I’m considering giving my manager an option to buy stock in my company. My thought is it wouldn’t cost me anything right now and it would give him incentive to stick around and help grow the value of the business. And, if things work out and he exercises the option, it could raise some funds for us, make him an owner and give him more reason to stick around and work hard. Does this make sense? Any tax issues I need to consider?

Answer:

If you can get comfortable with this person becoming an owner1; you make a condition that he must be employed to exercise the option; you can work out the valuation methodology so it’s clear and fair and will not give rise to disagreement; and the employee has (or should have) the cash that will be needed to exercise the option, it’s a great idea.

Let’s say you grant him a three-year option to purchase 10,000 shares issued from treasury, i.e., from your company, at the price of $3 each. There are currently 200,000 shares outstanding, all held by you, and so he could gain a 4.76% ownership interest. If the $3 per share reflects the current fair market value per share, there’s no tax due when the option is given — neither to your company (grantor) nor your employee (grantee).

Now let’s say in three years you value the stock at $5 per share and he exercises this option for all 10,000. He pays the company $30,000 (which does not trigger any tax; the amount is added to the company’s capital account) and the company gets a $20,000 tax deduction for the $20,000 of “value” it gave to the employee. Unfortunately, this “gift” amount is considered compensation to the employee at the time he exercises the option. Therefore, he must pay tax on this amount at his ordinary income rate. However, if the employee later2 sells his shares for a profit, he will enjoy capital gains tax treatment on the gain.

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1. ^{We recommend making any stock issued “nontransferable” and “non-pledgeable” as collateral for a loan. Further, institute an automatic buy-back provision such that, in the event the holder departs the employment of the company, the stock is valued at a set valuation methodology and the company buys back the shares.}
2. ^{At least one year after exercising the option.}

The U.S. Government is the world’s largest buyer of goods and services – some $425 billion annually – with $200 billion of that purchased from private U.S. businesses. Are you getting your share?

Learn how to sell to the U.S. Government and you might find a significant source of new revenue. Those who have sold to the government say that, once you become familiar with doing business with the government, it’s not bad at all. It might take a little work to learn the ropes, but the prevailing lack of knowledge of how to do business with the government soon turns to your advantage.

The Office of Government Contracting (GC) is the agency that coordinates government purchases. To foster equality between large and small companies, each government agency establishes goals for contracts let to small businesses. Currently, the overall small business goal is 23 percent. This includes the specific goals of five percent to Women-Owned Small Businesses (WOSB), three percent to businesses owned by service-disabled veterans, five percent to small disadvantaged businesses (SDBs), etc. Each federal agency reserves specific procurements exclusively for small business participation. These transactions are called “small business set-asides.”

What is a small business? It’s likely you’ll qualify. Size standards are set for each six-digit NAICS code. Some are employee count thresholds. Some are annual revenue. Here are the size thresholds for a few:

GC administers several programs and services that assist small businesses in obtaining government contracts. They include the Certificate of Competency, the Non-Manufacturer Rule Waiver, and the Size Determination Program. The office also oversees special initiatives such as the Procurement Awards Program, the Annual Joint Industry/SBA Procurement Conference, the Women’s Procurement Program, and the Veteran’s Procurement Program.

Find out more and get started at http://www.sbaonline.sba.gov/contractingopportunities. Then, send your success stories to editor@thebusinessowner.com.

• Area of a field cleared
• Rows of seeds sown
• Bushels of cotton picked
• Feet of track laid
• Number of garments sewn

Work looked like work and loafing looked like loafing. The practice of management wasn’t as tough then as today. Either the workers were cutting, clearing, hammering or sewing, or they weren’t. It was plain to see.

With the transition from a goods-based to a service-based economy, work changed from physical creation of tangible goods to intellectual creation of intangible products and services. Work is now done mostly by clicking, typing and talking. Incidentally, so is leisure. So bosses no longer can assess productivity by simple observation of workers or counting units of output. And if a manager cannot determine whether an employee is working diligently and productively, how is he or she supposed to know when intervention is needed? When coaching or corrective action is needed?

Monitoring More Difficult Now, but Necessary

We could judge a new salesperson simply by the number of sales he or she makes, or the quality of sales, but that’d be a bit like judging a new bricklayer merely by how long it takes for him or her to build a house, or the quality of the house. It’d be more prudent and less risky (and costly) if we monitored his or her work a bit along the way — particularly while he or she is new and unproven. Maybe watched and measured his or her first brick? Row? Wall? Archway? By doing so, we can spot troubling patterns before they turn into big problems. We can see signs of trouble and take corrective action while there’s still time to salvage success from what could become certain failure, even disaster.

Measuring activities that lead to success is what allows us to engage in the very practice of management.

Do you know the activities that lead to success in a certain job? You must, of course, if you are to manage. And once you do, you must monitor the employee’s performance of essential activities. If you measure and track only end results, such as sales, you are not engaging in management. Management is about monitoring performance — execution of essential activities that lead to success — and about taking timely corrective action to:

• Help cooperative and capable employees adopt behaviors that lead to success
• Spot habits or behaviors that produce unsatisfactory results
• Reassign or terminate employees unwilling or unable to perform key activities that lead to desired results

Yes, we must measure results as well as behaviors (or activities) that we know lead to desired results, but how? It is so much more difficult today. How do we know whether employees are working on their computers and phones at assigned tasks?

Keep Tabs via CRM

Virtually every successful company of any size today uses a customer relationship management (CRM) software program to track its customers, prospects, marketing campaigns, sales efforts, pipeline and sales. Popular CRM programs include Goldmine, SalesForce.com, SugarCRM, ACT, Microsoft Dynamics and Filemaker. Each allows you to track and monitor salesperson behaviors such as phone calls, in-person calls, meetings, emails, lead generation, proposals delivered, and sales won and lost. You also can track the number of keystrokes, time logged into the system and the number of entries.

So what are you waiting for? Track employee productivity, compare behaviors of your top performers and be a better manager. And the discipline of logging all prospect and customer activity into a CRM provides other very important benefits, such as lessening valuable information lost in employee turnover.

Monitor the Monitors

Many managers have begun using technology to actually “watch” what employees do on their computers. They argue that employee abuse is rampant and that managers must somehow fight back. Studies seem to support this assertion, such as the one conducted by Salary.com, which found that employees spend an average of 1.86 hours per eight-hour workday on something other than their jobs, not including lunch and scheduled breaks.

Necessity is the mother of invention, of course, and various software solutions are now available that will allow you, from the comfort of your own computer, to see or receive reports on what your employees do on their computers. Check out offerings by Spectorsoft, Track4Win and SpyTech.

If you decide to begin monitoring, you may want to talk to your lawyer about legal ramifications and also consider whether you should tell your employees. Odds are you’ll want to let them know and also add the monitoring policy to your employee manual. They’ll probably throw a fit, but such does not mean it’s not a smart move on your part.

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Monitoring employee productivity and on-the-job focus is not nearly as easy as it used to be. We can be sitting right across the room from an employee and not know whether he or she is working diligently on assigned tasks or emailing friends, checking Facebook or looking for a job. Two great tools that allow you to step out of the guessing game are productivity tracking via CRM and direct remote monitoring of computer usage. It may feel strange at first when you begin these types of monitoring and measuring, but, ah, it’s your job. Management is about monitoring and measuring performance. And, as management legend Peter Drucker famously said, “What gets measured gets managed.”

Monitor, measure, and be a better manager.

Want some suggestions? How about from one of the world’s foremost authorities on entrepreneurship, venture capital and business plan pitches?

John W. Mullins is a London School of Economics professor, consultant, author, speaker and investor. He regularly reviews business plans and sees the common mistakes made. He recently revealed¹ oft-made mistakes and gave suggestions he said should “get you invited back and, if all goes well, raise some capital.” He said good business plans contain three key elements:

1. A logical statement of a problem and its solution
2. A battery of cold hard evidence
3. Candor about the risks, gaps and assumptions that might be proved wrong

The common mistakes business plan authors make?

• Overemphasis on technical or functional aspects of the product
• Overreliance on the size of the market
• Failure to base projection on and/or anchor projection by cold hard facts

Mullins goes on to share the commonly used words and phrases that cause venture capitalists to send plans from their hands to the trash bin:

• “No competition.” Of course your business will have competition! Buckle down and figure out who they are or where it will come from. Further, competition is not a bad thing. Competition suggests that someone besides you thinks there’s a problem worth solving.
• “Huge.” Instead, why don’t you collect and provide reliable data on the market size as well as the narrow niche in which you intend to initially focus.
• “Conservative.” Let the numbers speak for themselves. Just make your best estimates. Capital providers know that the projection rarely pans out.
• “Assumptions.” Investors aren’t interested in investing in a business based on “assumptions.” Instead, find credible evidence that supports each of the figures used in your financial model.
• “We believe.” Similar to “assumptions,” above. Do the research and locate the data necessary to move from “we believe” to “the evidence shows” and “our research reveals.”

Just as anybody can talk about an opportunity or idea, anybody can write a business plan. But if you want to make the effort worth your while, John W. Mullins’ advice seems credible.

¹ In an article titled Why Business Plans Don’t Deliver that appeared in the Wall Street Journal on June 22, 2009.

Customers. What would be the impact on your company if you lost your largest customer? If the answer is “severe,” then you bear customer concentration risk¹. Do you think you have an exceptionally strong relationship with your largest customer? If so, can your relationship prevent such things as fire, fraud, death, divorce or change of ownership? Probably not.

Contrary to what many owners think, diversity is achievable. It may take years, but once you secure customer diversity, then you have significantly increased the chance that your company will be around for the long run. You have increased its value, too.

Most regular acquirers of companies consider 10% to be the threshold between healthy customer diversification and concentration risk. If the largest customer, or any customer, accounts for more than 10% of annual revenues, buyers typically reduce the price they’re willing to pay — to account for customer concentration risk. Business owners should use this gauge, too.

Industry. What industry do you serve? If you could answer this question with the name of a single industry, then you bear industry concentration risk. Only companies that sell into multiple industries enjoy industry diversification. Over time, small companies should identify and penetrate multiple industries. For example, a printer that specializes in Baptist church books and magazines should expand to other denominations, then expand outside of faith groups to produce corporate annual reports, for example, or travel-related magazines.

Product. The “category killer” of the 1800s, U.S. Saddle and Whip Co., no longer exists because of its failure to diversify its product lines. If the company had only diversified into other types of leather goods, such as automobile seats or driving gloves, its great-grandchildren might be graduating from Harvard Business School today and managing the family foundation.

Employees. Reliance on a single, or a few, talented employees has caused the failure of more than a few companies. A private company owner should do all that he or she can to reduce exposure to the sudden departure of key employees.

First, consider key-man insurance to insure against death or disability of key contributors. Next, break up key tasks performed by your most critical people and spread them around to as many people as possible.

Vendors. Private companies that purchase unique items or services from a single vendor, or purchase components that would be hard for another company to duplicate, may bear significant risk. Take your key vendors and ask yourself, “If XYZ vendor burned down or closed due to financial problems, how would my business be impacted?” If the answer is “greatly,” you need a contingency plan. You should consider insurance, and begin plotting a course of action to mitigate this random risk exposure.

Credit. The lifeblood of many businesses is their source of funding. What if your banker pulled your line of credit, or your largest vendor stopped offering you attractive payment terms? During difficult economic times, credit sources can dry up unexpectedly. Business owners should recognize credit risk and work to ensure that this lifeline remains extended.

Geography. The business cycle tends to roll through industries and geographic regions in a less-than-uniform manner. If all of your customers are in a single state or country, you bear risk associated with your lack of geographic diversification. Try to find customers located elsewhere.

¹ Concentration risk is lack of diversification in revenue or profit sources.

Are you looking for clarity about where to focus your energies this year, right now, or how to make your company stronger and more successful? Here’s the answer: Reduce your operating costs and invest the savings in sales and marketing. Yes, it’s that simple.

Reduce Operating Costs

Your largest expense categories offer the most promise for expense reduction. For most companies, they are labor, occupancy expense and vehicles.

Overhead Labor Expense: Every dollar of salary and wage expense that does not bring in revenue is a burden. Burden must be continuously cut away. Technology and the ever-expanding buffet of outsourced service options make it possible. And because it’s possible, it’s imperative. The competitive marketplace means you’re in a race against your competition to adapt and to adopt more efficient means.

By reorganizing necessary tasks this way or that, can one person do the work you’ve been paying two to do?

• Can a part-time contractor perform work you’ve been paying a full-time person to do?
• Can you use inexpensive technology — or train your customers — to do some of the overhead task work for you?

Also, if you’re a baby boomer, your formative working years were marked by inflation. Annual, automatic pay raises for each employee became the norm. But inflation is no longer part of our economy. At least not today. Stick with your automatic annual pay raises, and you’ll simply transfer your profit to your employees.

Occupancy Expense: Every dollar spent on facilities is a profit dollar lost. Do you really need all that space? Do you really need that quality of space? Does the premium you pay over “C-class” space really aid your ability to earn a profit?

If you own space that is larger or of higher quality than you need, sell it or lease it to a user who can garner higher utility from it than you (and therefore justify paying a premium to you). For your own needs, buy or lease more economical space elsewhere. Now’s the time to reduce occupancy expense. Real estate values are in the tank. Negotiating strength has shifted away from sellers and landlords to buyers and lessees. Get tough and lock in a deal that can save you big bucks for years to come.

Vehicle expense: Many owners and employees seem to think it’s important, or somehow required, to have expensive cars and trucks. Does the quality of your vehicles — or even whether you have them — really add value to your product or service? Cars and trucks are a terrible place to put your money. They lose 30% of their value in the first year — 95% over 10 years — and cost a bundle to operate, maintain and insure. If you deliver physical goods, consider doing what Michael Wasserman does — use contract carriers.

Where to Invest Operating Cost Savings

The fount of life for your business is sales. More buyers of your goods and services are “out there.” You just need to expose them to you as a source, and teach them to buy from you. To do so, invest in your brand and create awareness by sending salespeople out to court and serve. It’s a conventional war. You need “boots on the ground.” Send as many as you can afford to recruit and equip. Reductions in overhead expense will allow you to afford more and equip more.

Are these suggestions divine providence? Well, one thing’s for sure — these suggestions are pretty simple.

The result: less research and development and fewer new inventions, ideas and products. Intellectual-property laws also protect consumers from confusion, deception and harm.

Patents:

A patent is a grant by the federal government of a monopoly right to an inventor to make, use or sell an invention to the absolute exclusion of others for the period of the patent, currently 17 years from the date of approval or 20 years from the date of filing, whichever is longer. The owner of the patent also may profit by licensing to others a right to use the patent. Once the original patent term expires, it may not be renewed, the invention enters the “public domain,” and anyone then can use it.

The Patent Act specifies the types of inventions that may be patented: any new and useful process, machine, manufacture or composition of matter or any new and useful improvement thereof. To be patentable, it must be novel, have utility and not be obvious. Naturally occurring substances or “discoveries” are not patentable because the invention must be made or modified by humans.

Copyrights:

A copyright is a form of protection provided by federal law that protects an original expression of an idea. It extends to authors of original works such as literary works, musical works, dramatic works, pictures, graphic and sculptural works, motion pictures and sound recordings. Applications for copyright are filed with the Register of Copyrights, Copyright Office, Library of Congress. A copyright is actually a bundle of separable rights, including the rights to reproduce, distribute, adapt, perform or display a work. For example, an artist who sells a painting might give up the right to display that work, but none of his other rights. The owner of the painting does not automatically buy the remaining bundle of rights when he or she purchases the painting. The owner of the copyright has the exclusive right to use or reproduce the work or license such rights to others. The doctrine of “fair use” allows for limited use of any copyright in ways that facilitate criticism, comment, news reporting, teaching, scholarship, or research, but this is a very limited exception and often fails as a defense to copyright infringement.

Registration is not required for protection because copyright law protection begins as soon as the work is fixed in a tangible medium. There is no truth to the myth that you must send yourself a sealed envelope by registered mail to get a “do it yourself” copyright. Copyright registration is advisable, because it expands the remedies for infringement. Regardless of whether a federal registration is obtained, it is wise (though not required) to place a notice of copyright on all publicly distributed copies so as to give reasonable notice of the claim of copyright. A copyright notice typically consists of an encircled C, the author’s name and the year the work was created, e.g., © The Business Owner, 2003

The copyright law has been revised several times, resulting in different life spans of a work depending on when it was created and which law applies to it. Recently the Supreme Court upheld extension of copyright terms, meaning that many works from as far back as 1928 are still protected by copyright. It is wise to contact an intellectual-property attorney before making use of artwork or literature, since it is not easy to determine what’s in the public domain.

Trademarks:

A trademark is any word, symbol or device (even colors or smells) that identifies and distinguishes the source of a product or service. There are four types of marks: trademarks (used to identify goods, like cookies or clothing), service marks (used to identify services, like an insurance agency or car repair center), certification marks (indicating compliance with certain standards, like the Good Housekeeping seal of approval) and collective marks, which indicate membership in an organization, like The Boy Scouts of America. The federal government protects organizations and consumers by making it illegal for a person or organization to “palm off” or “pass off” goods from one source as goods from another, or “cash in” on the good will, good name or reputation of another.

To be federally protected, a mark must be distinctive so that it identifies the origin of the goods or services. Marks that are fanciful or arbitrary satisfy the distinctiveness requirement, whereas generic or descriptive designations do not. To obtain federal protection, the mark must be registered with the Patent and Trademark Office. Registration serves to notify all that the registrant has exclusive rights to use the mark, and permits the registrant to use federal courts to enforce the mark.

Trade Names:

A trade name is any name used to identify a business and its assets. The difference between a trademark and trade name is that the first distinguishes a particular product as coming from a particular source, even if that source is unknown. (For example, a consumer may be able to easily distinguish OREO cookies from Hydrox, without knowing what company makes either one of those cookies. A trade name, on the other hand, is the name a business uses to identify itself, like McDonald’s Corporation. Sometimes a company will use its trade name as a trademark on products or services (Coca-Cola or McDonald’s are good examples), but that’s not always the case. A holding company might be organized to own trademarks and service marks for tax reasons. Although a trade name may not be federally registered, trade names are protected and any person who attempts to “palm off” his goods as the goods of another is liable for damages.

SBA programs allow banks to take higher levels of risk and lend at reduced rates. Laughrey says monthly debt service reductions of 25 percent and 50 percent are common. It’s achieved by lengthening the amortization period on “term debt” and lowering the interest rate.

Current loan maximums and guarantee maximums under current SBA program law are $2 million and $1.5 million, respectively, but the U.S. Senate is considering a bill that would raise it to $5 million and approximately $3.5 million, respectively. Lenders and the SBA generally need the following from you when you apply:

• Business Profile: Description of your business. Include what it does, type of legal entity, its products, whom it sells to, number of employees, brief history and who owns the business.
• Loan Request: Description of how much money is needed and what the funds will be used for.
• Collateral: Description of collateral offered to secure the loan. Include equity in the business, borrowed funds, available cash, and assets such as accounts receivable, inventory, equipment and real estate.
• Business Financial Statements: Complete financial statements for the past three full years plus year-to-date. This includes balance sheets and income statements.
• Projections: Expected revenue, expenses and cash flow for the next three years. Must show that the business can support repayment of requested funds.
• Business Tax Returns: Most recent three years.
• Personal Financial Statements: For each person who owns 20 percent or more of the business, current personal balance sheets (i.e., list of all assets, liabilities and personal tax returns for the past three years).

Don’t sweat the paperwork. Banks that specialize in SBA loans can help you comply, as can independent SBA loan consultants such as David Laughrey. Finally, if someone asks you for a large up-front fee, find someone else. For more information, including a complete list of SBA lenders, go to www.sba.gov.

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^* David Laughrey does not have a website. You can reach him at 918-524-9400.

When a company embarks on a venture that’s high risk, it may make sense to protect the established company from liabilities that will or could arise in the new venture. A commonly used and quite effective (and relatively inexpensive) means is to set up a subsidiary corporation and operate the new venture within it.

A subsidiary corporation is one in which another corporation, the parent corporation, owns at least a majority of the subsidiary’s stock and therefore has control over it. Such a structure can be effective at protecting the parent company from liabilities that arise in or as a result of the activities of the subsidiary, but only if the subsidiary is managed in a certain manner:

• Both corporations are adequately capitalized.
• Corporate formalities (e.g., election of officers, annual board meetings, filing of separate tax returns, etc.) are observed for each entity.
• Both corporations are held out to the public as separate enterprises.
• The two corporations keep separate financial records and do not commingle funds.
• The parent corporation does not completely dominate operations of the subsidiary to advance only the parent’s interests.
• The parent corporation avoids contractually guaranteeing debt of the subsidiary.

Failure to adhere to these could result in creditors being able to “pierce the corporate shield” and hold the parent corporation accountable for the debts of the subsidiary.

Entrepreneurship is risky. Knowledge is power. Stuff happens.

Business owners should arm themselves with knowledge about how to minimize legal and financial exposure, then fully exercise their right to limit and manage liability. Before you sign a legal agreement, ask yourself:

• How can I minimize my financial exposure by the way I execute this agreement?
• Who is the actual counterparty to this agreement?
• To what extent do I rely on this counterparty to perform in the future —financially or operationally?

The primary way businesspeople limit financial exposure is the legal entity. It’s one of the great inventions of modern commercial society. It allows people to take risks and shield their personal financial lives and/or their other legal entities. But it must be used wisely and properly — such as by signing agreements as a representative of one of the legal entities in a way that clearly demonstrates that you are not signing them personally.

When binding a legal entity, the signature block must have the full and correct legal name of the entity entering into the contract. Then underneath the legal entity name is the name and title of the “authorized representative” who signs on behalf of the entity. Here is an example of a properly styled signature bar:

A signature block like the example above ensures that any party who makes a claim under a contract has recourse only against the legal entity.1 If an individual signs his or her name to a contract and there is no indication that the individual is signing on behalf of a legal entity, the individual could be held personally liable.

As a business owner, you should use legal entities to limit your personal exposure. If you have multiple legal entities, you should also choose wisely which legal entity to bind. Similarly, if your primary legal entity has considerable value and you enter into business ventures that are risky or could give rise to significant liability, talk to your attorney about containing the risk within a separate entity.

Make sure you can depend on your counterparty

The extent to which you rely on your contractual counterparty in the future dictates the level of care you should take to know his, her or its financial capacity and history of performance (or lack thereof). For example, if you buy a car in “as is” condition with no warranties of any type provided by the seller, there’s not much at stake in their financial wherewithal or trustworthiness.²

But, on the other hand, if you lease a piece of real estate for a multiyear term, as lessor, you rely on your lessee to pay sizeable sums over many years. You also rely on the lessee to care for and maintain the property and improvements. You have a lot at stake. Evicting and re-leasing can take a lot of time and money. Leasing to a party that is financially unfit or has a history of defaulting on commitments could result in considerable loss. You definitely want to investigate the financial condition and track record of the proposed lessee.

How? Ask questions. Who (or what legal entity) is the proposed lessee? Is it a subsidiary of another entity? How long has it been in existence? What is its federal tax ID number? Headquarters address? Corporate phone number? With the above information, run a Dunn and Bradstreet (D&B) report. Your banker can obtain it for you. Ask your attorney to search for legal filings that involve the entity and its owners and representatives.

Additionally, ask for financial statements, a current balance sheet and most recent full-year income statement and current year-to-date income statement. If they refuse, assume the worst. If they comply but you are not expert at reading financial statements, seek the assistance of your banker or accountant.

If you conclude the proposed entity is not fit for the task at hand, express your concern with the representative. Tell him or her you need greater financial strength to stand behind the agreement. Let them propose solutions: maybe a new legal entity, maybe a parent company, maybe a personal guarantee, or all of these. But, of course, investigate the financial capacity and track record of any new entities, including persons, they propose.

If they take offense, explain that it’s not personal, just business. Don’t take verbal assurances. Accept only factual evidence. Talk is cheap. Entrepreneurship is risky. Knowledge is power. Stuff happens. Conduct your affairs in a way that protects and maximizes your interests. It could mean the difference between success and failure.

¹ This relates only to contractual liability. The “authorized representative” who commits fraud or misrepresentation could be held personally liable for such acts.

² Assuming, of course, that you are able to fully assess the condition of the car prior to purchase, and you are able to confirm that the true owner of the car, or the legal representative of the same, is the person you are transacting with.