Understanding DPOs: Should Your Small Business Go Public?

“Going public” doesn’t have to mean heading to Wall Street. Small-business owners of any size can now use direct public offerings (DPOs) to sell ownership stakes in their company to raise capital, without the tight securities rules of an initial public offering (IPO). But is it a legitimate move for your small business? We spoke to Brenda Hamilton, a lawyer specializing in securities and going public with Hamilton & Associates Law Group, to get answers.

Small Business Center: What is the difference between an IPO and a DPO?
Hamilton: Both an IPO and a DPO involve the sale of an issuing company’s securities to investors as a way to raise capital. An IPO always involves a public offering registered with the Securities and Exchange Commission (SEC), and an underwriter sells those securities and receives a commission. In addition, the issuing company typically enters into an agreement with the underwriter that significantly impairs its ability to change its offering, offer other securities, and/or engage in certain transactions.

On the other hand, a business owner can register a DPO with the SEC, or can conduct an unregistered offering in some circumstances. The issuing company will market and sell its shares on its own behalf without an underwriter. As such, the success of the DPO is dependent upon the issuing company’s own efforts. Since the enactment of the JOBS Act, many companies conduct unregistered DPOs with accredited crowdfunding. This allows the issuing company to engage in advertising and solicitation as long as it verifies the purchasers are accredited investors.

Can any size business conduct a DPO?
Yes, that’s one of the benefits of this type of offering. Because you can structure DPOs in a variety of ways, you have flexibility. A DPO can be used by a startup company or an established company with a proven track record.

What other benefits can small-business owners realize from DPOs?
There are numerous benefits to DPOs. For instance, a DPO allows business owners to raise capital at their own pace, and the SEC doesn’t limit the amount of capital a company can raise in either registered or unregistered offerings. Both private and public companies can offer a DPO, and the issuing company can offer securities to investors without an IPO’s limitations. Finally, DPOs are less expensive than IPOs because there are no underwriter fees.

Are there any disadvantages to conducting a DPO?
The principal disadvantage of a DPO is that the issuing company is responsible for raising its own capital, and that could take time away from running the company.

How much does it cost to conduct a DPO?
The price will vary depending upon how the small-business owner wants to conduct the DPO. The minimum cost of a registered DPO is $40,000, and the minimum cost for an unregistered DPO is $15,000, and that includes fees to an accountant, attorney, transfer agent, EDGAR filing agent, and for a registered DPO, an auditor. However, a DPO costs hundreds of thousands of dollars less than an IPO.

How should small-business owners decide if a DPO is right for them?
To raise capital from investors, any company must be prepared to provide transparency. This means opening up the company’s books and records and disclosing all information that would be important to a reasonable investor. If a company cannot do this, it should not conduct a DPO or any other offering.

Another factor to consider is whether management has the ability to market its own offering. And even a DPO involves costs. In a registered DPO, these costs include legal, accounting, auditing, transfer agent, costs of electronic trading, and EDGAR filing fees, which is the SEC’s system for collecting, validating and publishing submissions by companies. For an unregistered DPO, the costs will vary depending upon the particular issuer, but will generally include legal, accounting, EDGAR filing fees and other costs.

How important is it to hire a securities lawyer for the process?
It is critical to hire a securities lawyer for the DPO process. There are expansive regulations that apply to both registered and unregistered securities offerings. Although the regulations are manageable with proper guidance, deviations can disqualify an offering and subject the issuing company to civil penalties and fines as well as investor rescission obligations.

What advice would you give to small-business owners who are considering a DPO?
If I had to choose one piece of advice, it would be to avoid professionals associated with multiple reverse-merger transactions, including lawyers, accountants, auditors, and transfer agents. Small companies and investors are often inexperienced in the financial markets and are easy prey to unsavory market participants in the micro-cap markets. Over the course of my career, I have seen numerous companies and investors devastated by reverse-merger transactions, some of which were actually recommended by securities lawyers. I would also encourage small-business owners to learn as much as possible about the process before they begin.


Courtesy: Suzanne Kearns - Freelance




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Kevin Minton
CEO
Chief Executive Boards International

http://www.chiefexecutiveboards.com/

KevinMinton@ChiefExecutiveBoards.com

Credit Freezing and Thawing as Protection from ID Theft

I recently had a CEBI member mention to that we should be on the alert for potential I.D. theft and that there is an effective tool for mitigating our risk for this to happen.  Credit freezes are one of the most effective tools available against economic I.D. theft available to consumers.  There are three major credit monitoring and reporting agencies from which your credit history and ratings are obtained:

1. Equifax
2. Experian
3. Transunion

Freezing your credit with each of these allow you to seal your credit reports and use a personal identification number (PIN) that only you know and can use to temporarily "thaw" your credit so that legitimate applications for credit and services can be processed.  That added layer of security means that thieves can't establish new credit in your name even if they are able to obtain your I.D.

Freezing your credit files has no impact whatsoever on your existing lines of credit, such as credit cards.  You can continue to use them as you regularly would even when your credit is frozen.

The cost ranges from $3 - $10 per bureau to freeze your credit and somewhere between free and $10 to thaw your credit for a specific period of time.

If your credit reports are accessed often for work or because you create new accounts with various financial institutions on a regular basis, it is not suggested that you freeze your accounts.  The cost to "thaw" your accounts would tend to be excessive.

For more on this topic and instructions from each of the bureaus on how to "freeze" or "thaw" your credit accounts, click on the following link.  http://www.clarkhoward.com/news/clark-howard/personal-finance-credit/credit-freeze-and-thaw-guide/nFbL/


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Kevin Minton
CEO
Chief Executive Boards International

http://www.chiefexecutiveboards.com/

KevinMinton@ChiefExecutiveBoards.com

Any Time is a Good Time to Harvest Some Cash

Your business may be a substantial piece of your personal net worth.   It may also be your most risky investment.  Most business owners fail to recognize that the money they have tied up in their businesses (fixed assets and working capital) is at considerable risk every day.  They believe so heavily in their own ability to mitigate risk that they leave all or almost all their chips in play at all times.   
     
What can happen?  Almost anything can take a small to mid-sized company (say, revenues of $50 million or less) out of business in less than a year.  Like what?   Like death or a disabling illness of the CEO.  Your business is just one stroke or one heartbeat from extinction, unless you have a fully-ready successor just waiting in the wings.  One sexual harassment suit.  One big product liability suit.  One major customer bankruptcy (or multiple small ones), leaving you holding the bag for hundreds of thousands or perhaps millions in uncollectable accounts receivable.  Be aware of the many things completely beyond your control that could wipe out a big piece of your equity in the business.  
    
We insure our businesses for fire -- an unlikely event that could happen and would be catastrophic.  Yet we're unwilling to recognize any of the far more likely events that could wipe our businesses out financially, and against which we may not be able to insure.  For this reason, we incorporate, to put a corporate veil between our personal assets and the company.  I was recently frightened to hear a member of Chief Executive Boards International say that he had $1 million in liquid assets inside his company.  That's an accident waiting to happen.  I don't think he's alone.  
    
What's the option?  Take some chips off of the table.  Take some money out of the company.   To do that, we'd have to borrow money for working capital, you say?   What's wrong with that?  If your credit is good, lenders will loan you money for working capital at ridiculously low rates right now.  So, borrow some working capital and take some cash out of the business and invest it elsewhere.  Almost any mid-to-long term investment will yield you more than you'll be paying in interest, and that money will be out of reach of creditors, judgments and other claims on your business assets.  
    
But "we're debt-free", you say?   Is that a good thing?  It's not typical of any major publicly-traded company.  Why is that?  Because shareholders would rather the company borrowed its working capital from lenders presently willing to take a return in the low single digits than to use shareholder funds for that purpose.  
  
"I don't know where to invest the money", you say?   Now would be a good time to start learning how to invest outside your business, because you'll probably live about 20-30 years after you sell and retire from your business and you'll need to know how to invest for both growth and income.  If you haven't taken time to become a knowledgeable investor so far, it's never too soon to start.  
  
Think about it -- would you rather have $100,000 in debt on the company's books and $100,000 in assets in your brokerage account (or gold or real estate or CDs or whatever) -- or neither?  Replace $100,000 with $250,000 or $1 million, depending on your situation.  Remember, you can ALWAYS loan money back into the company if the bank gets uncooperative in the future.  The point is that debt is a tool by which to leverage other people's money, and there's nothing wrong with it, as long as you have a plan by which to pay it back if you need to.   
  
I know I'm not on the same page as most business owners on this topic.  To post your point of view for the benefit of others, click "Comments" below.   

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Terry Weaver

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Chief Executive Boards International
http://www.chiefexecutiveboards.com/

TerryWeaver@ChiefExecutiveBoards.com

Key Man Insurance or Partner Insurance - Got it, so What?

Does your company have life insurance on its key players?  If so, don't dismiss the rest of this article – there are some minefields you may not have thought of.   If not, call an insurance agent today and then use some of these ideas in your conversation.     

In working with closely-held companies, including Chief Executive Boards International members, I find that even those who have "key man" insurance in place many times have not thought through the implications of just who owns the insurance and just who the beneficiary should be.  Many articles and many insurance agents assume the answers to both questions are "the company".   

Not necessarily.  There are actually two major reasons to insure a key player.  One is the traditional "key man" concept, where the insurance is meant to provide enough cash to hire, train and compensate a replacement.   In the case of closely-held companies, this may be an owner or it may also be a senior manager essential to the business, whether he owns shares or not.  In that case, the company as the beneficiary makes sense.    

The second and probably bigger reason for life insurance is to fund the provisions of a buy-sell agreement, providing the cash necessary to buy the shares left in a deceased co-owner's estate.   Call it "Partner Insurance", because the objective is completely different - it's to fund your estate and transfer ownership to your other shareholders.  This case is tricky and full of potential mine fields if not thought through initially and the beneficiaries updated regularly.    I've rarely seen one of these properly configured.  Why?  

Closely examine your company's buy-sell agreement.  You may find, as in many, that there's a provision whereby the company has right of first refusal to buy back a deceased partner's shares at a then-current valuation.  There are hundreds of variations on that theme, but generally those shares are bought back into the treasury, thereby "reverse diluting" the remaining shareholders.   The math becomes tricky. 

Let's say, for example, you're just starting to transition the ownership of your company and you have a 15% partner (someone who's been with you for years - your intended successor/owner) and two 5% partners (key players, with shares mostly for retention purposes), with your holdings at 75%.  At 100 shares outstanding, share ownership would be 15+5+5+75=100.  If the company is the beneficiary and there's enough money to completely buy back (retire) your shares, then the remaining partners' outstanding shares become 100% of the ownership of the company.  Proportionally divided, then, their shares (15, 5 and 5) end up being 60%, 20% and 20% of ownership.   You may be fine with that as far as the lead person is concerned, but what's happened is that the two minor shareholders have each suddenly "inherited" 15% of your company.  Was that your plan or your intent?    Probably not.  What's also happened is, in the case of a typical 67% super-majority requirement on major decisions (such as sale of the company), you've unwittingly handcuffed the majority owner, where either of the other two can block anything he wants to do.   Was that the plan?  You can see the problem.  By the way, the estate gets a step up in basis, meaning that the shares bought back from the company produce zero taxable income for the heirs - either ordinary or capital gains.   Good deal.   Unfortunately, the partners don't get the same deal.   Their basis is still their original investment - whatever they paid for their shares when they bought them. 

What's the alternative?  Depends on your intent.  For this case, let's assume what you really wanted was for your majority and long-time partner to inherit control of the company, keeping the minority shareholders at 5% each.   How would you do that?   Simple.  Make the majority shareholder the beneficiary of your "partner insurance" policy.  In other words, your partner receives (tax-free, it's life insurance) enough cash to buy your shares directly from your estate (which the buy-sell should allow).   This could be a win all around.  Your partner gets the insurance money, tax-free.  Your estate gets a step up in basis on your shares, and then sells them to your partner at that price for no taxable gain.  And your partner, since he paid real money for your shares also gets that amount added to the basis of his shares.   A win all around.  Despite the advantages of this approach, I've never seen a buy-sell initially set up this way.

Variations on this theme could include a small piece of the insurance proceeds for the minor partners, and if the death benefit exceeds the current valuation of the company, you could name your spouse or heirs for the rest.   Granted, this takes some management, updating the beneficiary percentages whenever you update the company valuation.  Among multiple partners, then, these policies need to name the surviving partners as beneficiaries to achieve the intended result in case of death of anyone (also known as a cross-purchase agreement). 

If you dismiss the "partner as beneficiary" option and the company remains the beneficiary, question two is, "What is the valuation of the shares the company is buying back from your estate?"  This is another minefield, particularly if the company is the beneficiary and the valuation process doesn't take insurance proceeds into account.  Let's say your company is worth $4 million and we have a $3 million insurance policy on yourself (to cover your heirs' 75% ownership), with the company as the beneficiary.   That's this week.   This weekend you get hit by a beer truck and expire.   Next week the insurance policy pays off and there's an additional $3 million of cash on the balance sheet.   What's the company worth then?  A capable attorney for your estate would argue it's worth $7 million.  Wow, then we're talking about buying back your 75% stake at a price of $5.25 million.   Where's the other $2 million going to come from?   This problem is a whole lot easier to solve.   Your buy-sell agreement should have a section on valuation.  In that section, simply state something like "for the purpose of valuing a deceased shareholder's shares, any proceeds of life insurance paid to the company will be excluded from the valuation."  One sentence that could save a $2 million dispute, in this sample case.   Note:  Insurance benefits paid to the company may be taxable, adding further complications.     

So, just like the rest of your buy-sell agreement, the insurance component needs to be carefully thought through and various possible scenarios played out.  In my experience, buying the life insurance is an afterthought and almost no thought is given to the beneficiary question - it usually defaults to being the company, with surprising unintended consequences.  

Finally, the purpose of this insurance is to cover a tragic situation.  As such, term life insurance with a top-rated company is the best vehicle.  Ignore pitches that suggest this is also somehow an “investment” and that cash value insurance is appropriate.  Invest the difference in your own company or distribute the money to shareholders.  

As always, check with your own legal, financial and tax advisors to be sure any of these ideas are right for your specific situation.  

If you have other approaches or scenarios relating to buy/sell agreements or key man/partner insurance, click "Comments" below and share them with others.   

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Terry Weaver

CEO

Chief Executive Boards International
http://www.chiefexecutiveboards.com/

TerryWeaver@ChiefExecutiveBoards.com

3 Ways to Accelerate Cash Collections

A member lamented in a recent Chief Executive Boards International meeting, "I have huge customers who hold onto my payments for 60 or 90 days. What can I do about that?" As always, other members had some good ideas. Here are some of those:

1. Become the squeaky wheel -- Your terms are net 30. You expect payment 30 days after you bill. So what's the matter with calling the person responsible for paying the bill (you will have to figure out who that person is) 15 days after the billing date to make sure he or she has received the bill and scheduled it for payment? At the same time, you can ask when that will be. If it's outside your 30-day terms, ask, "What can you do to move that date up?"
       
2. Become more squeaky -- If you don't receive payment at 30 days (or, say, 40 days), call again. Being firmly polite, you can ask again what the person can do to get your bill paid more promptly. Call weekly thereafter.  The member who uses this process says that the typical A/P clerk doesn't like getting these calls and after she figures out that you'll call every month she'll make sure your bill gets paid, whether others do or not. Again, the most important part of this strategy is polite persistence -- a businesslike, non-threatening call, simply asking for her help getting the bill paid more promptly.
       
3. Go to the top -- A business owner once told me he got so frustrated with a multi-billion dollar customer using him for a bank, he called the CEO and said, "Hello, my name is Mike and my small company supplies yours with IT services. My invoices wouldn't make the roundoff error in your cash accounts, but they're being held 90 days by the Accounts Payable department to conserve cash. I'm very happy to be an IT Services provider, but I have a problem with being used as a bank. My employees expect to be paid every two weeks, and I'm hoping you can do something to get my invoices paid in 30 days, per our contract terms." He said the results were amazing. When the CEO's assistant calls A/P and says, "Please make sure Mike's invoices get paid on time" it solves the problem. Again, politeness and a businesslike approach will usually work.

Here are a couple of other not-so-good ideas that were suggested and discussed:

1. Prompt Payment Discounts -- A discount of 2% for payment in 10 days sounds reasonable -- or does it? Let's do the math. Say the customer typically pays at 60 days, and your discount gets him to actually pay in 10-15 days (note that customers will regularly take the 10-day discount and then not pay within 10 days). So, you get the money 45 days early for which you paid 2% (think of it as borrowing the money back from the customer until when he would have normally paid you). What's the interest rate on that money? 365/45 times 2% equals 16%. That's why you have a bank and a line of credit. If you have big, creditworthy customers, your bank should be willing to loan you, say, 75% of your AR at decent interest rate of prime plus 0%, 1% or 2%. That's about a 5% rate right now, and you can go in and out of it only when you need it. If you haven't increased your line of credit recently, now would be a good time to do that.
      
2. Accounts Receivable Factoring -- One financial commentator called this the Crack Cocaine of Business Capital. It's easy to get on, and hard to get off.  This is a very expensive solution, suitable only for a last resort. In factoring, you discount all your invoices to the factor provider, they pay you and then they collect them. Their returns are handsome, ranging usually from 18% - 24%. Of course, that return represents your actual cost (as an interest rate).

If you have ways to accelerate cash collection that have worked for you, please click Comments below and share them with others.

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Terry Weaver

CEO

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http://www.chiefexecutiveboards.com/

TerryWeaver@ChiefExecutiveBoards.com

2013 Tax Rates - Another Kick of the Can

Chief Executive Boards International members have anxiously awaited resolution of the "Fiscal Cliff".  As some of us expected, Congress has kicked the can down the road another couple of months, slightly tinkering with a cumbersome and flawed tax code.   So, what is the result? 

I saw an email newsletter from Cincinnati-based CPAs Flynn and Company that's the most succinct article I've seen, particularly relative to small business.  Here's the article in its entirety:  

American Taxpayer Relief Act of 2012

On 1/2/13, President Obama signed the new legislation into effect which helped taxpayers by extending tax cuts that were set to expire, thereby preventing the fiscal cliff from occurring. The following is a summary of the important provisions of the new law.

INDIVIDUAL INCOME TAX PROVISIONS
Individual Income Tax Rates

• The American Taxpayer Relief Act of 2012 makes permanent for 2013 and beyond the lower Bush-era income tax rates for all, except for taxpayers with taxable income above $400,000 ($450,000 for married taxpayers, $425,000 for heads of households). Income above these levels will be taxed at a 39.6 % rate.

• The American Taxpayer Relief Act raises the top rate for capital gains and dividends to 20 percent, up from the Bush-era maximum 15 percent rate. That top rate will apply to the extent that a taxpayer's income exceeds the thresholds set for the 39.6 percent rate ($400,000 for single filers; $450,000 for joint filers and $425,000 for heads of households).

• All other taxpayers will continue to enjoy a capital gains and dividends tax at a maximum rate of 15 percent. A zero percent rate will also continue to apply to capital gains and dividends to the extent income falls below the top of the 15 percent income tax bracket—projected for 2013 to be $72,500 for joint filers and $36,250 for singles). Qualified dividends for all taxpayers continue to be taxed at capital gains rates, rather than ordinary income tax rates as prior to 2003.

• Installment payments received after 2012 are subject to the tax rates for the year of the payment, not the year of the sale. Thus, the capital gains portion of payments made in 2013 and later is now taxed at the 20 percent rate for higher-income taxpayers.

3.8% Tax on Net Investment Income

• Starting in 2013, under the Patient Protection and Affordable Care Act (PPACA), higher income taxpayers must also start paying a 3.8 percent additional tax on Net Investment Income (NII) to the extent certain threshold amounts of income are exceeded ($200,000 for single filers, $250,000 for joint returns and surviving spouses, $125,000 for married taxpayers filing separately). Those threshold amounts stand, despite higher thresholds now set for the 20 percent capital gain rate that previously had been proposed by President Obama to start at the same levels. The NII surtax thresholds are not affected by the American Taxpayer Relief Act. Starting in 2013, therefore, taxpayers within the NII surtax range must pay the additional 3.8 percent on capital gain, whether long-term or short-term. The effective top rate for net capital gains for many "higher-income" taxpayers thus becomes 23.8 percent for long term gain and 43.4 percent for short-term capital gains starting in 2013.

Alternative Minimum Tax

• The American Taxpayer Relief Act "patches" the AMT for 2012 and subsequent years by increasing the exemption amounts and allowing nonrefundable personal credits to the full amount of the individuals regular tax and AMT. Additionally, the American Taxpayer Relief Act provides for an annual inflation adjustment to the exemption amounts for years beginning after 2012.

New Limitations

• The American Taxpayer Relief Act officially revives the "Pease" limitation on itemized deductions, which was eliminated by EGTRRA as extended by the 2010 Tax Relief Act. However, higher "applicable threshold" levels apply under the new law:
  o  $300,000 for married couples and surviving spouses;
  o  $275,000 for heads of households;
  o  $250,000 for unmarried taxpayers; and
  o  $150,000 for married taxpayers filing separately.

The Pease limitation reduces the total amount of a higher-income taxpayer's otherwise allowable itemized deductions by three percent of the amount by which the taxpayer's adjusted gross income exceeds an applicable threshold. However, the amount of itemized deductions is not reduced by more than 80 percent. Certain items, such as medical expenses, investment interest, and casualty, theft or wagering losses, are excluded.

• The American Taxpayer Relief Act also officially revives the personal exemption phase-out rules, but at applicable income threshold levels slightly higher than in the past:
  o  $300,000 for married couples and surviving spouses;
  o  $275,000 for heads of households;
  o  $250,000 for unmarried taxpayers; and
  o  $150,000 for married taxpayers filing separately.

Under the phase-out, the total amount of exemptions that may be claimed by a taxpayer is reduced by two percent for each $2,500, or portion thereof (two percent for each $1,250 for married couples filing separate returns) by which the taxpayer's adjusted gross income exceeds the applicable threshold level.

Child Credits

• The American Taxpayer Relief Act extends permanently the $1,000 child tax credit. Certain enhancements to the credit under Bush-era legislation and subsequent legislation are also made permanent.

• The American Taxpayer Relief Act extends permanently Bush-era enhancements to the child and dependent care credit. The current 35 percent credit rate is made permanent along with the $3,000 cap on expenses for one qualifying individual and the $6,000 cap on expenses for two or more qualifying individuals.

Education

• The American Taxpayer Relief Act extends through 2017 the American Opportunity Tax Credit (AOTC). The AOTC is an enhanced, but temporary, version of the permanent HOPE education tax credit.
• The AOTC rewards qualified taxpayers with a tax credit of 100 percent of the first $2,000 of qualified tuition and related expenses and 25 percent of the next $2,000, for a total maximum credit of $2,500 per eligible student. Additionally, the AOTC applies to the first four years of a student's post-secondary education.
• The American Taxpayer Relief Act makes permanent or extends a number of enhancements to tax incentives designed to promote education. Many of these enhancements were made in Bush-era legislation, extended by subsequent legislation and are scheduled to expire after 2012. Some enhancements, notably the American Opportunity Tax Credit, had been made in President Obama's first term.
• Deduction for Qualified Tuition and Related Expenses-The American Taxpayer Relief Act extends until December 31, 2013 the above-the-line deduction for qualified tuition and related expenses. The bill also extends the deduction retroactively for the 2012 tax year.
• Student Loan Interest Deduction- The American Taxpayer Relief Act also expands the modified adjusted gross income range for phase-out of the deduction permanently and repeals the restriction that makes voluntary payments of interest nondeductible permanently.
• Employer-Provided Education Assistance-The American Taxpayer Relief Act extends permanently the exclusion from income and employment taxes of employer-provided education assistance up to $5,250.

More Individual Tax Extenders

• Teachers' Classroom Expense Deduction-The American Taxpayer Relief Act extends through 2013 the teacher's classroom expense deduction. The deduction, which expired after 2011, allows primary and secondary education professionals to deduct (above-the-line) qualified expenses up to $250 paid out-of-pocket during the year.
• Exclusion of Cancellation of Indebtedness on Principal Residence-Cancellation of indebtedness income is includible in income, unless a particular exclusion applies. This provision excludes from income cancellation of mortgage debt on a principal residence of up $2 million. The American Taxpayer Relief Act extends the provision for one year, through 2013.
• Mortgage Insurance Premiums-This provision treats mortgage insurance premiums as deductible interest that is qualified residence interest. The American Taxpayer Relief Act extends this provision through December 31, 2013. The provision originally expired after 2011.
• IRA Distributions to Charity-The American Tax Relief Act extends for two years, through December 31, 2013, the provision allowing tax-free distributions from individual retirement accounts to public charities, by individuals age 701/2 or older, up to a maximum of $100,000 per taxpayer per year. The Act provides special transition rules. One rule allows taxpayers to recharacterize distributions made in January 2013 as made on December 31, 2012. The other rule permits taxpayers to treat a distribution from the IRA to the taxpayer made in December 2012 as a charitable distribution, if transferred to charity before February 1, 2013.

BUSINESS TAX PROVISIONS

Code Section 179 Expensing and Bonus Depreciation

• Small Business Expensing-The American Taxpayer Relief Act extends through 2013 enhanced Code Section 179 small business expensing. The dollar limit for tax years 2012 and 2013 is $500,000 with a $2 million investment limit. The rule allowing off-the shelf computer software is also extended.
• The American Taxpayer Relief Act extends 50 percent bonus depreciation through 2013. Some transportation and longer period production property is eligible for 50 percent bonus depreciation through 2014.
• Bonus depreciation also relates to the vehicle depreciation dollar limits under Code Section 280F which imposes dollar limitations on the depreciation deduction for the year in which a taxpayer places a passenger automobile in service within a business, and for each succeeding year.  

Research Tax Credit

• The American Taxpayer Relief Act extends through 2013 the Code Section 41 research tax credit, which expired after 2011. The incentive rewards taxpayers that engage in qualified research activities with a tax credit.
• Commonly called the research or research and development credit, the incremental research credit may be claimed for increases in business-related qualified research expenditures and for increases in payments to universities and other qualified organizations for basic research. The credit applies to excess of qualified research expenditures for the tax year over the average annual qualified research expenditures measured over the four preceding years.

FEDERAL ESTATE AND GIFT TAX PROVISIONS

• The American Taxpayer Relief Act permanently provides for a maximum federal estate tax rate of 40 percent with an annually inflation-adjusted $5 million exclusion for estates of decedents dying after December 31, 2012.
• The maximum estate tax rate for estates of decedents dying after December 31, 2010 and before January 1, 2013 is 35 percent with a $5 million exclusion (indexed for inflation for 2012 at $5.12 million). Effective January 1, 2013, the maximum federal estate tax rate was scheduled to revert to 55 percent with an applicable exclusion amount of $1 million (not indexed for inflation), its levels before enactment of estate tax reform in 2001 and subsequent legislation.
• The American Taxpayer Relief Act makes permanent "portability" between spouses. Prior to the permanent extension, portability was only available to the estates of decedents dying after December 31, 2010 and before January 1, 2013.

Portability allows the estate of a decedent who is survived by a spouse to make a portability election to permit the surviving spouse to apply the decedent's unused exclusion (the deceased spousal unused exclusion amount (DSUE)) to the surviving spouse's own transfers during life and at death.

• The American Taxpayer Relief Act provides a 40 percent tax rate and a unified estate and gift tax exemption of $5 million (inflation adjusted) for gifts made after 2012.
• The 2010 Tax Relief Act provided that for gifts made after December 31, 2010, the gift tax was reunified with the estate tax, with a tax rate through 2012 of 35 percent and an applicable lifetime unified exclusion amount of $5 million (adjusted annually for inflation).



Thanks to Flynn and Co. for this well-written and timely guest article. 

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Terry Weaver

CEO

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10 Bad Money Habits to Break in 2013 - Behaviors Worth Changing for the New Year

I'm astonished at how little time and study business owners give to their personal financial lives.   Many have little or no net worth outside their businesses and many of those who do haven't a credible strategy for managing that personal wealth.  This incongruity is surprising, considering that when most people stop working full time, perhaps in their 60's they'll have about 25 years of life expectancy during which their only means of support will be the wealth they've accumulated and invested over 40 years of earning. 

A good friend and writer Shanda Jeffries published something in her newsletter that I thought was huge, as it captures in 10 categories the mistakes I most often see among my business coaching clients and CEBI members.   Here's her article in its entirety:  

Do bad money habits constrain your financial progress? Many people fall into the same financial behavior patterns year after year. If you sometimes succumb to these financial tendencies, the New Year is as good an occasion as any to alter your behavior.

1. Lending money to family and friends - You may know someone who has lent a few thousand to a sister or brother, a few hundred to an old buddy, and so on. Generosity is a virtue, but personal loans can easily transform into personal financial losses for the lender. If you must loan money to a friend or family member, mention that you will charge interest and set a repayment plan with deadlines. Better yet, don’t do it at all. If your friends or relatives can’t learn to budget, why should you bail them out?


2. Spending more than you make - Living beyond your means, living on margin, whatever you wish to call it, it is a path toward significant debt. Wealth is seldom made by buying possessions. Today’s flashy material items may become the garage sale junk of 2025. Yet, the trend continues: a 2012 Federal Reserve Survey of Consumer Finances calculated that just 52% of American households earn more money than they spend.(1)


3. Saving little or nothing - Good savers build emergency funds, have money to invest and compound, and leave the stress of living paycheck-to-paycheck behind. If you can’t put extra money away, there is another way to get some: a second job. Even working 15-20 hours more per week could make a big difference. The problem is far too common: a CreditDonkey.com survey of 1,105 households last fall found that 41% of respondents had less than $500 in savings. In another disturbing detail, 54% of the respondents had no savings strategy.


4. Living without a budget - You may make enough money that you don’t feel you need to budget. In truth, few of us are really that wealthy. In calculating a budget, you may find opportunities for savings and detect wasteful spending.


5. Frivolous spending - Advertisers can make us feel as if we have sudden needs; needs we must respond to, needs that can only be met via the purchase of a product. See their ploys for what they are. Think twice before spending impulsively.


6. Not using cash often enough - No one can deny that the world runs on credit, but that doesn’t mean your household should. Pay with cash as often as your budget allows.


7. Gambling - Remember when people had to go to Atlantic City or Nevada to play blackjack or slots? Today, behemoth casinos are as common as major airports; most metro areas seem to have one or be within an hour’s drive of one. If you don’t like smoke and crowds, you can always play the lottery. There are many glamorous ways to lose money while having “fun”. The bottom line: losing money is not fun. All it takes is willpower to stop gambling. If an addiction has overruled your willpower, seek help.


8. Inadequate financial literacy - Is the financial world boring? To many people, it is. The Wall Street Journal is not exactly Rolling Stone, and The Economist is hardly light reading. You don’t have to start there, however: great, readable and even entertaining websites filled with useful financial information abound. Reading an article per day on these websites could help you greatly increase your financial understanding if you feel it is lacking.


9. Not contributing to IRAs or workplace retirement plans - Even with all the complaints about 401(k)s and the low annual limits on traditional and Roth IRA contributions, these retirement savings vehicles offer you remarkable wealth-building opportunities. The earlier you contribute to them, the better; the more you contribute to them, the more compounding of those invested assets you may potentially realize.


10. DIY retirement planning - Those who plan for retirement without the help of professionals leave themselves open to abrupt, emotional investing mistakes and tax and estate planning oversights. Another common tendency is to vastly underestimate the amount of money needed for the future. Few people have the time to amass the knowledge and skill set possessed by a financial services professional with years of experience. Instead of flirting with trial and error, see a professional for insight.

Shanda Jeffries may be reached at 864-968-2319 or sjeffries@flynnwealth.com.

This material was prepared by MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. Marketing Library.Net Inc. is not affiliated with any broker or brokerage firm that may be providing this information to you. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is not a solicitation or a recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations:

1 – business.time.com/2012/10/23/is-the-u-s-waging-a-war-on-savers/ [10/23/12]
2 - www.creditdonkey.com/no-emergency-savings.html [10/9/12]

Thanks to Shanda for this well-written and timely guest article. 

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Terry Weaver

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http://www.chiefexecutiveboards.com/

TerryWeaver@ChiefExecutiveBoards.com

It's All About EBITDA

A prospect visiting his first Chief Executive Boards International meeting this month told a familiar story. He was going through the process of due diligence with a professional buyer looking at the purchase of his business. He was discovering, far too late, as many business owners do, what really drives the value a buyer is willing to pay for a business.

He went on to say that this had been "The most demeaning experience of my life." The professional buyer, a private equity group, was examining every nook and cranny of his business -- his financials, his facility, his process documentation, etc. and they were finding things he was surprised about. He's starting to realize that each one of those "finds" will become a downward notch in the value of the business. This is known as "deal creep" in the M and A business.

He mentioned that "you do things to reduce your taxes" when you own a business.  Many owners do, but I wouldn't suggest that if you're expecting to sell any time soon.

I was once looking at buying a small machining business, offered by a business broker. I'd visited the plant, which was pretty much a dump - looked like nothing had been cleaned up in at least 10 years. I asked the broker for the financials, and he said, "That's going to take awhile. We have to extract the vacations, trips, cars, boats and other personal expenses from the income statement." Enough said. This business owner had set up a distress sale for himself without even knowing it - the offer he'd likely get from me or from anyone else would be perhaps 1/4 what he'd like to sell the business for, simply because it's not in any shape to sell. I never heard from the broker again.

Want to hear abou how to get a great price for the sale of your business, from a guy who actually did? Here's a CEBI member's 3-minute video essay on how to increase the value of your business. In part, he says,

"Before you offer your company for sale, build value..... You want to drive your sales up as much as you can..... The most important thing -- increase profit -- I don't care what you have to do..... Don't worry about your taxes, remember, you're talking about a multiple of 5 or 6.... Don't worry about your own car, your own fringe benefits, your own golf club membership -- cut that out..... It's income-based."

Depending on the size of your business, this understanding could be worth something between a few hundred thousand dollars and ten, twenty or fifty million dollars. I was happy to see that a CEBI member who takes something valuable out of every meeting wrote on his meeting evaluation, "It's all about EBITDA."
        
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If You Can't Say "Yes", You Don't Have Enough

Can you really afford to sell your business? Can you afford to give it to your kids? Are you financially OK if your business vanishes?

In a recent Chief Executive Boards International meeting, a member was asked, "If your business went away tomorrow, would you have enough assets outside the business to last the rest of your life?" The member hesitated, stammered, and then another member made a profound statement, "If you can't say yes to that question right away, you don't have enough."

So, do you have enough? Do you know what "enough" is? If not, you have some serious homework to do, right away. So, how do you figure that out? Here are the steps:

1. What are you spending now? Most people don't know. If you're in that group, here's a suggestion. Install some personal finance software -- click here for some choices.   I prefer Quicken because it directly interfaces to my bank. 
   This isn't about budgeting -- its just about tracking what you're spending now. I've been doing this since 1996, and we know exactly what our annual burn rate is, by expense category. It's been surprisingly stable, year after year. Hugely helpful to be confident in calculation of your "number".   Just take each check and each credit card bill and break it down into a couple of dozen expense categories (doesn't have to be GAAP). 
        
2. Get all your assets and liabilities on a single balance sheet. Your personal finance software selection will give you a platform to do that.
    
3. Apply the 4% rule to your liquid assets (not including home equity, household assets, etc.). You can find countless articles saying that somehow this is no longer valid. In fact, it's as good as it gets when forecasting uncertainty. Over a 20 or 30 year time horizon, you can afford to burn 4% of your net worth per year at the start, while giving yourself a "raise" each year to keep up with inflation. That has about a 90% chance of keeping you from running out of money before you run out of heartbeats.  The assumed investment mix in this is 60% stocks, 40% bonds, although a 40%/60% mix gets you essentially the same result. 
    
4. If you have a real plan for cashing out of your business and an objective valuation to estimate those proceeds, you can apply the 4% rule to that amount, also.   Adjust for the possibility that it's your estate selling the business and discount accordingly for your absence. 
      
5. Add in any other cash streams. Do you have rental income?  What can you earn from part-time work or consulting? You'll be amazed at how $50k or $100k/year in consulting income improves this picture. That's only 2 to 4 billable days a month. Do you have any pensions, royalties or other annuity-style income? Of course Social Security is included. You get an annual forecast from the SS Administration of what that cash stream may be worth.
    
6. Do the math. Add the 4% withdrawal of your liquid assets and business sale proceeds to other cash streams and subtract your current burn rate of household expenses. Click here for a worksheet, borrowed from Lee Eisenberg's book, The Number.  Where are you?

If that answer is positive with a reasonable cushion - say, 25% to 50%, then you can confidently and immediately say "Yes" when someone asks "Do you have enough money to last you the rest of your life?" If you can't answer that with "Yes" right away, then you need a better plan. Either reduce the burn rate or figure out how you're going to earn, save and accumulate the assets necessary to give you the cushion you need. Part of that solution might be to just figure out how to accelerate the extraction of cash from your business.

Shortcut:  I just saw an article in Money Magazine, saying that for the average person with an ordinary asset base (stocks & bonds) a net worth of 10x-12x current income  (or current income necessary to support current lifestyle) would also be a good sufficiency test.   I ran that range on my own situation and it came out about dead even with the more technically correct 6-step approach above.   Try it for yourself. 

Escapingly simple, but surprisingly few business owners have this one nailed. Considering that when you and your spouse are 65, you have a better than 50% chance of either of you living to be 90, isn't it a good idea to figure out how you're going to be able to afford that next 25 years with minimal earned income?
        
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Take Some Chips off the Table

Yes, I've written about this before.  If you're a C Corporation, you have about 4 weeks to act at the lowest tax rates on dividends we're likely to see in our lifetimes.  If you're an S-Corp or an LLC, this is simply about self-preservation.
 
I've had multiple conversations with business owners lately who are having a record year and are sitting on piles of cash inside their businesses - one has over $1 million in cash inside his $8 million company.   That just sends chills down my spine. 
 
Why?  Because that money is just like chips on the poker table -- it's at risk every day.  What risk, you ask?  One stroke.  One beer truck.  One employee harassment suit.  One product liability suit.   That's how far most closely-held businesses are from extinction.  Would you want your surviving spouse to watch that pile of cash melt away while your estate is in the process of getting settled?  Wouldn't it be a whole lot better if that money was in your brokerage account?  
 
A good friend of mine and a CPA, Roger Clinkscales, explains it this way:   "Why did you set up your corporation (LLC, C-Corp, S-Corp) in the first place?  To put a firewall between your company and your personal assets, right?  So, why don't you use it?  Why don't you take the cash that's inside your company and distribute it to yourself, thereby taking it out of reach of creditors and judgments against your business?"   
 
Roger's right.  The next thing that comes up in this conversation is, "But I need that cash cushion for unexpected working capital needs."  Do you?  Why not "outsource" that problem?   Where?  To a bank, in the form of a line of credit.  Those guys are in the business of providing short term cash, and right now they're doing it at incredibly low interest rates. 
  
With a line of credit for a few hundred thousand dollars you have the flexibility you need to take that cash out of the business and then borrow for a few days here and there if you need some short term inventory or if a customer stretches you out a few weeks on payment.    
 
Think about it -- would you rather have $100,000 borrowed on your line of credit and $100,00 in your brokerage account, or neither?        


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We Grew Ourselves Down to Breakeven

I heard an interesting story from a Chief Executive Boards International member who is in the process of downsizing his company to profitability. He and his partner had been in growth mode, finding and booking more new business and hiring more people. They looked up one day to realize they weren't making money any more.

What happened? No financial model. No blueprint for how the business performs at the gross margin line, and no idea how much overhead the business can afford at any given level of business volume. They over-hired, took some lower margin business, and found themselves working twice as hard for no money.

This is another story that underscores the importance of business owners digging into their financials up to both elbows. Many don't and they ignore their financials at their own peril.

So, what are you watching for? Most importantly, ratios. Specifically, ratios of just about everything on the income statement to the top (total revenue) line. Gross margin, for example is revenue minus all variable costs. What are variable costs? The costs that move along with sales revenue, such as labor and material. If you do twice as much of the same kind of work, it's likely that your variable costs will be exactly twice as much -- the ratio will remain constant. Those variable costs are sometimes called Cost of Goods Sold (COGS).

Of course, not all the business you do is the same. On some lines of business you have better gross margins than others. Do you know which is which? If so, you can model your future income statement, based on its variations from the past. More of the higher gross margin business, and the GM % to Sales (revenue) will improve. The reverse is true, also.

Then you have costs of sales (CoS) or selling costs -- the money that goes into generating new sales. Advertising, marketing, travel and entertainment, commissions and so forth. For what you're doing right now, what is your CoS as a percentage of revenue? One could assume if you plan to grow revenue you'll have to front that with stepped-up CoS. Of course, you can model that in advance, and expect that new business to lag by several months.

And, finally, there's Overhead, sometimes called General and Administrative (G&A) Expense. That's the basic cost of keeping the doors open. Rent, Utilities, Office Salaries, etc. A lot of G&A is fixed in the short term. For a given size building, rent, utilities and maintenance will stay about the same. If you can push 25% more revenue and 25% more gross margin through the same facility, you'll get to keep most of it -- G&A may move, but probably not much. So G&A as a % of revenue is likely to drop, thereby raising Net Profit as a % of revenue. You can model those assumptions and predict your future income statement.

Hint -- If you're a QuickBooks user, there's a checkbox that adds ratios of most sections of the income statement, relative to total revenue.

This future income statement model becomes your operating benchmark, sometimes called the budget. As the year unfolds, you'll see where you were right in your assumptions and where you were wrong.

You can also model your Balance Sheet, the most important part of which is forecasting your working capital as your sales grow. How much more Inventory and Accounts Receivable will you need to support 25% more sales? That depends on ratios like Inventory Turns and Days Sales Outstanding (how many days of sales, on average, are tied up in AR?). Again, ratios you need to be watching month-to-month.

Your financials are your instrumentation -- if you know airspeed, altitude and compass heading, you can predict where your airplane will be in a couple of hours and that you won't hit the ground before then. You'd want to know you have enough fuel, as well.

If you don't completely understand your company's financials or you haven't used them to forecast your next couple of years of profitability, hire some help. Find a CFO for hire -- someone who will help you a day or two a week to turn your financials into instrumentation you can use.

If you've had a similar experience, or you've decided to find a part-time CFO, click "Comments" below and let others know. 
 

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TerryWeaver@ChiefExecutiveBoards.com

I'm Not Worth as Much as I Thought

A Chief Executive Boards International member, asked on a recent Executive Summit Evaluation for his major takeaway said, "I learned I'm not worth as much as I thought." He was talking about a workshop session titled, "What's My Business Really Worth?", where we had a panel of valuation experts walk through how businesses are really valued. 

Most business owners don't have the net worth they think they have, because their businesses aren't worth what they think they are. There's an old adage in the mergers & acquisitions business -- "You never want to be the first person to tell someone what his business is really worth." Business owners have a fanciful idea of what their businesses are worth, driven by both a host of misinformation sources and some fundamental misunderstandings about how businesses are valued.

So what's your business really worth? Strap yourself in. Businesses are valued on what I call the "magic coffee cup principle". I have a magic coffee cup. For its owner, it will spit out $1 million in cash a year from a slot on the side of the cup. Every year - forever. Like most things, there's some risk. You could lose the cup or break the cup, but otherwise you've got a $1 million per year annuity.

So, what am I bid for a magic coffee cup? I usually get a bid right off of $1 million. That would be a really good buy - pay only $1 million for a $1 million annual return. Somebody will quickly bid $5 million. I ask "what's your return on that investment?" and someone figures out 20%. Then someone else, figuring that a 10% ROI isn't bad in this market, says he's good for $10 million. That's 10 times the perpetual cash flow of the magic coffee cup.

Businesses are valued just the same way -- as a multiple of their free cash flow -- the amount of cash an owner can take out each year. But they're not magic, like a coffee cup. A lot of things can go wrong in a business that could cut the forecasted cash flow in half. Or worse. As a result, most businesses don't command multiples like 10x free cash flow. A 10% ROI is just not enough to cover the risk.

Notice the switch between "multiple of free cash flow" and "ROI on the investment". Actually, they're reciprocals. Take 100% and divide by the cash flow multiple and you get the ROI. A 5x multiple is a 20% ROI. 4x is 25%, and so forth.

That's why most businesses sell for multiples between 4x and 6x free cash flow. Those represent investment returns (25% to 17%) that are substantially high enough to offset risk of owning a small business.

Most owners then would then like to add to that valuation some balance sheet items, like inventory, fixed assets, accounts receivable and so on. Wait a minute. As a buyer, I realize I'm going to need all that stuff just to produce the current free cash flow. That's part of the deal -- the assets needed for the business to perform, and I'm not going to pay more for any of that -- it's essential to producing the cash stream (magic coffee cup) I'm willing to invest in at a multiple (price) I'm comfortable with.

That's where most business owners' bubble bursts -- when they realize that they're likely going to get paid only about 5 times their current annual cash flow for their business, and then they won't have it any more.

Are there ways to get more for your business? Sure. Here are a few:    

• Intellectual Property -- If you have protected intellectual property that would be far more valuable to a buyer than it is to you, that's a factor. For example, you have a patented product that a company 10 times your size could put in the hands of its sales force and sell 10 times as many units as you do (and could cover the working capital to make them, etc.)
     
• Distribution -- You have customers that would be far more valuable to a much larger competitor than yourself
    
• Geography -- You already cover a geography that a competitor doesn't cover, but would like to have -- particularly in a different country, continent or language.
     
• Product Synergy -- You have products a much larger competitor doesn't have, but could add to his line and multiply the margin you've been able to generate yourself on those same products
     
• Market Segment Synergy -- Your products are substantially up scale or down scale from a competitors', thereby giving him a "premium" product or an "entry level" product he doesn't have to develop. Especially if he's 10x or 20x your size.
     
• So, what's a business owner to do to increase his net worth? Drive free cash flow. Figure out how to get your business generating more cash. Interestingly, that not only makes the business more valuable to a future owner, but also makes it more valuable to you, as well. Your spouse will no doubt appreciate that. 

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