Integrated financial planning for business owners January 30, 2014

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1 Integrated financial planning for business owners January 30, 2014 Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International.

2 Presentation topics > Global business succession survey results > Integrated financial planning for businesses and business owners > Preparing your business for transition 3

3 Global business succession survey results

4 Global business succession survey results Eight principles of succession > Derived from the nearly 2,400 responses received from the Baker Tilly International Global Business Succession Survey, conducted across 55 countries in nine languages > Supported by analysis and narrative quotes from respondents 5

5 Global business succession survey results: Eight principles of succession Principle 1: Succession is not retirement > Instead focus on growth and opportunities available to you today > Explore options for ensuring your business s continuity and evolution Principle 2: Start with readiness > The succession process takes time, commitment, and motivation 6

6 Global business succession survey results: Eight principles of succession Principle 3: Set your goals before the journey > Establish clear, measurable, and compelling goals to energize and engage those involved in the process > Before, during, and after the process, respondents goals changed (e.g., during the process, respondents main outcome they achieved was a goal giving family members a better understanding of the demands of the business that wasn t even in the top five of outcomes they set out to achieve). 7

7 Global business succession survey results: Eight principles of succession Principle 3: Set your goals before the journey Before 30% 15% 15% Succeeding generation feel trusted and empowered Secure suitable retirement arrangement for relinquishing generation Identify the best person for the job Strategic positioning of the business for sale 12% 14% Equitable inheritance for all family members 14% Other outcomes* *Comprises five remaining outcomes 8

8 Global business succession survey results: Eight principles of succession Principle 3: Set your goals before the journey During 15% Give family members a better understanding of the demands of the business Identify the best person for the job 38% 13% Formal documentation of a succession plan Strategic positioning of the business for sale 11% 11% 12% Equitable inheritance for all family members Other outcomes* *Comprises five remaining outcomes 9

9 Global business succession survey results: Eight principles of succession Principle 3: Set your goals before the journey After Formal documentation of a succession plan 34% 15% 13% Succeeding generation felt trusted and empowered Equitable inheritance for all family members 12% 13% 13% Secured suitable retirement arrangements for relinquishing generation Identified the best person for the job Other outcomes* *Comprises five remaining outcomes 10

10 Global business succession survey results: Eight principles of succession Principle 4: Harmony is a must > Creating, sustaining, and enhancing family harmony throughout the process is important for not only supporting and delivering your goals, but also for weakening and removing barriers that might exist in achieving those goals. > Respondents said the importance of keeping family harmony never wavered throughout the planning process. 11

11 Global business succession survey results: Eight principles of succession Principle 5: Price is not first Key considerations > Continuity of the business and ongoing jobs for employees are the biggest concerns during planning no matter whether the owner is planning to sell, retain, or transfer the business but getting the best sale price is an outcome of the focus on continuity and jobs. > Before the process started, getting the best price for the business was considered an important factor, but its importance lessened significantly throughout the process. 12

12 Global business succession survey results: Eight principles of succession Principle 6: Plan early, start earlier > Because succession is about business continuity, ongoing jobs, and building capital value, you cannot start planning for succession too early. Principle 7: Equality is not equal Challenges > When family is involved, one of the key challenges is finding a balance of participation, ownership, and distribution of wealth. > You must be fair, rather than equal, and base your decisions on historical and future contributions of family members. > Achieving a fair distribution of assets among family members was one of the greatest challenges listed by respondents. 13

13 Global business succession survey results: Eight principles of succession Principle 8: Ask before you get lost > The succession process can be complex. Work with professional advisors who can help you achieve the best plan for your family and business. 14

14 Integrated financial planning for businesses and business owners

15 Life cycle of a business and business owner Business owners view their business and personal needs in tandem Business owners develop in stages over their business and personal lives Transitioning your business Expanding your business Growing your business Starting your business Transferring wealth Preserving wealth Building wealth Becoming established 17

16 Integrated financial planning > Smart planning is integral to building and retaining value. > Your entire financial picture must be considered and advice should be applied holistically. > A comprehensive approach leverages the similarities and differences between your business and personal planning goals. > This type of approach requires dedicated, ongoing oversight in order to review, monitor, and adjust the plan as needed. 18

17 Integrated advisory team > Comprises a head of finance, business managers, attorneys, CPAs, bankers, investment advisors, insurance specialists, etc. > Key objective: Apply similar business planning expertise and discipline to the personal sphere; communication and coordination is critical. > Advisors with the ability to handle business and personal financial matters should be able to preserve and build your capital, protect your family and business, and maximize tax efficiencies. 19

18 Integrated advisory team Your financial planning goals Business Family Philanthropic Personal You/Personal CFO CPA Attorney Banker Insurance advisor Investment advisor Other advisors 20

19 Building the blueprint Picturing the integrated financial situation > The same comprehensive financial analysis (using and reviewing balance sheets, income statements, tax projections, budgets, etc.) used to manage successful businesses should be applied to your personal sphere. > Integrated financial statements will clarify how changes in economic conditions and tax laws as well as family status and business decisions can affect your ability to sustain your lifestyle. > Having that framework will also make you better equipped to meet business and personal objectives and respond to unforeseen events. 21

20 Business and personal integrated financial statements 22

21 Essential components of the balance sheet > Taxable investment assets, such as cash, marketable securities, restricted stock, and hedge funds > Lifestyle assets, such as tangible property and personal residences > Business assets, such as the value of your company, property, and private equity investments > Tax-deferred assets, such as 401(k)s and IRAs > Insurance, such as life insurance cash value and death benefits > Liabilities, such as mortgages, private equity capital commitments, and income and estate tax 24

22 Family balance sheet Snapshot of total financial situation > Assesses your family s overall holdings and sources of income as well as how different types of assets impact your liquidity, tax burden, and cash flow. > Allows you to more easily shift components based on your planning objectives. > Helps you identify how potential problem areas, such as concentration risk, tax liabilities, or debt-to-equity ratios, can affect personal goals and business objectives. 25

23 Family balance sheet Included in estate Non-Includible Business owner Business owner's Spouse Joint Total Includible Family Trust Charitable Trust ILIT for Business owner ILIT for Business owner's Spouse Joint ILIT Total Non- Includible Total Non-Qualified Assets Taxable Investments - - 2,500,000 2,500, ,500,000 Total Non-Qualified Assets - - 2,500,000 2,500, ,500,000 Lifestyle Assets Tangible Property Personal Residences - - 1,500,000 1,500, ,500,000 Total Lifestyle Assets - - 1,500,000 1,500, ,500,000 Business Assets (C corp, S corp, LLC, LP, etc.) Business Assets 10,000, ,000, ,000,000 Total Business Assets 10,000, ,000, ,000,000 Qualified Assets Tax-deferred investments 500, , ,000 Total Qualified Assets 500, , ,000 Death Benefit of Life Insurance 1,000, ,000, ,000,000 Total Assets 11,500,000-4,000,000 15,500, ,500,000 Liabilities Mortgage and home equity Total Liabilities Total Net Worth 11,500,000-4,000,000 15,500, ,500,000 26

24 Preparing your business for transition

25 Preparing for transition > Step 1 Define your transition goals > Step 2 Develop your transition strategy > Step 3 Determine your company s worth in the current environment > Step 4 Prepare the business for transition > Step 5 Make the appropriate changes > Step 6 Monitor the results > Step 7 Make adjustments > Step 8 Execute your transition strategy 28

26 Define your transition goals What would you want to accomplish in a transition? > Legacy Family still in control Create a family office > Keep the business intact > Maximize proceeds > Provide an opportunity to loyal employees/management > Combination? 29

27 Develop a transition strategy How will you transition your business? > Gift to children/grandchildren > Sale to children/grandchildren > Sale to management > Employee stock ownership plan > Sale to third party Strategic Private equity > Leveraged recapitalization/dividend > Other reorganization 31

28 Develop your transition strategy Common errors entrepreneurs/family businesses make in a transition > Waiting too long to prepare: The business The management The family > Not addressing tax issues or using an overly aggressive strategy Corporate (federal, state, local, international) Personal Estate > Neglecting the company s capital structure and accounting and operational systems > Losing sight of the risk profile of the company 32

29 Develop your transition strategy Common errors entrepreneurs/family businesses make in a transition (cont.) > Failing to understand how a third party will view: The industry The company s position within the industry Operations The company s ability to generate economic earnings The company s growth prospects The risk profile of the company 33

30 Determine your company s worth It is critical for sellers to have a firm grasp of what their company is worth taking into consideration the current state of the company, the industry in which it operates, and general economic conditions. 34

31 Determine your company s worth Gordon model V = cash flow risk - growth 35

32 Determine your company s worth Maximize value = cash flow risk growth 36

33 Determine your company s worth Defining cash flows > EBIT Earnings before interest and tax > EBITDA Earnings before interest, tax, depreciation, and amortization > EBITDAOC Earnings before interest, tax, depreciation, amortization, and owners compensation > Recast EBITDA Discretionary expenses Unusual or one-time expenses > Free cash flows 37

34 Determine your company s worth Free cash flows = EBIT (1- t) + d ± WC - I t = marginal tax rate d = depreciation WC = change in working capital I = normal, recurring replacement of fixed assets 38

35 Determine your company s worth > Assessing risk General economics Industry specific Company risks Weighted average cost of capital: o Cost of equity reflecting systematic and unsystematic risks o After-tax cost of debt > Growth: The sustainable rate of growth in cash flows 39

36 Prepare the business for transition If you know the enemy and know yourself, you need not fear the results of a hundred battles. Sun Tzu, The Art of War 40

37 Prepare the business for transition Once the objectives and method of transition is determined > Determine the time line or transition target date > Make an objective assessment of family/management > Select your team will depend upon the nature of the transition Legal Management Tax Accounting/systems Investment banker and appraisers 41

38 Prepare the business for transition Have you communicated to family and management? > Family: Are they prepared to step into your shoes? Is there an obvious family successor? Are their goals consistent with your goals? > Management: Is the management team complete? Is there someone on the existing team that can or is willing to lead the company? 42

39 The third-party s perspective > Being committed to the transition process have you emotionally come to terms that you are ready? > Knowing your transition objective will the transaction accomplish your goal? > Timely and thoughtful responses everything is being observed. > Appropriate expectations of the outcome. > Appropriate representation. > Management team responsible, seasoned, diversified skill sets, and incentivized for a smooth transition. > Projections and forecasts eloquent and complete presentation of the growth plan. > Sound financial reporting completed audit and robust information systems. > Recasted earnings do they make sense and are they balanced? > Are you willing to participate in the transaction? communicates confidence in the growth plan and remaining management s ability. 43

40 The third-party s perspective Competition pricing strategy Product technology management efficiency EBIT margin Asset turnover Investment analysis and valuation process Credit conditions financial strategy Financial leverage (Assets/equity) Interest burden (EBT/EBIT) Return on equity (R) Government policy Tax burden (1-tax rate) Growth rate g=r(1-k) Free cash flows Accounting policy Earnings forecast Dividend policy Payout ratio (K) Stock value P=(KE)/(r-g) Financial market analysis Interest rates Equity risk premiums Company risk Sales volatility Operating leverage Financial leverage Liquidity of stock Beta Discount rate (r) Note: Adapted from Stalla Seminars 44

41 The third-party s perspective Operations > Collect operating metrics weekly, monthly, annually > Understand how the company compares to peers industry data > Know what data might be requested (varies by industry) Capacity utilization Production rates and through put Sales ($ and units, by SKU) Cost of goods ($ and units, by SKU, by type of cost) o Raw materials o Outsourced services o Labor o Overhead o Scrap or waste rates Quality metrics Supplier/vendor concentrations Condition of equipment 45

42 The third-party s perspective Quality of earnings > Revenue recognition > Monthly financials > Proof cash > Pricing strategy > Revenue and gross profit/contribution margin By SKU By division By customer By channel By key relationship manager By volume Seasonality Historical (10 years) 46

43 The third-party s perspective Quality of earnings > Cost accounting methods > Cost structure fixed vs. variable > Adjustments to earnings not-recurring and pro forma > Debt, debt-like items, related-party transactions 47

44 The third-party s perspective Summary income statement X1 X2 Sales $10,000 $11,500 Costs of goods sold 6,000 7,500 Gross profit 4,000 4,000 Sales, general, and administrative 2,000 2,500 Income from operations 2,000 1,500 48

45 The third-party s perspective Sales analysis X1 X2 Price variance Volume variance Change Product A $3,000 $4,000 $2,000 ($1,000) $1,000 Product B 1,500 3,000 1, ,500 Product C 1,500 2,000 (500) 1, Product D 2,000 2, Product E 2, (500) (1,000) (1,500) $10,000 $11,500 $2,500 ($1,000) $1,500 49

46 Make changes > A self-assessment will usually point the way for the critical next steps > Make changes that are only appropriate given the time line > Monitor the results of your operational changes > Make adjustments as necessary > Execute your transition strategy 50

47 Conclusion > Preparation is key start early > Understand your objectives and timing > Assemble a team of advisors Develop a process that is right for you and for the market Create a realistic time line 51

48 Disclosure The content in this presentation is a resource for Baker Tilly Virchow Krause, LLP clients and prospective clients. Nothing contained in this presentation shall be construed as legal advice, opinion, or as an offer to buy or sell any property or services. In conformity with U.S. Treasury Department Circular 230, tax advice contained in this communication and any attachments is not intended to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code, nor may any such tax advice be used to promote, market or recommend to any person any transaction or matter that is the subject of this communication and any attachments. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

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