Small businesses are facing an unusual moment. The economy is expanding, albeit gradually, but lending is still crushingly tight, causing many to miss out on the potential opportunities.
“Even clients with great credit are struggling because they don’t have the liquidity to take advantage of economic growth,” says Graydon Coghlan, CEO and president of San Diego-headquartered CFG Wealth Management.
Lack of liquidity—and other systemic, seemingly intractable problems—may not be new. Yet recent economic struggles have galvanized savvy advisors to find creative remedies for their small business owner clients. Here are a few of the current hot-button issues and some outside-the-box survival tips.
Cash flow is a constant worry. Rarely, if ever, has this been more true. “The problem is twofold: raising capital to grow the business and having the confidence in the economy to hire additional employees or take on more responsibility,” says David D. Doll, a senior vice president and senior investment management consultant at Morgan Stanley in Atlanta.
Larry Kline, a Bethesda, Md.-based lead managing director and tax-practice leader at CBIZ MHM, an accounting and business management services provider based in Cleveland, advises businesses to establish banking relationships early in their cycle. “It’s easier to get a line of credit when you don’t need it,” he says. “So it’s prudent to secure lines of credit ahead of time for a need that’s down the road.”
When conventional credit fails, though, some advisors design creative cash-raising solutions for their clients. Michael Pepe, a vice president of finance and a registered representative at JHS Capital Advisors in Tampa, Fla., helped one business owner issue “an industrial development bond,” he explains. “The client was allowed to issue that type of debt because the business operated out of the Port Authority here in Tampa. Instead of a taxable bond at a higher yield, it was a tax-free bond of a much lower yield, like a muni, saving the company a ton of money while preserving its liquidity.”
It’s equally crucial to keep clients calm and rational. If they get too desperate, they’re likely to make mistakes. “Often, these business owners want to engage their family and friends for fresh capital, [but] money and family simply do not mix,” says Doll. “Or they want to use too much of their personal assets … jeopardizing their retirement goals.”
For some small businesses, liquidity problems affect not just expansion plans but day-to-day operations. To stretch limited dollars, business owners may negotiate leniency from vendors. But they can’t delay paying their employees. “I’ve seen too many businesses pay their employees but forget to pay Uncle Sam the payroll taxes they withheld and the employer’s share of Social Security taxes,” says Kline. “People don’t realize the harm they do themselves by doing that.”
Not only will the IRS catch up with you, he warns, but those back taxes “become the employer’s personal liability,” says Kline. “Even if you are operating as a corporation, the IRS will come after you—the business owner—personally. Even if you file for bankruptcy.”
The solution, Kline says, is simple: “Use a payroll company,” he advises.
Employee Incentive Programs
Making payroll is essential to maintaining employees’ morale and loyalty, but it’s not the only way. Instilling a sense that they are part of the business also helps. “Business owners are at a disadvantage if their employees don’t truly understand how the business works,” says Rick Scruggs, principal and founder of Financial Designs in Forest, Va. “We introduced a concept called ‘ownership thinking,’ whereby employers teach their employees exactly how the company makes money.”
When employees are in on some of the basic financial dynamics, they are more likely to offer useful suggestions, he adds. “If you put a financial incentive in place whereby the company shares in any savings that employees bring to the table, your company becomes more competitive,” says Scruggs.
In addition to offering 401(k)s with matching dollars and similar incentives, Scruggs recommends rewarding “key employees, those who drive the business or take on more risk for the company, who show up early and stay late,” he says. Those incentives don’t have to be doled out monthly, quarterly or even annually.
Just knowing that a reward is in store if the company builds its margin and profits can be sufficient, as long as the employer honors that trust. “For this kind of nonqualified deferred compensation, the employer must set some money aside for those key employees down the road,” says Scruggs. “It’s a high-trust relationship between employer and employee.”
Needless to say, business owners must make sure employees realize these programs are in place. “You need to teach people not just what they do but why they’re doing it,” Scruggs says. “If you’re spending money on benefits that nobody understands or appreciates, you’re really not accomplishing much.”
Another common practice for garnering loyalty is to establish an employee ownership program. The typical model is an employee stock ownership plan (ESOP). “An ESOP can be extremely valuable,” says Coghlan of CFG Wealth Management. “It builds morale and improves employee retention.”
ESOPs can generate cash for the business owner, too, and play a role in transition planning, easing the transfer of a business to owner-employees over time. Advisors warn, however, that ESOPs aren’t right for every business.
“Employee ownership plans work well for companies with predictable and sufficient cash flow and in situations where retaining employees is important and the required skill sets are difficult or expensive to recruit,” says Patrick Robison, a partner with United Planners Financial Services in Los Angeles.
The downside? ESOPs incur legal and operating expenses. “The business has to go through annual independent valuations and follow strict IRS and Department of Labor guidelines,” says Scruggs.
What’s more, complications can ensue. “Be careful not to sell or give away too much,” warns Joel Johnson, a managing partner at Johnson Brunetti in Wethersfield, Conn. “A little goes a long way for morale and employee commitment. … Be cautious about overleveraging the business.” Buying employees’ shares when they retire, for instance, can become a tremendous liability, he notes.
“The biggest problem with giving actual ownership is figuring out how to unload it,” agrees Kline. He recommends securing a broad-based buyback right— in case, say, the business owner later decides to sell the company—and restricting employees’ right to sell their shares to outsiders.
Kline prefers what he calls “phantom stock,” a kind of bonus calculated as a portion of business growth. “The employee gets a preset percentage through a kind of employment contract, as if he or she owns stock, without actually giving legal ownership in the company,” he explains. “You give the right to a share of the future appreciation but you do it economically without an ownership structure.”
Business owners face additional risk if they don’t diversify their own holdings. “Small business owners tend to reinvest in their own company—they understand it, know how to deploy it, can control it and feel they’ll get their best returns in their own venture,” says Dan Sudit, director of planning services in the Seattle office of Chicago-headquartered BMO Private Bank.
Persuading them to diversify isn’t always easy. “We spend a lot of time dealing with this psychological shift,” says Sudit, “educating and empowering our clients to understand how to use their liquid resources to satisfy cash-flow needs or unanticipated expenses. Through this process, it is easier to diversify their assets from their business to liquid investments.”
Because a business is not a liquid investment, a business owner’s other investments should be both liquid and conservative. “They should typically be more liquid and conservative with their investments because their own company is like a micro-cap stock,” says Mark Tepper, president and founder of Strategic Wealth Partners in Seven Hills, Ohio.
Starting a pension plan is one way to get business owners to diversify. “You usually put pension plans into marketable securities, which means you’re diversifying away from your own business,” says Kline.
Another way is through real estate, especially buying the property where the business is located. Even if the business fails, your client still owns the real estate and can rent it or sell it. On the other hand, becoming a landlord has its own costs and aggravations. “You become responsible for the pipes and the trash and other maintenance,” says Coghlan. “Besides, there’s no guarantee the property will appreciate in value.”
The new health insurance requirements may be keeping other business owners up at night. It only applies to those with 50 or more full-time employees, but there are a few gray areas.
“Employers who are on the cusp, with 49 or 51 employees, or who own more than one business, need to be careful,” says Kline. “If you have 30 full-time employees in one restaurant and another 30 in a second restaurant, for example, they could be looked at as one business with 60 employees.”
Do all these considerations make your head spin? Sometimes, what business owners need most is levelheadedness and maybe hand-holding—or as Christopher Zelesnick, senior managing director at Chicago-based Ziegler Wealth Management, puts it, “a long-term strategy … to make sure they are building toward their future.” Without professional advice, he says, business owners are likely to “financially overextend” themselves.
Often, the business owner’s professional concerns dovetail with personal ones. Derek H. Holman, a managing director at EP Wealth Advisors, a $1.3 billion RIA in Torrance, Calif., recently coupled a client’s business plan with a personal financial plan. The end result demonstrated “what the short- and long-term impact of utilizing different strategies can have on the business and the business owners,” he says.
In sum, business owners need “a personal CFO to bring together a team of strategic partners, including a CPA, estate planning attorney and insurance specialist,” says Brad Welch, owner and president of Welch Financial and a branch manager of Raymond James Financial Services, in Tampa, Fla. “Surrounding ourselves with a strong local network of business owner problem solvers is paramount.”