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This year, Charlotte Douglas International Airport (CLT) will transform from the second largest hub of the new American Airlines—the world’s largest airline, into the most integrated global trade hub on the East Coast of North America.
It will encompass the most comprehensive transportation facility as air, trucking, and rail (with shuttles to the ports of Norfolk, Charleston and Savannah) will all have presence within the airport. It will become the most reliable because freight can be transferred to any mode without entering a city street. It will be the most cost-efficient because goods transfers take place without having to leave the airport area. This facility will elevate the Charlotte region from a local distribution role to a global competitor.
Important to the strategy is the massive project to widen the Panama Canal that will be completed in 2015. Ships laden with cargo nearly triple that of the current ships that can pass through the canal will be able to transverse from the Pacific to the Atlantic, transforming oceanshipping patterns. While the effects of the opening of the Canal on the East Coast ports of North America are still uncertain, what is certain is that the opportunity for expansion of direct trade between the East Coast and Asia will be greatly increased.
The plan for the CLT multi-modal hub began years ago; resulting from the recognition of rapidly increasing global freight flows after 1990 as the former Communist bloc countries became integrated into the world economy. By 2000, what had begun as accelerating growth turned into an avalanche of trade that altered the global economic landscape.
The Chunnel connecting England by a land connection to Europe for the first time in history, the Oresund Bridge between Denmark and Sweden connecting Scandinavia by surface transportation, and the widening of the Panama Canal are all projects of historic dimensions.
Within this context, the previous CLT Airport Aviation Director, Jerry Orr, initiated the process of exploring the possibilities of expanding airfreight volumes at CLT. Over 20 years ago, he recognized that change was coming; while passenger volumes were rapidly increasing, airfreight volumes remained pallid. The desired increase in airfreight volumes would represent an expansion of airport revenues, strengthening the airport’s financial profile and increasing its competitiveness.
The assessment of Charlotte’s role in the air-freight market of the East Coast airports revealed that the Charlotte region fulfilled a marginal role as a trade and transportation hub between the major trading regions of the Eastern United States, New York, Atlanta, and Miami. Unless Charlotte was to evolve as a more important trading center, airfreight would not increase significantly at CLT.
Developing the plan for the airport involved pulling together the major transportation, communications, and finance companies serving and located within the region. The plan was not academically-based, as was the struggling Global Transpark, but an industry-based plan that involved developing industry relationships that were vital to implementing the plan and operating the facility.
This strategic development plan called for the creation of the Charlotte Air Cargo Center, construction of a third parallel runway, and the relocation and development of an intermodal/bulk transfer rail facility. Geographic location would be crucial to the success of the global intermodal hub; the airport is located at the intersection of the Norfolk Southern mainline and interstate system and is bounded by I-85 to the north and I-77 on the east. Norfolk Southern’s rail line lies directly to the north of airport property.
A land envelope would be created by acquiring sufficient land directly adjacent to the airport. This would restructure the urban grid to create an “economic edge city” to strengthen the airport, the community and uptown, while creating new transportation opportunities through the relocation of rail lines and yards.
While a great deal of press and public attention has been given to the growth of trade on the Pacific Coast, especially in Los Angeles, it is predominantly goods arriving from Asia. Along the East Coast, trade is more balanced between Europe and Asia, with a significant portion from Latin America and to a lesser, but growing extent, Africa, the Middle East, and the Indian subcontinent.
From a local distribution market, companies from each of the other five major trading blocs will now flow through the Charlotte region, providing the area with an unprecedented opportunity to increase its visibility across the world and attract industry from areas that were not traditionally present in the region.
With its infrastructure in place, the Charlotte region has developed an unparalleled infrastructure that can provide it new global opportunities. CLT has just begun the next steps in fulfilling its desired goal of becoming a global leader in the logistics world. The future for new businesses, research and development, and manufacturing/industrial parks has yet to be realized.
For more than 15 years, CLT has been systematically assembling the necessary development components that were specified in the airport’s Strategic Development Plan. A new third parallel runway opened on February 11, 2011. Ground was broken for the new intermodal rail yard on May 2, 2012. In December 2013, Norfolk Southern moved its operations from its rail yard near uptown Charlotte to its new Charlotte Regional Intermodal Facility at CLT, 19 months after construction began.
The intermodal facility represents a $92 million investment in the region. Funding for the facility included $15.7 million in federal funds and some financial support from the State of North Carolina with Norfolk Southern funding the remainder of the project.
A total land envelope of approximately 4,000 acres on property and bordering CLT and the intermodal rail yard has been assembled and airport staff is working with the appropriate entities to ensure proper zoning, roadway and utility infrastructure and environmental compliances are in place so that compatible economic development may be pursued.
CLT is in the federal approval process to have local boundaries for the nearest Foreign Trade Zone (FTZ) adjusted. This will allow companies utilizing the intermodal facility and adjacent areas a competitive advantage of a tax relief business zone. Strengthening and enhancing CLT’s logistics infrastructure with the addition of a FTZ is another vital component that will allow Charlotte to continue emerging as a major East Coast economic center.
CLT will further invest in this effort by adding an economic development manager to create and promote additional cohesive and innovative strategic initiatives. The Charlotte Regional Intermodal Facility at CLT is expected to serve as a catalyst for entrepreneurial growth and innovation, while presenting the opportunity to strengthen existing business sectors and growing new sectors.
This article deals with another aspect of Step 3 of our firm’s six step planning process for helping business owners create an optimum succession plan for their business and exit plan for themselves which best meets their business and personal objectives. To recap:
Step 1: Help the business owner identify his/her life objectives including retirement income, manner of disposition of the business, and non-economic life objectives which add significance to the owner’s life;
Step 2: Determine where the owner (and business) is now and what the gap is in terms of meeting the owner’s economic retirement objectives; and
Step 3: Determine what steps the owner should consider to fill the gap by increasing the value (and selling price) of the business.
When it comes down to your business, a buyer only cares about two things: Return and Risk. How much profitability will your company make in the future (Return)? How reliable are your estimates of future profitability (Risk)?
In its simplest terms, Value = Return/Risk, where Return equals cash flow and Risk equals a buyer’s required return on investment. The Return is calculated as the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) of the business. The Return is normally easy to calculate (though don’t forget to consider addbacks, non-recurring revenue and expenses, etc.).
The Risk is dependent upon how reliable potential buyers of your business feel your estimates are as to your business’ future Return. If your future return is considered very risky, a buyer may require a 50 percent Return on his investment. If your estimates of future return are considered relatively safe, a buyer may only require a 10 percent Return.
Basically, the lower the Risk, the higher the multiple of cash flow you will receive upon sale. The multiple is the reciprocal of the required return. If the required return is 10 percent-, then the multiple equals approximately 10 (1/.10=10).
What all this means is that there are only 3 ways to increase the value of your business: 1. Increase Return; 2. Lower Risk; or better yet, 3. do both!
To increase Return and lower Risk, a business owner should employ “value drivers.” Value drivers are what qualified buyers look for in a business which increases the business’ value by increasing Return or lowering Risk. What are some of the key value drivers?
A Clear and Compelling Vision. This sets the expectations for employees and creates a common mission across the business, communicates culture and core values, and provides employees with significance from their job beyond a paycheck.
A Growth Strategy. A believable and executable plan to achieve the growth objectives within the vision. The more scalable your business is, the more likely a buyer will believe your projections since the business growth is not dependent on the owner.
A Stable and Motivated Management Team. A team capable of driving future success without the owner. These key employees should be tied to the company by carrots(incentive plans, possible ownership, stay bonus plans, etc.) and sticks (non-compete, non-solicitation of customers and employees agreements, etc.).
Products/Services. Includes vibrant, growing niche markets, proprietary or patented products or services, and contractual and re-occurring revenue streams.
A Diversified Customer Base. No one customer is larger than 15 percent of your revenue. Customers are financially healthy and have contracts with your company.
Excellent Operating Systems. Operating systems with the right operational performance metrics.
Fixed Assets. Facilities appearance and condition is excellent as well as the age and condition of operational assets.
Financial Systems and Effective Financial Controls. Financial reporting is accurate, timely and useful.
Financial Growth. Growth in all three areas of revenues, cash flow, and profitability at once.
Owner Removed. If possible, the owner is already removed from the business (one of the most important).
However, from our experience, the single most important value driver is your overall relational health with your employees, customers, suppliers, and co-owners. Always be respectful and kind to your employees and continuously recognize them for good performance. Make certain you are surveying your customers to ensure you are serving them to the best of your ability and you have no misunderstandings. (Try a tool called the “Net Promoter Score” as a proven and formal way to predict growth). Have great relationships with several separate suppliers. Work hard to keep your communications and understanding (as well as contracts) up to date with your co-owners.
Next month we will discuss a number of other ways to manage and lower your Risk that your cash flow will be interrupted or decreased.
Last month we discussed the first two steps of our firm’s six step planning process for helping business owners create the optimum succession plan for their business and exit plan for the owners (hereafter “owner” inclusive of group of owners) which best meets their business and personal objectives. These steps were:
Step 1: Helping the business owner identify his/her life objectives including retirement income, manner of disposition of the business and non-economic life objectives (objectives which add significance to the owner’s life); and
Step 2: Where is the owner (and business) now and what is the gap (in terms of meeting the owner’s economic life objectives).
This month’s article focuses on the next step of our planning process:
Step Three: Filling the Gap. What changes in the business’ value (and the owner’s net worth) are necessary in order for the owner to meet his/her economic life objectives?
In order to fill this gap, the owner’s advisors must be able to assist the owner in analyzing the following:
Assuming the owner has chosen an exit strategy of selling his/her business to an outside third party, what would be a reasonable expectation of the after-tax amount the owner would obtain upon a current sale of his/her business, i.e., what is the real market value of the business currently and, if sold at that value, what would be the taxes due upon the sale and what amount would left to be reinvested in marketable securities (or otherwise)?
If reinvested in the market, what amount of retirement income can the owner reasonably rely on? Most financial advisors conservatively will assume somewhere between 4 percent and 6 percent as a reasonable return on investment of the after-tax proceeds. Will this amount meet the owner’s objectives so that the business can be sold now?
If not, what is the gap, i.e., what is the increase in the fair market value (and sales price) of the business necessary for the owner to reach his/her retirement income and other economic objectives?
For example, let’s assume that the business has a current cash flow of $500,000 per year (after add backs and non-recurring expenses), and the business has a current market cash flow multiple of 5. Since the business also has $500,000 in long-term debt, a reasonable market selling price (after paying off the debt) would be approximately $2,000,000 ($500,000 times 5 equals $2,500,000 less $500,000 long-term debt equals $2,000,000).
Assuming taxes upon the sale are 25 percent of the sales price, the taxes would be $500,000. Therefore, the business owner would have $1,500,000 to reinvest after taxes ($2,000,000 minus $500,000).
Let’s further assume that the $1,500,000 can be safely invested at a 5 percent per annum return on investment and that this would produce $75,000 per year income. Assuming the business owner has approximately $100,000 per year of other retirement income from his/her assets other than the business (401(k) plan, Social Security, rental property, etc.), and that his/her objective is to retire with at least $250,000 per year pre-tax for his/her and his/her spouse’s joint lifetimes, he/she is $75,000 per year short of reaching his/her retirement income goals.
How much does the fair market value of the owner’s business have to increase before a sale can occur which will meet the owner’s objectives?
The answer is that the owner’s business needs to grow from a cash flow of $500,000 per year to $900,000 per year. An additional $400,000 per year at a 5 multiple will produce $2,000,000, which after taxes would give the owner another $1,500,000 to invest at an assumed rate of 5 percent per annum ($400,000 times 5 equals $2,000,000 less $500,000 taxes equals $1,500,000, times 5 percent equals $75,000 per year income).
Given the above facts, what steps should the owner take to increase his/her business’ cash flow?
Here is where the assistance of the owner’s advisors is critical. The items, common to all industries, which drive up the value of a business are called “value drivers.” Value drivers are what qualified buyers and investment bankers look for in a business that increases the business’ value.
Value drivers are characteristics of a business that either reduce the risk associated with owning the business (which increases the cash flow multiple which can be obtained in a sale) or enhance the prospects that the business will grow significantly in the future. There are many items that create value, including: proprietary technology, market position, brand name, diverse product lines, patented products, etc.
In next month’s article, we will look at those key value drivers that are common to most businesses.
The IRS released final regulations dealing with when taxpayers are required to capitalize and when they can deduct expenses for acquiring, maintaining, repairing and replacing tangible property. All businesses that own fixed assets will be affected in some manner and are required to comply with these new regulations as of January 1, 2014.
There are four basic areas which are impacted by the new regulations: (1) materials and supplies; (2) repairs and maintenance; (3) amounts paid for the acquisition or production of tangible property; and (4) amounts paid for the improvement of tangible property.
Materials and Supplies
Materials and supplies are those tangible items used or consumed in the taxpayer’s business operations and are typically expensed when they are consumed. These can include: (1) components acquired to maintain, repair, or improve a unit of property (UOP); (2) fuel, lubricants, water and similar items that are reasonably expected to be consumed in 12 months or less; (3) a UOP that has a useful life of 12 months or less; (4) a UOP with an acquisition or production cost of $200 or less; (5) or an item identified by the IRS in published guidance.
Routine Repairs and Maintenance
Taxpayers often capitalize costs that may be eligible for immediate expensing as repair and maintenance costs. The new regulations make clear that costs of certain routine maintenance need not be capitalized.
Under the routine maintenance “safe harbor,” the amount paid is deductible if it is for recurring repairs and maintenance that the business expects to perform to keep the UOP in its ordinary efficient operating condition.
Repair and maintenance costs are considered routine only if the business expects to perform these activities more than once during the MACRS alternative depreciation system class life of the property. For buildings and their structural components, maintenance can be expensed only if the taxpayer reasonably expects to perform the maintenance more than once over a 10-year period.
Asset Acquisition or Production
Taxpayers are generally required to capitalize amounts paid to acquire or produce a unit of real or personal property. Under the new regulations, the IRS has provided a de minimis exception to this general rule. Taxpayers with an applicable financial statement (AFS) may deduct up to $5,000 per invoice or item purchased. Taxpayers without an AFS may expense up to $500 per invoice or item purchased. For all taxpayers, amounts paid for property with a useful life of 12 months or less may be expensed. In order to apply this de minimis exception, you must (1) have a written capitalization policy in place as of January 1, 2014; (2) treat these expenses in the same manner on your tax return and financial statement; and (3) elect this treatment annually by including a statement with your tax return.
In general, the new regulations require taxpayers to capitalize amounts paid to improve a UOP. A UOP is considered improved if the amounts paid for activities performed result in a (1) betterment; (2) restoration; or (3) adaptation of the UOP to a new or different use. It is important to consult your tax advisor when making this determination.
The new regulations also include guidance pertaining to casualty losses, asset disposals, and favorable safe harbor rules for small taxpayers.
It is important to take action to comply with these new regulations. Taxpayers should analyze capitalization policies to determine compliance with the new standards, including having an adequate written policy for repairs and determining whether it is advantageous to make certain annual tax elections and/or file accounting method changes to conform to the new rules.
These issues are complex. There is no one-size-fits-all answer for every business. Your trusted tax advisor can provide specific guidance for your industry and your unique business situation.
The benefits companies receive from traditional annual budgets may be diminishing. Given the current economic environment that most businesses face, they are constantly dealing with volatility and ever changing risks, thus the past is not always a good predictor of the future.
Budgets are created based on prior periods and management assumptions, which now may be wrong. According to the Beyond Budget Round Table, by the end of the first quarter more than two-thirds of a corporation’s budget is completely irrelevant to actuals. Flexible planning is now vital to the ongoing financial success of a business and a stagnant, fixed-period budget leaves no room for actual implementation of change to match the environment.
Because of inefficiencies with traditional budgets, many companies are converting to a rolling forecast. With a rolling forecast, projections are reevaluated in shorter spans—for example, every quarter—then forecasted out a standard number of periods, usually 12 months. This allows companies to reevaluate assumptions and adjust forecasts closer to actual market conditions.
Rather than having a full year projected out and running down to zero and then starting the process over again, the rolling forecast allows for a continually updated horizon. Allowing the forecast to change, companies can then more closely monitor and evaluate their business on an ongoing basis, which holds managers accountable throughout the year rather than just at the end of the budget year.
Companies may start with an annual budget and then move to a rolling forecast at the end of the second or third month. The result is three months of actual results and nine months of projections. This process is continued throughout and into the next calendar year. By merging actual data into the budget, companies gain greater clarity into what is driving current results. It also forces managers to more closely monitor and track their financial performance.
Rolling forecasts give better insight into possible downturns or upturns, giving leaders an opportunity for discussions to help avoid or handle situations. With the greater ability for cash flow analysis, it allows decision makers to consider and structure large transactions on a timelier basis. There also is room within rolling forecasts to perform scenario and stress testing throughout the year which is almost nonexistent with a traditional budget.
Rolling Forecast: How to Get Started
Initial implementation of a rolling forecast may run into some resistance and can be time consuming, but it will reap worthy benefits for the company as it is streamlined. The most important factor in transitioning from a traditional budget to a rolling forecast is ensuring people in the company are willing to take part in the process. This can be done by getting employees to understand a rolling forecast will save time for departments and allow more time for focusing on driving actual results.
The company’s business will determine the complexity of the forecast and the drivers that need to be reevaluated and emphasized. The frequency for which critical drivers need to be updated depends on their importance to the company and their variability. Some items should be reevaluated weekly; others can be reevaluated bimonthly, monthly or quarterly. For some businesses an ad hoc approach is more reasonable with only significant changes prompting reforecasting.
Forecast assumptions should also be based on underlying physical factors and not on the hopes of management that things are going to improve. Also, different time horizons can be used as the company evaluates different planning decisions when dealing with factors like sales, operations, finances, and capital projects.
Since actual current data drives the rolling forecast, it is important for a company to maintain accurate and timely data that is usable and accessible by all vested parties. Depending on the size of a business, basic rolling forecast data may be maintained using simple spreadsheets. For larger or more intricate businesses forecasting, more complex software can be used to allow for consistent and flexible changes of assumptions with trusted output.
Processes should be repeated, but as the needs and priorities of the company change, models should be adapted to properly reflect business evolution.
Succession planning is a process for business owners to determine exactly how a business will continue after its current owner(s) leave through either sale of the business, retirement, disability or death by creating the right “exit strategy” for the owner(s).
We use a six step process for helping business owners create the optimum succession plan for their business and exit plan for the owner(s) which best meets their business and personal objectives. Here is a brief description of the first couple of steps in the process.
Step 1: Identification of Objectives. Assemble the Team, Determine the Goals, Identify the Stakeholders, and Identify the Owner’s (Owners’) Life Objectives.
The first step of the process is to assemble the right team of advisors to assist the owner(s) with the planning process. Owners simply cannot develop the best plan unless they have advisors who (a) understand the process; (b) understand all the options available; and (c) have the ability to work together to help the owner(s) understand all available options.
The team could possibly include the business’ CPA, life insurance agent, attorney, financial advisor, and anyone else necessary to make certain that all areas are addressed. From this team a facilitator should be chosen who is trained and knowledgeable about the issues involved, as well as the methods of building consensus among all the stakeholders who need to buy in to whatever plan is developed. The facilitator will work with the owner(s) and other advisors to drive the process to completion and implementation of the plan.
The team should first establish the corporate goals of the planning process. For instance, in a case where the business owner wishes to retire and ultimately transfer ownership, management and control to his key employees, the goals might be to establish a plan for ownership transition which:
(a) Provides the sellers (owner(s)) with a reasonable financial return on their investment in the business, including reasonable retirement income;
(b) Motivates potential internal buyers to become owners of the business by providing a reasonable price for ownership and establishing with buyers that the long-term financial prospects of the business are excellent so that they become loyal employees who desire ownership in the business to the maximum extent possible; and
(c) Is the result of a process which results in a plan which is perceived to be fair and is accepted by all stakeholders (current owner(s), potential owner(s), current non-owner key employees).
The team must also identify the stakeholders, i.e., every person who needs to buy in to this plan for it to be successful. They include current owner(s), key employees, potential future owner(s), spouses, and others.
Once this is completed, the planning process should begin by meeting with the owner(s) and helping the owner(s) identify his/her life objectives—both business and personal. Some of the questions which the owner(s) should answer are:
1. When do you want to retire?
2. How much after-tax income do you need?
3. What do you want to do with the company?
4. What are your charitable objectives?
5. What are the other non-economic life objectives which will add significance to your life?
Step 2: Where Are We and What is the Gap?
The second step is to perform due diligence on the business and on the owner(s) to determine exactly what the current situation is, i.e., the current net worth, cash flow, and market value of the business and the business’ projected future cash flow and market value.
Also, the owner’s (owners’) current personal financial resources must be analyzed to determine the gap which needs to be filled so that the owner(s) will be able to meet retirement income objectives.
The team must develop an intimate knowledge of every aspect of the business—including the risk issues which need to be addressed to ensure the stability of the projected future cash flows. This planning process should be treated in the same manner as an acquisition of the business in terms of the due diligence required.
In next month’s article, we will discuss the four remaining steps of our six step planning process for helping business owners meet their life objectives.
In 2011, I was fortunate to check a major item off of my bucket list: Visit New Zealand’s South Island. Knowing it would be an expensive adventure, I meticulously researched each hotel, restaurant and activity using TripAdvisor.com to ensure that I would get the best experiential value based on the reviews of others.
Advertising spent on brochures, web design, billboard advertising, TV or radio had no influence on me and where I chose to spend my money. Every decision I made was based on the opinions of others.
Well, I wasn’t let down. I had the time of my life!
Recently, while driving home from uptown Charlotte, I pulled into the parking lot of a recommended restaurant in Dilworth and read reviews about it on Yelp.com. Had the reviews been negative, I wouldn’t have gone in. My consumer behavior is consistent with Generation Y who place a premium on experience over expense and make decisions from quick research using a smartphone.
This behavior is not limited to the service industry, as I, and others like me, have conveniently selected dentists, doctors, computer repair technicians and a myriad of other services using review sites.
There has been a lot of criticism in the media about review sites like Yelp.com and others because of ‘review padding’ by owners of establishments who create positive reviews for themselves. If a business operator delivers a poor product or service, no amount of padding can outweigh the tidal wave of negativity that will crash on a business from savvy consumers.
Review sites are here to stay and effectively utilizing them is a key to business success today and in the future.
Word-of-mouth (WOM) has always been the most credible and effective mode of marketing, but its transmission beyond our small social circles had been limited by our interactions. Prior to the smartphone, an average consumer would tell three friends about a great experience and 10 about a bad experience.
Today, Facebook and Twitter deliver opinions, both good and bad, to thousands of people in seconds. A company’s survival centers around great service, selling an excellent product, and using new mediums for marketing.
Once considered to be in a different category from marketing, customer service has transitioned from being an extremity to being at the heart of influencing consumers on where to spend their money. Inspire your customers through exceptional service to utilize the technology available and create raving reviews.
Gaining Competitive Advantage: Leveraging WOM
Leveraging word-of-mouth is both effective and inexpensive when attempting to raise a company’s profile in a busy marketplace. An example of this is the story of my family and how they utilized TripAdvisor to transform their business.
My parents operate an eco-kayaking tour on the island of Antigua, competing with 67 other tour companies vying for cruise ship passengers arriving each day between November and April. How does a literal ‘mom and pop’ compete with no advertising budget and thrive? The answer: Craft a five-star experience complemented with superior service and then ask your customers to review the trip.
The result? Their business tripled after they moved up the TripAdvisor rankings from 26th to number one in the country. Their customers became the marketing team and word spread virally about the Antigua Paddles experience. Any company in any industry can adopt this strategy and be successful if implemented correctly.
The advent of the smartphone is a game-changer. At no time in history have consumers had the power to effect the success or failure of an organization’s outcome. The very survival of a company not only depends on a product or service but also how the customer feels and most importantly, how that feeling is shared.
Tips for Leveraging Review Sites
1. Know Your Ranking. Know where you stand and know what consumers are saying about you.
2. Create Raving Fans. Make exceptional customer service equally as important as the product.
3 Deliver. Deliver great service consistently everyday.
4. Address Negative Reviews. Post responses to any negative review, but never take a defensive position. Be positive in your comments and implement necessary changes to avoid the same negative review again.
5. Set Goals. Strive to break into the top-three ranked companies on various review sites.
6. Buy-In. Get buy-in from your staff to embrace a customer service culture and drive to hold a top online ranking.
7. Ask. Happy customers tend to be loyal and will happily write reviews to help with your success…you just need to ask them.
Although the tax law is modified each year, the types of taxes we pay remain relatively constant. These include taxes on sales, income, property, estate/gift, social security, unemployment, etc. However, beginning in 2013, there is an introduction of two new taxes, which are part of the Affordable Care Act: Net Investment Income Tax and an additional Medicare Tax on wages and self-employment income.
Net Investment Income (NII) Tax
As the name suggests, this is a tax on investment income. For the purposes of this law, investment income includes interest, dividends, capital gain, net income from rental and royalties, and income from business activities where the owner is considered to be a “passive” participant (does not materially participate in the business operations). Although this may seem straightforward, there are a number of gray areas regarding its application. The IRS has addressed many of these in proposed regulations as well as Q & A sections on its website.
For NII tax purposes, income NOT subject to this tax includes: wages, unemployment compensation, operating income from a business that is not passive to the taxpayer, alimony, tax-exempt interest, self-employment income, and distributions from qualified retirement plans, such as IRAs.
A particularly confusing topic regarding this tax is the treatment of rental activities. The current IRS position is that rental activity, which does not rise to the level of being considered a trade or business, will be included as income subject to this tax. An example of a rental activity that qualifies as a business and is therefore NOT subject to this tax, would be a taxpayer whose full-time job is managing the rental properties he or she owns.
However, from the IRS examples released to date, they appear to expect very few rentals to qualify for this exclusion. So the question for taxpayers whose full-time job is not related to the rental is: How involved in the rental activities do I need to be? Some advisers argue that if a taxpayer is involved with continuity and regularity with the primary purpose of making a profit, a trade or business exists. If the taxpayer’s position conflicts with IRS regulations, disclosures may be required, which would prevent IRS penalties but will also draw IRS attention to the position.
The NII tax is assessed at a 3.8 percent rate and is applied to the lesser of (1) net investment income, or (2) the excess of modified adjusted gross income for the year over a threshold amount. These applicable thresholds are $250,000 for married taxpayers filing a joint return or a qualified surviving spouse, $125,000 for a married taxpayer filing a separate return, and $200,000 for anyone else. Therefore, for this tax to affect you, you must have a certain level of income and net investment income included in that amount.
So what are some strategies that could be used to lessen this new tax for you? In addition to taking your rental to the level of a business, or increasing your participation in other activities to avoid the “passive” taint, you can shift the mix of your investments to assets that produce income not subject to the tax (i.e. municipal bonds, annuities, or life insurance).
Another strategy could be to smooth out income from year-to-year in order to stay under the gross income threshold mentioned above in order to avoid spikes in any one year that could make you subject to the tax. If you are planning to sell your stock in a closely held C corporation, arranging the financing of the sale as an installment sale (to be received over a number of years) may be a tax planning tool.
Additional Medicare Tax
Wages and/or self-employment income in excess of the same thresholds as the NII tax will be taxed at a 0.9 percent rate. This tax is more straightforward and tax planning more difficult. However, one possibility is for taxpayers to plan ahead to defer income such as bonuses and remain under the income thresholds.
The problem is that the definition of wages for the calculation of this tax is “Medicare Wages” which makes 401(k) deferrals still subject to this tax and tax will be imposed on deferred compensation when the income vests to the employee. A tax adviser can help you understand how the wage base is determined.
Employers also are required to withhold this tax when wages for the year exceed $200,000. If the withholding exceeds the actual tax owed, or vice versa, the difference is resolved on the employee’s tax return.
These new taxes clearly add to the complexity of the federal tax system and require consideration from both businesses and individuals. As with any complex issue, you should consider seeking help from a tax adviser familiar with the applicable law.
Charlotte is #1 in Employee Engagement
Charlotte has the highest level of employee engagement of all major U.S. cities, according to a recently released survey by Quantum Workplace, a company that provides the tools and strategic advice to improve employee engagement, organizational culture and financial success. Additionally, only Charlotte and Denver have shown consistent and significant increases in engagement since 2009.
What does that mean, exactly? “Engagement involves the presence of three outcomes among employees. First is discretionary effort—meaning employee willingness to go the extra mile; second is intent to stay; and third is advocacy—the employee’s willingness to brag about their workplace,” says Greg Harris, president and chief executive of Quantum.
Harris says that the biggest differentiator for Charlotte is the wildly high favorable ratings for the survey item that says, “I see professional growth and career development opportunities for myself at this organization.” For whatever reason, he says, employee responses to that item in Charlotte were miles above other cities.
Quantum Workplace has compiled its annual ranking since 2003. It evaluates 37 key items falling into 10 areas of engagement including perceptions of teamwork, manager effectiveness, trust in senior leaders, trust in coworkers, retention, alignment with goals, feeling valued, individual contributions, job satisfaction and benefits.
“The list is most helpful for employers as they recruit and Chambers of Commerce as they attract This data provides a lens into the quality of workplaces by city. This list gives cities a benchmark to build a story around attracting and retaining great talent.”
Levels of Employee Engagement
Top Five Cities
1. Charlotte, N.C.
2. Denver, Colo.
3. Sacramento, Calif.
4. San Antonio, Tex.
5. Washington, D.C.
Bottom Five Cities
1. Cincinatti, Ohio
2. Omaha, Neb.
3. Las Vegas, Nev.
4. Albuquerque, N.M.
5. Kansas City, Mo.
2014—The Year for Charlotte to Flourish
At its annual meeting on December 3, 2013 at the NASCAR Hall of Fame, the Charlotte Chamber celebrated its successes in 2013 under the leadership of Brett Carter, chief distribution officer of Duke Energy, and launched new objectives for 2014 with the installation of Michael Tarwater, chief executive of Carolinas Healthcare System. They also presented Dan DiMicco, executive chairman of Nucor, with its Citizen of the Carolinas award. With over 2,000 in attendance, its theme “Flourish” exemplified the ambitions of Chamber leadership to boost economic growth in a healthy and vigorous way.
In preparation for the Annual Meeting, Chamber leaders gathered at Pinehurst for the annual planning event that centered on the principle of finding ways to make Charlotte a healthier, more vibrant place to live and work. According to incoming chairman Tarwater, “Of the accolades in which Charlotte has earned high marks, healthy is not one of them. Yet more and more companies looking to relocate and more and more workers looking to plant roots in new communities are adding healthy criteria to their list of wants.”
Within the planning session, Chamber leaders talked about encouraging healthier workplaces and healthier lifestyles with the ambition of raising the identity of Charlotte as health conscious and focused upon green space planning, better public transportation, cleaner water and air so that the overall environment will be respected and cared for even as we experience economic growth.
Over 130 Charlotte business leaders participated in the 2013 Inner-City visit to Houston, Tex., and were able to compare notes on transportation, energy and health care sectors. Chamber leaders selected Minneapolis, Minn., for the 2014 Inter-City visit.
New Mayor Targets Job Creation
Newly-elected Mayor Patrick Cannon was sworn in to his new position at a Charlotte City Council Meeting on December 2, 2013. Having been chosen by 53 percent of the voters, Mayor Cannon defeated Republican Edwin Peacock.
In his remarks upon being elected, Cannon targeted job creation, both white and blue collar jobs; zoning, permitting and other steps to establish a more “business-friendly” community; and getting focused on building a “global distribution hub” taking advantage of the Charlotte Douglas International Airport, the new $93 million Charlotte Regional Intermodal Facility and Charlotte’s central location along the East Coast in the coming years.
Citing the low costs of the Charlotte airport, Cannon expects to compete with other distribution hubs to bring business to Charlotte and the region.
Succession planning is a process for business owners to determine exactly how a business can continue after its founders (or current owners) leave through either sale of the business, retirement, disability or death. It involves every aspect of the business and personal lives of the current owners and proposed future owners.
The typical end result of succession planning is the identification of an exit strategy for current owners that satisfies their ongoing needs and a plan for the identification and implementation of the structure necessary for the business to survive and thrive independently of its current owners.
Oftentimes, business owners do not consider that at some point, they will no longer be an owner of the business. Whether their exit is the result of a planned or unplanned departure and what happens to their business and their family before, during and after that departure can and should be positively affected by what they do today through the creation and implementation of an appropriate succession plan.
Though every plan and strategy will vary based on the objectives of each owner and each business, all succession plans have two common aspects: a plan for the transition of ownership; and a plan for the transition of management and control. The second aspect is both the most difficult and most important.
Possible Exit Strategies Available to Business Owners
1. A liquidation of the business: always an option, but this option is not likely to produce the highest value to the owner;
2. The sale of the business to “insiders” (other shareholders or employees): a possibility, however, in many cases, no other shareholder or employee will have funds to provide the “cash out” price except through the use of the assets and business operations of the business (which can create a problem of adequate financial security for the owner);
3. The sale of the business to “outsiders” (strategic buyer, financial buyer, foreign buyer): a possibility, but there is potential downside if the market learns that the business is “for sale;”
4. Creation of a “benevolent dictatorship” (leave it to the kids): a possibility, but the children may not know the business, and children typically will not have the funds to provide the “cash out” price except through the assets and business operations of the business;
5. A joint venture or merger: a possibility if it can be structured to provide results similar to “sale of business” to outsider; and
6. An initial public offering (IPO): only possible for a small minority of closely held business clients due to the complex issues involved.
The selection of an exit strategy and exit planning should commence no later than five years prior to the desired departure of the owner.
Consensus on a succession plan is best obtained when there is an atmosphere that permits sharing of information (especially financial data) and a clear willingness to seek and give input before major decisions are made.
Key Elements of the Succession Planning Process
The succession planning process is a complicated one which involves consideration of the following elements:
• the business’s strategic plan,
• the business’s current financial condition and cash flow,
• the corporate finance and options available,
• relationships among the owners and their families,
• stakeholders’ interests (current owners, potential successors, management and key employees),
• leadership abilities of potential successors,
• planning already in place (estate planning, life insurance planning, retirement planning, investment and funding mechanism planning, and business valuation),
• planning for the disability or death of the owners,
• organizational and entity structure as related tax effects,
• executive compensation planning (current and deferred),
• equity and non-equity incentive arrangements,
• owner’s agreements (buy-sell, cross-purchase, redemption, etc.), and
• the negotiation and mediation skills necessary in order to create and implement a succession plan which satisfies the interest of all stakeholders.
In next month’s article, we will discuss a Five Step Process for helping business owners create the optimum succession plan for their businesses which best meets the business and personal objectives of current and future owners and also leads to maximizing the value of the business.