market’s healthy and contracts when it’s not. Also, many large national or global companies lease space because they don’t want to be in the real estate business and worry about selling a property when they decide to relocate.
You also should look at the return on investment. In real estate, a typical return for a market transaction would be 8 to 13 percent on the property’s value. However, if you have a dynamic business that’s getting a 25 to 30 percent margin on your products, it may be better to put your cash into increasing manufacturing and market share for the higher ROI. In addition, our financial markets have changed over the past five years. In most cases, traditional real estate financing has higher equity requirements, such as 25 to 35 percent down, which could also be a deal killer.
How can a lease-purchase analysis help?
To determine the actual cost of occupancy, bring in a qualified broker or consultant to run a lease versus purchase analysis. On the lease side, you look at your base lease rate, utilities, pass throughs and any other additional costs. On the sale side, you’re weighing your equity requirement, mortgage payment, property upkeep, maintenance, insurance and taxes. The analysis gives you a clear-cut idea of whether you’re better off leasing or buying.
The final decision will not always be the lowest cost alternative, but this analysis will at least let you know where you stand based on the cost of occupancy. Then you can consider other factors, like proximity to your customer base as well as employees, flexibility and personal objectives.
How far out should you start considering whether to lease or buy?
The perfect situation is at least one-and-a-half to two years ahead of when you need to make a decision. You need to understand the current market trends, all of the logical lease and sale alternates and the price of new construction, while projecting where your business will be in five or 10 years combined with personal objectives. You can go into the market and identify the perfect alternative, but it could take a year to consummate a transaction — and even more time if you’re building new, retrofitting or applying for government incentives. If you let that fuse get too short, it limits your alternatives.
Joseph V. Barna, SIOR, is a principal at CRESCO Real Estate. Reach him at (216) 525-1464 or firstname.lastname@example.org.
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