Transitions Digest

By Holly A. Magister, CPA, CFP®

Do you know what is truly necessary?
 
With the multiple changes in the marketplace over the past six months or so, many Entrepreneurs find themselves overwhelmed.  They are reacting to client demands, changing vendor and employee relationships, increasing costs, and dwindling resources–financial, human and even their own energy.  They go home at the end of the day not truly knowing if they made any progress.  And that day was likely a 12-to-15 hour day! 
 
Does this sound familiar?  If so, know that you are in good company!
 
As you endure the chaos, it is impossible to have the insight to recognize what is truly necessary and what is distracting you from your best work and opportunities.  Unless, you stop and make a point of asking yourself “is this truly necessary?”
 
In many cases, Entrepreneurs spend inordinate amounts of time dealing with the matters that really mean the least to their future success.  And by doing this, they are expediting their failure.  Do you fear failure?
 
To ensure success, you must take time to reflect on matters that are critical and clearly understand and focus on the matters that are truly necessary every day.  As far as those matters that are not truly necessary, stop addressing them now! 
 
When you recognize how distracting those unnecessary matters are, you will quickly recognize the numerous expenses you will be able to eliminate when you let go of the unnecessary.  That is the good part!   When you eliminate the unnecessary, your life is simplified, some (maybe many) of your expenses are eliminated and your profit increases!  In my experience, “eliminating the unnecessary” has the potential to transform your business, your outlook as an Entrepreneur, and you.
 
Over the past few weeks, I have been sharing my insights through this blog series about how successful entrepreneurs are navigating the troubled waters we all share.  Successful Entrepreneurs are courageous as they consider their numerous options, they utilize their resources and eliminate the unnecessary.  And without exception, they understand the importance of the last principle…they find the humor in the situation.  In very simple terms, they laugh.  They apply this principle often!
 
I will share more about humor in my next blog posting.  In the meantime, stop and ask yourself “what am I doing today that is not truly necessary?”  Let us know your insights by commenting here.

Read the Previous Articles in this Series

Troubled Waters Part 1
Troubled Waters Part 2

Posted on May 20th, 2009 under Building Value, Business Growth, Economy, Exit Planning. Tags: Entrepreneur, Increasing Costs, Profit, Profitability, Simplify, Successful Entrepreneur. Comments: 1

Step 5

How do you successfully transfer your business to a child, key employee or co-owner? The most successful method is to follow a recipe that mixes, in equal measure, three key ingredients:

• One part: the ability, experience and dedication of the prospective new owners;
• One part: a company with strong, consistent cash flow and little debt; and
• One part: a transaction designed to prevent income taxes from eroding the cash flow available to you, the seller.

It should be obvious that a business cannot be successfully transferred unless the new ownership is capable. Furthermore, we cannot expect the transfer to be successful if the business itself lacks the ability to provide an ongoing stream of income with which to pay for the business acquisition. What may not be so obvious; however, is the corrosive affect of income taxation upon the transfer of a business to “insiders” — children, key employees or co-owners. Let’s look at two key facts associated with transferring business to an insider.

First, your children or key employees may not have cash to buy you out. Therefore, any sale may take many years to complete — a potentially risky prospect. Further, all of the cash used to purchase your ownership may come from one source: the future cash flow of the business after you have left it.

Second, without planning, the cash flow can be taxed twice. It is this double tax, (sometimes totaling more than 50 percent) that can spell disaster for many internal transfers. Through effective tax planning, however, much of this tax burden can be legally avoided. Witness what Karl Clark did.

Karl Clark agreed to sell his company to a key employee, Sharon Smith, for $1 million. This value was based on the company’s annual $250,000 cash flow, which Karl historically took in the form of salary. While Karl understood that Sharon could not pay $1 million (nor could she secure financing), he did think that she could buy out the company over a five- or six-year period, using the available cash flow of the company.

Karl’s calculations were way off the mark. The time needed for a buy out was at least 10 years. But why were his calculations so off base? In a word, taxes — actually in two words, double taxation. Without proper planning, this is what happens if Sharon buys the company (and what can happen to you when you attempt to sell your business to your children or employees):

1. Sharon receives the cash flow ($250,000 per year) and is taxed on it at an estimated 35 percent federal and 5 percent state income tax rate(These rates may vary depending on total income and your state’s tax rate).
2. Sharon pays $100,000 in taxes (40 percent of $250,000). This is the first tax on the business’s cash flow.
3. Sharon pays the remaining $150,000 (net after tax) to Karl.
4. Karl pays an estimated 15 percent federal and 5 percent capital gains tax on the $150,000 he has received for the sale of his ownership interest, or $30,000 in taxes. This is the second tax on the original stream of income from the business. The result?
5. The company distributed $250,000 of its cash flow, but Karl was only able to put $120,000 in his pocket.

Without proper tax planning, you too, may experience an effective tax rate that could be in excess of 50 percent on the company’s available cash flow used to fund your buyout. This is likely to prevent, as it did for Karl and Sharon, a consummation of the sale of the business.

How might you design your sale to lower taxes and maximize the opportunity for success?

1. Plan. Like Karl, you should have a plan that yields you a greater after-tax amount for the sale of your company. Since the cash flow of the company may increase, the key is to provide Uncle Sam a smaller slice of the available cash flow.
2. Use an experienced advisory team, usually consisting of a business attorney, CPA and insurance or financial professional. They should understand the importance of tax sensitivity to both seller and buyer in order to make more money available to you.
3. In addition, you and your advisors should use a modest, but defensible valuation for the company. Because a lower value is used for the purchase price, the size of the tax bite is correspondingly reduced. The difference between what you will receive from the sale of your business, at a lower price, and what you want to be paid to you after you leave the business is “made good” through a number of different techniques to extract cash from the company after you leave it.

Tax planning for the transfer of your company to an insider takes time, planning and knowledge. But it can possibly save a tremendous amount of money. Take time now to begin the planning process.

• Learn as much as you can about how to best accomplish the transfer of your business.
• Seek the advice of your advisory team. Taking action sooner rather than later may help your business transfer recipe provide a tastier result. Bon appetit!

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly A. Magister, CPA, CFP®) offers you unbiased information about what you may need to know. Subscribe to our free Exit Planning educational newsletter to learn more about how to grow and/or plan for your business exit.

 Complete Series

Posted on May 15th, 2009 under Exit Planning, Exit Planning Digest, Mergers and Acquisitions. Tags: acquisition, Add new tag, buy-sell transfer, buyout, companies change, Exit Planning. Comments: 4

By Holly A. Magister, CPA, CFP®

As you navigate these troubled waters, what resources do you draw upon?

Many good-intentioned entrepreneurs confuse being courageous (the subject of my last blog) with the notion that during difficult times they must become Lone Rangers in order to survive.  What I have observed is the truly successful entrepreneurs do the exact opposite.  They instinctively recognize the value of their resources and know exactly when to draw upon them for help.  Instead of retreating to their early days of entrepreneurship, where they were “rugged individualists” by necessity, they call upon the people, companies, and other resources from the past that have consistently provided them with “best of their breed” performances.  And if for some reason, they do not have access to such a resource in their time of need, they find them.  Someway, somehow they find them.
 
As your business is occupying its position in the marketplace today, the world is changing.  Really, really changing.  Stop for a minute and ask yourself the following question: “What is different today in my marketplace than one year ago?”  If you cannot list at least three differences, your head is buried in the sand.  And if that is the case, you have permission to stop reading this now.
 
With your list of three (or more) differences, you have the place from which you should start to work.  You must deal with these differences NOW to survive today AND thrive in the future.  This is where those valuable resources (old and new) become critical.
 
So how do you know if the resources you have drawn upon in the past, or are considering for your current and future needs, are truly “resourceful”?  Or do they simply go through the motions?  I recommend asking yourself if those resources have delivered, kept promises, or maybe even exceeded your expectations. Are they creative and capable of providing a point of view that may not be popular?  Is their advice, service and attitude one that makes you feel as if they truly are concerned about YOU?  The truly valuable resources in your world should not be afraid to make changes to the way they deliver their products and services to you.  They should be flexible, open-minded and capable of adapting to the troubled waters we are all sharing.  Technology and the knowledge base is changing and growing rapidly.   Your resources should be adopting these advances and excited to share with you the benefits from doing so.
 
One of my favorite quotes of Warren Buffett is “You never are hit by the bus that you are looking at.”  How so true, on so many levels!
 
The successful entrepreneurs that I work with have been run over by more than a few busses.  The difference between the successful ones and the rest is the attitude they carry as they react to the situation and the resources they have to draw from to help them.
 
Before you pull out your PDA to call upon your resources, we need to make certain you are applying them to the things that really matter.  And that leads me to the subject of my next blog–principal number three–Eliminate the Unnecessary.  In the meantime, think about your resources…Are they resourceful?
 
Read Trouble Waters Part 1

Posted on May 8th, 2009 under Building Value, Business Growth, Economy. Tags: Building Valuable Businesses, Business Growth, Business Resources, Economy, Entrepreneur, Growth Resources, Successful Entrepreneur, Warren Buffett. Comments: 1