Page 2 - TACC 2023 Program

2 HOUSTON BUSINESS JOURNAL FEBRUARY 24 - MARCH 2, 2023 FEBRUARY 24 - MARCH 2, 2023 HOUSTON BUSINESS JOURNAL 3

19th ANNUAL ACG CAPITAL CONNECTION SPONSORED CONTENT SPONSORED CONTENT 19th ANNUAL ACG CAPITAL CONNECTION

Improve Liquidity During Challenging Economic Conditions Chuck Johnson, SVP, Working Capital Considerations: Intra-Month Close Thomas Chance Teague, CPA, Director,
Middle Market, Fifth Third Bank
Transaction Advisory Services at FORVIS

Enhance management of cash flow and accounts credit only accrue interest when you draw on your available or other issue, it is important to have alternatives lined up and A dealmaker approaching the closing However, should the deal
receivable processes to storm a pandemic. credit, making either one a useful financial backup. ready to go in the event of a problem. table without having contemplated close at a mid-month date, the
the difference between month-end sufficiency and treatment of
While restrictions from the
COVID-19 pandemic are winding 2. Finance Insurance Premium Payments 4. Improve Your Accounts Receivable Policies and mid-month working capital deferred revenue, which was
never a component of a month-
balances could be facing significant
Companies can protect their existing capital by maximizing
Businesses of all sizes require multiple types of insurance
down, the chances of an economic policies, such as a business owner’s policy, general liability, account receivable (A/R) policies. Start by centralizing and purchase price adjustments, end balance sheet, needs to be
downturn are growing, and many and worker’s compensation. Your company could be subject automating A/R processing using software to expedite insufficient working capital, or a delay reevaluated as the balance of
businesses face an uncertain to even more requirements depending on its other assets, payments. It could also help to expand data collection and in closing. deferred revenue may be higher
recovery. Firms can navigate such as real estate or a vehicle fleet. analysis beyond days sales outstanding to include metrics In preparation for a transaction, during the month than it would
this volatility and mitigate risk by Improve liquidity by financing these capital-intensive such as past due invoices, unapproved discounts, and sales the financial due diligence team will be at month-end. The obligation
focusing on maintaining strong insurance premiums instead of paying upfront for annual team overrides. Thomas Chance often aid its client in preparing an to the customer would have only been partially satisfied rent, if paid at the beginning of a month, could be a routine
Chuck Johnson, SVP, liquidity in the months to come. coverage. The policy is used as collateral rather than using Firms can use that additional data to identify problem areas Teague, CPA, Director, estimated target of working capital despite having been paid in full. A buyer would now find itself adjustment to derive working capital delivered in the middle
Middle Market, Fifth Third As the early stages of the Transaction Advisory of a month that may not have been considered in the working
Bank business assets to secure the loan. This strategy frees up that need to be addressed. Depending on what issues arise, Services at FORVIS to be delivered with the business at with a portion of that month’s service yet to be delivered and
pandemic taught many business that lump sum of capital to remain more liquid throughout they may need to implement updates like changing the credit close. This is often referred to as the may incur costs to provide services without receivables or capital peg if set based on month-end balances. Similarly,
owners, the ability to be flexible is the year, without sacrificing a quality insurance policy. approval criteria for customers, shortening invoice net terms, “working capital mechanism” or the “working capital peg.” cash to offset those costs. Intra-month settlements should certain expenses should be accrued ratably during the month,
critical during periods of uncertainty. which would result in lower accrued expenses and thus higher
Here are ways to ensure your company’s liquidity remains 3. Create Better Inventory Management Systems or creating stricter guidelines for their sales team. Understanding the normalized working capital needed to be considered so the seller maintains sufficient cash in the working capital during the month in comparison to month-
business to service unsatisfied customer obligations. Deferred
operate the business helps to provide that the seller delivers
strong regardless of what happens in the economy. end.
Supply chain issues are increasing costs for businesses 5. Build a Relationship with Your Bank sufficient working capital to transition the business to the revenue can be excluded from the peg and treated as a debt-
while often hindering growth because of inventory delays. Having an existing relationship with a bank can help a buyer with little interruption. The working capital mechanism like item to be settled at close in a transaction contemplated The table above presents the fluctuating daily deferred
1. Focus On Cash Flow Management According to consulting firm McKinsey, shipping rates have business stay flexible and act quickly when needed. Many is often estimated as the average of the adjusted trailing on a cash-free, debt-free basis. revenue and accounts receivable balances for a services
Cash flow is an integral part of liquidity. Although accurate company that (i) provides services ratably across the month,
In other situations, companies may invoice customers
revenue forecasts may be difficult to calculate during periods quadrupled since 2019. In addition, 94% of Fortune 1000 business owners learned this during the early days of the 3-, 6-, or 12-month ending balances and uses a month-end for services in arrears, which may impact working capital (ii) bills its customers in advance on the first of the month, (iii)
companies report supply chain disruptions.
basis as it mirrors the financial reporting cycle, aligns with the
COVID-19 pandemic when the first round of Paycheck
of volatility, companies should focus on ways to reduce costs There are proactive steps that businesses can take Protection Program loans became available. presentation of other monthly due diligence procedures, and mechanism considerations. A software-as-a-service (SaaS) collects 80% of receivables via credit card charges on the fifth
while exploring alternative revenue streams. to better manage stock (and as a result, liquidity) in this Funds were exhausted within two weeks, and subsequent is generally derived from readily available data. business that bills its customers in arrears on the first of the of the month, and (iv) collects the remainder of receivables
Firms can also review and improve their hiring processes. ratably throughout the month and represents how working
However, dealmakers should be aware of working capital
For example, some large companies, such as Netflix, have challenging environment. One, invest in data tools to better research from the Federal Reserve Bank of New York identified differences throughout a month and anticipate that a working month for the prior month’s services should recognize revenue capital can fluctuate on a daily basis.
a correlation between funding approval and existing bank
analyze demand. Look at different options based on your
throughout the month as services are provided and report
implemented layoffs to cut payroll costs, while others see industry and volume. Second, make purchasing decisions relationships, according to the Journal of Accountancy. capital peg based on month-end balances may not approximate unbilled receivables—a component of net working capital—
increasing staff as a way to increase revenue. Companies may earlier. Prepare for upcoming inventory needs sooner than While this type of program may not be available again, it what a seller should be expected to deliver at a mid-month until the time of billing. However, for a company with limited Final Thoughts
want to identify the best opportunities for their industries and you usually do. Financing those upfront costs is easier when serves as an example of how developing a bank relationship closing date. While the timing of routine transactions can users of financial statements, this level of reporting may not be It can be easy to get the working capital estimate wrong
adjust their hiring goals accordingly. you have flexible credit available, like a business credit card makes it easier to identify and seize time-sensitive create working capital differences, other accounting policies necessary as the perceived value for the management team when the closing date does not tightly align with the basis
Opening a business credit card or applying for a line of credit on which the peg was contemplated. While these types of
are additional ways to improve cash flow management during or line of credit. Third, source and approve new suppliers to opportunities. can result in the need to contemplate components that may may be limited. In this instance, the company likely reports issues can appear as surprises when a mid-month close is
receivables when billed, resulting in understated balance
not have been previously reported on the balance sheet.
serve as a backup. Avoid relying on a single supplier for raw
volatile periods. Unlike a term loan, these types of revolving not expected, being aware of how working capital fluctuates
materials or production. In case one has a factory shutdown Items Not Reported at Month-End sheets and out-of-period revenue. If a seller starts to feel throughout the month can prepare a dealmaker to closely
Many of today’s technology, services, and that an inequity exists as a result of having borne the costs
telecommunications companies have adopted the practice to provide a partial month of services but been unable to bill, estimate the amount of working capital to be delivered at a
mid-month close. A skilled advisor needs to anticipate that a
Underutilized Tax Savings Opportunity—Investing in Qualified Small Business Stock (QSBS) Brian S. Masterson, Partner, of billing monthly customers at the beginning of the month, a deal issue could arise. If unbilled receivable balances are not mid-month close is likely and prepare early in the process by
Frost Brown Todd Attorneys
in advance of providing that month’s services. Often, the
included in the estimated working capital peg, including them
customer obligation associated with those services would in delivered working capital at a mid-month close date would asking the right questions, understanding the key transaction
Section 1202 of the Internal Revenue be operated as a C corporation and that QSBS must be C Specifically, businesses in the fields of health, law, engineering, be fully satisfied within the month resulting in no deferred be improper and could result in the seller ultimately walking drivers, and ultimately helping their client feel confident they
Code provides for a potential corporation stock. Before 2018, few attorneys and accountants architecture, accounting, actuarial science, performing revenue at month-end. The seller has collected cash, fully away with more than 12 months of revenue-related cash for are leaving nothing on the table. If you are contemplating a
exclusion from federal income tax engaging in choice of entity planning for Main Street businesses arts, consulting, athletics, financial services, and brokerage performed on its obligation and, all else equal, the buyer will providing 12 months of services. transaction or feeling as if a prior transaction lacked the forward
(including alternative minimum tax, would recommend operating through a C corporation rather services are ineligible. A variety of activities, however, qualify likewise invoice and collect in the days after close, generating In addition, routine monthly transactions may result in vision needed to navigate these issues, FORVIS has a fully
the 3.8% net investment income than a pass-through entity (e.g., LLCs, limited partnerships or under Section 1202, including many software, biotechnology, a sufficient amount of working capital to fund that month’s significant differences in working capital at month-end dedicated team of deal professionals who aim to provide an
tax, and often state income taxes) S corporations). pharma and manufacturing businesses. operations. compared to mid-month balances. The balance of prepaid Unmatched Client Experience™.
of 100% of the gain from the sale of There were a number of significant reasons why a C While QSBS must be originally issued by a C corporation,
QSBS if all Section 1202 requirements corporation’s tax features were unattractive for typical Main businesses operating in partnerships (including LLCs) or
Brian S. Masterson, are satisfied. Each taxpayer can Street businesses. Those reasons stemmed from the fact that S corporations can be converted into C corporations and
Partner, Frost Brown Todd potentially exclude at least $10 over the lifecycle of a business, the after-tax money landing in issue QSBS to former shareholders in connection with their The Era of Ultra-Low Inflation is Over, but the Demographic Tide for M&A is Still in its Swell Jacob Koenig, Partner - Deal Team
Attorneys Lead, Woodbridge International
million of gain from each issuing the owners’ pocket was often less if a closely-held business conversion. If a business operates through a partnership or S
corporation’s QSBS. was operated through a C corporation rather than a pass- corporation during the start-up period so that investors can The twin forces of hyper-active global starved Europe faces down the coldest part of Winter—but thus far more highly leveraged transactions than for strategic bolt-ons
through entity. take advantage of losses, the owners should be prepared to
If Section 1202’s benefits are so great, why hasn’t The overwhelmingly negative view of C corporations held convert to a C corporation before Section 1202’s $50 million trade and rapid technology growth the blessing of mild temperatures has countered the dire warnings and equity-funded purchases.
for Europe into 2023.
had been depressing prices since the
Anticipation of “peak rates” may foster deal hesitancy for some
everyone actively pursued QSBS investments? by many tax planners over the past several decades must fair market value threshold prevents qualification. 80’s—but now global trade is in its ebb Market predictions from big banks and asset managers into buyers, but the opportunistic type can always re-finance later if a
Section 1202 has been around since 1993 and has gone be reconsidered today. One of the most significant changes
through several amendments over the years. With Section introduced by the Tax Cuts and Jobs Act enacted in 2017 was Tax-Deferred Rollover of QSBS Sales Proceeds and Moore’s law may end up being this year were wide-ranging. While many stuck to their gloomy unique and performing asset catches their eye in the meantime.
more of Moore’s guess. By the end of
For business owners in this environment, it’s more important than
recession forecasts, others were positive about the signs of
1202’s potential for an outsized gain exclusion, you might reducing the corporate tax rate from 35% to 21%. This delivers Section 1045 allows sellers of QSBS who have not achieved the first quarter of 2023, we will have economic resilience. When it comes to Private Equity as an asset ever to go to the widest possible range of buyers in order to find
ask why the provision remains so obscure to many investors a windfall for businesses operating as C corporations, which the five-year holding period required by Section 1202 to roll passed the one-year anniversary of the class, however, the consensus was more positive. None that I read the right fit.
and tax advisors. Put another way, why isn’t everyone talking has caused business owners and tax advisors to reconsider their sales proceeds on a tax-deferred basis into replacement Jacob Koenig, Ukraine war. Higher commodity prices foresee a significant drop in multiples. Blackrock’s 2023 forecast Pent-up demand from the aging cohort of Baby Boomer private
about Section 1202’s benefits, and why isn’t everyone taking the C corporation. When Congress reduced the corporate rate QSBS. A successful rollover of QSBS sales proceeds under Partner - Deal Team Lead, will roll off the year-on-year inflation suggested that investors’ exposure to privately owned businesses business owners is still likely to offset any modest slowdown in
Woodbridge International
advantage of the gain exclusion? to 21%, the potential additional benefits afforded by Sections Section 1045 defers gain until the replacement stock is sold. readings, but the China tech trade war remains insufficient. MS noted that “Dry powder remains at record growth in the medium term. We started the year with a host of
From 1993 through 2017, there existed a combination 1202 and 1045 were hiding in plain sight. Today, while operating Assuming the replacement QSBS meets all of Section 1202’s
is likely to keep a floor on price growth.
of factors that made it unattractive for most founders and a business in a C corporation may not be optimal for every requirements, the taxpayer can take advantage of the Section The recent deceleration of interest rate hikes portends the end of levels of $3.6 trillion and should fuel high transaction volume.” With inquiries from curious business owners, perhaps acting out their
32 transactions completed in 2022 and 27 in 2021, we recorded an
New Years’ resolutions to gauge if now is the right time to sell
investors involved with Main Street businesses to consider situation, the potential use of the C corporation certainly 1202 gain exclusion when the stock is sold. The holding period the tightening cycle, but it remains likelier that the last few decades EXPANSION in EBITDA multiples year-on-year. their businesses. And while there remains legitimate concern that
Section 1202’s benefits. Until 2011, the Section 1202 percentage merits serious reconsideration. for the original and replacement QSBS are combined to satisfy of non-existent inflation will prove the aberration. As M&A advisors, our clients’ businesses generally have conditions could yet worsen, elongating decision times, this has
gain exclusion was less than 100% (at one point 50%, later Section 1202’s holding period requirement. Thus far, the macro environment has remained surprisingly remained robust, even as retail demand for goods pulled back only helped fuel the imbalance between supply and demand that
75%). Further, the gain exclusion was subject to alternative QSBS Requirements Business owners and professionals who want to learn about resilient. Aggregate employment numbers have withstood high from the Pandemic peak. The drumbeat of recession forecasts has propped up multiples. Despite rate fears, the M&A outlook for
minimum tax, and the portion not eligible for the Section There are many taxpayer and issuing- corporation-level tax planning opportunities presented by Sections 1202 and profile Silicon Valley mass layoffs. The COVID impact in China nonetheless collided with seasonality into year-end, leaving many the Lower Middle Market remains positive as the real-life needs
1202 gain exclusion was taxed at 28% (higher than the then- requirements for stock to qualify as QSBS, including a five- 1045 are directed to several articles on Frost Brown Todd. is taking its toll, but reopening there has coincided with a rapid businessowners and potential buyers trigger shy. Owners have of private business owners meets an ever-growing pool of capital
applicable capital gains rates). year holding period requirement. Section 1202 also limits reduction in shipping costs which should ease supply chain been taking longer to reach a decision to sell, and some buyers ready to be deployed in this asset class.
A key requirement under Section 1202 is that the business the types of business activities eligible for the gain exclusion:
bottlenecks. Russia tensions remain a worry, especially as gas- have pulled back—though the impact is greater for larger and