Despite the current economic environment, many companies still have healthy balance sheets and cash reserves to manage.  Corporate investment policies are something that come up from time to time among Board members, owners, firm partners, and financial departments of a wide range of companies.  But who’s really thinking about them?

It appears that not many professionals are.  At an event held by the Financial Management Association of NH on Monday, November 10th, less than a handful of financial professionals - out of a crowd of 100+ attendees - acknowledged implementing or being aware of any such policy within their organizations.  That so few of us were up to speed on the topic was a shocking realization to me.   Certainly the executives on hand are responsible leaders at the helms of successful organizations, therefore it stands to reason that such a fundamental step is more commonly deprioritized than it is taken to heart.  Here’s a primer on investment policies, courtesy of Morningstar.

Paul Miller of Axial Financial Group, who served on Monday’s panel along with Al Romero, SVP Business Banking at Bank of America and Matt Finn, VP Finance & Operations at Bradford Networks, highlighted two case studies that underscore the importance of using an investment policy.  One of the case studies  focused on a publicly-traded company that developed an investment policy stating that the “primary objective is preservation of capital and liquidity.”  This policy, which had been vetted by the management team and Board, was credited by that company’s CFO with helping them through the volatility of the past year and keeping them out of investment options such as auction rate securities.  Because of their policy, the company knew to immediately forego any goals of high yield in favor of keeping their cash in the safest vehicles available, and as a result were able to maintain the liquidity they needed.

An investment policy need not be overly complex, but I believe it is a fundamental building block for growing organizations, whether public or private.  And if the current economic climate does not convince us of that, perhaps nothing will!

As I sat late Tuesday evening on November 4^th watching the President Elect, Barack Obama, deliver his victory speech, a reality became apparent that the Bush administration is actually approaching its close and a new administration will be entering Washington.

It’s hard to believe that eight years have passed so quickly and also, as I reflect, that such an incredible number of historic tax law changes were enacted throughout Bush’s term. From tax rate cuts to Alternative Minimum Tax (AMT) relief to economic stimulus packages, the past eight years have been an extremely active time in taxation. As the country enters its next presidential term under new leadership, tax policy will undergo significant change.

One challenge for the new administration is the daunting task of balancing taxation with the government’s commitment to fiscal and social responsibility. If it reduces taxes, vital government programs face cuts, while an increase in taxes would result in a reduction of consumer and corporate spending, thus hampering the economy. President Elect Obama has addressed this dilemma by offering to reduce taxes to families making under $250,000 per year and subsidizing this reduction with increases to families making over $250,000 per year, a reduction of government spending and the elimination of abusive tax loopholes.

Under Mr. Obama’s plan, the following tax incentives are highlighted.

Middle Class Incentives (under $250,000/family)

- Tax credits of up to $1,000 for workers

- A $4,000 refundable credit for qualified tuition expenses

- A 10% refundable credit for mortgage interest payments

- Eliminate income tax for seniors making under $50,000

- Expand Earned Income Credit, child care credits, clean vehicle credits and retirement savings incentives

Business Incentives

- Elimination of capital gains tax on investors in small businesses

- Cutting corporate tax rates for companies creating jobs in the US

- 50% refundable credit for small businesses paying employee premiums

- Making the Research and Development Credit permanent

On the flip side, Mr. Obama’s plan includes the following tax increases and reform:

Tax Increases to Families Exceeding $250,000 and an adjustment to Estate Tax

- Top tiered income tax rates restored to pre-Bush levels of 36% and 39.6%

- Long-term capital gain tax rate increase from 15% to 20% (families making under $250,000 will continue to pay 15%)

- Qualified dividend tax rate increase from 15% to 20% (families making under $250,000 will continue to pay 15%)

- Estate tax will retain a rate 0f 45% for those estates over $7M

Tax Reform

- Reforming international tax loopholes by eliminating incentives for shipping jobs overseas

- Closing domestic tax loopholes by clarifying the economic substance doctrine and increasing reporting on capital gains

- Elimination of tax incentives of oil and gas companies

- Closing other loopholes such as taxing carried interest as ordinary income and closing the CEO pay loophole

- Increase in the investigation of offshore tax havens

As evidenced by the items above, it’s easy to conclude that embodied in Mr. Obama’s plan is an underlying (and well-publicized) theme of “redistribution of wealth.” The goal is primarily to lessen the gap between the middle class and upper class — a gap that has widened to historic proportions under President Bush’s administration. Using AMT as an example, a number of middle class taxpayers become subject to a tax that was intended for the wealthy, thus subsequently forcing temporary patches included in various economic stimulus packages.

“Change” was the theme of Mr. Obama’s campaign and this will be what we can expect with taxation. We also should keep in mind that regardless of the items listed above, it is likely that events will occur that can drastically change his comprehensive tax plan. We only have to look as far back as the changes enacted by the Bush administration, and certainly we don’t need to be reminded of the famous words uttered by the elder George H.W. Bush that helped him win the 1988 presidential election.  Luckily, we were not very good lip readers.

After 5 successive years of delays, fiscal year 2009 will mostly likely be the year of reckoning for non-accelerated filers. Those companies with market caps at or below $75M are the last group of publicly traded companies that will need their controls attested to for the Sarbanes-Oxley Act. Many publications have waxed philosophically about the woes and the benefits of SOX, all of which can daunt the most confident executives of a small cap company.

Due to the projected costs,and the associated burdens of compliance, some companies retain the hope and belief that another delay or even more optimistic, a repeal of the Act will occur. Though we at MFA cannot profess to be an Oracle of the foibles of the legislative process, at the current time with the current market conditions, the likelihood of such a reprieve is not great. That being said, management’s attestation of the design and effectiveness of their internal control environments will be evaluated by the external auditors.

It may appear that our prognosis is self-serving, so in the interest of transparency, here are two points that outline why we think the deadline will stay.

1.  We hypothesize that after the recent collapse of the credit market, it is reasonable to conclude that politicians will not be receptive to lessening business regulations in the near future.

2.  Accounting Standard 5 (AS5), released by the PCAOB in June 2007, has scoped the compliance effort and added substantial clarity on being compliant. Specifically, the Standard provides details on how all public companies can insist their external auditors place more reliance on a top-down risk assessment, which is to identify what truly is a risk to the enterprise in question. In place of a blanket and all encompassing risk-averse assessment as dictated in AS2, greater credibility can be placed on the work a public company and its internal auditors have completed identifying and demonstrating operating controls. In fact, the PCAOB has further extended clarification that external SOX audits are not to be started from scratch, and are not to be “one-sized” for all.

With no place to go but onward into SOX initiatives, small public companies should be aware that they are not compelled to invest in “kitchen sink” compliance. They can implement a “pared down” Section 404 controls framework, the key to which is a focus on solid entity-level controls that are pervasive, supported by auditable evidence and that are sufficiently robust with clear threshold triggers. Companies that have successfully designed and implemented this class of strong oversight controls typically experience fewer issues during day-to-day operations.

Thanks to Rich Pacheco, who contributed to this post.

At this point, everyone has heard of the new Emergency Economic Stabilization Act of 2008 (EESA), more commonly known as the “Bailout Plan.” This plan authorized the US government to spend up to $700B to rescue US financial institutions from the lingering effects of the sub-prime mess (to put it lightly). But the Bailout reached further than the banks and brokerage houses:  deeply rooted within the plan are tax provisions that will affect a large number of taxpayers.

One such provision is Alternative Minimum Tax (AMT) relief, which increases the exemption amounts to $69,950 for married filing jointly, and $46,200 for individuals (pre-EESA, the amounts were $45,000 and $33,750, respectively). The provision will also allow for personal credits against AMT. The cost of this provision is estimated at approximately $62B over ten years.

Also included are extensions expiring after December 31, 2007. For individual income tax some of the popular incentives include:

1.  the deduction for state and local sales taxes for those who elect to deduct sales tax in lieu of the state income tax deduction,

2.  deduction for qualified tuition expenses for higher education (subject to adjusted gross income limitations,

3.  teacher’s education expense deduction of $250,

4.  additional standard deduction for real property taxes for nonitemizers, and

5.  tax free contributions of IRA plans to qualified charitable organizations.

Extensions for some of the popular business tax incentives include:

1.  extension of the Research and Development Credit,

2.  15 year straight line depreciation for qualified leasehold, restaurant and retail improvements,

3.  section 199 deduction for Domestic Production Activity in Puerto Rico, and

4.  extension of Work Opportunity Tax Credits for Hurricane Katrina Employees.

The Bailout  also includes a number of renewable energy incentives enacted to encourage investment in this area, as well as  some revenue generating provisions. One provision that will affect many taxpayers is the new mandatory requirement for brokers to furnish basis information to the IRS relating to sales of publicly traded stock. In prior years, brokers were only required to report gross proceeds and it was up to the taxpayer to report the appropriate cost basis. It will be extremely important that taxpayers confirm that their broker has the correct basis on their portfolio, especially if funds were transferred to a new broker. This provision is expected to raise close to $6.7B in revenue over the next 10 years.

There is no question that the bailout, from a macro level, will ultimately cost Americans as Wall Street is slated for the bulk of the economic attention. Some studies have estimated the cost at around $5,000 per working American. However, the tax incentives included within the plan allow some relief for taxpayers and businesses.

Is the bailout plan perfect? This will likely be debated for some time, but one thing that is for certain is that the tax incentives were a necessary addition to the overall plan.

We have said before that despite the difficult market environment, “hunkering down” may invite even more trouble.  While prudence is a virtue, we always believe - in good times or bad - that efficient use of cash and resources is imperative to a successful business.  This is a time to be aggressive, not passive, in establishing a position of strength.

However, it must be acknowledged that there will be some adjustment to the times, and one area that companies can address is collections. Before considering cuts that could stall your company’s momentum, be certain that you are collecting on the profits you have already earned.

Here are a few tips on collections from Charlie Colarullo of Transworld Systems, a profit recovery agency:

1.  Regularly review all customer accounts and send written demands for accounts that are less than 6 months overdue. If you work with a collection agency, submit past due accounts on a consistent basis to ensure the recovery effort is always in motion.

2.  If you use an agency, become familiar with all the reporting tools that are available online and regularly view them to keep up to date on the performance of your account.

3.  Use verbal demands for accounts 6 months overdue and beyond.

4.  Don’t accept “payment arrangements” on accounts that are in the verbal demands stage. The debtor has already ignored your efforts to collect and written demands, therefore accepting payment arrangements now could only further delay the collection of the debt owed to you.

While it shouldn’t need to be said, please remember to take care of your business by remaining proactive on issues such as collections, business development, marketing and innovation.

Forward thinking activities are the differentiators in an otherwise difficult economy, and will set the stage now for future wealth creation and success.  Staying active in these areas will prevent stagnation, because once a business is stalled, it can be difficult to climb back into motion, regardless of market conditions.

Big news from Duane Reade, as the drug store chain is facing fraud charges that allegedly account for a $17.5 million overstatement of pre-tax income. Interesting, but more important are the fraud cases that we are not seeing publicized.

In fact, the Duane Reade article in Accounting Today is just the kind of high profile case that prevents executives of small to mid-sized private companies from recognizing that fraud is a much greater danger to them than to large publics.

The truth is that the large majority of fraud is committed against these smaller companies, and is extremely damaging. In fact, companies with less than 100 employees are most prone and often see losses eclipsing $200,000 – a crippling hit for a small company.

We always encourage owners and financial executives to understand where the opportunity lies for fraudsters and how to mitigate the risks. This presentation, which is a condensed version of a recent seminar, tells a compelling story.  Feel free to let us know if you think fraud is taken seriously enough at your company.

On Tuesday, September 23rd, the Financial Management Association of New Hampshire (”FMA of NH”) hosted its first event entitled “Preparing for a Successful Liquidity Event in Today’s Volatile Markets“.  I am fortunate to be among the founders of FMA of NH and to have had the opportunity to participate in the panel discussion on this very timely topic.  Peter Alternative and Bas van der Brugge of Mirus Capital started the evening’s discussion with a recap of the current market environment for merger and IPO activity, and touched on the availability of funds from the venture and investment community.  Steven Bell, Senior Director of Finance at venture-backed Vertica Systems, Inc., also particpated on the panel and gave his corporate perspective of deal activity and funding availability [in the way of full disclosure, Vertica is also an MFA client].

The evening’s discussion has me thinking more and more about this topic.  Let’s make no bones about it - the IPO market quite clearly is closed for the time being and we don’t expect to see any liquidity from that market in the near term.  Similarly, our guests from Mirus painted a pretty bleak picture on the M&A front.  However, there was a contrast worthy of note, and I continue to see anecdotal evidence in the market that suggests that all is not lost.  For example, one might think that this is not the time to be raising new money from venture or angel investors.  But as Steve fairly pointed out, companies like Vertica that have a solid business strategy, sound leadership team, and a market solution that customers are clamoring for, can still raise equity with relative ease.

I have been taking note these past few weeks of a number of examples whereby emerging technology companies have closed on new rounds with new investors, not just inside rounds.  Cash-rich investors, not just VCs, are still on the hunt for new deals and are approving and funding new deals.  Private equity investors are closing on new funds and are adjusting their models to rely less on the debt markets to get deals done.  We also have clients receiving LOI’s as early as this week from strategic buyers at healthy multiples.  An LOI doesn’t mean a deal will close, per se, but I find it to be an amazing sign of optimism in a market such as this.

I won’t deny that these are extremely difficult times for anyone looking to raise capital or execute on an exit strategy - they are.  The options have been severly limited by market forces.  But opportunities abound  in both day to day operations (as noted in Carl Famiglietti’s recent post) and capital strategy if you’re ready for the challenge of finding the right investment partner.  I encourage every entreprenuer reading this blog entry to stay true to his or her vision, focus on execution and market penetration, and continue to forge the necessary relationships to ensure success.

UPDATE:  I found this great blog post, even among others like Ron Conway’s recent email, that puts forth some great thoughts on this subject:  During Tough Times, The Echo Chamber Can Be Your Best Friend. 

A recent article in Accounting Today investigates a study on reporting practices by multinational companies, and seems to question the intentions of these filers.  Specifically, the report (conducted by the Government Accountability Office) concludes that current rules “influence company decision about how many workers to employ and how much to invest in particular activities and locations.”

One noteworthy comment from the article comes from GAO Chairman Max Baucus (D-Mont.):

I’ve said before that we will tackle tax reform in 2009 and this report underscores the need to review business taxes as part of our tax reform efforts in the next Congress. Simply put, I do not intend to allow U.S. multinationals to sidestep their fair share of taxes by moving income offshore.

This viewpoint may be grounded in sound information from the report, but reform is not necessarily the answer — the best recourse may simply be to clarify and better enforce the rules that exist.

Currently, the US has one of the highest corporate tax rates of any developed country in the world.  As a result, corporations looking to cut costs often determine where to set up business operations by looking to income tax rates as well as payroll and other costs associated with various jurisdictions.

But taking that measure does not exploit a loophole.  The Internal Revenue Code currently has significant rules that are specifically enacted to reduce the possibility of US taxpayers shifting income to foreign jurisdictions.  These include, but are not limited to, Subpart F rules, Transfer Pricing Rules and IRC Section 367, which governs transfers of property from the US to other countries.  Despite Senator Baucus’s quote, these rules make it very difficult for corporations to merely “sidestep their fair share of taxes by moving income offshore.”

That said, the rules are so complex that they are most likely applied differently by different corporations, depending upon how they interpret the rules relevant to their own particular fact pattern.

Back to the solution, then.  One thing the IRS could do is to provide better guidance as to how the rules should be applied.  A second thing would be to step up enforcement of reporting requirements currently in effect.  Proper reporting would provide the IRS with better information as to whether the rules were being applied properly.

Within the past month, the IRS has indicated they will start penalizing corporations for failure to file the necessary information returns.  Penalties have been applicable for many years, but have rarely been assessed.  Better enforcement could be the best way to help prevent any tax avoidance and clear up misunderstandings as to whether taxpayers are shifting income offshore to avoid taxes.

The volatility on Wall Street last week was another in a long line of events that is making for an historically unstable economic environment. However, in our line of work we see a lot of the activity on the front lines, and we want to emphasize that there is still business to win and still growth to attain. Despite a climate that is financially questionable relative to recent years, the capitalist nature of the country offers opportunities for businesses to thrive – even in anxious times.

Our latest audiocast is on this very subject, and I encourage you to give a listen below or download the mp3. Feel free to drop us a comment or an email if you have any questions…as always, we’re happy to engage in a discussion about what’s happening across the business landscape.

New M&A guidelines under FAS141R are taking effect in 2009, and there’s been some talk about how it might impact the deal process. In fact, this Accounting Today article cites a study by Deloitte that concludes “out of more than 1,850 executives, 40 percent said the revised standard would cause them to rethink deal strategy or have an impact on their planned deal activity.”

This doesn’t surprise me, as some of the pending changes will have a destabilizing effect on post-merger balance sheets. However, I also feel strongly that accounting challenges should never hold back a strategically sound deal. The accounting, valuation and auditing experts simply need to adjust to the new guidelines and structure deals accordingly – not forego or delay them.

Here are some of the significant changes headed our way:

1. Timing of deals and reporting

FAS141R provides a more stringent timeline for reporting business combinations, and if deadlines are missed then provisional amounts must be reported for incomplete terms. That means not having the most qualified information, which can lead to more serious issues down the road. Expanded disclosure requirements will make the deadlines even more difficult to meet and could force companies to speed through the process, so prioritize the planning process and have the right team in place early to avoid sacrificing quality and accuracy for speed.

2. Contingent consideration

The purchase price of a business combination now includes the fair value of contingent considerations. This change could significantly increase the upfront purchase price recorded on deal transactions, as well as increase the volatility of subsequent accounting. Given the major uncertainties as to future amounts and timing of payments of the contingent payment, the fair value of this liability may materially fluctuate over time as more information is obtained.

3. In-process R&D

Under previous regulations, companies could record the fair value of IPR&D as a period cost of a transaction. FAS141R, however, requires that it be recorded as an intangible asset on the balance sheet. If the IPR&D does not come to fruition, it will subsequently need to be written down to its fair value, potentially zero, resulting in an impairment charge to the income statement.

These changes and others will bring us closer to international standards, and they will in the end make for a clearer picture of deals. We’ll take a more in-depth look at FAS141R in an upcoming MFA Perspectives article, and we encourage you to check it out when it’s posted on our Thought Leadership page.