By Gary Pittsford, CFP®
President and CEO, Castle Wealth Advisors, LLC
Over the years, you have grown your company and have managed it with the goal of making a profit and, hopefully, building the value of your business, so that you can eventually sell it and retire, knowing that you’ve left a valuable legacy.
We’ve helped many business owners value their companies, and make decisions about retirement income, reducing taxes, and building their net worth for the future. Sometimes, business owners who have run their companies for more than 20 years have been surprised when the valuation report was finished—they thought their company would have been worth more. After all, shouldn’t more time create more value? Unfortunately, that isn’t the case.
To increase the value of your company, there are a few key items that you should focus on.
First, focusing on increased sales is always a good idea, but the more important topic is your gross margin. If you don’t strive for the highest gross margins in your market area, then increasing sales won’t help much. For example, for the next 12 months, strive to increase your gross margins by 1 percent or 2 percent and, at the same time, to decrease your expenses by 1 percent or 2 percent. After a year, you’ll see a more profitable income statement. Increasing your gross margin and decreasing expenses will help tremendously in increasing the value of your company.
Second, focus on your largest expenses. For most of you, that would be your payroll and occupancy cost. Managing expenses is one of the most difficult topics for closely held business owners. If your gross margin, or usable cash flow, is 39 percent of sales and your annual expenses are 39 percent, then don’t expect to build much value in your company.
For most closely held business owners, the largest expense is employee payroll. Too many business owners allow their payroll to creep up over a period of many years. If the national average for payroll is 20 percent of gross sales and your payroll costs are 25 percent, then you’re not increasing the value of your company. For most owners, the second-biggest expense is the occupancy of their facilities. However, if the owner of the business also owns the real estate and is paying rent to himself, then high rent is fine. That excess rent can always be added back at the time of sale.
In short, focus on growing your business income, but, at the same time, try for the highest gross margin that you can and spend time every month managing all of your expenses— but especially your employee cost.
The next important item to focus on is tax management. If you work hard and make a profit, then you also need to spend time minimizing taxes and maximizing the amount of profit that you can retain. If you plan to retire in 5 to 10 years, ask your accountants to be thinking about the future and the best way to minimize taxes when you sell the company. Talk with your accountants about the type of entity that you’ve chosen to house your business. Should you have a limited liability company (LLC), an S-Corporation, or a C-Corporation? Are you maximizing your depreciation and other deductions annually? All of these tax decisions are difficult, because most business owners are not experts in these tax fields.
This is where I recommend to most business owners to surround themselves with excellent advisors to help you with tax, legal, and financial decisions. You need to concentrate on what you do best and let your advisors help you in these other areas that you aren’t comfortable with. Corporate attorneys can help you with corporate minutes annually, updating stock redemption agreements, and reviewing contracts before you sign them. Estate tax attorneys should review your wills, trusts, titling of assets, and beneficiaries at least every four to five years. Your accountant normally wants to know what your business did last month or last year, and those are also the same advisors who prepare your corporate and personal tax returns. They are important individuals not only to document what you did yesterday, but also to help you project where you’re going tomorrow.
Your attorneys and the accountants all are paid on a fee-only or fee-for-service basis. The third member of your team should also be an independent Fee-Only financial advisor who understands closely held family businesses.
Over time, you’ve hopefully pulled income out of your business and have put some of that profit into conservative liquid assets that you can use in the future. Also, if you sell the business, you’ll have more liquid assets that need to be invested prudently with the least amount of cost in order to provide you with future income and also to provide for your spouse, your children, grandchildren, and other beneficiaries. I’ve always told business owners that if you’re going to take a risk, do it inside the business where you can control the risk. If you’re lucky enough to make a profit at the end of the year, don’t take that profit and risk it a second time.
Building value requires increasing corporate income, increasing gross margins, and properly managing all of the expenses. Retaining that value usually requires that you have an excellent team of advisors to help you manage your corporate entity and your corporate and personal income taxes.
Being able to pass on that higher business value to the next generation within your family requires the combined efforts of you and your handpicked advisory team.
Pick that team carefully, and make sure that they understand not only closely held family businesses, but also family dynamics. This next item is important: Invite them all to come together for at least two hours every six months so that you can pick their brains and get all of the new ideas that they can provide you. Soak up all of their advice, and put it to good use in building value, retaining value, and passing on the value of your company.
Gary Pittsford, CFP®, is President and CEO of Castle Wealth Advisors, LLC. Castle specializes in helping families and closely held business owners with valuations, succession planning, estate and income tax analysis and retirement income security. Castle’s senior partners work with clients throughout the country in making logical decisions that help them fulfill their personal and business financial goals. For more information visit www.Castle3.com, call 1-888-849-9559 or e-mail Gary directly at .