Using EBITDA to determine a company’s value

In evaluating the estimated value of a company, many experts will use a multiple of the earnings of the company before interest, taxes, depreciation and amortization (EBITDA) and then add cash and subtract debt. This calculation provides a potential investor with the estimated cash flows that they should expect if they would purchase the company. Determining the multiple to use to apply to the EBITDA, however, along with the other factors that contribute to a company’s value, is a more difficult issue.

Smart Business spoke with David E. Shaffer, Director, Audit & Accounting, at Kreischer Miller, about how to calculate the multiple in an M&A transaction.

Why is it that some businesses will sell for higher multiples than other businesses?

Historically, multiples for privately held businesses would range between four to six times EBITDA. However, some businesses will sell for less than four and some will sell for more than six. The main determinant of the multiple is the risk that the buyer is taking when they estimate the cash flow of the company.

Take, for instance, the following examples as an illustration of the effect risk has on the value of one company versus another. If you have a scrap metal company that is highly dependent on the commodity prices of different metals, the EBITDAs in these companies fluctuate widely from year to year based on scrap metal prices. As such, you would not expect these companies to sell at a high multiple. However, if you have a software company that is highly integrated into its customers’ businesses — those customers rent the software on a monthly basis and the customer retention rates are very high — these companies could sell for multiples far higher than a six because the cash flows are highly predictable.

Also, larger companies will typically demand higher multiples because there is less risk. Larger companies tend to have a larger sales force and are therefore not as dependent on a limited number of people for the results of the company. Additionally, larger companies have systems and processes in place for risk management.

Why are interest expenses and depreciation and amortization added back to EBITDA?

Interest expense is an annual expense that the company is going to incur and will negatively impact the buyer’s cash flow. It is added back because the resulting expected cash flow is then reduced by the debt of the company (usually limited to bank debt).

Sometimes depreciation and amortization are added back to EBITDA, and in other cases, they are not. If you have a business that requires replacement of its fixed assets periodically, a buyer will typically reduce the EBITDA by the expected annual cost for fixed assets. If, however, the company does not purchase many fixed assets, there may be no adjustment for the expected cost of the fixed assets.

What are some of the other factors that generally determine the value of a company?

  • A few key drivers that could help enhance the value of your company include:
  • Consistent increases in annual EBITDA.
  • A management team that understands the company and the needs of its customers.
  • Clear focus on the market with a solid strategic plan for growth.
  • A demonstrated ability to change with fluctuating market conditions.
  • Risk management processes that are in place and operating effectively, especially with regard to cyber security.
  • High return on invested capital.
  • A clear succession plan for senior management.

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What should you expect from your accounting firm relationship?

Business owners often have a stereotypical view of the relationship with their accounting firm — that they’ll get a financial statement audit or tax advice, and that’s it. That mindset, however, can result in a missed opportunity to build a more meaningful relationship.

“Businesses often see their accounting firm as a group of professionals who just do the taxes and other financial statements that all businesses are required to produce — things that they might see as a necessary evil,” says Lisa G. Pileggi, director-in-charge, Tax Strategies, at Kreischer Miller. “And accounting firms, similarly, can be so focused on these compliance matters that they neglect to communicate to their clients all of the other services that their firm can provide. The result is that both parties are missing out on an opportunity to have a deeper relationship beyond just the traditional services.”

Accounting firms are capable of helping companies save money, improve business operations and achieve the owners’ goals when companies see their accountant not as an external service provider, but as a business adviser and an integral part of their team.

“When companies and accounting firms take a bigger-picture approach to their relationship, it benefits everyone,” she says.

Smart Business spoke with Pileggi about how businesses and accounting firms can form a more rewarding relationship.

What should businesses expect from their accountant?

Businesses should expect an open, year-round dialogue. Things may seem quieter after the taxes or audit are completed, but there should still be regular touchpoints so the firm can understand what’s happening with a client’s business. It shouldn’t be a purely transactional relationship — one in which a few emails are exchanged at tax time, files are transferred and deliverables received.

Having a more in-depth relationship allows your accounting firm to provide proactive guidance that’s uniquely tailored to your business and its needs. For instance, the U.S. just went through the biggest tax reform since 1986. Some companies are still working their way through that, trying to understand the implications for the business as well as its owners. There are elements of the tax plan that are not yet well understood, but that could have significant ramifications for a business. So, a conversation with your accounting firm can help you sort through the intricacies and determine which areas require greater focus.

In a good company/firm relationship, companies should feel comfortable asking their accountant questions to better understand an issue. Where clients don’t initiate that dialogue, it’s on the accounting firm to reach out and help their client understand the issue better.

How should businesses go about choosing an accountant?

The best fit will be with someone with whom the business owner feels comfortable. This needs to be someone who an owner respects, values their input and is open to their guidance. There are many reputable accounting firms with highly skilled professionals. But it takes a strong relationship to have an open dialogue that ensures an owner’s business and personal goals can be achieved every step of the way.

What mistakes do businesses make in the process of selecting an accountant?

Businesses tend to undervalue the investment that needs to be made in accounting services. Sometimes it can be hard to distinguish between firms on the surface and it can be tempting to select the lowest cost provider. But the decision really shouldn’t hinge on price alone. The quality and depth of the relationship, as well as the breadth of services provided, are what matter.

Sometimes, in dealing with difficult business decisions, the answers that come from an accountant may be frustrating. That’s why it’s essential that the business owner trusts the person providing the advice. Having a strong relationship and regular contact with your accountant means they can stay on top of issues, leaving you to focus on running your business.

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The limiting effect of seeing your workforce through a generational lens

In the workplace, managing generational differences can be seen as critical to an organization’s success. However, as with any stereotypes, using them exclusively to manage, lead or judge comes with great risk.

“Business leaders often focus on differences between generations, which makes it difficult to develop the leaders coming up behind them and ultimately, allow them to come to a level of comfort handing the business over to them,” says Bobbi D. Kelly, PHR, SHRM-CP, Director, Human Resources, Kreischer Miller. “Instead, leaders should also identify traits shared across generations in order to effectively motivate their workforce.”

Smart Business spoke with Kelly about how to look beyond stereotypes to more effectively manage an age-diverse workforce.

What can leaders miss if they look at their workforce only through a generational lens?

While there is a tendency to concentrate on generational differences, it’s equally as important to identify traits that people across generations have in common. For example, the following characteristics can help leaders recognize that focusing on positive traits can lead to positive results.

Strong Work Ethic: According to a review by the Journal of Business and Psychology, studies found there is no real generational difference in work ethic. Where the work occurs is where generations differ: Boomers hold strict office hours but will bring work home when needed. Xers will work expanded hours in the office and take pride in being the ‘first to arrive and last to leave.’ Millennials have flexible hours and are confident that the work will get done, even if it’s not how you would have done it.

Healthy Question of Authority: Traditionalists were the last generation that exhibited uninhibited acceptance of authority. Boomers, Xers, and millennials have varying levels of trust in authority. Boomers believe that hard work equals respect, Xers look for authority figures to prove themselves, and millennials will give respect to authority when they feel respected in return. The commonality among these generations is that while they challenge authority, they all have the ability to respect it, given the right environment.

Thirst for Knowledge: Each generation outpaces the previous in their pursuit of higher education. According to Pew Research Center, employed millennials were 35 percent more likely and Xers 18.75 percent more likely to hold a bachelor’s degree or higher when they were between the ages of 25 and 29 than baby boomers in that same age bracket. While each generation values training and education, boomers see it as a reward, Xers see it as security and millennials see it as necessity. All generations have a desire to grow and learn in their careers. Knowledge transfer is one of the greatest challenges between generations because it feels like a monumental task to get the next generation up to speed on years of amassed knowledge.

Recognition: According to a 2018 study by the MidAtlantic Employers’ Association, over 50 percent of Xers and millennials, and almost 50 percent of boomers, look for recognition and reward. Recognition for a job well done is a driver of almost all humans. The different generations value different types of recognition; boomers feel recognized by financial reward, Xers feel rewarded by time off, and millennials feel recognized by praise from superiors. This factor that we all have in common is heavily affected by the life cycle stage an employee is in. When it comes to recognition, it’s critical to ask for clarification on what it is that the next-generation leader you are developing values as a reward. Just because Xers value time doesn’t mean they don’t value money, and just because millennials value reassurance doesn’t mean they don’t value time.

How should leaders apply these insights to their workforce?

In order to avoid limiting (or failing to identify) potential by seeing your workforce only through generational stereotypes, keep in mind that everyone is an individual. Generations are lenses to help us understand, but at the end of the day, we are more alike than we are different.

Acknowledge what your workforce has in common instead of focusing on how they are different. Roots are just as important as wings. Successful ‘older’ generations understand that you must provide both to the next generation.

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How not-for-profits should answer the call for greater sustainability

Sustainability. What does it mean for a not-for-profit organization and how are leaders addressing it, if at all?

“For many not-for-profits, sustainability has become one of the leading topics of discussion in board meetings and strategic planning initiatives, and is considered by management in their approach to each day’s operations,” says Elizabeth F. Pilacik, director, Audit & Accounting, at Kreischer Miller.

Smart Business spoke with Pilacik about sustainability in the not-for-profit world: what it means, why it is so important and how organizations can take steps to achieve it.

Why does sustainability seem to be at the forefront of conversation in not-for-profit organizations?

The subject has become more prevalent through conversations with funders, grantors and donors as their focus has changed from immediate support for a worthwhile mission to a long-term outcome approach; namely, an investment in the future of the organization and the community it serves.

Faced with changes in funding models and with a highly competitive process to access new financial resources, organizations need to evolve their focus past simply delivering on their mission.

What is meant by sustainability in the context of the not-for-profit world?

By definition, sustainability is ‘the ability to be sustained, supported, upheld or confirmed.’ To further deepen that understanding, to sustain means to provide for an establishment or institution by furnishing means or funds; to support means to maintain and/or provide for an establishment or institution by supplying them with things necessary to exist; uphold means to keep up or keep from sinking; and confirm means to make firm or more firm, adding strength.

Leaders in the not-for-profit world need to ask if they are providing for their organizations with means or funds for the things necessary for their continued existence, thereby adding strength and keeping it from sinking.

How is sustainability implemented?

Taking action to protect an organization’s sustainability may be much more complex than many in management or members sitting on the board realize.

While the concept of sustainability may have found its origins in the management of financial resources, it has developed into a more complex and challenging topic. In a continuously changing landscape, sustainability is not only financial but also programmatic, technological, strategic, and dependent upon human capital.

Defining sustainability for an organization is the first step; from there, the next step is to strategize to build strength and capacity. The decisions fall among choices such as how to diversify resources, how to go about recruiting team members and/or volunteers, the ways in which organizations address succession planning at various levels, and/or an organization’s approach to building mutually beneficial strategic partnerships and alliances.

When thinking about the sustainability of an organization, adaptability and perspective are two essential aspects — the organization needs to monitor, assess, respond to and create change while also focusing on its ability to connect with stakeholders, and to emphasize organizational outcomes and performance.

What should be the expected outcome once a more sustainable organization is created?

While just the act of addressing sustainability may present a challenge in many ways, it will ultimately strengthen and help preserve the organization in fulfilling its mission for many years to come.

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How the section 199A deductions might apply to your company

The Tax Cuts and Jobs Act made over 100 changes to the federal tax rules when it was enacted on December 20, 2017. The most significant change was the creation of an income tax deduction for nearly all businesses that both operate in the United States and that employ workers and/or place in service significant depreciable assets. A deduction is available to all taxpayers, other than C-corporations, equal to 20 percent of the qualified business income of a trade or business for tax years 2018 through 2025. This 20 percent deduction has the effect of lowering the taxpayer’s effective tax rate attributable to the qualifying business from 37 percent to 29.6 percent.

Like many changes in the tax law, this new incentive did not come without complexity, as there were many questions regarding who would qualify and how to calculate the deduction.

“The IRS did a commendable job on publishing the final rules in the early part of 2019 to provide much needed clarity,” says Carlo R. Ferri, director, Tax Strategies, at Kreischer Miller. “Although this addressed many of the questions that existed at the time, there still are a number of open issues that need further guidance.”

Smart Business spoke with Ferri about some of the more common issues and where guidance on those issues stands today.

What businesses qualify for the deduction?

Companies that mainly focus on manufacturing and distribution of their product within the United States that have employees and/or have significant fixed assets generally will qualify for the 20 percent deduction. Companies that generate revenue by providing a service generally will not qualify for the deduction.

The final rules provide comprehensive examples of which service businesses will not qualify with a narrower definition to give more clarity in this area.

This sounds very straight-forward until you start having conversations with real taxpayers with real facts. Their facts become quite messy because they may operate multiple trades or businesses, which can make applying the new rules to determine if they qualify very complex.

Does rental real estate qualify for the deduction?

Determining if rental real estate qualifies for the deduction is still challenging. If you own real estate that rents to your business, then the final rules clearly allow you to take the 20 percent deduction. However, if you own rental properties outside of the context of your business, then the rules are not very kind. The final guidance released by the IRS provided a safe-harbor for taxpayers to follow in determining if the rental property qualifies, but this analysis is quite complex, which often results in many taxpayers being unable to qualify. The taxpayer’s only alternative is reviewing the inconsistent tax case law in this area to make a determination for inclusion.

Does switching to a C-corporation now bring any advantages?

With the lowering of the corporate tax rates to 21 percent, many taxpayers have inquired if it would be best to convert their S-corporation or Partnership business to a C-corporation to save on income taxes. After going through the analysis for many companies, it became quite clear that if these companies were going to fully benefit under the 20 percent pass-through deductions, there would have been a significant reducing effect on the overall individual effective tax rate, and that lowering of the tax rate would make conversion to a C-corporation less advantageous. Also, it became quite clear that many business owners desired the tax efficiency and flexibility to take profits out of an S-corporation or Partnership compared to the double-taxation in a C-corporation. Therefore, business owners concluded it’s better not convert to a C-corporation.

Much progress has been made by the IRS and the business community on addressing the major issues and questions that existed in determining the new 20 percent deduction. Even though the final rules have been published by the IRS, there are still many open questions that have not been addressed and are left to taxpayers to make a reasonable interpretation of the rules.

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Is your leadership style helping or hurting your company?

Leaders take many forms, ranging from task-oriented tacticians to big picture-oriented strategists. The better leaders demonstrate flexibility among approaches, adjusting to the needs of their company, which can change as their company advances through the stages of its life cycle. Inflexibility, or failure to delegate leadership responsibilities to those better suited to a specific task, could cause setbacks — losing top talent to frustration, or draining value from a company because it’s unable to adapt.

Smart Business spoke with Chris Meshginpoosh, Managing Director of Kreischer Miller, to discuss the pros and cons of different leadership styles, and the importance of recognizing when to adjust.

What are the attributes that make for a good leader?

Aside from the obvious traits of integrity and good communication skills, leaders must make sure that their leadership style matches both the task in front of them and the talent of their other team members. For example, when leading a group of inexperienced team members engaged in a time-sensitive task, an autocratic leadership style may be highly effective. However, if a team is addressing a problem that requires creativity, an autocratic style can stifle the team’s efforts. Similarly, when leading a team of experts, an autocratic management style can result in lower levels of employee engagement and higher turnover rates in top talent.

There are stories about Bill Gates’ authoritarian management style in the early days of Microsoft. However, as the company grew, he was able to keep that style in check, understanding that exercising too heavy a hand could stifle innovation.

In the early stages of a business, an autocratic style is often necessary. The founder may be the only subject-matter expert at the company and, as a result, cannot delegate critical tasks to others without remaining heavily involved. Unfortunately, leaders who do not evolve with the business or devote the time necessary to recruiting and developing others and then trusting them to make important decisions, risk causing their companies to hit a wall. Great leaders evolve along with the needs of their organizations.

How can leaders tell if their style is not working?

Sometimes the symptoms, such as the loss of key members of the management team or deteriorating company performance, do not surface until the style is so deeply embedded in the culture that it is difficult to remedy. Employees — even those most trusted by the CEO — may not feel comfortable providing constructive feedback regarding the CEO’s leadership style. In these cases, creating a board of directors or a board of advisers can often help, because they can bring some level of objectivity to the table and can provide proactive feedback to make sure leaders adjust as the business grows.

What are some other potential long-term problems and what can leaders do to prevent them?

The reality is that, whether owners want to think about it or not, they are all going to exit their business at some point. There’s nothing worse than getting to that point only to find out that their successors — whether they be inside managers or outside buyers — value the business at only a fraction of what the owner expected.

Leaders can ensure they do not find themselves in that situation by devoting the time that’s necessary to develop the next generation of leaders. It also means having the courage to step back and give them the room they need to try, fail and learn. By doing that, and by providing support and feedback along the way, the business will have a strong foundation for future growth that will be much more highly valued by either internal or external buyers.

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Create and protect the value of your business

Many successful businesses start with a period of strong initial growth, but eventually level off as they mature. When that happens, it is common for the entrepreneurial spirit to diminish as the company’s leaders tend to focus less on the value proposition that inspired the initial growth period and spend more time on the day-to-day operations. Along with maintaining current operations, it is critical for leaders to continuously assess the valuation factors that impact their business on a regular basis.

Smart Business spoke with Brian J. Sharkey, director-in-charge of the business advisory group at Kreischer Miller, about what drives value in a business.

How is business value determined?

In its most simplistic form, the monetary value of a business interest is based on the future expectation of cash flows, which is why most valuation drivers revolve around the ability to replicate sustainable cash flows into the future for as long as possible.

As a result, the fundamental question every management team should ask themselves is: ‘What drives the value proposition for this business?’ Most of the time the answer will gravitate towards the ability to put forth a profitable product or service that customers will return to. But it’s also a bit deeper than that.

Value creation can also be achieved with improved processes. By implementing more streamlined and efficient processes, in the course of producing a product or providing a service, the company will have the ability to offer a lower price than competitors while still maintaining similar or better profitability. In addition, the company will be able to increase its market share, which will improve brand recognition.

How are brand recognition and value linked?

For most businesses, the value in brand recognition is immeasurable. Brand recognition is what keeps customers coming back to a product or service; without it, a company loses the ability to generate those recurring revenues, which are critical in measuring a business’s value.

Ask the management team how customers perceive value and whether the business is meeting those expectations. This concept goes beyond just quality and value, and into evaluating the overall customer experience. A business can have the best product or service out there, but if the customer experience is awful when dealing with the company, then none of it will matter and customers will look for alternatives.

What do employees contribute to a business’s value?

Employees are the most valuable asset of a company; an asset that does not show up on a balance sheet. If a business neglects to develop and retain those individuals who are critical to the organization, they can be recruited by a competitor who is looking to get a leg up. The knowledge and skill sets of a workforce are difficult to replace without significant time, costs and effort. Having to constantly retrain or develop new members of management is a distraction from the other activities that should be the focus of the company.

How can business leaders continue to drive up their company’s’ value?

Once a business becomes mature, as much attention needs to be paid to protecting the value as to creating value. This starts with never being comfortable, as complacency generally leads to declining value or vulnerability from competition. The companies that continue to succeed and build value are the ones that are constantly investing in process improvement, innovation and product development with aspirations of finding that next big thing. By doing so, they are hitting on many of the drivers that positively impact valuation, such as creating a recurring revenue model, diversifying their product or services, creating their own intellectual property, maintaining state-of-the-art facilities and employing top-notch people.

Focusing on tasks and objectives that increase company value will not only drive short-term results, but more importantly will also allow owners to maximize the valuation upon a future sale of their equity interest in their business. Even though a sale may not be in the immediate future plans, it is still wise to focus on valuation factors in the event that an unexpected, unsolicited offer is made.

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How the search for top talent changes in a tight labor market

“It’s a tight market for C-level talent, and the most competitive environment for top performers that I’ve ever seen,” says Tyler A. Ridgeway, director of human capital resources at Kreischer Miller.

He says companies looking to recruit A-players in this formidable landscape need a well thought-out strategy to attract that level of talent.

“Highly talented executives aren’t going to respond to a want ad, but if you can find someone who’s not really happy with the company they’re working for, they would answer a call from a recruiter who has a compelling offer,” he says.

Smart Business spoke with Ridgeway about strategies to consider in the search for and acquisition of top talent in a tight labor market.

What should companies understand about recruiting top talent?

Companies looking to recruit top-tier C-level talent need to understand that these individuals will be evaluating the company as much as the company is evaluating them. That means companies doing the recruiting need to put a good deal of thought and effort into the process.

Companies should invest a good amount of time before the search process begins to develop their recruiting story and ensure everyone is on the same page. That way, as candidates come into the process and meet the individuals who might ultimately be their C-level peers, the message they receive is clear and consistent. This should not be thought of as a sales pitch. Rather, the aim is to be open and transparent about expectations, the position the company is in and why it’s looking to fill this executive role.

It’s also critical to think about compensation beforehand, and consider a strategy that will reward long-term growth. While candidates likely won’t take a reduction in overall compensation for a new position, they might very well make a base-salary-lateral move if the long-term compensation, based on performance, is attractive.

What mistakes lead to companies missing out on the better candidates?

One common mistake is an interview process that is unnecessarily long. Due diligence is vitally important for these roles, but you also need to be mindful of the candidates’ circumstances. They are key employees in their companies, so their time is limited. They also may be fielding other offers. Therefore, try to keep the process moving along as much as possible to limit the risk of losing out on a candidate.

Transparency from the outset of the process is also key. Companies should tell candidates how long they expect the process to take, and what steps are involved. Some candidates may admit right away that they can’t commit. But for those who can, a transparent process can help build trust between both parties — candidates know what they’re getting into and companies can feel confident that they’ve found the right fit. An in-depth process also creates familiarity with the company, enough so that the candidate can hit the ground running right from the start.

How should companies adjust their staffing strategy during a tight labor market?

Be proactive. Companies that are really ahead of the curve are doing a lot of aggressive succession planning, and for more than just the CEO position. It’s important to have someone in the organization examining each department to see whether or not there are people who could climb the metaphorical ladder.

Consider this exercise: Imagine who in the organization would be tough to replace if they were to suddenly give notice to the company on a Monday that they’re leaving. Then, talk with those people and try to determine whether they feel they’re properly incentivized to stay. Also, consider whether there are people below them who could be trained to take over the position. From there, you can formulate a plan for what it will take to keep the top performer in place, as well as how you can build bench strength should the need arise in the future.

The war for talent is real. Those companies that want to hire the best candidates need to be prepared: have a great story and a compelling incentive program to put your best foot forward as an organization.

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How to develop the next generation of leaders

It’s unfortunately very common that many businesses do not have any sort of leadership development program in place. Typically, that’s because most owners are too involved in the business to work on the business, so strategic initiatives like leadership development are an afterthought.

However, businesses that do have leadership development programs tend to also have formal governance and a more sophisticated management team. These factors often translate into companies with higher employee retention rates and better financial performance.

Smart Business spoke with Steven E. Staugaitis, a director at Kreischer Miller, about how to set up a leadership development program.

What are the most critical aspects of a leadership development program?

A central piece of it is identifying the right candidates, which requires flexibility. How leadership is aligned today — its skills and knowledge — may not be what the business environment demands in the future. Running a business is so dynamic that what a company thinks it needs today could be very different than what it actually needs five to 10 years from now.

Family businesses that are intentional about their family legacy tend to have good leadership development plans. They’ll identify family members who have certain qualifications and help support their growth through a variety of activities. For example, companies might rotate their leadership candidate through different roles and departments in the company, assist them to obtain advanced degrees or send them to specific training. Mentoring relationships with people inside or outside the company is also a common practice.

How should companies choose candidates for leadership development?

It’s the tendency of companies to choose leadership candidates based on strong technical competencies. But when looking for a future leader, it is also critically important that they have the right leadership skills. As the leader of any organization, you are expected to motivate and encourage people, and hold them accountable for their performance. Leadership is more about managing people and driving a strategic vision rather than being a good technician.

What do companies tend to get wrong when it comes to leadership development?

The most common problem is that companies don’t do anything or wait too long to start. Leadership is not a switch that gets flipped just because someone’s title has changed. It takes years to develop internal candidates — a five-to-seven-year runway should be expected when grooming an internal candidate for a leadership position. And for those companies that don’t have internal candidates, it can take the better part of a year or more to hire an outside candidate for a key position.

In any transition, there is always risk in the process. When companies invest in people to make them better, they also need to empower these candidates along the way and give them a chance to implement some of their ideas. If not, there’s a good chance that they will take their skills and go somewhere else.

What are the differences between developing leaders and hiring them from the outside?

Often an internal candidate is perceived as less threatening to the rest of the organization than bringing in an outsider since they are known within the organization and also by their clients and customers. Promoting someone from within sends the message that there are similar opportunities for other people in the company.

Interviewing outside candidates for leadership positions can be a little like dating. Candidates and companies are on their best behavior. It’s not until someone is hired that their nuances and true personalities are revealed. Taking your time to thoroughly vet outside candidates for critical positions is a good idea.

Regardless of whether a leadership position is filled by an internal or external candidate, the process can’t begin early enough. It may seem overwhelming at times, but at least starting with something, even if it’s something small, is a far better alternative than do nothing at all.

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How the Wayfair decision is playing out in the U.S. market

It has been several months since the U.S. Supreme Court rendered its historic decision in the South Dakota v. Wayfair Inc. case and taxpayers are still grappling with its implications.

Prior to the Wayfair decision, a business had to have physical contact with a state before becoming subject to its sales tax collection and reporting requirements. As a result of Wayfair, physical presence was no longer required to establish a substantial contact with a taxing state for sales tax. The new sales tax nexus standard is now commonly referred to as economic nexus.

“The reality is that the U.S. Supreme Court changed the sales tax compliance landscape overnight, because states were very quick to get on board and adopt an economic nexus standard that was identical to the South Dakota standard at issue in Wayfair,” says Thomas M. Frascella, J.D., director of tax strategies at Kreischer Miller.

Smart Business spoke with Frascella about the Wayfair decision and how the change is affecting both businesses and states’ sales tax collection practices.

What has changed because of the Wayfair decision and who is affected?

As a result of the Wayfair decision, approximately 36 states now consider a remote seller to be subject to a state’s sales tax rules when the remote seller has either a specific number of transactions with residents in that state or a specified dollar amount of sales in that state. Generally, $100,000 of sales or 200 transactions will subject an out-of-state business to a sales tax collection responsibility in states adopting an economic nexus standard.

The decision affects many businesses, especially those that operate from a single location but use multiple channels, such as marketplace facilitators or internal e-commerce platforms, to generate sales. Often these businesses do not have either the personnel or financial resources to comply with these new requirements and must now navigate this new reality. Although there have been attempts at the federal level to pass legislation to minimize the impact to small businesses by narrowing the nexus generating activities, these attempts have failed and businesses remain subject to the requirements of each and every state.

How are businesses responding to the law change?

Businesses will now need to determine how to move forward. Some may decide to take a wait-and-see approach to the matter and do nothing, opting instead to see how aggressive states become in identifying and pursuing remote businesses for sales tax. Other businesses will be more proactive in managing their new filing requirements and begin to explore solutions. These solutions will most certainly require some type of technology investment to enable a business to charge the proper sales tax, as well as collect and remit that tax to the appropriate state and local taxing jurisdictions.

Businesses should take the time to understand the states where they have met or exceeded state economic nexus thresholds for sales tax purposes to determine if they have an issue. It will also allow a business to assess their potential exposure if they have nexus and decide to do nothing.

How are states’ collection practices changing?

States are likely developing discovery tactics and collection practices to identify out-of-state businesses with sales tax nexus. Once a state identifies an out-of-state business that should have been collecting and remitting sales tax, it will pursue recovery of past due sales tax with penalty and interest, which could be difficult for a business to recover from customers.

Many states are operating in a deficit and need to find new sources of revenue. It is no longer a ‘if they find me,’ but rather a ‘when they find me’ scenario. No business should consider themselves too small to pursue. Businesses need to develop an action plan to avoid being caught holding the liability for a tax that could have been passed along to customers in the normal course of business.

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