According to Slee’s research, the United States economy experiences a recession (or other economic downturn) during the first three or so years of every decade.  The capital supply to the private markets becomes restricted, primarily because lending is restricted, which reduces the leverage a buyer can achieve and lowers valuations as well as limiting access to working and investment capital.

This begins to transition around the fourth year as companies improve profitability which leads into a period of free-flowing capital into the private market.  Humans are creatures of habit, so we quickly forget the recession we recently survived and continue to spend and invest until we are over leveraged and over invested.  At this point, parts of the economy begin to feel the strain and the economy as a whole is affected by the end of the ten year period.

Why will such a cycle be expected to continue?  Because the nature of people, namely, the private business owners, bankers, investors, and politicians in America, is to be overly optimistic in the good times and overly pessimistic in the bad times.  We also take a predictable amount of time to adjust to changing conditions and we can be counted on to react in certain ways.

Today, the catalyst for our recession was sub-prime mortgages followed by complete financial system meltdown, bankruptcies, and major fiscal policy changes.  Impending commercial mortgage uncertainty will help us to remain in a deal recession for the next several years.  Business values will remain flat or fall further as we struggle to adjust.  But adjust we will (or go bankrupt) and the survivors will profit again.

In my last post on business value, I mentioned that you can expect to achieve the highest return when selling your business at the right market timing.  If the transfer cycle holds, the best time to buy a business will be any time from now through 2013 or so.  The best time to sell a business will be toward the end of the prime selling time, or roughly 2016 – 2018.  Obviously, businesses will continue to be bought and sold every day, but a savvy business owner will look to exploit this cycle to his or her advantage.

There are three factors that affect the value of your business the most: Timing, Timing, and Timing.  Assuming you’ve got a profitable enterprise with value outside of your own day-to-day involvement in the operations, your decision to sell the business will be most highly rewarded when three timings all line up perfectly.

1. Personal Timing.

   What’s your Plan B?  What is it that you want to do next?  If you realize you won’t have anything to do after you sell your business, then you’ll be reluctant to give it up until you have to.  When you do have something to do, say, another investment or business or even taking a trip around the world, then you will be much more inclined to do what is necessary to sell your business.

2. Business Timing.

   Ok, so you’re ready to sell, but is your business ready to be sold?  If you sit down with an advisor because you’d like to cash out in the next six months and they find that major changes need to be made to your operations or your financials then you either have to wait or understand that the buyer will discount their offer as a result.  Always be ready to sell!  Look at your business today and make the changes now because someday, you will transition your business.  You never know when someday will come, because of…

3. Market Timing.

   This is the one that is completely out of your control.  It is also the reason why your business should always be ready for transition and you should always have a Plan B.  When the market is ready, you must be ready.  It’s not always clear when the market will be primed to provide you with the highest return although there is a general cycle in the United States economy, which we’ll talk about more in the next post.

Most business owners outsource many functions of their business including tax preparation, legal counsel, and hiring personnel.  It’s fairly obvious that it’s cheaper to hire a tax expert once a year than to retain a tax accountant on staff or to stumble through the process yourself.  Let’s look at a slightly less obvious function that can be outsourced: payroll processing.

Scenario 1: You’ve finally hired enough employees that there’s just no way to justify them as “contractors” and your tax preparation fees have tripled as you try to sort things out at the end of the year.  Your business is growing and you need to get some basic structure in place.

Scenario 2: You’re a healthy mid-sized company with a couple of million in annual revenue and a single staff accountant whose time seems to be completely monopolized with processing bi-weekly payroll for your 20+ employees.  It’s a miracle when bills are paid on time and don’t even talk about collections on those old invoices.  You’d like to refocus that accountant on activities that actually bring cash in the door.

Scenario 3: You’ve grown still further into the lower middle market and you now have a dedicated AP clerk, AR accountant, and a controller.  Unfortunately, your controller’s time is still wrapped up in that pesky payroll though you’d really rather have their help analyzing your financials to prepare management reports and budgets.

Scenario 4: You’re in negotiations to sell your company and the buyer’s due diligence reveals you owe $75,000 in payroll withholdings from Scenario 1…

Each of these scenarios highlights a decision point in the typical small business where outsourcing payroll should be considered.  Before that last scenario becomes your reality, take a look at whether you should be outsourcing payroll.

What is Outsourced Payroll?

Outsourcing payroll simply means utilizing a payroll service provider to handle the calculation of payroll checks; perform tax calculations, deposits, and filings; and to assist with payroll tax law compliance.  This third party serves to insulate the company from liability and risk associated with doing any of these things incorrectly.

What are my options?

Your CPA is the first place to look since they may offer the service or they may have a preferred method that fits with their year-end process to save you money on tax preparation.  They might recommend a software-based service such as QuickBooks or Peachtree, or they might have a relationship with a company that specializes in payroll processing such as Paychex.  You bank might also offer a software package or a service, or they may also have a relationship with a third-party provider.

What kind of business should consider Outsourcing Payroll?

Unfortunately, a company that has one employee will have the same compliance requirements and penalty percentages for late payments to the State and the IRS as a company with a hundred employees.  This means that your company is never too small to worry about payroll.  In fact, businesses of all sizes should periodically analyze the cost-benefit of maintaining a full internal payroll department versus utilizing an outsourced option.

What kinds of benefits can I expect from Outsourcing Payroll?

First of all, the knowledge that all payroll related tax deposits and returns are filed timely and properly and that the IRS will not be knocking on your door tomorrow should help you to sleep soundly at night.  Other immediate benefits include more time back in your day, reduced compliance/audit risk, and happier employees.

Companies that use a payroll service provider should maximize their relationship to take advantage of even more benefits including worker’s compensation reporting, 401k administration, human resources compliance, time & labor tracking, and more.  Outsource more than just payroll and reduce administrative burden even further by using the third-party provider for all the ancillary services that rely on payroll data.  For example, ask them to help with the annual Worker’s Compensation Audit.  This annual audit ensures that the insurance company was paid all the premium money owed for the previous year.  Since the outsourced payroll provider knows what each employee was paid, they can help with the premium calculations to generate the annual report for the audit.  More importantly, they can generate a monthly report to alert you if you are tracking higher or lower than your estimate for the year.  This means, no more Worker’s Compensation Audit surprises and a great budgeting tool.

But I’ve heard there are problems with outsourcing…

Some of the perceived concerns with outsourcing payroll include losing control and access to information, fears that your payroll is too unique or complex, or the assumption that it is less expensive to do everything yourself.   However, today’s technology continues to enhance payroll processing capabilities and make it even more cost effective.  It is worth exploring whether these concerns are real or whether your situation would be simplified and streamlined with an outsourced solution.

If I decide to go down this road, what will the transition process be like?

A good payroll provider will strive to make the transition as seamless and easy as possible. Generally, your representative should be able to get everything they need to configure your new system from your existing records and will take care of all the data entry as part of their service.  During the initial setup process, errors may be identified and appropriate steps presented to you for fixing them.  The first outsourced payroll should be ready for processing within 3-4 days of data collection.

Ok, sounds like something I should look into.  What will this cost me?

Your cost will depend on your specific situation including your payroll frequency, number of employees, and types of services requested.  As an example, a one person S-Corporation, with the owner as the only employee paid monthly, is $39.00 per month at Paychex and includes direct deposit, payroll processing and tax payment/filings.  By way of comparison, the IRS estimates it should take nearly 3 hours just to complete one of the quarterly forms!  Of course, it costs nothing to call an expert and ask them to analyze your business and give you a quote.
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This article was prepared with input from:
Meike Alberts
Paychex, Inc.
Meike@EasiestPayrollService.com

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It wasn’t long ago when it seemed that the answer to every business challenge was to “get out and sell more.”

Now, business owners are scrutinizing their operations for ways to squeeze out every last drop of profitability.

This is a healthy exercise for any economy to undergo, and the surviving businesses tend to emerge from difficult times as leaner, more disciplined enterprises poised to take advantage of every opportunity as  general market conditions improve.  Let’s look at four ways to increase your profitability and grow your business:

1. Increase Average Price
2. Increase Transaction Size
3. Increase Transactions
4. Reduce Costs

Head over to the Colorado Springs Business Journal to see the rest of the article.

1. Assemble a team to help you sell
2. Get your family out of the business
3. Report all income for at least three years
4. When trust is involved in a decision, it’s always better to be trustworthy
5. Begin to document everything

Please check out the full article for all the details.

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Etienne Hardre is a Senior Associate with BiggsKofford, P.C. specializing in helping entrepreneurs buy, grow, and sell businesses.

This morning’s panelists:

• Matt Barrett, Colorado Springs Small Business Development Center
• Karl Dakin, DaVinci Quest, LLC
• Jeff Schneider, Entrepreneurial Finance and Accounting Services (This guy is everywhere!)

The moderator for today’s featured presentation was Jeff Chapman of Pivotal Path, LLC.  Each of the panelists was asked about creative ways for entrepreneurs to fund their companies.  Below is a brief list of their suggestions.

Investor-backed Bank Lines of Credit: Although this is a traditional line of credit from a bank, the difference is that a business that might not otherwise qualify on its own can achieve the same result by getting an investor (or investors) to sign a guarantee for the bank.  Provided the investors qualify for the line of credit, the business owner can generally get approved.  In exchange for the guarantee, the investor usually receives stock warrants.

Strategic Investments: These are investments made by other companies, generally strategic partners such as a key supplier or customer.  If your business is critical to another business or vice versa, consider exploring a strategic investment to support one another.  Another way to structure a strategic investment is for a manufacturer to build your first shipment in exchange for equity.  After that, cash flow can keep them paid.

Letters of Commitment: So, Wal-Mart is excited about putting your product in 500 stores as soon as you can produce 10,000 units.  Unfortunately, you’ll need a large amount of cash to ramp up manufacturing operations.  If your key customer will sign a commitment letter promising to purchase a certain amount of product, investors and others will generally loan you the money to get started.

Factoring Accounts Receivable: There are investor groups and factoring companies that will purchase your accounts receivable at a discount in exchange for giving you cash up front.  For example, if customers owe you $500,000 over the next six months, a factoring company may give you $400,000 in cash now in exchange for the cash flow from the customers as they pay off the receivables.  Factoring has a bad reputation with most business owners because it is extremely expensive.  However, it is ultimately less expensive than giving up equity and you may have few other options if you need cash.  Be careful with factoring: one of the panelists related a story of a client factoring their receivables and then offering a discount if customers paid early.  Unfortunately, the client ended up receiving no additional benefit from early payment but was forced to reimburse the factoring company for the cost of the discount for a double whammy.

Patriot Express Loans: This is a guarantee program through the Small Business Administration (SBA) for veterans and their spouses.  One interesting note about these government guaranteed loans is that banks still have the ultimate authority over whether they will lend you the money.  In most cases, banks are most interested before the business is actually formed and after the business has at least 2 years of history.  If the business is less than 2 years old it is considered much higher risk.

What about Grants? In general, the SBA offers no grants.  There are other government organizations that have grants available, but they are usually for very specific uses and have strict qualifications, such as the business being located in a rural area.

Enterprise/HUB Zones: These only apply if your business is located within an area defined by the U.S. Census.  Most of the time businesses are incentivized to relocate to otherwise underserved parts of the country in the form of tax credits or other reduced fees.

Alternatives to Cash: All of the above options are creative ways of producing cash for your business.  Below are several ways to achieve the same effect without actually using cash at all.

1. Joint Advertising: Perhaps you own a fresh new technology or product but lack the cash to advertise properly.  Joining with a larger company that has a well established marketing budget that may benefit from being associated with your “freshness” and “newness” can get publicity for you while the larger company still spends the same marketing dollars.  For example, if a startup condiment manufacturer teams up with Wells  Fargo Bank, the bank’s new ad could read “We’ve got the special sauce” and a free bottle of sauce for all new accounts.  The startup benefits from a national ad campaign while no additional cash is actually spent or transferred.
2. Equity in Lieu of Salary: Often, a startup is selling stock to raise the capital to hire top talent.  Why not give that equity directly to the new hire instead of salary for the first year?  The effect is the same but the business avoids the hassle and expense of preparing presentations for investors and managing diverse groups of stakeholders.

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Etienne Hardre is a Senior Associate with BiggsKofford, P.C. specializing in helping entrepreneurs buy, grow, and sell businesses.

Jeff Schneider

Laura Benjamin interviewed Jeff Schneider, president of Entrepreneurial Finance & Accounting Services to get his top tips for entrepreneurs and small business owners.  Although you might recognize these tips as the very basics it is definitely worth a reminder.  Take a look at Benjamin’s Business Blog for the full article.  There is also an audio interview.

With the recent economic downturn, more of my clients have been asking themselves the hard question of “will I survive this?”  That is leading to a lot more of what Schneider recommends: Plan, plan, plan.

Nearly all business owners can project revenue or even just sales for the next 12 to 24 months.  Some financially savvy entrepreneurs can take this a step further and project all revenues & expenses to produce net income for the next two years.  Very few have the time or the skill to produce an up-datable financial model that not only projects Profit & Loss, but also projects the Balance Sheet and the expected Cash Flows for 24 months.

It is important for business owners to understand their cash flow needs, but in lean times it becomes critical.  If you want more information on financial modeling and the services we can provide at BiggsKofford, please give Etienne Hardre a call at 719.579.9090 or use our handy contact form.

What Happened

After several successful tech companies, Al Davis started a company that developed a software product aimed at assisting engineers with calculating the optimal mix of features in a product. After four years and several investment rounds, the company liquidated, paid its remaining debts, and returned pennies on the dollar to its shareholders. So what went wrong?

What Went Wrong

According to Davis, the company’s most visible failure was the late addition of a qualified marketing & sales executive. His company went through three marketing/sales directors, each with a dramatically different focus and with varying levels of understanding of both the company’s product and its customers. The first involvement from marketing wasn’t until 6 months after the company was formed and by the time they found a marketer with a deep understanding of their customers and technical knowledge of the product, it was too late. Davis’s hindsight advice is to involve a professional marketer at the very beginning, along with the rest of the skill sets generally considered critical to your success such as financial, management, and legal professionals. Make sure this person understands your customer and your product and knows the appropriate sales methods to utilize.

Another failing was the attempt to create a complete “Cadillac” solution right out of the gate. The software product they developed contained all the bells and whistles they could think of and was priced accordingly. They had trouble selling the product because their customer didn’t even realize their need for all that software. Davis calls it a “solution looking for a pain”. Instead, they ended up stripping many of the features and selling an entry level tool at an entry level price.

Starting with a simple product has several advantages:

1. It is less expensive to develop
2. It is faster to develop, allowing you to reach your market sooner
3. It is easier to explain lowering the average time to close a sale
4. You can add the more complex features your customers really want by soliciting their feedback
5. It brings cash in the door today

Finally, spend according to your means. Davis developed a detailed business plan for his company that included targeted levels of investment at each round and expected uses of that capital to meet growth targets. When one of the investment rounds brought in less than projected, Davis chose to continue hiring personnel according to the plan to drive growth. Looking back, he recommends scaling growth investment to the level of available capital, especially if sales are less than expected. In addition, the company was renting Class A office space, and he had personally guaranteed the lease, when their customers rarely visited headquarters. A much less expensive location would have met their needs and freed up cash for reinvestment.

What Went Right

Al Davis has actually been quite successful over his career and the reason he attracted investment in the first place was because there are many things he did right. In fact, a major contributor to this particular failure was the market downturn in 2001.

My favorite positive feature is his employee and investor friendly equity structure. Davis reserved 1/3 of the equity for the founders, 1/3 for future investors, and 1/3 for his employees. Nearly everyone to whom he presented his plan applauded his balance of employee motivation and investor reward.

Davis went even further for his employees and removed nearly all symbols of hierarchy in his company, down to maintaining the same size offices for all employees (including himself). He also went out of his way to keep them informed, even as the company was on its way down. This style of management kept panic to a minimum and employee involvement high which turned what could have been a precipitous plunge into a quiet exit.

Another powerful decision was for the principals to personally invest in every round. Other investors will ask you two questions and personally investing allows you to truthfully answer both questions correctly:

Question: Am I the first investor?
Answer: No, you are not.

Question: Do you have skin in the game?
Answer: Yes, I do.

Finally, and probably most importantly, Davis organized powerful external boards to oversee his company. Not only did he find a qualified board of directors with a variety of useful experience (except marketing, of course), but he also developed an external advisory board in addition. The combined experience and knowledge of these individuals might have prevailed even as the company learned the lessons above had the market not also contributed by reducing the capital expenditures of their customers.

Thanks to Al Davis for his frank and humble commentary. If we are wise, we will let his experience teach us how to become more successful entrepreneurs.

Resources:

• Colorado Springs Gazette Article

Being a CPA, I always read the fine print attached to the asterisk and these offers are just never as good as they initially sound.  I thought I’d take the time to calculate exactly how much interest a business would really end up paying if it utilized this “line of credit” under a couple of scenarios.  I’ll give you a hint: the hidden killer is in the fees.

Let’s take a look at the fine print.

…For each check posting to your Account, we will assess a Promotional Discount Transaction Fee (FINANCE CHARGE) equal to 3% of the check ($5 minimum).

Well, that’s not so bad, you say.  A little transaction fee will at least be offset by the low, low interest rate, right?  Maybe, but probably not.  A 3% fee sounds an awful lot like an additional 3% interest and since this offer is good for exactly one year we can just add the two together to get a real rate for borrowing money under this program and paying it off as late as possible (before the rates rise, of course).  If a business borrowed $1,000, paid $30 in fees (3% * 1,000) and paid it off in a year, there would be $39.90 in interest (3.99% * 1,000).  If you’re paying $69.90 for the privilege of borrowing $1,000 for a year, that’s equivalent to a 6.99% real interest rate ($69.90 / $1,000).

Still not a terrible interest rate for a line of credit, but what if you pay it off sooner?

If you paid it off in 6 months, that $30 fee turns into the equivalent of a 6.00% interest rate (3% / 0.5 for half a year).  Now you’re paying 9.99% annual interest when you add back in the 3.99% interest already being paid.  That sure grows quickly.

Let’s max this program out and assume you borrowed the $1,000 and paid it off in just one day.  3% paid for the privilege of a single day’s worth of credit is a staggering 1,095% annual interest rate! (3% fee * 365 days in a year)  That means if you were to borrow that same $1,000 each day and pay it off a day later for one year you would pay $10,950 to essentially borrow $1,000 for just one year.  And that isn’t even counting the fabulous 3.99% interest they’ll charge you on top of those fees.

Businesses are faced with these kinds of hidden interest costs on a daily basis.  Discounts for paying vendors early and penalties for paying vendors late are among the most common examples.  Overdraft fees due to poor cash management, payday and bridge loans from loan sharks, points and closing costs to refinance, and profit sharing with investors are all components of the real interest cost of borrowing money for a small business owner.  If the real cost of capital is more than what you can get somewhere else or, God forbid, more than the profit you’ll make, it isn’t worth it.  Make sure you do your homework with your accountant before accepting the next “deal”.