Employee Retention Credit - A Top Level Overview

Over the past year plus, the U.S. Government has rolled out a variety of programs to help businesses as we work through the pandemic.  The Employee Retention Credit (ERC) is available for businesses that sustained declines in their gross receipts as compared to 2019.  The credit is available both in 2020 and 2021 although the rules for eligibility differ between those two years.  The eligibility rules are easier to meet for 2021 as compared to 2020 (e.g. 500 employee cap vs. 100 in 2020, only a 20% decline in a quarter's gross receipts needed in 2021 as compared to that same quarter in 2019 vs. a 50% threshold in 2020 vs. 2019).  Further, the credit available for 2021 is up to $7,000 per employee, per quarter vs. $5,000 per employee for the full year in 2020.  The numbers add up and the credit generated is quite meaningful.

A business can go back and file amended payroll tax returns for previous quarters in which they qualify to claim the credit.  For payroll tax returns in future qualifying quarters (the program has been extended through the end of 2021) the credit can be claimed while preparing those returns.  For a business with 50 employees, in 2021 an eligible business clearing all the issues that need to be addressed (notably PPP covered period), up to $350,000 in credit can be generated.  This is for each qualifying quarter.  If a business qualifies for one quarter, the subsequent quarter will also qualify.

In addition to understanding the program, it's important to note that a business cannot "double dip" with other programs offered.  For example, wages paid claimed as part of the loan forgiveness for PPP are not eligible to be used as part of the ERC.  As a result, it is important that a borrower of PPP funds be careful about how they complete their PPP round 2 loan forgiveness applications.  Many borrowers have taken the easy path of claiming labor, and only labor, when completing these forgiveness applicatoins.  It's important to use the other factors available, such as rent, utilities, health/welfare/pension benefits for unions, etc. to achieve loan forgiveness.  This preserves wages that can be used for the ERC.

For further reading and a nice summarizing table, see this ERC Overview Article.   

SBA Paycheck Protection Program

Information and developments are flying fast these days. With the recent passing of the Coronavirus Aid, Relief, and Economic Security Act (CARES), another SBA program has been made available for businesses to gain much needed access to working capital.

The Paycheck Protection Program, part of the CARES Act, provides a path for businesses, through a participating SBA Lender/Bank, to be able to apply for funds as defined in the program.  The loan window will open up on Friday, April 3, 2020.  It is advised to wait until your bank sends the application as those applications may be adjusted right through the last minute.  The basic elements of the program are:

·        Must have 500 or fewer employees (beware of aggregation rules)

·        Maximum Loan will be $10 million

·        The loan can be forgiven if used for:

o   Payroll costs

o   Rent

o   Utilities

o   Mortgage/Existing Debt as defined

o   Other designated costs

o   Due to high subscription expectation, not more than 25% of loan forgiveness can be for non-payroll costs

·        Provisions for employee retention as defined.  Caps re: highly compensated employees

·        Debt forgiven will NOT be included as taxable income for federal tax purposes

The links below are official US Department of Treasury links (they are safe).

Department of the Treasury Press Release on the Paycheck Protection Program

Paycheck Protection Program - Borrowers Info Sheet

Paycheck Protection Program - Lenders Info Sheet

SBA Disaster Relief Loans

At the end of January, when I wrote about the possibility of a recession, I obviously had no idea anything like this would happen.  It turns out those graphs were solid evidence we weren’t far away from whatever factor may become the trigger for difficult times in the near future.

So here we are, dealing with a completely new set of circumstances.  The main objective for businesses right now is to make it to the other side of this.  It will hit different industries in different magnitudes and at different times, but all will be hit to some extent.

The government is rolling out new assistance programs as the days roll on, the one I wanted to get out to everyone now is the U.S. Small Business Administration (SBA) is offering low-interest disaster loans up to $2,000,000 for affected businesses.  The application process is online and can be found by clicking this hyperlink.

I strongly encourage business owners to immediately draw down on their lines of credit now to ensure liquidity for at least the next three months (maybe draw all available capacity).  I also suggest for those feeling they may need additional working capital sometime in the next three to six months or so, to apply for this SBA loan program and get in line.

The name of the game right now is to preserve capital and make it past this event.  Consider talking with your business partners, vendors, landlords, etc. as to how they can help your business if you feel your business will be significantly adversely affected.

This too shall pass.  It will pass better for those who execute well and make good decisions now to mitigate the impact.

Some more info...

SBA Disaster Loan Fact Sheet

SBA 3 Step Guide

Consumer Confidence, Unemployment Rate and Recessions

Last month I attended an economic forecast event and a few of the slides really caught my attention.  As business owners and advisors we are always looking forward, around corners, etc. in an attempt to see what lies ahead in order to make sound, prudent business decisions.  The following slides both contain shaded areas denoting periods of recession in the U.S. The first slide below is the Conference Board Consumer Confidence Index.  The index basically assesses consumers present feelings about the economy as well as their outlook for business and employment over the next 6 months; how they feel they will fare economically.

This next chart shows the actual unemployment rate against the natural rate of unemployment.  The natural rate of unemployment is the premise that even when the economy is at full employment, there is still a segment of the workforce who are unemployed.  What the chart indicates below is that the economy is so robust currently that organizations are really tapping deep into the available pool of workers, causing actual unemployment to dip below the natural rate.  You can see clearly in the chart that when this happens usually within a few years of going below the natural rate a recession typically begins (again, the shaded areas).  We've been below the natural rate for a few years now, and by many measures this economic expansion is long in the tooth.  We've also heard that expansions don't die of old age, it's generally some catalyst, often times monetary policy, that triggers a recession.

This time could be different/unique.  Perhaps it already is.  We have historically low interest rates that generally cause capital to move into risk assets and foster business investment.  We have technology advances that contribute to greater efficiency, productivity and profit margins.  Our clients 2019 calendar year results are rolling in with, in some cases, record level profits and in most cases healthy profits.  The business outlook for our clients is also strong, looking ahead to 2021 as well.  As always, remain vigilant, capitalize on opportunities and use this strength in the economy to shore up balance sheets.  This balance sheet strength is always a welcome position to be able to withstand the eventual slowdown that will come at some point.

2020 Construction Industry Outlook (So Cal Edition)

It’s been a good last few years in the construction industry, certainly here in southern California.  Most contractors have been reporting year over year revenue growth and strong profits.  Most contractors in the 10M to 25M revenue range have taken advantage of the recent law change allowing them to report taxable income on the cash basis method helping them boost cash reserves.  Larger contractors are generally ensuring their job budgets include contingencies resulting in conservative profit estimates.  Times are good.

Looking ahead, we see strong backlogs for most contractors.  We can already see a strong schedule through 2020, with many booking work in 2021 and some projects scheduled in 2022 as well.  Of course committed backlog isn’t a guarantee of precisely when that work will actually occur, however the backlogs we are seeing look good into the near future.  Many here in southern California point to some large scale events that will be visiting our region in the coming years as support for our market.  These include the following:

·         Super Bowl, being hosted in SoFi Stadium in Inglewood in 2022 (construction ongoing)

·         World Cup Soccer in 2026, Rose Bowl among the U.S. venues.  Canada and Mexico will each get 10 matches in this tournament as well.

·         2028 Summer Olympics, Los Angeles is the host city.  The events will use many venues already built or under construction, with a new arena in Inglewood proposed for construction for use by the LA Clippers.  There are many infrastructure projects on the boards for the LA area in anticipation of this event.

In addition to the work that will need to be done in anticipation of these events, there are many projects starting or proposed here in southern California.  Even if you aren’t associated with any of the big event projects cited above, construction resources will be utilized by those projects taking supply out of the market.  This should help with both opportunities to win new work as well as bolster pricing.

The rising tide doesn’t necessarily float all boats, although it does for most.  If a contractor isn’t making money in the last year or two, likely the issue is company specific.  Boats with holes don’t float in any tide.  We have seen a few cases where contractors in the market are having some challenges, however we can usually identify key areas they need to address.  Examples include not dealing directly with personnel issues (poor execution in their roles) including challenges with transitioning the business to new leaders.  If an owner is looking to pass the baton on to the next generation, s/he must make sure that the new leadership has a good grasp on that baton before letting go.  Labor is always the most difficult variable to manage, across all levels of the organization.  Be sure to address, in a direct and timely fashion, any issues your business may be encountering.  If one can’t make money in these times, it won’t be any easier when things slow down.

In summary, the outlook remains bright for at least the near term.  The hope is that the activity southern California will be enjoying over the next several years will continue to support the market.  As we know, it’s a cyclical industry and we are bound to see a slow-down at some point.  The last recession we saw 10 years ago was the “Great Recession” and was painful for many.  The next recession likely won’t be as deep or as long however it will still need to be managed.  For now, enjoy these good times and as always, have a plan ready for when things get slow.

Getting The Most Value When Selling Your Business

I was recently asked to speak about how business owners can maximize the value of their business as they prepare for an exit.  More and more business owners are starting to think about the next chapter in their lives and the demographics support this.  Note the following:

·         One quarter of business owners today are over age 60 (Source: Kiplinger Letter May '19)

·         Many of those intend to sell relatively soon, half of them within 5 years (Source: same)

·         Few of them have a solid exit strategy in place (Source: same)

Generally, it is best to have a 3 to 5 year runway of planning to execute a proper exit strategy.  The more time one gives to the process, the more options will be available.  The following are some bullet points I covered in my talk:

·         Valuation is key, depends on your sector, past performance, future outlook, composition/quality of customer base, management team, etc.

·         Re: management team, buyers just don’t buy businesses, of course they are also buying talent.  The more talent you have in management beyond the owner, the more valuable a business is.  If the business relies heavily on its owner, it’s more of an alter ego and lesser so a business.

·         During a potential sale, when going to market, stay focused.  Stay focused on business execution to maintain strong results (i.e. business value).  It’s easy to get distracted by the prospect of the exit, whether sale, ESOP, etc.  If business results start lagging, often so too will the value of the transaction.  Further, not all transactions are completed and if your business weakens as you lose focus, it's all your problem to solve when a deal falls through.

·         Have a strong accounting/reporting function.  The owner may know what is transpiring in the business, but outside parties such as prospective buyers and their due diligence teams, valuation firms (including for ESOP), etc. do not.  They rely on strong financial reporting to understand the intrinsic value of the business.  Incidentally, strong reporting is also useful in running the business regardless of potential exit.

·         Have a written strategic plan.  While the reporting function tends to tell the story of the past, a strategic plan provides insight into the future.  At the end of the day, valuation of a business is a discounting mechanism of the future cash flows of the business.  The strategic direction outlining opportunities/threats and how to address them is a useful document for prospective buyers as well as management.

·         Get year end CPA audited or reviewed financial statements.  Having this outside attestation regarding the quality of the financial statements is another useful resource for outside interested parties.  This will lend credibility to the financial data used by prospective buyers and valuation firms.

·         Curtail discretionary spending and ensure normalization of earnings during due diligence.  There are certain types of expenditures that a strategic buyer would not incur and those should be added back to earnings for a proper measure of enterprise value.

·         Run lean.  Ensure efficiency with your labor force.  This is one of the most difficult areas to manage in a business and not having unnecessary slack capacity is helpful to force efficiency into your business and improve earnings results, a key driver in valuation methodologies.

·         To the extent possible, avoid customer concentrations.  This is often times the norm, however mitigating these concentrations when all other things are equal is good to avoid questions with the associated risks and a potential downward adjustment to value or worse, a deal not happening because of them.

·         Build quality backlog (as you would ordinarily do).  Backlog is a clear indication of future earnings and will be built into the measure of enterprise value.

·         Sell at a good time in the cycle.  This seems obvious, but is sometimes hard for business owners to do.  Similar to walking away from the blackjack table when you are ahead, selling at a time of strong earnings and future prospects will lead to a higher valuation.  Waiting until the next downturn when things are not looking quite as good and when others are also looking to get out will have downward pressure on value.

·         Understand your enterprise value.  If you don’t, there is a risk you will not get a fair price for what you’ve built.  Be sure to have professionals on your team that can help in this regard.  You need to know the right price to make an educated decision regarding offers.

·         Understand the tax implications of the proposed transaction.  Entity structure, transaction type (e.g. stock vs. asset deal), and a myriad of other factors can significantly affect the net amount of the transaction.  It’s not what you sell for, it’s what you keep after taxes that counts.  Again, be sure to have professionals on your team that can help.  Work with these professionals on deal structure to maximize the benefit for all involved, both seller and buyer.  It’s generally best for all parties to “win” in any transaction.

·         Do not be distracted by purchase price.  There are other considerations such as non-compete, cash vs. credit (or some combination), the deal vs. the “after-deal” for you and your employees.  What will professional life look like for you and/or your team after the deal consummates?  Will your key people be happy in the new environment?  Will your customers be happy?  Is this the right fit?

As you can see, there are many considerations when thinking about your off ramp from business ownership.  The longer that off ramp is, the more likely it is to be smoother.

Transitioning your Family-Owned Business to the Millennial Generation

Family-owned businesses are a strong part of the fabric comprising the American business landscape.  They create an environment full of dynamics, both wonderful and challenging.  One area we are advising in more and more lately is business transition from one generation to the next.  We have a number of companies we work with where the business is being transferred to the Millennial generation.  For the last several years we have heard of Millennials and their place in the workforce.  Now, we are seeing examples of businesses, both large and small, where individuals in their mid- to late-30s have controlling stakes in their old line, successful family businesses.

These individuals are bright and eager, and now have the daunting task of leading their family business forward to the next chapter.  It is exciting for us to be an integral part of their team of trusted advisors.  These young owners lean on us to help solve problems in both financial as well as the operations side of the business.

In one case a father is selling majority ownership to his son.  The challenge is the method used to value the business was based primarily on the father’s monthly personal cash flow desires versus the true value of the business.  The valuation used was approximately double the true value.  That company is now in the process of bringing the valuation in line with reality and restructuring the debt.  In addition to constraining working capital for operations and growth, sufficient capital would not have been available to properly reward the efforts of the management group and employees.  Difficult conversations are being had; however, ultimately it is critical that fairness prevails - to all those who rely on the business. 

Other examples of Millennial owners being consultative include two late-30s owners taking over from one of their fathers.  Their management and financial reporting systems lack the quality needed to properly reflect the results of their operations and manage key performance metrics on a regular basis.  Our team is working with them to put the appropriate systems in place and train them on how to maintain and use the data.  In addition, we identified a number of areas in their tax returns that resulted in their business paying too much in taxes.  Lost tax deductions had cost them tens of thousands of dollars annually.  We were able to amend their prior tax returns within the statute and recapture those monies.  Another set of young owners who broke off from their former employer to start their own engineering firm is relying on us for similar consultative and tax services. 

We are working with young owners, helping them become high-level business operators by providing an education in business ownership and management.  It's great when we can help that next generation of young and eager new business owners looking to take their businesses to the next level!