How Small and Midsize Companies Can Generate Growth

Transcription

CFO
Handbook
Think Big
How Small and Midsize
Companies Can Generate Growth
SMALL AND MIDSIZE COMPANIES THINK BIG
Small and Midsize Companies Think Big is published by CFO Publishing LLC, 51 Sleeper Street, Boston, MA
02210. Mary Beth Findlay and David Owens edited this collection.
Copyright © 2012 CFO Publishing, LLC. All rights reserved. No part of this book may be reproduced, copied,
transmitted, or stored in any form, by any means, without the prior written permission of CFO Publishing,
LLC.
www.cfo.com
Cover design by Robert Lesser.
ISBN 978-1-938742-03-3
TABLE OF CONTENTS
FOREWORD: GROWING RESPONSIBILITIES
6
THE EXPANDING ROLE OF THE CFO
8
A More Influential Finance Function
Growing Through Innovation
Managing Your Time to Manage Your Business
Dealing with Organizational Fatigue
9
11
13
15
FINDING FUNDS BANKING AND FINANCING 17
Finding the Right Bank for Your Business Help for the Little Guy
Overcoming Hurdles: Smoothing the IPO Path
Thinking Outside the (Traditional Banking) Box: Alternative Financing
18
22
26
28
GOING GLOBAL32
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Opportunities Overseas: M&A
Business Beyond Borders: Supply Chain
33
38
UNDER PRESSURE WORKING CAPITAL AND CASH MANAGEMENT
42
Creating a Secure Foundation for Growth
Constant Pressure on Working-Capital Improvement
Funding Alternatives: Auctioning Receivables
Supply Chain Financing: Shoring Up the Supply Chain to Support Growth Many Hands Make Light(er) Work: Getting Your Organization on Board
43
45
48
51
54
FROM TAX TO TECH THE BACK OFFICE
57
Staying on Track: 401(k) Considerations for Growing Companies
Covering Costs: Health Care Advice for Growing Companies
Navigating Complex Waters: Tax Advice for Growing Companies
An Additional Technology Challenge: Security
58
61
65
68
CONCLUSION: MAKING THE MOST OF OPPORTUNITIES
72
FOREWORD
GROWING
RESPONSIBILITIES
F
rom stewards to strategists.
That’s the path that CFOs at many small
and midsize companies have travelled in
recent years. Once the embodiment of the
number-crunching class—preoccupied by precision,
and dazzled by data—CFOs thrived on fulfilling
requests for financial information, delivering results
in a timely fashion and in an appropriate format. To
the extent they shared a broader understanding of
the business, CFOs were typically cast as the voice
of unreason, injecting a CEO’s often optimistic
outlook—about any large-scale business move—
with a strong shot of reality-based skepticism.
But that’s all changed—well, most of it anyway.
While CFOs haven’t lost their affinity for properlyprepared financial statements, technology has
enabled them to automate many of the low-level
transactional functions that once consumed much
of their time. That change has helped free senior
finance functions up to shift their focus to more
strategic aspects of the business. And just in time,
too. In recent years, several factors—from the 2008
credit crisis to the new regulatory demands brought
on by legislation—have forced them to abandon
their silos and join the management team in uniting
around the bigger picture. Working side-by-side
with operating executives, CFOs have helped the
executive group manage business risk by evaluating
opportunities and strategic initiatives, ranging from
geographic expansion to making investments in
R&D.
In a rapidly changing economic environment, it
has become the CFO’s job to provide much more
than numbers, peering beyond the P&L to provide
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useful insight and analysis to support decision
making. Nowhere is this role more pivotal than in
resource-challenged small and midsize companies,
where a misstep can lead to a dangerous fall. With
market expansion now a priority, CFOs have stepped
out again, moving beyond their recession-related
role as cost-cutting strategists to evaluate growth
opportunities. Theirs is a complex and evolving
task, continually growing ever more vital.
That’s where this CFO Handbook comes in. In
the following pages our goal is not only to define
the CFO’s changing identity at growth companies
but also to share tools and tips that we’ve gleaned
from other senior finance executives at small and
midsize companies. They, too, have been required
to supplement their more tactical and compliancedriven duties with the more critical financial and
strategic challenges of company-building. And if
there’s one thing we’ve learned from a decade’s
worth of surveying CFOs of small and midsize
companies, it’s this: they are up to the challenge.
Mary Beth Findlay
Editorial Director, Product Development
CFO Publishing, LLC.
THE EXPANDING
ROLE OF THE CFO
“More than half of all respondents to a 2011 CFO
Research survey say that improving finance’s ability to
identify growth opportunities would contribute most to
their small and midsize companies’ ability to succeed over
the next two years.”
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CFO PUBLISHING
A MORE INFLUENTIAL
FINANCE FUNCTION
I
f you’re a CFO at a small or midsize company and
your role hasn’t expanded in the past two years,
you might want to think twice.
In 2007, CFO Research Services published
The Superstar CFO, documenting the views of
senior finance executives on the attributes that
characterize highly successful CFOs. In responding
to the survey, one executive wrote at the time that
“extraordinary CFOs know no boundaries.”
That statement is even more true today. In a world
changed by technology as much as by economics,
CFOs need to be persuasive agents of change for
their companies. They must first have a vision
for improving the company, and then be able to
build credibility with other leaders within the
organization to “sell” the vision. In a 2011 followup to The Superstar CFO, Sarah Urban, finance
director for the Americas for Brady Corporation,
observes, “The CFO roles are transforming over
time to be much more focused on general business
leadership. That really brings strength to your whole
organization.”
“Strengthening the whole organization” has
become the mandate for finance leaders, especially
in difficult times. A 2011 survey of CFOs conducted
independently by Accenture found that the vast
majority of them have been asked to take on new
responsibilities in areas outside of finance. At small
and midsize companies, these include areas such as
information technology, client services, strategy and
business development, operations, and marketing
and sales.
“The key messages are really the same at small
and large companies,” says Paul Boulanger, global
managing director of Accenture’s finance and
performance management group. “Challenges in the
business environment over the past 24 months have
driven CFOs to play a bigger role in profitability,
though that takes different forms in different
industries.”
But circumstances at small and midsized
companies have rarely been more favorable to senior
finance executives eager to make improvements.
As the financial system teetered on the brink of
collapse in the fall of 2008, freezing credit markets
and chilling economic activity around the world,
finance executives took the lead in securing funding,
managing cash and working capital, paying down
debt, and implementing the financial disciplines—
including cost discipline—that often proved
essential to their companies’ survival.
Survey results confirm that the finance function—
already highly influential at most small and
midsized companies—has gained in organizational
stature in the wake of the recent downturn.
Seventy-two percent of respondents confirm that
the experience of the recent downturn has enhanced
the finance function’s standing and influence at
their companies. These results suggest that many
CFO PUBLISHING
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finance executives are well positioned to gain
organizational buy-in and support for the initiatives
they deem important in the post-downturn
environment—including the maintenance (and even
improvement) of cost discipline.
In our 2011 study, Dave Martin, vice president
and CFO for Dimensional Fund Advisors, describes
his role as “all of the above.” As he tells us, “It’s
compliance. It’s accounting. It’s tax that gets
increasingly complex. [It’s] understanding the
drivers of the business; trying to make sure that
our headcount is growing at the right pace and not
faster, in step with the firm; predicting where we
are in terms of bonus and shareholder distributions;
communicating with shareholders. It’s all the way
from the strategic to the very tactical and everything
in between.”
In all this, today’s CFOs continue to develop
their financial expertise, their understanding of
their companies’ markets and businesses, and their
relationships throughout the enterprise in order to
remain—as one of our interviewees puts it—“the
best business partner” to both the CEO and their
operations colleagues.
Or, simply put, according to Wong Wai Ming,
senior vice president and CFO of Lenovo in Hong
Kong, “Over the next two or three years, the finance
organization will focus more on how to accelerate
the growth of the company.”
Find out how Finance
Chief Wayne Lipschitz of
Make Meaning is leading
his company to growth.
Read Hands on Growth.
10
CFO PUBLISHING
CFO Summary
• Senior finance executives (SFEs) have played a
key role in their companies’ ability to weather the
economic downturn.
• SFEs’ mandate today: “Strengthen the whole
organization.”
• Now SFEs must continue to grow their financial
expertise, understanding of their company, and
relationships with other functions.
GROWING THROUGH
INNOVATION
H
ow can CFOs discover new growth
opportunities? Overall, the CFOs interviewed
report that they spend the largest portion
of their time working with others in the
business on optimizing operational and financial
performance. In this, they emphasize the importance
of meeting regularly with all the operating units to get
to know the business better—and to let the operating
units know the CFO better.
Marcelo Martins, CFO of the Brazilian sugar
producer Cosan SA Indústria e Comércio, says, “I
think the most important characteristic of a CFO
is the ability to influence the top and the middle
management of the company. It derives from his
abilities to draw respect from his peers. It’s not
only his technical expertise, but also the ability
to understand the problems of the company—
both the need of the company to rationalize and
become more efficient, and from the long-term,
strategic view of the business of the company.” For
this reason, the CFO should “have the capacity to
interact with colleagues [who have] different views,
different skills, and different ambitions,” advises
Michel Allé, CFO of the Belgian national railway
SNCB.
And chances are your employees have some ideas
about how to make the business better. Some of
them might be brilliant; others abysmal. But few
companies are able to effectively corral the ideas and
separate the wheat from the chaff, meaning many
so-called growth strategies are simply the product
of political savvy rather than holistic calculations.
Enter John Varvaris, CFO at health company
Best Doctors. He joined the $120 million firm,
which provides an employee benefit in the form
of a network of leading specialists for additional
consultation on major medical decisions, in late
2008 to help it move “from the go-go stage to the
middle market,” says Varvaris, the former Ernst &
Young partner and insurance-company CFO. Besides
building a finance function and tightening up the
accounting, one of his first steps was to almost
immediately put a process in place to support
innovation.
“We have a culture of experimentation; we like
to try new markets, extensions of products, new
distribution partners, etc.,” says Varvaris, “though to
do it in a risk-balanced way is a challenge.”
A decision-making team was his first response
to that challenge. The team, which includes
Varvaris, the rest of the executive team, and any
senior-level staff relevant to a particular issue, is
scheduled to meet once a month but also convenes
ad hoc for more pressing opportunities. Employees
present the committee with business cases, often
based on companyprovided templates and
sometimes prompted
by client requests.
The committee then
assesses risks, looks at
cost-benefit analyses,
and decides whether the
proposal should go on to
the next phase.
Projects that get
the nod go to a team
of project managers
who map out what
other functions in the
organization need to
get involved to make
the idea come alive.
Most new ideas “have legal, finance, and/or transferpricing issues, so they can get complex quickly,” says
Varvaris. Those that appear to have enough upside
to justify the cross-functional effort then become
business plans, though tentative ones.
“It’s really a series of go/no-go decisions,” says
Varvaris. “We first look at ‘What do we have to do to
“We have a culture of
experimentation; we
like to try new markets,
extensions of products,
new distribution partners,
etc. The real challenge for
us is doing this in a riskbalanced way.”
CFO PUBLISHING
11
CFO Bill Chorba describes
innovation as his growing
company’s core product.
Can you say the same?
Read On the Fast Track:
Nine Sigma.
12
CFO PUBLISHING
deliver the project with low to moderate risk?’ Then,
if it’s working, we build resources around it. That
allows us to say keep going, build bigger, or stop, as
the case may be.”
Over time, employees have become more
accustomed to what they’ll be asked and come to
meetings better prepared, Varvaris says. That means
a high percentage of projects, around 70%, now
make it to the second phase; about 20% make it
beyond that. Currently, about 30 projects have gone
through the committee, including major technology
implementations such as rolling out a global CRM.
“The goal for me is to build a dynamic
infrastructure so we can tell the businesspeople
to bring it on,” says Varvaris. From a topline
perspective, that seems to be working. The benefits
firm grew revenue 30% [in 2010], to $120 million,
and its staff by 21%, to 400 people, in large part by
expanding in overseas markets such as Australia,
Portugal, and Canada. It’s on track to hit $150
million [in 2011], says Varvaris, an implied 25%
growth rate. He also helped raise $20 million in
equity from strategic investor Nippon Life, at a
corporate valuation of $230 million.
All of which leads to the next post-go-go phase:
being “IPO ready,” one of Varvaris’s top priorities for
2012. “It’s one thing that you can grow, but are you
growing the right places in line with the corporate
objectives? If you’re not growing in that scalable,
profitable way, you might have all the right controls,
but you don’t have any résumé, so you can’t go ask
that next investor for a higher valuation,” he says.
“Does being IPO-ready mean we’ll do an IPO? Not
necessarily, but it’s one of [the] ways we prepare for
liquidity.”
CFO Summary
• Optimizing your company’s operational and financial
performance requires working with colleagues to
develop ideas to improve your business.
• Support innovation by developing a decisionmaking team that meets regularly to present ideas
and analyze associated risks and costs.
MANAGING YOUR TIME TO
MANAGE YOUR BUSINESS
A
s many CFOs of small and midsize
companies have learned, CFOs have a
special opportunity when it comes to
growth. But many factors can intercede
between an initial idea and the successful nurturing of
a growth strategy.
CFOs face plenty of hindrances in trying to get
their job done right: office politics, sluggish staff
members, and a never-ending set of new regulations
demanding compliance, to name a few. Which one is
most vexing, though?
“Time” is the ever-popular answer, particularly
for small and midsize CFOs with too many roles.
This response underscores how broad and vast the
CFO role has become at many companies. Feeling
overwhelmed is common among executives, but it’s
a manageable problem if they’re willing to be more
proactive about planning and managing schedules
and, in particular, meetings, experts say.
“It’s not about managing time; it’s about managing
events,” says William Staats, an executive coach with
Peak Performance Plus and a certified instructor for
Franklin Covey, a well-known time-management
consulting firm. Staats suggests several practical
steps to make meetings more effective, including
always having an agenda for them (published ahead
of time so people can prepare), always starting
meetings on time, and always ending them on time.
Naming meetings can also be very effective. “Is it
an update meeting, a forecast meeting, a jump-start
meeting, or a clear-the-air meeting? It shouldn’t be
a surprise to people when they arrive,” says Staats.
Pushing for a decision at a meeting is critical, as
well as keeping notes to record that decision and
any associated deadlines, so that people can refer
back to them as needed.
Outside of meetings, CFOs also need to protect
their time to focus on what’s important and most
urgent. Using the phrase popularized by Stephen
Covey’s book The 7 Habits of Highly Effective
CFO PUBLISHING
13
The structure of your
finance department
can make a world of
difference. Read How to
Structure Your Staff for
Success.
People, Staats says, “You’ve got to stay in Q2,”
referring to Covey’s four-quadrant diagram that
puts activities that are “important” but “not urgent”
in the second quadrant CFOs, in fact, should make a
door hanger that says “Q2” that can signal to others
they’re not available at certain times, he advises.
Above all, it’s important to acknowledge that in
almost any given amount of time, some work will
have to fall by the wayside. Finance executives may
take some comfort knowing that even the CFO of
Franklin Covey, Steve Young, shares that pain.
Young follows many of the
steps recommended by his
firm’s consultants, planning
out each week to address the
most-important items and
checking in with his staff to
help them prioritize weekly
as well. Yet, he confesses,
“I can’t remember a time in
the last 11 years that I could
get everything on my plate
in a given week done.” Given
that, he says, “it’s all the more
critical that you focus on the
things that are important.”
A 2011 Accenture survey
showed that CFOs at smaller
companies, in particular,
are focusing hard on finding
ways to free up time for
the finance function itself.
Between 70% and 80% of
CFOs at midsize companies
(those with $100 million to $1
billion in revenues) said they
needed the finance function
to be more flexible, which
Accenture’s Paul Boulanger
says often means turning to
outsourcing or shared services.
In the full survey, more than 40% of CFOs from
companies of all sizes said they have increased their
use of outsourcing or shared services, while another
40% plan to do so in the next 18 months. “Small
companies can’t push as far down that path,” notes
Boulanger, “but where they have the scale, it’s still of
value to them.”
For example, at Brady Corporation, finance
director Sarah Urban says that her company’s
recent consolidation of transactional activities into
shared-services centers has been good for both the
“The move to sharedservices centers has
really allowed my team
to have more scale, not
have to worry so much
about transactions,
and be able to give
better support to their
business leaders. As
a result, we’ve been
able to spend more
time on the things that
actually drive business
decisions.”
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CFO PUBLISHING
business and the finance function. Ms. Urban’s team
members are getting more out of their own jobs as
the scope of their responsibilities has expanded into
more value-added areas. “[The move to sharedservices centers] changed my job in good ways,” she
says. “It has really allowed my team to have more
scale, not have to worry so much about transactions,
and be able to give better support to their business
leaders. We’ve been able to spend more time on the
things that actually drive business decisions rather
than managing accounts receivable and accounts
payable.” The move has also helped the finance
function to become more efficient; they’ve been able
to reduce headcount, while doing more with less.
“[One finance manager] can now support multiple
businesses effectively,” Ms. Urban explains.
As a result, Ms. Urban notes, “we are able to
spend much more time helping to drive business
decisions.” Even with the lower headcount, she
explains, business lines “get more time from us
rather than less, and they get better reporting and
analysis.”
CFO Summary
• Conquer time crunches by taking a proactive
approach to planning and managing your schedule.
• Make sure your meetings are as effective as
possible. This means always having an agenda,
starting and ending on time, naming meetings (e.g.
forecast meeting, update meeting), and keeping
notes.
• Prioritize your tasks and work with employees to
make sure the most-important items that week are
their focus.
DEALING WITH
ORGANIZATIONAL FATIGUE
I
n these efforts, CFOs know they must work
hand-in-hand with all the business units to
develop a deep understanding of the real drivers
of the business. Finance provides the numbers
and analysis that allow business units to optimize
performance in line with corporate growth strategies.
CFOs also see themselves as the stewards of profitable
growth, protecting the bottom line and ensuring that
the rewards for new directions the company takes are
commensurate with the risks.
But it’s not always so simple. In one of CFO
Research’s 2011 surveys, finance executives see a
lack of cross-functional collaboration (particularly
between finance and the operating business lines)
as a major obstacle. Aside from the universally
problematic “lack of time, attention, and
resources,” survey respondents most often choose
“organizational resistance in other functional areas
or in the business lines” as a barrier to finance’s
ability to contribute to growth (35%). (In addition,
more than one-quarter of respondents see the
“absence of a broad organizational mandate for
finance’s participation in identifying, evaluating,
and pursuing growth opportunities” as a substantial
barrier.) (See Figure 1.)
Many also may need to make major IT upgrades
or better hires before they can feel more in control.
After time, many small and midsize CFOs encounter
IT problems in the form of lack of or delayed data,
making financial analyses and ensuing decisions
more time-consuming than they need to be.
For example, in a 2011 Accenture survey, very high
Figure 1. Aside from the perennial lack of time, attention, and resources, organizational resistance from outside of
finance is the most-often cited barrier to finance’s ability to contribute to growth?
In your opinion, what are the greatest barriers to making the finance-related improvements that would contribute most to your company’s overall
growth efforts?
Lack of time, attention, and resources
40%
Organizational resistance in other functional areas or in the
business lines
35%
Inadequate IT systems
29%
Absence of a broad organizational mandate for finance’s participation
in identifying, evaluating, and pursuing growth opportunities
27%
Business/organizational complexity
22%
Lack of access to competitive intelligence or relevant benchmarks
22%
Lack of knowledge/training in analysis, decision support,
forecasting methodologies, or other specialized finance activities
Scarcity of finance talent
Organizational resistance within finance
17%
8%
6%
CFO PUBLISHING
15
percentages (between 70% and 85%) of CFOs at
midsize companies said they have needed to make
changes to the financial planning and forecasting
function in the past 18 months. Accenture’s Paul
Boulanger says that often means “industrializing”
the planning process, upgrading its technology
from a morass of spreadsheets to a software tool
and incorporating macroeconomic indicators that
may not be on the sales team’s radar screens.
Faced with these kinds of barriers, CFOs at
small and midsize companies tell us that they are
most concerned with fatigue—an understandable
concern, given the persistent atmosphere of
scarcity and the amount of time and attention that
cost control efforts can absorb. Forty-six percent of
all respondents say that “organizational resistance/
fatigue” will rank among the greatest obstacles to
maintaining cost discipline at their companies over
the next two years, followed somewhat distantly
by “increasing business complexity” (33%). (See
Figure 2.)
CFO Summary
• SFEs tell us that in addition to a lack of time and
resources, they also face significant organizational
hurdles.
• Evaluating and upgrading your IT support systems
may be the quickest way to conquer one barrier to
finance-related growth.
Figure 2. Organizational fatigue will likely be a serious barrier to maintaining cost discipline over the next two years,
respondents say.
In your opinion, what will be the greatest obstacles to maintaining cost discipline at your company over the next two years?
Organizational resistance/fatigue
46%
33%
Increasing business complexity
Lack of a standardized approach to cost management across the
company
25%
22%
Lack of access to competitive intelligence or relevant benchmarks
Lack of time, attention, and resources in finance
21%
Lack of communication among finance, operations, and/or
procurement
Lack of tools, frameworks, and decision-making methods for cost
management
19%
18%
Lack of benchmarking data to evaluate vendor offerings/provide
leverage in negotiations
Lack of robust reporting on spending
16%
6%
Sources for The Expanding Role of the CFO:
0
10
20
30
40
“Enemy Number One: The Clock,” Alix Stuart, CFO.com, July 6, 2011.
“Finance’s Expanding Borders,” Alix Stuart, CFO.com, February 7, 2011.
“Teaming Up on Innovation,” Alix Stuart, CFO.com, January 25, 2012.
“The Path to Prosperity: CFOs at small and midsize companies on post-downturn cost control,” CFO Research, June 2011.
“The Superstar CFO: After the Crisis,” CFO Research, June 2011.
“The Superstar CFO: Optimizing an Increasingly Complex Role,” CFO Research, May 2007.
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FINDING FUNDS BANKING AND FINANCING
FINDING FUNDS
BANKING AND
FINANCING
“The CFO of a small telecom company laments, ‘There’s
more money out there, but we either don’t fit many banks’
profiles, or the rules remain problematic and ultimately
prevent banks from lending their money.’”
CFO PUBLISHING
17
FINDING THE RIGHT BANK
FOR YOUR BUSINESS
I
Click here to access CFO’s
latest articles on Credit &
Capital.
18
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n early 2011, small and midsize companies were
still feeling the effects of the recession in the
form of credit scarcity. Relationships between
businesses and their banks were still tense,
according to a 2010 Greenwich Associates’ annual
survey of banking experiences for companies in
was already in decline. Not surprisingly, about
one-quarter of the businesses surveyed reported
having switched banks over the course of the year, up
from a traditional norm of about 11%, according to
McDonnell.
While banks were becoming increasingly
the $1 million to $10 million revenue range. Overall
satisfaction levels were down across the board, in
large part because companies were having a hard
time borrowing, according to Chris McDonnell, a
vice president at Greenwich Associates.
The national mean for banking-satisfaction scores
dropped several percentage points from 2009, which
comfortable lending to larger, more-stable
companies, many remained wary of loans to
smaller businesses, which were still viewed as
risky. McDonnell described a nearly one-to-one
relationship between a company’s size and the ease
of borrowing. Small and midsize companies gave
the highest marks to banks that were able to get out
there and talk to their customers and put fears in
context.
Faced with difficulty borrowing from big banks, it
is no surprise that many small and midsize business
owners grew to love their local banks. In 2008,
Jamie Pennington, founder of Atlanta-based Flexible
Executives, moved most of her company’s money
to The Bank of Sandy Springs in Sandy Springs,
Georgia. The reason? The Bank of Sandy Springs
agreed not to put holds on her customers’ payment
checks, unlike the big bank she had been using. “As
a small-business owner, we like doing business on
a handshake,” says Pennington, who started her firm
in 2005 to help source part-time executives for
growing businesses.
Pennington was so impressed by her new bank,
in fact, that she stayed with it even when its parent
company, Buckhead Community Bancorp, went on
the Federal Deposit Insurance Corp. (FDIC) list of
“problem” banks amid rumors of its demise. “That
bank was so supportive when we started out, if
they were going to survive, we wanted to keep our
assets there,” she says, noting that she protected
her deposits by keeping them under the $250,000
insurable maximum. “I wanted to repay the favor.”
Such loyalty couldn’t prevent Buckhead from
failing, though. In December 2009, the FDIC took
over the bank, which held $856 million in assets, and
sold it to State Bank and Trust, a regional bank with
$2.8 billion in assets. Pennington’s own assets were
safe, but the allure was gone. State Bank “sent a nice
letter about wanting to have a relationship with us,
but almost immediately, the fees changed, service
charges started piling up, and we just didn’t know
anyone at that bank,” she says. Searching for another
local option, Pennington moved to the Bank of North
Georgia, not realizing it was owned by Synovus, an
even larger southeastern bank with more than $30
billion in assets.
After her local banks were gobbled up, Pennington
was biding her time. “We need to find another real
community bank, but I’m waiting for things to settle
out before switching, to see which community banks
survive,” she says.
Unfortunately, by 2011 the outlook for businesses
looking to work with small, local banks was
bleak. Thanks to a variety of factors, experts were
predicting more and more consolidation in the
banking industry—meaning that friendly local banks
will become fewer and farther between. As for new
banks, “it’s tougher now to form a bank than it has
ever been,” says Chris Cole, senior vice president
and senior regulatory counsel for the Independent
Community Bankers of America. Only 11 new banks
were chartered in 2010, he notes, compared with 190
in 2006. For businesses that depend on small banks,
this meant reduced access to credit, higher service
fees, and fewer handshake deals.
Undercapitalized and Overregulated
By early 2011, bank mergers in the wake of the
financial crisis mostly centered on targets that were
distressed or, like Pennington’s bank, had failed
and were sold with some backing from the FDIC.
Excluding the failures, the number of mergers
involving banks with assets under $1 billion rose
37% in 2010, to 153, according to SNL Financial.
One universal reason
for the uptick in
bank mergers was the
new compliance and
reporting burdens on
banks stemming from
the Dodd-Frank Wall
Street Reform and
Consumer Protection
Act. These regulations
made it more expensive
for banks to stand on
their own. “No matter
what size a bank is, it
believes it needs to be
bigger to digest the
cost of the increased
regulatory burden
that’s coming its way,”
says Michael Clarke,
president of Access
National Bank, which
is based in Reston,
“It’s tougher now to form
a bank than it has ever
been.” Only 11 new banks
were chartered in 2010,
compared with 190 in
2006. For businesses that
depend on small banks,
this has meant reduced
access to credit, higher
service fees, and fewer
handshake deals.
CFO PUBLISHING
19
Virginia, and has $832 million in assets. In response
to the Dodd-Frank Act, many banks had to add fulltime compliance staff members and they also had
to lower “swipe” fees charged when customers used
bank debit cards for payments. While smaller banks
were “carved-out” from this mandate, they were
forced to adopt the same price level in order to avoid
the risk of losing business to the largest banks.
And many local banks may have simply been too
small to shoulder the new regulatory burden. Joseph
Fenech, a banking analyst with Sandler O’Neill,
expected banks would need at least $1 billion to $2
billion in assets to sustain the additional costs, since
“it’s going to be really hard for some of these smaller
institutions to make do.”
Bigger Banks, Less Credit
Talk of such mergers made executives at small and
midsize companies nervous about future access to
credit. CFOs were concerned that big banks’ lending
decisions would be made at “arm’s length” using
a formulaic decision process with no regard for
a business’s credit and repayment history. These
decisions did not contemplate the opportunity for
discussion that small, community banks gave to
businesses seeking funds. Indeed, 73% of small
businesses using a small bank got the credit they
sought in 2010, compared with 48% of those using
a large bank, according to a report by the National
Federation of Independent Business.
Credit access wasn’t the only problem for finance
executives in a shifting banking environment.
Sharon Gottlieb, CFO of LogicMark, a fast-growing
maker of personal emergency response systems,
with more than $5 million in sales, saw her bank
service fees go up by 30% from 2010 to 2011, largely
due to hikes in checking-account fees and creditcard processing fees at larger banks. By 2011, such
fees consumed about 1% of LogicMark’s revenues.
Unlike community banks, where fees are somewhat
negotiable, Bank of America and others “are very
polite but very firm about their fees,” she said.
Gottlieb couldn’t escape the large banks—Bank
of America, for example, has a secure online
wiring service that she needed to pay her overseas
manufacturers—but she’d like to. “They’re charging
me more and giving me less,” she says. At the
community banks she works with, “you have [your
banker’s] cell-phone number, so when there’s an
issue you talk to a real person who knows who you
are. At the big banks, you have to go through all the
layers of the phone menu, and my ‘banker’ takes
three or four days to call me back.”
Added Dr. Michael Lesser, owner of a $6 million
specialty veterinary practice in Los Angeles: “I know
[large banks] don’t really care. I just want someone
who will pretend to care.” He has grown frustrated
with Citibank after banking with them for 9 or 10
years, in part because they held up the sale of his
wife’s business by forcing him to come up with
more than $400,000 in less than a week to replace
collateral for a property loan he has with the bank. As
soon as a third-party lawsuit involving his real estate
was resolved, Lesser planned to roll over his loan to a
smaller, more local bank.
But by late 2011, the banking picture for small and
midsize businesses seemed a little brighter. The
Small Business Lending Fund (SBLF), enacted as part
of the Small Business Jobs Act of 2010, encouraged
lending to small businesses by providing capital
to qualified community banks. In September 2011,
Centennial Bank announced that the U.S. Treasury
Department had granted it $1.8 million through the
SBLF. Jim Basey, Centennial chairman and CEO,
says the Greenwood, Colorado-based bank was
glad to take the capital, for several reasons. It came
with a low interest rate (1% at press time) and few
restrictions, other than confining loans to businesses
with fewer than 500 employees and capping loan
amounts at $2 million.
The recently recapitalized bank has been growing,
with $70 million in business loans outstanding and
an acquisition underway. But has the federal boostershot led to any loans Centennial wouldn’t have made
“Big banks are charging me more and giving me less. At the
community banks, you have your banker’s cell-phone number. When
there’s an issue you talk to a real person who knows who you are.
At the big banks, you have to go through all the layers of the phone
menu, and my ‘banker’ takes three or four days to call me back.”
20
CFO PUBLISHING
otherwise?
“No,” says Basey, without missing a beat. “We do
the same credit screen on everything; we have to
make sure every loan is done prudently.” In fact, the
bank places a great emphasis on relationships, so “if
someone walked through the door whom we didn’t
know, we’d be pretty skeptical.”
But so far the SBLF has not proven to be a miracleworker. Experts caution that it’s still early to assess
the results of the federal boosters, many of which
have only recently left government coffers. Yet the
outflow into the marketplace seems to be weak,
for reasons that have virtually nothing to do with
the availability of capital. “Quite honestly, I don’t
think banks want to lend right now,” says Lawrence
Manson, CEO of Nexgen Capital Partners, which
advises banks on their investments. “You can have
all the programs in the world, but it’s not the cost
of capital that is constraining [banks]. It’s the
inability of people to get comfortable with where the
economy is going.”
Michael Eldredge, CFO of the $16 million telecom
company AST Technologies, might agree that it’s
all about confidence. His company recently received
$5 million from PNC Bank on very favorable terms,
but it didn’t come easy, despite the fact that AST
has seen revenue increase by more than 30%
and EBITDA (Earnings Before Interest, Taxes,
Depreciation and Amortization) grow by more than
80% in the past year. Eldredge spent a year working
with bankers to secure a $2.5 million, five-year loan
and a $2.5 million revolver. Thanks to a positive
audit, the bank agreed not to tether the revolver to
the state of payables and inventory, but the company
will report on those monthly to the bank. And
there are personal guarantees attached to the loans
that will likely be removed in about a year pending
favorable 2012 financials.
In the end, things worked out well for AST, but
Eldredge doesn’t believe a spate of new government
programs had anything to do with it. “While there
is more money out there,” he says, “we either don’t
fit [many] banks’ profiles, or the rules remain
problematic and archaic and ultimately prevent
banks from lending their money. But if you can
demonstrate a history of meeting or exceeding
your goals, that gives bankers a comfort level that
you’ll do what you say you’re going to do.” Also key,
he adds, is developing a personal comfort factor
with your bankers. “You have to form business
relationships,” Eldredge says. “We’ve worked with
some of the people at our bank for years.”
CFO Summary
• After being turned down by big banks, small
and midsize companies turned to local banks
that understood their unique financial needs and
fostered close business relationships.
Don’t be the last to know!
Click here to read Vince
Ryan’s Banking & Capital
Markets blog.
• But banking consolidation led to fewer community
banks and a shortage of credit for smaller
companies.
• The Small Business Lending Fund (SBLF)
encourages lending to small businesses by
providing qualified community banks with capital.
• Even with these federal boosters, CFOs remain
concerned about getting financing from banks
because of economic uncertainty.
• The key to working with banks today: Develop a
strong relationship with your bank so that they
know your company’s history of meeting and
exceeding business goals.
CFO PUBLISHING
21
HELP FOR
THE LITTLE GUY
B
anks unquestionably have money, and
some companies are getting it, but what
does that mean for small businesses in the
current credit market? We surveyed the
banking landscape for smaller companies, including
assessments of what banks are doing to help and
and low demand from banks, in part because
small-business loan volume must increase in order
to keep interest rates low. Banks applied for only
$11.8 billion of the $30 billion Congress initially
earmarked; just $4 billion in requests was ultimately
approved, and then only to the healthiest banks.
where some of the recently launched programs
designed to improve the climate stand.
About half of those banks were former recipients
of the Troubled Asset Relief Program, and were
required to use the funds first to pay off that debt.
That cautious strategy may keep taxpayers whole,
but it puts the government in the position of
lending to banks that in many cases don’t really
need the money.
Small Business Lending Fund (SBLF)
This ambitious, one-year program aimed at
smaller banks (those with under $10 billion in
assets) was dogged by both procedural problems
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CFO PUBLISHING
So far, it’s unclear whether or not that money is
spurring any lending that wouldn’t have occurred
otherwise. In January of 2012, the Treasury
Department reported that banks had collectively
increased their lending by $3.4 billion over the
program baseline; the trouble is that the baseline
was an average of (generally low) 2009–2010 levels.
Many had made progress even before they got the
Treasury funds in mid-2011. The banks have some
incentive to increase qualifying loans to maintain a
low cost of capital, but many say that’s not a driving
factor for them.
For example, the 140-year-old Blue Hills Bank,
based in Hyde Park, Massachusetts, launched its
commercial lending division in early 2011, about
a year before the Treasury granted the bank $18.7
million in SBLF funds. Starting with only $1.7
million in loans, “we don’t need [to make] much
more than $17 million in loans for us to fill the plate,
and our business plans go far beyond that,” says
Stephen McNulty, longtime CFO of the $950 million
(in assets) bank. “If there had not been [an SBLF], or
if we had applied for it and gotten rejected, we still
would have proceeded—and succeeded—with our
plan.”
Bank executives also acknowledge that much of
their loan growth often comes from taking market
share from other local institutions, meaning that
the total pool isn’t necessarily growing. The bestcase scenario is that the money somehow creates a
rising tide, where banks’ overall health sparks more
lending. “The thinking was that the capital was
available, and while we didn’t need it short-term...
it sets a base for more-aggressive loan expansion
in 2013 and beyond,” says McNulty. Even if the
money helps fund more bank consolidation, it could
be helpful, he adds, since “one larger bank has the
ability to provide more capital than two or three
smaller banks.”
How to get it:
Businesses with fewer than 500 employees
can qualify for the loans, with no revenue limits.
The Treasury Department maintains a list of
participating banks on its website. Note that,
unlike the Small Business Administration process
(described below), banks are not generally creating a
separate category of “SBLF loans.”
State Small-Business Credit Initiative
The $1.5 billion program (which ultimately
dispersed $1.4 billion) is much smaller than the
SBLF but has great potential, since the government
is asking lenders to leverage the capital 10
times over. According to a recent Government
Accountability Office (GAO) survey, recipients
expect to use the funds to create or support 153
lending programs, ultimately fostering up to $18.7
Bank executives acknowledge that
much of their loan growth comes from
taking market share from other local
institutions, meaning that the total pool
isn’t necessarily growing. The best-case
scenario is that the money somehow
creates a rising tide, where banks’
overall health sparks more lending.
billion in new private financing and investment. All
but two states applied for the funds, and all were
approved.
Perhaps most helpfully, the SSBCI is designed
specifically to help generate nontraditional loans.
California, which in October 2010 received $168
million (one of the largest tranches) in SSBCI funds,
is channeling them through two programs in the
form of loan guarantees. One of the programs,
the California Small Business Loan Guarantee
Program, is available for nearly any company that
is considered “near-bankable.” Loans (which go
to California-centric businesses) can range from
$5,000 to $2.5 million, and include companies with
up to 500 employees.
The state’s loan-guarantee program existed
CFO PUBLISHING
23
before the SSBCI was launched, says program
director Merrill Stevenson, but “had pretty much
gone dormant” in 2009. With the fresh infusion
of funds, the program (propelled by local financial
development corporations, or FDCs, that advocate
for the companies) had convinced banks to make
110 loans through the end of 2011, and is hoping to
hit 200 in 2012. “A lot of banks are hesitant about
getting back into lending, but FDCs are working
with them and that’s helping,” says Stevenson.
Other states are using the money, in part, to set
up venture funds. Missouri, for example, has used
$16.9 million of its $27 million in funding toward a
state-run venture capital (VC) fund that has already
invested $7 million in 18 small businesses, according
to Treasury Secretary Timothy Geithner’s October
2011 testimony to Congress.
Since the government has not yet set up a
reporting system for this program, and since much
of the money was only recently disbursed, little is
known about its progress. The ambitious multiplier
effect is one likely future disappointment; the
GAO report noted that some recipients “expressed
concern that achieving a 10:1 leverage ratio of
private financing and investment to program funds
could ultimately prove challenging.”
How to get it:
The funds are mainly administered by statesponsored economic development agencies, so start
your research at the state level (and, in a handful of
cases, at the municipal level). Some of the programs,
like Missouri’s venture fund, have standard
application cycles with universal deadlines; others
are more ad hoc.
Small Business Administration Loans
Is the freeze in smallbusiness financing
starting to thaw? Read
Warming Signs?
24
CFO PUBLISHING
The longest-standing federal program to aid
small-business lending has had several good years,
in part due to the same Small Business Jobs Act of
2010 that created the SBLF and the SSBCI. In the
last quarter of 2011, though, it seems to be taking
a hit, with the number of SBA-backed loans down
about 50%, compared with the same quarter of
2010.
It’s not that the SBA is being cheap. Andrew
McCune, an attorney with McDermott, Will &
Emery who helps arrange SBA financings for clients,
says he has never seen the SBA so proactive at
trying to educate the marketplace on its offerings
and, in some sense, sell them to banks. (The SBA
generally guarantees the vast majority of a loan
that a bank deems risky.) But, as noted by Lawrence
Manson, CEO of Nexgen Capital Partners, many
banks are averse to even the hint of risk these days,
and the guarantees do not change their minds.
One frustrated former CFO who has been pursuing
an SBA-backed loan in the hopes that it will allow
his company to acquire a small, profitable business
in the Houston area says the program’s inflexible
criteria are obstructing his progress. “While money
is available, the terms are so severe that it is next
to impossible to qualify,” he says. (He asked that
his name not be used, as he hopes to work with the
banks in the future.) One example: the bank will
consider only tax returns from the selling business,
and not the interim results, which show 40%
growth this year. It also won’t allow for adjustments
to back out the current owners’ personal expenses
and reflect its higher real cash flow.
Collateral is another problem; the banks require
it, “but will not utilize the existing $700,000
in inventory or receivables as collateral,” since
they deem it unsellable, says the former finance
executive. Instead, they want a lien on his house.
(The SBA website notes that it “will generally not
decline a loan when inadequacy of collateral is
the only unfavorable factor,” but for all SBA loans,
“personal guarantees are required from every
owner of 20% or more of the business, as well as
from other individuals who hold key management
positions.”)
One potential ray of hope emanating from the SBA
is the increase in other types of funding the agency
is promoting, beyond standard bank loans. The
agency’s budget indicates it is aiming to make more
microloans available to “unbankable” entrepreneurs,
while it is also crafting a new venture-like program.
Parallel to all of that is the increasingly successful
SBIC program, which lends money to private-equity
firms at low rates for middle-market financing.
How to get it:
The list of SBA lenders is on the agency’s website
(www.sba.gov). It’s also worth poking around
the byzantine site for some of the lesser-known
alternatives.
Large Banks: Ready and Willing?
Government efforts aside, how easy is it for
smaller companies to get a conventional bank
loan or line of credit these days? The answer
largely depends on whom you ask. Multiple
sources indicate that credit is still tight for smaller
companies. Between Q3 2010 and Q3 2011, the
majority of finance executives polled in our Duke
University/CFO Magazine Business Outlook Survey
said they found borrowing to be about the same or
slightly more difficult. Few said it was much more
difficult, although those who did were concentrated
in the under–$100 million revenue range.
Executives at the biggest banks counter that they
are, in fact, aggressively seeking to lend to smaller
companies. “We are all extremely motivated to
extend more credit [to smaller businesses], and
our people are very focused on it,” says Robert
Hilson, head of Bank of America’s small-business
segment, targeted at companies with up to $5
million in annual revenues. The dollar volume of
new originations (including credit-card-based debt)
to such companies increased 21% in 2012, he points
out, with loan-approval rates doubling in the past 18
months.
That growth has been bolstered by an internal
reorganization and the presence of 700 newly hired
small-business bankers in branches across the
country. “We’ve always had people in our branches
available to talk small business, but to be fair, we
did not have the level of expertise in those banking
centers that we have today,” Hilson acknowledges.
Such bankers still don’t make the final decisions on
loans, but “at the end of the day, they get paid for
making good loans.”
As far as credit standards, “I don’t want to say
our credit standards have loosened,” Hilson says,
but the improving economy is allowing loan officers
to be “more accommodating” and look at variables
like future orders and interim reports along with
historical financials when assessing a client’s ability
to repay.
The same trend holds true at Wells Fargo, which
saw new lending to companies with under $20
million in revenue rise 8% in 2012, to almost $14
billion, including a 40% spike in SBA-backed 7(a)
loans for federal fiscal-year 2011. What drove the
increase? “The quality of applicants has improved,”
says Marc Bernstein, head of Wells Fargo’s smallbusiness segment.
He sees the decline in lending over the past
several years as a function of several factors. When
the recession began, many businesses were carrying
high levels of debt and faced declines in sales that
made it harder to obtain additional credit. During
the recession, “it’s not as if we required something
dramatically different, it was that the businesses
coming in looked weak,” says Bernstein. Now, loan
approval rates are “the same as they were before the
recession.”
Those claims are supported by data from
the Thomson Reuters/PayNet Small Business
Lending Index, which measures the volume of new
commercial loans and leases to small businesses.
It was up 18% in 2011, hitting a four-year high
in November (when the annual statistics were
compiled).
The situation is frustrating, to be sure: piles of
money (including hard-earned taxpayer dollars)
are parked at banks, while many businesses starve
for lack of funding. In the end, despite the positive
statistics at the macro level, many individual
companies are left feeling that they still can’t get
the money they need. In the not-too-distant future,
the federal programs may live up to their lofty
potential and create enough competition to spur
banks to lend more readily. That certainly hinges
far more on what’s happening beyond the banks’
vaults and approval systems. Says Andrew McCune
at McDermott, Will & Emery: “Once there is more
confidence in the economy, there is extraordinary
liquidity available.”
If things go well, that could be the understatement
of the decade.
CFO Summary
• The Small Business Lending Fund (SBLF)
encourages smaller banks to lend to businesses
with fewer than 500 employees. Visit the Treasury
Department website for a list of participating banks.
• The State Small-Business Credit Initiative (SSBCI)
aims to generate nontraditional loans for small
businesses, with funds administered by state
economic development agencies.
• Small Business Administration Loans (SBA-backed
loans) guarantee the vast majority of a loan that
a bank deems risky, and include a variety of loan
programs for specific purposes. Visit www.sba.gov
for a list of SBA lenders.
• In addition to government programs, larger
banks have increased loans to small and midsize
companies. One big bank executive explains, “The
improving economy has allowed our loan officers
to be more accommodating and look at variables
like future orders and interim reports along with
historical financials when assessing a client’s ability
to repay.”
CFO PUBLISHING
25
OVERCOMING HURDLES
SMOOTHING THE
IPO PATH
T
he year 2010 showed yet again how volatile
the initial-public-offering market
can be. The Securities and Exchange
Commission kicked off its latest effort
to open up funding options for private companies
with an all-day meeting of its new advisory
committee on small and emerging business in late
October 2011.
“People have woken up to the fact that funding
innovation is a problem we should do something
about,” says committee co-chair Stephen Graham,
an attorney with Fenwick & West who represents
growth companies in financing deals and IPOs.
He says the group will be making ongoing
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CFO PUBLISHING
recommendations to the SEC during its two-year
lifespan.
The group was formed in summer 2011 in
response to concerns that the IPO process is
too high a hurdle for growth companies, that
Sarbanes-Oxley compliance may be too costly
for them, and that smaller companies need other
means for raising capital from private investors.
The biggest issue the group confronts: coming up
with alternatives that lift the burden on companies
while still offering investor protections that the
SEC would deem adequate.
The idea of an “IPO Lite” is one of the more
alluring options the committee is considering.
“How do we make it so that it’s
not either on or off; one day
you’re a private company and the
next you’re a public
company. . .spending $3 million
on compliance?” muses Graham.
He points to some alternative
models, like a phased series
of compliance hurdles that
independent group IPO Task
Force has proposed, as avenues of
exploration for the committee.
Others are looking to work
within the current boundaries of
the SEC’s Regulation A process, a
modified IPO in which companies
can register shares without
producing a full set of audited
financials. Reg A is rarely used,
because companies can raise
only up to $5 million and must
comply with a variety of state
securities laws. At the meeting,
SEC officials explored how they could make the
process more useful. Congress is also looking at
Reg A, with the House of Representatives passing a
bill to raise the limit from $5 million to $50 million
in the week following the meeting. However,
the efforts in Congress and at the SEC are not
dependent on one another. Says Graham: “We’re
focused on making recommendations the SEC
could implement without an act of Congress.”
If the Reg A cap were raised to $50 million,
and if the state compliance burden were reduced,
the process “would be worth looking into for
my company,” said Kathleen A. McGowan, vice
president of finance for Tobira Therapeutics,
at the meeting. Tobira is a venture-backed
biopharmaceutical company focusing on HIV
treatments that raised a B round of funding in
September 2010.
Indeed, some investors seem very open to
something less than a full-blown SEC reporting
regime from the companies in which they invest.
“Why couldn’t the SEC come up with a one-page
reporting [format] that a company could post on
the web?” asked Milton Chang, managing director of
Incubic Venture Fund.
On the flip side, Richard L. Leza, chairman of
Exar, a company that makes specialized silicon and
software products, suggested the cost of complying
with reporting structures like Sarbanes-Oxley
might not be as great as some people supposed,
particularly as corporate executives learn the
process over time. Exar, a Nasdaq-traded company
with close to $150 million in revenue, saw its audit
and compliance costs double, from $1.5 million
to $3 million, when it initially began hewing to
Sarbox rules. Now, those costs are back down to $1.5
million, Leza said.
By early April 2012, President Obama had signed
the Jumpstart Our Business Startups (JOBS) Act
into law, easing the way for small and midsize IPOs.
The bill rolls back some SEC rules to make it easier
for more companies to become publicly traded by
bypassing audits and disclosures once required for
investors. Under the JOBS Act, companies with less
than $1 billion in gross revenue seeking to go public
would have up to five years, or until revenues reach
$1 billion, to supply the SEC with an independent
audit and certain investor disclosures.
CFO Summary
• Smaller companies looking to go public face
considerable hurdles, particularly the expense
of complying with Sarbanes-Oxley and raising
adequate capital from private investors.
• In response to frustrations with IPO hurdles for
small, private companies, a new bill has eased SEC
rules for some companies to bypass the audits and
disclosures required for investors.
The group was formed in summer 2011 in response to concerns
that the IPO process is too high a hurdle for growth companies, that
Sarbanes-Oxley compliance may be too costly for them, and that
smaller companies need other means for raising capital from private
investors.
CFO PUBLISHING
27
THINKING OUTSIDE THE
(TRADITIONAL BANKING) BOX
ALTERNATIVE FINANCING
A
t a late October 2011 meeting of the
Security and Exchange Commission’s
(SEC) new advisory committee on small
and emerging business, a discussion of
crowd-funding revealed the committee’s frustration
with some of the current SEC rules. While most
crowd-funding raises are now outside the purview
of the SEC, since they involve a company offering
a product rather than securities in exchange for
money, some companies would like to raise more
money through such platforms and offer debt or
equity.
While that is technically possible now, investor-
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CFO PUBLISHING
protection laws often hamstring them. The rules
limit how and to whom the deals can be marketed,
making it difficult for companies to reach a critical
mass of investors.
Considering Crowd-Funding
Many argue, in fact, that attempts to confine the
marketing of such deals to the traditional “friends
and family” is unrealistic in the world of Facebook,
LinkedIn, and other web-based networks. “The
SEC cannot lock down everything,” said Shannon L.
Greene, CFO of Tandy Leather Factory, a small-cap
company traded on Nasdaq. “If someone wants to
put something stupid out there, you can’t protect
every $100 investor. Some of the onus of investor
protection has to be on the individual investor.”
Meanwhile, Paul Maeder, general partner with
Highland Venture Partners, pooh-poohed the
whole notion of crowd-funding. “What problem
are you trying to solve?” he shot at SEC officials,
suggesting that qualified investors such as his firm
are very easy to find. “If you don’t have an angel
network, it’s because you don’t know how to use a
browser, which arguably means you shouldn’t start
a business,” said Maeder. For small companies, he
argued, “access to capital is not a problem.”
But access to capital often varies greatly by
region, other panelists countered, and asking a large
group of people for investments doesn’t always
mean a company is too weak to get funded by
traditional means. Sean Greene, the Small Business
Administration’s special adviser for innovation,
said: “There are a lot of smart, interesting people
looking at this, not just people with wacky ideas.”
Another Option: Angel Investors
When finance executive Ane Ohm joined Harqen,
an early-stage company that makes tools to index
and analyze recorded phone conversations, one
of her reasons for taking the job was, in a sense,
lofty: she hoped to meet angels. While the ones she
was targeting are not quite as rare as the heavenly
variety, angel investors are not as commonplace as
smaller companies would like.
With bank financing still uncertain, small and
midsize companies are looking to alternatives, with
mixed results. Angel groups generally invest in only
1% to 10% of the opportunities that come before
them, according to Marianne Hudson, executive
director of Angel Capital Association. Those are
slightly better odds than companies seeking venture
funding or private-equity infusions will encounter,
according to a recent survey by the Pepperdine
Capital Markets Project, but just 13% of businesses
that responded to that survey reported getting
funding from any of those sources.
Small businesses on the hunt for cash may,
however, benefit from the massive cash hoards
that large companies possess. According to one
recent study of more than 800 public companies,
cash balances at the end of 2010 had more than
No matter how the
capital comes in
the door, finance
executives need to
understand that by
cashing the check
they are accepting
a new and active
partner. That
involvement can take
the form of board
seats, coaching
programs for top
executives, and
even business-plan
revisions.
quadrupled, on average,
compared with 10 years earlier.
Indirectly, these deep pockets
may help growth companies
by providing tired investors
with renewed liquidity. “If the
large corporates make more
acquisitions and create more
exits, they may get people
excited about investing again,”
says Jeffrey Sohl, who tracks
angel investing as director of
the Center for Venture Research
at the University of New
Hampshire’s business school.
More directly, many large
companies are looking to sink
money into companies that
can possibly speed their own
growth. An increasing number,
including EMC, Google,
and Juniper Networks, have
established or renewed such
efforts. “Corporates see [such
venture efforts] as outsourcing
R&D,” says Gerald Brady,
managing director with Silicon
Valley Bank’s venture-capital
group, who previously worked
with Siemens’s ventureinvestment arm.
No matter how the capital
comes in the door, however,
finance executives need to understand that by
cashing the check they are also accepting a new and
active partner. Experts say that both angel and largecompany investors want to be intimately involved in
the business. That involvement can take the form of
board seats, coaching programs for top executives,
and even business-plan revisions.
For Ohm at Harqen, such intervention has
been a benefit rather than a burden. “I can’t say
enough about how much value I’ve gotten from
our angels,” she says. As vice president of finance
and operations, she has participated in coaching
and strategy programs run by her angel investors.
That has helped her track what’s happening on
the competitive landscape, and develop a vision
CFO PUBLISHING
29
For more information
on working with angel
investors, read How to
Dance with Angels.
30
CFO PUBLISHING
for how the company should grow and evolve over
time, so that when it’s time for an exit, “it’s a good
transition,” she says.
Ohm joined after Harqen had raised two rounds
from angels. The company is currently seeking
its third round to help launch a new product. In
her time with the company, Ohm has learned
that angels stick close. The same investor, Lauren
Flanagan, has led all three rounds, and has helped
introduce the company to others that could help,
including angel groups that aim to invest in
woman-led companies.
Such closeness has drawn a tight circle around
the types of investors Ohm will approach in this
latest round. “When you have a really good group,
you want to think very critically before you go
outside of it,” she says. Her main goal is to make
sure any additional investors contribute specialized
expertise, a goal that could at some point extend to
a corporate venture arm.
Angels typically look for high-growth firms with
great market potential, even if they have no current
revenues. Such firms are typically valued at $1.5
million to $2.5 million before the investment, with
median deal size between $500,000 and $750,000,
says Angel Capital Association’s Hudson.
Larger sums, however, may be more readily
available because angels are increasingly syndicating
their deals. Jeff Gray, CEO of cloud-computing
start-up Glue Networks, says that “more than
$4 million appeared [practically] out of thin air,”
thanks to two angel groups that syndicated the deal
with four others.
Here Come the Corporates
Corporate venture investors are also getting more
involved in portfolio-company operations, in large
part because they view such investments as a vital
part of their own growth strategies. In the past,
“they kind of stood back, and did not take board
seats or an active role,” says Mark Heesen, president
of the National Venture Capital Association. “Now
they want to be an integral part of helping that
company grow to the next level.”
“Our investment efforts are generally intended
to be friendly; we’re fairly straightforward in the
terms we propose, and we try to add value to the
companies and make them successful,” says Jeff
Lipton, a former engineer and VC who now heads
up Juniper Networks’s venture efforts. Juniper
reviews more than 200 companies a year, and ends
up investing in only 7 to 10, about a 5% hit rate.
The firm is open to acquiring, and has done so in at
least two cases recently, but its main aim is to help
products come to market that complement its core
platform, Lipton says.
While corporate venture funding tends to rise and
fall with corporate fortunes, the volume of dollars
coming from corporate venture arms was up to $1.4
billion in the first two quarters of 2011. That puts it
on pace to be the best year in a decade.
Most deals involve a co-investment between
traditional and corporate VCs. Traditional VCs
are more open to getting help than in the past,
particularly in capital-intensive industries like
clean technology and semiconductors. “There’s a
sea change in how the corporate VCs are perceived;
they are now the well-heeled, deep-pocketed
investors that are also the likely acquirers,” says
Gerald Brady at Silicon Valley Bank. For their part,
corporates appreciate the deep deal experience
they can gain from partnering. “We like to follow
financial investors and have them set the financial
valuation,” says Lipton.
Each corporate fund has its own mandate, and
it can vary greatly even within the same firm, as
Juniper’s funds demonstrate. While the bulk of the
investments go toward a broad range of early- and
late-stage software firms, the $4 billion maker of
high-speed switching routers will also consider
hardware and component makers at any stage. It is
also willing to consider even younger companies,
though its investment time horizon is generally one
to four years.
The moral of the story? With a little creativity,
high-growth companies may find ways to shake
loose much-needed capital from investors both
large and small. To do so successfully, CFOs should
research what investment groups are looking
for—their goals and rules can vary widely—and be
patient and persistent in wooing them. It wouldn’t
hurt, of course, if the stock market were to make a
spectacular recovery.
CFO Summary
• Research what investment groups are looking for
and be persistent.
• Crowd-funding has attracted both interest and
skepticism. For some companies, access to capital
can be hard to come by, but critics say that isn’t
really a problem for small and midsize companies
looking for investors.
• Another alternative to consider: angel investors.
While angel groups only invest in a small
percentage of opportunities that come their way,
they bring considerable knowledge to growing
companies and often take an active role in the
business.
• Venture capital (VC) investors are interested in
acquiring smaller companies as part of their own
growth strategy. Most deals are co-investments
between traditional and corporate VCs.
Corporate venture investors are getting more involved in portfoliocompany operations because they view such investments as a vital
part of their own growth strategies. In the past, “they kind of stood
back, and did not take board seats or an active role. Now they want
to be an integral part of helping that company grow to the next
level.”
Sources for Finding Funds: Banking and Financing:
“A Small Problem,” Alix Stuart, CFO Magazine, April 1, 2011.
“Capital vs. Confidence,” Alix Stuart, CFO Magazine, March 1, 2012.
“Credit Still Scarce for Small Companies,” Alix Stuart, CFO.com, January 27, 2011.
“Just Call Me Angel,” Alix Stuart, CFO Magazine, October 1, 2011.
“Smoothing the IPO Path,” Alix Stuart, CFO Magazine, December 1, 2011.
CFO PUBLISHING
31
GOING
GLOBAL
“Exploiting fast-growth markets is certainly one reason
to take the plunge. But midsize CFOs beware. ‘To be
willing to take on that level of risk and complexity,
you’ve got to have really good reasons, like new markets,
new technology, or new sourcing,’ says one midsize
corporate finance executive.”
32
CFO PUBLISHING
GOING GLOBAL
OPPORTUNITIES
OVERSEAS M&A
A
s many CFOs at small and midsize firms
search for growth, the most popular growth
strategy remains expanding within U.S.
markets. But over time, companies in this
revenue range expect to be more reliant on overseas
markets. “Because there’s such a high concentration
of revenues today within U.S. borders, it’s natural for
them to look outside for new growth opportunities,”
says Stephen McGee, head of corporate finance
for Grant Thornton, a firm specializing in advising
growing, privately-held companies. The Asia-Pacific
region, China, and Western Europe top the list of new
markets that companies are pursuing.
Making an overseas acquisition is a true test
of CFO savvy. Such transactions are rife with
things that can go wrong, including due-diligence
roadblocks, regulatory missteps, and cultural snafus.
In fact, because cross-border acquisitions are “as
hard as it gets,” says McGee, “many companies,
particularly midmarket companies, just choke on
that risk and bypass such deals.”
Of the 41% of privately held companies that plan
to grow through acquisition in the next three years,
for example, fewer than a third plan to do so through
foreign acquisitions, a ratio that, McGee says, has
remained fairly constant through different economic
cycles. Instead, most companies without a dedicated
international M&A team tend to get a toehold in a
foreign market by first setting up a sales office or
working with a local partner, then slowly adding
more people as operations expand.
But not every CFO has the luxury of taking
that slow-and-steady approach, particularly in
geographies that are booming. “Brazil is growing so
fast you can’t keep up just by growing organically,”
says Michael Lucki, CFO of CH2M Hill, a $6.3
billion global engineering and construction firm.
CH2M Hill has had a presence in Brazil for more
than 10 years, and now has about 180 employees
there, but the company is currently evaluating
Brazilian businesses that it could merge with its
existing operation. “In a good year, we can double
head count from, say, 200 to 400, but the change
in Brazil is so great, we probably need 1,000 people
there tomorrow,” Lucki says, noting the country’s
projected 9% GDP growth rate for 2011 and equally
impressive government construction budgets.
Exploiting fast-growth markets is certainly one
CFO PUBLISHING
33
reason to take the cross-border plunge. And with
the domestic economy expected to limp along for
the foreseeable future, those with aggressive growth
goals may be forced to look overseas. CFOs also say
they are buying abroad to follow existing clients, or
to tap new sources of innovation.
Very rarely, however, are they buying companies
with assets that could easily be found or replicated
stateside. “To be willing to take on that level of
risk and complexity, you’ve got to have really good
reasons, like new markets, new technology, or new
sourcing,” says McGee.
Approximately 450 U.S.-based companies
acquired businesses outside the United States in the
first quarter of 2011, up from 370 in the first quarter
last year and on track to surpass the 1,666 such
deals in 2010, according to Capital IQ. At companies
with revenues between $100 million and $1 billion,
finance chiefs completed 45 cross-border deals in
the first quarter of 2011, compared with 31 in the
first quarter of 2010 and 136 during all of 2010.
Europe is still the hottest place for midsize
companies to seek targets, but Asia is quickly
gaining ground. “We haven’t seen a lot of M&A in
China, because of the complexities of acquiring
there,” says Larry Harding, president of High Street
Partners, a firm that helps U.S. companies with
back-office functions overseas, “but I would expect
that to change in the next 18 to 24 months.”
So how can CFOs contemplating their first
overseas deal avoid a disaster? Several finance chiefs
who have recently been through the process—some
for the first time—share their best advice.
1. Find a Stunt Double
Antenna Software, a venture-backed software
developer focused on mobile applications, recently
bought Volantis, a mobile Internet specialist, based
in Guildford, England, in order to complement its
core product lines. Antenna CFO Bill Korn’s first
A finance chief considering an overseas
acquisition will likely need lots of
assistance, much of it not available
in-house. Indeed, part of the recipe for
cross-border success is recognizing the
need for a significant amount of help.
34
CFO PUBLISHING
step along the path to a successful transaction was
to find himself a stand-in: a UK-based CFO with
M&A experience who could head up due diligence
on the company before the purchase.
While Korn himself was on-site for the first week
of due diligence, he considers it essential to have a
trusted adviser “living” at the company throughout
the process. Brian Knight, whom Korn found
through the Financial Executives Networking Group,
an international cross-industry organization, spent
four to five days a week at Volantis for a month,
in part to help foster camaraderie with employees
at the target company. He also passed along key
insights, Korn says. “When you have a question,
you have someone who can walk across the hall
and ask, ‘Why was this deal structured this way?’“
he says, an approach that is much faster and less
confrontational than the alternative, “which is to
have your lawyers call their lawyers.”
Knight’s job was done when the deal closed, but
Antenna retained Volantis’s former CFO as the vice
president of finance for the global company, which
helped accelerate integration in both directions.
The distance “is not a problem,” says Korn, and
he expects his new UK-based colleague to be
“instrumental” in helping prepare the company for
its initial public offering.
2. Don’t Skimp on the Help
A finance chief considering an overseas acquisition
will likely need lots of assistance, much of it not
available in-house—particularly at a smaller
company or one that is new to international
markets. Indeed, a part of the recipe for cross-border
success is recognizing the need for a significant
amount of help.
In general, a company needs either two sets of
attorneys—one based in the United States and
one based in the country of the acquisition—or an
international law firm with offices in both locations.
For its part, Antenna hired a hybrid team of UK- and
U.S.-based law firms that were able to work together.
Antenna’s UK attorneys led the process, says Korn,
but with advice from its U.S. lawyers, “who were
most familiar with Antenna and comfortable with
its process of completing acquisitions.”
Of course, lawyers are happy to point out the
perils of getting that equation wrong. One attorney
with a multinational firm notes that a new client, a
private-equity-owned company looking to expand
abroad, made such a disastrous initial cross-border
acquisition that it is now considering less-radical
expansion options. By using only Brazilian legal
GOING GLOBAL
counsel when it bought a company in Brazil, the
company misunderstood some of the regulatory
approvals it had to get and was ultimately delayed in
its efforts to go to market there.
Similar regulatory red tape abounds in other
high-growth emerging markets, including China,
adds Mark Harris, a partner with McDermott
Will & Emery. “Local counsel may understand the
landscape, but may not be able to communicate it
back [to you],” he says.
Finance chiefs acquiring abroad need other kinds
of expertise as well. For example, InnerWorkings,
a $482 million public company that helps manage
print procurement for large global companies,
bought a company in Chile in order to better meet
the needs of its global clients. The company had
made many acquisitions—five or six per year—in
the past, but this was only its second international
deal and its first in South America.
As such, CFO Joseph Busky did something he says
he would never do for a U.S. acquisition: he hired
a Big Four accounting firm’s Chilean office to help
investigate the target firm, CPRO.
“The risk for fraud in South America is much
greater than in the United States, so make sure
you have the right controls and...have someone
on your side who knows the pitfalls,” Busky says.
“Having someone on your side who speaks the same
language and who knows what the pitfalls are is
invaluable.”
That doesn’t mean that a company should
simply outsource all due diligence, of course.
“There’s no replacement for having someone in
your organization do the technical due diligence
[on intellectual property], if the acquisition is
within your industry,” says Duncan Perry, CFO of
PeopleCube, a maker of facilities scheduling and
management software. Perry has been involved
in several international acquisitions in his
career, including one in the United Kingdom for
PeopleCube in the past year. “If you don’t know
what you’re getting in terms of intellectual property,
you’re missing half the value,” he says.
3. Don’t Ignore Workforce Issues
Many parts of Europe are famous for their laborprotection laws, which generally make it very
difficult to fire people. “Reductions in the workforce
usually take longer and cost more than you would
ever imagine,” says High Street Partners’s Harding,
in part because “the concept of ‘at-will’ employment
doesn’t exist outside the United States,” he says.
CFO PUBLISHING
35
To learn more about
potential overseas tax
issues, read Don’t Get
Caught in an Overseas
Tax Trap.
For that reason, PeopleCube’s Perry recommends
getting a good handle on a workforce strategy
preacquisition. “If you’re going to be losing people,
you should handle it prior to the acquisition, since
the seller may have more flexibility on terminations
than the buyer,” he says. If not, a company may be
locked into a higher head count than it needs for
longer than it expected.
Case in point: after a recent acquisition, one
company chose to close an operation in the UK
that was performing well, rather than a somewhat
poorer-performing location in the Netherlands,
simply because Dutch labor laws made it so
“difficult and expensive to terminate employees”
that closing the UK operation “was the far cheaper
alternative,” says Michael Martell, an attorney with
Morrison Cohen in New York. Hiring contractors
overseas can also be tricky, since short-term
contracts can quickly trigger long-term obligations
on the company’s part.
But while new territories present plenty of new
labor laws to digest, understanding local culture is
equally important for buyers that want to get off on
the right foot with new employees overseas. “Often,
you can adhere to all the legislative requirements
very carefully, but miss the one factor that
employees in the office really care about,” says Perry.
In his experience, flexible work hours can be one
such perk. “It’s easy for U.S. employees, in a car
culture, to concentrate on arrival time as something
important, but that’s not as easy when you’re
dependent on public transportation,” as most UK
employees are. “If you were to impose hours that
were inconsistent with the train and bus schedules,
for example,” he says, it could be a disaster.
4. Take Care with Taxes
Tax liabilities count among the greatest hidden
risks of cross-border expansion, says Harding,
who adds that “it often takes a while—up to three
years—before such liabilities arise.” Tax issues fall
into a couple of buckets, many of which a finance
executive will be familiar with if the company
already has a sales office or other presence in a
country.
Transfer pricing, or the way the company prices
the goods and services it receives from the foreign
entity, is a major issue, and one that tax authorities
are getting more aggressive about scrutinizing.
In this case, “the proper documentation of the
methodology is almost as important as the
methodology itself,” says Harding.
36
CFO PUBLISHING
While the documentation requirements vary by
country, few companies have fully documented
their positions, and the task only gets harder as
the volume of transactions piles up, so Harding
recommends starting early. Companies may also
consider setting up an advance pricing agreement
with local authorities to avoid later challenges, a
strategy that is becoming increasingly popular.
Value-added tax (VAT) in European countries
is another important topic to address early, since
such tax is “hard to fix retroactively,” Harding says.
(Rule number one is to never do business in Europe
without a VAT registration number; rule number
two—ideally and where possible—is to maintain
that registration in only one EU country and clear all
EU-based goods through customs there.)
One other VAT tip: explore the potential tax
benefits of establishing a foreign subsidiary, rather
than opening a branch office. The latter could face
much higher tax liabilities.
Outside Europe, Brazil and India present
particularly thorny tax requirements, “most of them
not intuitive to U.S. finance professionals,” says
Harding. Those countries, as well as China, also
have strict rules about repatriating profits and other
transfers of currency to foreign destinations, which
can affect the overall tax picture.
And if corporate tax rules don’t offer enough
complexity, potential buyers should also be aware
of the personal tax implications for owners and
executives of foreign companies. “Personalcompensation tax overseas can be significant, and
you can create disgruntled employees very easily
if you convert their tax status,” says PeopleCube’s
Perry.
One often-overlooked incentive is the InterestCharge Domestic International Sales Corporation
(IC-DISC), which can save small and midsized
companies as much as 20% on income from
exports. The provision enables companies that
manufacture and ship products or services abroad to
reduce their tax bill by creating separate tax entities
called IC-DISCs that are taxed at the capital gains
rate, a lower rate than income taxes.
Here’s how it works. A company pays a taxdeductible commission based on its export income
to this separate entity, its IC-DISC. The IC-DISC
then pays dividends to the exporter that may be
taxed at a capital gains rate of 15%, a lower rate than
the ordinary income tax rate, which could be as
much as 35%.
Parts manufacturers can also qualify for this, for
GOING GLOBAL
example. Thus, a company that builds tires for cars
that are shipped overseas could take the credit,
says Dean Zerbe, national managing director at
alliantgroup. And architectural and engineering
firms can take the credit if they design buildings
in the United States that are then built in other
countries. The downside: the provision that allows
companies to pay tax on these IC-DISC dividends at
the capital gains rate will expire at the end of 2012,
unless it is extended. Companies must therefore
consider carefully whether it is worth the cost of
setting up an IC-DISC right now.
5. Be Patient
Antenna has a track record of completing U.S.
acquisitions within four weeks, a strategy Korn
feels gives the company an advantage in bidding
even though it means a very intensive due-diligence
process. “A large company might pay more, but
it could take six months to get a term sheet and
another six [to close the deal],” says Korn.
He acknowledges, though, that cross-border deals
will inevitably take a bit longer—eight weeks in
Antenna’s case. He also says that companies should
devote time to communication, because “in any
deal the experience level of the parties will vary, so
maintaining a dialogue is key.”
The time lag can arise from time-zone differences,
but also from cultural differences. “The culture in
Chile is such that nothing is a rush, and the level
of sophistication of the staff and the accounting
systems is much lower than we have here,” says
Busky. Accordingly, buying CPRO in Chile took
InnerWorkings about nine months. Busky estimates
that an equivalent domestic deal would have taken
two months or less.
Bear in mind, too, that the target firm may feel the
due-diligence demands are over the top, even if they
are standard for the United States. In general, U.S.
investors “ask for much more detailed information
than European lawyers would be interested in,
like asking to review leasing agreements for
photocopiers, agreements with office cleaners,
parking spaces, and so forth,” notes Martell of
Morrison Cohen. “In Europe, counsel tends to be
more focused on the important agreements.”
Patience, however, has its rewards, including a
nice résumé boost for the CFO who can pull off
an international acquisition. Companies looking
for a new finance chief, particularly in the middlemarket revenue range, consider such experience a
big plus, says Jim Wong, an executive recruiter with
Chicago-based Clear Focus Financial Search. Even
if the deal doesn’t go perfectly, “if the candidate can
communicate his analysis of what to do the next
time around, that’s just as important as the net
result.”
Indeed, making an overseas acquisition is a rite
of passage both for a company and for a CFO.
Demonstrating a talent for strategic growth is now a
CFO skill highly prized by recruiters. No CFO would
pursue a deal simply to burnish a résumé, of course,
but it certainly yields a halo effect—if the deal goes
well.
CFO Summary
• Making an international acquisition is an invaluable
experience for CFOs at small and midsize
companies.
• Get a toehold in the foreign market by setting up a
sales office or working with a local partner, and then
add more people as operations expand.
• Make sure global expansion promises enough
reward to counter the risk: “To be willing to take
on that level of risk and complexity, you’ve got to
have really good reasons, like new markets, new
technology, or new sourcing,” explains one SFE.
• Have a trusted advisor on the ground at your
overseas office.
• Consider the legal complexity ahead: retain two set
of attorneys (one here and the other in the country
of your acquisition), and make sure your team
understands any regulatory red tape it might expect
to encounter along the way.
• The greatest hidden risk: tax liabilities. Prepare
for documentation requirements and personal tax
implications, but consider the often-overlooked
incentive of the Interest-Charge Domestic
International Sales Corporation (IC-DISC) which can
save your company as much as 20% on export
income.
CFO PUBLISHING
37
BUSINESS BEYOND BORDERS
SUPPLY CHAIN
I
38
CFO PUBLISHING
n line with anticipated global expansion, smaller
companies are increasingly using offshore
suppliers. In a 2012 survey among senior
finance, IT, and line-of-business executives
at U.S. companies, respondents anticipated that
their companies’ use of third parties would grow
relationships commonplace. “You’re going to pick
the best supplier regardless of where they are,” says
Grant Barber, executive vice president and CFO of
Hughes Communications, which designs, builds,
and launches communications satellites for its
broadband service. (See Figure 1 on page 39.)
in the next two years, both domestically and
internationally. (See accompanying figure.) In
particular, the mobilization of large, increasingly
skilled, and cost-effective workforces in a
wide range of developing economies, as well as
advances in the information technologies that link
widespread enterprises, are making longer-distance
For the past two decades, Tennessee-based Storm
Copper Components has sourced the raw copper
bars and sheets that go into its products solely from
U.S. suppliers. That strategy has worked well, says
CFO Vince Schreiber, because the heavy materials
are expensive and slow to transport, and customers
want their orders fast.
GOING GLOBAL
Around 2009, however, it became clear that the
fast-growing private company (150 employees)
needed to diversify its supply base to work around
the problem of sporadic domestic shortages and
slowdowns. The solution: two additional suppliers
on two different continents.
“Our preference is generally to do business with
U.S. suppliers,” says Schreiber, “but, ultimately, this
is a customer-service decision.”
James P. Jones, CFO and COO of Edward Don &
Company—a U.S. maker and distributor of foodservice equipment—points out that even his
company’s domestic suppliers are now depending
more on overseas vendors. “We don’t manufacture
as much as we used to in the U.S.,” says Mr. Jones.
“The business world continues to seek more value,
and that has forced us over the years to be more
offshore.”
That sentiment is increasingly being echoed at
companies both large and small. Looking beyond
U.S. borders for supply “is becoming much more
mainstream, primarily due to competitive forces,”
says Bob Ferrari, a supply chain analyst. In some
cases, firms are simply being proactive; in others,
they feel pressured to explore such options because
they fear competitors will undercut prices by
making the move first.
But managing global suppliers isn’t easy. Even
a company as sophisticated as Apple has trouble
keeping its offshore suppliers in line, as the
consumer-electronics giant disclosed in a recent
groundbreaking report. Environmental and ethical
violations abounded, such as using underage labor
and underpaying workers.
“You obviously can find cheaper-made goods”
outside the United States, says Gene Tyndall,
executive vice president of global supply-chain
services at consultancy Tompkins International.
But the real question for a CFO, he adds, is whether
the so-called total delivery cost—the one that
takes into account operational risks and potentially
disastrous financial-statement effects—outweighs
the cost-savings.
Companies that want to extend their supply
FIGURE 1. A majority of executives say that they regularly work with third parties, and very few expect their
companies’ reliance on third parties to weaken.
Over the next two years, how would you expect your organization’s use of third parties to change?
Decrease use
Domestically
Internationally
No change
9%
6%
49%
46%
Increase use
40%
37%
CFO PUBLISHING
39
chains overseas should keep the following
considerations in mind, say experts:
Longer order cycles
The most immediate difference with a global
supplier is that everything is likely to take longer,
at least initially. For Chinese suppliers, a midsize
company should plan on a 12-week cycle from
ordering goods to receiving them, says Tyndall.
The smaller the volume, the longer the cycle is
likely to be.
Longer order cycles can have an impact on a
company’s finances. New suppliers may expect
payment upon shipment,
potentially tying up cash for
long periods. “You go from
dealing with suppliers you
know, who give you normal
payment terms, to a situation
where they’re expecting
you to pay before you have
product,” says Schreiber.
There are ways to avoid
sending cash into the
ether immediately. One of
Schreiber’s new suppliers
has credit insurance, which
effectively covers the seller’s
receivable until the product
arrives and the buyer pays
the invoice. Schreiber says he
negotiated directly with the
credit insurance company to
get a line of credit sufficient to
cover the full value of Storm
Copper’s first order with
the supplier. Over time, the
terms have improved as both
parties have become more
comfortable with each other.
“When we’re on the
shop floor, we look at
how clean it is, what
kind of attitude people
have about their work.
It’s important that
we don’t just talk to
people who have been
prepared to speak to
us. We look employees
in the eye and ask
about what they focus
on every day.”
Myriad costs
It’s important to have a cash cushion for the
myriad smaller, often unexpected costs associated
with foreign suppliers, experts say, costs that
include customs duties, insurance, letters of credit,
and even payment-processing fees. One surprise
for many firms is that “the first time your company
brings a container from anywhere else, customs
opens it up and then sends you a bill for as much
as $2,000,” says Shawn Casemore, president of
Casemore & Co., a supply chain consultancy.
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Tax and tariff policies
It’s also essential to think about how a supplier
country’s tax and tariff policies are likely to evolve.
If a country is experiencing a manufacturing
downturn, for example, the government might try
to protect the industry by slapping export tariffs
on unfinished goods rather than finished, packaged
goods. “Chances are you’re not going to be in and
out in a year, so you need to try to get a handle
on the volatility in the environment,” says Gary
Lynch, global leader of Marsh’s supply chain riskmanagement group.
Balance-sheet issues
Schreiber, who is now receiving copper from
Europe and Latin America, says that since Storm
Copper technically owns the material as soon as it
ships, he must carry it on the books as inventory
for the entire eight-week journey (something he
doesn’t have to worry about when the copper
comes from New York). That leads to an “artificial
inflation” of the balance sheet, he says, which
can affect debt agreements. “You have to test
debt compliance ahead of time to make sure you
don’t violate any covenants by adding a bunch of
inventory and payables.”
Foreign exchange
Foreign exchange is another potentially thorny
issue that comes along with buying global. At oralcare product maker Dr. Fresh, CFO Duane Horne
says 85% of its products are sourced from China
and have been since the company’s 1998 inception.
For simplicity’s sake, the company still pays for
the product in dollars, although it is moving toward
paying in Chinese renminbi. Meanwhile, Horne is
using 30-day nondeliverable forward contracts to
help hedge part of the company’s exposure that
is baked into its current prices. (In general, prices
will be slightly higher in dollars to compensate
the supplier for the exchange risk it takes on.) The
forwards “have been successful to date, but you do
have to watch them very closely,” warns Horne.
Getting to Know You
Several of the executives we interviewed for a
2012 research report emphasize the importance
of getting to know the global partners they will be
working with firsthand. So when Julian Eames, SVP
of Business Operations at networking technology
provider F5 Networks, is investigating a potential
third-party partner, he makes sure to visit the
supplier’s operations onsite as well as to sit down
GOING GLOBAL
frequently with its management.
“When we’re on the shop floor, we’re looking
at how clean and tidy it is, what kind of attitude
the people have about their work,” he says. He
watches employees at work and talks to them “to
sniff out whether they have a sense of ownership,
and a sense of pride in what they are doing.” It’s
important, he insists, that “we don’t just talk to the
people who have been prepared to speak to us. We
look employees in the eye and ask about what they
focus on every day.”
With the growing use of overseas partners, having
local visibility can be even more critical. “There’s
a lot more vetting” when it comes to international
suppliers, says Mr. Jones, the joint CFO/COO for
Edward Don & Co. “We have our folks make sure
that they are overseas enough visiting, developing
the relationships, understanding the failure points
and the risk mitigation strategies.”
One result of this close attention is simply
more confidence in your partner company’s
performance, as well as its financials. Mr. Jones
says that “we know the senior management at
our strategic partner companies.” He continues:
“We know the people we’re working with, as well
as their organizational strategy, risk management
techniques, and the durability of their financing.
We develop personal relationships with our
strategic partners.”
Getting Started
factories on our behalf and are in contact with them
on a daily basis,” says Horne, adding that it’s also
beneficial to have staff members in the U.S. who are
fluent in the suppliers’ language. Brokers and other
middlemen can also be helpful as volumes grow.
Above all, it’s important to act with speed when
an opportunity with a global supplier comes up—or
it may soon be gone. Given the unpredictability
of factors like labor costs, oil prices, taxes, tariffs,
and natural disasters, cost advantages shift quickly,
often to surprising places. “You’ve got to be flexible
and agile,” Ferrari says. “Today, supply chain
sourcing is a very active process.”
CFO Summary
• Smaller companies are increasingly turning to
offshore suppliers to avoid domestic shortages and
slowdowns.
• Weigh the total delivery cost of using a global
supply chain against your company’s potential cost
savings.
• Plan ahead: global suppliers often have longer order
cycles, at least initially; budget for unexpected costs
to arise; research tax policies and foreign exchange
issues.
The best approach, then, is often to start slow,
and make sure not to neglect existing suppliers in
the U.S. “Pick one commodity that you know is
available in China and do a pilot test with one or
two suppliers there,” counsels Tyndall. “Meanwhile,
manage your supply base in the U.S., because if
they get upset, that can affect everything.”
Over time, there are a variety of best practices
for vetting and managing foreign suppliers. For
one, with sufficient volume, a company may want
to establish a representative office in the suppliers’
country. That’s an approach Dr. Fresh has taken in
China; about seven employees “coordinate with the
Sources for Going Global:
“Making the Leap,” Alix Stuart, CFO Magazine, June 1, 2011.
“Midsize Companies See Growth Ahead,” Alix Stuart, CFO.com, April 26, 2011.
“Not Made in America,” Alix Stuart, CFO Magazine, March 1, 2012.
“Three Overlooked Small-Business Tax Breaks,” Marielle Segarra, CFO.com, February 27, 2012.
“Working Well Together: Managing Third-Party Risk in a More Integrated World,” CFO Research, April 2012.
CFO PUBLISHING
41
UNDER PRESSURE
WORKING CAPITAL
AND CASH
MANAGEMENT
“Frozen out of credit markets, finance executives call for
a self-funding growth strategy driven by
cash flow from operations.”
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CFO PUBLISHING
CREATING A SECURE
FOUNDATION FOR GROWTH
I
t’s the kind of problem a company should be glad
to have: Maintaining financial discipline often
becomes more difficult as the business starts to
grow again. Growth can stretch working capital
as urgent spending and investment needs outstrip
companies’ immediate ability to convert inventories
and receivables to cash—which means that cash and
working-capital discipline becomes, if anything, even
more important during growth periods.
In a survey conducted late in 2010 among small
and midsize companies, we found that senior finance
executives had once again begun to anticipate top-line
growth for their firms. In our survey of more than 300
senior finance executives at companies with less than
$250 million in revenue, nearly 75% of respondents
said that they expected growth to come from selling
to new customers—a strategy that is likely to
consume more capital than, say, penetrating existing
accounts more deeply. (See Figure 1.)
Where will companies go to get that capital? During
the downturn, small and midsize companies—just
like consumers—found themselves forced to live
within their means, looking in all corners before going
out and spending. During the depths of the recession,
the lack of access to credit made it a challenge
for them to stay solvent. One survey respondent
expressed that frustration by issuing a plaintive plea:
“Get the banks to start making loans.”
But even with economic growth slowly lumbering
back to life, financial leaders at these businesses find
themselves in the unhappy position of having to “grow
it alone,” with little recourse to financial partners.
Frozen out of credit markets, finance executives call
for a self-funding growth strategy driven by cash
flow from operations. Fully 72% of the respondents
agreed with the statement, “My company’s growth
is fueled more by cash from ongoing operations than
by borrowing or equity.”
Figure 1. As economic growth picks up, nearly 75% of finance executives at small and midsize companies see
growth in selling to new customers.
Which of the following do you see as your company’s most important opportunities for increasing sales over the next two years?
Sales to new customers in current product/service lines
73%
Sales to existing customer base
57%
New product/service lines
45%
Domestic expansion
International expansion
25%
20%
CFO PUBLISHING
43
determining your business’s ability to improve its
cash position?”—could be summarized in a word
cloud that contains such phrases as: better terms,
accurate invoicing, faster collections, timely billing,
tightened credit policies, and access to bank line of
credit, to name but a few.
If only it were as simple as twisting the sales
spigot and standing back to give the cash some
room to flow. One respondent, an executive at an
aerospace firm, pinned his company’s hopes on just
this strategy: “Most financial problems can be solved
by increasing sales. When we want to increase our
cash position, we bite the bullet in the short run and
increase our sales team, which leads to better cash
flow later.”
For most midsize companies, however, selffunding will require just about every form of
operational tweaking that they can imagine. All but
18% of the respondents said that growth, by itself,
wouldn’t generate sufficient retained earnings.
Which means that finance executives are turning
over all the working-capital rocks they can find to
wring cash from them. In other words, finance is
on the hot seat. Fifty-eight percent of respondents
considered it very likely (23%) or somewhat likely
(35%) that they would hold the finance staff more
accountable for maintaining a strong cash position.
They’re making sure their reports are relentlessly
focused on shepherding working capital, in all its
forms. (See Figure 2.) Respondents’ written answers
to an open-text question in our survey—“In your
opinion, what are the most important factors
CFO Summary
• To meet growth targets, SFEs are looking for selffunding growth strategies driven by cash flow from
operations.
• Faced with high expectations for working capital,
the finance function is tasked with maintaining a
strong cash position for their company.
Figure 2. Senior finance executives stick with what’s tried-and-true, not what’s new.
To what extent is your company likely to pursue the following steps in the next 12 months in an effort to strengthen its cash position?
Very likely
Somewhat likely
23%
35%
Hold finance staff more accountable for maintaining a
strong cash position
Renegotiate business terms with suppliers
19%
Borrow from commercial banks
17%
Alter internal processes for collecting accounts receivable
16%
Raise prices for goods and services
12%
Offer invoice discounting or other incentives
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CFO PUBLISHING
40%
35%
48%
20%
8%
Curtail payments to investors
7%
Raise capital from investors
7%
Liquidate receivables through third parties
41%
3%
14%
18%
7%
CONSTANT PRESSURE
ON WORKING-CAPITAL
IMPROVEMENT
D
iligence—not necessarily innovation—
is the essence of working-capital
improvement. The finance executives who
participated in the 2010 study emphasized
consistency, focus, and continual engagement as keys
to better cash and working-capital management. “I
don’t think there are any silver bullets here,” one CFO
told us. “It really is the basic blocking and tackling.”
Survey results suggest that midsize firms have
already been working hard at trying to extract
payments faster from customers, negotiate more
favorable terms with suppliers, and reduce inventory
levels while maintaining overall margins. They
claim they’ve had some degree of success. In
another CFO Research survey conducted in mid2011, two-thirds of respondents reported that their
companies’ days-working-capital (DWC) position
was better than three years ago. Effort applied to
collections was the primary contributor to this
improvement; respondents are much more likely to
report improvement in days sales outstanding (DSO)
(56%) than they are to report improvement in days
inventory outstanding (DIO) (41%) or days payable
outstanding (DPO) (42%). (See Figure 1.)
And, even following a year of concentrated
working-capital improvement in the aftermath of
the financial crisis, many midsize firms were able to
achieve further gains. Across the survey population,
respondents who reported improvement in DWC
over the previous year outnumbered those who
reported deterioration by a wide margin. (Fiftysix percent of respondents reported improvement
in DWC; only 17% reported deterioration.)
Again, improvement in collections led the way:
respondents report improvement in DSO over the
past year (47%) much more often than they report
improvement in DIO (33%) or in DPO (36%). (See
Figure 2.)
As they strive for new gains, midsize companies
are likely to continue focusing their efforts on
Figure 1. Current Working-Capital Position vs. Three
Years Ago
Figure 2. Change in Working-Capital Performance
over 2011
A majority of finance executives report improvement in their overall
working-capital position. Improvements in inventory and payables
positions lagged, however, behind improvement in receivables.
Improvement in DSO, in particular, led to overall improvement in working
capital performance.
DWC
DSO
DIO
DPO
DWC
DSO
DIO
DPO
n Much better
n Somewhat better
n No change
n Somewhat worse
n Much worse
CFO PUBLISHING
45
receivables performance, followed closely by better
inventory management. (See Figure 3.) For instance,
they might see opportunities to lower DSO by
becoming more aggressive on the collections end or
by tracking payments with problem codes so that
recurring issues can be identified and addressed.
One respondent, the controller of a transportation
firm, advised financial chieftains at other companies
to “have a strong internal focus on DSO and the
individual factors that affect it.” Through “focused
improvement in these areas and understanding
the industry norms,” this finance leader suggests
that small and midsize companies can gain an
“understanding [of] where real improvement can
come from.”
Taking control wherever they can:
Lack of bargaining power is a challenge
So what’s blocking small and midsize firms from
fortifying their cash and working capital positions?
The results of our survey show that midsize firms
are systematically at a disadvantage compared to
large companies—simply because large firms, with
their vast buying power, have a degree of bargaining
clout that their smaller counterparts lack. For many
smaller companies, the truth is that while they may
have every intention of self-funding, their finance
heads are keenly aware of the challenges of being the
little guy. Most small companies, after all, sell to big
companies.
Survey results confirm that midsize companies
do a lot of business with companies larger than
theirs. (See Figure 4 on page 47.) Survey respondents
also frequently note that larger companies aren’t
hesitating to exercise their bargaining power, to the
detriment of midsize companies’ ability to convert
receivables to cash. Respondents who agree that
larger companies have used their bargaining power
to force them to accept slower payments outnumber
those who disagree by a wide margin (47% versus
31%).
Large companies aren’t the type of customers
that respond well—or at all—to nagging. Writes
one respondent, a top executive of a $50 million
engineering services firm, “We deal primarily
in unbalanced negotiation. Our clients are
substantially larger and perceive unlimited choice
in suppliers. Clients are imposing unilateral changes
to payment terms. They are not willing to negotiate
and have no consideration for impact on their
supply chain. Clients that do agree to reasonable
terms at times do not honor those terms, and
that trend is increasing.” Another executive, who
heads up a contract manufacturer, flatly concedes
that his company’s success in self-funding is tied
to “our ability to block large companies’ attempts
to unilaterally, arbitrarily, and officiously extend
payment terms on sales to them.”
Of course, turnabout is fair play. Finance
executives for midsize companies readily admit
that they’re looking to extend their payments to
their own suppliers. Sixty percent of respondents
deemed it “very” or “somewhat” likely that they
would renegotiate terms with suppliers. Throughout
Figure 3. Working-Capital Priorities
Receivables performance and inventory management surface as high priorities for improvement. A fairly large number of respondents decline to
choose just one area, saying they plan to focus on “all three” equally.
“Of the three main dimensions of working capital, __________ will be the
highest priority for improvement at my company over the next year.”
Receivables
performance
38%
Inventory
management
34%
Payables
performance
7%
Note: 3% of respondents answered “Not sure.”
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CFO PUBLISHING
All three
18%
the open-text responses, finance executives called
for extending accounts payable (AP) in ways to
match accounts receivable. So, for example, while
the finance head of a business services firm says
his company will “continue to focus on speedy
invoicing,” he also says they have “created alternative
payment schedules for independent contractors,
delaying payment similarly to the delay we’re seeing
in receivables (change of 15 days).”
Those who agree that increased control over
payments would yield a meaningful improvement
in working capital (48%) outnumber those who
disagree with that proposition (19%) by more
than two-to-one. At the same time, a plurality of
respondents (44%) admits that they have difficulty
requiring their suppliers to accept modifications in
payment terms.
These results suggest that a lack of negotiating
leverage places midsize firms at a disadvantage
not only when they seek to collect briskly from
their largest customers, but also when they look
for more favorable terms from their own suppliers
and vendors. Midsize companies’ working-capital
accomplishments in recent years seem even more
impressive when viewed in this broader context.
But until the economy returns to robust growth and
demand for goods and services rebounds strongly,
midsize organizations can expect that their relative
lack of bargaining power will continue to complicate
their efforts to free cash on their balance sheets in
the months to come.
CFO Summary
• SFEs tell us that consistency, focus, and continual
engagement are the keys to working-capital
improvement.
• Collections efforts have led to days working
capital (DWC) improvements for small and midsize
companies. Now, to make new gains, companies
are likely to focus on receivables performance and
inventory management.
• Smaller companies are at a disadvantage because
larger companies, their biggest-volume customers,
have a better bargaining position in payment
negotiations, hurting small and midsize companies’
ability to convert receivables to cash.
Figure 4. From which customer
segments do companies derive a
large volume of business?
Firms most often derive a large volume of
business from other companies that are bigger
than they are.
9%
Same size
companies
15%
57%
Respondent
population
Larger
companies
25%
20%
Individual
consumers
Smaller
companies
Government/
Public
organizations
CFO PUBLISHING
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FUNDING ALTERNATIVES
AUCTIONING RECEIVABLES
A
s small businesses hunt for working
capital, alternatives that let CFOs quickly
turn receivables into cash are growing in
popularity. The results from our previous
surveys suggest that there aren’t very many easy (or
even not-so-easy) gains left to capture internally, with
relatively large numbers of respondents seeing “no
change” across the three main dimensions of their
working-capital performance. For example, 71% of
respondents in our 2010 survey said they already had
very effective AR processes, and nearly two-thirds
disagreed with the statement that “my company is
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CFO PUBLISHING
reluctant to pursue collections aggressively.”
They’re already doing what they can—which
means that many midsize firms are likely to find
it difficult to continue to register working-capital
improvements.
Having watched as their liquidity evaporated over
the past couple of years, smart finance chiefs aren’t
assuming they know the next wave of challenges
they will confront. More important, some of
them are anticipating that they will be able to
avail themselves of new tools. Or, for that matter,
reconsider existing possibilities. In fact, when we
asked them whether greater access to certain cashgenerating options would have a substantial impact
on their company’s performance, 14% reported
that they “didn’t know” about the effect of “selling
or auctioning individual customer invoices on a
spot market.” That option attracted the highest
percentage of respondents to that category. It
suggests a seed of curiosity.
That seed will likely mature into a full-blown
need. Having tidied up their accounts receivable, it
will become clearer that their growth goals are still
out of their financial reach. At that point—which
will come soon, given how little waste finance
executives already acknowledge seeing in their
operations processes—they will start casting about
for new options.
To operate in a changed financial environment,
small and midsize companies are going to have to
look beyond the conventional financing options.
When it comes to external sources of cash, finance
executives cited a broad array of sources that they
use. “Our chairman buys our receivables,” wrote
one manufacturing CFO. Equity holders, too, were
identified as a useful source of short-term liquidity.
Strong relationships with commercial banks
and asset-backed lenders were also mentioned
frequently.
Rarely mentioned were factoring and collection
agents, regarded as a “last resort” because of their
perceived high cost and possibly detrimental effect
on customer relationships. When we asked about
the frequency with which they use certain cashbuilding techniques, the two least-used options
were factoring of bundled receivables through a
third party (91% of respondents report that they
seldom or never go with this option) and selling or
auctioning individual customer invoices on a spot
market (94%).
What financial executives at small and midsize
firms want, it seems, is a source of liquidity that can
bolster their short-term cash flow while addressing
their concerns about affordability and allowing them
to approach their customers with sensitivity. In
general, small and midsize businesses would prefer
that their customers didn’t know that they had
resorted to factoring, which tends to emit a whiff of
distress.
Typically, factoring also requires small and
midsize companies to give up something they often
consider more precious than even getting full value
for their receivables: control. Having offloaded all
of their receivables to a factor, they are in effect
washing their hands of their own customers. Says
the CFO of a $10 million manufacturer: “Nonrecourse factoring or discounting AR will always
have a negative effect on customers. That’s one of
the trade-offs.”
Or is it?
Loyalties shifted—ever so slightly—when finance
executives were asked about the likelihood of using
certain techniques in the next two years. Fewer
ruled out the possibility of factoring their bundled
receivables through a third party or of selling or
auctioning individual invoices on a spot market.
In each case, a few more CFOs slipped out of the
“seldom or never” category. After the “liquidity trap”
of the last few years, CFOs weren’t automatically
expecting that any of their assumptions would be
intact two years hence.
It should come as no surprise, then, that
businesses are becoming more receptive to services
allowing them to cash in sooner. Transaction
volume on The Receivables Exchange, an online
auction platform for invoices, grew five times
over in the space of a year, and president Nicolas
Perkin expected similar growth in 2011. The
Interface Financial Group (IFG), a 39-year-old set
of franchises that buys small numbers of invoices
straight from business owners, said that volume
was up between 10% and 12% in 2010. And a new
PayPal-backed business aimed at guaranteeing
payments from consumers, BillFloat, attracted 100
businesses within six months of its launch.
What financial executives at small
and midsize firms want is a source of
liquidity that can bolster their shortterm cash flow while addressing
their concerns about affordability
and allowing them to approach their
customers with sensitivity.
One reason for the spike is that banks remained
loath to lend to small and sometimes young
companies. “In normal times, the businesses
referred to us by banks would be one, two, or three
years old,” says David Banfield, president of IFG.
“Now we’re seeing all of those plus more mature
companies with five to seven years in business being
referred to us. There’s no indication that will change
in the near future.”
The relative ease and speed of the programs are
also appealing. IFG, which says it can get cash into
the business owner’s hand within four days of its
first discussions with the company, conducts a
standard credit check on the business, as well as
verifies that the company’s customer has received
the product and is satisfied with it. “It’s a much
more streamlined process than factoring all your
receivables,” says Banfield. IFG’s typical client has
CFO PUBLISHING
49
between $400,000 and $4 million in annual revenue
and needs about $30,000 to $60,000 for a given
transaction, he says.
On The Receivables Exchange, sellers must
register and meet certain criteria, such as being in
business at least two years and having at least $2
million in annual revenue. But there are no rules
on which invoices they can put up for sale or how
much they can ask. Buyers, however, can see if the
seller has a history of invoices that were not paid.
“Companies usually sell their best invoices, because
they want to establish a track record and reduce
their cost of funds,” says Perkin. The exchange had
about 1,450 registered sellers by early 2011.
A different approach, and one that requires even
less effort or risk, is to offer customers an easy way
to finance their outstanding balances. NewWave
Communications, a Midwestern cable operator,
introduced BillFloat on its website, giving its
100,000 customers an online way to borrow money
to cover their bill rather than just ignore it. “There’s
no cost to us, and we’re getting payments before
their due dates rather than late,” says Kathy Klipfel,
NewWave billing and credit director. “Even if we
did offset some revenue associated with late fees
[currently $7 per month], it’s still worth it to deal
with our aging accounts,” she says.
The terms of such deals can vary quite a bit.
Banfield says IFG will pay anywhere from 91% to
96% of an invoice’s value, depending on its age.
On The Receivables Exchange, sellers set their
own terms. In both cases, sellers are ultimately
responsible for nonperforming invoices. With
BillFloat, however, a company such as NewWave
gets its money free and clear.
As alluring as such easy fixes sound, some point
out that prevention is still the best cure for aging
receivables. Such services cost “10 to 20 times
what it would cost you to do internally,” estimates
Pam Krank, president of The Credit Department,
a credit-management outsourcing firm. “If you’re
liberal on credit, you need to be conservative on
collections. It just takes a little discipline up front:
you set up terms and you stick to them.” She also
advocates taking a second look at extending credit at
all. “If you have to offer terms, you must make sure
the risk makes sense,” she says, and perform some
type of credit check to make sure the client doesn’t
have other unpaid invoices or outstanding liens.
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CFO Summary
• In a challenging economic environment, CFOs must
consider a variety of financing options.
• For many small and midsize company SFEs,
factoring is traditionally a “last resort” because of
its high cost and detrimental effect on customer
relationships. But now businesses are less likely to
rule factoring out as they look for ways to cash in
sooner.
SUPPLY CHAIN FINANCING
SHORING UP THE SUPPLY
CHAIN TO SUPPORT GROWTH
I
n order to improve working capital and
strengthen supplier relationships, a large
number of respondents to a CFO Research
survey conducted in December 2010 report
that their companies already participate in supply
chain finance (SCF) programs (66%), or at least are
considering starting them (17%).
SCF is intended to link buyers, their suppliers,
and financial institutions through a web-based
platform where suppliers can view their buyerapproved receivables and choose early payment on
them for a small discount based on the strength
of the buyer’s credit rating. The goal is to reduce
suppliers’ costs and working capital requirements,
as well as improve their cash flow. The buying
organization may then build on these supplier
benefits to support better supplier relationships
and a range of supplier initiatives, including
harmonizing or extending payment terms. The
SCF solution provider may also support these
efforts with payment-terms benchmarking or other
procurement-related services.
Even in a buyer’s market for goods and services,
finance executives recognize that key components
of the working capital equation run through the
supply base. Finance executives in our 2010 report
CFO PUBLISHING
51
expressed concern with how well their companies
were managing their supply chains, with 73%
saying that supplier relationships are a top priority.
In response to an open-ended question, a treasurer
from the construction industry explains, “In order
to reduce inventory on hand, we need to shorten
the supply chain to ensure that, when business
needs increase, the inventory is quickly available.”
Similarly, a director of finance in the energy
industry cites the need to “optimize the supply
chain network, make it more flexible to external
shocks and crisis in supply.”
The survey was conducted at a time when finance
executives appeared to be looking cautiously ahead
for renewed growth for their companies. Credit
remained both tight and expensive—especially for
midsize and smaller companies— and the path to
economic recovery looked like it would be a long
and gradual slope upward.
In this environment, cash very much remains
king, and effective management of both working
capital and supplier relationships gains added value.
Finance executives reported that they were looking
to improve all components of working capital—
DSO, DPO, and DIO. In these efforts, maintaining
and strengthening working relationships with
vendors and suppliers will be important.
In other words, businesses have a vested interest
in how their suppliers are doing. Yet volatility
within the supply base presents challenges for
strengthening supplier relationships and managing
working capital. Few respondents from our survey
said they expected their companies to make no
changes in their supplier base over the next year.
Some anticipated their companies would diversify
the supply base, while others expected to add key
suppliers or rationalize and consolidate suppliers.
Further complicating supply chain and working
capital management, respondents also say that
their companies have had to deal with a range of
supply chain problems over the past two years. The
survey revealed a lengthy list of supplier challenges
that finance executives said they were dealing with
during the recession. Several of these issues are
related directly to payables, such as increases in
suppliers’ product pricing, inflexibility of suppliers
in negotiating terms, or supplier demands for faster
payment.
But many issues with suppliers flow out of
the suppliers’ own difficulties in coping with
the economic downturn. The poor financial
condition of suppliers is cited by about 4 out of 10
respondents as one of the issues their companies
had to deal with. These respondents are much
more likely than others to cite additional supplier
issues, such as the inability of suppliers to respond
to changes in production requirements or the
poor quality of suppliers’ products. Substantially
more of these respondents than others in the
survey say that their companies lack alternative
sources of supply, and more than half report that
their companies have had to support key suppliers
financially. These companies, in particular, seem
to have a compelling reason to improve working
relationships with their suppliers.
SCF programs typically are designed to offer the
potential for improving supplier relationships
and ease the financial strain on suppliers while
supporting the buyer’s working capital initiatives.
In fact, 82% of finance executives in the survey
conducted in 2010 believed that SCF could be used
to improve a company’s working capital efficiency.
The benefits of SCF are widely recognized by the
finance executives participating in our survey. More
than 70% of respondents think that SCF is either
moderately or very effective in delivering each of
the specific benefits we asked about:
• Strengthening working relationship with
suppliers
• Improving the financial health of suppliers
The survey revealed a lengthy list of supplier challenges for finance
executives during the recession. Several of these issues are related
directly to payables, such as increases in suppliers’ product pricing,
inflexibility of suppliers in negotiating terms, or supplier demands
for faster payment. But many issues with suppliers flow out of the
suppliers’ own difficulties in coping with the economic downturn.
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CFO PUBLISHING
•
•
•
•
•
•
•
Improving working capital efficiency
Improving the efficiency of accounts payable
Lowering the cost of goods sold
Extending supplier payment terms
Increasing early payment discounts
Supporting low-cost-country sourcing
Helping to move suppliers from Letter of
Credit to Open Account payment terms
Importantly, respondents recognize the mutual
benefits of SCF for suppliers as well, with 72%
saying that SCF is effective in improving the
financial health of suppliers and 78% saying that
these programs strengthen working relationships
with suppliers. As one vice president of finance
writes, the “mutual commitment to work together
for better results for both sides” is one of the most
important changes his company can make.
However, unusually large numbers (typically 6070%) of finance executives who are not planning
on using SCF also indicate that they do not know
enough about any of its benefits to comment on
them. In addition, less than 20% of the companies
represented in the survey employ structured
competitor benchmarking to determine supplier
payment terms, relying instead on largely ad hoc
negotiations to agree on terms.
The pieces are in place to take advantage of
SCF. Two-thirds of all respondents agree that
the technology to implement an SCF program
is readily available. Further, two-thirds of
respondents view the ability to involve multiple
banks in their SCF programs through a single,
open SCF platform as a requirement for success,
and an equal number of respondents see services
provided to assist in supplier outreach as critical.
As companies cast about for every advantage to
help them manage through a sluggish recovery,
it will be important to be able to make informed
decisions on the role that SCF might play in a
broader supplier management strategy.
CFO Summary
• Supply-chain financing (SCF) programs link buyers,
suppliers, and financial institutions through a
web-based platform where suppliers can view
their buyer-approved receivables and choose early
payment on them for a small discount based on the
strength of the buyer’s credit rating.
Keep up with the latest
findings and insights from
CFO Research.
Visit cfo.com/research
• The goal: reduce suppliers’ costs and working
capital requirements while improving cash flow.
• Improving working capital requires maintaining and
strengthening working relationships with vendors
and suppliers. SCF programs have the potential to
improve these relationships.
CFO PUBLISHING
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MANY HANDS MAKE
LIGHT(ER) WORK
GETTING YOUR
ORGANIZATION ON BOARD
W
hile CFOs of small and midsize
businesses have to learn to live
with the imbalance between their
employers and customers, it’s a reality
that makes them want to exert control where they
know they can do so effectively—over internal
processes.
What other obstacles do midsize companies face
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CFO PUBLISHING
as they work to improve their cash and workingcapital management? We asked respondents to
evaluate a wide range of potential barriers. The
ubiquitous “lack of bargaining power” surfaces as
the most-often cited problem. But survey results
reveal that organizational and cultural issues—
including lack of coordination, internal pressure
to accept unfavorable terms, and lack of a shared
organizational mandate for improvement—follow
close behind. Indeed, as barriers to cash and
working-capital improvement, organizational and
cultural matters edge out both process weakness
and technological inadequacy by a narrow margin,
and they far outstrip financial matters like
weakened credit ratings, credit constriction, or
lack of access to affordable financial products and
services. (See Figure 1 on page 55.)
Because organizational and cultural problems
emerge as some of the most substantial barriers
to better cash and working-capital performance,
we might expect midsize firms to make cultural
and organizational change a centerpiece of their
improvement efforts. But survey results show
something different: when asked to assess four
major improvement categories, respondents most
frequently report that process improvement will
play a “major” or “supporting” role in their plans
(84%), followed by increased automation (71%).
Cultural and organizational change follow distantly
(55% and 50%, respectively). (See Figure 2 on page
56.)
Viewed together, these results suggest some
intriguing questions: are respondents relying on
process change as a precursor for organizational or
cultural adjustment? Put another way, are better,
more streamlined and standardized processes
seen as a useful (or even necessary) framework for
further change? Can process improvement serve
as a mechanism to influence company culture or
organization (as opposed to a mere expression of
a firm’s culture and organization)? Or is process
improvement simply a worthy—but also a lesschallenging and more-comfortable—substitute for
tackling amorphous (and recalcitrant) cultural and
organizational problems?
For now, however, perhaps the main conclusion
to draw from these survey results is this: effective
cash and working-capital management is the work
of the whole company—not the work of finance
alone. Coordinated, cross-functional effort—
especially among finance and account-relationship
holders across the organization—is one of the most
reliable paths to improvement.
Those working in sales and operations have
tremendous influence over the day-to-day
decisions that can have a profound impact on a
company’s working-capital position. At the same
time, it comes as little surprise that the daily
demands of closing deals and filling orders can
sometimes edge out working-capital considerations
in resource-strapped sales and operating units.
But the finance executives who participated in
this study agree that encouraging decision makers
to factor working-capital into their thinking
can make a difference. “Don’t underestimate the
benefits to be realized from educating those in
the organization who have customer or vendor
contacts on the importance of cash and workingcapital management,” writes the CFO of a midsize
professional services firm in response to an openended question.
Ultimately, say executives, the issue is one of
Figure 1. What stands in the way of cash and working-capital improvement at small and midsize companies?
A lack of bargaining power, combined with internal problems with coordination and alignment, surface as the most prominent obstacles.
34%
11%
11%
Weak credit rating
after recent
financial crisis
Lack of access to
cost-effective products and
services to support cash and
working-capital management
20%
Lack of coordinated effort
to support collections and
29%
Process
weakness
34%
40%
25%
Internal pressure to
accept less favorable
terms to close sales
Lack of bargaining
power
11%
Difficulty selling
Lack of access to
financing/Constriction excess inventory
in credit markets
6%
Other
20%
Organizational
fatigue
Inadequate
technology
systems
Note: Respondents were asked to choose up to four barriers.
32%
Lack of shared
organizational
mandate to
improve cash and
working capital
management
CFO PUBLISHING
55
finance leadership: creating a cash-conscious
culture, setting expectations, measuring progress,
and insisting on accountability. “Implement a ‘cash
is king’ philosophy across the board,” writes the
controller of a midsize manufacturing company.
“Hold key management personnel accountable for
their operations.” Senior finance executives know
that there’s no magic bullet for cash and workingcapital improvement. But when it comes to cash and
working-capital discipline, following fundamental
management principles—like ensuring that those
who have control over cash and working-capitalrelated decisions are also accountable for the
consequences of those decisions—can work some
magic of its own.
CFO Summary
• SFEs most often cite “lack of bargaining power”
as their biggest obstacle to working-capital
improvement, but organizational and cultural issues
follow closely behind.
• Instead of tackling these organizational and cultural
barriers, SFEs most often tell us they expect process
improvement to play a “major” or “supporting” role
in their plans.
• Effective cash and working-capital management is
the work of the whole company—not the finance
function alone.
• How can you take the lead? Create a cashconscious culture, set expectations, measure
progress, and insist on accountability.
Figure 2. What broad types of cash and working-capital improvements will small and midsize firms pursue?
Process improvement outpaces other broad improvement categories, including increased automation and cultural and organizational change.
Supporting role in improvement n
Major role in improvement n
45%
47%
30%
31%
39%
Process
improvement
24%
25%
Increased
automation
Cultural
change
19%
Organizational
change
Sources for Under Pressure: Working Capital and Cash Management:
“Bridging the Liquidity Gap,” CFO Research, November 2010.
“Cash and Working-Capital Discipline: CFOs at midsize firms face their top financial challenges,” CFO Research, March 2012.
“Fast Cash for Small Firms,” Alix Stuart, CFO.com, February 25, 2011.
“Strengthening Supplier Relationships Through Supply Chain Finance,” CFO Research, December 2010.
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CFO PUBLISHING
FROM TAX
TO TECH
THE BACK OFFICE
“Experts say fast-growing companies are particularly
prone to having their 401(k) plans get off track in one way
or another. The combination of fluctuating asset levels,
executive overload, and complex IRS rules means CFOs
need to keep a close watch.”
CFO PUBLISHING
57
STAYING ON TRACK
401(K) CONSIDERATIONS
FOR GROWING COMPANIES
T
he headlines about 401(k) plans vaunt the
perils of employers offering employees too
few investment choices, or too risky ones,
or ones with fees that are too high. But
none of those are Chris Beck’s problem. Instead, Beck,
CFO of BirdDog Solutions, a private-equity-backed
logistics provider, is now sifting through a list of the
more than 50 investment options that are currently in
his company’s plan for about 160 employees with $3
million in assets.
As BirdDog has made three acquisitions in
Beck’s two-and-a-half-year tenure, and merged
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CFO PUBLISHING
new employees into its 401(k) plan, “we’ve tried to
be very accommodating by adding a fund here or
there,” says Beck. That courtesy has now yielded
a volume of options he considers overwhelming.
“We’ve got bright people but they’re not financial
types; people kind of shut down when they have
to decide if they want to be in the energy fund, or
international emerging markets,” or other highlyspecific individual investments. As a result, more
than half of the plan assets are in the lifestyle and
lifecycle funds, effectively prepackaged portfolios
that change over time. The task now: “We are going
through to find the best of breed in individual
funds,” says Beck, who is working with advisers,
with plans to drop the rest.
Fast-growing companies are particularly prone
to having their 401(k) plans get off track in one
way or another, say experts. The combination of
fluctuating asset levels, executive overload, and
Internal Revenue Service rules that are structured in
a way to almost ensure closely held companies will
violate them means that CFOs at those companies
need to keep an especially close watch on them, at
least at a high level. “You’d think I’d be most focused
on the finance aspect [of the 401(k) plan], but
that’s secondary,” says Gene Lynes, CFO of energymanagement consultancy Ecova, which has rapidly
grown its plan assets in the past few years to close
to $15 million. “Being a good employer, we’re trying
to protect people for the future and create high
morale”—no easy task these days.
The move toward fewer 401(k) options is one
that has gained a lot of fans from companies both
small and large in recent years. J.P. Morgan, for
one, recently proposed a winnowing down, or at
least an aggregation, of investment options to
make things easier for participants. And such
screening is a hallmark of plans that are targeted
at smaller businesses. At Sharebuilder 401(k)
(a division of ING Direct), for example, “our
investment committee manages the fund lineup,
and takes on the fiduciary responsibility,” giving
everyone a fairly slim menu of 16 ETFs or one of
five model portfolios, says Stuart Robertson, head
of the division, which is aimed at plans with 250
employees or less. While there is still some choice
and education involved, “we try to make it hard for
participants to get off on the wrong foot,” he says.
That philosophy is extending to other parts of
the plans, as well. Vanguard recently announced a
new offering aimed at plans with under $20 million
in assets, with standardized record-keeping and
administration to help keep fees and hassle low.
For example, there’s a prototype plan document
that plan sponsors are asked to adopt that “has
less flexibility than the standard one, but still has
everything you need to operate the plan,” says Kathy
Fuertes, who leads Vanguard’s new effort.
Testing 1, 2, 3
While the marketplace for smaller 401(k) plans
may be getting richer, the new plans are no panacea
for the antidiscrimination test violations that take
many CFOs by surprise. Such tests include the
actual deferral percentage (ADP) test, the actual
contribution percentage (ACP), and the topheavy test. Their aim is to ensure that highly paid
executives and owners of the firm aren’t reaping
disproportionate benefits relative to rank-and-file
employees, so they cap the amount that executives
can contribute based on the amount that employees
contribute. Violations, even unwitting ones, can
wreak havoc on corporate cash flow and executive
taxes.
One of the easiest tests to fail is the top-heavy
test, which looks at the ratio of the accumulated
plan assets of key employees (usually the executive
team, and possibly others with ownership) to
those of rank-and-file employees, says David
Wray, president of Profit Sharing/401(k) Council of
America. If key employees have more than 60% of
the plan’s assets, the plan fails.
Many smaller companies “unsuspectingly
walk into the experience” of failing, says Wray,
because closely held companies with low employee
participation and/or high employee turnover will
almost certainly fail within several years. “When
you first set up the plan, it’s not top heavy, but it
doesn’t take more than four years before it becomes
that way,” he says. “And it’s a dagger into the heart of
small companies where cash flow is very uncertain.”
The ADP and ACP tests are also easy to fail for
rapidly-growing companies, but the problem is
not without a solution, notes Joseph S. Adams,
an attorney with McDermott, Will & Emery in
Chicago. “You can basically buy your way out of the
discrimination tests by setting up matching safe
harbors,” he says.
There are three options to achieve safe-harbor
status, and they largely involve employers
committing to match at least 3% of employees’
contributions, vesting the contributions faster, and
One of the easiest tests to fail is the
top-heavy test, which looks at the ratio
of the accumulated plan assets of key
employees (usually the executive team,
and possibly others with ownership) to
those of rank-and-file employees. If key
employees have more than 60% of the
plan’s assets, the plan fails.
in some cases, automatically enrolling employees in
the plan, says Adams. A profit-sharing contribution
is also an option and protects against all violations,
but is typically more expensive. A company can
elect to change its safe-harbor status from year to
year, but cannot change midyear.
Not surprisingly, many companies elected to drop
the safe-harbor status in the depth of the recession,
when 401(k) matches were one of the few sources
of cash left. Both Ecova’s Lynes and BirdDog’s
Beck say they have run into problems with these
tests based on decisions made before their tenures.
“Prior to my arrival, the company went through
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some tough times and had to pull back, which
may be why they didn’t use a safe harbor,” says
Lynes. Unfortunately, that resulted in failing one
of the tests and executives having to make 401(k)
withdrawals, which he says “was a bad scenario,”
carrying some severe tax consequences for those
who were affected. Now Ecova has increased its level
of match and changed the vesting time frame to
qualify for a safe harbor, a decision Lynes doesn’t
expect to revisit any time soon.
Beck has a similar story. To resolve issues related
to a failed test a few years ago, BirdDog set up
automatic enrollment and boosted its matches as
required for a safe harbor. “It’s better for recruiting
and budgeting anyway,” says Beck. Now, “we’ve taken
the philosophy that we’re committed to the 401(k)
plan, and to the extent we run into a blip we’ll
manage it in ways outside the retirement plan.”
Fees Freezer
All that being said, it’s still worthwhile for CFOs
to consider the basic task of negotiating on fees
as the assets in the company plan grow. “It’s very
important to renegotiate fees every five years,”
says Wray. The metric to track is average account
balance, rather than total assets, he notes, since
that’s where profits come from. “The economies
of scale here are just so enormous, and the use of
technology [makes a big difference]; you should
have a lot of leverage.”
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CFO PUBLISHING
CFO Summary
• Growing companies can easily face 401(k)-plan
perils because of fluctuating asset levels, executive
overload, and complex IRS rules.
• Companies are moving toward fewer 401(k) plan
options to simplify matters for both employer and
employee.
• Keep in mind potential antidiscrimination test
violations when determining your company’s 401(k)
plan structure, and consider achieving safe-harbor
status to avoid this pitfall.
• Renegotiate 401(k) fees as your company’s plan
assets grow.
COVERING COSTS
HEALTH CARE ADVICE FOR
GROWING COMPANIES
W
ant to save money on health-care
insurance? Try this strategy: stop
buying it.
While self-insurance is nothing
new to large companies—some 90% of those
with more than 5,000 employees have been
doing it for years—a growing number of smaller
companies are self-insuring to cut costs. According
to data collected by PricewaterhouseCoopers, the
percentage of employers with fewer than 1,000
people in their health-care programs that self-insure
has almost doubled, from 29% in 2008 to 48% in
2010.
“In my view, self-insurance is a way for a company
to save money, because you typically spend less
on claims and reinsurance than you would on
premiums,” says Ariann Lawhorn, human-resources
manager for Mid-City Supply, a privately held
wholesale distributor of plumbing and heating
supplies in the Midwest. The 95-employee company
(with a total of 250 people covered by insurance,
including dependents) has been using self-insurance
“on and off” since the mid-1980s, says Lawhorn, and
during her entire six-year tenure with the firm.
Conventional wisdom has long held that selfinsurance works best for larger populations, because
the claims tend to be more consistent across bigger
groups of people. The rule of thumb has been
that it takes a minimum of 1,000 “covered lives,”
or employees and their dependents, to make the
strategy work.
Now, though, smaller companies are reevaluating
this rule, in part because they want to take more
control over rising health-care costs. “The reality
is that companies with below 1,000 lives do
experience more fluctuation [in cost] than [larger]
ones,” says Michael Thompson, a principal in PwC’s
human-resource services group, “but insurance
companies don’t necessarily protect them any
better, because they just base their rates on their
past experience.” And while self-insured companies
will still have to comply with the mandates of
federal health-care reform, they may be able to
avoid a layer of other regulations that fully insured
companies face.
The basic principle of most self-insurance
programs is this: the company agrees to pay
for employees’ claims (minus whatever co-pay,
co-insurance, or deductible is built into the
arrangement) as they happen, rather than paying
a preset, monthly per-employee premium to
an insurance company. A self-insured company
may still rely on an insurance carrier for some
administration of the benefits, notes Thompson,
and may also purchase stop-loss insurance through
CFO PUBLISHING
61
the carrier to cap its potential cash outflows. (Stoploss insurance typically kicks in to cover claims
above a certain amount, up to a preset limit.)
Among the immediate benefits of going the
self-insurance route: avoiding state taxes on
premiums that insurers pass along to clients, which
run between 2% and 3% of premium costs; and
avoiding certain state benefits mandates, which
can add anywhere from 0.5% to 4% of premium
costs, depending on the state. Using self-insurance
also eliminates the profit and risk cushions that
insurance companies build into their rates.
Companies that use self-insurance also tend to
be wiser about plan design,
Thompson says, looking harder
for ways to control underlying
medical costs. Mid-City, for
example, has saved about 16%
by creating higher co-insurance
levels for using out-of-network
providers, and another 10%
by using a co-pay structure
rather than a deductible with
prescription benefits. Other
progressive approaches include
offering special incentives
for employees to use medical
facilities that have proven to
excel in certain areas, and hiring
company doctors.
Lawhorn says self-insurance
is also a good way for
companies to better target the
benefits to participants. Her
company, for example, covers
some prescription drugs, such
as growth hormones, that
wouldn’t normally be covered
by an insurance company.
Mid-City maintains some cash reserves to cover
spikes in claims, and as a backup uses stop-loss
insurance that kicks in both when an individual
reaches a certain limit and when the aggregate
volume of claims hits a larger limit. “We’ve never hit
the aggregate limit, but it helps you sleep better at
night knowing it’s there,” says Lawhorn.
Stop-loss insurance can be proportionately
pricey for a small company, so some are looking at
purchasing it as a consortium. The notion of a group
stop-loss program is attractive to Jim Knutson, risk
manager at Aircraft Gear Corp., a self-insuring carparts maker in Illinois with about 100 employees
Among the immediate
benefits of going the
self-insurance route:
avoiding state taxes
on premiums that
insurers pass along to
clients, and avoiding
certain state benefits
mandates, which
can add anywhere
from 0.5% to 4% of
premium costs.
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CFO PUBLISHING
and 300 covered people. “We have not had stop-loss
for several years, but with new possibilities in the
market, we expect to have it again soon,” he says.
To be sure, self-insurance does not completely
shield a company from the ups and downs of
medical-market trends. After five years of holding
medical expenses flat, Lawhorn is expecting to see
an increase of more than 25% in the coming year
and following years, thanks to higher reinsurance
rates and higher charges from health-care providers.
“There’s so much uncertainty about health-care
reform, [both insurers and providers] are trying to
capture as much revenue as possible in the next four
years [before the full impact of reform kicks in],” she
says.
On average, stop-loss rate increases were “running
in the upper teens to low 20s this spring” before
adjustments that would somewhat lower the
effective rates, says Carl Austin, assistant vice
president at A.M. Best, which provides credit ratings
for insurance companies. So far there’s “no firm
evidence” that the increases will abate, although
most carriers expect “the worst is over,” he adds.
Still, Lawhorn says, “I think self-insurance is
the one thing that’s helping us, by allowing us to
be more strategic with plan design and the costsharing structure.”
Occasionally, insurers will offer great deals to
entice companies they deem as good risks back
into their pools, says Thompson, something that
can make switching an attractive option in the
short term. Over the long run, though, self-funding
will beat any deal insurers can offer, he says. “The
question is, can the company absorb the risk in the
short run?” says Thompson.
Which companies should not consider selfinsurance? Those in industries where cash flows
are scarce or unpredictable, for starters. Companies
with big changes in the works, such as a major layoff
or acquisition, should also refrain, since reshaping
the employee group can change the cost dynamics.
Smaller companies without a substantial,
experienced human-resources team may risk
overlooking some fundamental requirements
for complying with health-care-related laws and
regulations. The firms might get away with such
an oversight for a while, but could be subject to
significant fines if they’re randomly selected for an
audit.
Even something as simple as maintaining required
plan documents—a technical document that details
plan compliance with Employee Retirement Income
Security Act (ERISA) rules for such things as claims
procedures and eligibility provisions, as well as a
summary plan document for participants—can fall
through the cracks.
“These documents have been required since the
1970s, yet many of my clients think they are in
compliance because they have insurance contracts.
In 99% of the cases, that is not enough to meet
ERISA’s standards for plan documents,” said
Benjamin Lupin, director of compliance at healthcare program broker Corporate Synergies Group, at
one of CFO’s recent Leadership Summits in Orlando.
Evidence that insurance contracts aren’t sufficient
showed up in an audit letter from the Department
of Labor that some of Lupin’s clients received.
The letter specified that the DoL would be looking
at plan documents and contracts with insurance
carriers.
Not supplying such documents within 30 days of
a written request from an employee can result in
a fine of up to $110 a day. “This is an unnecessary
liability,” said Lupin. “Putting these documents in
place is not that costly.”
Smaller companies also may fail to retain planrelated documents—including amendments to
original plans and open-enrollment materials—for
enough time after a plan year ends, Lupin noted.
ERISA requires that employers keep them for at
least six years. But some states, like Texas, have
longer statutes of limitation on claims against
health-benefits plans. Corporate Synergies
recommends that clients hang on to documents for
8 to 10 years.
Failure to file Form 5500 each year can be even
costlier. The form, required for plans with more
than 100 participants, contains basic information
such as the number of people covered under
the plan, the amount of assets in the plan, and
identification of plan providers. The fine for
noncompliance is a maximum $1,100 a day.
Lupin pulled data showing that in Florida
alone, between 2000 and 2012, 10 employers paid
between $50,000 and $100,000 for Form 5500
noncompliance, and 46 employers paid between
$10,000 and $50,000. “And those were just the
unlucky ones that were audited,” he pointed out. “It
doesn’t mean everyone else was compliant.”
Meanwhile, the DoL is becoming more vigilant
about enforcing compliance with the Health
Insurance Portability and Accountability Act of 1996
(HIPAA). The department started a pilot program
in which it’s auditing 150 randomly selected
employers. Auditors come to a company’s offices for
3 to 10 days and go over its HIPAA documentation
with whomever is responsible for monitoring
compliance with standards under the law. Penalties
are up to $2,500 per incident of noncompliance per
standard.
In a high-profile case in 2009, CVS Caremark
was fined $2.25 million for violating standards of
privacy for participants in health-care plans after
the company’s human-resources leader left a laptop
computer loaded with customers’ HIPAA-protected
information in a taxicab. CVS was also required to
submit to an audit of its health-care program every
other year for 20 years.
Lupin also addressed some aspects of the twoyear-old health-care reform law that are relevant
to 2012. For one, starting in 2013 employers with at
least 250 employees must report on each person’s
Failure to file Form 5500 each year can
be even costlier. The form, required for
plans with more than 100 participants,
contains basic information such as the
number of people covered under the
plan, the amount of assets in the plan,
and identification of plan providers. The
fine for noncompliance is a maximum
$1,100 a day.
Form W-2 all prior-year costs for health insurance
paid by both employer and employee.
“That might not seem like a big deal if you have
a fully insured plan, because the cost is essentially
just the premium dollars you’re spending,” he said.
“But here’s the problem: things happen. Say an
employee joined a company in February. He gets
married in March and adds his wife to the plan. She
has a baby in November and now they go to a family
plan. That’s got to be tracked, and the numbers
have to be accurate.” Reporting the information
incorrectly will subject the employer to the same
$200 fine per Form W-2 that already applies for
CFO PUBLISHING
63
errors on the form.
Although the information is to be reported on a
tax form, the plan costs will not be taxable—for
now, at least. Many observers have suggested that
the government will use that information to identify
companies subject to the “Cadillac tax” for lucrative
plans that is scheduled to take effect in 2018.
Second, a new plan document is required for
plan years with open enrollment taking place after
September 23 of 2012. Called Summary of Benefits
and Coverages (SBC), it’s a mini-summary plan
document. Failure to provide the SBC may result in
an excise tax equal to $100 per plan participant per
day of noncompliance. Should the DoL deem the
noncompliance to be “willful,” an additional $1,000
fine per violation may be assessed.
“All these things may not be high priorities for
CFOs,” said Lupin. “But they should not be an
afterthought. For years the DoL focused mostly on
retirement plans. But now, because of health-care
reform and other issues, health-benefit plans have
become much more of an issue.”
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CFO PUBLISHING
CFO Summary
• A growing number of smaller companies are cutting
costs by becoming self-insured. Companies then
pay for employees’ claims as they happen instead
of paying preset, monthly per-employee premiums
to an insurance company.
• Self-insured companies typically spend less
on claims and reinsurance than they would on
premiums. Another immediate benefit: avoiding
state taxes on premiums that insurers pass along
to clients.
• Be careful: self-insurance does not completely
shield your company from medical-market trends.
Self-insurance may not be right for industries with
unpredictable cash flows or companies without an
experienced human resources team.
• Consider the necessary paperwork. Make sure
to retain plan-related documents, even after a
plan year ends. If your plan has more than 100
participants, you must file Form 5500 each year, or
face fines for noncompliance.
NAVIGATING COMPLEX
WATERS TAX ADVICE
A
s tax season approaches, many small and
midsize companies turn to temporary
tax accountants for help. But one
executive at a prominent finance and
accounting staffing firm says these companies
might be taking the wrong approach.
First, companies chronically underestimate the
availability of such workers, contends Andrew
Reina, managing director of Accounting Principles.
Among the many types of positions the firm fills,
tax people are in the scarcest supply. Yet every
winter, the firm is flooded with requests for them
just as tax season begins, or even worse, later on
as IRS or internal-reporting deadlines loom and
companies realize
they’re short-handed.
“Almost all the tax
people are already
working,” Reina says.
“There never seems
to be a shortage of tax
need out there.” Those
with tax degrees are
gobbled up quickly
coming out of school
by public accounting
firms, and after they’ve
completed a couple of
years of work there,
corporations grab them
just as enthusiastically.
Plus, tax professionals
tend to be fairly
conservative careerwise,
staying with employers
longer than their
counterparts in other
finance and accounting
disciplines.
And it’s not like the
pool is big to begin with. Tax work is specialized,
technical, and demanding; subject to an unending
stream of new rules and regulations to absorb; and
perceived as less sexy than some other finance
roles. All of that serves to dampen interest in
pursuing the field.
One would think that after a company encounters
a shortage of tax talent one year, it would be aware
the next. But some of Accounting Principles’s
procrastinating clients make the mistake repeatedly.
“They’ll literally call the week before their tax
provision work is supposed to be done and say they
need somebody tomorrow,” says Reina.
Also, companies routinely take on such workers,
CFO PUBLISHING
65
give them a one-day orientation, and expect them
to be fully up to speed on the organization and its
systems. There needs to be a better support system,
Reina urges, with seasoned professionals available
to answer additional questions. “Companies
should expect high-quality work from anybody
they bring in, but it’s not fair to compare those
folks to employees who have been there for years.
There need to be goals and expectations that are
challenging but achievable.”
Companies between $100 million and $500
million are most likely to need temporary tax help,
“There needs to be a better support
system, with seasoned professionals
available to answer additional
questions. Companies should expect
high-quality work from anybody they
bring in, but it’s not fair to compare
those folks to employees who have been
there for years. There need to be goals
and expectations that are challenging
but achievable.”
Reina observes. Larger ones have deeper internal tax
departments and use the tax services of large public
accounting firms, and smaller companies often have
less-complicated tax situations.
Tax Rules to Take Advantage Of
The language of tax rules is often considered
dense, confusing, or downright off-putting. Indeed,
the complexity of understanding and qualifying for
tax incentives often leads small companies with
limited resources to avoid them altogether, says
Karen Kurek, national leader for manufacturing and
distribution at McGladrey.
“I think that few mid-small manufacturers really
take advantage of these [incentives] because they
perceive that they are too complex and too costly,
or they think they don’t have the internal resources
to devote attention to them,” Kurek says. But small
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CFO PUBLISHING
businesses that count themselves out could be
leaving much-needed money on the table, she says.
Here are three tax incentives that experts say
small companies often overlook, and should
consider.
1. The Research and Experimentation
(R&E) Tax Credit
The R&E credit reduced companies’ cost of doing
new qualified research by an estimated 6.4% to 7.3%
in 2005 (the last year available), according to a 2009
Government Accountability Office (GAO) report.
But many small companies don’t take advantage
of the credit, because they don’t consider what
they do to be “research and experimentation,”
says Dean Zerbe, national managing director
at alliantgroup and former tax counsel to the
U.S. Senate Committee on Finance. “Small and
medium businesses often think they need to have a
laboratory full of scientists wearing white coats to
qualify,” Zerbe says. In reality, improving a product
or a process that already exists can also count as
research and development, he says.
One example: a company that Kurek worked with
implemented a process-improvement initiative on
its factory floor and took an R&E tax credit for many
of the costs of redesigning its production flow, she
says. Companies that improve or extend the life of a
product can also qualify for the credit, she adds.
For instance, consider a company that
manufactures automobile engines and redesigns
a valve to make it compatible with five kinds of
engines. Even though that valve currently only
works with one engine, the redesign could still
qualify for R&E tax consideration, Kurek says. The
R&E credit was envisioned as a temporary measure,
but has been continually renewed over the years.
In 2012, however, President Obama has proposed
making it permanent.
2. The Interest-Charge Domestic
International Sales Corporation (ICDISC)
Another often overlooked incentive, the IC-DISC
can save small and midsized companies as much as
20% on income from exports. The provision enables
companies that manufacture and ship products or
services abroad to reduce their tax bill by creating
separate tax entities called IC-DISCs that are taxed
at the capital gains rate, a lower rate than income
taxes.
Here’s how it works. A company pays a tax-
deductible commission based on its export income
to this separate entity, its IC-DISC. The IC-DISC
then pays dividends to the exporter that may be
taxed at a capital gains rate of 15%, a lower rate than
the ordinary income tax rate, which could be as
much as 35%.
Parts manufacturers can also qualify for this, for
example. Thus, a company that builds tires for cars
that are shipped overseas could take the credit, says
Zerbe. And architectural and engineering firms can
take the credit if they design buildings in the United
States that are then built in other countries. The
downside: the provision that allows companies to
pay tax on these IC-DISC dividends at the capital
gains rate will expire at the end of 2012, unless it
is extended. Companies must therefore consider
carefully whether it is worth the cost of setting up
an IC-DISC right now.
3. The Energy Efficient Commercial
Building Deduction
Small businesses can take this deduction,
which expires at the end of 2013, if they build or
retrofit their offices, warehouses, or factories or
other commercial buildings to be energy efficient.
Such buildings must have 50% lower energy and
power costs than buildings that adhere to 2001
federal energy standards for lighting, heating,
cooling, ventilation, and hot water. Architectural
or engineering firms can also tap into this benefit
if they design energy-efficient buildings for the
government, such as dorm rooms for public
universities.
Qualifying for this deduction isn’t very difficult.
That’s because many companies must already
comply with state energy-efficiency laws that are
stricter than the federal standards, Zerbe says.
Businesses can also partially qualify: If they don’t
hit the target percentage, they can still receive a tax
credit that comes out to “a very significant savings,”
he says.
In addition, companies that take this credit may
save on energy costs in the long run. But there’s a
cost to qualifying, since companies must hire an
independent engineer to evaluate the buildings.
The deduction may thus not offer much return
on investment for buildings smaller than 50,000
square feet, he cautions.
CFO Summary
• Don’t wait until the last minute to retain temporary
tax help.
• Create a support system for temporary tax
accountants to turn to seasoned professionals at
your company if they have additional questions after
orientation.
• Don’t leave money on the table. Many smaller
companies avoid taking advantage of tax incentives
because of intimidating tax rules.
• Your company may qualify for the Research and
Experimentation (R&E) tax credit if you have
improved a product or process that already exists.
• The Interest-Charge Domestic International Sales
Corporation (IC-DISC) incentive can save your
company as much as 20% on export income.
• The Energy Efficient Commercial Building Deduction
may apply if your company has built or retrofitted
your offices or commercial building to be energy
efficient.
CFO PUBLISHING
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AN ADDITIONAL
TECHNOLOGY
CHALLENGE SECURITY
Y
esterday’s hackers, whose exploits were
often designed to earn bragging rights within
the hacker community, have given way to
far more sophisticated cyber criminals in
pursuit of cold, hard cash. Some penetrate databases
to steal the personally identifiable information (PID)
of employees and customers. Others steal intellectual
property and business data. Some use it, while others
sell it to other criminals.
Which companies are hackers targeting? “The
main focus of hackers seeking PID is midsize
companies,” says Paul Viollis, CEO of Risk Control
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CFO PUBLISHING
Strategies (RCS), a security and investigative firm.
Why? “They’re perceived as the path of least
resistance.”
Midsize organizations with up to 100 employees
and $100 million a year in revenue “lack the security
budgets of their big-business peers,” explains
Tim Matthews, director of product marketing at
Symantec, a leading security systems provider.
A recent Symantec survey of more than 2,000
small and midsize enterprises found that 73%
had been victimized by cyber attacks, and the cost
cannot be measured by dollars alone. “There’s always
the risk of customers no longer conducting business
with you,” Matthews says. “Once your reputation
is tarnished, shutting down becomes a very real
possibility.”
Breaking and Entering
Midsize enterprises are vulnerable to a variety of
exploits, including “phishing,” in which employees
are lured to phony Websites through e-mail or IM;
SQL injection attacks that invade operating systems
to gut the contents of poorly designed websites;
bots that take over machines, turning them into
“zombies” that criminals can control—the list is
long. Legacy systems that haven’t been diligently
patched or upgraded to guard against new threats
are particularly vulnerable.
Social engineering—the art of tricking people—
has caused more security breaches than all external
attacks combined, according to 403 Web Security, a
web-application development company.
Social engineering was behind a March 2011 data
breach at security firm RSA. Employees received an
e-mail and an attached spreadsheet with the subject
line, “2011 Recruitment Plan.xls.” Once opened, the
spreadsheet installed a backdoor in RSA’s system
that compromised the code of RSA’s SecurID token.
Estimates of what RSA’s parent, EMC, spent to clean
up the fallout have run north of $66 million.
“We’ve estimated that a data breach costs
companies an average of $214 per compromised
record, and this excludes litigation and reputationrelated issues that are difficult to measure,” says
Larry Ponemon, founder of the Ponemon Institute,
which focuses on data-protection practices.
Ponemon agrees that today midsize enterprises
are in the crosshairs. “Why hack into a major retail
bank that has topnotch security when you can hack
into a much smaller enterprise that has access to
the bank’s data?” Ponemon asks. “It’s easier to break
into the side door than the front door.”
And those side doors aren’t locked at many
midsize organizations. Of the 761 data breaches
investigated in 2010 by the U.S. Secret Service
and Verizon Communications’s forensics analysis
unit, 63% occurred at companies with 100 or fewer
employees.
Most of those breaches were not as sophisticated
as the RSA hack. A recent Ponemon survey cites lost
or stolen mobile devices as the greatest trending
security risk. The risk doesn’t necessarily decline
when the focus shifts. “Companies think because
they outsource services or security they also
outsource liability,” says Toby Merrill, vice president
at insurer ACE Professional Risk. “They’re wrong.”
“You Will Be Sued”
Forty-six states have data-breach laws that require
organizations to notify anyone whose personal data
may have been compromised. Massachusetts’s is the
toughest, stipulating penalties
of up to $5,000 per violation.
Multiply that by thousands of
affected customers, and the
potential cost to the enterprise
is staggering. These laws make it
clear that responsibility lies with
the company that collected and
stored the data. “That’s who will
be sued,” Merrill says.
But many midsize businesses
believe the cloud offers greater
security. Boloco, a $20 million
chain of 18 burrito restaurants,
stores customer information in
the cloud via NetPOS, a pointof-sale systems provider. “No
credit-card swipe lives in our
system,” says Boloco CFO Patrick
Renna. “Our philosophy is to
leverage the security expertise of
much larger companies that have
resources we don’t.”
Boloco requires its various
software-as-a-service providers to comply with the
payment-card industry’s data-security standard and
with the SAS 70 auditing standard, which permits
an independent auditor to evaluate and issue an
opinion on the provider’s security controls. Boloco
also assesses its providers’ finances. That’s smart,
says Tracey Vispoli, global cyber solutions manager
for the Chubb Group of Insurance Cos. If you’re
suing, you want your provider to be solvent.
But many midsize
businesses believe
the cloud offers
greater security. “No
credit-card swipe
lives in our system.
Our philosophy is to
leverage the security
expertise of larger
companies that have
resources we don’t.”
Hack Counterattack
What else can midsize companies do? If they
had the cash, they could hire a security guru,
CFO PUBLISHING
69
and implement encryption, firewalls, intrusion
detection, and other security tools. But today, as
RCS’s Viollis notes, “how many midsize enterprises
have cash to spare?”
There are, however, measures that won’t break
the bank, notes Alan Wlasuk, CEO of 403 Web
Security. He suggests starting with a relatively
inexpensive scan of your IT system to determine its
vulnerabilities, educating your staff about the threat
of social engineering, and keeping up with security
fixes.
And, since hackers aren’t the only ones breaking
into databases (disgruntled employees and
those experiencing tough financial times are
other threats), it’s smart for CFOs to insist upon
background checks for new employees and the
implementation of strict data-access rules, such
as making sure HR can’t access customer data and
sales can’t access employee data.
Other relatively low-cost measures include
mandating strong passwords (at least eight
characters, a mix of numerals and upper- and
lower-case letters). Customer data should be kept
off of laptops, smart phones, and USB drives unless
encrypted or, at least, password protected. Also, it’s
not smart to store unneeded data; erase it.
Finally, consider buying cyber insurance. The cost
has come down by more than 20% from five years
ago, according to Robert Parisi, senior vice president
of insurance broker Marsh. Plus, he says, insurers
are tossing in freebies such as security assessments,
victim breach notification, and credit monitoring.
“In an era where a lot of companies have cut into
IT resources, insurance can be as important as the
firewall,” Ponemon says. “With cyber insurance,”
ACE’s Merrill adds, sounding like a salesman,
“you’re buying more than coverage; you’re buying
peace of mind.”
CFO Summary
• Because they lack the security budgets of bigger
companies, midsize companies are an appealing
target for hackers seeking personally identifiable
data (PID). Legacy systems are particularly
vulnerable.
• Data breaches are expensive, and responsibility lies
with your company if you collected and store the
exploited data.
• To counter this risk, many companies are turning
to the cloud. One CFO tells us, “Our philosophy is
to leverage the security expertise of much larger
companies that have resources we don’t.”
• Other relatively inexpensive measures include
scanning your IT system for vulnerabilities,
purchasing cyber insurance, and educating your
employees about risks.
Sources for From Tax to Tech: The Back Office:
“401(k)s: Watch Out for Speed Bumps,” Alix Stuart, CFO.com, November 15, 2011.
“A Lesson in Self-Reliance,” Alix Stuart, CFO.com, July 14, 2010.
“Five Costly Health-Care Compliance Slips,” David McCann, CFO.com, March 14, 2012.
“Hiring Temp Tax Workers: Open Your Eyes!,” David McCann, CFO.com, October 20, 2011.
“Three Overlooked Small-Business Tax Breaks,” Marielle Segarra, CFO.com, February 27, 2012.
“Where the Money Is, and the Security Isn’t,” Russ Banham, CFO Magazine, February 1, 2012.
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CFO PUBLISHING
CONCLUSION
MAKING THE MOST
OF OPPORTUNITIES
J
ust as many small and midsize companies
are now in a period of transformation and
reinvention, so too are their CFOs.
As small and midsize companies scour
the economic landscape for growth opportunities,
senior finance executives are acting as the
navigators—delivering insight-rich data to decision
makers and helping to ensure that business
decisions are grounded in rigorous financial
analysis. Rather than simply tracking the company’s
performance, CFOs are now in a position to help
drive improvements, prioritize resource allocation,
and quantify the risks associated with untested
opportunities and assumptions.
Such duties represent a turnabout from where
senior finance executives focused their efforts in
recent years, when dropping demand led them
to devote themselves to refining their abilities to
manage costs and enhance efficiencies. Their goal
stayed fixed: protecting the company’s revenues and
profit margins.
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CFO PUBLISHING
As CFOs today look forward to a period of
growth—no matter how plodding it may be—they
will inhabit a key role in helping the executive team
to pursue opportunities in a sustainable fashion,
making sure that capital and cash management
remains an overriding concern. Continuing resource
constraints on their companies will require CFOs to
elucidate the financial risks associated with specific
growth initiatives. And it will be up to CFOs to help
make sure that new lines of business are creating
value. As growth picks up, the strategic questions
will come at them furiously: Should the company
expand its footprint abroad? Should it focus on
organic growth or entertain acquisitions? As the
company finds it necessary to broaden its portfolio
of capabilities, how far will the business model
stretch—without snapping?
Faced with these tough questions, CFOs may
not yet have all the answers, but it’s our hope that
this CFO Handbook has inspired you to go beyond
focusing on numbers and to start thinking big.

How Small and Midsize Companies Can Generate Growth

Transcription

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