Sauder & Stoltzfus Blog

Preface: “One’s destination is never a place, but always a new way of seeing things.” — Henry Miller.

“Success is about dedication. You may not be where you want to be or do what you want to do when you’re on the journey. But you’ve got to be willing to have vision and foresight that leads you to an incredible end”. — Usher

Navigate Business with a Good to Great Balance Sheet (Segment I)

Credit: Jacob M. Dietz, CPA

Where is your business, and where is it going? Good to great financial reporting helps answer these questions, but too often the accounting records of a business cannot be trusted because of inaccuracies. If you want more accurate numbers, take the time to clean up your balance sheet. Trying to navigate a course for your business using inaccurate financial reports can be like trying to navigate with a 50-year-old atlas. You may miss your intended destination on the journey. Alternatively, you might reach your destination, but it may take you on a long route. Using accurate financials can help you reach your goals on your journey.

General Principals

If you crave an accurate profit and loss statement and statement of cash flows, start with an accurate balance sheet and end with an accurate balance sheet. If the balance sheet is wrong, then the profit and loss statement and the statement of cash flows may be wrong as well.

If the balance is wrong, how do you fix it? Begin with the beginning balances. Generally, treat the balances that were used to prepare the last tax return as correct. If the tax return contains significant problems, however, then consider starting with balances used for an earlier tax return. For this example, assume that there are no known problems with the last tax return. Let’s explore how to generate accurate balances.

Assets

The first part of the balance sheet lists what the company owns. Accountants call these items assets. Assets include bank accounts, inventory, accounts receivable, etc. Verify that the beginning balances for the year equal the ending balances used for the tax return. In a balance sheet, the asset ending balance for the previous year is the beginning balance for the current year. Sometimes accountants adjust the balance sheet when preparing the tax return but don’t adjust the company’s accounting records. If the beginning balances do not tie, adjust the balance sheet dated at the end of the previous year to tie the beginning balances to the ending balances used for the tax return.

What adjustments might be made by an accountant but not entered in a company’s accounting records? Accountants frequently adjust inventory at year end through cost of goods sold. If your accountant adjusted inventory for the tax return, but that adjustment was not made in your accounting records, then adjust your inventory to match the inventory that was used on the tax return. Accountants frequently adjust depreciation when preparing a tax return. Depreciation adjustments affect the balance sheet account Accumulated Depreciation. If Accumulated Depreciation in your accounting system doesn’t match the balance sheet used for the tax return, then adjust it to match.

If all the beginning balances match the ending balances used on the last tax return, examine the ending balances of the period being considered. A balance sheet is a snapshot of a company’s finances at a specific point in time. It is therefore important to know which date is being considered. For this example, assume that the balances are for December 31. Examine every line item in the asset section of the balance sheet, and consider if it is accurate.

Start with cash. If petty cash is listed on the balance sheet, is it accurate? If there is only $25 in the petty cash drawer, but the balance sheet says $1,500, then adjust petty cash to match the counted value. If an item is small, judgment can be used regarding how much verification to do. For example, if petty cash says $45, you might decide to skip counting petty cash since it is insignificant.

Verify the ending balances for bank accounts. Each account should have either a bank statement or a bank reconciliation that ties to the amount on the balance sheet. If a checking account has outstanding checks, review the outstanding check list to see if there are any old items there. For example, suppose there are 2 checks listed from 11 months ago. Why did those 2 checks not clear? Were they duplicated in the accounting system?

If there is inventory on the balance sheet, is it counted regularly? Many companies need to count inventory regularly or else the balance will be incorrect. If the balance differs from a physical inventory count, then adjust the balance to match the count.

When inventory is adjusted, the other side of the adjustment is cost of goods sold, which is on the profit and loss statement. If the beginning and ending inventory balance is not correct, then cost of goods sold may also be wrong, leading to an incorrect profit and loss statement. Therefore inventory, a balance sheet account, impacts cost of goods sold on the profit and loss statement.

If the company has accounts receivable (AR), examine an aging report for accuracy. Does the report list amounts that will never be collected? Consider if any AR should be written off as bad debt.

If there are other items in the asset section of the balance sheet, consider if they are accurate. Also, consider if there are items that are not in the asset section that should be. For example, did the company loan money to another company? If so, ensure that the loan receivable is recorded in the accounting system.

Segment I Summary: Where is your business, and where is it going? Good to great financial reporting helps answer these questions, but too often the accounting records of a business cannot be trusted because of reporting inaccuracies. The above steps as a good beginning step, with the guidance of your CPA, can begin to create an accurate map of your business financials.

Working Capital Tools for Successful Business Performance (Segment V)

Credit: Donald J. Sauder, CPA, CVA

 Looking Towards the Future

Working capital management is imperative to successful entrepreneurship because agreement on its relevance is a real deal when transitioning business ownership. Working capital requirements are often a key valuation feature in business exits.

Let’s look at some relevant marketplace data from Keystone Business Transitions for confirmation:

• You are far from the only fish in the sea. Estimates indicate that there are approximately 7.5 million business owners in the United States, and 65% of survey respondents planned to leave their company within a decade or less. That could result in a glut of companies on the market, driving down valuations and giving new leverage to buyers.
• If you are a Baby Boomer (born between 1946 and 1964) the generation following you is not nearly as big so expect far more sellers than buyers in the marketplace. This too, adds to the glut.
• Even during boom times less than half of the owners who tried to sell their business actually were able to sell.
• Unless your company is superior to its competitors because there’s something about it that a buyer can use to make more money than you do (or other businesses in your industry do) a rising tide is going to lift you only as much as it lifts that glut of competitors.

If three out of every five businesses plan to sell in the decade, the a superior business should have adequate working capital levels to gain an edge in the increasingly competitive transaction marketplace.

If your business lacks adequate working capital, at best, your business will only confabulate with regards to exit planning because it will not have the cash available to appropriately prepare qualified successors for ownership, e.g. adding and developing partnership/successor trainee(s),  or pay advisors to gear-up the business for  a successful sale, and further, substantiate that your business has an appropriate [any] value for a vertical or horizontal industry integration, i.e. even the tykes like the big fish; and those small fish, why bother right?

Entrepreneurship can be likened unto the Parable of the Talents in Matthew 25. Your business is an alike talent. There is risk, but if you’ve counted the cost, and faithfully apply your expertise, there are often rewards, i.e. your working capital levels will flourish. Similarly, your working capital levels will likely lead to entropy if you or your employees do not put diligent effort forth to continually develop the business.

It is advised to measure working capital levels, i.e. how many fish you have, and how many fish you need for the month, to keep the business continually flourishing financially. If your business faces continual pressures on working capital levels, your advised to get advice [early] on how you too can develop adequate working capital balances with improved business processes, communications, and strategies for successful business performance, e.g. acting [quickly] on working capital concerns improves your probabilities of being a long-term profitable servant.

Businesses succeed because of others, i.e. customers and clients. Some businesses cajole for development, and for others, “Honor lies in honest toil” to quote Homer. Yes, absent a customer(s) or client(s) to transact with in the marketplace community, their would be no business at all; people needs businesses, and businesses need people. Every big fish, began as a small fish, and the big fish are the result of a conducive environment i.e. working capital levels always sustained developments.

While the unprofitable servant likely didn’t realize he should pay an advisor, in addition, he took zero action towards profitability. If you’re investing in your future and your businesses future, you’re likely not an unprofitable servant.

Working capital and sparkling water have shared a value. Too few realize how precious it truly is. Effective management of working capital and the effective management of operating capital and the cash flow cycle is imperative for successful business performance, e.g. the fish will flourish and you will too.

Adequate working capital is your businesses sparkling well. If you’re one of three out of five entrepreneurs transitioning ownership in the next ten years, you’re now advised why you should start investing in the necessary financial tools to measure and manage working capital.

 

Preface: Prevention of backsliding in already optimized working capital levels, and developing deeper and more conservative convictions on managing working capital to encourage the life of a more successful financial business environment, are truly inherent skills associated with decades-long successful entrepreneurship.

Working Capital Tools for Successful Business Performance (Segment IV)

Credit: Donald J. Sauder, CPA, CVA

Working capital management has two non-financial centric benefits. 1) To prevent backsliding in already optimized working capital levels, and 2) Developing deeper and more conservative convictions on managing working capital to encourage the life of a more successful financial business environment.

The discredit of the merits of working capital management is often par for business, until a shortage results in acute financial pains. In these scenarios, an awareness of the appropriate steps to take to manage and alleviate that financial pain, work to restore the financial vibrancy of the business. While those steps are not the subject of this article, at those time, few financial advisors measure working capital as a key financial metric. While that is not necessarily a mistake entirely, from an accounting standpoint, meticulous financial management and assessment of historic data, e.g. working capital measurement, will highlight changes, and bold concerns with organizational communication and cohesiveness, customer service, and marketplace conditions (i.e. customer inventory purchasing characteristics.) These are common quantifiable concerns that lead and precede extensive working capital atrophy.

Abrupt changes in working capital management such as extending payment terms on vendors from 15 to 30 says to improve the cash conversion cycle, can result in increased prices on purchases, and changes in vendor terms. Reducing inventory levels can lead to forfeited sales revenue, and customer atrophy. With appropriate data, chief financial officers can support these technical parameters to manage onboard assets, and unboard ancillary cash requirements.

It is of note to ensure that the data gathered is not a burdensome or intensive effort. The data collection is usually facilitated with IT systems that intuitively analyze and identify key parameters of both financial and non-financial data to provide informative data maps on customer activities. There is no business without sales. Data driven sales metrics lead to a greater appreciation of what drives customer revenues that are either recurring or discretionary.

Too often a lack of appropriate attention and guiding convictions towards the value of working capital management oversight, results in navigational challenges when financial turbulence occurs. Entrepreneurs cannot appreciate that in formative years they’ve run the entire business from an intuitive sense. Then when (the entrepreneur) begins to develop the business beyond what they comfortably can manage individually, they eventually face pressure because they do not have proven processes in place for monitoring delegated tasks, nor a process to track key performance data. As key persons revolve, the unattended monitoring of processes from a data standpoint, that can result in atrophy of working capital, eventually leading to financial turbulence.

Importantly, when a business is experiencing atrophy in working capital levels, if the business has not identified and quantified the root causes of backsliding performance, often the safest approach is to immediately scale back business activity as opportunity permits, to a more manageable level. Following re-stabilization, then develop processes of data management both financial and nonfinancial to effectively manage operations, and resulting working capital adjustments. Secondly, oftentimes businesses in turbulence need bolstered with working capital. Minimal risks on the additional credit is imperatively prudent.

Businesses that are solidly established from a working capital perspective, often have developed valuable convictions, and disciplined themselves to invest the time and have devoted proactive attention to prevent backsliding and atrophy of working capital levels, accomplished with timely measurement and reflections on historic, current and future data, and communication of likewise performance metrics. The big-ticket items on management include – inventory, customer deposits, and accounts receivables and payables.

Research at Harvard Business School by Lynda Applegate, Janet Kraus, and Timothy Butler takes a unique approach to understanding behaviors and skills associated with successful entrepreneurs. “The entrepreneurial leaders we know are constantly searching for tools that can help them become more self-aware so they can be more effective,” Kraus explains. “This tool is going to be uniquely useful in that it was specifically developed to help entrepreneurs gain a deeper understanding of the skills and behaviors that they need to be successful.”

Prevention of backsliding in already optimized working capital levels, and developing deeper convictions on managing working capital [conservatively] towards building a more successful business, are truly inherent skills associated with successful decades-long entrepreneurship.

Preface: Don’t tell me what you value, show me your budget, and I’ll tell you what you value.” –Joe Biden.

Working Capital Tools for Successful Business Performance (Segment III)

Credit: Donald J. Sauder, CPA, CVA

Working Capital Measurements    

Working capital is an easy calculation (current assets minus current liabilities equals working capital). Working capital measures the operational liquidity level of a business. Currents assets are primarily the cash and equivalents accounts, accounts receivable, vendor prepayments, and inventory. Current liabilities are primarily accounts payable, credit cards, line of credit, tax liabilities, accrued expenses, customer prepayments and deposits, and current portions of debt.

To accurately measure working capital, it is necessary to have accurate financials with appropriate accountant oversight to classify accurately current and noncurrent assets and liabilities. The current ratio applies the same financial numbers as working capital, yet instead of subtracting current liabilities from current assets, the current ratio divides current assets by current liabilities. Typically, a current ratio should be greater than two and likely 2.5, to be solidly established from an analytical measurement metric.

Working capital measurement and management are synonymous; an analytical approach to monitor a business’ capacity to continue operations with sufficient cash flows and to pay operating expenses and satisfy short-term debt obligations.

Sauder and Stoltzfus, and an entrepreneurs CPA firm, has developed a working capital grading tool to help clients measure optimal working capital levels, i.e. how much is enough when discussing working capital? Let’s call it the working capital grader.

Working capital seems easy enough to calculate. You look at your financial statements and subtract current liabilities from current assets. If you should have the financial accuracy to calculate the balance, the numbers independently, do not provide much analytical guidance. Tracking the balance from consecutive period to period will provide a data map, but you need to know, “Do you have enough yet?”

Numerous business owners have an intuitive feeling on working capital levels, but quantifiably grading working capital provides understandable and mathematical measurement where your business is at now, and where your business working capital could and should be.

Here’s how we grade working capital at our firm. You can do math or follow along (current assets minus current liabilities is the formula.) Now contrasting that mathematically to the profit and loss statement, measure your direct labor expenses,+ operational or general and administrative expenses on a quarterly basis, e.g. what do you pay in direct labor expense or general and administrative expense, on average, every three months?

A business with a direct labor expense of $1,000,000 per year, you would multiply the twelve- month fiscal year number by 0.25; that calculates to $250,000 per quarterly ($1,000,000 * 0.25). If your operating expenses or general and administrative expenses are $1,200,000 for the twelve-month fiscal year, then you would multiple that balance by 0.25 to arrive at a calculated $300,000 ($1,200,000 * 0.25). The greater of those two numbers is your optimized working capital or $300,000, e.g. your business is a solidly pillared if you have the greater of these two numbers in the working capital formula.

If you have working capital in-excess of the calculation your business can take on additional risk to safely develop the expansion of operational activity.

Now if working capital (current assets in the hypothetical business are $900,000 and current liabilities are $725,000) at $175,000, the $175,000 compared to the optimized $300,000 provides an accurate measurement and comparison; $175,000 is what is; $300,000 is the goal for optimization.

Here it is, the grading tool:

1. 35% equals one month of working capital
2. 70% equals two months of working capital
3. 100% equals three months of working capital.

In the above calculated working capital scenario, the 175,000/$300,000 is a lackluster 58% grade. If your business working capital grade is below 5%, your business likely needs immediate help from “Now Man Central”. On the other hand, the $125,000 increase required from $175,000 to achieve $300,000 can be obtained with additional earnings and profits retained in the business, or long-term amortization of say a line of credit.

For a well-managed business, it is an achievable goal to work towards, and exceed a 100% working capital grade; For entrepreneurial businesses with optimized working capital at 100%, say  “Happy Birthday!”

Now comparing this to the current ratio; the current assets of $900,000 divided by $725,000 of current liabilities equals a current ratio of 1.24. A current ratio of greater than 2 would require more than $1,450,000 of current assets say in this hypothetical calculation with no changes in current liabilities.

Typically, as an entrepreneur builds equity with profitable earnings, liabilities decrease as they are paid, and equity increases. Therefore, the measurements and grades improve with time. Startup business ventures should appreciate that their largest risk is liquidity, i.e. measured as working capital.

Working capital tools advisedly should be continually applied and monitored for businesses in every industry.

Summary: “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case”. –Robert G. Allen

Preface: The cash conversion cycle to accrual method accounting is like photosynthesis, its happens every day but only few take the time to consider the importance of the process and the intricate implications. If your business is managed starboard, you can appreciate that reality that calm weather is more agreeable, i.e. satisfactory levels of working capital lead calm business management.

Working Capital Tools for Successful Business Performance

Credit: Donald J. Sauder, CPA, CVA

Liquidity measurements in an accounting equation calculate the ability of a business to pay and satisfy current period cash uses with assets that are easily convertible into cash, e.g. current assets. Liquidity measurements speak to the traction of liquidity, i.e. pace of collections of account receivables, inventory turns and inertia of liquidity, paying accounts payable or term loans to rapidly. In addition, fluctuations in line of credit from lack of operating cash can also lead liquidity volatility.

Strategy-Business.com journalist Matt Palmquist wrote an interesting article on working capital balances vs. shareholder value; excerpt-

“… the importance that companies attach to having plenty of working capital on hand, the firms in the study put an average of more than 27 percent of their total assets into net operating capital—a rather substantial amount. But the stock market’s reaction to the building up of strategic reserves was somewhat less substantial, the authors found.

For the average firm, every additional dollar converted into net operating capital was valued by shareholders at only 52 cents. Not only is this number obviously much less than the actual value of the amount being invested, but it’s also far below the US$1.49 valuation that shareholders place on any additional dollar held in cash or liquid securities”.

Certainly research supports that working capital doesn’t leverage business value, but it is like an insurance policy, if you don’t need it, you don’t need it. And If you do….?

Buoyed With Optimized Liquidity

Improvements in liquidity for entrepreneurs begin with increasing cash and cash equivalents, obtaining term loans, or line of credit increases for additional operating capital, i.e. finance inventory or accounts receivable increases, or reducing the cash conversion cycle, i.e. gaining traction on liquidity.

The cash conversion cycle calculates the amount of cash necessary to finance inventory and accounts receivables and keep accounts payable balance normalized. The cash conversion cycle is calculated with the formula of 1) number of days’ inventory is outstanding; plus, 2) number of days’ receivables are outstanding; minus, 3) number of days’ payable are outstanding.

Tracking the cash conversion cycle for one period is relatively uninformative; but tracking consecutive periods and changes in each consecutive segment, i.e. 60 to 50 days of inventory outstanding, 30 to 25 days of accounts receivable outstanding, and 20 to 22 days of accounts payable outstanding, will measure the cash conversion cycle analytics change from a metric of 110 to 97. Changes in the formula monitored consecutively period to period, will provide helpful analytical detail of the cash levels and when compared to competitors will offer visual insights into a business measurement of optimized accrual accounting working capital levels necessary for period cash inflows and cash outflows. This effort increases the likelihood of realistic financial projection on cash flows too.

With changes in a cash conversion cycle when adjusting from check payments to credit card receivable, the collection times of cash are markedly improved. Managing inventory dimples with reductions of obsolete or slow moving merchandise, as an analytical approach to cash, can usually free up more liquid cash to satisfy immediate debt obligations, or finance other short-term liquidity obligations.

The cash conversion cycle to accrual method accounting is like photosynthesis, its happens every day but only few take the time to consider the importance of the process and the intricate implications. The larger the business the more analytically valuable the financial measurements provided by an expert i.e. a chief financial officer (CFO), or accountant (CPA).

Preface: Monitoring your business from an analytical vantage point, results in greater awareness of financial performance trends. The larger the business venture, the more financial expertise required. To quote Kevin Harrington, “People must be realistic in evaluating their business.” Realistic, in the sense of working capital tools, whether you agree or disagree, seems to be that absent working capital there is zero liquidity.

Working Capital Tools for Successful Business Performance

Credit: Donald J. Sauder, CPA 

Working capital and sparkling water have shared a value. Too few realize how precious it truly is. Effective management of working capital and the effective management of operating capital and the cash flow cycle is always required for successful business performance. Adequate working capital is your businesses sparkling well.

Many entrepreneurs that habitually worry about managing their business ventures while applying skip planing financial metrics, would be advised to immediately develop effective working capital systems to guarantee long-term business success. That latitude of working capital techniques can vary from business to business, and entrepreneur to entrepreneur; and the forward supervision of entrepreneurial working capital for a venture is a continuous process.

Inadequate working capital usually results in a unwieldly web of financials perplexities in business. Those webs can range from shifts in vendor’s trust and credit ratings or flooded employee morale, to forfeited profit opportunity. Vendor credit trust is often essential and vital for a consistent supply of products or services to conduct vibrant daily business operations, e.g. if you lose credit with vendors, or your credit rating is impacted negatively, it is not an easy task to get the wagon backup to speed.

Should employee morale be flooded from delayed payroll checks, a high-tension work environment , or from vendor communication stresses, the intangible assets with substantial value from years of invested expertise and experience with your business products, processes, and customers, can evaporate too quickly, e.g. employees can depart. Forfeited profit opportunity occurs when neglected chances to obtain purchase discounts or incurring late payment fees lead to increased costs.

Optimal working capital permits you to keep sufficient levels of liquidity in the business at all times, fueling operational costs of say payroll or general expenses, or balance sheet developments with the financing of inventory and account receivable expansion.

Often busy entrepreneurs are inexperienced in effective working capital management managed with financial ratios and key performance indicators, or additionally, thoroughly understanding the analytical tools to measure and manage liquidity. You need to keep tabs on the complete sphere of financial data in your business. Financial resource monitoring requires advisedly a financial expert, e.g. a chief financial officer, or an accountant.

Monitoring your business from an analytical vantage point, results in greater awareness of financial performance trends. The larger the business venture, the more financial expertise required. To quote Kevin Harrington, “People must be realistic in evaluating their business.” Realistic, in the sense of working capital tools, whether you agree or disagree, seems to be that absent working capital there is zero liquidity.

Some goals of working capital management are 1) manage and balance resources and liquidity to optimize a business’s financial position 2) guide business expansion at a conservatively risk sustainable pace, and 3) monitor operational cash flows.

Preface: The tax reform passed in 2017 changed taxes in many ways. One change that excites tax preparers is the Section 199A Qualified Business Income Deduction. This section gives taxpayers a “free” deduction by allowing them to honestly deduct an expense that cost them zero dollars. Section 199A allows for a 20% deduction starting in 2018, and taxpayers may want to start thinking about it now.

New Tax Law Per  The 199A Qualified Business Income Deduction

Credit: Jacob M Dietz, CPA

The 199A Qualified Business Income Deduction provides a very helpful tax deduction to many businesses, including manufacturing and construction. The new tax deduction has numerous complexities and more details will follow.

The well advised will start the conversations early with their tax accountant about the 199A Qualified Business Income Deduction and the tax benefit implications to business, since it can substantially reduce tax liabilities in certain instances.

Brief Overview The Section 199A Qualified Business Income deduction is not available to C Corporations, and some of the details of the calculation have not been released yet. The 199A section provides a threshold ($157,500 for taxpayers filing single and $315,000 for married taxpayers filing jointly with their spouse) above which there is a phaseout of the deduction for service businesses. For nonservice businesses, this threshold triggers the need for additional calculations involving W-2 wages paid and unadjusted basis in property. Although there are many more details to this section, this bird’s eye overview provides a starting point for planning.

Income Threshold First, will your personal income be under the $157,500 if filing single or $315,000 if married filing jointly threshold? If so, then you don’t need to worry about a service business classification or your paid W-2 wages and unadjusted basis in property. If your income will exceed the threshold, then you may want to consider if there are ways to defer some of that income, such as by accelerating depreciation or using the installment method to report a large sale. If your personal income looks like it will still exceed the threshold after considering income deferral options, then consider if you are a service business.

Service Business What happens if your personal income will exceed the threshold when your business is a service business? A phaseout will begin for the deduction. The phaseout could eliminate your deduction completely. How do you know if you operate a service business? The Internal Revenue Code clearly defines certain activities as service businesses, such as an accounting firm. Other businesses, however, may fall under the classification of a service business if the business is “any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.” It is unclear how aggressively the IRS will classify businesses with the service designation, but more details may come later.

Other Businesses What about businesses that do not fall under the service business classification? These businesses, as they reach the threshold, may avoid the phaseout IF the deduction does not exceed either

1. 50% of qualified W-2 wages
2. Or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property.

Planning Opportunities

1. Reasonable Compensation Reasonable compensation and guaranteed payments are excluded from the calculation of the deduction. Carefully consider what constitutes reasonable compensation and guaranteed payments if your business is taxed as a partnership. Consider consulting with a tax advisor early in 2018 regarding your guaranteed payments.
2. W-2 Wages and Unadjusted Basis A nonservice business above the phaseout threshold may still take the deduction if it has enough W-2 wages and/or unadjusted basis in qualified property. A nonservice business could make some projections to predict if it has enough W-2 wages or unadjusted basis to still take advantage of the deduction if the owner is above the threshold.

The 199A Qualified Business Income Deduction provides a very helpful deduction to many businesses. It has many complexities and more details will follow, but start the conversation with your accountant soon about the 199A Qualified Business Income Deduction and the relevance to your business tax planning.

This article is general in nature, and does not contain legal advice. Please contact your accountant to see what applies in your specific situation.

Preface: Partnerships require courage, collaboration, trust, risk and effort. These business pillars lead to a long and successful business relationship, e.g. partnership.

Business Partnerships

Credit: Donald J. Sauder, CPA, CVA

Partnership Buy-Sell Agreements

Let’s say you get along well with your boss, and you like the idea of share driving responsibility, and you want to drive the bus. Great! Then be certain to compose an articulate buy-sell agreement. A buy-sell agreement is a necessary legal document for any business with multiple owners. The cost and time to compose a buy-sell is miniscule compared to the benefits incorporated. A buy-sell agreement can help peacefully resolve family business disputes resulting from values-based or relational conflicts that require a change in ownership. It can help keep a business flourishing and help avoid liquidity or goodwill problems that arise during partnership conflicts, with a limit on the intensity of the conflict.

Buy-sell agreements can be either cross-purchases or redemptions say. A cross-purchase permits another partner to purchase the business interest while a redemption permits the business partnership to purchase the interest. In a partnership, these purchases have specific tax rules applicable with a IRC 754 step-up with either a Section 743 or Section 734 partnership tax basis adjustment.

A buy-sell agreement can result in automatic and involuntary sales of a partnership business interest, even at a specific price, should certain events occur, e.g. disability or death. It can also specify valuation metrics and sale parameters should a partner want to voluntary egress ownership, e.g. new opportunities, relocation, etc. Some businesses have specific rules that prevent business interests from being entangled in certain disputes with proactive involuntary rules of sales written in the buy-sell agreement.

A buy-sell agreement for a business should be composed with a business or tax attorney and your trusted advisors, e.g. accountant, to appropriately protect your business value should an activation of the agreement be necessary. A buy-sell agreement should include an umbrella of applicability, i.e. terms of who is bound by it and how it can be revised. It should include a metric for determining the price of buyout and timing of the payout, along with necessary funding rules. Applicable loans or security and collateral of the payout should also be addressed. Finally, rules of not-to-compete should not be omitted. In addition, transfers to owners trusts or estates and spousal involvement in ownership are pertinent, along with family transfers to children.

If you decide to enter a partnership, you should also write a business partnership values constitution. Easier said, harder to do. The partnership values constitution should outline what you “rules” you will govern the partnership with, and address the treatment of problems that could derail the partnership, mitigation of those problems. A partnership values constitution requires the hard discussions beforehand, well in advance of the day you sign on your share on partnership ownership

Conclusion:

Partnerships require courage. Partnerships require collaboration. Partnerships require trust. Partnership require risk. Partnership require effort.

“There are moments in our lives when we summon the courage to make choices that go against reason, that go against common sense and the wise counsel of people we trust. But we lean forward, nonetheless, because, despite all risks and rational argument, we believe that the path we are choosing is the right and best thing to do.” Starbucks CEO Howard Shultz.

Preface: Partnerships require courage, collaboration, trust, risk and authenticity. These business pillars lead to a long and successful business relationship, e.g. partnership.

Business Partnerships

Credit: Donald J. Sauder, CPA, CVA

Conflicts from personality differences or value differences, result in stress that will reach beyond the business partnership; and the stress will usually interfere with healthy relationships with employees and immediate family. Then again, is that any more stress than being an employee? Maybe. Because the cost of a partnership dispute is not only emotional, but financial; and since can employees feel the stress, it can be double concern.

Trust is a pillar of any highly successful partnership. Long-lasting, enduring trust keeps partners working together for life-time. Every successful partnership, has a substantial of trust among the partners. Honesty, Integrity, Ethics. Trusted character results in respect. If you look at the best examples of business partnership, the recurring theme is pillared trust, gilded with collaboratively supportive talents that power the partners individual respect for each other’s unique and differing strengths. That respect for the unique contributions of each partner’s skills, builds the business supported with a pillar of trust that accomplishes lasting business partnership success. The eye has need for the mouth, and the mouth for hand. Again, the best domestication of successful partnerships is established on the appropriate trust and respect among the partners.

One item of note, is the lack of educational efforts towards preventing partnership conflicts and disputes before they occur. Firstly, you have a good idea right now if you’d be a good partner. If you have doubts that business collaboration is for you, or you cannot get along with your current boss, then you’ve answered your question relatively honestly. Periods of long silence when discussing key circuits of a partnership are also telling. Some people have great opportunities with great ideas for a great business, and never realize those dreams and opportunities because they cannot implement solo, and are afraid of sharing with partners for various reasons.

Jim Collins in the book Good to Great, uses the metaphor of getting the right people on the bus. It is applicable to business partnerships too. “You are a bus driver. The bus, your company, is at a standstill, and it’s your job to get it going. You must decide where you’re going, how you’re going to get there, and who’s going with you. Most people assume that great bus drivers immediately start the journey by announcing to the people on the bus where they’re going—by setting a new direction or by articulating a fresh corporate vision. In fact, leaders of companies that go from good to great start not with “where” but with “who.” They start by getting the right people on the bus, the wrong people off the bus, and the right people in the right seats. And they stick with that discipline—first the people, then the direction—no matter how dire the circumstances”.

If you dislike the idea of sharing driving responsibilities, or don’t want to drive the bus, then you don’t want to be a partner in a partnership.

 

God blesses all those who believe in him. May the light of faith in God grow each day; and may the miracle of Easter bring you renewed hope, faith, peace and joy. Wishing you a pleasant and blessed Easter!

May God Bless,

Sauder & Stoltzfus, LLC