Finances & Accounting

Exposure to accounting decisions is a key part of leadership training

As a family business owner, you are pleased when you walk by a marketing team meeting and see your son suggesting ideas for the new website. You are impressed when you observe your daughter working with the operations team to reorganize warehouse layout. You have built a strong, successful business, and you are proud to be able to pass it down to your children someday. While running your company, you are also preparing your next generation to take over. Early exposure to all facets of your business, including accounting decisions, is vital for the development of strong, wise leaders.

Why is it so important to involve your next generation in accounting conversations? Typically, the financials are the most intimidating aspect of the business, as well as the most fraught with family dynamics. Here are seven ways your business will benefit from including your next generation in accounting meetings.


Clear explanations about ownership transfer plans and timing help avoid conflict between and within generations. Imagine a family business in which three daughters are involved. The oldest daughter is clearly the leader. The middle daughter works for the business, but in a specific operational role. The youngest, a schoolteacher, wants to be involved as an owner. How is ownership determined? For an S corporation, ownership distributions must be pro-rata to ownership. A plan to financially recognize the additional time and investment of the older daughters must be made clear in order to avoid conflict among the sisters.

Open conversations about how and when ownership transfer will take place, and why, puts all family members on the same page. Your children are dedicating their careers to your business and working hard, and they may wonder why you are holding off on giving them ownership of the company. Explaining certain tax benefits of delaying ownership transfer can avoid a great deal of conflict caused by unasked questions.

How: Being transparent sounds simple, but managing the emotions involved in these conversations can be stressful for a family. How best can you balance the family dynamics involved while still being direct and transparent? First, set up a special meeting to discuss just this one topic. Avoid allowing the subject to come up naturally at a family event and instead plan a time to meet in the office. Second, involve a professional like your trusted accountant, financial planner or family attorney to help keep the meeting on topic and focused on the business, not the family dynamics. And finally, remain professional at all times, continually recognizing the contributions of all of the family members involved.


Educating the next generation about accounting early on provides several benefits. Your children can ask questions in a safe environment before they assume a leadership role; as leaders, they might feel they should already know the answers.

Questions from the younger generation may help you see the accounting area of your business from a new perspective, perhaps drawing attention to changes that need to be made. They may ask why a particular bonus formula is used when a new compensation structure might make more sense, given changes in your business.

The next generation will gain exposure to areas they may not be involved with on a daily basis. For example, they will gain an understanding of the movement of accounts receivable, learning about the timing of the collection process and its impact on cash flow. They may even come up with ways to speed up cash collection.

How: Invite your children to meetings with accountants, financial planners, management and your board. Encourage future leaders to observe various departments within the organization. Help them see the interconnections of the different roles and departments, and how decisions cascade throughout the business. For instance, how does inventory represented on a balance sheet correlate to the inventory in the warehouse, and how would a change to process for either affect the other?


Accounting involves a great deal of long-term planning, and those long-term plans may very well still be in place when leadership transitions. Ensuring that your children understand and buy into these strategies early on increases the likelihood that your goals will be achieved. Consider a son who decides upon taking over that he can get a better deal with the banker down the street than he can with the banker his father built a relationship with over the last 25 years. The decision may seem sound in the short term—perhaps because it results in lower fees. However, Dad stuck with this banker because the banker knew him. When Dad had a down year, the banker knew it was just a blip and trusted that business would soon return to normal. The guy down the street may not be as understanding because the relationship is not as strong. Understanding the long-term plan helps your younger generation appreciate the nuances of the decisions you've made over the years.

How: Provide access to long-term planning documents and ask your future leaders their opinions on your long-term plans. Once again, encourage the younger generation's involvement in meetings with your accountant, attorney, financial planner and other professionals.

Relationship building

Working with advisers early on helps your younger generation build strong relationships with professionals who can help them. They will learn not only when to seek advice and what kinds of questions to ask, but also that the willingness to seek input is a hallmark of a strong leader. They will observe you and other business leaders asking your advisers how decisions will affect long-term plans, bouncing ideas off one another and tapping into the minds of objective third parties. For example, if a competitor approaches you with an offer to sell you their business, your children will observe you asking your advisers to offer perspective and conduct due diligence before simply jumping on the idea.

How: Include your next-generation team in meetings with your professionals. Also include your future leaders in networking and social events that involve these trusted professionals to build relationships outside of the conference room.


Future owners learn how to lead by observing how you and other executives act, what kinds of questions you ask, how you weigh options and what the various roles involve. A next-generation leader learns a lot by watching the mannerisms, tone and approach you use when talking to key team members about accounting data. By observing and interacting with a wide range of team members, they learn how to create and manage professional relationships.

How: Following meetings or other important interactions, debrief with your future leaders. Ask them what they learned from the meeting, how they would have responded to the situation and what additional questions might have been asked. Encourage them to ask questions and offer constructive feedback. Continually increase the next generation's leadership responsibility. Encourage leadership activities not only within the company but also in professional associations and non-profit organizations.


Accounting and tax decisions are just one piece of running a business, but they have a serious impact on every other aspect of the company. As future business owners learn about the various aspects of running a business, being a part of accounting decision making helps them recognize how these decisions affect every other part of your business, including operations, marketing and human resources. When an inventory audit is conducted, the accounting story could uncover issues in accuracy and throughput. Your next generation might observe that the warehouse is disorganized and inventory numbers are growing because inventory is not going out the door. An examination of the issue begins, and your future leader learns about assessing purchasing, warehouse operations, sales and more.

How: Encourage your next generation to spend time in all areas of the company. When reviewing financial statements or making accounting decisions, ask a future leader to do some sleuthing by visiting an affected department. If the issue at hand is depreciation of machinery, for example, consider a tour of the machines or even, if appropriate, provide training in how to use the machines. Understanding the items on the accounting reports makes them come to life.


As young leaders learn about and become a part of the company culture, understanding how accounting decisions support that culture can help guide them in the future. A future business leader will need to understand if the company belief system supports maximizing profits for the owners or if an employee profit-sharing plan is a better fit with your core values.

How: Encourage the younger generation to get to know team members in all areas of the company. Future leaders should participate in team-building activities: team lunches, summer outings, company-sponsored charitable activities, etc. They should get to know as many team members as possible and become a part of the company culture. After all, some day they will be the ones who guide the company and develop the culture

Karen Snodgrass, CPA, MBA, is a principal at Cray Kaiser, a firm that provides tax, accounting and strategic services to family businesses (

Copyright 2017 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact

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Commitment guaranteed

Last September the Wall Street Journal reported that the Cababie family’s Grupo Gicsa, one of Mexico’s largest real estate development companies, was in danger because the family had made personal guarantees in the hundreds of millions of dollars on loans they used to finance two major U.S. projects. In August, the Cababies filed for Chapter 11 bankruptcy protection on their Everglades on the Bay condominium tower in Miami.


Another real estate family, the Soffers of South Florida, lost control of their unfinished Fontainebleau Las Vegas casino-hotel in February after the project went bankrupt. The family had grappled with a litany of financial problems, including $220 million in personal loan guarantees signed by the founder’s son, Jeffrey Soffer. Debt problems also threaten another Soffer property, the original Fontainebleau hotel in Miami Beach, which the family bought in 2005.


If these megamillion-dollar family enterprises can teeter on the brink when their lenders threaten to call in their personal loan guarantees, is there any hope for a smaller family business?


A personal loan guarantee is a promise by a company principal to use personal assets to repay the loan if the business cannot do so. The promise is backed by all assets of the guarantor. Collateral, by contrast, is the pledge of a specific asset, like equipment, inventory or receivables. Especially during periods of tight credit, most banks require business owners to sign personal guarantees on commercial loans, often in addition to requiring collateral.


Risking the loss of personal assets is sobering. But bankers and financial advisers say a personal guarantee need not cause sleepless nights (not too many, at least)—as long as borrowers keep a sharp eye on their businesses and carefully manage their relationships with lenders.



Borrowers’ obligations


In 2007, Jim Sagalyn, 64, president of Holyoke Machine Company in Holyoke, Mass., wanted to purchase an office building for a side venture. Initially, the local bank—where he does most of his personal and other business banking and knows the president and loan officer—wanted a personal guarantee for the full amount he was borrowing. He managed to negotiate to have the guarantee diminish over time. “As I pay down the principal, the amount of the personal guarantee is reduced,” explains Sagalyn, whose company was founded in 1863. He says he’s not particularly nervous about the guarantee because even with a few vacancies, the office building produces enough rental income to more than cover his monthly payments.


At Sunwest Bank in Orange County, Calif., virtually 100% of the loans made are backed by personal guarantees, according to Glenn Gray, the bank’s president and CEO. Gray says that when a family business owner approaches his bank for a loan, he pays close attention to the company’s net worth. “Family businesses tend not to leave much profit in the company because they want to minimize the tax situation,” Gray says. “It’s a two-edged sword. They take distributions, pay themselves well and find other ways to run personal expenses through the company. The result is they’re not building up much of a net worth, so you see requests for personal loan guarantees.”


Gray says that in the four years he has worked at Sunwest, there have been only two cases in which the bank has had to act on a personal loan guarantee. In one case, Gray says, he had to make the borrower aware that “if he didn’t live up to the obligations in the loan agreement, I would strongly consider going after his personal guarantee. He did have a fair amount of real estate and liquid investments, and he worked hard to get my loan paid off.” This borrower ultimately defaulted on a loan from another bank that did not require a personal guarantee, Gray says.


In the other case, Gray recalls, Sunwest Bank had to take legal action to get a writ of attachment (a court order to seize an asset). The court action “didn’t even give us a senior position on [the borrower’s] home, but it brought the business owner to the table,” Gray says. “That’s all we ever wanted in the first place.”



Two schools of thought


There are two schools of thought about personal loan guarantees. In one camp are bankers who argue that borrowers who are confident in their ability to repay the loan should not hesitate to sign a personal guarantee. “It’s more of a psychological edge that keeps people focused on taking care of problems should they arise,” says Gray. “At the end of the day, [a guarantee] only gives a lender the right to sue the borrower.” Gray says that if a borrower hits hard times, his bank will go after personal assets only if the borrower is capable of paying down the loan but does not cooperate with the bank to do so.


If hard times cause a borrower to struggle, Gray says, his bank is willing to work with the business owner to restructure the loan. “Bad things happen to good people,” Gray acknowledges. “If they’re working through the issues and doing everything they possibly can, going after the personal guarantee doesn’t make things any better.” On the other hand, Gray warns, “If I know someone has the ability to pay the loan, but he’s still pulling excessive money out of the business and has a lot of liquidity on the side, then I’d go after [that borrower].”


Those who oppose personal guarantees believe that a banker who lacks confidence in a business owner’s ability to repay a loan should simply not lend that company any money.


Patrick K. Hines, principal of the Rainier Group, a Bellevue, Wash., financial consulting and wealth management firm, says that in the mid-1980s, many banks began hiring sales-driven loan officers who lack relationship banking skills. “As long as the economy is healthy and profits are expanding, everyone is happy,” says Hines, who formerly was a senior commercial banker with Wells Fargo Bank. “But when things turn, they lack the ability to help solve clients’ problems and don’t know how to apply liquidity with a reasonable rate of return that can be paid on time.” Loan guarantees are a way of protecting banks from bad loans they shouldn’t have made in the first place, Hines argues.


Before the days of mega-mergers, banks weighed a potential borrower’s character heavily when making lending decisions, and assessed the business owner’s collateral and capacity (essentially, cash flow). Today, with so few independent local banks remaining, loan officers are less likely to know business owners personally and have all but removed character from the equation, says Hines.


“Most business owners that have homes feel as if their bank is asking for the shirt off their back for what they consider to be a fairly straightforward financing, with cash flow of the business plus fixed assets sufficient to repay the loan,” Hines says.


In reality, few borrowers’ homes are at risk. Bankers would likely prefer to target other assets, such as investment portfolios. With the real estate market currently in a slump and many home values dropping, banks would have a hard time extracting much value even if they could sell a borrower’s residence. Moreover, the process of foreclosing on a residence using a personal guarantee is not simple, says Hines. The guarantee only allows a banker to petition the court to allow the bank to put a lien on the borrower’s assets. It doesn’t necessarily mean the bank will ultimately liquidate those assets. In addition, other creditors, such as the first mortgage lender for the guarantor’s home, generally have priority ahead of the commercial lender. 


Even so, Jim Barrett, managing director of Cresheim Management Consultants in Philadelphia, says personal loan guarantees, which also require the signature of a business owner’s spouse, can put stress on a marriage. “The spouse now becomes a guarantor for the business,” Barrett says. According to Barrett, many loans don’t go forward because the business owner’s spouse refuses to sign the personal guarantee.



Negotiating tactics


How can you protect yourself if your lender insists on a personal guarantee and you can’t afford to walk away?


• Get your accountant in on the act. Your accountant can help you through the often-arduous application process and assist in negotiating the terms of the loan. But be sure your accountant’s reputation will be an asset, not a liability, Barrett warns.


• Provide collateral. The more collateral your business can offer and the more liquid those assets are, the less important personal guarantees may be. Typically, lenders look for company assets that can easily be liquidated if necessary. Receivables are generally pretty good collateral, but inventory can be hard to value and hard to sell. While hard assets such as vehicles, buildings and equipment are strong sources of collateral, if their value falls below the outstanding loan balance, that could put the borrower in technical default and trigger a loan recall—even if the borrower has not missed a single payment. Gray points out that some banks that need liquidity will call in loans based on technical defaults. That is why the next point is so important:


• Do your own due diligence. Ask your advisers, colleagues in your community, vendors or customers if they can offer insights on the reputations of the banks you’re planning to approach. Also make sure the bank is financially stable. You can look up a bank’s financial statements through the Federal Deposit Insurance Corp.’s website (


• Refrain from withdrawing assets from your company for at least a year before applying for a loan. That will lower your debt-to-equity ratio and strengthen your position. “Pulling out a lot of assets from the company tends to drive requests for the guarantee,” says Gray. If your debt-to-equity ratio is higher than 3:1 or 4:1, your banker will be more likely to insist on a personal guarantee.



What to do if problems arise


If you already have outstanding loans with personal guarantees and your company encounters difficulty making payments, you’re in a better position if your lender knows you personally. Here are some steps to take in an effort to avoid having your personal assets seized by the bank.


• Discuss problems right away. Don’t wait until you fall behind on payments, Barrett warns. “If they hear about your problem from you, you’re in much better shape,” he says.


Many people are reluctant to discuss the situation, Gray observes. “It could be an honest distrust of the banker, or a perception the banker won’t react well,” he says. “Or the business owner may believe, ‘Maybe if I can turn this around before the banker notices, I’ll be OK.’ That’s not a good strategy. Bankers don’t like surprises.”


• Be aware that a business bankruptcy will not necessarily release you from a personal guarantee. “The guarantee is separate from the assets of the company,” says Hines. When a private company declares bankruptcy, Hines says, that “severely impacts the financial status of the owner. But, with the guarantee in place, the bank has unfettered access to them and their personal assets.”


• Ask for a meeting with senior bank personnel. If you’re worried that your loan officer will not be sympathetic, Gray suggests, ask that the bank’s chief credit officer be included in your meeting (or, at a larger bank, ask if the senior credit officer or administrator can join you). At a small bank, ask to meet with the president.


• Don’t just report the problem; offer your banker a potential solution. For example, if sales are off, margins are compressed and you are likely to have a loss, explain how you are planning to cut back. Tell your banker that you will take less of a draw. If you do so, more often than not your banker will be willing to help you get through a rough period. If you’re paying principal plus interest, the bank may allow you to pay just the interest for a while or cut back on principal. If your loan is set to amortize over three years, your bank may restructure it to five years, which would lower monthly payments.


• Ask the banker to show you the note. If you have taken a loan with a large bank that has sold off portions of its loan portfolio to Wall Street (a practice called securitzation), it will no longer physically possess the loan document, Hines explains. If that bank threatens to exercise your personal guarantee, you may be off the hook in some states, such as California, if the institution cannot produce evidence of the obligation upon request.



Other alternatives


It should be noted that there are other sources of capital that don’t require personal guarantees. Your company could seek private equity or venture capital funds, or go public. But François de Visscher, a Greenwich, Conn.-based financial consultant to family businesses, notes that each of these alternatives has its own disadvantages. Private equity and venture capital funding often require giving up an equity stake in the company and taking on an outside partner. And companies that go public must report their financial information, including profit-and-loss figures and family executives’ salaries and compensation packages.


Without question, times have been tough for many business owners, but bear in mind that banks, too, have been affected by the economic downtown. It’s as important to maintain your relationship with your loan officer as it is to keep your eye on your company’s bottom line. Even if you’re in a bind, there’s a chance you can negotiate a plan to satisfy your debts. Most banks would prefer to avoid a legal battle—but they want assurance that borrowers are dealing fairly with them. If your case is suspect, a lending institution will muster all the power it can wield.



Jayne A. Pearl, a freelance writer and editor based in Amherst, Mass., is co-author (with Richard Morris) of Kids, Wealth, and Consequences: Ensuring a Responsible Financial Future for the Next Generation (Bloomberg Press, 2010;


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Coping in the Economic Downturn: Financing family firms in a time of frenzy

It’s been more than a year since the wars in the Middle East were driven from the front pages by the hurricane of economic and financial trouble. Here’s a report on the character-building experiences ten family-owned firms I know have had during that time.

1. Money-management firm

A money-management boutique in the New York City area had been exploring combining with another firm. Firm A’s experienced second generation ran the place day to day; the founder, nearing age 70, held the reins loosely. The leader of firm B, age 60 and without a successor, had to hold his key professionals, who were valued assets.

As their Wall Street world imploded, customers fled, margins shrank and the staffs worried. They firms decided not to wed yet but, in modern tradition, to live together. A had empty offices, and B and his professional group moved in. B agreed to outsource his back-office operations to A. Two of B’s support people then were hired by A; the other two were let go. Both are operating profitably in snug quarters.

2. Car wash

This well-capitalized operation, still in startup mode, features a state-of-the-art, highly automated, inviting facility requiring very little labor in a good location. It had agreements with nearby auto dealers to wash every car they sell or service for a lower price than the dealer could. That was its primary customer base. On top of that, service directly to consumers added the cream. As unemployment rose, consumer car washing vanished. Volume from dealers plummeted. The company reduced all prices 50%, and business returned quickly to positive cash flow. Says the GM: “We’re going for the fast nickel instead of the slow dime.”

3. Auto dealer

In 2000 the owner of this business told me, “General Motors and Chrysler will never make it, and Ford is a long shot.” He had come to this conclusion in 1990, when he owned three American dealerships. From 1990 to 2005, he added six more stores featuring Asian or European brands.

The firm is operating profitably, but every month is a squeaker. New car sales have been a loss leader for more than two years. Service work is profitable and parts are about break-even. Used car sales and extra traffic owing to strong web marketing produce the profit.

The disappearance of financing for buyers created great difficulty. Loss or reduction of financing help from the factories has raised inventory costs. Advertising and sales staff have been slashed. The skilled non-family executives, led by a third-generation nephew, have been creative in generating sales and in cost reductions. Two American brand stores are expected to close eventually. The remainder are expected to be back to robust health by 2012.

4. Heavy and highway construction

This company moves earth, prepares building sites and constructs airports, highways, office parks and factories. The owners are used to seasonal work, demanding project schedules and equipment-intensive crews. They understand the value of planning.

For this firm, planning is paying off. The company has had heavy reverses in the current climate. Business in its home market in 2008 declined from the volume in 2007. A big drop in new orders for 2009 gave early warning. The company began to prepare for a tough 2009-10. A sister division (similar business) in a fast-developing area in a neighboring state was hard hit in 2008 and closed abruptly.

The company is well financed. Much of its heavy equipment is rented rather than owned. Most of the premium paid for rentals can be recovered in good times if purchase options are exercised. Thanks to a third unit that provides industrial maintenance and plant repairs, the company is cash-flow-positive; a low-profit year is the worst scenario.

5. Developer

This third-generation firm, working in the suburbs and exurbs of a major metro area, had three live developments in its pipeline in late 2007 when red flags began to fly on condo markets. One was about 90% sold; a second was under way with the third of six 36-unit, three-story buildings complete; and site preparation was in progress for another development.

The company’s local banks disappeared to merger or failure, and Wachovia emerged as an aggressive lender to the business. The firm went wild with ambitious plans in 2008 despite growing signs of trouble all around. Early in 2009 Wachovia (North Carolina) disappeared into Wells Fargo (California). A month later, the bank seized the family company’s cash. Days after that, the company filed for bankruptcy protection. It’s a 50:50 bet that its Chapter 11 (reorganization) will convert to chapter 7 (liquidation). Management errors cannot be ignored. The bank looked out for its own interests, but the firm was already weak before the bank took action.

6. Ethnic food supplier

A couple, immigrants from India, launched a business six years ago. The wife and a kitchen crew prepare delicious Indian specialties that they sell in a retail shop in the same building. The husband and another crew handle catering and sell these and other products at a farmer’s market stall in an upscale neighborhood. Their older daughter, age 12, works in the business after school and loves it. Their bootstrap financing, supported by a home equity line, was sufficient until rising unemployment in the area reduced catering and retail sales. Their income for now is whatever is left after expenses. They are smart and committed and likely to succeed as the economy improves.

7. Industrial distributor

This firm, with a huge central warehouse and nine branches, needs lots of capital for inventory and receivables. It sells equipment and supplies to commercial and industrial accounts (40%), direct retail to consumers (10%) and to contractors (50%). Banks were lending 60% to 80% against receivables and inventory to customers with long relationships and good records. This family was at 80%. After Lehman Brothers and Bear Stearns went bust, the bank proposal for 2009 was for 50%.

Through October and November 2008 the young second-generation owners weeded out 10% of the customers considered unacceptable risks by a tighter standard. A dozen of the 200 employees were discharged; 50 more had their hours reduced. Less expensive benefits were arranged. The company reduced inventory and instead pays premiums for overnight freight when a high-cost item is needed quickly. Suppliers were also cutting credit terms, and the second-generation management team negotiated extended terms for specific jobs in which the factories had a special interest.

Armed with these results, the second-generation members went back to the bank. The lenders were impressed with these actions as well as the firm’s readily available detailed information and proposed reporting system. The leaders’ deep knowledge of customers’ finances (especially contractors’) and long history of attention to credit and collections (including documenting the liens on construction jobs) led the bank to agree to 75%.

The company’s current strategy is to run a tight ship and watch for opportunities to develop as weaker competitors struggle.

8. Materials producer

This 75-year-old provider of stone, sand, blocks, cement and allied products operates over a five-state area. The business is seasonal. Production employees, many of whom are long-tenured, usually have some weeks on layoff and quite a few on overtime. The company is very conservatively managed, with consistent attention to many operating, financial and safety concerns.

During early 2009, volume was down. A few failures among smaller customers produced accounts-receivable losses, and more staffers than usual were on layoff. In an effort to avoid still more layoffs, production crews spent a lot of time on maintenance and cleanup in late 2008. The company’s facilities now look splendid.

With a strong balance sheet, a profitable history, and a competent third-generation group teamed with excellent non-family executives, this firm has no serious problems and is on the hunt for acquisitions.

9. Body shop

In 2006 the owners of this business concluded that the future belonged to industry players who were modern, high-tech, well regarded by auto insurance companies, and well managed. By 2008 the business had moved into a brand-new, state-of-the-art facility. The highly experienced and motivated manager was performing well, and business was growing. The business is still profitable, though profits declined as economic activity lessened.

A key to its continued profitability is the fact that it invested plenty of capital in the remodeling, with terms on the long-term debt that left room to breathe during the economic decline. As struggling competitors collapse, this business will grow.

10. Professional design and installation services

This 25-year-old, award-winning firm with a national reputation operates in a ten-state area. Managed by professionals and highly seasonal in nature, it struggles continuously. The addition of an excellent controller a year ago has helped a lot, but the root problem is undercapitalization. Every hiccough leads to a mini-crisis.

The firm’s founder—the lender of last resort—personally guarantees bank financing for the company. In 2004 a term loan was negotiated. That extra capital was a huge help, and the business grew. Some benefit was lost because the design and project work and marketing efforts led to further neglect of the management function. Loyal, repeat clients provide excellent future prospects, and staff turnover is lower than normal in the industry.

Term loan payments to the bank have been sent on time, and the relationship is good. However, the firm does not qualify for more money or a renewal of its loan. Other banks have declined to lend. Before the arrival of the new controller, a pattern had developed. The company would issue checks without sufficient funds. The bank would pay these overdrafts and charge $25 per check. Within a couple of weeks money could be deposited to cover.

When the new controller arrived he surveyed the situation. He went to the bank and confirmed that the branch manager supported the firm. He also made a professional presentation for more money, but the higher division office refused the loan. So he negotiated a lower overdraft fee. This has continued for months. I’ve labeled this “the don’t ask, don’t tell financing approach.”

The bottom line

If your firm is undercapitalized, undermanaged or highly leveraged, you’re in mortal danger this year of falling into trouble that could wreck the firm.

If you are well capitalized, have strong planning and controls in use and are leveraged conservatively, this is a time of great opportunity.

If you’re between these two extremes, 2009-10 will be difficult and tense.

There’s a silver lining in these clouds. Older family firm owners and veteran advisers have long worried because younger owner-managers lacked the experience of running things during a severe economic downturn. Now the younger generation is getting all they need. That’ll do it for the next four decades!

James E. Barrett ( heads the family business practice of Cresheim Inc. in Philadelphia.


Panel: Cost reduction must be sustainable

In a program on managing privately held businesses through the downturn, held on March 25 in New York, a panel of advisers from PricewaterhouseCoopers noted that cost reductions must be made with business sustainability in mind.

“There’s clearly a reduced appetite right now for investing in capital expenditures,” said David Zimmerman, the firm’s Private Company Services tax leader for the New York metro area. “[But] the fact remains that if you’re going to come out of this even stronger, there is a recognition that you’re going to need to continue to invest in research and development.”

Zimmerman said companies are implementing tax strategies to enhance their liquidity. “They’re looking for something that they can do today that will immediately enhance their liquidity by reducing the current tax liability or creating opportunities for refunds,” he said. “You’re seeing tax strategies and tax savings right now, not only at the federal level but also on the state level.” Such strategies include taking advantage of incentives for creating or retaining jobs as well as seeking reductions in property tax assessments and state taxes, he said.

Companies are searching for ways to bring cash into the business quickly, noted Dave Pittman, a partner and national leader for sustainable cost reduction at PwC. A way to conserve cash, he said, is to eliminate the need for spending where possible. He also suggested reducing the number of employees with authority to spend money.

For highly leveraged companies, there is little benefit in attempting to get customers to pay more quickly, Pittman noted. “[If] I’m already leveraged 85 cents on the dollar, to reduce the receivables doesn’t really help me, because I only get 15 cents,” he explained. A better strategy, he suggested, is to go after past-due receivables. “Banks don’t lend on receivables past due 60 days,” he pointed out.

Companies reducing inventory must do so with caution, Pitt-man said. “If I don’t have that inventory, my customer service can suffer,” he said.

Alterations in the business model could result in cost reduction, Pittman advised. When times were good, companies may have added brands or models that “created a lot of complexity in the organization, which is driving a lot of costs,” he said.

Many companies are learning from the cost-cutting mistakes they made during the last recession, Pittman noted. “As soon as the cycle turned, within a couple years, those costs came back,” he said. Today, business leaders are seeking management information that sheds light not only on profit-and-loss figures, but also on the factors that are driving the costs, Pittman said. Rather than creating an annual budget by simply adding or subtracting 2% or 3% from last year’s figures, executives are asking, “What should I have spent?”

Seeking sustainable savings requires a cultural change in the organization, Pittman acknowledged. Communication and accountability are essential, he said.

—Barbara Spector

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Protecting and preserving your business for the future

Building a successful business takes dedication and a lot of hard work. Like anything of value, your company must be protected—not only against risks such as fire or theft, but also against less tangible hazards, like the loss of an owner or a key employee.

Let’s face it: At some point in the life cycle of every business, an owner or key employee will die, become disabled or simply decide to retire. Unfortunately, many business owners don’t take the time to plan for how their business will be run —or liquidated—following such an event. Yet without this kind of planning, generally known as “buy/sell” planning, even successful companies face the threat of failure.

Planning for the sale or transfer of a business or business interest (shares) should begin as soon as possible—while the business is thriving and the owners are healthy. Such planning should include a buy/sell agreement, which spells out the process by which the business or shares will be transferred following a “trigger” event—usually the death, disability or retirement of an owner.

A properly structured (and funded) buy/sell agreement can help answer these questions.

• How will the transfer be funded? Will the money come from the owners themselves, or will the business fund the arrangement?

• What kind of event will trigger the sale—death, disability, retirement or all three?

• Who will actually buy the business interest, the shareholders or the business itself?

Most buy/sell agreements are either redemption plans, in which the business agrees to purchase an owner/shareholder’s interest in the business, or cross-purchase plans, in which the business interest is purchased by the other owners. Each type has advantages and disadvantages. But in many cases, neither arrangement fully meets the owners’ expectations or objectives. Tax issues, administrative headaches, funding inequities, multiple insurance policies—to name just a few impediments—can take much of the luster out of both types of buy/sell agreements. That’s where a general partnership plan can help. Under a general partnership arrangement, the benefits of both stock redemption and cross-purchase plans can be made available, without the drawbacks associated with either method.

A general partnership plan

As an entity, the general partnership can be used to purchase life insurance policies for the business owners. Each owner becomes a general partner, and one policy is purchased on the life of each partner. Each partner enters into an agreement that obligates the partnership to purchase his or her interest following one of the usual trigger events. Each partner also enters into a buy/sell agreement pertaining to the primary business. Funding for the insurance premiums can come either from the owners’ personal resources or from the primary business corporation itself.

Since each of the policies is owned by the general partnership, the owners would contribute cash (personal or company-provided) to the partnership as a capital contribution. The partnership would use the cash to pay the premiums. The general partnership structure allows the partners the flexibility to allocate items of income, profit, gain and loss among themselves in a manner that meets their business objectives. This allows the partners to equalize cost and fairly distribute life insurance proceeds.

After the death of a partner, the life insurance proceeds from the policy covering that partner would flow into the partnership and be allocated to the surviving partners. The partnership would use a portion of the proceeds to purchase the deceased partner’s interest in the partnership. The balance of the proceeds would be distributed to the remaining partners. The surviving partners would then use those proceeds to purchase the deceased partner’s interest in the primary business. If a cross-purchase buy/sell agreement is used, the partners can purchase the deceased’s shares directly. If a redemption buy/sell agreement is used, the partners can contribute or lend their insurance proceeds to the business so that the business can redeem the shares.

Using a general partnership to manage a buy/sell agreement can also be advantageous upon an owner’s retirement or disability. The partnership can distribute the disabled or retired owner’s life insurance policy to that partner in exchange for his or her interest in the partnership. The departing owner would assume ownership of his or her policy free from any income tax liability by taking the policy with a cash value equal to the partner’s basis in the partnership immediately before the distribution. Overfunding of the life insurance policy (or policies), a common strategy, would allow the remaining owners to access a portion of the policy’s cash value (prior to distribution) to help them fulfill their obligation to purchase the departing shareholder’s interest in the business.

Could a general partnership be right for you?

There are many advantages to using a buy/sell agreement to transfer a deceased, disabled or retiring partner’s share of a business to the remaining owners. But unfortunately, the traditional methods don’t always work in the best interests of the business or business owner. Using a general partnership to manage your buy/sell planning could help mitigate the disadvantages presented by redemption and cross--purchase plans.

The general partnership approach:

• Requires only one life insurance policy per owner.

• Avoids the corporate alternative minimum tax.

• Minimizes, through special allocations, inequities among partners in the cost of insurance coverage.

• Provides a full-basis increase to the surviving partners after a partner’s death.

• Allows the surviving partners to distribute the insurance proceeds to themselves, generally free of income taxes, in order to accomplish the business buy-out.

• Permits the transfer of the policy insuring a departing partner to that partner without recognition of any policy gain, and without raising any “transfer for value” concerns.

As a planning vehicle, a general partnership combines the benefits of both redemption and cross-purchase plans—as well as additional benefits that are not present in either type of plan—while avoiding the disadvantages inherent in both. Such a partnership administration success strategy could be the way for you and your partners to meet your business objectives.

Alan Meckler ( is a partner in Cornerstone Financial Group, based in Succasunna, N.J., which specializes in insurance and investment planning for family-owned and privately held businesses. He is a registered representative of Hornor, Townsend & Kent Inc.

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Keeping the wolf from your door

If your family business has never hit a low point, consider yourself lucky. And if your profits have done nothing but grow since day one, make that extremely lucky. Even so, you're apt to find yourself in financial difficulties at some point, for any of several reasons. For instance, you may misjudge the market, hit an economic downturn or simply have insufficient capital.

Some families in business are able to work through the hard times, while others aren't as lucky. A number of factors may contribute to failure, according to Gary Brooks, chairman of Allomet Partners Ltd., a risk assessment and crisis intervention firm in New York. Some business owners may throw in the towel because they lack extra resources, are unwilling to expose the family to additional risk or simply lack management skills. Others are overly optimistic and remain in denial until the company is forced to go out of business. In difficult times family members may fight and blame each other. And in extreme cases—often involving dysfunctional families with a long history of jealousy and animosity—family members can end up suing each other.

Then there are the families who pull together during times of financial struggle. The Shaws, owners of the Coffee Beanery chain, based in Flushing, Mich., and the Pomerleaus, who own Augusta, Maine-based NRF Distributors, are two families who experienced a major business setback, were determined to meet the challenge and ultimately were able to evade the wolf at their door. Their stories serve as a primer on avoiding financial stumbling blocks.

Too many commitments

The Coffee Beanery got its start in the mid-1970s, when coffee drinkers shifted loyalties from freeze-dried (instant) coffee to freshly brewed. The company found itself at the forefront of a trend. Over the next 15 years, it expanded to 25 stores in five states. JoAnne Shaw, 60, serves as CEO; her husband, Julius, 67, is chairman of the board. Their two sons are vice presidents. Kurt, 42, is in charge of franchise development. Kevin, 40, is head of the real estate division.

In 1985, riding a wave of success, the company began franchising its stores. In 1998, the first international Coffee Beanery location opened. The Shaws also have a few wholesale accounts and a small office coffee business.

In the 1990s, the Coffee Beanery's corporate-owned stores were becoming a headache. JoAnne Shaw freely admits that trying to oversee 25 stores in a five-state area was a stretch. “We were simply not good at managing that many,” she says.

In 1995, the Shaws faced another problem. You might think it was competition from the publicly owned, ubiquitous Starbucks chain, but that wasn't the matter. The Coffee Beanery had committed to mall leases for about 60 franchisees and had helped with financing when necessary—a big mistake, JoAnne says. When their franchisees experienced problems, some tried to increase sales and work their way out, but a number went bankrupt or just walked out and left the Shaws holding the lease.

Between being burdened with leases and overloaded with corporate stores, the company had amassed liabilities that far exceeded what was reasonable. To remedy their situation, the Shaws negotiated with their mall landlords and sought advice from Ernst & Young, the firm that does their yearly audits.

When the family realized they were in trouble, they adjusted their plans to focus on one goal: improving their balance sheet. They stopped guaranteeing ten-year leases and, when possible, transferred leases to franchisees as they came up for renewal. Ernst & Young advised them to take a hard look at their real estate holdings and formulate a plan for paying down debt. That's when they decided to shed some of their corporate stores and tighten up their lease agreements. Still, “it took almost ten years of weathering the storm,” JoAnne says, to achieve the profitability they were after.

When anyone asked how business was during this time, JoAnne recalls, she painted a rosy picture. “Business is great,” she would say. “We have 40 stores in development. Our current franchises are expanding, and we have a lot of interest internationally.” She firmly believed there was a way out and projected that confidence.

Not all family businesses are so focused, notes Ernest A. Doud Jr. of Doud Hausner & Associates, family business advisers in Glendale, Calif. In Doud's experience, when money problems hit, family members often let their ego get in the way of taking action. “An important part of family business success is the ability of family members to put family and business purpose ahead of personal power and pride,” Doud says. “That is certainly true when money problems hit. It will be more difficult to correct the problems if individuals are more intent on protecting their positions than on working collaboratively to find solutions.”

Resolving to improve the balance sheet is one thing if you're in over your head, but without the necessary skills to do so, a company may find itself floundering. In many companies, the family member in charge of company finances may have a sales and marketing background and lack the financial acumen to solve a money problem of any magnitude, Doud says. Ideally, a family member or non-family manager should have a core competency in finance, the consultant says, but barring that, the family should be willing to ask for help from an outside source, as the Shaws did. The Coffee Beanery also has a chief financial officer who helps manage the relationship with the banks and with Ernst & Young, and Julius Shaw oversees the company's finances, checking to ensure that they don't make mistakes like double-paying bills. When the company was in trouble, Ernst & Young served as outside observers who provided an impartial view of the situation.

After a faltering family company agrees to work on finances and determines a strategy comes the hard part—actually facing the people banging on the door. “In the short term, you've got to buy yourself time with your creditors,” Doud advises. “Don't alienate good suppliers; work to get their forbearance.” On the other hand, you don't want to tell them too much about your troubles. “If it's bad enough that you need to seek relief,” Doud says, “go to your trade creditors first and ask them if they can extend your book. It's more powerful if you can also say, ‘These are the steps we're taking to correct the problem.'”

It's best to be open and honest with everyone you deal with, says JoAnne Shaw. “Make your suppliers your partners in working through the problems; don't go it alone,” she says. The Coffee Beanery's long-standing relationships with suppliers counted for a lot during the company's rough period, she notes. The Shaws asked some creditors for an extra 30 days and were never refused.

While they were putting on a happy face for their creditors and competitors, the Shaw family was bolstering each other. “Our whole family is very committed to the business, so we were all involved in the plan to work through the problem and were encouraging each other to do whatever it would take” to get back on track, JoAnne says.

By 2004, the Coffee Beanery had closed or franchised all but four stores, which are now used as R&D units and as training sites for franchise owners. Franchising now accounts for 97% of the Shaws' business. JoAnne Shaw declines to disclose the company's annual revenues but says they run in the multimillions.

A bank asserts its power

In the mid-1980s, while the Michigan-based Coffee Beanery was beginning to franchise its stores, NRF Distributors in Maine was filing for Chapter 11 bankruptcy protection. This 30-year-old family-owned flooring company was on the verge of insolvency in 1986 after the Bank of New England called in a large loan and lowered the company's borrowing power.

Norman Pomerleau, 71, serves as president of the company, and his three children are vice presidents. James Pomerleau, 49, leads the commercial carpet division, Terry Pomerleau Gray, 42, is in charge of marketing, and Deborah Pomerleau Giordano, 46, runs the wood division, the only department established after the company emerged from the filing. In 2002 Norman's brother Roger joined the business as treasurer and liaison with state and local government.

The early part of the 1980s were flush in New England, as they were everywhere, but then the stock market crashed and the economy took a nosedive. The flooring company was just matching what the mills were doing—extending credit up to $100,000 to their customers—and that's how the business got into trouble, says Terry Gray. “It's like what's happened with consumers and credit cards,” she says. “Our customers got in over their heads with generous credit terms.” The bank dropped a bombshell when it told NRF it wanted the company's operations loan of more than $1 million off the books.

“We didn't want to file [for bankruptcy], and we tried to stretch our cash, but we had no choice,” Terry recalls. Although the Pomerleaus kept mum beforehand when anyone asked how business was, in a rather remarkable action, the company alerted suppliers before the bankruptcy filing and canceled all incoming orders. “Our lawyers told us to keep quiet,” Terry says, “but ethically, we felt we had to tell people.” The company was due to file on a Monday. On the Friday before, employees called the vendors and canceled the trucks that were ready to leave for the NRF warehouse.

NRF paid dearly when the news hit. “People told us it was almost impossible to get out of a Chapter 11,” Terry says. “A huge part of our business is sample costs, and in the past, our vendors would help us with financing. When we were trying to get back on our feet, these costs tripled.” The family begged vendors to sell to them, Terry remembers. No one would let them make COD purchases.

And so they started on the long road to recovery.“Our vendors set up a committee to oversee our business, and they helped us finally get out of Chapter 11,” Terry says. “We cut a deal with them, paying 35 to 37 cents on the dollar. We had to build our inventory back up and prove we would survive. It took two to three years.” Yet there were bright spots, she notes. For example, although the family feared they would lose salespeople, the staff remained loyal. Terry attributes that largely to her father's reputation. In addition, employees knew the company had identified the problems and was working toward fixing them. “They had confidence in us,” she says.

Blame and infighting were never an issue, according to Terry. At the time, her grandfather Frank (now retired) and uncle Roger owned a furniture business that sold NRF's products, and Terry recalls her father being embarrassed to tell them about the filing. But Roger and Frank were able to look past the problem, she says. “We were going to help each other through this no matter what,” she explains. “It's always been that way.”

It helps to understand how she grew up. When other families sat around and talked football on Sundays, the Pomerleaus discussed sales. When she asked to borrow the car at 16, Terry relates, her father told her to start to work in the business. “I'm glad he did,” she says now. Another motivating factor in the Pomerleaus' recovery was the family's commitment to the community, Terry says. “It's a small town,” she says. “Our main concern was keeping people employed.”

The experience taught the Pomerleaus not to overextend credit, even in flush times, Terry says. They owned up to their responsibility for what happened to them, she reflects: “It was partly our fault.” Today, she notes, the company's finance and credit departments are much more stringent about terms. Her advice to other businesses in the same boat: In addition to watching out for credit limits, try to obtain personal guarantees.

Terry says NRF has tripled its business since the bankruptcy. Like the Coffee Beanery, NRF will not disclose its revenues; the family will say only that the company enjoys multimillion-dollar sales. The company reports that it's the ninth-largest flooring distributor in the U.S., selling to 3,000 retail stores in eight states in the Northeast; 1,800 of its accounts are currently active. At least 100 dealers are “aligned” with the company, which means that they buy 80% of their stock from NRF. One indicator of the company's level of growth after emerging from Chapter 11: NRF had 25 trucks in the mid-'80s; today, the company has a fleet of 66.

NRF also has a Mannington division—devoted to this national company's vinyl, wood and ceramic flooring—and a supplies division, which includes sundries and ceramics. The company represents 15 ceramic tile vendors. And its full-service graphics department supports its in-house merchandising needs as well as its customers'.

The family doesn't worry about the future, according to Terry. “We have a much better handle on things today,” she explains.

Patricia Olsen is a New Jersey writer whose work has appeared in the New York Times, the San Francisco Chronicle magazine, Financial Planning and other publications.

Five tips for handling difficult financial situations Ernest A. Doud Jr. of Doud Hausner & Associates, family business advisers in Glendale, Calif., offers the following suggestions for family companies facing hard times:

1. Don't wait. If you see a declining sales trend, for instance, jump on it quickly. Numbers can be a good trigger for investigating the whys and wherefores. But don't whip the sales force; it's obvious that what you're doing isn't working, so more of the same isn't likely to fare any better.

2. If your company is small, look into short-term financial help. Your accountant can certainly be an asset, but consider engaging a chief financial officer through a temporary agency. You need someone with an analyst's eye to decipher financial statements.

3. Institute stronger reporting systems to catch any future problems early. Most problems don't crop up overnight, so you need an effective early-warning system.

4. Focus on identifying causes and thinking creatively about solutions rather than pointing fingers. Aggression breeds aggression, and playing the blame game takes energy away from problem solving.

5. Find out what help your vendors can provide. If you have had a good history with vendors and you have a viable recovery plan, chances are they will work with you to temporarily extend payment terms to secure your patronage over the long haul.

— P.O.

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Safeguard your company against embezzlement

An ebony-framed pen-and-ink sketch of the Cincinnati skyline hangs in the spacious office of Susan Morin, second-generation owner of Gorman Supply Inc., a Cincinnati firm that supplies equipment and advertising specialties to the food and beverage industry. The eye-catching artwork serves to remind Morin of an ordeal that nearly destroyed her business. It was a gift, Morin says, from Tami Jordan, a former employee who in 2000 was convicted of felony theft charges and sentenced to prison for embezzling more than $300,000 from Gorman Supply. Morin says she later discovered that Jordan had purchased the drawing with the stolen money. Why does she keep the piece? “Because I paid for it,” she asserts.

Jordan, now in her mid-30s, served 2 1/2 years at the Ohio Reformatory for Women and after her release lived at Talbert House, a Cincinnati halfway house for ex-offenders and recovering addicts. Although Gorman Supply's attorney in 2000 obtained a $308,765 civil court judgment against Jordan and her husband—who was also convicted in the case—Morin says that as of 2004, she had received only about $1,000 in restitution.

“It damn near killed the business, about sent me into bankruptcy,” says Morin angrily. “If it wasn't for my longtime vendors who trust me and know me, then it would be over.”

Unfortunately, cases like Morin's are common. “Family-owned businesses are more vulnerable to embezzlement,” says Detective Steve Beck, a white-collar-crime investigator with the West Chester Township Police in Ohio, the department that handled Morin's case. In family firms, says Beck, “management wants to create a family environment, so they're more trusting.”

The 2004 “Report to the Nation on Occupational Fraud and Abuse,” a study of 508 cases conducted by the Association of Certified Fraud Examiners—a professional association based in Austin, Texas, with more than 100 chapters worldwide—indicates privately held companies are at greater risk of fraud. According to the report, the median loss experienced by small businesses in the study was $98,000—higher than the median loss experienced by all but the very largest organizations. “Small businesses are less likely to be able to survive such losses and should better protect themselves from fraud,” the report says.

Among the victim organizations examined in the study, the median recovery was only 20% of the original loss. Almost 40% of the defrauded organizations recovered nothing at all. “The most cost-effective way to deal with fraud is to prevent it,” the report notes. Unfortunately, Morin and her family learned this lesson too late.

Morin's father started Gorman Supply Inc. in a spare bedroom in 1972, after being laid off at age 56 from his job as operations manager for a major soft-drink bottler. At the urging of his wife, he started the company with no money down. “He knew a lot about the industry,” Morin says, “so he went to companies in Ohio, Kentucky and Indiana to find manufacturers for products he could sell—many of whom remain vendors even today.” He started out by selling coolers, waste receptacles, dispensers and other equipment. Business in the early years came from people with whom he'd established relationships at his former position. His customer base grew quickly. Within two years, the business had outgrown the extra bedroom.

When he retired in 1989 at age 74, Morin's father passed the reins to Susan and her sister Mary-Jane. They worked as partners until 1996, when Mary-Jane decided to sell her portion of the business to pursue other things. It was during this time that Tami Jordan was hired as a bookkeeper. But, Morin notes, her voice rising a few octaves, “We paid a national accounting temp service thousands of dollars to get an employee, and background checks are not included in their fees.”

The family selected Jordan because she had bookkeeping experience and was friendly and personable, Morin says. She adds that she considered the bookkeeper a close friend. “I had been invited to her mother's birthday party,” Morin recalls, “and she had attended parties at my home.”

When Jordan was hired, the company was experiencing steady growth with about $1 million in annual sales. The five full-time employees received benefits like profit sharing, a retirement package and generous medical insurance, an unusually comprehensive package for a business the size of Gorman Supply.

In late 1997, Morin says, she noticed a drop in cash flow but thought it was due to the recent loss of a major account. She also remembers noticing several details that investigators say are often warning signs of business fraud. Jordan, who paid the company bills and managed the books, began to work long hours. She was meticulous with her bookkeeping and pointed out a few vendor billing errors. But she guarded the books from anyone else's view, Morin recalls.

Meanwhile, Jordan was purchasing a luxury SUV, jewelry and vacations, according to court records. Although Morin thought it was unusual at the time, she did not connect her lack of cash flow to Jordan's lavish new lifestyle, she says.

When the cash flow problem did not improve although sales had risen, Morin says, she knew something was wrong. “I thought, I can't work any harder; what's going on?” she recalls. “I had two CPAs called in to find out what was going on. I was losing money, and that had never happened.”

The investigation revealed that Jordan had been writing checks to her relatives and creatively managing the books to hide the fraud, Morin says. Jordan had also managed to cash a cashier's check from the company bank account although she wasn't a cosigner, according to Morin.

By the time the police got involved with the investigation, the company Morin's parents had worked so hard to build was on the verge of bankruptcy. Morin says she had to lay off five full-time employees as a result of her financial losses due to the embezzlement. Morin remembers feeling shocked and devastated. “I just never thought [Jordan] would do that,” Morin says. “I thought of her as family.”

Five years after her business nearly went belly-up, Morin is proud to have weathered the storm, although she acknowledges that even now, “every day is a struggle.” Hard work and strategic planning have allowed her to put the business back in the black; she has increased sales and landed several major new contracts. At the moment, the only employees are Morin herself and her daughter Carolyn, 26. When she's ready to hire again, Morin says, she plans to take measures to prevent fraud.

Ron Evans, a CPA with John F. Dickey & Co. in Fairfield, Ohio, explains that there are generally two types of embezzlers. “One is professional; the other is someone who has pressure from a need like gambling, drinking, drugs or income loss, and they need cash quickly,” says Evans, who has pursued several embezzlement cases in small businesses. “Most of the time when fraud starts, it's someone who's short of cash at a particular time and they intend to pay it back—and sometimes they do. They then notice that no one missed the money, and that's why they do it again.”

Embezzlers often engage in “lapping,” or juggling the books to cover up fraud, Evans says. Eventually the fraud gets written off as bad debt. That's when accounts receivable start creeping over 45 days, Evans points out. He urges owners to review their adjusted journal entries. If someone is stealing cash, he notes, the person will make a journal adjustment to cover it up.

Evans also recommends that business owners be on the lookout for fake companies. “It's easy for a thief to create a company using basic software,” he notes. “They then send out invoices, which can easily get paid if you don't pay close attention to your accounts. If you're sending checks to a P.O. box address, call to make sure it's connected to a real company.”

He advises against the use of company credit cards, which can be abused. “Have employees use their own card and submit a detailed receipt for reimbursement,” Evans suggests. “If you must have cards, don't let the person using the cards receive the billing statement, and verify every item and amount that appears on the card statement.”

What if you suspect that a family member is committing fraud? Evans recommends engaging a forensic accountant, “who can dig in and find the problem.” It's best to have concrete evidence before confronting the relative, “if you want to keep peace in the family,” Evans says.

Evans says the best advice for business owners is to purchase bond insurance, which will provide reimbursement for an amount stolen from the business. “It's reasonably priced,” he says, “but most small businesses don't bother because they feel it's not necessary.”

In the privately held companies examined in the Association of Certified Fraud Examiners study, more than one-third of the fraud cases were detected accidentally. According to the report, this finding suggests that “private organizations are missing an opportunity to reduce costs by proactively seeking out occupational fraud.”

Experts say a business owner's best route to recovering money from an embezzler is to hire a private detective who can uncover hidden assets the thief might have, and then to sue the person in civil court. But like many legal battles, that can be a long and tedious process—“and if the person decides to file bankruptcy you'll likely be stuck with a lot of legal fees,” says Evans.

Although Jordan was convicted in criminal court, Morin says she has spent more than $12,000 on private detective and attorney fees to build a civil case—but it's unlikely she'll recover her money. “I think it's outrageous that you can have a judgment against someone and they don't have to pay,” she says.

Morin says that despite the nightmare she endured, she remains “a trusting, giving person,” although she adds, “I'm more conscious of things than I was before.” She serves on the board of her local Chamber of Commerce and says she helps other small businesses grow by steering work to them whenever possible.

“The people who stole from me are not going to win,” Morin says. “Am I going to continue with this business? Do I love it? Yes, of course I do.”

Angela Black is a freelance writer based in Cincinnati.

Ten fraud prevention tips Detective Steve Beck, a white-collar-crime investigator with Ohio's West Chester Township Police, and Ron Evans, a CPA with John F. Dickey & Co. in Fairfield, Ohio, suggest the following measures to protect yourself from falling victim to an embezzlement scheme:

1. Check your business credit report annually to make sure no unauthorized person has taken out a credit card in your company's name.

2. Establish a personal relationship with your banker and make sure you understand the bank's procedures for handling your money. Be aware of the bank's process and regulations for handling your business account. Ask questions.

3. Require two signatures on checks exceeding a predetermined amount.

4. Ensure that your business bank statement is sent to your home or to the company accountant before it's passed along to the bookkeeper.

5. Keep good records of check numbers, and always reconcile your checking account immediately. Find out how your checks will be processed under the new “Check 21” law. It's good to be able to view digital check copies online, but it's preferable to actually see the checks, even if you have to specially request them from your bank. The bank may charge a fee, but it's worth it.

6. Purchase bonding insurance and have background checks performed on any of your employees who handle funds.

7. Use a payroll service, which can help prevent theft of payroll tax funds. By the time such a theft is discovered, you're likely to be in trouble with the IRS for non-payment of taxes.

8. Review your journal entries monthly and go over any adjustments with the person who made them.

9. Call all new vendors, introduce yourself and get to know them. This not only is a mark of a good business relationship but also will enable you to immediately identify a fake business.

10. Pay attention to an increase in bad debt or aging accounts receivable. If customers who always pay on time or early suddenly stop, find out why.


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Poisoning the kids

The two-man crew arriving at my home to install a heavy washer-dryer combination unit in our second-floor laundry knew they'd need an extra hand at a couple of lifts and turns. So they recruited a store salesman, Joe, to stop in and help. I commented to Joe that he looked familiar. Had he been the one who'd sold me the units I was now replacing when I bought them 15 years ago? No. He'd been working for another family-owned retail appliance store then. That store went out of business about eight years ago. Two years before that company failed, he left to join this one.

I asked if his former employer had been knocked out by one of the big-box national chain stores. No, he told me sadly. The owner, Mike, did himself in.

The store was in dire need of renovation, but the money that should have gone to an overhaul went instead to Mike's wife for a new kitchen. The service department should have been strengthened, but the cash was allocated for an addition to Mike's weekend home. The needed replacement for the delivery truck lost out to country day school tuition for Mike's kids.

“We used to try to explain to Mike that you have to keep reinvesting in your business,” Joe lamented. “But he just told us that the owner is entitled to a good lifestyle. We needed extra help on Friday and Saturday, but Mike left Thursday nights to go to his weekend house. Gradually the two delivery trucks became one, and it wasn't needed every day. I knew it was time to leave.”

The family business Joe now works for supports three third-generation employee-owner families, plus a sizable staff of non-family employees. The company competes vigorously and well in the marketplace. “They run it like a business, not a private piggy bank,” Joe commented.

The need for counter-pressure

Among the hundreds of thousands of family-owned businesses, a majority are subject to the stresses that Mike experienced. The controlling owner has sole authority to balance the financial needs of the business with his or her personal standard of living.

In another large segment of family firms, this issue creates some immediate pressure. In those companies, two or more siblings or cousins are active in the business. For them, disaster can strike if the family settles a difference of opinion by distributing money to each of the owners for personal needs. If this goes on too often, they'll eventually have to borrow to get the needed cash. Then the bank will insist on installing controls as a provision of the loan agreements.

Large numbers of businesses suffer each year because the owner lacks the self-discipline to control personal spending. Many others simply have weak financial functions with no annual review of how much needs to be invested to expand, modernize or remain at the cutting edge.

For successor generations, these two failures mean the offspring will acquire bad habits. If you've grown up watching your parents use the business as an ATM, you are more likely to do the same thing and never realize that you're starving the business. You're also more likely to tolerate bad financial practices that are the despair of bankers and advisers.

For the third generation, a steady diet of generous entitlements can be disastrous. A wise attorney told me some observations he made while visiting the Florida home of a northern client. Across the Intercoastal Waterway, they could see the home of the client's 28-year-old daughter. Her mortgage-free million-dollar home had a 38-foot boat at the dock. On a weekday afternoon, she was enjoying a swim in her pool. “They have everything,” the lawyer commented. “They have nothing to look forward to.”

Her parents did not understand that, with the best intentions, they were administering entitlement poison to her and to their grandchildren. The drive to achieve and the discipline necessary to manage risk and avoid failure gradually atrophy. Never having had to deny themselves anything or live paycheck to paycheck, the younger generation loses touch with that shared reality popularly called common sense. Eventually they can become worthless as managers and incompetent as owners. They're lost in their own world, but employees like Joe the appliance salesman can see how it all will end.

James E. Barrett ( heads the family business practice of Cresheim Inc. in Philadelphia.

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Is your controller out of control?

Is the current financial control of your business giving you a false sense of security? Are family relations unnecessarily complicating the financial aspects of your business?

Combining family dynamics with business affairs can lead to trouble. All too often, turnaround specialists who work with family companies find that the business owner has interpreted the controller's responsibilities in a way not found in any management or accounting textbook.

In some cases, the owner or other family members see the controller as the keeper of their personal checkbook. In other companies, the controller doesn't want to disappoint the owner, so he or she tries to make poor business results look good. And then there are the family business owners whose financial knowledge is so weak that the controller can—intentionally or unintentionally—get away with inaccurate reporting.

When turnaround specialists or lenders try to uncover the problem, they generally have trouble getting the family's equity players to place all their cards face up on the table. Family business owners are notoriously reluctant to let outsiders know about their financial matters—much less their dirty laundry.

Here are some commonly encountered scenarios:

1. Back off: “It's my company and my checkbook.”

2. Lucky gene pool: “Who else can you trust?”

3. Undersized: “Just give my accountant the shoeboxes.”

4. Survivor: “They have been here since Day One.”

5. Defector: “They must be good; they used to work for my accountant.“

6. Teflon owner: “They don't have a clue what it takes to run this business.”

7. Big league: “They got tired of working for the big corporation.”

8. Tag team: “If one is good, two are better.”

9. Jumping ship: “I knew they were the problem.”

Let's take a closer look.

Back off. There is no question about who is in control here. This family business owner tries to do it all, including keeping the books. No one else is trusted with the company's financial information—sometimes not even the outside accountant.

Under this style of control, lenders are way down the food chain. Typically, calls from a lender are put off, or they are not returned at all. It is a case of “my way or the highway,” even if “my way” involves going off the edge of a cliff.

Lucky gene pool. This family business owner often shrugs off financial control by saying, “I don't have time for that stuff.” Such owners cite numerous examples of why they can trust only their spouse, son or daughter. This family controller's education or outside experience usually does not qualify him or her for the position.

Sometimes the son or daughter fresh out of school with no outside experience is given the job of controller. If the son or daughter attempts to improve financial controls in the company, he or she risks straining relations with the parent running the business, at home as well as in the office. Unfortunately, members of the lucky gene pool can sometimes be swayed by the promise of another perk from Dad or Mom.

Undersized. Family businesses often grow their financial control titles faster than the knowledge or experience of the person in the job merits. When family businesses experience rapid growth, business systems and manager skill sets often lag behind.

At one client's company, the controller was asked for a cash-flow report and responded, “What's that?” At another company, the vice president of finance wrote payroll checks in longhand!

Survivor. Owners often have a non-family confidant in the business. Typically, this employee joined the company shortly after the business got going. The confidant has been there through the ups and downs, and the owner has faith in the person: “He pulled me through before.”

The confidant typically has worn many hats. Even when the business is in a crisis, the owner is very reluctant to break this bond. “After all, he is part of the family,” the owner might say. “The banker is used to working with him.” Once again, individuals who fit this profile often have titles and compensation that exceed their capability.

Defector. This scenario arises when a member of the family business's accounting firm has come to know the company. A working relationship develops between the family business owner and the outside accountant. This comfort level leads the family to disclose more information to this person than to other internal or external contacts. As a result, the family hires the accountant as a controller.

Sometimes this situation works out well. Other times, this may be her first move away from public accounting, and she lacks hands-on business experience in costing and other managerial accounting functions. An intervention strategy, coupled with coaching for such a controller, can often yield significant benefits.

Teflon owner. When a family business is in need of a turnaround, it often turns out that the owner does not understand how to read financial reports and act on them. “I give the controller anything she asks for,” the owner says, “and I get back all these reports. What good are they?”

In these situations, problems can arise even if the controller has the right skills and knowledge. The owner washes her hands of any accountability and lets the controller take the heat.

A clear understanding of the owner's specific individual strengths and weaknesses is essential to providing the necessary direction. It's very important to establish clear responsibilities for the owner and the controller, and hold them accountable for their actions.

Big league. In this scenario, the controller came to work for the family business with a wealth of knowledge and experience from her tenure at a major corporation. This type of controller is usually brought on board during a stage of significant growth, when a well-intentioned owner sets out to “professionalize” the business. This situation can sour if the controller has difficulty making the transition to the family company, typically a smaller organization with significantly fewer resources.

Tag team. This structure is often an outgrowth of the “big league” scenario. When the controller from the big corporation is promoted to vice president of finance at the family business, a new controller is hired. This may seem logical, but if this new structure is implemented prematurely, the family business may be unable to carry the added financial burden.

Jumping ship. “How can my controller wind up with such a great job at another company when we have so much to offer?” a genuinely bewildered owner may ask.

What this family business owner fails to understand are the consequences of withholding information from the controller or pushing him into questionable accounting practices. Faced with such a situation, a good controller will look for employment elsewhere, and often lands a better job. The owner often blames the company's problems on the inability of the departing controller. Consultants digging into the root cause would be wise to interview former employees.

Taking action

Successful family businesses may encounter similar scenarios, but they work through them. They succeed because they recognized the problem and corrected it to emerge from a crisis or to avoid the predicament altogether.

All family business owners must ask themselves whether their company's controller is qualified for the position. Good communication and people skills, along with a high degree of technical skill, are crucial to the financial management of a family business.

Other important questions, regardless of the scenario, are: Who is really in control? Who has all the facts and knows how to use them to develop a detailed plan of action for the future? Are family and business issues kept separate?

To help resolve these issues, family councils or advisory boards can be used as forums to educate the family about the power of shared information and proper financial control.

Gerry Murak is a consultant and Turnaround Performance Specialist at Murak & Associates LLC, Williamsville, N.Y. ( He is the author of the forthcoming book Straight Line into the Turn.

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Take a lesson from the Rockefellers

“Fortunes are made through concentration and are kept through diversification,” goes an old family business adage. The Rockefellers made their fortune from Standard Oil and kept it in ventures like Chase Manhattan Bank, Eastern Airlines and McDonnell Douglas. The Pitcairns went from Pittsburgh Plate Glass to real estate, airlines and their family-run Pitcairn Trust Company. The Phippses of U.S. Steel transformed their family office into a financial advisory business.

But how many other family companies actually follow that sage advice? From the Fords to Bill Gates, a brilliant idea has often spawned a vast family empire. As the business passes from the founder to the sibling generation and then to a cousins' coalition, most families have continued to concentrate their wealth in the original family business.

Why is “diversification” such an alien word in many business family circles? To many families it's tantamount to rejecting the family's heritage. Diversification requires sacrificing precious cash flow from the family business to be invested in building other assets. In some cases, it may even require sacrificing a slice of ownership to outsiders in order to free up funds. Business-owning families tend to want to preserve the family business to the detriment of preserving or growing the family wealth. The family business has been the “baby” for many generations. It required so many sacrifices, so many efforts, so many risks to evolve into the family's primary “cash cow.”

But the bottom line is this: The family grows faster than the business does. And succession, liquidity needs of shareholders and wealth return expectations can often prevent the smooth passage of a single business through the generations.

So consider some compelling arguments for spreading the family wealth beyond the family business:

“Stay rich to get rich,” goes another old saying. The stock market slump during the last two years has provided a rude lesson for many families with all their eggs in one basket. Even owners of private companies have seen the value of their businesses diminish commensurately with the decline in public-market value.

Contrary to the false lessons of the high-tech '90s, building family wealth is a long-term process. It requires vision, heritage and long-term strategic investment decisions. Any large fluctuations of value can jeopardize the long-term investment strategy or even the very rationale for investing together as a business-owning family.

The need for steady wealth building is particularly true with multi-generation families whose risk tolerance is relatively limited. Shareholders depend on the family wealth for income and for asset growth. A large decline in the value of family wealth, in or outside the business, can negatively impact inactive shareholders' patient capital, resulting in defections and sometimes, in the worst circumstances, sale of the entire business. Proper diversification and allocation of family assets helps the family build wealth and ultimately control the timing and the price of future value realization.

But where and how should you diversify your assets? Obviously, proper diversification requires judicious investment allocation. Typically, a family would place its “diversification assets” in classes of assets whose value doesn't fluctuate with the value of the business: real estate, say, or private equity, and in some cases public stocks.

If financial considerations were the only reason to diversify, that should be sufficient motivation to run out and do it. But there's another important advantage: Diversification can also help you pass wealth from one generation to another.

One of the greatest impediments to orderly succession is to reconcile goals of active and inactive shareholders. Active shareholders typically feel entitled to market-based salaries and benefits and want to reinvest much of the company's cash flow to expand the business. Inactive shareholders often prefer that the company provide them with liquidity in the form of dividends and other benefits, which limits the capital available for the company's growth.

Diversification can be a very powerful tool to avoid such conflicts and allow the family business to stay in the family's hands. By passing on shares of the business to active shareholders and non-business assets of equivalent value to inactive shareholders, you avoid this common collision of goals.

Consider a Swedish family business that had diversified and built up considerable wealth outside the business over the years. By the time the third generation came along, only one family member remained in the business. He inherited 100% ownership, while his siblings and cousins inherited real estate and financial assets of equal value.

One of the critical hurdles of diversifying family wealth is the need to pass on a business family heritage, not just a family business. A business family heritage goes beyond the bricks and mortar of the family business. It is the heritage of the wealth built over generations. Even at the founder generation, some visionary patriarchs understood this well and focused on “total family wealth.” In his own lifetime Matthew G. Norton, a founder of Weyerhaeuser Corp., diversified into construction materials, real estate and financial management through Laird Norton Trust Company.

Another hurdle is persuading business owners that not all siblings or family members need to inherit the same assets. The emotional obstacle here is often based on the strong attachment family members may feel to the business. If they no longer own shares of the company, how can they remain connected and identified with that important aspect of the family legacy and identity?

How much should you diversify?Just how much should family businesses diversify? That depends on the number of generations and inactive shareholders.

There are no exact ideal numbers, but in general a new business usually requires all available capital, just to stay afloat. As the accompanying graph illustrates, by the second generation, when one or more siblings may have inherited shares, the family should consider diversifying as much as 30% of the company's value into other assets, which could include real estate, other business ventures or a family foundation. By the third generation, when multiple cousins may have inherited shares, the family might diversify another 10% to 25% of the company's value into outside assets.

As a business passes from the founder to the next generation, the owners' first responsibility is not necessarily to save and build the family business, but to save and build the wealth—by diversifying—so that wealth can perpetuate throughout future generations. In the process, you could be saving the family business as well.

François de Visscher is founder and partner in de Visscher & Co., a Greenwich, Conn., financial consulting and investment banking firm for closely held and family companies (

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No time to hide in a cave, but ...

Before September 11, several of my family business clients had mapped out clear plans for growth and financing. Lately they've been calling me with a deceptively simple question, which every business owner should be asking: Should we do anything differently?

Unless you're in the security or construction business, the consensus seems to be that the events of September 11 caused an economic slowdown. As I told my clients, there are several ways any company must prepare for economic uncertainty—and one extra issue family businesses must confront.

• Revise the business plan. Look at your budget projections. For starters, the demand for your products and services may fall off. Your receivables may take more time to collect. This will have a negative impact on cash flow, let alone growth plans. Consider what expenses you can cut or defer. For instance, can you upgrade your company's computers instead of buying all new ones?

This doesn't necessarily mean you should ditch your expansion plans. In fact, this may be a great time to consider acquiring competitors, especially if you can concoct more creative ways to fund them. Which brings me to the second point:

• Rethink your capital structure. What ratio of equity vs. debt will you need to carry your firm through a possibly lengthy recessionary period? What is your debt capacity? Do you have financing flexibility to satisfy the continued expansion of the company, plus working capital, if cash becomes short?

Banks and some credit institutions are tightening up, so don't count on having the same lines available, at least not on the same favorable terms. For instance, in good times, banks may extend credit up to an amount equal to three times your annual cash flow—that is, they'd allow you three years to repay your average debt. But in recessionary times, banks may extend you credit only up to two times your annual cash flow.

Similarly, in good times banks may lend you as much of 80% to 85% of your receivables. In recessionary times, they'll allow you to borrow only 70% to 75% of your receivables.

Don't forget equity! You can help cushion your company during hard times by maintaining more conservative ratios. If your debt-equity ratio is four-to-one now ($800 of debt for every $200 of equity), consider moving closer to a ratio of three-to-two ($600 of debt for each $400 of equity).

• Re-evaluate shareholder liquidity needs and sources of funding them. Some shareholders may be tempted to sell to meet personal cash needs, although the per-share value may become depressed.

If your company's cash is already tight, what are some alternatives? Develop a menu of different liquidity alternatives for shareholders. With interest rates coming down, you may want to consider mortgage financing on your business property, or asset-based loans on the debt side.

The private equity market is still flush with cash for investing in family-owned companies—and the number of sound investments out there is limited. Consequently, private equity investors are reducing their return expectations. In the past, private equity investors might offer to invest $3 million for a 30% stake in a $10 million business. Now, they might be willing to invest even more for that same 30% ownership—partly because they recognize that their investment will create a more conservative debt-equity ratio, which will lower the investment's riskiness.

One caveat: In these uncertain times, private equity investors will probably require greater control over their investments—additional seats on your board, for example. And be prepared to wait longer to get your cash. While in buoyant times private equity deals might take 60 to 90 days to close, now they could take 90 to 120 days or longer. Private investors are simply asking a lot of what-if questions—which you should be asking yourself, of course.

• Nurture the patient capital of your shareholders. During tough times, owners might tend to hunker down and not communicate with shareholders, especially when you're uncertain yourself about where your company and your industry are headed. If you have less capital available for dividend payouts, for example, you may be tempted to shield inactive shareholders from such unpleasant news. Resist that temptation. Keeping them informed in down times is the surest way to rally their support.

Consider how these tactics have helped White Mountain Co., a $20 million corporate-training firm run by two brothers in partnership with several inactive relatives. White Mountain (not its real name) couldn't get its bank to lend it $2 million to fund the shareholders' continuous liquidity demands—and now the shareholders' liquidity demands are increasing just as the company feels compelled to conserve its cash.

To address the shareholder needs, the company approached its commercial bank. The bank wouldn't extend its lines for shareholders, but it was willing to provide a company-sponsored loan program, in which shareholders use their stock as collateral.

In such a company-sponsored loan program, the company would “stand by” in the event of a shareholder default. During economic slowdowns, banks are more than happy to provide this service, because the bank can lend less money for the same amount of risk.

For instance, if a shareholder pledges $100 worth of stock as collateral, in good times the bank would lend $100. But now the bank might lend only $50, assuming a loan value ratio of 50%.

White Mountain also investigated ways to cut back on overhead, as a contingency plan to conserve cash. It's also looking into hard-asset lenders, which require a smaller percentage of receivables than a bank but charge higher interest.

Finally, White Mountain is getting cozy with private equity investors—but only as a fall-back option, because White Mountain is reluctant to grant outside investors some control of the company.

• Don't forget to access your company's social capital. Make employees and shareholders, and their networks, part of your solution by giving them incentives (not necessarily monetary) to collect ideas for saving money and pursuing new business.

This is no time to go into a cave. It's a time to keep your own eyes and ears open for opportunities. Call your advisers, board members, friends, relatives—even your competitors—just to check in and reinvigorate your information sources.

During economic slowdowns, many owners just sit, worry and wait to get hit by the recession. Not enough business owners step back, search for ideas and revise their plans. Those who do are more likely to survive. And they'll undoubtedly emerge stronger when the economy and society get back on track.

François de Visscher is founder and partner in de Visscher & Co., a Greenwich, Conn., financial consulting and investment banking firm for family- and closely held companies (

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