What I Learned at FinCon2019

What I Learned at Fincon19

Like most jobs, my work requires a little bit of travel every year.  Since we moved down to Sacramento from Portland, I head back up to Oregon 2-3 times per year to see clients.  I also attend 2-3 conferences each year, to keep abreast of what’s going on in the industry and to make sure I’m consistently able to deliver the best advice to my clients.

This year I had two conferences on the agenda.  The first conference I had penciled was one I’ve been trying to attend for several years: FinCon.  FinCon is a gathering of bloggers, podcasters, YouTubers, reporters, financial planners, and others who produce or promote financial content.  FinCon was held in Washington D.C. this year, directly before the second conference on my agenda: XYPN Live, which I just returned from this week.

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6 Reasons Basic Estate Planning is So Important for Business Owners

In general I am not a fan of “listicles”.  They feel like a cheap, click-baity, headline grabbing way to produce content and drive traffic to your website.  Reading them can feel…yucky.  So I typically try to avoid publishing them.  I care greatly about the integrity of this site, and avoid content that I don’t think is genuinely valuable.

Recently I’ve run across a number business owners who’ve done ZERO estate planning.  No idea who steps in to run their business if they’re not around.  No will.  No trust.  Nothing.

This is pretty common, unfortunately.  Hundreds of thousands of small businesses out there have done no estate or succession planning.  A study of 200 by Wilmington Trust found that 58% had no plan in place whatsoeverI’ve written on this subject recently.  Because this is such an important topic, I’m going to break my rule about listicles today to drive the point home.  (Hey, in moderation they can be an effective way to communicate.  Who doesn’t like digestible, bite sized snippets?).

Here are my top six reasons estate planning is so important for business owners.

 

 #1: You & Your Family Probably Depend On It

For most business owners I speak with about financial matters, a substantial portion of their net worth consists the equity in their business.  And when I say substantial, I mean up to 75-80%.  Without any type of plan in place, there’s a very high likelihood that the value of this equity dissolves entirely if you become incapacitated or die unexpectedly.

Even if you have a long term disability insurance policy in place, losing the equity in your business would probably have a significant financial impact on your family.  Having a succession plan in place in just in case something does happen is the only way to preserve your equity.  And therefore your family’s balance sheet.

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How Long Is Your Runway? Establishing a Cash Reserve When Starting a Business

Starting a business involves a great deal of risk.  You’ve probably run across this statistic from the small business administration before: 30% of new businesses fail in the first 12 months of operations.  50% fail in the first 5 years, and 66% fail in the first 10.  The odds are not terribly good that a new venture will grow into a viable company.

For many businesses that do end up failing, the problem usually isn’t that there’s no market for new product or service and the founder’s idea doesn’t work.  The problem is that the founder runs out of money.  I’ve heard the story at least a dozen times: entrepreneur quits a stable job to start a new business.  Their objective is to make the new venture profitable enough to fund their living expenses before their savings run out.  It takes a little longer to get up and running than initially thought, and their savings accounts falls to dangerously low levels.  They can’t hold out any longer, and are forced to cease operations, take a step back, and find a job that offers a steady income.

The amount of cash you have in the bank is commonly known as your “runway”.  The longer your runway, the more likely a business will succeed.  So how long should your runway be, exactly, when starting a business?  If you’re about to take the leap into entrepreneurship, these are the exact steps I’d take to figure that out.

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A Beginner's Guide to Cash Balance Plans

A Beginner’s Guide to Cash Balance Plans

In my financial planning practice I work with a good number of business owners who want to make aggressive contributions to their tax deferred retirement accounts.  This helps put them on strong footing for retirement, but also provides a generous tax deduction.  While the 401k plan is the primary retirement plan most business owners are familiar with, a cash balance plans is one I often recommend in addition.  In fact, cash balance plans can actually allow for far greater contributions & tax advantages.

A cash balance plan could be a good fit if you’d like to contribute over $50,000 per year to a tax advantaged retirement plan.  They don’t come without their nuances though.  This guide will explain how cash balance plans work and whether they might be a good fit for you.

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It's Never too Early to Start a Succession Plan

It’s Never Too Early to Start a Succession Plan

So here’s a topic that all business owners have thought about but few have taken action on: succession planning.  I was reading a study by Wilmington Trust the other day that polled 200 different owners of privately held businesses.  Personally, I’ve yet to meet a business owner who doesn’t agree that succession planning is important to their company and stakeholders.  Yet in this study, 58% of the businesses polled don’t have one in place!

Successions impact…everything: your family, your legacy, your finances, your employees, your partners, your customers, your stakeholders, and anyone else who touches your company.  My guess is that you want all these pieces intact throughout your transition and after you leave.  Yet most business owners don’t tackle the issue until a) it’s high time to exit, or b) they’re forced to for a reason out of their control.

Why?  Many people start to realize that the emotions involved are heavy and deep.  Your business is probably something that you’ve poured your heart and soul into for a long period of time.  You may have taken significant financial risks that have impacted your family along the way.  The decision making required in succession planning brings up a lot of emotion, and many business owners prefer to kick the can down the road rather than deal with them.

Problem is, there are many situations out of our control that could force a succession at an inconvenient time.  Health problems, car accidents, or even changes in the economy or your industry could easily force your hand.  Rather than rush into a transition unprepared (and in a potential fire sale), you’ll reach a far more desirable outcome when your succession is planned for.  What happens if you get into an accident and come out with diminished mental capacity?  What happens if you have a heart attack & die tomorrow?  What’s the game plan?  Who will step in, and how will your family, employees, customers, and other stakeholders be taken care of?  These are the questions a good succession plan answers.  They’re also the questions that must be made while you’re in a calm, stable, and clear state of mind.

 

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Investing in Yourself as an Entrepreneur

Investing In Yourself as an Entrepreneur

Many of us feel an innate need to make contributions to tax advantaged retirement plans every year.  When it comes to personal finance, much of what we read, hear, and see in the media centers on plowing money into your 401k every single year, no matter what.

In general it’s great advice.  Save early and often, and take advantaged of tax deferred compound income.  And if you’re lucky, your employer might match your contributions or make a profit sharing contribution.  If we’re going to build up enough savings to sustain our lifestyle through retirement, this makes perfect sense.

Every once in a while I’ll speak with an entrepreneur who is really working hard to build their business, but they can’t quite scratch together enough cash to fund their retirement plan for the year.  They’re putting all their effort into their company and things are still just a bit tight financially.  They feel like they should be contributing to the 401k they set up for themselves and their employees, but they can’t quite pull the funds together to do so.

For many business owners I speak with, the fact that they can’t fund their 401k for the year makes them feel inadequate.  Like they’re not good at their job.  Like they’re unsuccessful.

I wanted to write a post on this topic because entrepreneurs who feel this way are missing the forest from the trees.  Regardless of whether you contribute to a retirement plan in a certain year, it’s far more important to sustain & grow your business.  Because if you can find a way to grow your business each year, the increased value in your ownership stake will dwarf what you could ever contribute to 401k!

 

It’s OK to Skip a Few 401(k) Contributions

Aswath Damodaran is a professor at NYU who teaches corporate finance, investing, and business valuation.  He publishes estimates of EBITDA multiple benchmarks for use by his students, and anyone else who’s interested.  EBITDA is an accounting measure that stands for “earnings before interest, taxes, depreciation, or amortization”.  It’s a decent proxy for free cash flow, and is often used in quick and dirty business valuations.

For example, let’s say your business does $350,000 in revenue one year.  If your costs & operating expenses totaled $250,000, you’d be left with EBITDA of $100,000.  Here are Professor Damodaran’s valuation estimates for 2018.  The list of multiples ranges from 5-6x EBITDA on the low end to nearly 20x on the high end.  Meaning, it’s very possible that a business with $100,000 in recurring annual EBITDA is worth at least $500,000 ($100,000 * 5).

Now, when I mean quick and dirty, this example is very quick, and very dirty.  Business valuation is a field of its own, and not something I claim to be half way competent in.  There are a ton of factors that go into what a business is worth, and EBITDA certainly doesn’t paint the whole picture.  Nevertheless, the takeaway is important: if you can build a business with recurring annual revenue, that will persist even if you’re not around to drive sales, there’s a good chance you’re creating far more wealth than what you would maxing out your 401k contributions.

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Maximizing Your 199a QBI Deduction as a Specialized Service Business

Maximizing Your 199a QBI Deduction as a Specialized Service Business

As you’re probably aware, we’re working with some new tax laws as of January 1st, 2018.  The tax change that will have the most impact for many business owners out there – particularly owners of pass-through businesses – lies in section 199a.

Section 199a specifies that qualified business income is eligible for a 20% across the board deduction on the owners’ personal tax returns.  20%!  This is a big deduction, and falls in line with all the political rhetoric about making the country a more business friendly environment.

Unfortunately, not every business owner will be able to claim it.  One of the more controversial aspects of section 199a is that the deduction phases out at certain levels of taxable income, if your business is considered a “specialized service business” (SSTB).  In 2019, this phaseout range is $315,000 to $415,000 of taxable income for married people filing jointly, and $157,500 to $207,500 for everyone else.

What exactly is a specialized service business, you ask?  It’s one whose principle asset is the skills or experience of one or more professionals.  This includes medicine, law, accounting, financial services, athletics, and several others.

With the introduction of section 199a & the QBI deduction, there are a number of tax planning opportunities for business owners.  Qualifying for the deduction and maximizing its benefit could easily have a significant impact on business owner’s total tax liabilities.  This post will explore three different types of tax planning strategies owners of specialized service businesses may consider to maximize the benefit of the 199a deduction.

 

Income Reduction Strategies

The first, most logical way to maximize the QBI deduction is to find ways to reduce your taxable income.  The lower you are in the phaseout range, the greater portion of the deduction you’ll qualify for.  Note here that the phase out isn’t based on your adjusted gross income or modified adjusted gross income (which is common for most other phaseouts, like IRA/Roth IRA contributions).  The QBI deduction phases out based on your taxable income, which is after you take itemized or standard deductions.  Here are a couple ideas to consider.

 

Qualified Retirement Plan Contributions

Establishing & funding a qualified retirement plan is usually the low hanging fruit for owners of specialized service businesses.  The best plan structure and form for your situation will depend on a number of factors, of course.  And if you have employees, chances are you’ll need to make contributions on their behalf as well.

The usual suspects here are SEP-IRAs & solo 401(k) plans for those without employees, and 401(k) & profit sharing plans for those with employees.  You can also tack on a cash balance plan or defined benefit plan if you want to be aggressive (and are comfortable with mandatory contributions each year).  In either case, every dollar you contribute to a qualified retirement plan, both as an employee deferral or employer contribution, will be deductible.  And, of course, every dollar you deduct gets you one dollar closer to the beginning of the phaseout range.

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8 Considerations When Protecting Your Business With Life Insurance

8 Considerations When Protecting Your Business With Life Insurance

I read a stat recently that stated 71% of small businesses depend heavily on a few individual owners and/or employees.  This number makes quite a bit of sense, once you consider the limited resources most small businesses have to work with.  It also presents a great deal of risk.  Losing a key employee, manager, or professional could easily be the death knell for businesses without much bench strength.

To protect themselves, their families, and their businesses from this possibility, many business owners use life insurance.  As you probably know, life insurance comes in many shapes, sizes, and forms.  Depending on your business and objectives, there is probably a way to minimize the risk of your or your colleagues’ premature death using life insurance.

There is a lot to write about on this topic – in part because there is such a wide variety of life insurance products available.  This post will review 8 considerations when protecting your business with life insurance.  If you’re dipping your toe into the subject for the first time, this is a good place to start.

 

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Family Business Succession Planning: 3 Best Practices & A Review of the Statistics

Family Business Succession Planning: 3 Best Practices & A Review of the Statistics

If you’re reading this post, you’re probably familiar with the statistics: the failure rate for second generation family businesses is very, very high. When you consider the fact that family businesses make up about 60% of the gross domestic product in the U.S., it’s easy to see that succession planning is a major issue facing business owners across the country.

Transitioning a family owned business to the next generation is challenging for many different reasons. This post will review the statistics on family business succession planning, cover three common problem areas, and offer best practices for navigating them.

 

Family Business Succession Planning: The Statistics

To get us started, let’s review the statistics and examine why thoughtful succession planning for family businesses is so important.

First off, only about 30% of family businesses even make it to the second generation.  10-15% make it to the third, and 3-5% make it to the fourth.  These numbers sound pretty low, but they’re only counting businesses run by families’ younger generations.  Many businesses are sold or merged, which I would argue isn’t a failure at all.

Additionally, according the Conway Center for Family Business, 40.3% of family business owners expect to retire at some point.  But of those planning to retire in less than 5 years, less than half have selected a successor.

That alone tells me that many failed successions are probably a result of poor planning.  In fact, other research from the Conway Center for Family Business tells us that 70% of family businesses owners would like to pass their business on to the next generation.  But only 30% are actually successful in doing so.

 

Common Succession Problems

Just to give us some context, the landscape of family businesses across the country is as diverse as our economy.  Family businesses cover all corners of industry in this country, and range in size from single person sole proprietorships to Wal-Mart.  There’s a lot of space in between those extremes.

Because of the large universe of companies, the specific problems impeding successful transitions is diverse as well.  Nevertheless, regardless of a company’s size, industry, profitability and other nuances, succession problems are usually tied to two fundamental issues: poor planning and long term family dynamics.

 

Entitlement & The Fall Back Plan

Through years of effort and grind, successful companies often produce significant wealth for founders and their families.  Whereas the founder may have developed his or her work habits out of necessity, their children are often brought up in a more comfortable environment.

This financial success also gives founders’ children far more options, and allows them to pursue whatever path they choose in their careers.  As great as this sounds, flexibility allows the children to treat the family business as a fall back plan, rather than an objective that they’ll need to work toward.

The downside here is pretty obvious.  Kids comes back to join the business, and are often propelled into management positions sooner than they should be.  Not only are they inexperienced and prone to make critical errors, but their career trajectory will undoubtedly alienate other employees.

Insisting on proper training and screening is a good place to start.  You can always give your kids an opportunity, but a job with the family business shouldn’t be an entitlement.  Family members should go through the same formal vetting process that other employees do.  Implementing a minimum education and/or experience requirement, and formalized training process is a good place to start.

Again – you can always give your kids an opportunity, but resist the temptation to thrust them into a leadership position.

 

Familial Ties vs. Diversity of Experience

In medium and larger businesses, it’s common for immediate family members to follow their parents to certain departments.  For example, let’s say a founder’s daughter is interested in finance and spends most of her career as the company’s CFO.  If her children park decide to pursue finance because of their mom’s influence, they often have a hard time developing the skills necessary for upper management.  Rather than blazing their own trail in an area of interest or gathering experience in multiple areas, younger generations often tend to go with what’s familiar.

The solution here is to try and minimize the amount that family members report up to each other.  All employees, family or otherwise, should be held to the same standards and expectations.  Business coaches and mentors can be helpful here as well.  Any way to offer outside influence, objective feedback, and accountability tends to help, and will prepare the next generation for management responsibility.

 

Business Size: Supporting the Family

Starting a business can be quite a challenge, and most founders spend a few years struggling to put food on their family’s plate.  As the business becomes more financially successful this tends to be less of a problem.  Once founders reach the point where they’re comfortable and have met all their financial objectives, many tend to take their foot off the gas, rather than continue to grow the company.

Now consider what happens when the founder’s children enter the picture.  If the founder has two kids, and both kids have two of their own, all of a sudden there are a lot more mouths to feed.  Whereas the founder was originally responsible for supporting four people (including the kids and his spouse), now the business needs to support 10!  To stay in the family long term, the business will need to generate a great deal more revenue.  If it can’t, it will need to merge, be sold, or fold.

To avoid this problem, all new employees should have a responsibility for growth.  This could be in the form of direct business development or preparing the business for scaling.  A good example might be a new family member that comes on board right after college.  They may not be experienced enough to interact directly with clients or develop business, but they could be responsible for updating the company’s CRM system to support more efficient growth.

 

Successful Family Business Succession Planning

It’s no secret that succession planning is a huge challenge for family-owned businesses. Family dynamics, communication, trust issues, preparedness of the younger generations, and different expectations for family members vs other employees can all contribute to problems.

There are far more causes to the low success rates than what we reviewed in this post.  The point here is that many of these issues can be solved or eliminated by prudent planning.  Experienced attorneys, accountants, financial planners, and bankers can all be valuable resources who can help you reach a desirable outcome.  If succession is in the cards for your business, the input of a qualified professional is often worth its weight in gold.

Woman Owned Business Tax Benefits: What's Out There?

Woman Owned Business Tax Benefits: What’s Out There?

Several weeks ago I was in a meeting with a small business owner at my office.  She’d come by to talk about her plans to transition away from her business, as she is in her 50’s and getting burnt out.  She’s built a successful enterprise over the years, and stands to make a nice profit on the sale of her equity stake.

Her biggest problem in this transition?  Taxes, of course!  Although she stands to receive a nice chunk of change from the sale, she’ll end up owing several hundred thousands of dollars between state and federal taxes.  And as we worked through the mechanics of the transition and how she might reduce her tax burden, she asked a question I hadn’t thought much about: “aren’t there tax benefits I can claim as a woman owned business?”

I hate to admit this, but woman owned business tax benefits aren’t a subject I’d looked into before.  I’d always assumed there were some tax benefits for women and minority owned businesses, but I’d never looked into what they were exactly.

So I researched it.  And since I’m certain there are thousands of women entrepreneurs out there wondering the same thing, I consolidated my findings into this post.

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