When companies do business overseas, they have the added stress of dealing with foreign currencies. And if it’s not done right, what initially appears to be a profit could turn into a loss, says Brian Simonson, senior vice president of foreign exchange trading at Bridge Bank.
“Companies should consult with a banking partner to help them navigate overseas currency markets,” says Simonson. “While you need to understand what you’re doing in that regard, you also want someone who deals in foreign currency markets on a daily basis, someone who’s watching those markets and who understands the nuances of foreign currencies.”
Smart Business spoke with Simonson about how to approach foreign currencies so that what appears to be a win doesn’t turn into a loss.
How should companies approach doing business overseas?
It’s best to have a foreign exchange strategy in place before expanding to a foreign country, even if there’s not going to be a lot of activity initially. As your volume grows and your needs get more sophisticated, you have to make sure that you’re getting a competitive exchange rate on the conversions you’re doing, whether that is sending money to another country or receiving foreign currency payments from customers abroad.
Companies also need to be cognizant of how they invoice for their products. Invoicing in U.S. dollars, for example, can make what was once a competitively priced good not as competitive in foreign markets. So while using the U.S. dollar for invoicing may reduce the burden on accounting, it may also inadvertently reduce demand for your product.
As your business grows, you want to protect your profit margin against adverse exchange rate movements, which you can do through hedging by locking in a rate today for future payment. If you have a subsidiary in another country that you fund every month, you want to make sure that when you go to your board with a budget that you have correctly factored in the amount it’s going to cost (in U.S. dollars) and that that amount isn’t going to be adversely impacted by currency movements.
Conversely, if you have a large receivables base or large contracts in other currencies, make sure that you are protecting your profit margin. If you don’t, you could have a 10 percent profit margin today, for example, but when it’s time to collect that money, you could find the currency has moved against you and reduced your potential profits.
How can a business identify the right banking partner to help it navigate foreign currency markets?
If you’re working with a small bank, make sure it has a SWIFT terminal that allows it to communicate with banks globally. Does it have its own trading desk? A bank with its own trading desk gives you full access to whatever markets tools are available on the foreign exchange side, as well as the most competitive pricing. If that particular service is being outsourced to another bank, you’re more likely to incur an additional layer of fees before the money finally gets to the customer.
A good bank will take a consultative approach to how it does business with you. Many money center banks have international products and services, but they mostly serve Fortune 500 companies. If your business is small, or even mid-sized, you may not be running the volumes to get on their radar screens.
Instead, by partnering with an experienced smaller bank, you’re much more likely to receive a higher level of service so that you can focus on growing your business, not on figuring out the nuances of foreign exchange.
When you’re thinking about expanding your business overseas, at what point should you engage your banker?
You should form that relationship early on as part of a longer-term strategy, before even venturing overseas. An experienced banker can provide advisory services to help get your international business established and can help connect you with other professional service providers such as accountants and lawyers.
You may also need to set up foreign bank accounts, and it can be helpful to have a U.S.-based bank facilitate an introduction to a reputable and experienced institution.
A good guideline for when to consider doing FX hedging for your business is when you begin transacting in foreign currency amounts of more than $100,000 U.S. dollar equivalent. A banking partner can also help you to monitor your firm’s global financial situation. Currency markets inevitably change over time, and what’s appropriate for your firm today might not be advantageous for it in the future. Once you understand your transaction activity, you and your banker can determine whether it might make sense to realign your strategy with your business trends. A good banker will constantly evaluate the success of the program and make corrections as necessary.
What mistakes do companies make when trying to expand overseas?
In the case of foreign exchange, they fail to set up clear risk management objectives. They also tend to focus on trying to capture potential upsides in the market, rather than protecting their bottom line. So, instead of consulting various FX forecasts and allowing a ‘market view to drive strategic hedging decisions, keep risk mitigation your top priority. Companies often reach out to their bankers after taking a significant FX loss. By that time, it’s too late. Be proactive and reach out to your banker before any potential adverse FX rate volatility impacts your bottom line.
Any time a business is venturing overseas, the prospect can be daunting. Each country has its own way of doing business and its own way of banking, and it’s important to consult with a professional who is familiar with the pitfalls of setting up overseas and knows how to avoid them.
Brian Simonson is senior vice president of foreign exchange trading at Bridge Bank. Reach him at (408) 556-8377 or Brian.Simonson@bridgebank.com.
Insights Banking & Finance is brought to you by Bridge Bank
If you’re thinking about selling your business, there are a lot of factors to consider before making that decision.
“First and foremost, you need to determine whether it is a good time as it relates to you, as the business owner, to help meet the goals and objectives of the business life cycle,” says Albert D. Melchiorre, president of MelCap Partners, LLC, a middle market investment banking firm. “Other factors include trends in the business and the industry, and economic trends.”
Smart Business spoke with Melchiorre about how to evaluate whether now is the right time to sell your business.
How can a business owner begin to evaluate whether selling is the right decision?
Beyond whether it’s a good time for the business owner and current trends, do you have a successor in place? Are you aging and considering a sale because you’re 75, or are you 55?
Is it a good time as it relates to trends in your specific business? Is the business performing at high levels, with the added opportunity for further growth? Is it a good time in your industry? You may be performing, but if your industry is declining rapidly, is the business’s performance sustainable based on what’s going on in the industry?
Also consider whether it is a good time from a mergers and acquisitions perspective. Is capital plentiful? Are there plenty of potential buyers?
It’s good to have all of these factors lined up. Historically, it’s rare, but in the current economic environment, for a lot of business owners, they are lining up.
How can the current mergers and acquisitions market impact the decision to sell?
Although some areas of the economy are still struggling, other industries are doing very well. As a result, the earnings of corporations remain strong, giving strategic buyers the financial resources to be able to buy companies. Right now, there are trillions of dollars sitting on corporate balance sheets resulting in an incredible amount of liquidity from a strategic buyer’s perspective.
In addition, although the availability of bank debt to lower- and middle-market companies remains tight, overall, banks are beginning to lend money again. And with lower interest rates, the cost of capital remains low and there are a lot of private equity dollars looking to invest in good, quality companies.
So if your business has performed well and has good prospects for growth, the trends in your business are positive, and it’s personally a good time for you, it may be a good time to consider a sale.
How could the potential end of the Bush-era tax cuts impact a decision?
Nobody has a crystal ball, but in all likelihood, the extension of the Bush-era tax cuts will come to an end this year. Whether or not new tax cuts go into effect, there is a strong likelihood that taxes will be going up for businesses and that you will pay more next year on the sale of a business.
I would look at that as the tipping point. I don’t think it’s necessarily a primary driver in determining whether it’s a good time to sell, but it may be a secondary driver if everything else lines up for you.
How can an outside expert help you through the process to maximize your return on a sale?
For most business owners, this is a once-in-a-lifetime event, the most significant liquidity event in their lives. Business owners should focus on what they do best and let investment bankers focus on their expertise. The role of the investment banker is to help business owners maximize the value of their business to allow them to reach their goals and objectives in the sale of their business.
The investment banker will also work with the business’s other advisers, such as an attorney, an accountant and financial advisers. While the investment banker may be leading the charge, it is clearly a team effort.
How can a business owner’s decision about whether to stay with the business after the sale impact that transaction?
Some business owners, especially if they are the founder, may be key to the continued success of the business. But many just want to sell the business and walk away today.
If you’ve taken the step of bringing in key managers or finding your successor, you’re more likely to be able to exit the business at sale. But those who have not taken those steps from a succession standpoint will find it much more difficult to exit upon sale, because if you are still very key to the business, that will have a negative impact on the value of your company if you were to leave upon a sale.
How far in advance of a sale should a business owner begin to prepare?
It varies from owner to owner, but you should begin thinking about it years in advance. This is not a decision any business owner should take lightly, just suddenly deciding, ‘Today, it’s time.’
Having an early conversation with an investment banker can help you think through the process and evaluate where you are with the business today, what you can expect to receive and provide you with an overview of the process. It’s a very good exercise to get the input, advice and assistance of someone who can help you execute on that transaction.
Because this may be a once-in-a-lifetime event, you need to make sure it is the right time for you before moving ahead.
Albert D. Melchiorre is president of MelCap Partners, LLC. Reach him at (330) 239-1990 or email@example.com.
Insights Mergers & Acquisitions is brought to you by MelCap
Any company can attract average employees, but it takes developing your brand to become an employer of choice to attract and retain the best and brightest, says George Thomas, senior vice president of Everstaff.
“Developing your brand is key,” says Thomas. “You need to have a consistent message, a strong ethos and a clear vision that can be understood at all levels of the company. Everybody needs to be able to conceptualize and understand that vision, and everyone needs to be working toward a common goal.”
Smart Business spoke with Thomas about how to develop your brand to become an employer of choice.
Why is it important for everyone to understand the vision?
If don’t have a clear vision as a company, you’re dead. To use a military analogy along the lines of the Napoleonic leadership style, Napoleon was a very successful leader because he knew what he did well, understood his limitations and always had a clear vision for his troops. There was always a clear focus on everyone in every unit (including the lowest ranking foot soldier) understanding all of the tactics to be used in a particular encounter (or battle) and thus bought in to the big picture and were better prepared and motivated to influence the outcome. Having a vision is key, and to develop the vision, you have to understand first what you do well as a company and then what you want to do well. Once you align those two, you can make it happen.
How do you begin communicating that vision to employees?
The goals and vision should always be simple at all levels — don’t complicate it and make sure everyone knows how they impact the ‘big picture’ at their level. There should be reports and metrics that can be used daily by employees so that everyone understands exactly where you are as a business, why you’re there, where you need to be and the steps you need to take to be successful. If everyone understands the vision and expectations, no one should ever be surprised by anything that happens in an organization.
What is the difference between a good company and a great one?
To move a company from good to great, everyone needs to understand where the company is going and that, no matter their level in the company, they play a key role and more importantly, understand what that role is. They’re not doing things just because you said so but because they understand their role in getting the company and themselves to the next level.
Too often, the vision gets watered down. Many times at the senior level, there is a complicated vision that is then simplified for mid-level employees. But it shouldn’t be that complicated at any level, as everyone should be able to understand it and conceptualize it in the same manner.
Without a common goal that they can communicate to each other, people become siloed and are likely to just do what they have to do to keep their jobs. They aren’t sharing ideas or communicating about how to improve the company, they’re just working for themselves. In that case, you are not going to get buy-in, which is the key to success in any organization. You only get buy-in when people understand why they are doing what they’re doing and how it impacts the overall success of the company. If you don’t get buy-in, people are just going to be processors, not producers. And processors don’t make a company great.
How can a company begin to change its culture to become an employer of choice
Start with introspection and be most critical of yourself first. Say, ‘I’ve done a lot of things right to get where we are now, but I may have a dysfunctional company because we don’t have a strong ethos, or I don’t have a clear vision, or people don’t understand why they do what they do. I want to stop treading water and go from good to great, so what do I need to do to improve?’
Then get input from middle management, as they are key to understanding what is going on at your company. Next, go down to the employee level to get feedback on what they think you’re doing well and what you’re not doing well. You’re going to hear a lot of things you may not want to hear, but you need to encourage honest feedback in a professional and constructive manner because it’s going to help you improve your company. Once you’re gathered that information, you can work with senior management to produce a vision and a plan to get your company to the next level
Is this a difficult process?
Change management is by far the most difficult thing you are ever going to deal with as a company. But if you can figure it out, you are going to succeed. It’s well know that employees don’t necessarily love sweeping changes and especially in a company that has been siloed, they’re going to be suspicious. Overcoming that suspicion takes time and patience. If you try to change too much, too quickly, you’ll throw off your operations and productivity because people will be focusing too much on the changes. You have to be willing to invest the time and money to implement change properly.
How can creating this culture help improve your brand?
By attracting the best people. If you can get your best employees to take ownership and have a sense of worth in where the company is going, then they will network with other great people and you will attract the best talent instead of having to search for the best talent.
Your brand is a byproduct of your company culture. You can have a strong brand, but if your culture is not good and everyone knows that, people may recognize your brand, but they recognize it for the wrong reasons.
Take it slowly, get buy-in, make sure people know why they’re doing what they’re doing and communicate the vision in such a way that everyone can conceptualize. Develop the culture, and the brand will follow.
George Thomas is senior vice president at EverStaff. Reach him at (216) 369-2599 or firstname.lastname@example.org.
Insights Recruiting & Staffing is brought to you by Everstaff
If investors hold several different mutual funds in their portfolios they are probably pretty well diversified, correct? Not necessarily, says John Micklitsch, CFA, director of wealth management at Ancora Advisors LLC.
“The sheer quantity of holdings in a portfolio is largely irrelevant in terms of diversification, if the funds you hold all behave the same way at the same time. A more useful diversification plan looks at your portfolio in a way that, regardless of the environment, inflationary or deflationary, bull or bear, you hold some investments that have the potential to step up and provide positive returns,” says Micklitsch. “Not only can this approach be good for your long-term investment results, but it can be good for your emotional well being,as well. With potentially less volatility, you’ll be less likely to sell out at market lows and therefore be more likely to reach your long-term goals.”
Smart Business spoke with Micklitsch about correlation and how to build potentially more diversified portfolios.
What is correlation?
Correlation is the tendency of two investments to move in tandem with each other. It is measured on a scale of +1.0 to -1.0. If two investments move in perfect tandem with each other, their correlation is +1.0. If they move perfectly opposite each other, their correlation is -1.0. But it is never that perfect unless it is the exact same asset. In practice, correlations are almost always somewhere between +1.0 and -1.0.
Why is correlation important to investors?
Let’s face it, most investors focus on picking funds or securities with the highest recent returns. This leads to a portfolio of holdings that share common characteristics. The risk is that when the market environment that led to them all doing well changes, there is nothing in the portfolio to step up and take their place.
One way to measure this crowding effect is through a correlation analysis of your portfolio’s holdings.
How can investors assess the correlation in their portfolios?
Online correlation calculators are available that allow investors to see how their holdings behave relative to each other. If you use one of these calculators and see that your assets have correlations all in the .8 to .9 range, you probably don’t have the diversity you might think you have because your holdings are likely to rise and fall pretty much at the same time.
If you don’t feel like doing this sort of calculation yourself, you can ask your advisor to do it for you.
Is this approach to analyzing portfolio diversification unique?
It is not a unique approach in the institutional world of investing, but it is a fairly new concept with individual investors. The market crash in 2008 was a watershed event, when many traditional diversification models that focused on spreading assets across the lines of small versus large and growth versus value, did not protect investors from significant losses. As a result, investors are looking for different approaches to protect their assets.
How can investors begin to build lower correlation portfolios?
You should start by making sure you have core stock and bond positions. This is the starting point. Then look at adding asset classes that bring return streams with potentially lower correlation to these two core holdings. Gold, international fixed income, real estate, commodities, MLPs and alternative investments such as hedge funds, private equity and venture capital all have the possibility of having a low or lower correlation to core stock and bond positions.
With the growth of Exchange Traded Funds (ETFs), a diversifying asset such as gold, for example, can be purchased as easily as shares of IBM.
What are the negatives of correlation?
Intuitively, it makes sense and appeals to investors to protect their assets throughout a variety of market environments. The problem is that this strategy will not outperform in every market environment.
By definition, an asset with a low or even negative correlation with equities, for example, is a hedge against equities. If equities are going up, then this is going to cause a drag on the portfolio and lead to underperforming an all-equity benchmark. The idea is that slow and steady really does win the race in the long run.
How often do investors need to revisit their allocation?
That is a key question. When you have multiple, different asset classes, there is the eventuality that some are going to perform better than others. When certain assets classes do better than others, they become a larger percentage of the overall portfolio than they were originally intended.
As a result, from time to time, you should evaluate your holdings relative to your original plan and rebalance back to target levels. This can remove some unintended risk that lies from hot asset classes dominating the portfolio. The tech and housing bubbles are both good examples.
John Micklitsch, CFA, is the director of wealth management, as well as an Investment advisor representative of Ancora Advisors LLC (an SEC Registered Investment Advisor). Reach him at (216) 593-5074 or email@example.com.
Insights Wealth Management & Investments is brought to you by Ancora.
Classroom learning can get you a long way, but UCLA Anderson School of Management’s Executive MBA program takes learning to a whole new level.
In the later stage of the program, students have the opportunity to immerse themselves in the business world of another culture, says Eric Sussman, a senior lecturer at UCLA.
“The program affords students the opportunity to gain a broader perspective of what is happening on the ground in another country or geographical region,” says Sussman, who has led student groups twice to Dubai and, most recently, to Brazil. “They learn how business is conducted in that particular country and have the opportunity to network by meeting a number of representatives from both the public and private sectors across a number of industries. I don’t think you can graduate from a top business school without having that experience nowadays, and students who participate in this program get that in spades.”
Smart Business spoke with Sussman about how an international travel component can enhance an Executive MBA degree.
How has the EMBA program evolved over the past 10 to 15 years?
There have been two broad trends since I joined the faculty in 1995. One is the increased adoption of technology, and the second is the internationalization of the program. In the 1990s, we might have talked about international markets and about the growing importance of China, but we would be doing so from L.A.
That has changed 180 degrees. In any given year, there are at least half a dozen, if not more, of these international work/study trips. It’s amazing how much it has really changed, going from zero five years ago to about 10 this year.
How does the program work?
The international component consists of a full class lasting three-months. There are lectures and typical classroom activities before the course culminates in the actual trip. We talk about issues relating to that particular country or geographic region, whether it is China, Africa, the Far East or the Middle East. Then we spend one week in the country, generally in one particular city.
Students have the opportunity to listen to and meet with representatives of a host of organizations in both the public and private sector across a variety of industries to learn about what’s happening within their organizations specifically and in the country more generally. It’s a win-win-win all the way around, for the school, the faculty and the students. It’s a great opportunity to really understand what is happening globally. The reality is that what happens in Spain or China absolutely affects what happens here, and as business becomes more global, students need to broaden their understanding and perspective.
What is the typical day like for students on a work/study trip?
The day usually starts by 8 a.m., and meetings start by 9 a.m.. For example, on the Brazil trip, students met with a representative of Banco Central de Brasil, who gave a one-hour presentation on the central bank and what’s happening in Brazil macroeconomically, followed by a Q&A session. That was followed by a presentation from another organization.
The afternoon includes additional presentations, such as one from a representative of a very large and well known oil company who talked to us about the country’s growing oil reserves, what is happening off the coast of Brazil, how that’s affecting the economy, and how it’s going to change Brazil going forward. At the end of the workday, students have the opportunity to explore, as it’s also important to go out and see the culture and what’s important to Brazil in terms of its people. Culture is really important in cross-border negotiations, and you have to look at the whole picture. It’s very intensive and very tiring, but it’s exceptional in every way.
Do students have any say in the focus of the course and the destination?
Absolutely. Students vote with their feet and we have to offer programs that the students want. There’s an add-on cost for them to participate, so we absolutely take into account where their interests are. Once the country or region has been determined, students then have to apply for the course.
This year, for Brazil, we had 60 spots available, and 100 students applied. The school then had to determine who would benefit most and who had participated the most in the international program.
How does the experience impact students?
I think if I’d asked students in January, when the course started, to tell me what they knew about Brazil, I would have heard things like, ‘Samba. The Amazon. Supermodels.’ As far as business goes, that knowledge was probably pretty limited to knowing that it’s a fast-growing economy, part of the BRICs.
If I asked them now, following their trip, however, they could easily talk for an hour about everything that is happening in Brazil, and provide specifics in terms of the economy and demographics, as well as the sources and risks of future growth. Most of them have traveled before, but they haven’t had this kind of immersive experience.
When we get back, we do a debriefing. I’ve done a tremendous amount of international travel and taught around the world, but on each of these trips, I come away with a real change in viewpoints and a much greater understanding of the places we’ve been. And I know if it affects me that way, it affects the students that way, as well.
Eric Sussman is a senior lecturer at UCLA Anderson School of Management. Reach him at firstname.lastname@example.org or (310) 825-3564.
Insights Executive Education is brought to you by UCLA
You’ve found the perfect office or commercial space and you’re ready to commit to a lease. But before you do so, you need to be aware of potential issues so that you don’t make costly mistakes, says Simon Caplan, SIOR, a partner with CRESCO Real Estate. “By the time the tenant and landlord start negotiating a lease, they’ve already agreed to the major lease points, such as what the rent is, the space buildout plan, the amount of tenant improvement dollars, etc.,” says Caplan. “Once you’ve got those together, you’re ready to negotiate the lease, but you need the help of an expert in order to avoid potential red flags.” Smart Business spoke with Caplan about some common red flags for tenants to look out for and issues you need to raise for your own protection. What are the major issues to be aware of in a lease? The normal process for a potential tenant is that you hire a broker to show you the best spaces for your requirements, then you look at spaces and you choose the best space for your needs. From a tenant perspective, you want to know how big the space is and how much you are going to pay and for how long of a term. What is the buildout going to look like? What are the tenant improvement dollars? Is there a period of free rent? Once you have negotiated those major points, the next step is to start negotiating the lease. What are some common red flag issues to look out for? One of the biggest areas tenants should be aware of are pass-throughs, that is what costs the landlord is allowed to pass through to the tenant. Based on that, when the landlord is doing a buildout for the tenant, if it is extensive, the tenant should have the ability to monitor the landlord’s contractors to make sure the work is of good quality. It should be specified in the contract that the tenant is allowed to observe/inspect the landlord’s work When you rent space, the landlord is usually willing to give a tenant a one-year warranty on the space. Then, after a year, the tenant is responsible for all in-suite maintenance. So if the buildout is not done right – or if the existing space is not in good condition – you don’t want to be stuck with a problem down the road. You really need to know what you’re getting into and who is financially responsible for what. Also regarding maintenance, the tenant should agree to maintain the space and do minor repairs and attempt to get the landlord to do major repairs and replacements. This issue needs to be explicitly addressed as to who is responsible for what in areas including roof repairs, the parking lot and common areas. In most leases, the tenant pays for repairs and the landlord pays for replacements, but you need to spell that out. In addition, the tenant should ask for the right to audit common area maintenance reimbursements once a year. At the beginning of every new year, the landlord should have figured out all of the costs for the previous year and submits them to the tenant to justify what the tenant has to reimburse. If the tenant thinks the numbers are high, that right to audit would then allow the tenant to inspect the landlord’s records to make sure that what the landlord is billing them is correct. Are there any issues that tenants should raise for their own protection? If the tenant has a problem such as a leaking roof, there is nothing worse than an unresponsive landlord. To protect yourself, you should try to include a self-help clause. That way, if you repeatedly have to call the landlord to fix things and the landlord doesn’t take care of it, you have the right to take care of the problem yourself, pay for it yourself and then bill the landlord or subtract it from the rent. You will have to give the landlord proper notice, but if the landlord is not responding, you can notify him that if he doesn’t take care of it by a certain date, you’ll do it yourself. In addition, every lease has a ‘Damage and Destruction’ clause. If there is a fire, or major storm damage, what are you going to do? How long will you give the landlord to put the space back together for you? And what will you do in the meantime? What you want to pay attention to is how long will you give the landlord to put the space back together for you. The goal is to get the landlord to fix the building as quickly as possible. But it takes time and, as a tenant, you have zero control over that. The Damage and Destruction clause gives the landlord a certain amount of time to do the work, and if it’s done within that time, you have an obligation to come back to the space when it’s ready. Make sure you have Business Interruption Insurance. Also, for your own protection, include an option to extend the lease. Normally there will be some type of increase in rent, sometimes tied to the Consumer Price Index. This gives you the guaranteed right to stay in the space for an extended term at this agreed-to price. You still have the option to try to negotiate a better rate at the extension time. Finally, ensure that you have the ability to install high-speed Internet, satellite dishes and other high-tech communication systems through common areas such as roofs, halls, etc., to get into your space. Tenants often make the mistake of assuming they’ll have access, but the landlord doesn’t have to grant you access. How important is it to have an outside adviser review a contract or lease before signing? You absolutely need a professional to work with you through the process. With a lease, the tenant, the broker and the lawyer should all go over the lease individually and make comments on different clauses, then compare notes before responding back to the landlord. Landlords expect tenants to make reasonable changes to the lease terms, and when you’re leasing office or industrial space, just about every clause is negotiable. There are many other issues that your professional can advise you on to help save you future grief. Simon Caplan, SIOR, is a partner with CRESCO Real Estate. Reach him at (216) 525-1472 or email@example.com. Insights Real Estate is brought to you by CRESCO Real Estate.
Successful retirement plan financial management requires careful coordination on the part of the employer. Without the knowledge to properly manage the plan, plan sponsors could face serious repercussions, says Gary Gausman, a senior consulting actuary at Towers Watson.
“For plan sponsors to manage their programs, there are four main areas to focus on — benefits policy, funding policy, investment policy and accounting policy,” says Gausman. “There are a number of things you can do in each area, and there is a lot of interaction between them that you need to be aware of.”
Smart Business spoke with Gausman about the keys to successful retirement plan financial management.
What do plan sponsors need to know about their benefits policy?
Look at the plan design to determine benefits that are going to be earned in the future and how you are going to deliver those. Also, look at your exit strategy for legacy liability. Employees have already earned benefits for service rendered to date, and there’s liability associated with those that you need to deal with. With legacy liability, there are former employees who are retired and are currently receiving benefits, those who have terminated employment and are not earning additional benefits but are entitled to benefits in the future, and active employees.
Retirees are receiving a monthly benefit and there’s not a lot the employer can do because benefits have already been earned and are being received. But you can mitigate the risks associated with retirees by purchasing an annuity contract from an insurance company to take that liability off your hands.
For those who have terminated employment who have not yet started their benefits but are entitled to future benefits, consider offering them the benefit in one lump sum payment. If someone is 45 and entitled to $1,500 a month starting at age 65, perhaps that person would rather get a lump sum now equal to the value of those payments. That removes some employer risk. Annuity benefits are payable until the person dies, which might not be for decades. But if you pay a lump sum equal to the actuarial value of the payments, you are done.
With active employees, look at plan design. Traditional plans are final average pay plans, where if you work for a company for 30 years, you get, for example, 1.5 percent of your final average pay per year, or 45 percent of your final average pay, starting at age 65. The risk to the employer is that the benefit is indexed to what the employee earned, for example, in the last five years before retirement, which could spike dramatically in an inflationary period. As a result, many employers have shifted to a career average approach, in which benefits are instead based on what the employee earned ratably over his or her career.
How can employers address funding policies?
To maintain the tax-qualified status of plans, employers must satisfy various rules, including putting in a certain amount of money every year. Historically, some have put in the bare minimum, but in 2006, new rules said that, in addition to satisfying minimum funding requirements, you also have to maintain a certain funded ratio, which is the assets of the plan divided by liability, to continue to operate the plan according to all of its intentions and be able to take advantage of funding exemptions. For example, if a plan allows lump sums, it must maintain an 80 percent funded ratio in order to be able to pay out lump sums
If a company is just trying to satisfy the minimum funding rules while maintain that 80 percent ratio, additional volatility in the contribution amount could ensue. Companies could instead consider a more generous funding pattern to develop a cushion so that in lean years, when plan assets may have dropped and business results aren’t up to expectations, you can draw on that excess. This funding policy could involve, for example, contributing a certain percentage of pay each year.
In the 1990s, when things were going well, some companies took their eye off the ball. They didn’t have to make minimum contributions because their assets were doing so well, and in many cases, that has come back to bite them, as they haven’t built up the excess they now would like to have.
How can investment policies impact employers?
For years, employers chased returns and forgot about liabilities in the plan and how those would play out over time. In the last 10 years, that strategy has not worked well, as the stock market has been very erratic. As a result, when liabilities increase, assets may decrease, creating an even wider gap. Employers are taking a more focused look at investments, trying to better match assets and liabilities so that if liabilities increase, assets increase, as well, and the gap will not change as much. With the transition to cash balance type plans that allow employees to take lump sums at termination, you need to make sure you have the liquidity to pay those out. And to do that, employers need to look at investments in a different light and better align them with their liabilities.
How do accounting policies play into the mix?
When implementing pension plans, companies made certain elections, and they are mostly tied to those. If you change your accounting policies or methods, it must be to a ‘preferred’ method. For example, many companies chose smoothing in their accounting policies. Depending on the methods chosen, this could mean that if assets tanked last year, they would not have to recognize the full decrease in one year, but rather could spread it out over up to five years. That’s been fine, but the trend in accounting is toward ‘mark to market’ accounting, which eliminates smoothing. The auditor wants to know exactly what your assets and liabilities are based on current market conditions, i.e., current interest rate market and current asset markets. This can have implications for a company’s investment policy and funding policy, for example. By understanding each of these areas and how they work together, companies can position themselves for successful retirement plan financial management and minimize their risks.
Gary Gausman is a senior consulting actuary at Towers Watson. Reach him at (818) 623-4763 or Gary.Gausman@towerswatson.com.
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Many investors avoid microcap stocks, thinking that companies in that category are too small or too risky.
However, the term “microcap” is misleading and stocks in that sector can provide a good return on investment, says Denis Amato, CFA, chief investment officer at Ancora Advisors LLC.
“There is a misperception of microcap stocks being this crazy, wild area, so a lot of people shy away because they think this is a terribly risky area,” says Amato. “But by focusing on the value component, you will normally get good results over time, and if you put a microcap mutual fund in your portfolio, as opposed to buying individual companies, your risk is not as great as people’s perception of the area.”
Smart Business spoke with Amato about how to invest in microcap stocks.
What are microcap stocks?
Microcap stocks are generally those with market capitalization of $500 million and below, generally corresponding to the smallest 20 percent of the stock universe.
Many times, when people think of microcaps, they think of a new IPO or a penny stock. But that is not always the case.
There are two categories of microcaps. First is growth oriented microcap stocks, which may only have a few million dollars in revenues but market caps in excess of several hundred million dollars. Not always a good combination from a risk perspective. The better area to focus on, in our opinion, is microcap value stocks. These are stocks that often have several hundred million or even $1 billion plus in revenue, but market caps of just a couple hundred million dollars. This represents much better risk-reward to us than a company with low sales and high market cap. The price could be down because of the sector the business is in; it could have stumbled in some way or it may have had an earnings problem and the stock has been driven down because of it. And sometimes it is just a matter of the market ignoring the stock or the industry, or that the company is being followed by so few analysts that the stock is inefficiently priced. So the opportunities are real.
In fact, studies have shown that over a 50-year period, returns for microcap value stocks have exceeded the microcap growth category by a factor of almost four to one. That is why it is better to focus on microcap value stocks.
For what kinds of investors can microcaps be a good investment?
Microcap stocks make sense for a lot of people, but because it is a more volatile area, it makes the most sense for investors willing to take some risk and who have a large enough portfolio to make this a component.
How can an investor get involved in microcaps?
You can invest in microcaps through individual ownership of stocks, but to do that, you have to have a pretty broad portfolio because you need diversification to lessen the single company risk factor. Because they are smaller, they are riskier, so you need to have more than a handful of companies so you do not get stuck with the one or two that run into trouble.
Microcap index funds and exchange traded funds are also options, but studies have shown that the lack of Wall Street research devoted to these companies, makes microcaps an area where an actively managed fund has a good chance of outperforming passively managed strategies over time.
What timeframe should investors in microcaps be looking at?
Two to four years is reasonable because it can take several quarters to turn a company around and change the fundamentals that might be hindering the stock. Even after a company changes its fundamentals, sometimes it takes longer for the market’s perception of it to change. If you are going to get a really good return on a stock, it takes not only earnings going back up but also price earnings multiples to start reflecting that better result. The combination of those things generally takes two to four years.
What criteria should an investor look for in microcap stocks?
First, because microcap value stocks are where the better returns are, we always look for stocks that are undervalued in this sector. The financial condition of the company and its balance sheet also must meet strict criteria.
Finally, look for insider buying which is especially significant with small companies. With a large company, there may be 100 vice presidents, and five are buying and three are selling, so what does that really mean? With smaller cap companies, there are fewer insiders, and they tend to know what the real value of the company is. Management in small companies can be more aware of positive catalysts and this frequently gets reflected in insider buying.
A good microcap fund manager will take note of this and incorporate it into their decision-making process, especially with regard to the timing of the fund’s purchases. It is easy to find microcap stocks, but finding those stocks that are a good value and have other characteristics that will enable them to provide a good return are best left to professional managers.
What percentage of a portfolio, in your opinion, should be invested in microcap value stocks?
Studies have shown that 5 to 10 percent of an equity portfolio can be put into this sector. These stocks have a diversifying effect relative to an all S&P 500 oriented portfolio so investors can actually increase their returns without significantly increasing risk.
Denis Amato, CFA, is chief investment officer as well as an Investment Advisor Representative of Ancora Advisors LLC (an SEC Registered Investment Advisor). In addition, he is also a Registered Representative of Ancora Securities, Inc. (Member FINRA/SIPC). Reach him at (216) 825-4000 or firstname.lastname@example.org.
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Doing business with a large bank may seem like an attractive option for a growing business. But at a large bank, a smaller business can get lost, as some banks are increasingly turning their focus to larger customers, says Kevin Ball, head of commercial lending at Lorain National Bank.
“A local bank can offer a number of unique value propositions, including experienced staff who are familiar with your industry, a flat organizational structure allowing access to decision makers and quick decision making and execution,” says Ball.
Smart Business spoke with Ball about how a local bank can tailor its services to your business’s needs.
How can partnering with a bank whose staff has decades of experience benefit a business?
That kind of experience is necessary in order to quickly understand a business and determine its needs and if the bank can meet those needs. Businesses often complain that banks take their information, then it takes forever for them to come back and make a decision.
If a bank can make a quick decision, even if the answer is no, and explain its reasoning, the relationship can be preserved, leaving the door open for future opportunities with that business. That sounds easy to do, but it is quite rare to find in the banking world.
How can industry-specific experience help a bank serve businesses?
If a bank has done a lot of business in a certain industry, its bankers have built up experience with and knowledge of that industry. Because they see different companies in the same industry and know how things are done, they can provide more than banking solutions; they can also provide insight into that industry and advise a business owner on something he or she may not have thought about.
Bankers at smaller, local banks are also more likely to sit on boards in the community. They are deeply ingrained in the communities they live in and attend functions and get to know the community’s business leaders. This can help them spot potential needs and allow them to talk with potential clients about their needs before they even walk into the bank.
What are some other pieces of the value proposition of a local bank?
A smaller, local bank doesn’t have layers of management and is more streamlined than a national or international bank. Bankers can visit a business owner and bring with them the head of credit, or the president. Those are the decision makers, and that gives them the opportunity to really get to know your business. There aren’t many large banks where you will get that kind of personalized attention.
In addition, smaller banks tend to be heavy participants in the SBA loan programs. That helps them mitigate some of the risks that might be involved in the transactions and can accelerate lending to small businesses.
How can partnering with a local bank help a business owner develop long-term relationships?
At a local bank with experienced bankers, business owners get to know their bankers. At larger banks, people are often trained by rotating them through departments, and business owners may speak with someone different every time they call the bank. Smaller banks are less likely to do that, and with an experienced staff, you are dealing with the same people every time you call, giving you the opportunity to build that relationship.
How do those relationships result in a better match of banking products?
It allows the bank to better tailor products to a business’s needs. The banker has time for work with individual businesses to find out exactly what they want and need, tailoring solutions to that, as opposed to a big bank approach, which often views smaller businesses as too small to do business with.
A lot of big banks say they’re lending, but they’re not. A business owner might find more success with a local bank, which will take the time to understand their business.
Are a local bank’s clients limited to the area?
Not necessarily. With today’s technology, the reach is broader. It’s no longer necessary for banks to have branches on every street corner. Modern treasury management provides the technology to scan items and use an Internet-based system. If you find a bank that offers great service and solutions that fit your business, its physical location isn’t as important.
How does the market for lending look going forward?
There is currently a good balance of activity and an increasing amount of optimism in the marketplace. Car dealers are having a great year so far, business is booming for some manufacturers and industrial space is starting to get tighter. Although the media tend to focus on negative stories, there are a lot of businesses that are thriving.
Kevin Ball is senior vice president of commercial lending at Lorain National Bank. Reach him at email@example.com.
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If nothing changes by end of the year, more of your income in 2013 will go toward taxes, says Steve Magovac, CPA, MT, an associate director in tax at SS&G.
“With the tax cuts that are expiring at the end of 2012, everyone is going to be facing a tax hike in 2013, from those with moderate incomes up to the highest-income individuals,” says Magovac.
Smart Business spoke with Magovac about how the expiring tax cuts and new tax increases will impact your income in 2013.
What can taxpayers expect in 2013?
President Bush implemented tax cuts in 2001 and 2003 tax bills and President Obama extended them through 2012. If nothing is done legislatively, come 2013, those tax cuts are going to expire and tax rates are going to go up. The 10 percent tax bracket would disappear and move up to 15 percent for income levels below $35,350 for filing single. All other tax bracket rates would increase, with 39.6 percent being the highest bracket for income levels making over $388,350.
Currently, the maximum tax rate on long-term capital gains and qualified dividends is 15 percent, with lower income filers having a 0 percent tax rate. The expiring provisions would remove the capital gains rate back to a maximum of 20 percent, and qualified dividends would resume being taxed at the ordinary rates, as high as 39 percent.
With other expiring provisions, we’ll see the return of the ‘marriage penalty,’ limitations on itemized deductions and personal exemptions for high-income earners, reduction in the child tax credit to $500 and tougher eligibility requirements, loss of the American Opportunity Credit for eligible higher education expenses, the temporary 2 percent reduction in the employee share of FICA tax rate, and many others.
What new laws will impact taxes?
In 2011 and 2012, many employees and self-employed individuals benefited from a 2 percent Social Security reduction that is withheld from payroll checks. In 2013, the rate will revert back to 7.65 percent. In addition, as a result of the health care act, there will be an additional hospital insurance tax. This payroll tax of 0.9 percent will be paid by wage earners who make $250,000 or more if married and filing jointly, $125,000 if filing separately and $200,000 if single or head of household. This new tax does not apply on income earned up to the limits but kicks in on income above the set amounts.
Another tax being rolled out in 2013 is the Medicare contribution tax. This 3.8 percent tax will be paid by those individuals at the same income limits as the hospital insurance tax. The Medicare contribution tax is on net passive income — investment income, interest and dividends, royalties, rents, capital gains, annuities, etc. — in which high-income individuals will pay an additional 3.8 percent on that income over those levels. For example, if you are married filing jointly and your total income is $260,000, with $20,000 of it from interest, only $10,000 will be subject to that 3.8 percent tax.
What other changes are coming in 2013?
As part of the health care act, the medical expense deduction that currently applies to medical expenses over 7.5 percent of adjusted gross income will increase to 10 percent making that even more difficult to receive a medical deduction. In addition, under current law, you can put an unlimited amount — up to your earned income — in a medical flexible spending account. Beginning in 2013, that limit will decrease to $2,500 as a result of the government’s efforts to raise funds to supplement public health insurance.
In addition, some education benefits are going to decrease and some, such as the American Opportunity Credit, disappear at the end of 2012. The student loan interest deduction is also changing, reverting to an older law in which that deduction is only available for the first 60 months of repayment. Finally, the Section 179 and bonus depreciation limits are also changing; Section 179 is decreasing from $500,000 in 2011 to $125,000 in 2012 down to $25,000 in 2013, and bonus depreciation is decreasing from 100 percent in 2011 to 50 percent in 2012 and is eliminated in 2013.
How will these changes impact the way high-net-worth individuals think about tax planning?
Typically, people try to accelerate deductions and defer income into future years. However, if no new legislation changes are made to the expected 2013 tax code, it may be a better idea to reverse your thinking. If tax rates are going to increase next year and you know you are going to have a higher income, you may want to accelerate some of that income and take deductions instead in 2013, when the rates might be higher. One tax planning idea is if a Roth conversion is a worthwhile option, consider converting in 2012 rather than 2013.
There is a lot of uncertainty right now and it’s a guessing game what new legislation will be in place in 2013, if any. However, as of now, there is nothing good coming in 2013. The rules as they are now written show a large tax increase in 2013 for high-net-worth individuals. With the tax rate increasing to 39.6 percent, plus the additional 3.8 percent on the Medicare portion and the 0.9 percent additional payroll tax, high-net-worth individuals will be paying a tax rate of more than 44 percent.
If the economy is still fragile in late 2012, there may be a possibility of more favorable tax provisions passing to stabilize and improve the economy. But in my opinion, with the tax laws as they are, someone is going to be footing the bill, and that is more likely than not going to be higher-income individuals.
This year, it will be more important than ever for high-net-income individuals to work very closely with their tax advisers. You should be thinking about it now, but it’s really difficult to put anything into motion yet because it’s practically impossible to predict what will happen in 2013.
Steve Magovac, CPA, MT, is an associate director in tax at SS&G. Reach him at (330) 668-9696 or SMagovac@SSandG.com.
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