While appropriate funding and growth potential are critical factors for a successful acquisition or merger, the people who come along as part of the acquisition could be one of the most important assets. Companies don’t generate profits, people do, and they often hold the key to strategic customer relationships and possess institutional knowledge that just can’t be captured in a computer program.
For CEOs, an important part of the due diligence process lies in assessing the cultural fit between the two organizations and the similarity in corporate goals between the two groups of employees. Without employee retention, the merger or acquisition may never live up to the profit potential that was promised on paper.
“You can’t just look at the assets because, at the end of the M&A process, the assets won’t get up and walk out the door, but sometimes people do,” says Wayne Pinnell, managing partner with Haskell & White LLP. “It’s critical for the CEO of the acquiring firm to spend time communicating with key personnel and be appropriately transparent in his or her communications throughout the M&A process in order to minimize turnover.”
Smart Business spoke with Pinnell about how CEOs can evaluate the intangible match between companies when considering potential mergers and acquisitions and how to effectively manage the communication process with employees and other constituents.
How can CEOs evaluate the prospective cultural match between two companies?
First, acquiring CEOs should spend time with the employees in the firm being acquired to see how they interact. You want to observe how the employees communicate with one another and the pace of the work environment to see if you think those employees will blend with your company’s work force. Each company develops its own culture; people are attracted to jobs where they feel comfortable and they leave when they are uncomfortable.
Second, review the prospective company’s policies and procedures to get a deeper understanding of the operating philosophy.
For example, if the company allows its employees a great deal of autonomy in decision-making, it will be reflected in the way the policies and procedures are written and the way decisions are made. Conversely, companies with a great deal of structure will have lots of rules and binders containing forms and approval procedures. Employees who like structure will be lost without it, and employees who relish autonomy don’t like being told what to do.
How can CEOs assess which employees must be retained?
Spend time with employees in one-on-one meetings and quickly identify any personnel who hold key customer relationships or institutional knowledge that must be retained. Also, assess if the top executives in the two firms can work together, because competing egos can get in the way. You can address some of the ego issues through the M&A planning process, but you need to take those challenges into account before proceeding. Last, don’t assume that all the important people hold top jobs in the organization. The key knowledge holders or customer relationship managers often work throughout the organization, from customer service to accounts receivable, so don’t overlook them when you’re deciding who must be retained as part of your assimilation planning process.
What are the communication best practices for executing successful mergers and acquisitions?
CEOs should communicate frequently, and be sure to include as many specifics as possible about the pending transaction throughout the entire M&A process. Remember to communicate internally with employees and externally with customers and suppliers because it’s important to communicate with all constituents. People are always concerned about change and, in the absence of information, those fears will grow.
Whether you’re talking about executive egos or valuable employees, proactive out-reach can help the acquiring company cultivate champions for the acquisition among key managers and executives within the candidate company. Having leaders on board with the idea will ensure a smooth assimilation because others will naturally follow.
How can my CPA assist with the human side of mergers and acquisitions?
Your CPA should have experience with mergers and acquisitions and should be able to give you advice and transition plan assistance. Having a comprehensive assimilation plan that covers sales and marketing, operations, finance, R&D, customer relations and human resources is vital. Within the human resources portion of the plan, you should address compensation, benefits, titles, training, retirement plans, bonus structures and other people-related issues to assure retention through creation of a win-win situation. Your accountant can assist by suggesting ideas that have been successful for other CEOs facing similar challenges and by running financial models comparing comp and benefit plans. Employees who feel valued throughout the M&A process are more likely to stay on and contribute to the newly combined organization, and that’s good news for the bottom line.
WAYNE PINNELL is the managing partner for Haskell & White LLP. Reach him at firstname.lastname@example.org or (949) 450-6314.
CEOs face monumental challenges when navigating issues surrounding their aging work force. In order to avoid the predicted brain drain caused by retiring baby boomers, many CEOs are orchestrating knowledge transfers between retiring employees and less-experienced workers, while other executives face retention issues with younger employees, as middle-aged managers stay longer and limit opportunities for up-and-comers. The best solution for CEOs is to control when workers retire.
As it stands today, the baby boomers are in control of their retirement dates and many aged 55 to 65 are choosing to stay on the job longer because they just can’t afford to leave or are anticipating limited access to affordable medical insurance. The more employers step in to help solve some of the problems facing prospective early retirees, the more they’ll be able to control their exodus.
“There are many issues facing employees who might like to retire early,” says Jon Joss, senior retirement consultant with Watson Wyatt Worldwide, San Francisco. “Without 401(k) oversight, retirees are forced to manage their own asset portfolios and the volatility of the financial markets doesn’t portend enough income stability for prospective retirees. If CEOs want to get a handle on the issues and control the timing of employee retirements, they really need to provide more assistance to potential early retirees.”
Smart Business spoke with Joss about what CEOs can do to support early retirees and exercise better control over the egress of middle-aged workers.
How can employers provide more stable retirement income to early retirees?
In order to help employees retire early, employers should consider offering annuity options under their 401(k) or other defined contribution plans. Over the past few years, financial services firms have introduced insurance products to help fill the hole left by the winding down of traditional plans, where vested participants are promised a lifetime monthly benefit at retirement. The growth of 401(k) and other defined contribution plans place the investment management and draw down burden on employees as retirees receive a lump-sum benefit when they leave. Consider offering employees the choice of several annuity plans and the option to invest all or part of their defined contribution retirement assets into the program. Because employees will feel more secure receiving a guaranteed income and relieved from the burden of managing their investment portfolio, they may retire earlier.
Offering annuities as an option can also keep scarce knowledge workers on the job longer or assist with retaining younger workers who frequently say they want guaranteed retirement benefits. By leveraging their purchasing power, employers may be able to offer retirees better annuity programs than those they could purchase on their own. The Pension Protection Act has provided some good guidance around the selection and protection to employers for offering annuities, making employers feel more comfortable.
Should employers offer planning assistance to prospective retirees?
Employers can provide modeling tools that will help prospective retirees determine how much money they’ll need to retire and their projected income levels resulting from a variety of portfolio investment scenarios. Employers can also continue to make those tools and investment advisory services available to employees once they retire. This type of assistance provides reassurance to prospective retirees, because navigating the volatile investment markets can be treacherous enough.
How can employers help employees obtain medical coverage before they reach the age for Medicare eligibility?
There are several options that employers can consider to help prospective early retirees obtain affordable health coverage. Under one strategy, the employer can create a defined contribution type plan used to pay health care premiums for the employee based upon a length of service formula. For example, let’s say that an employee has 20 years of service, the employer can allocate $1,000 per service year, or $20,000, and place that money in a separate account, or leave it unfunded and use it to pay for medical premiums. Or the employer can place the funds in a Health Savings Account that the employee can use to meet deductibles and uninsured expenses. Another option is to make the company’s group health coverage available to early retirees.
By leveraging their group buying power, employers can offer retirees more affordable, guaranteed coverage with no eligibility requirements. Employers can decide if they want to contribute all or part of the premiums, and some of the cost could even be covered by the defined contribution plan allocation. There’s a great deal of flexibility available to employers in meeting this need.
What other health care assistance might early retirees need?
CEOs should consider maintaining the claims administration for early retirees and, if they decide to extend group health coverage, offer HMO or PPO options, which will help retirees manage their costs and achieve greater financial security. The more financially secure employees feel, the sooner they’ll retire.
JON JOSS is a senior retirement consultant with Watson Wyatt Worldwide, San Francisco. Reach him at (415) 733-4466 or email@example.com.
When a major customer files for bankruptcy, you may think that the receivables you have already collected are safe in the bank. That is, until you are confronted by a demand letter and ensuing litigation from counsel for a trustee, debtor in possession or unsecured creditors’ committee seeking repayment of all transfers received from your customer within the 90 days prior to the bankruptcy petition date known as the “preference period.” Your business is then faced with the prospect of not only having to disgorge what was received but also with the costs of defending the claim.
“While it is important for CEOs to act decisively once such a claim is made, because of prior inattention to the receivable, many times it is simply too late to significantly alter the outcome,” says Jeffrey Isaacs, a partner within the Finance, Restructuring & Bankruptcy practice at Procopio, Cory, Hargreaves & Savitch LLP.
Smart Business spoke with Isaacs about how CEOs should handle adversary proceedings in bankruptcy court and some of the proactive measures that are helpful in defending bankruptcy-related litigation.
What are bankruptcy avoidance powers?
As a CEO, you may not be aware that some of the companies you are dealing with are on the verge of bankruptcy and, should they file, you may be subject to litigation based on what are known as ‘the trustee’s avoiding powers.’ Avoiding powers are statutory rights provided to a bankruptcy trustee or debtor in possession in a Chapter 11 case to recover certain transfers of property such as preferences, transfers in fraud of creditors or avoidance of certain liens created before the commencement of a bankruptcy case.
Even if your debt is secured by a lien, it may be divided into a secured claim, to the extent of the value of the collateral, and an unse-cured claim equal to the remainder of the total pre-petition debt. Generally, a secured claim must be perfected under applicable state law to be treated as a secured claim. In this regard, a perfection problem that is corrected at the eleventh hour is often treated as an avoidable preference.
What are adversary proceedings in bankruptcy court?
Bankruptcy litigation, known as ‘adversary proceedings,’ is litigation conducted pursuant to the specific Federal Rules of Bankruptcy Procedure. One unique feature of the litigation is that personal jurisdiction may be easily acquired through service by mail. Usually, bankruptcy adversary proceedings will be commenced in the district where the underlying bankruptcy case is pending, which may have no relationship to where the facts giving rise to the claim occurred and is therefore convenient only to the trustee or debtor in possession and its counsel.
Because of this, from a pure tactical standpoint, the deck is decidedly stacked in favor of the trustee or debtor in possession. Also, fees for prosecuting the preference action are normally borne by the bankruptcy estate, whereas fees in defending a preference action are borne solely by the creditor alleged to have received the avoidable transfer.
What immediate steps should CEOs take if their company is sued?
Because there is normally only 30 days to respond to an avoidance action once it is filed, it is important for the CEO to act decisively and receive advice as to whatever options are available in defending the action, such as abstention or change of venue.
Do CEOs need local or specialized representation?
If you end up defending the action in a distant jurisdiction, it's often important to hire local counsel because the judges and attorneys who work bankruptcy cases in a given judicial district tend to have very collegial relationships, so this will level the playing field to some extent. However, the creditor's general counsel may also participate on a pro hac vice basis to avoid duplication of effort and reduce defense costs.
How can CEOs evaluate the costs of defense in determining their options?
Since your company will be responsible for the costs of defense in any event, it is important to weigh the projected expenses of defense and the potential outcome. CEOs do not want to find themselves in a position where the already incurred cost of defense becomes the primary factor in whether the litigation should go forward. Experienced bankruptcy counsel can provide realistic estimates that can help with this risk/benefit analysis at an early stage in the case.
What proactive steps can be taken to ensure success in bankruptcy-related litigation?
It is important to monitor how your customers are performing in regard to payment of your accounts receivable and how much credit you are extending to them. If it appears that a customer is having financial difficulty and is falling behind in payment, decisions as to how any monies received against those receivables is applied may be vital to the ability to defend a subsequent preference claim.
Since we may be headed toward an economic downturn, it’s likely that these issues will arise in greater frequency.
JEFFREY ISAACS is a partner with the Finance, Restructuring & Bankruptcy practice at Procopio, Cory, Hargreaves & Savitch LLP. Reach him at (619) 515-3213 or firstname.lastname@example.org.
Sarbanes-Oxley (SOX) compliance rigors have affected the exit strategy landscape for CEOs and investors of privately funded and venture-backed companies. While the initial public offering (IPO) is still the outcome desired by many who toil to build a company, an acquisition may well be the exit event of choice, given the current compliance requirements and IPO climate.
During the boom era in the late '90s, some venture-funded technology companies went public without posting significant sales dollars to their ledgers. Today, companies must generally post above-average performance results or have a very compelling story to garner interest from underwriters.
“If your company is doing reasonably well but not great, then chances are, as a CEO, you should think about how ready you are for an acquisition, because it’s more likely an acquisition will be your exit strategy,” says Paul Johnson, partner with Procopio, Cory, Hargreaves & Savitch LLP.
Smart Business spoke with Johnson about both exit strategies and what CEOs should consider when evaluating their options and preparing for the event.
What are the IPO advantages and disadvantages that CEOs should consider?
During the IPO, there’s the chance that the stock held by the executive will increase in value, and holding the shares over time creates a residual incentive that engenders both a sense of accomplishment and a financial reward for the CEO. This can be especially gratifying for founders who have nurtured the company from conception. However, another consideration is that regulations usually only permit executives to sell their stock over the course of time, and there’s no guarantee that the shares will appreciate. There’s greater access to public equity markets after an IPO, so companies that require additional funding to reach the next level of development may find more readily available financial resources after going public.
What are the acquisition advantages and disadvantages?
Unlike the IPO, where executives may usually only sell their stock over time, depending upon how it’s structured, an acquisition event can offer immediate cash gratification for investors and executives. Also because the executive's entire stock position is usually sold at the time of the event, without a new option or a stock grant from the acquiring company, there’s no future upside or downside. While taking stock in the new entity rather than cash is sometimes an option, and doing so preserves some of the upside potential for the executive, the former company generally becomes a smaller part of a larger whole. Accepting the acquiring company’s stock is a change in the risk proposition for executives since it’s likely that the acquiring company will be run by others.
Are there other advantages driving the acquisition exit trend?
Perhaps one of the main attractions to the sale event is that, under most circumstances, the selling executive will not have to directly face the relatively new rigors of public company reporting in the post-SOX era. Examples of the burdens of being a public company include the pre-SOX obligations of filing 10-Qs every quarter and 10-Ks every year, preparing and filing annual proxy statements and filing 8-Ks. Sarbanes-Oxley has added to this list CEO and CFO certification of 10-Qs and 10-Ks, which comes with potential criminal liability for misstatements, a significantly accelerated time frame for 8-K filing, an expanded list of 8-K-triggering events as well as SOX 404 attestation by auditors and management as to the company’s internal controls. Few entrepreneurs really want to deal with all of the administrative headaches that public company executives must face.
What else should be considered when choosing between an acquisition and an IPO?
Certainly both processes are long and arduous, and the due diligence process is more thorough than many imagine, so executives should get professional advice and prepare for the event by cleaning up any intellectual property and stock ownership issues. Executives should also consider the tax consequences resulting from each event. Because an acquisition for cash is a liquidity event, it usually results in immediate tax consequences, whereas the IPO itself does not have tax consequences on the stockholder until he or she sells.
Should CEOs consider their future goals when selecting an exit strategy?
An important consideration in choosing an exit strategy is the CEO’s future plans. In theory, founders and executives who choose to stay with the company should have more control following an IPO. Although they still must report to a board and please public shareholders every quarter, any retained executives won’t have to report up through an additional layer of management, which becomes the most likely scenario if the company is acquired.
For certain execs, becoming part of a larger organization offers advantages. If they want to continue to be involved with the organization because they believe that it can truly benefit from being acquired, this is often an option. But, the acquisition will change their focus and their ability to control the outcome. Knowing yourself and your goals as well as contemplating the notion of reporting to others are important considerations when evaluating your options. I’ve observed that many entrepreneurs start another venture after they’ve cashed out. Launching a new company just seems to be in their blood, but dealing with SOX compliance isn’t very appealing.
PAUL JOHNSON is a partner with Procopio, Cory, Hargreaves & Savitch LLP. Reach him at email@example.com or (619) 525-3866.
The financial evidence supporting the return on investment for wellness programs is growing. Recent studies show that the medical care costs for people with chronic diseases account for more than 75 percent of the nation’s total medical care costs. In addition to incurring the direct costs of higher premiums, employers lose more than 39 million employee workdays each year just due to obesity-related illnesses. For example, according to the Centers for Disease Control and Prevention, people with diabetes lose 8.3 days per year from work, accounting for 14 million disability days compared to 1.7 days for people without diabetes.
Perhaps the most impressive statistic of all is the ROI achieved by employers who invest in employee wellness programs. According to Michael Pondrom, employee benefits specialist with Westland Insurance Brokers, on average, employers are saving between $1.50 to almost $5 in premiums for every dollar they invest in these programs. The key to actually realizing the savings is getting employees to act.
“True employee engagement results from increased focus on communication and, perhaps more importantly, incentives,” Pondrom says. “Since half of Fortune 500 companies offer wellness programs, it’s perceived to be a luxury that only large employers can afford, but fortunately, it’s possible for mid-sized employers to also offer this benefit without significant expense by outsourcing the design and administration of the program to an insurance broker.”
Smart Business spoke with Pondrom about how CEOs can achieve a next-level employee wellness program without the associated costs.
What evidence exists that CEOs will achieve ROI by investing in employee wellness programs?
For starters, more than 80 percent of chronic disease is preventable. So if employers can help to prevent the disease, they prevent most of the related direct, or hard, and indirect, or soft, costs. As an example, all of the research I’ve read indicates that an employee who controls his or her diabetes costs an employer only $24 in monthly health care premiums versus $115 in premiums for diabetic employees who don’t control the disease.
What constitutes a next-level employee wellness program?
Taking your wellness program to the next level of engagement is really a three-step process that can be facilitated by your insurance broker: Identify the risks, educate your employees and, most importantly, offer incentives.
The first step is to review the potential risks posed by the specific demographics of your employees. The most efficient and accurate way to accomplish this would be to first review your company’s claims data for clues. As an example, in reviewing the claims data for one of our clients, it became evident that they had an above-average incidence rate for cardiovascular-related claims among employees. As a result of the findings, we scheduled an on-site health fair for the employees, offering free screenings for early signs of cardiovascular disease through a specialized cardio-assessment firm. Many employees were unaware that they were at risk for cardio disease, and the screenings provided them with both the information and the incentive to take action and to make lifestyle changes.
Broker-coordinated health fairs are also an excellent avenue to reach out to those employees already diagnosed with a disease who just need information on how to enroll in a program.
How does employee education play a role in achieving engagement?
Education is an ongoing and critical element in any successful wellness program. There are numerous sources of free information that help employers achieve awareness among employees. The goal is not only to educate your employees on what programs are available, but also on how to use them and the advantages of using them. Your insurance carrier and broker can provide brochures, posters, online information sources, payroll stuffers, newsletters and nurse hot lines. Most of the materials are free; all you have to do is request them from your broker.
How do incentives drive employee engagement?
It’s vital that employers offer no-cost or low-cost incentives to incite employee lifestyle changes. Some employers are providing subsidized on-site healthy lunch programs or discounted gym memberships. I’ve seen very effective programs that pay employees as little as $1 for each pound of weight they lose. Like any incentive program, the plan must be well communicated and reinforced in order for it to work.
Which employee wellness program elements can be outsourced and what does outsourcing cost?
Your broker can implement and administer an employee wellness program that will not only provide all of the necessary employee education and on-site health fairs, but brokers can design, implement and coordinate low-cost or no-cost employee recognition and incentive plans free of charge. An employee walking club is an example of a zero-cost program that your broker can organize for you; low-cost programs that engender employee engagement include bonuses for weight loss and personalized coaching programs that average $4 per month per employee. All employers can impact their bottom line by driving employee engagement toward wellness, and it doesn’t require any additional internal staff time when they outsource.
MICHAEL PONDROM is an employee benefits specialist at Westland Insurance Brokers. Reach him at (619) 641-3241 or firstname.lastname@example.org.
Should owners of closely held businesses plan for the ultimate sale of their business from the outset or as the sale date appears on the horizon? The answer: They should do both, says Peter G. Dolbee, corporate tax partner with Haskell & White LLP.
Dolbee says that both short-term and long-range planning are vital when it comes to achieving the optimal return from ownership and the subsequent sale of a closely held business. Planning should be an ongoing owner activity that starts before the business is launched and ends only after the business is sold and the final check is cashed. Along the way, there are strategies and supporting activities that can help owners achieve the maximum return on their business investment.
“The problem is that owners generally think about short-term tax-savings opportunities without considering the long-term consequences,” says Dolbee. “Effective exit strategies are conceived from the outset, and they should be considered when the business is first formed. Very few owners do this well. I have seen sales transactions where we structured the sales strategy about 12 years before the business was sold, and it resulted in millions in tax benefits for the owners.”
Smart Business talked to Dolbee about how owners can achieve maximum return by conducting short-range and long-term planning around the sale of their business.
How does the initial selection of the business entity impact return when the business is sold?
It’s important to think long-term when planning for the sale of your business, and an important consideration when selecting the appropriate form of business entity is how long you intend to keep the business. Many owners think that if you’re only going to keep the business short-term, it’s best to structure as a C corporation, but that can be a bad strategy for closely held corporations because a sale or liquidation of the assets by a C corporation results in double taxation. Structuring as an S corporation or an LLC is a popular alternative because the tax consequences resulting from the sale of the business are more favorable than those resulting under a C entity. However, C corporations that convert to S status within 10 years of the sale may be subject to built-in tax gains at the highest corporate rate.
Also, don’t be ambiguous by structuring one component of your operations as a C and another as an S corporation. I’ve seen this before, and it makes no sense because you may not be getting the advantages of either type of entity. Last, keep your personal and real estate assets out of the business. If you wish to purchase such assets, do so in your own name and then lease them back to the company. Otherwise, when the business is sold, any assets will be taxed based upon their appreciated value.
What type of presale planning benefits business owners?
First, consider if you want to transfer the wealth resulting from the sale of your business to your heirs. Valuations of the business made in advance of the sale can be substantially less than at the time of the actual deal, and waiting until the sale is imminent imposes negative tax consequences. Anticipation and planning are vital, because when the gift is made well in advance of the sale, you can employ estate-planning techniques allowing you to transfer substantial value to your heirs at reduced gift-tax levels, and valuation principals decrease the amount of the gift.
Second, consider transferring a minority interest in your business to charity before the transaction to get the full benefit of the deduction without the taxable gain. You don’t want to make a gift with after-tax dollars. Third, consider transferring ownership to your children before the transaction, which can save substantial taxes resulting from the sale.
What records are needed to complete the transaction?
Once the deal starts, things happen quickly, and the better organized the seller is, the more likely the deal is to close. Get a list of what records you need to keep and how long you need to keep them before you launch your business. Organize the files for easy access because recreating documentation is costly and delays can kill the deal.
Also, document all employee compensation agreements in writing. There can be substantial confusion as to what was promised once the deal is imminent, and having properly executed contracts in place will eliminate misunderstandings and ease the transaction
Where should owners go for advice?
Don’t assume that your traditional advisers are the best ones to turn to when you need advice about selling your business. You want to select lawyers and accountants who specialize in mergers and acquisitions, and they should know the latest techniques. To select competent advisers, consider asking these questions:
- Should I do a stock sale or asset sale?
- Do you know what constitutes typical representations and warranties, indemnities, and sale provisions?
- Do you know what a basket, cap, claw-back and antichurning mean?
Asking screening questions like these will assure business owners that they are selecting the right team when it comes time to sell their company.
PETER G. DOLBEE is a corporate tax partner with Haskell & White LLP. Reach him at email@example.com or (949) 450-6307.
As the sponsor of a retirement plan, CEOs are helping their employees achieve a secure financial future.
Sponsoring a plan, however, also means that you, or someone you appoint, will be responsible for making important decisions about the plan’s management.
The Employee Retirement Income Security Act (ERISA) requires that those responsible for managing retirement plans, referred to as fiduciaries, carry out their responsibilities prudently and solely in the interest of the plan’s participants and beneficiaries. Among other duties, fiduciaries have a responsibility to ensure that the services provided to their plan are necessary and that the cost of those services is reasonable.
“With more companies offering defined contribution plans rather than the traditional pension plans and given that the future of social security is hazy, there’s both a legal and moral obligation to make certain that the company’s 401(k) plan is managed prudently,” says Roy Rader, manager for audit and business advisory services for Haskell & White LLP.
Smart Business spoke with Rader about what CEOs should know concerning the responsibilities of 401(k) plan sponsorship.
What steps can CEOs take to evaluate plan fees and expenses?
Oversight of the plan’s costs is getting harder to do because many of the plan administration fees are not fully visible to the plan participants. Many CEOs, especially in smaller companies, also serve as trustees or fiduciaries of the 401(k) plans. Therefore, in that capacity, you should first ask for full disclosure of all plan fees and administrative costs. Second, monitor what you are charged via monthly statements and audits to make certain that the plan is compliant. You can certainly shop various firms to see if what you are being charged is in line with market comparables. Before you seek bids or estimates, establish your requirements. You will need to know how much of the work will be done in-house and what duties will be required of an outside administrator. This will help you compare service plans and the proposed fees.
In addition, ask each prospective provider to be specific about which services are covered for the estimated fees and which are not. To help in gathering information and making comparisons, you may want to use the same format to review the pricing for each prospective provider. The U.S. Department of Labor Web site is a very good reference tool that can help you know what fees will be charged and what is reasonable and customary.
What other responsibilities rest with the plan fiduciary?
The fiduciary is held to certain standards of conduct and certain responsibilities including:
- Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them
- Carrying out all duties prudently
- Following the plan documents (unless inconsistent with ERISA)
- Diversifying plan investments
The bottom line is that, following Enron, plan administrators have greater responsibility to educate their employees about how to manage a defined contribution plan and to make certain that they provide a wide array of investment choices for their employees. Also, if company stock is offered as an investment option in the plan,make sure to stress the importance of diversification through educating the employees about how to choose investments that will fit their risk tolerance and future financial and retirement needs.
What education should fiduciaries provide to plan participants?
Many firms are hiring outside consultants to conduct seminars, and they are providing employees with access to Web sites that provide plan information and help employees figure out how much they’ll need to retire. These same sites provide a long-term forecasting tool that can show expected returns by investment type as well as historical trends. Employees can become more comfortable with their own risk tolerance and how to plan for their financial needs at retirement.
Are 401(k) plan audits required?
All 401(k) plans are required to file a form 5500 annual return/report with the federal government. An audit is required once a plan elects to file as a ‘large plan’ after reaching 100 participants at the beginning of the year. A copy of the auditor’s report must be attached to the form 5500 filing. The information reported under the 5500 is distributed to all of the various governmental agencies that oversee pension plans, including the Department of Labor and the IRS, as well as the public and the plan participants. There are penalties for failing to file required reports and provide required information to participants.
What penalties can be levied against a fiduciary for failing to meet the administrative responsibilities of 401(k) plan management?
Fiduciaries who do not follow these principles of conduct may be personally liable to restore any losses to the plan or to restore any profits made through improper use of plan assets. With so much riding on the success of these plans, it behooves all executives to make certain that their firms are fully compliant with their fiduciary responsibilities.
ROY RADER is manager for audit and business advisory services for Haskell & White LLP. Reach him at (949) 450-6315 or firstname.lastname@example.org.
When Peter Farrell and a team of investors bought the rights to manufacture a medical device designed to solve snoring-related issues, he knew he was going to need a strong entrepreneurial culture in order to succeed.
Farrell helped develop the device while serving as vice president of research and development at Baxter Healthcare, so he understood the product very well. The challenge was that no one else really understood it or the problem it was supposed to solve.
The early estimates projected that 2 percent of adults might suffer from the condition that would be relieved by the device. But when Farrell launched ResMed Inc., sleep-disordered breathing remained largely unidentified as a medical problem by patients, and recognition of the disorder was nonexistent within the tough-to-convince physician community.
In classic marketing terms, Farrell, who serves as the company’s chairman and CEO, had to create the need for the product before he could meet the need through sales of the device.
The only way to do that was by establishing an entrepreneurial culture where everyone understood the product, so that the entire organization could help Farrell solve problems. It also required the establishment of a multifaceted strategic marketing plan that would continually build support and media exposure for the company.
Creating the culture
To help inspire the culture he desired, Farrell and his five founding partners distributed stock options to the staff, from the top of the organization to the bottom, including the employees out on the shop floor. Giving everyone on the team a stake in the outcome established trust and helped the firm attract and retain talent while the company was struggling to develop a market for its product.
“In the early days, trust was the glue that held everything together,” says Farrell. “I was very careful not to overpromise, and I wanted to make certain that people were looked after.
“The culture helped us retain people, and it actually helped us get investors because they knew we would need that type of culture to succeed, and it generated excitement.”
In addition to giving employees ownership in the company, Farrell maintains an open-door policy despite the firm’s growth. He says that hearing messages directly from the staff fosters a non-political environment where everyone feels free to speak up, and in the long run, he’s convinced that, as a CEO, having an open door is a profit-making posture.
“I’d rather get 10 e-mails on the same issue than not to hear about it at all,” says Farrell.
He says that his philosophy has contributed to the firm’s success by serving as the catalyst for directional changes within the organization.
For example, Farrell says that in the early days, the firm was developing a sleep diagnostic system intended for use in sleep labs. One day, a delegation of employees appeared at his office door and announced that after several years of investment, the plan had failed and needed to be scrapped.
“I was continuing to stay with the idea, and the physicians virtually ignored it,” says Farrell. “We must have wasted three to four years developing it, but the employees convinced me that we needed to go in a different direction, and it was the right call. As the CEO, you need to have an open-door policy because you want to find out where the next problem is coming from so you can focus on continuous improvement, and you have to be flexible and listen to your employees.
“I think my experience working for a large company like Baxter really shaped my thinking. In the early days, in particular, we really strove to keep things simple because bureaucracy is a cancer. We really needed to be fleet-footed and focus on outcomes.”
In order for the firm to succeed, it would need to continue to develop new medical devices as well as marketing strategies. Farrell says that he has maintained a lean organizational structure to keep new ideas surfacing and moving quickly through the pipeline.
Hiring for entrepreneurial spirit
Since its beginning with a staff of six, ResMed has grown to more than 3,000 employees worldwide. Sourcing and hiring large numbers of employees who demonstrate both a strong entrepreneurial spirit and the ability to thrive in the corporate culture have resulted from a hiring process that Farrell describes as both an art and a science.
“I like to hire opportunity-seekers who will also get things done in a timely fashion,” says Farrell. “We use the interviewing process, references and checklists to assess for traits like intelligence. I also like people who have a strong sense of urgency and will just go ahead and do something and ask for forgiveness rather than permission, because it’s essential to making progress.”
He says that he prefers apolitical employees for the firm’s candid culture, and he frequently asks candidates if they have ever said that they believed in something when, in fact, they really didn’t, as a barometer of their political nature.
“I also think that checking references and getting copies of transcripts are very important because I won’t hire a candidate who has lied on their resume,” says Farrell. “You can’t fix broken ethics.”
While hiring movers and shakers has been critical to the firm’s success, Farrell is the first to admit that hiring isn’t easy, and he doesn’t always succeed. However, he strongly values education and leads by example because he possesses a doctorate degree. Once he has the employees on board, he supports their development by advocating a continuous learning culture.
Through development of an internal university called The Learning Center, Farrell educates ResMed employees on everything from sleep-disordered breathing to leadership skills and how to work effectively in teams. The goal is that people grow along with the business, and employees feel valued and want to stay with the organization.
The other major challenge Farrell faced was to educate the health care market about the problem his product solved.
“The medical community works in silos, and traditional medicine stops when the lights go out, so no one understood the problem,” says Farrell.
ResMed initially funded medical research studies because Farrell says that he needed data to win the battle against ignorance and to convince the medical community of the disorder’s existence. The research studies found that sleep-disordered breathing was much more prevalent than Farrell had originally forecasted, affecting as much as 20 percent of the adult population.
Additional research studies showed links to other diseases, as well, but progress was slow. After several years of trying to convince doctors of the medical need for the product, Farrell finally achieved a breakthrough with cardiologists. Cardiologists were not initially projected to be the early adopters, but Farrell says that he learned from his experiences to be flexible and that start-up ventures are marathons, not sprints. So he took the initial endorsement from the cardiologists; then he focused on gaining the support of other physician groups.
Farrell compiled his first physician success stories and the results of the medical research studies, and he took the message out on the road. Because peer endorsement is important when marketing to professionals, ResMed uses thought leaders, who are recognized medical experts in their fields, who speak at medical conferences and symposiums, and convey the medical findings from the firm’s research studies.
His vision is effective marketing through education, and his goal is to educate everyone who will listen.
“We invite the physicians to seminars to educate them on the results of the research studies, and we even go out and educate our distributors’ sales forces because they have to have credibility and knowledge when they meet with physicians face-to-face,” says Farrell.
He also developed a public relations program built on unique alliances. Farrell approached a competitor with the idea of co-funding PR campaigns designed to build worldwide awareness of sleep-disordered breathing and its associated impact on other illnesses and conditions. The program raised device sales for both firms.
“This is not Coke and Pepsi,” says Farrell. “There’s a giant under-served market out there, and we needed to get the word out. There’s no industry association, so we had to make our own.
“Initially, it was also very difficult to get the attention of the medical community, so we tried something different. We launched an education and awareness campaign aimed at the patients. The idea is that by educating the patients, they will bring up the topic with their doctors. Our goal is to have something in the media every day which announces the results of one of our studies and helps to educate patients.”
His marketing campaign has solved the problem of demand as evidenced by 48 quarters of successive growth for ResMed, and his open-door policy keeps the news coming in, even when it’s not good.
“You can have a lot of success by getting into a monster market early,” says Farrell. “You are going to run into challenges and roadblocks along the way, but I get up in the morning and I’m glad I’m in the business. Of course, I also think that I’ve been successful because I have a high tolerance for bad news.”
But for the most part, the news has been good.
The company posted $607 million in net revenue in 2006, and its innovative culture has fueled approximately 1,300 patents granted or pending and 565 design registrations granted or pending worldwide as of December 2006.
“Now that we are successful, many people ask me why Baxter wasn’t interested in developing the product and the marketplace for themselves,” says Farrell. “If you’ve ever worked for a big company, that’s a really dumb question. Once a company gets big, (the executives) are so busy thinking about next quarter and maintaining their existing business that an idea like this would just die on its own backside there.”
HOW TO REACH: ResMed Inc., www.resmed.com
Succeeding a much revered founder can be a daunting challenge for a CEO. Now consider becoming the head of Directed Electronics Inc., famous among San Diegans for being the company that Darrell Issa (R-Calif.) and his wife, Kathy, built. Creating further potential jeopardy was the task of repositioning the firm to move beyond its run rate of $100 million in annual revenue.
In 2001, all of these challenges awaited Jim Minarik, a veteran of Clarion Corp. as he accepted the role as president and CEO of Directed Electronics when Issa sold the firm to a venture capital company following his election to Congress.
Directed Electronics possessed a dominant 50 percent market share position in a niche electronics business vehicle security systems and was very profitable. As it existed, although tremendously successful, the company was positioned to maintain revenue and profits, but not to increase them.
“My first rule was don’t break what wasn’t broken,” says Minarik. “It was a tough first six to eight months and quite a challenge getting the employees on board with all of the changes.
“Before, everyone reported to Darrell. My initial thought was that in order to make the business scalable, I needed to create a business plan and an infrastructure that would support the growth.”
But all of the plans in the world wouldn’t end up meaning much if the company couldn’t survive the initial change.
As the first firm’s post-entrepreneurial period, Minarik demonstrated that he could successfully follow a politician by using his own political savvy. He set out to win over the existing staff and to take them along on a journey to the next level a professionally managed company.
Succeeding with people
Minarik knew he had to change the tone and set new expectations immediately.
“I wanted to let everyone know that I wasn’t the new ‘daddy,’ this was now our company,” says Minarik. “I clearly communicated the risks to everyone. We could succeed from here and take the company to the next level or we could fail if we couldn’t change. The choice was ours.
“Often what came up was that they hadn’t done things this way in the past. Coming from a Japanese company, I let the staff know that I wanted their feedback and I wanted to build consensus because that’s what I was used to, but that we needed to change to move forward.”
Frequently in entrepreneurial firms, the intellectual capital of the business is housed in the memory banks of the existing staff and the processes are inadequate to effectively continue the business if too many people leave at once. Sensing that might be the case at Directed Electronics, Minarik decided to add onto the house, not tear it down to the foundation.
Minarik says he decided to strategically deliver “carrots” to the existing staff to keep them on board by increasing vacation, sick leave, health benefits and the 401(k) plan.
He also needed to get the employees more involved in decision-making. As is often the case in entrepreneurial firms, decisions and accountability for results resided at the very top of the organization. Minarik says that the limited decision-making structure contributed to a sense of complacency among the staff and a culture where no one took accountability for results.
To help get the change he desired, Minarik promoted many of the existing staff into management roles that increased both their authority and responsibility for results including accountability for profit and loss. Because he wanted to retain the newly promoted employees and have them build the business, Minarik needed the new managers to think more like owners than employees, so he also gave them a stake in the business.
Minarik’s actions were the result of a lesson that he says he learned early in his career.
“The first company that I worked for was run by an iron-fisted entrepreneur,” says Minarik. “I finally left because he had to make all of the decisions. The company made it to $100 million and hit a wall.”
A plan and a team
Minarik says he wanted to achieve balance between effectively paying respect to the history of the company and repositioning the firm to grow through the addition of new product lines. After securing the base, Minarik’s next steps down the path toward building a high-growth company included creating a more scalable infrastructure by adding new leadership who could close gaps in the firm’s expertise, building a cohesive team and teaching the existing management staff to make decisions through data analysis and process improvement.
Minarik hired a new CFO and a vice president of corporate development from outside the company.
Because blending new hires into an existing company can be difficult, he didn’t rely on gut feel. Instead, he used a system called “top grading” to help him select the right external candidates.
“Top grading is a defined program for hiring ‘A’ players using formal candidate assessments,” says Minarik. “It starts with defining the competencies you are looking for and then you develop the questions that probe into those competencies using several interviewers over three-to four-hour interview sessions. The candidates are scored on their responses, which quantifies the selection process.”
The next step was to fully engage the newly merged leadership team into a growth mindset for the company through the creation of a business plan and vision for Directed Electronics. Minarik structured a senior management committee comprised of the new and old leaders and led the team in creating the strategy that would take them forward.
The team’s plan called for doubling the business within three years and hitting $1 billion in revenue within 10 years. Minarik says that he perceived that the most likely succession scenario for Directed Electronics would be that the current venture owners would sell to another venture firm, after realizing some financial gain resulting from
acquisitions and growth. So a near-term public offering was not part of the initial strategy. Had he envisioned the possibility of going public earlier, Minarik says that in hindsight, he would have added even more infrastructure to the company to support all that goes along with being a public company.
“Our plan focused on growth and where we had gaps in our product lines,” says Minarik. “Once you define them, there are three ways to fill the gaps: You can close them with existing product lines via organic growth, you can close them by developing strategic partnerships that will give you access to new products, or you can make acquisitions.”
While Minarik developed a strategic partnership with satellite radio selling aftermarket equipment, which effectively closed one gap, he was also armed with venture money to spend. Consequently, the most obvious route to quick growth was through acquisitions and it was what Directed Electronics’ new owners were expecting. Based upon the business plan strategy, Minarik went on a shopping trip looking for potential acquisitions in the hot home theater speaker manufacturer marketplace, but first he developed a comprehensive checklist of acquisition attributes.
“There were three things that were important considerations as we looked at prospective companies to acquire,” says Minarik. “First, the firm had to be making money and growing at above-average margins. Second, they had to possess a defendable market position or brand by being the industry leader, and third, I was looking for businesses we could expand so I wanted a lower level of customer concentration and a strong distribution network. I didn’t want them to already have 90 percent of the customer base.”
By selectively taking Directed Electronics into targeted markets, Minarik has achieved growth initially as a result of an acquisition and then subsequently he has achieved additional expansion growth within the brand. The plan is designed to optimize the firm’s smallish infrastructure by making the acquisition digestible initially, and then optimizing incremental sales through the firm’s existing distribution network.
This strategy also helps Minarik achieve growth while keeping debt and expansion costs at acceptable ratios when related to revenue growth rates. For the full-year 2006, Directed Electronics reported revenue of $438 million while generating $27.3 million in net income representing top- and bottom-line growth achieved both organically and through new acquisitions.
Minarik says that management decisions should always be supported by data not hunch or whim. Given his roots in the Japanese business culture, he’s a proponent of Six Sigma methodology, which uses the DMAIC problem-solving process to improve quality and productivity. DMAIC stands for: define, measure, analyze, improve and control, and this level of justification for financial expenditure requests represented uncharted waters for many of Directed Electronics’ staff.
He used real situations to teach employees who were raised in an entrepreneurial environment how to analyze the facts and then present their requests along with cost justification.
“As an example, the customer service manager came to me and said that she needed more staff because wait times were getting too long for customers, but there was no data” says Minarik. “So we established metrics, looked at call volumes and sure enough, the metrics supported the fact that we needed to add a couple of [employees].
“Under DMAIC you don’t always add to headcount because sometimes you can improve the processes and achieve the productivity results without increasing expense. The company had systems in place but in many cases they were just enough to get by and when you grow, you find that you have really big holes and you have to scramble to get things fixed. I have been doing a great deal of training so we can get better processes in place.”
As the growth of the company accelerated, the option of going public as opposed to selling to another venture firm became more viable because costs of both transactions began to equal out. In early December 2005, going public became a real possibility.
“That’s when the nightmare began because right when we went to file our S-1, we had to replace our accounting firm and re-audit the previous three years,” says Minarik.
“I would tell anyone reading this article, if you are even thinking about going public you should meet with your accounting firm a couple of years ahead of time. It was absolutely a huge headache. What gets you through it is a lot of persistence and determination and in the end it’s worth it because as a CEO I like the way it looks on our balance sheet, but I wish I would have started a whole lot earlier.”
HOW TO REACH: Directed Electronics Inc., www.directed.com
If you are the CEO or a CFO of a private company, beware the wrath of Sarbanes-Oxley (SOX). In the post-Enron era, the heavily criticized American Institute of Certified Public Accountants (AICPA) has issued audit reform standards that will affect private companies. The eight new standards will be effective for audits of financial statements for periods beginning on or after Dec. 15, 2006.
The new standards require auditors to look more carefully at every organization’s financial reporting process and business environment, and they require auditors to obtain more evidence before rendering an opinion on the financial statement.
“We are moving toward having the same types of internal controls in private companies as are required of public companies,” says Sam Salty, audit manager with Haskell & White LLP. “Auditors can no longer merely inquire about the controls; we have to test them.”
Smart Business spoke with Salty about the impact of the suite of new standards on companies and organizations and how CEOs can prepare for the changes.
What audit changes will affect private companies?
There are eight major provisions designed by AICPA SAS 104 through SAS 111 that will affect the audits of private companies. The impetus behind the provision changes is to drive more effective audits and to enhance the auditor’s application of the audit risk model in practice.
The provisions establish standards and provide guidance concerning the auditor’s assessment of the risks of material mis-statement in a financial audit. In addition, the new standards provide guidance on planning and supervision, the nature of audit evidence, and evaluation of whether the audit evidence is strong enough to support the auditor’s opinion on the financial statements under audit.
How will these changes affect the way audits are conducted?
Auditors will no longer be able to rely on one-size-fits-all checklists. They will need to customize each audit and prioritize their time according to the risks of the business. Depending on the auditor’s judgment about a financial statement’s level of risk, more experienced members may be necessary on the audit team.
Simply stated, audits will be more thorough.
As an example, one of the major changes is that SAS 104 expands the definition of ‘reasonable assurance.’ In the past, auditors were required to collect enough evidence to be reasonably assured of the audit findings as a way to limit audit risk. Now the auditor must obtain a higher level of assurance by looking at more evidence.
Essentially, auditors will need to perform more testing and they will need to see evidence that internal controls are documented and implemented. In the past, we gained an understanding of the existence of internal controls and only for audit planning purposes. Now, gaining an understanding is not sufficient and documentation alone is not enough. We now must evaluate the design of internal controls and decide if they have been implemented.
The new standards effectively eliminate the ability of the auditor to assess risk related to controls at a maximum level without having a basis for the assessment. Audits may become a bit more time-consuming, but there are steps that can be taken to help reduce the time and cost of upcoming audits.
How will SAS 104 through SAS 111 require the auditor to examine the business risk from new perspectives?
The auditor is now required to examine how the business compares to other businesses or competitors in the same industry as part of the documentation that supports the auditor’s risk assessment of the business. In addition, the auditor will dive deeper into an analysis of the skill level and the tone set by the management team in order to assess the organization’s internal control environment.
How can CEOs and their auditors prepare for these changes?
Document your existing controls and make certain they are in place. Tasking small steps like designing flow charts of your control processes before the auditor arrives will not only save time and money once the audit begins, but the mapping process itself may expose gaps in your processes so that CEOs have the opportunity to take the necessary steps to close the gaps.
Consider having an audit planning conference with your auditor to know how to collect the documentation necessary for the new audit process. Not only will you save on billable hours once the auditor arrives, you can avoid costly rework resulting from the need to restate the documentation or capture the information once the audit has commenced.
While controls in smaller organizations can be less formal, they must be equally effective. By starting now and talking with your auditor about what will be required, you will be able to save time, money and headaches once audit time rolls around.
SAM SALTY is an audit manager with Haskell & White LLP. Reach him at (949) 450-6359 or email@example.com.