CFOWise

Venture Capital for a Fortune 500?

Did you know that large companies like IBM, Novartis, Samsung, Intel, and many others have and will continue to be venture capitalists to younger firms? These large corporations are looking for new technologies, products, and services that will enhance or add value to their core business. In return, these smaller and younger firms may be able to benefit from (besides the capital) affiliation with these larger firms from a marketing, operational, and back-office perspective.

Corporate venture capital funds last year invested in 8% of the total $31 billion in venture money that was was poured into young firms, report the National Venture Capital Association and PricewaterhouseCoopers (USA TODAY, 20 May 2008, Companies Give Start-Ups Billions in Venture Capital). The large companies create their own venture capital funds and scour the marketplace for opportunities.

If you are considering venture capital either as an exit strategy or an opportunity to grow your business, perhaps you should consider which large corporations may be interested in what you do. The numbers tell us one thing for certain – large corporations will continue to play a critical role in giving smaller and younger firms access to the venture capital markets. Contact a business financial consultant to help you gain access to the venture capital markets.

Economic Stimulus Package

The Economic Stimulus Package for the American People Act of 2008 signed in February by President Bush has a couple of minor benefits for emerging and medium-sized companies. The package doubles the limit for equipment and qualifying investments from $125,000 to $250,000. This is a benefit if you are expanding or you need to upgrade certain fixed assets in your business. If, for some reason, you exceed $800,000 in capital in the year, then this deduction is phased out for you. However, the package also allows for 50% bonus depreciation on qualifying investments, regardless of your total capital expenditures for the year.

If you are on track for a profitable year, then this can be a big help. Since many businesses are struggling in these recessionary times, the tax savings may not be as significant or lucrative as one might hope. Whatever your circumstance, it may be worth considering in your capital budget strategy. Since entity types, tax structures, and other items determine how this benefit will affect your business and you personally, we recommend you seek expert advice from a CFO Consultant to guide you through this strategy.

How Many Hours do Your Employees Work?

We do not often think how our work week might compare to other areas of the world. Taking a look at just college grads, a much higher percent of them plan on working more than 40 hours per week relative to their peers around the world. A couple of items to consider:

If your employees are working more than 40 hours, are they in an exempt or non-exempt status? I know you may have an opinion on this, but it is important to be objective and try to understand how the Wage and Hour Commission of the Department of Labor would view this. This agency continues to target emerging and medium-sized companies for failing to pay their non-exempt employees over-time. You may want to take a look at this in your business.

Also, how productive are the 40+ hours you are getting from your employees. Whether your employees fall into the knowledge-based worker category or some other, you need to understand and own the productivity of your staff. In every business we have seen, the first or second largest expense is labor. You need to know if you are getting your money’s worth. If you want to know if you are getting your money’s worth out of your labor force please contact a CFO Advisor today.

Entrepreneurs Drive the Economy

We salute the entrepreneurs and leaders of start-up, emerging, and medium-sized companies in the United States. The Small Business Administration basically defines any company with fewer than 500 employees as a small business, yet these small businesses employ half of the private-sector employees in the country! Over the last decade, these small businesses have accounted for between 60 and 80% of new jobs created annually.

Entrepreneurs and small business owners are, collectively, the driving force of innovation and economic progress in our country. While each is motivated by a unique set of personal and professional agendas, one thing is clear – without small business, the fiscal fabric of our country would unravel! To receive financial help for small business owners, please contact us.

Do Employers Benefit from Their Tuition Reimbursement Plans?

While the potential benefits of tuition reimbursement plans are widely discussed, the real question is can they prove that they are actually receiving these benefits, and that the benefits are outweighing the costs.

According to an article in CFO in April 2008, a recent study of 180 companies found that almost half of them neither measure the impact of their tuition reimbursement plans on retention and recruitment nor follow-up with employees and managers to learn how the programs affect job performance.

For emerging and medium-sized companies, this can be a powerful benefit to offer. The key is to track the investment you make to make sure you are receiving an adequate return. Deciding whether a tuition reimbursement plan is right for you can easily be decided by an interim CFO Advisor.

Cost of Debt Drops, But is it Harder to Get?

The main reason the Fed is cutting rates is to spur borrowing and economic spending. In response, the commercial banks are cutting the prime rate from 5.25% to 5% (USA TODAY, 1 May 2008). This means that the cost of debt for businesses should be on the decline.

However, the credit crisis caused by the collapse of the sub-prime lending market has banks tightening their lending policies. In the past few months, we have been told by several loan officers and other bankers that banks are just not doing many deals right now. It seems to me that the Fed’s actions are having no real affect on getting borrowed funds into the hands of businesses. The borrowed funds that their customers already have are just cheaper. A knowledgable CFO consultant can help you with acquiring financing.

Should Your Company have Debt

INTRODUCTION
A lot of business owners have a hard time differentiating between their personal and company finances, yet they need to be regarded as completely and wholly separate. Many business owners who subscribe to a debt-free philosophy for their family (except for a home mortgage) want to impose the same philosophy on their business. Experience shows that not only is this not prudent, but it actually will cost them money in the long-term. Allow me to explain:

COST OF CAPITAL
Every company has a cost of capital, or in other words, a cost associated with the money it either borrows or receives as equity contributions. The cost of debt is typically much lower than the cost of equity, but this is what confuses business owners – they do not associate a cost with the equity they either have or are going to invest or retain in their company. We know that traditional debt is costing most businesses 8-9% per year right now (not including the tax benefits associated with debt), but how much does equity cost?

COST OF EQUITY
Using a basic analysis, let’s assume that a large, well-established, multi-national corporation returns 10% per year to its shareholders (in the form of dividends and growth in stock price). This 10% return represents the firm’s cost of equity, or the return with which the shareholders are satisfactorily compensated for their risk. Your company’s cost of equity is most likely higher because your business represents much more risk. Perhaps you are not very geographically diverse, or perhaps you have one customer that accounts for more than 50% of your business. Maybe your industry is traditionally volatile and/or cyclical, or maybe your product or service is not yet proven. And don’t forget that emerging and medium-sized businesses are viewed as more risky than larger companies.

RISK PREMIUM
There are many ways to quantify this risk, and it is called a risk premium. In other words, how much more than the 10% would someone expect to earn from investing in your firm. Assuming your risk premium is 6%, then your cost of equity is 16% (average market return of 10% plus your risk premium of 6% equals 16%).

EXAMPLE
So, how does this apply to you? Let’s use an example that assumes your cost of debt is 8% and your cost of equity is 16%. First of all, since interest is tax deductible and equity is not, we need to reduce your cost of debt to truly understand your overall cost of capital. Assuming you are in a 35% tax bracket (federal and state marginal brackets combined), your cost of debt drops to just 5.2% (one minus 35% equals 65%, then multiply 65% by 8% to arrive at 5.2%).

Now, let’s assume you need $100,000 to grow your business to the next level. You could draw against your company’s line of credit at 8% or sell enough of your company to raise the $100,000 required. The debt will cost you $5,200 in interest the first year, but your investor will be looking for a return of at least $16,000 in the first year (sometimes they are willing to wait longer than a year to realize their return, but they eventually will want at least a 16% annualized return). Obviously, the debt solution is the most prudent for the current shareholders.

LEVERAGE
Even if you want to put the capital into the business yourself, your ownership won’t change (if you already own 100% of the company). So, you would be risking $100,000 for no additional stake in the business and its future profits. Sure, you would benefit from the growth your $100,000 facilitated, but you could still benefit by using the bank’s money. In essence, you give away $5,200 per year to the bank until you can pay back the line of credit in return for keeping all of the profits and value generated from the capital. No matter how you slice it, you would be much better served to use the bank’s money than your own capital. The best case scenario is you generate a return far in excess of 16%. The worst case scenario is $5,200 per year, not your entire $100,000.

SHAREHOLDERS SHOULD DIVERSIFY
You should, for all intents and purposes, diversify yourself personally with your $100,000. Most of your net worth and your salary probably come from your business. It is your role as a shareholder to diversify yourself. And, although this may seem counter-intuitive, investors and outside professionals do not normally favor or assess any additional value to a firm that operates debt-free. According to an article in the USA TODAY on April 17, 2008, the 164 companies (including Microsoft and Google) in the S&P 1500 that are currently debt-free have experienced worse returns during this credit crisis than those with debt (“Lack of Debt Doesn’t Boost Firms’ Stock”). A Financial model can help you keep to the goals you have with your business.

CONCLUSION
The proper structure and utilization of debt is one of the most beneficial financial strategies a business can have and execute. In fact, research and experience have shown over and over that the right use of debt in your business will increase the value of your business. Contact a CFO consultant to see if your company should have debt.

debt-free philosophy

IRS Audits more small to midsize Companies

While IRS audits of large firms declined, as depicted above, “the IRS increased audit rates of small and mid size corporations (USA TODAY, IRS Cuts Back on Audits of Large Firms, 14 April 2008) Consider this fair warning – the IRS is looking very hard at S-Corps. The single largest item they target in S-Corps is the wages paid to officers and owners of the company. With the pass-through benefits afforded to S-Corp shareholders, some forgo taking a wage in lieu of distributions. The distributions avoid traditional payroll taxes, while wages do not. If you have an S-Corp and you have any net income in that entity, you should strongly consider paying yourself some wage to avoid the chances of popping up on the radar screen of the IRS. We recommend you work closely with your tax CPA or CFO advisor to implement a strategy for officer wages that is best for you.