Estate Planning for Entrepreneurs – Part 3: Appraising Your Most Valuable Asset

A small business owner typically has the vast majority of their net worth invested in one asset – their business. While the situation is often unavoidable and ultimately difficult to change, the business owner is in a high risk position.

The July issue of the Journal of Accountancy included an excellent article written by Justin R. Ransome and Vinu Satchit (read here) that discusses the recent developments in the law regarding valuation discounts for closely held businesses.

More SBA Loan Funding Available Through Federal Stimulus Funding

I wrote some time back about the challenges that many small business owners were having in obtaining financing. Some of these businesses would probably have qualified for the financing they need just two years ago.

A big part of the problem is that banks are still too skittish. We’ve seen the folks responsible for making loans go from one extreme to the other. Just a couple years ago we heard of people applying for an receiving credit in the name of young children, and even heard of a bank who sent a pre-approved credit card for someone’s dog.

Now some banks are even calling loans and lines of credits that are performing under the terms of the contract.

Even after that’s been said there may be a glimmer of hope.

I ran across an article by Dave Copeland in the Boston Globe which discussed the fact that SBA loan guarantees have increased based on the availability of funding in recently passed Federal Stimulus Bill (American Recovery and Reinvestment Act).

Some highlights include:

- $730 million allocated for Small Business Loans
- Increase in loan guarantee percentage to 90% from 80% [On 7(a) Loans]

Some eye openers in the article included:

- 73% increase in small business loans in Massachusetts since the Stimulus Bill passed
- Even with the Stimulus SBA backed 35% fewer loans in 2009 than in 2008
- Total amount loaned through SBA guarantees dropped by 27% from 2008 to 2009

The way 7(a) loans work is that customers apply for a loan through a participating bank and if necessary, and if the customer meets the SBA’s criteria, then the SBA will guarantee the loan and basically as as a cosigner.

The Pursuit Small Business Roundtable

On Friday October 16 we’ll be kicking off our monthly roundtable for our firm’s small business clients. I believe that all small business leaders and entrepreneurs should be part of at least one regular roundtable group.

The key benefit of a roundtable is ability to share knowledge and support with other similarly situated business leaders.

I recently read a book called Influencer that was written by the folks who wrote the book Crucial Conversations. In that book they gave an illustration that I think perfectly sums up the power of groups. The point to a study by British scientist Francis Galton who asked 787 residents to guess the weight of an ox at a regional live stock fair. Well when Galton averaged the estimates given by the residents it turned out to be 1,197 pounds.

The actual weight of the ox? 1198 pounds. Not bad huh?

They key to me, from standpoint of a small business roundtable, is the fact that your colleagues can help to identify blind spots in your thinking that you might miss. A good roundtable maintains a provides a sustained assault on common business problem, and as Voltaire is quoted as saying, “no problem can withstand the assault of sustained thinking.”

Here are some things to look for in a small business roundtable group:

1. Regular meetings – Whether the roundtable meets semi-monthly or monthly, the roundtable should have a regular schedule and the schedule should be consistent.

2. Committed members – If possible, speak with the members of the group and gauge their commitment to the group. If a significant number of the group’s members consistently miss meetings that’s a pretty big red flag.

3. Group size – My ideal roundtable group would have between 5 and 10 members and there should be a facilitator. The facilitator may be a member of the group or as in the case of our roundtable – I serve as the facilitator and the members are clients of our firm.

I’m happy to answer any of your questions.

Advisory Board Rules

Your advisory board members are not a board of directors and they are not employees. Since the odds are you don’t have several thousands of dollars to pay each of you members each month, it is unreasonable and unrealistic to expect them to give several hours per month.

You have to show your advisory board members early on that you respect their time and won’t make unreasonable requests. The most frequent areas of abuse are as follows:

1. Meetings – meetings with a clear plan, and that are not designed to accomplish clear objectives should never happen. Don’t include people in meetings that don’t absolutely have to be part of the meeting. If your staff are in the meeting, be sure that they are clear that meetings will not be allowed to run on with irrelevant conversations.

One hour each quarter is about as much as you should reasonably expect from your advisory board. To get the full benefit, you may choose to meet each member of your board two times per quart for 30 minutes each time. If you have a three-person team, that’s six meetings every 3 months. Each meeting being very pointed.

2. Costs - business etiquette and common sense dictate that you shouldn’t place an undue financial burden on your advisors. If you’re meeting will be over lunch, come with a plan and leave with the bill.

3. Strictly Business – don’t try to get too chummy with the advisors. Business first. If the advisors want to invite you to personal events they will. Exception: Provide at least one thoughtful and inexpensive gift to each advisory board member at least once per year. THe gift should be thoughtful and consider the individual’s personality. It should be relatively inexpensive, because if you can afford to buy expensive gifts, you should probably be paying your advisory board better.

Creating Your Advisory Board

A few years ago when I was doing some research on some of the consultants and coaches who have been advising small business leaders, the concept of the small business advisory board appeared in a few innovative companies.

While the concept of an advisory board is nothing new, the use of formal advisory boards among small and medium sized businesses is still quite infrequent.

Many business leaders are reluctant to create an advisory board for several reasons. Chief among the reasons include:

1. Lack of time – Business leaders believe that it would take lots of time and interviews to identify the right advisors for their business.

2. Perceived cost – Its not hard to understand why a small business leader may scoff at dropping a few grand each month on some “expert” that they don’t know, and who knows even less about their business.

3. Skepticism about “experts” – Business owners know what its like in the trenches, and they’ve also heard the old saw – “Those who can do, those who can’t teach.”

The reality though is that it doesn’t have to take a lot of time, the cost can be very reasonable, and some “experts” actually know what they’re talking about.

In my practice I help people to create their advisory board. I work with my clients to learn their business and help them to identify their key business needs. Business advisors can be very inexpensive, so work for no fee and are only reimbursed for their costs. Your business advisory team may be made of retired executives, MBA students and even legal, banking and accounting professionals.

Its important to know what you need and what you bring to the table (see my article on negotiation). If you’re looking to break into government contracting, you’ll need someone with some experience in winning government contracts on your team. You could also benefit from a banker on your team and maybe an attorney.

The make and number of people on the team can vary, but before you put your team in place you’ll have to have a clear understanding with each member of the team regarding roles and expectations.

TX SOS Website Back Up 8/14/09

After 9 full days of inactivity the Texas Secretary of State’s online registration is back up and running. Not a minute too soon for many Texas lawyers and entrepreneurs.

The lack of reporting on this issue was shocking to me.

I had three separate clients who had blown deadlines because new entities couldn’t be registered in Texas.

Thankfully they seemed to bring on extra capacity to handle the backlog. I’ll keep you posted.

No New Entity Filings In Texas Since 8/5/09

It is an absolute scandal that since Wednesday August 5, 2009 the Texas Secretary of State’s office in Texas has been unable to accept new filings.

The SOS Direct website is down and their internal systems are also down.

There has been the following message basically buried on their website saying:

Notice: We are currently experiencing technical difficulties impacting services provided by our office. Our vendor is working around the clock to restore service. Progress is being made and service to our customers will be restored as soon as possible. We appreciate your patience while repairs are made.

This message completely understates the magnitude of the problem that has been going on for 5 days now, and has not gotten any serious media attention.

I will keep you posted, but this serious problem that will likely cost Texas valuable business and jobs.

Estate Planning for Entrepreneurs – Part 2: Buy-Sell Agreements

The Buy-Sell Agreement is an indispensable tool in the formation of any closely held entity where there is more than one owner. The Buy-Sell agreement answers a few very important questions, including the following:

(1) What happens if an owner dies?

(2) How do we handle it if someone wants to cash out?

Think of a scenario where three engineers own an equal share in a firm without a Buy-Sell agreement and a succession plan. If one of the partners dies, what happens to his share?

Maybe the partner who dies happens to leave a husband and two minor children. Suppose her will leaves her interest in the firm to her husband. her husband may be able to step in and fulfill her former role. However, it is more likely that he doesn’t have her background and expertise and can’t fill her shoes. Additionally, there may have been a chemistry between the former partners that would likely be disrupted by the husband presence. This is not an attractive situation.

Maybe the husband gets his wife’s interest under the will and wants to cash out. How much should he receive? This is a difficult question especially in a closely held entity because there is likely no established exchange for the stock in interest in the company so fair market value may have to be estimated through an independent business valuation.

- Who will perform the valuation?

- How will the parties know that the valuation is accurate or reasonable?

- Who should pay for the valuation?

- What is a reasonable amount to pay for the valuation?

- What happens if there are conflicting valuations?

There are too many questions to leave something like this to chance!

More than a few otherwise viable and successful businesses go down in flames because the above questions ultimately get answered in a courtroom after years of litigation, rather than upfront in a Buy-Sell agreement.

There is so much more to Buy-Sell agreements that can’t be appropriately covered in an article this brief.

Estate Planning for Entrepreneurs – Part 1: Key Man Insurance

Key man insurance, as the name suggests is an insurance policy purchased by the business on the lives or life of a few or one key employee.

Having this policy in place is a recognition that, especially in small closely held companies, the loss of one employee can have catastrophic effect on the viability of the company going forward. Think about many of the small or medium sized businesses that are driven largely by an iconic owner or CEO. That person may be the source and repository of the organization’s marketing and sales strategies, and also may be the organization’s go-to person for internal management and still the public face or name associated with the company.

Many of the entrepreneurs who read this will undoubtedly experience butterflies, because this centralization of knowledge and resources happens to be the reality for many of us in business.

A key man policy is part of your organization’s risk management plan, but it should really be secondary to a carefully considered succession plan. The elements of a good succession plan are addressed in another article on this blog.

The business pays the monthly premium for key man life insurance policy and the proceeds of the policy are paid to the business at the death of the key person.

The premium payments are not deductible for Federal income tax purposes, and the payout to the company is also not taxed as taxable income.

It is important that the formalities are observed and respected though. If the employee is a controlling stockholder (50% or more ownership) and the proceeds of the policy are paid to someone other than the company then the proceeds may be included the the key employee’s taxable estate for estate tax purposes.

Avoiding The Perils Of Partnership

There are many reasons why the world’s most successful companies had multiple partners.
(I use the term parter to include LLC members and Corporation Shareholders)

One obvious reason is that the more investors a business has, generally the easier it is to raise capital for the business. Another valuable upside to having multiple partners is that they may bring diverse professional and social backgrounds which compliment the others partners. But even more, a business partner can be a source of encouragement when things just aren’t going great.

You may have heard the saying, “as iron sharpens iron, a man sharpens the countenance of his friend.”

It is so important to choose your business partners wisely, and to have a clear understanding of each person’s role and expectations. It seems obvious, but it is apparently so obvious that people overlook it.

The clarity that you need in your partnership or operating agreement doesn’t come from a 50-page contract. It comes from the detailed discussions that you have with your business partner before you register the business. At the very minimum you need to be clear on:

(1) What will each partner’s initial cash or asset contribution be? How about subsequent contributions?

(2) How will the profits and losses from the organization be shared?

(3) Who will be actively involved in the day-to-day operation and management of the business?

(4) What will be each person’s specific role in marketing the the business?

(5) How will decisions be made?

The typically short-cut response to each of the above questions is that everything will be handled equally. That approach however is unrealistic and a is recipe for disaster. We are not all equal. We don’t have the same strengths.

The most certain outcome when business partners don’t have clear roles and responsibilities is the the more vocally assertive partner will seem to overrun the other partner(s) and the other(s) will engage in passive aggressive behavior that will ultimately lead to the destruction of the company and losing lots of money and time. Another potential outcome where all the partners are equally assertive is constant bickering – which sometimes leads to a venting and resolution of the issues, but often leads to costly legal disputes.

Just like it is more productive to create a will when we’re in good health, its easier and also more productive to discuss and outline your partnership or operating agreement early in the planning process.