Your Key Group Has Great Value And Creates A Better ROI For Your Company’s Value!

Over the years I have written of the importance of the key group in your company is, and how they enhance your profitability and company value. Not only do they make you profitable while you are running your business, but this group is the key element to selling the business for the highest potential value in the future.  

 The inside key group creates the actions that help enhance value, such as implementing value drivers and making sure they are being applied correctly. Key management groups make sure the value drivers are implemented, working, and being enhanced constantly. 

The Key group learn about the business, in some cases better than the owner. They make business more valuable. They are so talented the competition is aware of their value, and in many cases would like to recruit them.  

It would be wise for the owners to recognize the value of the person or group (key person) and put in place strategies to keep them.  

  1. Incentive programs:  The purpose of this is to keep the key person around. To continue the growth of the person within the business. He may be the person who buys, or totally runs the company.  
  1. A vested incentive program:  This is to carry out #1, but also to protect the employer from the key person leaving.  
  1. Address the potential of your exit strategy in advance. This can be in the form of a discussion about a “stay bonus.”  The “stay bonus,” is used when an owner wishes to sell the company but would like the key person to stay on with the new owner. This enhances the value of the purchase price.  
  1. Keyman/group:  Potential purchasers of the company. It is also important to recognize that the owner may be thinking of becoming a passive owner, wishing to have the key group run the company while the owner peeks their head in occasionally.  

There are many ways to address the future knowing the key group is key to your exit strategy. This can range from incentive plans, to things like stock options.  

 Existing Key Employee  

Equity Based Incentive program:  

  • Stock Bonus 
  • Stock option 
  • Stock Purchase
  • ESOP

Cash based incentives 

  • Cash bonus 
  • Deferred compensation 
  • Phantom stock bonus 
  • Stock Appreciation Right 
  • Supplemental Employee Retirement Plan (SERP) 
  • Executive Coaching Program 

Awards based on 

  • Individual key employee performance 
  • Key employee group performance 
  • Company net income growth 
  • Company sales growth 
  • Vesting Formula 
  • Forfeiture Events 

      Agreements 

  • Non-compete 
  • Non-disclosure 
  • Non-solicitation 
  • Any other agreements that will protect the owner should the key person (group), leave 

Success In Business Is Not Without Challenges!

DEFINITION OF BUSINESS GROWTH AND TRANSITION 

I often refer to my business planning as “Business Growth and Transition,” because I consider the business and the owner, as two separate and distinctive entities.  

For example, when the business is growing, the owner of the business needs to grow with the business and envision needed growth. As a business owner, he/she needs to continue to learn, ask more questions, depend on their instincts, experiment, be willing to fail, along with many other experiences to create the changes neededWithout the business owners’ creativity and involvement, the business will stop growing.  

Likewise, when planning for the business entity, we also plan for the owner personal needs. The business success creates personal challenges for the business owner, such as succession, estate taxes, family distribution, protection of the assets, and a host of financial and personal planning areas.  

STAGES OF A BUSINESS 

The business has two distinct stages it goes through which are critical; I define them as survival period and growth period 

Survival period is just what it means! Staying alive! This is where owner learns how to maneuver through the maze of “business savvy” strategies. “What doesn’t kill you, will make you stronger.” 

The survival period of business consists of: 

  • Excessive amount of time, sweat, and patience, luck, and much more.  
  • Bottom line:   Survive staying in business.  
  • Cash flow, Capital improvements, Inventory, client development create many challenges. 

The Growth Mode: 

 Not to simplify, but this is where the action is. It is up, up, and awayWhat needs to be done during this stage:  

  • Creates the opportunity for the future value of the business.  
  • To expand in all areas of the business. 
  • Inventing yourself and the company if needed, this includes building value drivers and transferable values. 
  • To become creative, reinventing of products, customers, process. 
  • To reinvent your markets and your clients. 
  • To build a customer base with loyalty, creating culture, and next level management. 
  • Much More… 

The expansion in Growth, (NOT ONLY) in markets and products, but also employees and the culture of the business. This is extremely important for the future of the business value, with the focus on growing your business value and to create transferrable value for the future. Owners need to start the process of giving up some of the control to middle management. This also means creating strategies which allow the owners to walk away and allow the business to run effectively and efficiently normally. This is my “Can you Take three months off” question, without an impact on your business profits?   

Disadvantages of Growth/ and letting Go 

You are giving up control to your management team! You are giving up things you controlled from the very infancy of the business. This is good because a future purchaser wants to buy your business as a running entity. They want a business that can run, and without YOU!  

When you start to delegate to others, things can happen. Your key people will learn how to run your business, and start thinking like an employer. They will develop greater relationships with your customers, advisors, and vendors. They will start to create profits for you, ease your time in the business, and allow you to enjoy more free time, however, there could be a price to pay!  

Tough Questions to Ask 

  1. What if your key people got to know your business so well, and they wanted to buy it from you, what would you do 
  1. What if you did not want to sell it to them at the time they want to buy? Will they walkWill they stay? Will the relationship change?  
  1. Will they go to a competitor 
  1. Will they take your customers and employees with them 

If this happened, what are you doing to protect yourself 

Consider this:  I recently had a client who went through this nightmare. The key people (2 key employees), left and started their own business. They also took other employees and customers with them.  

Unfortunately, the protection which we outlined to the owner three years prior was never implemented, and they are paying the price for it now.  

We told them to make sure they had programs in place to protect themselves from the business growth and success. 

Things Such As:   

  • Key person documents:  such as non-compete, non-disclosure and non-solicitation of customer and employee agreements.  
  • Benefits with Vesting:  We also suggested that they put in a vested benefit package for them and stagger the time where they would only have a partial vesting immediately  (we have found this to be a valuable motive to stay).  

Lesson to be learnedIf it happened to them, it could happen to you. Your key people will take over your business, which is good because as it creates transferrable value for the future. However, you must protect yourself from your business success.  

Insight 18 Key Groups Have a Voice In Your Company!

Your Key Group Holds The Key To Your Success! But! You Need To Listen To Them!

This was an interesting case we worked on. There were a few educational moments that I would like to share with you. 

Scenario:  Three brothers owned a successful manufacturing company. The company had several government contracts over the years and built an exceptionally good reputation with the government agency. These contracts were very profitable and kept the company busy. The company took pride in its work, delivery of the projects, and having the staff to accommodate the project, which lead to ongoing contracts. Over time, it became clear that doing work for the government and a few other companies was all the manufacturing company needed to be profitable and grow. 

So, what is the problem? On the outside, nothing, but inside there were some disturbing situations brewing. 

This scenario set up the problem we had to deal with. The key person in the firm developed a strong relationship with the agency head who awarded the contracts. He did an excellent job enhancing the relationship over the years. Through his efforts, the owners were able to be very profitable and to take sizable salaries each year. 

Because the key person ran the business like he was the owner, the three owners were able to take a lot of time off. They usually spend about two days in the business a week and took long vacations. 

The problem started when the owners decided to give the key person a large bonus the past year for doing a fantastic job. However, the key person assumed this would be the norm each year. A good salary and a fabulous bonus, which the key person was looking for each year. So, when a new year rolled around, there was anticipation by the key person to receive the bonus. When he approached the owners about the bonus, there was a clear disconnect between their vision and the employees. 

The owners felt that the bonus was based on performance of a particular year and did not think the key person would be looking for this substantial bonus each year. In a way, the owners felt they were being held hostage by the key person. “Once a luxury, it became the necessity”

However, when we broke it down for them, they realized the key person had the relationship with the government agency, not the owners (they did not even know the contact). The government contract represented about 40-50% of their sales. The keyman also had a great relationship with the private companies. We suggested to the owners that key person was more than a key person, he was their middle management! 

PROBLEM: The key person wants to receive a bonus as if it was part of his salary each year. Owners did   not want to pay it! Also, the company had 40% or more of its revenue in one basket (the government agency). 

Our part:  We communicated to the owners that based on the relationship the key person has with the vendors and customers, there would be a potential disaster if the key person were to leave. A few things which would happen: 

  1. He would take the business to a new employer.
  2. He could take employees with him. 
  3. He could stay but put less of an effort in building the business. 

After looking at all the facts, the owners realized they had a great deal and what they were receiving from the efforts of the key person was certainly more than what the keyperson wanted. 

 Educational moment:  We suggested the following.

  1. Owners communicate to the key person that he is a part of the growth of the company, and not only give him a bonus, but include an incentive of a % of business growth, or some metric that was measurable.
  2. Create a “graded-vested benefit,” which would be hard for the key person to walk away from. 
  3. Execute a non-compete clause and a non-disclosure agreement concurrently with the implementation of a selected benefit for the key person. “This is what we would like to give you, but for this we want you to agree to this.
  4. We discussed the disproportionate revenue from the government and discussed ways to increase their customer base. We suggested that no more than 10-15% of revenue should be coming from one source. 

These were only a few of the steps we suggested. 

It is common for owners to reevaluate their middle management; however, compensation is only part of the equation. Creating a middle management culture takes time, loyalty, along with compensation and benefits. Your key person(s), may be one of the most valuable assets of your company. Certainly, it is one of the value drivers which increase the value of your company. 

Without A Conclusive Direction, We Know This Case Will Go Bad for The Family!

Re:  Limited Information Case!

Current fact-pattern (albeit scarce)

This was a case which a professional advisor brought to us. We did not engage this client because there was a lack of facts collected. However, we did want to demonstrate to the advisor, that there were options his client could consider if there were more accurate facts.[1]  As a professional advisor you must obtain many accurate facts of the current situations.  This was a case which had great potential; however, the client was not willing to put the work needed to find solutions.  

Dad is planning on leaving family business to son A, with son B to inherit other assets.  Dad is hell-bent on leaving business at death to get the stepped-up basis. Which is fine if you know all the facts, but he didn’t know all the facts, nor did his advisor council him on them.  

There is no certified appraisal of the business, worth $10,000,000(owner suggested). Spouse would inherit other property (rental real estate and residence along with stock portfolio about $5,000,000). There are no mortgages on the commercial real estate or the residence. 

  1. There is no certified appraisal of the business. 
  2. No estimate of real estate value. 
  3. Dad’s health is questionable. 
  4. No life insurance or corporate benefits other than health insurance.
  5. Estate documents are very old- 25 years old. 
  6. Accountant was not proactive in the planning.
  7. Advisor did some investing for the estate owner.

MODELING:  Until we had more facts about the client’s situation we are limited in our models. However, there are some hypotheticals as options.  As mentioned, the options available need more facts before for these can be considerations. 

  1. Do a current certified appraisal. The cost to litigate in Federal Tax Court compared to a certified appraisal is dramatic. 
  2. Recapitalization of company, creating non-voting stock to create a minority discount, and to use the gift tax exemption to gift this stock to his son maximized before 2026 the gift tax exemption and estate exemption ends.  
  3. Family trust for income purposes for the spouse with son B as beneficiary.  (stepped up basis, and unified credit available)
  4. If exemption credit were less at dad’s death after 2026, use marital deduction and continue gifting program.  
  5. There is also the possibility that Dad could gift limited shares to Son A and then also sell the other shares to Son A with a SCIN[2]. Self-Cancelling Installment note based on his health this could be a consideration.
  6. If company was a pass-through company, spouse could enjoy income from the company after dad’s death without employment.   
  7. Suggested using the company to create tax-effective benefits for the family members, such as a Cash Balance AccountExecutive Compensation such as Deferred Compensation.  
  8. Family could set up an irrevocable trust funding it with a second to die life insurance policy and gift the premiums to the trust.   The tax-free life insurance death benefits could clear up any liabilities, taxes, or level more of the estate value to the sons. 

Keep in mind, this is a hypothetical model, and there are many more directions which we could go.  It is extremely important that the professional advisor get as much information they can from the clients, and their other advisors, so there is a correct representation of the current situation.   In this way, you can build the models needed to satisfy the clients financial wishes.  


[1] DISCLAIMER:  we did not engage this client. Lack of facts.

[2] This is a method of transferring property when the mortality of the owner is questionable because of health issures. There is a premium that must be paid on the sale.  If the owner lives longer than mortality, the family will end up paying more.  However, if death occurred less than mortality, the note would be cancelled.  (owner must not be terminal ill when they enter this transaction.) 

Planning Your Business For An Exit! 

Repeatedly, when the topic of exit planning is discussed in conversation with   my business clients, they tell me they are not ready to sell their business.   In which I reply, “the moment you started your business, your “exit planning” should have started.  I get the raised eyebrows.   

Let me explain why this happens; The generic term “exit planning” has taken on a meaning of, “when I want out of the business and when I am ready to sell.”    Advisors use the term as though it was a noun, such as a piece of property.     

To me “exit planning” means: “Actions taken by an owner to create the highest potential value for their company, so when the need arises in which they wish to sell,   or make a financial transition with the company they are prepared”.   

I liken my reasoning to owning a home, keeping it up to date, and fixing problems as they arise, knowing at some point someone may knock on the door and make a great offer to buy the home.  The great offer is the highest potential value for the home.    

If on the other hand the homeowner let the home deteriorate over time, under the same type of scenario the offer the owner would have received would have been much lower, if any.    

If an owner chose to use my definition of “exit planning,” they would start at once to implement the value drivers needed for a company to create the highest potential value for the future. Creating these transferrable value drivers take time, in many cases years to implement.    

There are 8 Value Drivers:  

  1. Financial Performance:  Your history of producing revenue and profit 
  2. Growth Potential: Your likelihood to grow your company in the future and at what rate.  
  3. Structure:  How dependent is your company on any one employee, customer, or supplier?  
  4. Valuation:  Can your company control cash flow?  
  5. Recurring Revenue:  The quality of automatic revenue you collect  
  6. Exclusive control: How are you differentiated from competitors in your industry?  
  7. Customer Satisfaction: The likelihood customers will re-purchase and refer your company.  
  8. Are you needed:  How would your company perform if you were not able to work for three months?   

As you can see there is a difference in the term “Exit Planning.”  Therefore, I suggest, to everyone who opens a new business that they should start their exit planning at once, so all the value drivers needed to increase their company to its highest potential value will have time to create the value.   

 

THE SECRETS OF BUILDING A GREAT ORGANIZATION

I recently read a book called,” The Secrets Of Building A Great Organization”, by Bruce Clinton owner of BusinessWise, L.L.C., a business consulting and coaching firm based in Connecticut.

I found the book to be very interesting because, not only does it provide a road map of management for newer managers, but it re-educates older experienced managers in the most up to date strategies.

Bruce is the first person to mention that there are no magic formulas in being a good manager, however, with the basic strategies that he covers, a good manager, through their own talents, can become a great manager using the strategies Bruce discusses.

Many of the strategies are ones that Bruce uses in his practice as a business coach, and strategies developed while he ran different businesses.

For anyone who is a business owner or running a business, I would suggest this read.  In the book it is mentioned that most business owners don’t consider themselves good managers or they feel they don’t know enough about managing.

Any business owner who does $1-$150 million in annual sales, has 8-200 employees, is family owned and may be facing growth or succession issues, should read this book.

What I really enjoyed about the book is the small details that Bruce covers which are needed to build a successful business.  These are details which are not normally discussed in detail.  The book covers the importance of them.  These are the small details that make all the difference in the world of a business’ success, and Bruce covers them extremely well.  For example:

  • Overcoming communication breakdowns
  • Dealing with levels of incompetence
  • Fitting family members into the business
  • Retaining good employees
  • Building a workable succession plan

Continue reading “THE SECRETS OF BUILDING A GREAT ORGANIZATION”

Why Use Non-Compete Agreements!

Non-compete agreements (NCA) represent a separate agreement. They could be in an employment contract, or as a separate article in a buy and sell agreement. Sometimes they are referred to as Covenants not to complete. “

This is based on the possibility that an employee can do harm to a company upon termination.  They could know sensitive information about the company’s operation, owners and employee’s personal information, special operations, and proprietary information to a competing advantage, along with so much more.

Picture a very long-term employee working side by side with the owners, for many years, and then leaving to work for the owner’s competitor.  Certainly, there can be issues.

No compete agreements (NCA), can be used to retain employees also.   It would be very difficult to change jobs within an industry or profession when the leaving employee is limited to compete in a geographic and specific industry for a period of time.  However, non-compete agreements are hard to enforce, because in many instances the agreement has overreached and is very broad in the definition of industry and geographic coverage.

Continue reading “Why Use Non-Compete Agreements!”

Critical Questions That You Need To Answer If You Own A Business!

Building a business is hard work. Protecting and preserving it is even harder and overlooked by business owners.

While many owners expect family members to take over the business (69%), very few have actually made plans to make sure their wishes are accomplished (26%), even though they realize the importance of estate and succession planning as is an integrated part of that planning.[i]

A succession plan is complex, time consuming and involves attention to details along with many hard questions which need to be answered for a comprehensive and effective succession plan.  It is also the key element in maximizing the return on the investment of your business. This is the big financial payout, the sale of your business.[ii]

SOME MAJOR QUESTIONS AND ISSUES TO ASK YOURSELF!

What if a shareholder wants to sell their interests?

  • Is there a right of refusal for the other owners?
  • What are the financing arrangements?
  • What are the recourses if you fund the buyout especially if the funding is over a long period of time?
  • What is the arrangement if the business fails, how will you get your money if you financed the sale?

 Who steps in your shoes if you want out? 

Not everyone has the luxury of leaving a business when and how they want to.  Things like death, disability, and situations are uncontrollable.

  • What are your contingency plans when a trigger occurs (death, health, non-voluntary situations)?
  • Do other members of the firm have access and authorization to use funds to keep the business going if there is such an event?
  • Does your family take on personal obligations for financial notes and loans you have signed personally to fund your business operation?
  • Do you have estate documents and health care directives, should you have a disability or become incapacitated?

Taxes- and the planning for them Continue reading “Critical Questions That You Need To Answer If You Own A Business!”

Disadvantages Of The Buy And Sell Agreement! [i]

Certainly, having a Buy and Sell Agreement (BSA) has many advantages, many of which I have discussed in our past posts (May 2019, Advantages of Buy and Sell Agreements).  However, I would like to go over the disadvantages of a BSA.

RESTRICTIONS ON ESTATE PLANNING

BSA can restrict ownership transfers and consequently management duties. These restrictions can be applied to you also. The restrictions could limit your personal planning by limiting your options for the ownership interests during your lifetime or at death. It may prohibit you from making gifts of your ownership interest to your family. Depending on your planning, your BSA could limit your plans to leave ownership interest to your family. The BSA may require your ownership interest to be sold at your death.

RESTRICTIONS ON FINANCIAL PLANNING 

A BSA can restrict the persons to whom you could sell your ownership interest to and restrict when you can sell it.  An example would be in a situation that you need to sell your interest because you’re in a financial bind. The BSA may require you to sell to your entity or your co-owners, who may not want to buy.

Special election to the defer federal state tax of deceased owners

This could limit an estate owner from using Code Section 6166 which is a way of paying your estate tax over a period of time, giving you the option of paying over a 15-year period, five years of deferral and a ten-year payout.  A purchase from your estate could cause the loss of the right to defer the estate taxes.

A sale of Corporate interests may result in a loss of the entities corporate structure

This could limit the entities right to use its own loss carry back and carry forward losses on a significant change in ownership, which is possible without a well throughout BSA.

The cost of putting together a BSA

It takes time and money to put together a solid buy and sell agreement, Of course this is a disadvantage and it can be expensive, however, in order to have an optimal BSA, you will need to invest time and money.  You will also need a competent council to prepare the necessary documents.  This incurs costs.  Being educated in this strategy is to your advantage when designing your BSA.

A poorly drafted buy sell agreement can be costly:  By failing to carefully work out the terms of buy-sell agreement or by having mismatches between triggering events and the identity of the purchaser versus the funding source, a real mess could be created.

[i] Buy -Sell Agreements for Baby Boomer Business Owners Z. Christopher Mercer, ASA, CFA, ABAR

Be An All-Star Employer and Build Future Value In Your Business!

When you go into your own business, do you have a place to go, a paycheck, and a position?  You basically have a job.   However, when entrepreneurs go into business, they look for the big payday, the selling of their business.    Would it be nice to sell your business for 10 or 20 times your annual salary?

Building a business is not easy.  If you are going to put your efforts into building a business, build a business with a great foundation.  It is easier to build value in a business with a good foundation.  Let’s assume you have systems in place and a business presence.  What is needed for real growth once you get through the systems and organization formats, is to create and develop a business culture!

By having a business culture, marketing and recruiting get easier and less expensive as people are more attracted to your company.  Long –term employees get to know the business, your customers you’re your suppliers.  They become more efficient and become the “team”.   You will attract better quality candidates to hire.  You can become more selective and create the right roles for your employees.

Go to Trader Joe’s and ask the employees how they like working there.  You will soon find out that there is little stress, a lot of fun, and the employees want to be there working side by side with each other.

When employees are happy and like their jobs, they stay, they learn, and they attract investors and future purchasers.  This culture promotes profitability and consistency, which is how you maximize your potential profitability of the company.  Consumers like consistency and the added value of having a company that is easy to work with.  I like to call this the “Amazon Factor”.  Who doesn’t like ordering from Amazon? They make it easy for many reasons.

Having this type of environment doesn’t automatically happen.  You need to invest in it to create it, however, it will pay off in the future.  They key is to start early creating the vision you have for your company long-term. Create the vision of being the “All-Star Employer”, and you will attract the best, like minded employees, and create a great business that people will want to work at.