Businesses are successful in part by remaining keenly focused on a core product or service offering. This focus includes allocating management time and cash to support and grow the business. Often companies that own their real estate are able to redeploy these resources for additional growth by executing a sale/leaseback strategy.
“Many companies that own real estate are able to generate substantial proceeds through a sale/leaseback,” says Ben Smith, vice president of Plante Moran CRESA.
In addition to monetizing an owned real estate asset to provide cash flow to reinvest in your core business, sale/leasebacks can allow you to devote more time to your business.
“Being a tenant in your building instead of an owner may shift the responsibility of property management to another party,” he says.
Smart Business spoke with Smith and Josh Lanesky, senior associate at Plante Moran CRESA, about who can benefit from sale/leasebacks and how to approach them.
What is a sale leaseback?
A sale leaseback occurs when a business sells a building that it owns and occupies to an outside investor and subsequently enters into a long-term lease agreement with that investor as part of the transaction.
Once any pre-existing debt on the building is retired, the company is able to utilize the sale proceeds to reinvest in its core business or to meet other financial obligations. While this results in an ongoing lease obligation, the return on investment on redeployed capital can often outweigh this cost.
What are the drawbacks?
Because of the dramatic reduction in real estate values that has occurred since 2008, the existing debt on a building may exceed its market value, even with a lease in place. If this is the case, it is not advisable to perform a sale/leaseback transaction until that debt obligation is reduced. There are also instances, particularly in family-owned businesses, whereby the corporate real estate portfolio is held in a separate entity also controlled by the family. Often, this is considered a separate profit center and is used as an estate planning tool.
What kinds of companies qualify to execute a sale/leaseback?
Companies or other organizations with a strong balance sheet and owned real estate are excellent candidates to enter into a sale/leaseback transaction. It is important to note, however, that to successfully execute this strategy, the company must be willing to enter into a long-term lease with the investor purchasing the building.
At a minimum, the financial and risk metrics of the transaction will not be palatable to an investor unless a lease term of at least 10 years is in place. Effectively, these investors are purchasing a stream of future rental payments, so the investment is analyzed based on the overall risk and stability of that future cash flow. Accordingly, investors seek companies with a healthy balance sheet and a proven operating history. This allows for easier leveraged financing for the investment, and supports investor interest in the transaction.
Finally, sale/leaseback transactions often occur as part of a merger or acquisition transaction. If the purchasing company does not desire to acquire the real estate with the business, it will many times conduct a sale/leaseback transaction concurrently with its acquisition of the business.
Why is now a good time to consider this?
The current state of the capital markets is extremely favorable for investors — interest rates are at historic lows, and this low cost of capital allows investors to earn greater returns on leveraged investments such as real estate.
Additionally, many market analysts expect inflation to occur over the next several years. Deploying capital at low interest rates in stable real estate investments allows investors to ‘hedge’ against inflation and protect returns.
Where can a business turn for assistance with a sale leaseback?
Any organization considering a sale leaseback should consult with an independent, professional real estate adviser to ensure that its interests are represented. Your adviser should have the ability to assess the transaction holistically, understanding the perspective of the investor and providing advice as your fiduciary to ensure that the value of the transaction is maximized and the terms are fair. Utilizing this perspective, your adviser can present the investment to a broad marketplace of potential investors to fully leverage a competitive environment and help you identify and select the best offer.
How can a business initiate the process?
The first step is to consult a professional real estate adviser who can help identify the parameters of the transaction and the potential value that could be generated by the sale/leaseback. Together, you can determine the value and impact of the transaction to your business and define the best path forward and implementation strategy. Your adviser will help you gather and review the due diligence items required for the transaction, including financial statements, environmental reports, surveys, historic operating expenses, maintenance records and title work. These items are crucial for investors to review when determining the risk and return associated with doing the deal.
How long does a transaction take to close?
The timing can vary, but typically there is a defined marketing period for the investment, followed by a ‘call to offers.’ This can last from 30 to 60 days. Once offers are reviewed and one is chosen, the investor will require additional time to review due diligence items and arrange financing. This period could be up to 90 days. Once that is complete, if the investor opts to move forward with closing, the transaction should be complete within 30 days.
Ben Smith is vice president of Plante Moran CRESA. Reach him at (248) 223-3275, email@example.com or visit www.pmcresa.com. Josh Lanesky is a senior associate with Plante Moran CRESA. Reach him at (248) 603-5092 or firstname.lastname@example.org.
Insights Real Estate is brought to you by Plante Moran CRESA
Strategic and financial buyers have different characteristics when purchasing a business, and as a seller, dealing with each has its advantages and disadvantages.
The current deal environment is very robust, and financial buyers have raised a lot of private equity dollars that couldn’t be fully deployed when the economic downturn hit. That money is still out there and now financial buyers are under pressure to put it to work.
In addition, strategic buyers are sitting on record amounts of investable cash, much of which is earmarked for acquisitions, says Kevin W. Bader, an associate at MelCap Partners, LLC.
“It’s a really good time to be a seller,” says Bader. “And if you’re looking to maximize your chances of success in a sale, you want to reach out to both types of buyers.”
Smart Business spoke with Bader about the differences between strategic and financial buyers and how each approaches buying a business.
What is a financial buyer?
A financial buyer is typically what you think of when you hear the term ‘private equity.’ Financial buyers are institutional investors who pool their money together to grow through acquisitions. They raise a fund that typically has a 10-year life put together for the purpose of investing in a portfolio of companies.
The first five years is typically the investing stage, in which they make several investments to establish or supplement the portfolio. They’ll then grow those businesses by bringing in resources such as alternate sources of capital, improved financial disciplines, or increased operating efficiencies.
The second five years is the ‘harvest’ phase, in which they hopefully have a larger and more profitable business to sell to another private equity group or to a strategic buyer who sees value in the company.
Financial buyers typically maximize their returns by leveraging the assets of the companies they acquire, which minimizes the amount of equity investors have to put in at the outset.
Many times in a leveraged buyout, financial buyers will require that they have a controlling stake in the business. However, there’s often an opportunity for the seller to co-invest back into the new business alongside the buyers, in effect rolling over some of the equity. If the investment is successful, the seller has a portion, usually a minority stake, which gets sold down the road. We call this a ‘second bite at the apple,’ and it can be a very powerful wealth creation opportunity for the seller.
What is a strategic buyer?
Unlike financial buyers, strategic buyers are not in business solely to buy other businesses. Instead, they can often operate in a similar industry, or in the same industry, as a selling company. Their mandate is to grow the business by acquisition if it makes sense, but they also have a core business to run.
Because of the business cycle we’ve just come through, operations are typically getting better across the board and strategic buyers are doing better with fewer resources. We’re seeing that strategic buyers are being very active in M&A because of the excess cash they have on their balance sheets and the pressure they have to show a return on that cash for their shareholders.
Strategic buyers create value by realizing synergies through acquisitions because of their similarities with the target and the ability to eliminate redundant functions. Sometimes this can mean they’ll pay a higher price than a financial buyer will, but this is not always the case. Often, strategic buyers use less leverage than a financial buyer, which can create a cleaner and quicker deal for the seller. In addition, a strategic buyer will typically hold the business indefinitely, so there’s no pressure to sell in five to seven years.
It’s possible that the new company, beyond a transition period, would employ the seller, but there’s definitely a change of control and the seller may have concerns over what happens to its employees. Depending on the synergies and the overlap with a strategic buyer, there can sometimes be less of a need for the company’s employees, as opposed to a financial buyer.
Why would businesses choose one type of buyer over the other?
One consideration is confidentiality, another is the speed of the deal. Regarding confidentiality, strategic buyers can often be from the same small industry and there could be concern over word getting out about the sale prematurely. However, confidentiality agreements can cover those risks.
With regard to speed, strategic buyers — if they’re big enough or have enough cash on their balance sheet — may be able to close more quickly because they may not need a bank to get a deal done. However, strategic buyers might need a little more hand holding to keep them moving along in the sales process because they also have a business to run and don’t solely focus on acquiring companies.
From a sale standpoint, reaching out to both types of buyers allows you to cast the widest net possible in order to identify the best buyer for you and your business.
Kevin W. Bader is an associate at MelCap Partners, LLC. Reach him at (330) 239-1990 or email@example.com.
Insights Mergers & Acquisitions is brought to you by MelCap
Corporate policyholders often spend significant sums on insurance coverage to protect themselves against loss or injury. These policies are important assets and policyholders should be mindful of ways to protect and maximize them, particularly when an insurer has denied a claim or reserved its rights to deny a claim, says Amanda M. Leffler, partner with Brouse McDowell.
“There are fundamental principles of Ohio law that favor policyholders,” says Leffler. “Policyholders have the ability to use these principles to negotiate favorable outcomes with their insurance companies and often have more leverage than they think they do.”
Smart Business spoke with Leffler about the leverage you have as a policyholder and how to use it to your advantage.
What are the defense rights of policyholders?
Policyholders have some fundamental rights with respect to any defense provided by their insurance company, the first of which is the ability to choose and control their counsel when the insurer has reserved its rights. Many third-party insurance policies say they will pay for defense costs for policyholders if they are the subject of a suit. The right to defense costs is significant and can operate as leverage in a dispute with an insurer.
Many insurance companies attempt to impose upon their policyholders counsel of the company’s choosing, and policyholders frequently don’t want to use that counsel because they don’t feel those attorneys have their best interests at heart. When there is a reservation of rights, the insurer cannot control the litigation and can’t mandate the counsel that will act on behalf of the policyholder.
What are policyholders’ defense rights regarding multiple claims?
In Ohio, the insurer must defend all claims pled in the suit, even if they are unrelated to coverage. If a complaint sets forth multiple claims, but only one of those triggers coverage, the insurer must pay all defense costs and cannot require the policyholder to contribute unless the policy states otherwise.
Also, insurers in Ohio are not permitted to recover defense costs paid, even if the claim is ultimately not to be covered. For example, if a policyholder were sued for both negligence and intentional conduct, the claim for negligence would likely be covered, but the claim for the intentional tort would likely not be covered. Nonetheless, the insurer must defend the entire case. If the policyholder were ultimately held liable for only the intentional tort claim, the insurer would not have to indemnify the policyholder for the damages for which it was liable. The insurer, however, could not recover its defense costs, even though the claim was not covered by the indemnity provisions of the policy.
What is important to understand about the interpretation of insurance policies?
Insurance policies are contracts, and most disputes between insurers and policyholders present claims for breach-of-contract. Actions for breach of insurance contracts differ from other breach-of-contract actions in certain respects. Significantly, courts in these actions apply rules of contract interpretation that strongly favor policyholders, which provides leverage to policyholders in disputes with their insurers.
Where provisions of an insurance contract could have more than one interpretation, courts will adopt the interpretation that favors the insured. The test applied in determining whether there is ambiguity is not what the insurer intended its words to mean, but what a reasonably prudent person applying for insurance would have understood. Under such circumstances, any reasonable construction that results in coverage of the insured must be adopted by the trial court.
The burden is always on the insurer to prove the language of an exclusion bars a particular claim. Moreover, for a court to apply an exclusion to bar coverage, it must be clear and explicitly stated.
When must an insurer provide a defense for a claim?
An insurer’s duty to defend is distinct from and broader than its duty to indemnify. A liability carrier has the duty to defend its policyholder whenever the allegations against the policyholder arguably or potentially state a claim within the coverage of the policy.
Where the insurer’s duty to defend is not apparent from the pleadings in the action against the insured, but the allegations do state a claim which is potentially or arguably within the policy coverage, or there is some doubt as to whether a theory of recovery within the policy has been pleaded, the insurer must accept the defense of the claim.
What types of damages can a policyholder recover from its insurer?
This is a significant leverage point in Ohio because damages go beyond what you would typically think of being able to recover as compensatory damages. In insurance coverage matters, if you win, you can be made completely whole.
If policyholders are required to litigate with their insurer, they can expect to obtain damages that include the amount the policyholder had to pay to settle the claim, the amount the policyholder had to pay to satisfy a judgment against it that should have been covered, and, if the insurer refused to defend the action, the reasonable and necessary cost incurred to investigate and defend the underlying claim.
Policyholders may not be aware they will also be awarded attorneys’ fees if they win a breach-of-contract case. The Ohio Supreme Court has made it clear that the state recognizes an exception to the American Rule to permit policyholders to recover attorneys’ fees when they must litigate with their insurers to enforce policy rights. The rationale is that the insured must be put in a position as good as that which it would have occupied if the insurer had performed its duty. This does not require the policyholder to demonstrate any impropriety on the insurer’s part, and these coverage case attorneys’ fees can be a significant component of a damages award.
Amanda M. Leffler is a partner with Brouse McDowell, L.P.A. Reach her at (330) 535-5711 or firstname.lastname@example.org.
Insights Legal Affairs is brought to you by Brouse McDowell
There are basic elements of marketing a commercial property that may make it seem simple, such as putting sign in front of the property. However, there are many dimensions to a marketing program that inexperienced sellers might not realize.
“You can’t sell real estate like somebody might sell shoes at Nordstrom,” says Terry Coyne, SIOR, CCIM, an executive vice president with Grubb & Ellis. “You can’t create demand. Either people have a need or they don’t, and if they don’t, then there’s nothing you can do about it.”
An owner can be as involved as he or she wants to be in the marketing of a property, and clearly, the more attention paid to detail the better. But by utilizing a broker, an owner will likely get more money on the sale, sell a property faster and be relieved of a lot of stress.
Smart Business spoke with Coyne about what to consider when putting a commercial property on the market.
What are the basic components of marketing a commercial property?
The aspects of marketing a commercial property include a sign in front of the property and postcard mailings that utilize a mailing list that’s well thought out. Sellers should ask their brokers how they arrive at their mailing list. Do they clean them out, use a mailing list service or are they buying a list and throwing postcards out there? Also, make sure that, as an owner, you’re on the mailing list, so every time something goes out, you’re getting a copy.
Other marketing components are print advertising, whether in newspaper or magazines, and online marketing. With a website, you’re getting immediate coverage that extends to the region and across the country. These websites might have virtual tours, one-click scheduling of site tours and an online offer option.
It’s also easy to measure traffic because you can ask a broker how many visitors his or her website gets, how long visitors are staying, where are they coming from and what are they looking at. Also ask your broker about his or her experience in getting people to follow through on their Web visits.
While it is common for people not to have building plans and site plans, it’s a critical component of marketing. When you’re looking to pay million of dollars on a property, you’d like to know the actual size of the building. A broker can get a fire exit drawing of the building, along with other measurements, and send them to a company that will then turn that into a CAD drawing in about a day and at a low cost. Typically these costs are covered by the broker.
What should sellers keep in mind when choosing a broker?
Oftentimes, people will choose a broker based on the broker’s knowledge of a specific market, but they don’t usually look at the person’s process. So before you hire someone who is the king of a small market, see if that person has a proven process. Ask a broker what steps he or she takes when selling a property. You’ll also want references and examples of similar types of properties that person has sold.
It’s critical that the broker marketing the property is there when the property is being shown because he or she might hear someone say, ‘I don’t like this building because it doesn’t have X’ when, in fact, it does. The seller has got to make sure the broker is at every showing.
What elements of a commercial property should be listed?
List as much as you can because you never know what someone is looking for. A good example is a stamping plant that was sold because it’s on bedrock. Who knew that sitting on bedrock would be a selling point? The more you know about a building and the more you can list, the better.
Another thing to consider is that a commercial building always sells better empty. Owners should do as much as they can to clean it, from getting a compressor and cleaning the ceiling to getting a floor scrubber and making the floors shine to painting the walls.
If you want to move the property up in the line of interest, the cleaner the building is, the better. However, that’s something the seller will have to pay for.
Could building owners market and sell a commercial property on their own?
They could, but it’s hard without a broker to buffer emotions. You can say things to a broker that can be then filtered in a way that is unemotional, but if you say it directly to the seller, it could blow a deal up. Brokers understand how to work their way through the emotional part of a transaction.
What are some common mistakes owners make when selling?
One is that they misprice the property. It’s hard to get good, comparable sale information on commercial property. The assets are very different, so it’s hard for someone who’s not in the industry. Go to a commercial appraiser with an MAI designation from the Appraisal Institute and pay for a formal appraisal.
Another mistake is not making it clear whether they’re willing to work with a broker. If they market it themselves and say ‘brokers protected’ or ‘brokers welcome,’ they could get brokers showing up and saying, ‘Hey, I’ve got a buyer.’ But if you’ve mispriced it and you have no clarification on brokers, then you’re wiping out a big part of your market. In the event that a broker approaches the seller with a buyer, the seller signs a commission agreement specific to that buyer.
Terry Coyne, SIOR, CCIM, is an executive vice president with Grubb & Ellis. Reach him at (216) 453-3001 or email@example.com.
Insights Real Estate is brought to you by Grubb & Ellis
The U.S. government views export control laws and regulations as serving a critical function in safeguarding national security and promoting foreign policy interests of the U.S.
“The regulatory regimes have imposed very significant penalties on certain companies and individuals for export control violations, so given the nature of how trade is conducted, and the threat of terrorism, there definitely seems to be greater scrutiny by regulators,” says Aneezal Mohamed, of counsel with Kegler, Brown, Hill & Ritter.
Smart Business spoke with Mohamed about how to ensure you are complying with export control laws.
Why should a company be concerned about export control laws?
Penalties for noncompliance could be very severe and hinge on how pervasive the noncompliance and violations are, whether the exporter has self-reported violations, etc. Penalties could include seizure of export and import shipments, criminal and civil penalties, appointment of a special compliance officer, debarment from exporting and employment ramifications.
Who administers the export control laws and who is subject to it?
Several agencies are involved, including the Department of State Directorate of Defense Trade Controls (DDTC), which administers the International Traffic in Arms Regulations (ITAR) and the Arms Export Control Act that control items considered defense articles and services; the Department of Commerce Bureau of Industry and Security, which administers the Export Administration Regulations (EAR) that control dual use technologies; the Department of Energy; U.S. Customs and Border Protection; and the Bureau of Census.
Every ‘U.S. person’ must comply with export control laws and regulations. All U.S. individuals and companies, and green card holders are considered U.S. persons under these laws.
What type of registration is required under ITAR?
Under ITAR, if you manufacture or export defense articles, you have to register with the DDTC. The annual registration fee ranges from $2,250 to $2,750. Disclosures required by the registration statement are technical and detailed, so getting expert counsel to help would be in your best interest. If you’re exporting defense articles or services, you’ll need licensing and approval from the DDTC.
What is the meaning of ‘export?’
Exporting is not only transmitting something outside of the U.S. If someone who is not a U.S. citizen or a green card holder is employed in your U.S. office and views controlled information, you have exported that controlled information to that individual’s country of citizenship; it’s called a ‘deemed export,’ and it is a violation of export control laws.
Exporting also includes sending or taking defense articles outside the U.S.; transferring ownership or control to a foreign person; transferring or disclosing technical data to a foreign person inside or outside the U.S.; and performing a defense service for a foreign person inside or outside the U.S.
What defense articles and services are controlled under ITAR?
Defense articles are any article or service specifically designed, developed, configured, adopted or modified for a military application.
Defense service means furnishing training and assistance in the U.S., or outside the U.S., for the design, development, engineering, manufacture, production, assembly, testing, repair, maintenance, modification, operation, demilitarization, destruction, processing or use of defense articles.
What articles and technical data are subject to ITAR and EAR regulations?
The U.S. Munitions List contains all defense articles subject to control under ITAR. There are 22 categories that are broadly interpreted by the DDTC. Technical data is information required for the design, development, production, manufacture, assembly, operation, repair, testing, maintenance or modification of defense articles, and software for defense articles.
EAR controls dual use items such as those with primarily commercial uses that also have military applications.
Is it critical to determine if an item is controlled under EAR or ITAR?
Yes. Making the right determination is critical because if you incorrectly classify your item as being controlled by EAR and it is actually an ITAR controlled item, then you face disclosure, penalty and other sanctions. In the reverse case, you have created unnecessary work and an administrative burden.
What steps need to be taken before exporting?
The significant steps are classifying items as ITAR or EAR controlled; verifying if a license is required to export your item to the target country; verifying that no prohibited end-users (countries, groups, individuals, etc.) are involved with the export transaction; verifying that no prohibited end uses (intended purposes) are involved with the export transaction; if a license is required, determining if there are exceptions; and if no exceptions are available for your transaction, filing for and obtaining the appropriate license before exporting.
Are export control laws complex?
Export control laws are complex, but that is why you hire experts. If done right, they offer significant benefits. If done wrong, the penalties for noncompliance could be costly for the company and for individuals. It is best not to have to defend yourself from charges of jeopardizing U.S. national security and foreign policy interests.
Aneezal H. Mohamed is Of Counsel with Kegler, Brown, Hill & Ritter. Reach him at (614) 462-5476 or firstname.lastname@example.org.
Insights Legal Affairs is brought to you by Kegler, Brown, Hill & Ritter Co., LPA
Determining how much credit your business can obtain or should have can seem like a complicated endeavor for businesses. However, your banker can simplify the process and help you determine that figure, says Stephen Klumb, senior vice president and chief lending officer, National Bank & Trust.
“A line of credit is a commitment by a bank to a borrower to advance short-term money, working capital or receivables financing over a specified period of time for short-term working needs,” says Klumb. “And that line of credit can be estimated through a fairly simple formula.”
Smart Business spoke with Klumb about how to work with your banker to determine your line of credit and how to identify the right banker to help you through the process.
How can a business determine what its line of credit should be?
Take your total estimated annual gross revenue (sales) and divide by 365. That gives you your daily cash need. Next, determine your total number of accounts receivable, plus inventory days on hand (Use of Funds) and subtract your accounts payable days on hand (Source of Funds), and this is your usage. Multiply your daily cash need times the usage (accounts receivable days less accounts payable days) and you will get the estimated line of credit needed for your business.
Sales ............... $9,125,000/365 = $25,000 (daily cash need)
Accounts Receivable days on hand ............. 68 days (usage of cash)
Add Inventory days on hand .................... + 30 days (usage of cash)
........................................................................98 days (usage)
Less Accounts Payable days on hand ........ - 52 days (source of cash)
Multiply by usage ................................ x $25,000 (daily cash need)
..........................................................$1,150,000 (estimated need)
Your company estimated line of credit need is now known ($1,150,000 in the example) and that number sets the tone for discussion in terms of the amount of money you need in working capital to operate your business.
Is this number a moving target?
Generally, it’s a one-year commitment. Most customers do an annual projection, but if, for example, the business picked up a new contract or lost an existing contract, then it would become a point of discussion. A new contract could require an adjustment to the working capital needs. However, the number is not always a moving target. You might instead do a guidance line, which is a little extra during a period of time that eventually comes back to the normal operating line.
Is there such a thing as too much credit?
Absolutely. Too much credit, when not monitored, could become a problem if you’re allowing your receivables to go out too far. Talk to your bank about what your peer group average receivable days are and to get perspective on where you fall within that group. If your receivables are coming in later than those of your peer group, a good bank would recommend that you address your internal collection process to get your receivables in more quickly; otherwise, you’re borrowing money and the additional credit is taking up profits.
How do banks determine what credit line they’re willing to extend?
Because they’re giving you a line of credit to operate, they need to know your liquidity, so they’re going to use a current ratio. Current ratio is determined by taking current assets minus current liabilities, or a quick ratio, those assets that can be easily turned within a short period of time to produce cash.
Sometimes a line of credit will be established, but if it never goes to zero during a 12-month cycle ,you might lower your line and make a portion of it term debt to get back in balance between term debt and line of credit debt.
What can a company do to set itself up for a line of credit?
The best way to do it is to be on top of your accounts receivable aging report. Monitoring your accounts receivable for payment and having those reports available lets the banker know you are aware of where your receivables are. Having receivables crawl into 90 days could affect your operating line and won’t be counted as collateral.
What are some common mistakes businesses make when applying for a line of credit?
Not having their controller or accountant in meetings with their bankers. When you’re talking to a banker and he’s asking specifics, having the people there who know the answers makes the banker feel more comfortable. Meetings should include the owner, accountant and CFO for lines of credit or term debt. And be honest with your bankers. If you’re having a problem, the bank’s going to know, and it gives you the opportunity to explain why it happened.
How can your choice of bank affect how creditworthiness is determined?
A very large bank may use systems to determine credit. In short, the commercial lender feeds information into an often-automated system, and it comes back with an answer.
At community banks, generally speaking, there is individual involvement. They don’t use those types of systems and instead give more attention to the numbers and to understanding the individual business’ situation.
Regional banks are compartmentalized by market size and often have multiple officers handling each market. Once a business jumps into another category, it has to get a new loan officer. Today’s market is not just about being a lender, it’s value added. If your banker can’t bring value to the table, the bank is just a commodity, and the lowest price wins. Community banks provide a higher value because they are selling the value that can be brought to the relationship going forward.
Stephen Klumb is senior vice president and chief lending officer with National Bank & Trust. Reach him at 1-800-837-3011.
Insights Banking & Finance is brought to you by National Bank and Trust
While it may be uncomfortable for founders of a new business to talk about issues that may lead to disputes between them in the future, it’s important to address, resolve and document those issues before they start the company. Otherwise, disputes can often lead to litigation.
“Having a written agreement is crucial. It’s one thing to agree upon various issues up front, it’s another to have the agreement in writing so the founders have something to refer to when questions or issues arise,” says Jeremy Suiter, Shareholder and Chair of the Business and Commercial Litigation Practice Group at Stradling Yocca Carlson & Rauth.
“Founders may operate on a handshake, but it can be hard to recall exactly what the terms are later on down the road. It’s important to have something in writing that sets out in detail how you’re going to deal with various scenarios,” he says.
Smart Business spoke with Suiter about what company co-founders should do before forming a company to prevent the often-disastrous results of litigation later on.
What are some common reasons company co-founders might sue each other?
The most common reason involves a fight for company control. A failure to address equity and management rights up front may lead to an impasse down the road. This is particularly common when co-founders reach a stalemate, and there’s no provision for a tiebreaker.
What issues should founders discuss up front?
Prior to forming the startup, founders should discuss their goals and vision. These may include services or products the company will provide, the company’s growth plan and the role of each founder. For example, one founder may see the company as his long-term employer, while another may see the company as a shorter-term investment in anticipation of a liquidity event. Goals are going to change, but founders who discuss issues ahead of time and develop a plan to resolve differences are better positioned to avoid the types of stumbles that can lead to litigation.
What specifically should they iron out?
They’ll want to determine how ownership interests will be divided; how decisions will be made; whether the company will employ founders; and the exit plan if a founder dies or wants to leave the company. It’s also important to have a plan for dealing with events that may change the company or how it operates. There are myriad possibilities, but the most common include selling the company, acquiring another company, taking on new partners, raising money or going public.
What provisions should they include in their written agreements?
Once founders decide which type of business entity they want to form, they should enter into an appropriate written agreement that outlines their ownership interests and explains how the company will operate. The agreement should explain how decisions will be made, who will make them and what to do if founders disagree. For example, the agreement may provide that material decisions, such as selling the company may not be made unless both founders agree, while other decisions, such as the day-to-day operations of the company or expenditures of less than $10,000 may be made by a single founder. There also should be procedures in place for the exit of a founder — voluntary or not — and an explanation of each founder’s responsibilities.
The agreement should specify what happens if one of the founders isn’t living up to their responsibilities, and how to resolve disputes that may arise. Dispute resolution procedures should include provisions requiring founders to mediate disputes before pursuing litigation, and if mediation is unsuccessful, the forum for litigation — court vs. arbitration; litigation location; and which state’s law, or any other rules that the parties may choose, will apply. This final provision is particularly important if founders reside in different states.
What methods can resolve disputes prior to litigation?
The best way for founders to resolve disputes is to be upfront with each other. Maintain a good relationship with your co-founder and try to talk through and resolve issues. Agree there will be times when you’re not going to agree, but for the betterment of the business you’ll try to resolve your disputes.
If this doesn’t work, founders should ask a neutral party to mediate. It doesn’t have to be a formal mediation service; it could be a trusted third party whose recommendation each founder trusts.
What damage can result if litigation occurs?
The time and expense of litigation can be substantial. Litigation often impacts not just the founders, but also company personnel and resources, which can ultimately hurt the business. In extreme cases the company may be dissolved if the founders are unable to resolve their dispute. Under California law, that’s the nuclear resolution where the court dissolves the company and divvies up its assets.
How can founders think of everything they’ll need in a contract up front?
Retaining qualified counsel is a good first step. While every business venture starts off with good intentions, disputes arise and that should be recognized. Qualified business counsel can raise potential disputes and incorporate terms into a written agreement for the founders to resolve up front.
Having industry specific counsel doesn’t hurt but isn’t required. Instead, look for a firm that has experienced corporate counsel involved in company formation and litigation counsel familiar with the disputes that typically arise. They can help formulate an agreement to address the real issues that come up and offer advice on how to prevent those issues from becoming disputes in the future.
Jeremy Suiter is a Shareholder and Chair of the Business and Commercial Litigation Practice Group of Stradling Yocca Carlson & Rauth. Reach him at (949) 725-4000 and email@example.com.
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For executives interested in branching out and starting their own business, the UCLA Anderson School of Management offers entrepreneurship courses designed to help them better understand what it takes to make that happen.
“Executives who enter the course have ideas they want to explore either related to their job or not. The course helps them think through the process of whether or not they should give up their job, incur the opportunity costs and strike out on their own,” says George Abe, lecturer and faculty director for the Strategic Management Research (SMR) Program at the UCLA Anderson School of Management.
As they work through the courses, students can begin to better answer questions such as: How do I raise investment capital? What’s the difference between an angel and a venture capitalist? Should I seek outside financing at all? I have an idea, how do I know it’s a good idea?
“They enter school with these questions and we try to be pretty direct on how to answer them. So the way entrepreneurship courses help them is to answer these questions. We do this by having them work through deals and providing examples of best and worst practices,” Abe says.
Smart Business spoke with Abe about how entrepreneurship courses can help prepare executives to start their own companies.
What do the school’s entrepreneurship courses cover?
The school has tried to establish a brand of entrepreneurial education. Faculty thinks entrepreneurship can be taught, at least aspects of it. So the courses are heavy on jargon — the newspapers are full of business jargon and students really want to know what’s going on — how deals are done; how to look at feasibility; and learn about early stage legal formation, financing, venture capital and angel financing. That takes about 10 weeks of study and is the first entrepreneurship class. In that class they’re asked to come up with some kind of business idea they think would be worth pursuing.
Then they take another class called Business Plan Development in which they take the idea they’ve thought about in the first course and write a business plan. The first course is primarily analytic — mainly to analyze markets, themselves, products and make a determination as to whether a company idea is feasible. Once having determined that it’s feasible they go about writing a business plan, which is an action-oriented document, in the latter 10 weeks.
The courses also delve into areas of entrepreneurship beyond starting up companies where acquisitions and spinoffs are discussed.
After that there’s a field study in which some students implement the business plan they’ve developed previously. There also are two elective courses, one on entrepreneurial finance and another on entrepreneurial operations.
What are some reasons executives take these courses?
Many students in the class have thought about their business ideas for a while and they’ve got a lot of the product ideas nailed down, but they don’t know how to think about the financing, marketing and operations pieces. That’s why they’ve come here. In fact, many of the students are ex-entrepreneurs who’ve failed previously and don’t want to fail again.
Another thing faculty tells students is even though you’ve got this nice cushy job at some big company it’s not necessarily secure. The greatest job security you can have is the ability to withstand a layoff and go off on your own.
What kind of time investment should be expected?
Classes are every other week, staring Thursday afternoon and going through the weekend. Faculty, then, assigns two weeks of homework. They have case studies, which are a set of facts about a particular business and they’re given open-ended questions about it. The cases address famous companies like Starbucks — for example, what made Starbucks work while thousands of other coffee shops didn’t scale up — and not-so-famous cases that did or did not succeed. Also, guest speakers come into class to talk about their experiences attempting to get a business up and running.
For each class, students can expect to spend three hours in the classroom and six to seven hours on homework and other preparations. Therefore, the workload is about 10 hours per session minimum. They’re going to take two to three classes at once, so they’re looking at 20 to 30 hours every two weeks.
The workload isn’t trivial, but it’s directly related to their entrepreneurial aspirations. In addition, there is a six-month field study project called Strategic Management Research (SMR) in which students are placed in a company in groups of five for six months. SMR frequently involves international travel.
What can executives expect to gain from this experience?
Students who come back tell me they learned a lot about themselves and whether or not they should be entrepreneurs. They learn how to execute deals. Both the entrepreneurship courses and others emphasize deal-making discussions and what deal terms look like. We walk them through the deal process; help them get familiar with term sheets; and advise them on how to work with legal counsel.
They also leave the program with a network of other students and faculty who can help them with their businesses. You’ve got this group of people you’ve been in this foxhole with for two years and they tend to stick together for a long time. This EMBA group is pretty close. There are only about 70 of them and they see each other every other week for two years. They get to know each other pretty well and they often get together and cooperate.
George Abe is a lecturer and faculty director for the SMR program at UCLA Anderson School of Management. Reach him at (310) 206-3082 or firstname.lastname@example.org.
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Dealing with the daily responsibilities of running a business can distract an owner from the big picture. To take some of the burden off of CEOs running small and mid-sized companies, Professional Employment Organizations offer services that handle outsourced aspects of daily business, including recruiting, payroll, workers’ compensation, risk and safety management, and training and development.
However, selecting the right PEO for your company requires thoughtful consideration. And J. Richard Hicks, CEO of HR1 Services Inc., says that working with a PEO requires cooperation and commitment.
“This is really a partnership to help streamline and make your company more cost and time efficient. You need to work closely with your vendor and treat the relationship like a partnership to make it work for you,” Hicks says.
Smart Business spoke with Hicks about what to look for when choosing a PEO.
How does a PEO work?
A business and a PEO establish a three-way relationship — a co-employment arrangement — among the PEO, the client company and the company’s employees. This means the PEO co-employs your work force and becomes a legal employer responsible for such functions as payroll, recordkeeping, benefits and services, and participation in hiring, evaluation and firing. This frees up business owners to focus on the core operations of their business.
What do companies need to understand about the co-employment relationship they establish when working with a PEO?
The co-employment relationship allows your employees to participate in the PEO’s benefit programs, as well as its risk management programs. The employer retains control of the workplace, but when it comes to government compliance, the PEO takes those burdens off its hands.
What differentiates one PEO from another?
PEOs can be grouped by the range of services that they provide. Some could be considered turnkey and take care of the company’s employees from top to bottom. Others simply provide payroll and workers’ compensation services.
Every company has its own specific needs. Generally, the more people you employ, the more important HR functions become. Conversely, fewer employees mean fewer stresses exist on that aspect of your business, and all you would likely need to outsource are a few administrative services.
There are also PEOs that specialize in certain industries and you want to work with one that has experience relevant to yours. When you evaluate a PEO, ask whether it’s done work with companies in your field because that experience helps with the back end legal responsibility and mitigates your exposure. A PEO will never completely remove your legal exposure, but it will greatly reduce your risk.
Does hiring a PEO mitigate any legal risks associated with the services it provides?
It does mitigate them, but they never go away completely. An example of some items that will go away when you enter into a co-employment relationship with a PEO are 401(k) fiduciary requirements, health care fiduciary responsibilities in terms of COBRA administration and workers’ compensation liabilities.
Working with your PEO can also help protect you from many types of employee lawsuits. While the arrangement doesn’t prevent a lawsuit from being filed against your company, having a relationship with a PEO can greatly increase your protection.
Companies should make sure that their PEO has employers’ liability insurance, as well as errors and omissions coverage in suitable amounts that cover its entire block of business. You should also look into what resources it has available in terms of legal counsel.
How can a company rate a PEO’s affordability?
Look at your business and the issues you’re having with running it, specifically with issues such as all forms of insurance administration, insurance procurement, employee administration and federal, state and local compliance. Brainstorm those items out, pencil in who is doing that work and how often it’s being done. Typically when you’re looking at a company with about 35 employees, the person doing most of that work is the owner or CEO. Even if he or she doesn’t do it all, that person is involved in a lot of it. As a result, your cost for handling those issues increases dramatically, both with the owner’s time and with opportunity costs in terms of the time lost pursuing company growth.
The best way to evaluate the savings impact of a PEO is to look at the cost of employing someone to do that job, including salary, continuing education, vacation, coverage for when that person is on vacation and turnover cost, as well as any software or hardware expenses associated with a new position and new full-time employee.
When you hire a PEO, you’re hiring a team of experts, not just one person. The organization will have experience across a broad range of areas, and it never calls in sick, goes on vacation or asks for a raise every year.
How can a company determine which PEO is right for it?
The most important thing when choosing a PEO is to find a company that believes in doing business the way you do business — that treats employees the way you do. You should feel confident that you can reach the right person within the PEO to get a problem resolved. It comes down to finding people you want to do business with and who treat employees the way you want them to.
It’s not for every company, but if you have fewer than 200 employees, a PEO is something you should consider.
J. Richard Hicks is CEO of HR1 Services Inc. Reach him at (800) 677-5085 or RHicks@HR1.com.
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Treasury services provided by banks can allow businesses large and small to grow without the cost of adding labor. And those services can lead to higher profitability long term and introduce efficiencies of scale, allowing companies to redirect some of their personnel to higher value, more profitable activities, says Debbie Innes, executive vice president, retail banking and treasury management, at Cadence Bank.
“Everything done in treasury services is built around the cash flow cycle, so the products are targeted at bringing greater improvements to that process,” says Innes. “It not only makes it more convenient for employees in a purchase environment, but it’s more economical for the business on the outflow and the information reporting sides.”
Smart Business spoke with Innes about advancements in treasury management services, the associated technologies and how that translates to greater efficiencies and profitability for your business.
What are some of the latest advances in banking technologies?
One of the greatest technologies that treasury management services has been able to bring to businesses is remote depositing, which allows customers to deposit from their desktops, saving a trip to the bank. Desktop scanners, printers and other TWAIN-compatible devices allow businesses to make deposits without investing in special equipment. And now there’s the onset of mobile payments.
The use of text alerts is also increasing. Businesses can set preferences that, for example, alert them of a payment deposit received by their bank. Business owners can use text messaging to access almost limitless amounts of data regarding receipts, which is so critical for shipping orders or releasing products.
Because of technology improvements to lock boxes, banks can offer much faster throughput, shortening reporting times so clients know earlier when payments are received. Equipment is less expensive now, so the cost has come down. And the associated optical and image character recognition has been perfected, significantly improving the quality and clarity of the images.
Storage has also become less expensive, so banks are able to retain information longer. Three years ago, if a client wanted to store statements for seven years and provide access to those online, it would be very expensive to the bank and to the client. Today, bandwidth is much greater, which means prices for that service are value added and not a deterrent.
On the merchant services front, one of the most recent advances is multifaceted terminals. Businesses no longer need multiple pieces of equipment to accept credit cards, checks and cash, so they don’t need dedicated counter space or to make additional investments. Mobile also has entered merchant services. Instead of traveling with hardware to trade shows, for example, businesses can take payments with mobile devices.
What new services are available to businesses?
There is a new service called a payables lock box. A company’s bills are mailed to the bank, which scans and indexes the images. Through the Internet, the bank then provides the client the ability to see details of the bills and routes them to the appropriate business unit for payment approval, which the bank will do for you.
Also, companies often have multiple login IDs and passwords to get balances, conduct transactions, make payments, access merchant services and view credit card statements. Now there is a service, pioneered by Cadence Bank, that utilizes a single sign-on portal, allowing you to log into the bank and access every service you subscribe to using just one login ID, password and security authentication method.
How can treasury management help a business keep its cash secure?
Instead of having someone issue invoices and receive checks, a lock box outsources some functions to the bank so the issuer of the invoice is not the receiver of payment, minimizing the opportunity for theft. Banks offer malware software to buffer between the banking application and your hard drive, which can detect a Trojan virus and allow the bank to stop the online banking application. The bank then notifies the customer to take action. Because most cyber attacks are focused on payments, banks provide business customers with hard tokens for protection. Some customers don’t like carrying the hard token device with them when traveling, so now, by using a mobile device, the client can generate the number to key in through text messaging.
How can a business measure the return on investment associated with treasury services?
Typically, companies can realize savings though staff reductions and redeployment of personnel to higher-value work responsibilities, such as collecting overdue receivables. Going from paper payments to plastic also can offer savings on materials. And when a company switches to a card, routing becomes automated, reducing the time it takes for the transaction. Some companies will allow payments with later terms if a customer pays electronically because they have much less risk.
Treasury management products automate data integration, which makes collecting, reconciling and posting receivables faster. Also, the amount of data provided allows a company to examine its inflow and outflow and more efficiently invest unencumbered funds.
How can businesses work with banks to drive better relationships?
Banks want customers driving their development efforts. They don’t want to invest in products clients don’t want, so it’s important for banks to understand clients’ business. Through that discovery, banks can better pair their technologies, process and services to their clients’ needs. Banks can build solutions because they have programming resources, information technology and strategists. If they understand a business’ situation, they can offer creative ideas to resolve their issues.
Debbie Innes is executive vice president, retail banking and treasury management, at Cadence Bank. Reach her at (713) 871-3915 or email@example.com.
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