Business Planning Includes Succession Planning

Not long ago two brothers I knew had a landscaping business.  They told me that they had recently taken out life insurance on each other in case one of them dies so their families and business’s debts would be taken care of.  One brother was against it, while the other was in favor of it.  But he acquiesced.  It is a good thing that he did.

A few years later, one of the brothers had a fatal accident while working.  The other brother was left to run the business.  He was so happy that the insurance was in place that it helped him continue the business and take care of his brother’s family to the extent that his nieces and nephew could attend college without worrying about the expense.  It was due to the fact they had taken out the life insurance policy.  Now that business has been taken over by the surviving brother’s son-in-law and is doing great.  A second-generation business.

Think about this:  if you suffer a heart attack and need time to recover, you need the ability to have other people step in and manage the business and pay the bills.  Exceeding a month’s convalesce could mean that you could lose the business.  A successful neighborhood fish business was being sold.  The agent told me that the owner suffered a debilitating heart attack and could not return to the business.  He had no insurance.

Owners of businesses should plan a “what if” scenario indicating in writing who should take over his tasks.  Perhaps it is a trusted staffer, relative or friend who could sign checks and purchase orders, and have access to accounts and records.  They should purchase insurance that provides money to hire someone to run the business if they become incapacitated for an extended amount of time. If there is no one running the business, vendors and customers might get nervous and discontinue their patronage.  Bankers can decide to start calling in credit.

These stories should make sole proprietors and partners consider succession planning.  Some owners feel that their children will take over the business.  It rarely happens – children want to do their own thing. Other management options to consider are current employees, customers or competitors who would purchase your business.

Finding your replacement is difficult so plan ahead, it is best to start early. Leaders are not always easy to find and it takes time to mentor someone into a management role. You will need to identify potential successors in your family or among your employees. You can hire from outside the company, but it’s helpful to groom someone already in your business over time so the transition to new leadership will be smooth.

Planning for continuity or retirement wise.  Be sure to do it!

Why Do Businesses Fail?

We have a great idea and we are anxious to go into business and become an entrepreneur.  You are advised to do your market research, consult with focus groups to test the market, determine your competitors, and write that business plan.  You look for investors and put your own money and probably friends and family money into the business.  You plan, strategize, write and then you are on your way. You are energized with the hope that your business will be great.  But what can go wrong?

Here are five common reasons why new businesses fail:

  1. Lack of Sufficient Capital

Opening a new business, no matter how small or large takes a lot of money, and many new owners do not foresee this.  I recommend planning your strategy and write a formal business plan.  It is important to understand the difference between a startup budget (money you will need to open your doors) and an operating budget (money for your monthly costs and expenses).

  1. Insufficient Marketing

You may think that you must hire a public relations firm to write your news articles and keep your name out front.  But as a startup you do not have the money to do this.  There is so much out there that is free or relatively inexpensive in the way of social marketing tools, like, Constant Contact, Twitter, Instagram and Facebook. You can use these initially.  You can even have a presence on the Internet by creating a website.  In today’s world, especially with the Millenniums and their use of the smartphones, you need to have a website.

  1. Not Understanding your Target Market

You need to know that the market you are entering is growing or self- sustaining.  It is foolish to enter a market that is declining; you will be unsuccessful and waste the investment you have made in the business.  You need to understand the demographics of the area and what their buying habits are and what they like to do.  Gearing products to the wrong group of people are recipes for disaster.  If you find that you have targeted the wrong market, you may not have enough time to pivot to another market.

  1. No Experience in the Business

It is beneficial to have some experience in the type of business you want to establish.  If you want to open a restaurant, and never have been in a restaurant’s kitchen or know what the margins are for running the business, you are wasting your time and money.  You will need to know what you are getting into.

  1. Going into Business for the Wrong Reasons

The entrepreneur Guy Kawasaki says that going into business to get rich is the wrong reason for going into business.  You should go into business to fulfill a need of society, or what can make life better for us.  It takes a lot of time to run a business, probably up to 80 hours a week, and the entrepreneur can become overwhelmed with the responsibilities.  It is important to have a support group, especially your family, going into it.

When Plan A Doesn’t Work

When Plan A Doesn’t Work

The entrepreneur sets out to create or manufacture a product for a certain target market. We hold focus groups and send questionnaires and analyze their responses. We analyze the competitive marketplace and determine that we have a viable product. We do all the things that the marketing gurus say we should do to communicate our product to potential customers.  We forecast the sales we believe we could achieve and cover our costs well enough to provide a profit.

We launch and we are excited about our product, but something happens along the way.  Those customers whom we targeted are not infatuated enough with our product to make it sustainable.  Our sales forecast is not met. We are losing money.  What happened?

Perhaps you created a product that would saturate the market in a few years.  Were you wise enough to have created a core product so that you could change it or modify it into another product that would attract the same customer group who purchased the initial product?

We gather our team together to discuss the nature of our product.  Did we create value for the price offered?  Did we make it easy to use?  Was there something else in the marketplace that we did not discover?  We invested all this money on plant and equipment, inventory, and personnel, now what do we do? Give up? NO! We pivot.

Pivot?  What does that mean?  It is “a structured course correction designed to test a new fundamental hypothesis about the product, strategy and engine of growth.”  (See, The Lean StartUp by Eric Ries, Crown Business, 1978). This is a word that is especially used in the start-up technology world, but it has application for other industries as well.

When your business model is not working, you leave Plan A and turn to Plan B. You reimagine your product and your market. You find another use for the product, or we target another customer group.  We review how the original customers used our product.  Do they use it in the same way that we anticipated?  Is the size of the product appropriate for the customer?  Can these customer interactions be made more lasting and valuable? Can the recurring revenue services and products extend beyond the initial sale?  You are not alone in making changes.

There are many companies which started off with one idea and then had to change it to another idea.  These include:

Twitter  –  from Odeo which offered a network where people could find and subscribe to podcasts.  But I-Tunes came into being as a strong competitor.  Then they brainstormed and came up with the microblogging platform Twitter.

PayPal – originally allowed people to “beam” payments from their PDAs.  After merging with a financial services company called X.com, PayPal became the preferred payment system for EBay.

Instagram – It began as Burbn, check-in app that included gaming and a photo element as well. The owners worried about its clutter and potential actions.  They stripped all the features but one: Photos.  So, they rebuilt the app and focused solely on photography.

Wrigley – Wrigley, a salesman, offered chewing gum for the purchase of his soap and baking powder.  The chewing gum became more popular than the soaps and baking powder.  He went on to manufacture his brands: Juicy Fruit, Spearmint and Doublemint. The rest is history.

Fab.com – began as Fabulis, a social network targeted towards gay men. Although it tanked, in their side jobs the founders had a knack for selecting products the customers liked.  And took a new direction with Fab selling hand-picked home goods, clothing and accessories.

If you find yourself in a position like those above, don’t fret be innovative and pivot.  Find a use for your existing product, or change your target market, or even use the customers you currently have to develop a new product.

Sources:

What “Pivot” Really Means by Alan Spoon, Inc.com, August 10, 2012

Anatomy of a Business Pivot, by Mike Periu, American Express Open, Oct. 28, 2013

14 Famous Business Pivots by Jason Nazar, Forbes, Oct. 8, 2013

 

The Trump Tax Plan and What It May Mean to You

The President-elect made a few campaign promises to us regarding taxes.  And since the Republicans are controlling the House and the Senate, we are likely to see tax changes if his campaign plans and promises hold.  These may not go into effect until the 2018 tax year.  Since his campaign promises were without specificity, below is what we do know.

Business Taxes

Trump has promised to repeal the estate tax, reduce corporate taxes to a flat 15% and simplify individual taxes.  Trump has indicated he will first focus on changing business taxes before individual ones.

C-Corporations currently have a graduated tax rate to 35%, he is proposing that any business would be taxed at 15%.  However, we do not know what expenses would still be allowed, and there is talk that Trump maybe moving toward a gross receipts tax, where very few expenses can be deducted. This would be good for some industries and not for others.  It would discriminate against certain types of businesses – those that are very heavily expense-laden, like retail; they would pay more.

S-corporations and partnerships, which are pass-thru entities, presently are taxed on the individual level, but they would have the option to be taxed at the 15% corporate rate.

Personal Taxes

For individuals, Trump may take the top rate down by 6.6% to 33%, repealing the alternate minimum tax and reducing the number of tax brackets from seven today to three.  Those with taxable income between $0 and $37,500 ($0 to $75,000 for married filers) would be subject to a 12% tax rate, while those with taxable income between $37,500 to $112,500 ($75,000 to $225,000 for married filers) would be subject to a 25% rate.   And those with taxable income above $112,500 ($225,000+ for married filers) would be subject to a 33% federal tax rate.  This may sound beneficial to some people, but there might be some negative surprising results as to what some people’s tax liability might be.

Trump may change the standard deduction and it would more than double to $15,000 for single filers to $30,000 for married couples filing jointly while eliminating many itemized deductions and capping all deductions at $100,000 for single individuals and $200,000 for married couples.  This increase along with the lower tax brackets would see the federal tax liabilities go down for most Americans, and is in line with Trump’s goal to simply tax rules and present the rich from taking legally gray deductions.  Charities may suffer if there’s a cap because this would not incentivize charitable deductions.

Under the Trump tax plan a middle class tax payer would likely see modest tax savings while those in the highest income ranges would actually see the most in savings given the lowering of the highest marginal tax rate, increase in the standard deduction and repeal of the Alternative Minimum Tax.

For those of us with businesses it would behoove us to consult with an up-to-date accountant regarding year-end tax planning.

Ways to Fund Your Business

question-markStarting and planning a business can be fun as well as a daunting experience, especially when it comes to being able to pay for all the equipment, inventory and payroll that goes along with it. How am I going to pay for all this, you may ask.  How much will a bank loan me, or who is likely to be an investor in my company?  I offer some solutions to these questions which further discusses these options mentioned in my August 23, 2016 essay on Funding Options.

For a start-up business it will be difficult to get an investor interested in it unless you have a hot, trending business and the personal skills and background that goes along with your ability to run the business.  An investor focuses on your product and proven market demand for it indicated by sales growth and the cash flows that can be generated.  Growth from year to year of say,  20% to 50% would pique his interest.  He wants to be able to get a return on his investment for a period of years and then he may sell out in 5 to 7 years. He will determine your commitment to the business by asking how much of your own money is invested.

If you get an offer from an investor, he will most likely want preferred stock in the business. Preferred stock is stock in the business but with some differences. It has a maturity date and there is interest or  dividends paid on the amount of the issue which is paid semi-annually.  Here the investor is getting interest paid on the use of his money, and the maturity date indicates that the principal amount is repaid at the maturity date.  The investor also has a higher claim on the business because of his position as a “preferred” stockholder.

Bonds are another instrument to consider.  However, they are used to fund projects.  If you are considering purchasing a building, for example, you could get a bond from your municipality issued for this purpose which will have a benefit of being tax-free to the investor and a lower tax rate for you to pay.

Bank loans are difficult for a start-up to obtain, but if you are in business for a few years and have growing sales and good cash flow, then a bank would consider you.  Of course, there are the issues of collateral, character, capacity and economic conditions which will be considered.  You can apply for a small business loan guaranteed by The Small Business Administration at banks in their program. The SBA loans feature interest rates that are below market.

Equipment can be purchased with an equipment loan and the equipment will be collateral for the loan.  The beauty of this kind of loan is that the manufacturer may work with you on the amount of interest to be paid.

Of course, there is the Crowdfunding route you can take.  Prepare a presentation of your product or project and the amount of money to be raised.  Different crowdfunding platforms have different requirements and features for hitting your target amount.  Read their requirements carefully and make sure the particular platform is right for you.

The above are considerations that must not be weighed lightly.

 

 

Startup Funding Options

So, you want to start a business; you have this great idea for one; or, you have a product that you want to introduce to the marketplace.  But what is holding you back?  Money?  Well, there are several options for you to take advantage of.  Let’s take a look at them.

Many aspiring entrepreneurs will say that they will take the money out of their savings.  According to a recent study funded by the Ewing Marion Kauffman Foundation, nearly 70% of entrepreneurs rely o their personal savings. About a quarter of entrepreneurs rely on venture capital and “angel” or private investors (see my earlier essay on Angels vs. Venture Capitalists), while only 15% rely on friends and family. An even smaller percentage — about 7% — received funding through corporate investments. Crowdfunding is also a popular alternative. According to Fundable, a small business crowdfunding platform, crowdfunding raised $5.1 billion in capital in 2012.

There are other options other than those indicated above.  Depending upon the state you live in, you will want to reach out to an economic development agency.  There you will be able to find financing through tax-free bonds.  For example, in New York State there is the New York State Industrial Development Agency, which issues double tax-free bonds.  That is, the income earned from the bond interest exempted the purchaser from both New York State and federal income taxes.  These will offer a much lower interest rate to you from those in the market.

If you are contemplating a manufacturing-based business, you may consider leasing equipment, the supplier of the equipment will finance the purchase of the equipment.

If you are looking to purchase an existing business, the seller may be willing to fund at least a portion of the sale with a mortgage.  This is true especially in the restaurant business and other small businesses. The seller will usually stay with you in the business for about three months to make sure that everything is going smoothly for you and to introduce you to suppliers and other vendors.

Your success in this regard is to think about other financing sources and to think outside the box.

 

 

Time to Sell Your Business?

Business owners will be confronted with the decision whether to sell their businesses. True, it is a very emotional decision to make.  You conceptualized the business from the very start, built it, endured trials and tribulations,and now the thought is blooming whether to hang it all up.

Just as there are many businesses, there are as many reasons to have thoughts of selling. Here are some of them:

  1. Financing may not be available for capital investments, or too expensive to undertake.
  2. The industry is turning down and you want to sell while strategic buyers are still willing to buy.
  3. Conversely, the industry may have seen some events which have driven sales prices high and you want to take advantage of this “window of opportunity”.
  4. You want to retire and reap rewards of your hard work, and  you didn’t plan for  a successor.

If you decide to sell, you should think about how to get your business spruced up for sale. You need think along the lines of asset values,  product lines, customer list, sales force, distribution channels, and employees.

One of the first things to consider is the items on your balance sheet. What is the investment you made in equipment.  What is the state of your equipment; is it technologically advanced or is to ready for the junk heap? How much is it worth?  What is the value of your intellectual property? Do you own any patents and/or trademarks?  Would you be selling them or keeping them for their royalties?

A potential problem area is that of inventory.  What is its value: is it overvalued or undervalued?  Is there any obsolete inventory or failure to properly count inventory? What is the return rate on your inventory,and why was it returned?

Are the liabilities recorded properly, are there any missing?  Are the accounts up to date?

Are the receivables collected on time and recorded properly?  Are there sufficient reserves for doubtful accounts, sales returns and allowances?

The Customer List is a valuable asset.  Many companies would love to obtain a good customer list to increase their own businesses.  What is the concentration of your customers?  Do you have a few large customers with frequent orders?  Where are they located? What is your distribution channel like, distributors, dealers or direct to consumers?

What are your key competitors’ market share?  Are they growing, or declining?  What is the impact of foreign competition?

With regard to your products, who are your suppliers?  Do you manufacture yourself or outsource all or some of your production?  Does your production process require skilled labor?  What are the production costs?  Are you sales increasing or decreasing?  Can you supply three years of projections, including trends and seasonal or cyclical fluctuations?

Any potential buyer will want to look at your financials.  Three years of up to date historical numbers is the norm.  Depending upon the sale date, you may have to obtain interim financial statements.   All of the financials will have to be audited.

So you see, the decision to sell should not be taken lightly.  There is a lot to do to get your business in shape and attractive to a potential buyer.  So, take this advice.  Keep your records and agreements in order, and keep your books up to date.  Run a business in good order, and your business will be attractive to any suitor.

 

 

 

 

 

 

The Advantage of a Diverse Product Portfolio

 

Recently, I attended a conference on small business funding given by Launchpad LI.  There were three entrepreneurs on the panel who discussed various topics in establishing and funding a small business.  The moderator had asked one of them about the sale of one of his businesses and what had made it attractive to the buyer.

He responded that it was because he had developed a sustainable business, one that would last for a long time.  What did that mean? He developed a good management team.  He advocated continuous improvement in his manufacturing. He developed many products, not just one, that would carry the business. And, the business was profitable.

The lightbulbadvantage of having several products is one of the products would be able to carry the business as a “cash cow” thus providing funds to be able to develop and market a new product.  The “cash cow” would provide enough profits or cash flow surplus that introducing a new product would not require outside financing.

If a product were to go out of demand or was replaced by technology, the new products would fill in the gap left by the outdated product.  Thus the company would not suffer the loss from the discontinued product.

This discussion reminded me of when I was with an investment bank.  The owner of a business, who created an
anti-theft device for automobiles, wanted to bring his business public.  The business was doing quite well making over $250 million in sales with a gross margin of 50%. The business was not only in the United States but the owner had expanded to markets in the Far East and Australia.  What a business!

After much investigation on this company, we decided that the company was not a candidate to go public.  Why?  This company only had one product; there were no other products being developed at that time.  Surely, when the product saturated the markets it was in, his demand would decrease, sales would fall, and he would become unprofitable. And because he had only one product, the business was unsustainable!

Getting to the Next Level – Purchase Order Financing

You have just received a large sales order for your designs, a great opportunity for you, and you cannot possibly fill it because your small business is low on cash or below water to purchase supplies in order to fill the order.   So what are you going to do?  Consider the hurdles:

  • Purchase the goods you will need from your suppliers, with upfront money you don’t have
  • Get the money you need from a bank, but without a long track record or history of impressive financial statements this may not work
  • Accept not receiving payment from your customer until 30 or 60 days after they received shipment, creating a cash flow gap you can’t manage.

If you turn down the order, you may lose your customer to a competitor and you will lose out on your opportunity to grow the business.  You will have to get creative.

There is a way to remedy this situation and that is through purchase order financing.   Purchase order financing (or funding) looks to the credit worthiness (and good fashion sense) of your customer.  Your creditworthiness or the fact that your business may be underwater is not an issue; your customer’s creditworthiness is.  A purchase order financing company works with your supplier or manufacturer to get your garments produced on time.  It also works with your customers to ensure payment of the invoice.

Here is how it works.  A purchase order loan is a fee-based, short term loan and there is no interest charged.  To see if the loan can be made, the purchase order lender investigates the credit history of your customer.  If the customer has a good, solid track record of paying its bills and has the cash flow to pay for the goods it has ordered, a loan can be made.  But there is some information required on your part.  You must know your costs for the product and the gross margin attributed to that product.  If you have a gross margin of 25% or more, then it is possible to execute a purchase order transaction.  This means that you will have enough room to make a meaningful profit.

If your customer has good credit, the purchase order lender delivers a letter of credit to the manufacturer that guarantees payment for the needed goods.  The factory then makes the products, and a third party verifies that the order is complete.  The factory gets paid and ships the goods off, usually to a third party warehouse.  It is rare that you would take delivery of the goods; they are usually shipped directly to the customer.po_financing_process_800

When the bill is paid, the funds go to the purchase order lender, which subtracts its fee and sends the remaining profits to you.  This fee may amount to 4%.

There may be a hitch to the receivables portion of the transaction.  If you have given the customer payment terms of 60 or 90 days, another type of specialty lender, a factor lender, comes into play to provide immediate payment to the purchase order lender. (See my post dated June 21, 2016). The factor lender buys the outstanding invoice at a discount and then waits and collects the full amount owed later, pocketing a profit in the process.  Meanwhile, the purchase order lender and you get paid immediately.  Thus, with this good news comes the bad, there is another layer of costs involved with factoring but this may be required by the purchaser order lender.

Here is what you do to start the Purchase Order Financing Process.  You provide a valid purchase order with a credit worthy customer and the expertise to  manage the process.  The purchase order lender provides payment to your supplier, allowing your goods to be produced and shipped.  Payment is typically completed through issuing letters of credit and ultimately the payment of the invoice.

Benefits to using a purchase order lender.  While you stand to get 94-97% of the profit (implies a 25% gross margin), you are getting money to help you grow your business. You can use a purchase order lender many times; there is no restriction.  The transaction does not show up on your balance sheet (off balance sheet financing) as a liability, thus working capital is not impaired by this transaction and your total debt to equity ratio is not increased.

Who, other than the fashion industry, use purchase order lending?  Importers, exporters, wholesalers, assemblers, distributors and manufacturers, who are experiencing rapid sales growth, capital constraints, sales volatility, seasonal sales spikes, high development costs, stretched credit, new product launches can take advantage of this type of financing.  Industries that can benefit are electronics, housewares, sporting goods, toys/games, furniture, food products, hardware and industrial goods.

To find a purchase order company you can look at industry information and the yellow pages.  Make sure you check references first.