Header graphic for print

Tilting the Scales

Business Issues with a Legal Slant

Selling Your Business: Top 5 Critical Deal Points

Posted in Company Management

Vacant Retail Building with For Sale Real Estate SignThis is the fifth installment of a series discussing potential pitfalls affecting the intended sale by JR and Sue Ellen Pawlenty of their business Pawlenty Energy. Recently Tilting the Scales highlighted Successfully Selling Your Business: Top 6 Potential Pitfalls; So You Might Sell Your Business Someday: Do You Need a Broker?; Successfully Selling Your Business: 4 Tips – No Matter the Buyer and Selling Your Business: Why Accurate Financials are Important. This month we discuss the Top 5 Critical Deal Points and Recommendations.

Get to the Offer Stage Quickly by Term Sheet or Letter of Intent.  Before signing any written understanding, JR and Sue Ellen should consult a trusted representative to assist them in preparing a well drafted non-binding Letter of Intent, which is critical to setting goals and expectations for a clearly understood, viable offer that represents a good probability of closing.

  1. Payment Terms – Price and Timing. Unless you are paid in cash in full at closing, there’s more than setting price. Expect to negotiate both time and money – deferred and/or contingent payments such as earn-outs, seller notes and stock all depend upon whether your buyer is strategic or financial. Taking a modest down-payment with a note secured only by your company assets and giving the buyer control over your company’s operations, for example, is a recipe for probable disappointment, if not certain disaster.
  2. Reps and Warranties. These are essential statements of fact made by the buyer and seller to each other about various aspects of the transaction, typically including finances, customers, taxes, contracts, ownership, legal issues, intellectual property and more. While both pledge their statements to be true, difficulty of proof and ability to collect realistically impact any agreed upon remedy. Making sure that the statements (promises) you make are clear and accurate is critical.
  3. Indemnification. If a representation or warranty of either you or the buyer is incorrect, the transaction documents address who is responsible and how damages are determined; attorney’s fees are frequently assessed against the loser. Careful attention to contract language addressing both the promises made and the scope of liability imposed for misstatements is crucial.
  4. Transition. Expect the buyer to require your continuing participation to transition the sale. Delaying negotiation of your role and compensation risks an undesirable commitment of time at an almost certainly reduced compensation.
  5. Employees. What assurances does the buyer require about key employees? What is the buyer’s plan for both key and support employees post-closing? Will the buyer retain them with the same compensation and benefits? Be careful when you tell your team. Wait for a solid plan and a solid buyer so you can answer– what does this mean to them?

Tilting the Scales in Your Favor

Beyond the deal points there are some lessons learned that are worth knowing, particularly if this is your first “rodeo”:

  1. Your first “buyer” likely won’t.
  2. Run your business as if you were going to own it forever – it improves your negotiation position.
  3. Due diligence is a two-way street. Check out your buyer’s ability to perform.
  4. Run a litigation check on your prospective buyer.

Presidential Privilege? Why Presidents Can’t Escape Litigation in Office

Posted in *BTW - Noteworthy

Unless you’ve been living under a rock for the past three weeks, you know Donald Trump was elected the next President of the United States.  You also probably know that some of Mr. Trump’s companies are defendants in various lawsuits.  Individuals have also threatened to file individual lawsuits against Mr. Trump.  Can Mr. Trump be forced to sit for a deposition while he’s in office?  Can plaintiffs take his cases to trial during his presidency?  Or does Mr. Trump enjoy a “Presidential Privilege” during his term that bars litigation against him that is unrelated to his office?

Presidents Are Not Immune From Lawsuits for Acts Outside of Office

Generally, Mr. Trump is not immune from lawsuits that do not relate to his activities in office.  The United States Supreme Court ruled in Clinton v. Jones that a sitting president is not immune from litigation for acts that occurred before he became president.  This means presidents may be forced to go to trial and engage in discovery, such as a deposition, during the presidency.  However, the Supreme Court noted that in “cases of extraordinary public moment,” such as times of war, a plaintiff may be required to delay prosecuting his or her case against the president to allow the president to perform his duties to promote “public welfare or convenience.”  So, for example, a plaintiff may be required to delay trial while the president deals with a natural disaster or a terrorist attack.

Will Presidents Always Be Required to Appear for a Deposition?

It’s important to remember that Mr. Clinton was being sued by a woman who claimed he sexually harassed her.  Mr. Trump faces similar allegations.  But some of his companies also face claims (Mr. Trump settled the Trump University lawsuits shortly after his election).  So can Trump be forced to sit for a deposition relating to the claims against those companies while he’s in office?  In addition to the Supreme Court’s concerns about the burdens on the office of the presidency, Mr. Trump might not have to appear for a deposition unless his personal involvement is significant to the case. Some courts have adopted an “apex deposition” doctrine that protects high level corporate executives from deposition where the executives do not have personal knowledge of facts or issues that are relevant to the lawsuit.  Thus, Mr. Trump may not be subject to deposition if he lacks that knowledge.

Tilting the Scales in Your Favor

Just because the president does not enjoy immunity probably does not mean there will be a rush of lawsuits against him.  As the Supreme Court notes in Clinton v. Jones, frivolous and vexatious lawsuits are usually terminated at the pleading stage and require little personal involvement from the president.  There have also been a small number of lawsuits filed against sitting presidents for acts that occurred before they took office.  It’s thus unlikely that the American public will be subjected to a “trial of the century” involving a sitting president.

Mandatory Wage Exemption Changes

Posted in Company Management, Employment & Labor, Money

HiResGunner Gunter employs dealership manager Sayles and computer technician H. Packard (“Pack”) at Falconaire’s Fine Ford and pays these “white collar” employees $40,000 per year. In busy sales months, each averages 50-60 hours a week without paid overtime. Do the new FLSA regulations affect Gunner?

Yes. Effective December 1st, Sayles and Pack must either be paid for their overtime hours or to avoid this mandate, their minimum annual salary must be $47,892 (up from the current $23,600 minimum per year) assuming they are Fair Labor Standards Act “white collar” employees (i.e., executive, administrative or professional) under the exemption, and not otherwise entitled to overtime pay.

The Labor Department estimates the new rules affect some 5 million exempt workers, predominantly in Texas, California, Florida, Illinois, New York and Pennsylvania, which have the largest number of newly eligible workers – 200,000 or more in each state. Of those numbers, hardest hit are lower-wage businesses and service industries like hospitality and retail, which identify the new rules as “Career Killers.” Rather than increasing salaries, many business may elect to reclassify professionals as hourly workers and reduce hours, adjust or remove existing benefits and flexibility (including loss of their more prestigious titles) or cut base salaries. “Comp time” (working overtime for future days off) is not an option for these newly eligible overtime workers. Even with labor reductions, the projected additional administrative costs to businesses to track hours of more employees and updating payroll systems are estimated to cost $745 million.

Employers who fail to comply after December 1st risk Department of Labor (DOL) investigation. More daunting, perhaps, is the threat of private litigation, including class action litigation – a risk with substantial downside potential.

Tilting the Scales in your Favor

Evaluate your current employees and salary levels to assess your company’s possible DOL exposure. If you elect to reclassify employees from “overtime exempt” to “overtime eligible”, develop comprehensive plans to (1) determine new hourly rates for impacted employees; (2) revise or update current timekeeping programs and policies to reflect the changes; and (3) implement training for both managers and employees addressing the changes. Congress may attempt to redirect these changes with legislation, but it’s more likely that the results of the November election  will dictate whether that momentum is sustained. Consider using a Checklist.

For more insight on cutting edge employment issues, including federal changes to overtime exemptions, visit the Texas Employer Handbook blog, written by Gray Reed employment partner Michael Kelsheimer.

Selling Your Business: Why Accurate Financials are Important

Posted in Company Management

This is the fourth installment of a series discussing potential pitfalls that JR and Sue Ellen Pawlenty, who own Pawlenty Energy, should be wary of when they are trying to sell their business. Recently, Tilting the Scales highlighted Successfully Selling Your Business: Top 6 Potential Pitfalls; So You Might Sell Your Business Someday: Do You Need a Broker?; and Successfully Selling Your Business: 4 Tips – No Matter the Buyer. Today, we’re going to discuss why it’s important for your business’s financial records to be in order.   

Avoid Losing the Sale

Many business sales begin with a letter of intent that gives the buyer a due diligence period to investigate and evaluate the business.  Inaccurate financial statements will send up a red flag for potential buyers and probably cause them to walk away from the sale.

Potentially Avoiding Litigation

When there’s a falling out between the buyer and seller after the sale, particularly where the business isn’t doing as well as it was before the sale, the buyer usually complains that the seller’s financials were inaccurate. Although you can’t control whether the buyer sues you, you can create a paper trail during the course of the sale that will make it easy to present your defense.  One way to do that is to pay your accountant to perform an audit of your financial statements before you put the business up for sale.

Boosting Your Business’s Market Value

Inaccurate financial statements might also lead to a below-value sale. For example, if your financial statements inadvertently omit the extra $100,000 in revenue you made last month, the business doesn’t look as valuable to a prospective buyer, meaning you will probably sell the business for less than it is actually worth.  You should also consider having the business appraised.

Other Important Records

If your business is regulated by the local, state or federal governments you want to make sure all of your required licenses are in good standing.  Potential buyers who discover that a business’s licensing is not in compliance will question whether the business’s financial records are also sloppy.

If you incorporated your business, you need to make sure that you have filed all necessary documents with the secretary of state.

You may also want to consider obtaining an environmental audit of the property where your business operates if you handle hazardous chemicals.

Tilting the Scales in Your Favor

Although getting your financial and other documents in order may take some time and cost some money, doing so before you put your business up for sale will save you from surprises later on. If a buyer finds flaws, it will delay the sale, may cost you the sale and may have cost you other potential buyers while you were trying to fix these problems.

 

Do I Owe Income Taxes When I Rent Out My Home?

Posted in Money, Property Issues

Home for RentOver the summer, Brad Bevos’ company relocated him from Austin to Springfield, Illinois. A University of Texas alum and huge Longhorn football fan, the move bummed Brad because he won’t be able to attend home games this season.  Because hotels are scarce during home game weekends, and other special events at UT, Brad decides to list his downtown Austin apartment for rent on VRBO instead of selling it.  Brad manages to rent the apartment for 12 nights during the season for $2,400.   Brad doesn’t include this income on his tax return, and when he gets audited the IRS finds out about his side business.  Is Brad in trouble?

Issues to Look Out for When Renting Your Home

Many people now rent out their homes on VRBO or Airbnb websites to make extra income. Before entering the rental industry it’s best to understand how renting will affect your:

  1. income taxes;
  2. local taxes (do you owe hotel occupancy taxes?);
  3. property taxes (do I keep my homestead exemption?);
  4. homeowner’s insurance (does my policy cover me for tenants?); and
  5. whether you are complying with your HOA’s rules.

Do you owe the IRS?

It depends on how often you rent out your home during the year. The IRS has an exception – dubbed by some as the Master Exception for homeowners who rented out their Augusta homes during the Masters golf tournament – that permits you not to report rental income if:

  1. you rented the home for 14 days or less during the year; and
  2. you used the property yourself for 14 days or more during the year, or for more than 10% of the total days it is rented.You may be able to deduct some of your expenses to offset your rental income, so discuss with your tax advisor.

Does Brad owe the IRS?

No, because Brad rented out the house for less than 14 days, and he had lived there for more than 14 days before he was relocated. But, Brad will likely owe income taxes in future years if he rents for more than 14 days, or didn’t visit Austin for at least 14 days.

Tilting the Scales in Your Favor

Before getting into the rental business make sure you have a full understanding of the financial implications. If you are renting out a second home, you should consider hiring a rental management company who can handle day-to-day issues that arise, such as maintenance.

Successfully Selling Your Business: 4 Tips – No Matter the Buyer

Posted in Company Management

Business For SaleAmong the growing number of business owners looking to sell their business, JR and Sue Ellen Pawlenty are in the market to sell their company Pawlenty Energy. Recently Tilting the Scales highlighted Successfully Selling Your Business: Top 6 Potential Pitfalls and So You Might Sell Your Business Someday: Do You Need a Broker?  For multiple reasons, such as family, health, age or interest, you have decided to sell your business. Now what do you do?

4 Tips – No Matter the Buyer

  1. Get your House in Order – all of your records, especially financial records should be reviewed by a competent accountant and be consistent with GAAP accounting methods.
  2. Assemble your Asset Financial Information for Buyer Due Diligence – contracts with buyers, employee policies and contracts, and overall business structure for legal and tax implications.
  3. Business Valuation – get an early idea from a competent valuation adviser and ask your expert for ideas to improve valuation, including identifying and perhaps courting your current competition. Careful: it may not be worth what you think, know what you need to retire.
  4. Plan – identify specific shareholder objectives and a transition plan. If your primary plan is a family transition plan, WAIT, there’s much more!

9 Specific Tips for Succession Planning of a Family Business

Family businesses account for a staggering 50 percent of the gross domestic product of the U.S., and it is not just in small storefronts or website businesses: 35 percent of Fortune 500 companies are private or public companies that are controlled by families. Key issues for succession planning include:

  1. Generational Transition – only a third of all family businesses successfully make the transition to the second generation.
  2. Alignment of Family Interests – alignment becomes more problematic as members retire and turn over the reins to the new generation and expect retirement income from the company.
  3. Balancing Financial Returns – buyout agreements are challenging when retiring family members look to the balance sheet value rather than an earnings capitalization model.
  4. Interfamily disputes. Family member interests may not be aligned, becoming even more difficult upon a family owner’s divorce or death and the surviving spouse holds stock (and voting rights) but is not actively contributing to the business.
  5. Estate and Inheritance Issues. Taxes and probate upon a family owner’s death can complicate business continuation.
  6. Identify and Groom the Successor. Identify a competent successor then develop them to assume the headship of the business by on-the-job training, working under mentors and advisors, and delegating before the actual passing on of the baton.
  7. Document the Succession Plan. A concrete, straight forward and not open to interpretation at a succession plan should be written: identifying the successors both in ownership and management; roles of both active and non-active family members in the business; and the support system for the successor from family members as well as the company.
  8. Create a Plan for the Transition. Establish how the business will be handed over – will the successor purchase the company, or will it be gifted? And when? If sold, what purchasing options will the older generation offer the successor? Minimizing taxes to all is critical.
  9. Communicate. The Plan must be timely communicated to the family and those active within the business, as well as non-active members, preferably by the current ownership. Every family member and employee must fully understand how the succession will work, and what their part is within it all. 

Tilting the Scales in Your Favor

You can’t sell your business like you sell your car. It’s more like selling your house, but even more challenging than just timing the market, de-cluttering the inside and slapping a coat of paint on the outside. Beyond just the physical assets and the economic climate, you are dealing with people – employees, customers and vendors. Even more complicated is the addition of continuing family ownership, management and control to the mix. It takes time, planning, decision making and then decisive communications to all concerned for success. Success won’t happen overnight; failure almost certainly will happen if you don’t.

Personal Guaranties: What? Me Worry?

Posted in Property Issues

Franklin, a Senior at Fraternal State, is finally moving off campus to his own apartment with four of his buddies. Before Owen Ohner, the landlord, will approve their lease, he requires a personal guaranty from all the parents. The landlord’s rep Lyn Lackey assures Franklin’s Dad Milton Munney that the guaranty is “standard.” Could this be a problem for Milton?

Yes. The “standard” guaranty that Milton signs almost certainly guarantees his unconditional and absolute payment of the entire debt – whether Franklin’s frat friends and their parents pay or not. Worse yet, a “standard” guaranty waives all tenant defenses or rights of offset against the landlord, meaning Milton would have to pay in full and separately get reimbursement from the other parents. And, if Franklin has any claims against Ohner, they are not offset against Milton’s guaranty. Franklin must sue Ohner separately and then collect his judgment, without any right of offset landlord’s claims under the lease.

Separate Obligations

Under Texas law, the Guaranty and the Lease Agreement are separate undertakings. One who guaranties payment and waives the requirement that the holder of the note exhaust its rights against the maker, (1) becomes an absolute guarantor, (2) is primarily liable, and (3) waives all defenses and any requirement that the landlord first act against the lessees, or, in this case, any other guarantor. As a general rule, an absolute guaranty imposes liability on the guarantor even if the underlying obligation cannot be enforced against the principal.

Because Milton waived all affirmative defenses, he is liable on the guaranty even if the lease is unenforceable against his buddies because of some alleged breach.

Tilting the Scales in Your Favor

A personal guaranty is not likely to be avoided. Milton is better off co-signing the lease as a tenant than as a guarantor. A second option would be to modify the guaranty so that Milton is responsible only for Franklin’s twenty percent share of the lease – which is not likely. If all else fails, at least plan to meet with the parents of Franklin’s friends and talk about their views of the lease and the relative responsibilities of each. Good luck.

So You Might Sell Your Business Someday. Do You Need a Broker?

Posted in Company Management, Money, Property Issues

Business For SaleThis is the second installment of a series discussing potential pitfalls of which closely held business owners should be wary when they are trying to sell their business. Here’s a link to our first installment.

After a lifetime of pouring time and energy into growing and expanding, Pawlenty Energy, JR and Sue Ellen Pawlenty are ready to sell their business and retire. Having never sold anything of this magnitude, JR and Sue Ellen have no idea where to start to try to sell their company.  Even more challenging is that, until the money exchanges, they must continue to run their business. Marketing to sell their company will be a hassle that could negatively affect their operations, their personnel and their reputation both with their customers and with their vendors.  Their friend Nancy Noitall recommended that they hire a business broker to assist them in handling the sale.  Is this a good idea?

Benefits of a Business Broker

Business brokers can provide a valuable resource to sellers. For example, a business broker can mass market a company when the seller does not already have a prospective buyer lined up.  The broker also serves as the seller’s spokesperson, allowing the seller to concentrate on running the business instead of dealing with the daily distractions that arise from trying to get a deal done.  This includes screening prospective buyers to ensure they can afford the sales price.  A broker can also come up with a market value for the business based on the sales prices of similar businesses.

Risks of Using a Broker

Sellers face some risks using business brokers. Because a business broker is the seller’s spokesperson, the seller would likely be liable if the broker misrepresented the business to a buyer.  Business brokers also typically use form agreements for each transaction.  If there are unique aspects of the transaction, or the business, that are a material part of the sale, form agreements may not address those issues and create the potential for litigation between the buyer and seller down the road.

Should I Involve Other Professionals?

Yes. If you have an accountant, he or she can help you get your financial statements in order before you advertise your business for sale.  If your accountant did not previously do so, he or she may be able to audit your financial statements, which will improve your business’s value.  If you hire a broker, your broker can deal directly with your accountant on any questions from potential buyers about the company’s financials.

You should also involve an attorney who can review and advise you about the broker agreement. Your attorney can also review and revise the broker’s form sales contracts to try to protect you from certain risks if the sale fails.

What Should I Look For in a Broker?

If you want to hire a broker, you should look for someone who has a proven track record selling similar businesses, or who has experience in your industry. The broker should be willing to work with your financial and legal advisers.  Most importantly, you want a broker who puts your interests ahead of his or her fee.

Tilting the Scales in Your Favor

Whether you use a broker to help you sell your business depends on your personal circumstances. If you choose to use a broker, conduct a thorough background check, including references, of all potential candidates before hiring one.  You also need to make sure you have a clear understanding of how the broker is compensated under the broker agreement – which you should have an attorney review with you.

Employee Embezzlement: 4 Tell-Tale Signs

Posted in Employment & Labor

Having started as a bookkeeper and worked his way (fifteen years later) to become controller of the Bunz in the Oven family owned business, Swendoll Hugh felt underpaid andbusinessman hiding envelope with money in pocket at jacket under-appreciated by Bertha Bunz and her highly successful business. When Swendoll’s grandmother passed away, he “borrowed” funds from Bunz in the Oven to cover funeral expenses. Easily repaying the money without detection, Swendoll “borrowed” again and again, and eventually quit repaying the “loans” amounting to hundreds of thousands of dollars. What’s the crime? How could that have happened? What might Bertha and Bunz in the Oven have done to discover Swendoll Hugh’s embezzlement earlier?

It’s a crime to steal all or part of the money or property entrusted to you for management or monitoring. Beyond merely stealing, embezzlement is also a violation of a special position of trust. For embezzlement of money or property valued over $200,000, Texas penalties include a fine of up to $10,000, at least five (and up to 99) years in prison, or both.

Be Vigilant.

Embezzlement often occurs when there is a lack of accounting controls. For smaller companies with minimum gross revenues, missing money is more obvious and the cost to implement necessary controls may be cost prohibitive. Yet, as the company and its gross revenues grow, so must accounting controls.

Embezzlement can be as simple as issuing and then voiding a check to a customary vendor at a time when the expense is expected, and then issuing a check for an identical amount to cover personal expenses. According to news accounts, that’s exactly what the controller of Collin Street Bakery did on his way to stealing nearly $17 million from the landmark Corsicana business.

Look for These 4 Warning Signs.

Beyond making prudent accounting changes to match your business success—and avoiding placing trusted employees into a predicament tempting their violation of company trust—these warning signs should alert you to be more vigilant:

  1. Significant Lifestyle Changes. Just like the Collin Street Bakery controller who spent millions on watches, cars and vacation homes, that were noticed and ignored for years, unexplained upgrades in automobiles, exotic vacations and expensive apparel merit close attention and perhaps investigation.
  2. Financial Difficulties. Employees with constant financial troubles have a greater incentive to steal and can generally rationalize almost any behavior when faced with enough pressure from friends, family and creditors. Often not intending to commit fraud, many act out of desperation.
  3. Never Wants to Take a Vacation. Certain types of fraud have to be monitored to maintain and remain undetected. The perpetrator will be unwilling to take a vacation and risk detection.
  4. Constantly Works Overtime and Wants to Take Work Home. Embezzlers often avoid the watchful eyes of co-workers. They need privacy and might work late or take work home to eliminate unannounced visits from fellow employees when dealing with incriminating evidence.

Tilting the Scales in Your Favor.

Trust but verify. Be vigilant. And, be careful. Your self-indulging employee may have won the lottery or inherited from a rich uncle. It might be prudent to offer aid to an employee with a sudden death in the family. Cross-train employees so that trusted, dedicated employees can confidently go on vacation knowing that a competent co-worker is filling in. Consider re-arranging the workloads of those constantly working overtime to improve their work-life balance.  Explore the value of both a periodic financial audit by your outside accounting company and their examination of your appropriate financial safeguards.

Successfully Selling Your Business: Top 6 Potential Pitfalls

Posted in Company Management

ABusiness for salemong the growing number of business owners looking to sell their business, JR and Sue Ellen Pawlenty are in the market to sell their darling Pawlenty Energy. This month, Tilting the Scales highlights a variety of issues is its first installment of a series discussing the potential pitfalls that closely-held business owners should be wary of when selling their business.

Top 6 Potential Pitfalls

  1. Personal Issues & Exit Plan – Exit plan, succession and transition, will you get enough? What is your answer to the question, “Why are you selling your business?”
  2. Business Plan – Do you have one? What makes your business special and worth the premium? Why would someone buy your business?
  3. Accurate Financials and Legal/Regulatory Affairs Current – What do your financials disclose about the quality and sustainability of your earnings?
  4. Value & Timing – What’s your business really worth? When is the right time to sell? What can you realistically expect to be offered?
  5. Deal Points – What are your options? What terms are realistic? What terms are critical? Why should you care about reps and warranties? Should you draft your own documents?
  6. Business Brokers & Other Critical Advisers – What should you be looking for? Can the broker help you avoid selling to the wrong buyer? Your accountant? Your attorney?

Be on the lookout for us to cover these issues in depth with the Pawlenty family over the next several months.