Monthly Archives: August 2011

Watching the recent US debt limit debacle was quite fascinating. While Republicans seem to oppose any tax increase, at any time, for any reason, hearing the rationale presented by their “experts” on talk news TV was illuminating.

That rationale focused on job creation and, in particular, small business. The engine of job creation is small business. Yet they presented as fact that small businesses were not creating new jobs because of the uncertainty of possible tax increases and the possibility of more administration costs due to “Obama-care.” These pundits were absolutely certain that the population would oppose any small-business tax increase for this reason.

What they didn’t describe with as much certainty was why raising taxes on hedge fund managers making billions of dollars a year would reduce job creation. (That’s a topic for another blog.)

While the Republicans present these assertions as absolutes, they actually offered no evidence to support this particular hypothesis.

At Silver + Goren, we help hundreds of clients develop small business plans to build business value. This includes many cases of expansion, new business development and expanding product lines.

While clients are always concerned about structuring things to pay the smallest amount of taxes legally possible, the actual rate of tax is never discussed. A small business person looking at an opportunity considers the total potential return on their investment and evaluates this against the business risks. In the small business environment, potential return needs to be big to warrant taking on major risks. If the potential return is realistically available, an extra 1% or 5% in income taxes won’t affect the decision.

The largest factor that affects small business plans is availability of capital. In order for a new venture to get started, you need working capital. If this is available through banks or other third-party lenders, getting a business going and hiring new people becomes much easier. While many small owners complain about the rate of interest paid on this capital, in reality the rate is nowhere nearly as significant as access to capital to get new business started in the first place.

A second major factor is access to sufficiently skilled people to work in the business. If the right people aren’t available it becomes difficult to develop a new opportunity.

An issue that does affect small business planning is the cost of government compliance. This can be onerous both financially and in terms of the time required to stay up to date. Many small business owners try to change the way they would normally do business, just to avoid the burden of government compliance.

This is particularly true in the area of employees where payroll burden and reporting costs are substantial. A strategy that many small (and not so small) businesses try to follow is to take people who may otherwise be considered employees and hire them as “contractors.” This scenario has significant risk and can be quite costly if you do it wrong. Stay tuned … I’ll discuss that topic in a blog coming soon.

We just came back from a summer beach vacation. Aside from obvious pleasures of sun, sand and overindulging in good food, vacations give me a chance to catch up on reading.

I overdosed on whodunit’s and espionage. I find Amazon quite insidious in successfully putting lists of books in front of me that I just have to buy and read.

Vacations also give me time to catch up on what’s new in business theory. My son in law is a recent Dean’s list MBA graduate from the Rotman School of Business at the University of Toronto (I write with much obvious pride). He referred a book written by the Dean, Professor Roger Martin, called The Design of Business.

The book talks about how innovation is necessary to sustain even the most successful businesses. That’s because there are always competitors and upstarts looking to innovate and alter how the marketplace consumes your particular product or service. He quotes the statistic that of the original Fortune 100 companies published in 1955, only 11 are still on the list.

Prof. Martin’s thesis says many successful companies focus on protecting what they currently do and improving efficiency of current operations without devoting resources to innovation. His recommends businesses think like designers to create sustainable advantages over competitors.

He uses the word “design” in the broader context. He means not only product and packaging design, but also design of systems and processes and how the consumer interacts with the organization. He provides a number of useful examples of different organizations who have used this methodology to effectively create new market opportunities for themselves.

The core of his model is the need for organizations to understand customers in a deep and meaningful way. It’s the superficial understanding that perpetuates the current model. For example, Prof. Martin recommends for car companies: “Consider, instead, actually spending time with your customers and those of your competitors, going to their houses and garages to listen to them talk about their cars, how they make them feel, what makes them happy, and what frustrates them.” It’s about really learning the in-depth needs and frustrations of your customers, and building on that imaginatively to design solutions that satisfy those needs.

Normally when I thought of innovation, it was a process that happens spontaneously and without structure. Interestingly, Prof. Martin presented a theoretical model with a number of real-world examples of how businesses can innovate in a methodical and structured way.

The ability to innovate formally would be a marvellous tool in small business planning.

While the stock market can be unpredictable, here’s a guarantee: when markets go down, the number of calls to our office goes up. Last week’s plummeting stock market was no exception. Many people are worried about future budgets and cash flow, and want advice as to what to do.

The right answer should be: “nothing!”

Most people are fascinated by the movements of the market. While it’s going up, watching the market is enjoyable. But beware the downward turn. A calm investor turns into a stressed out, traumatized being instantly. Watching business TV or reading investment advice in the papers makes it worse – it seems to focus on promoting hysteria.

It’s one thing to have high blood pressure; it’s another to let that drive investment decisions. We often see people making decisions based on prevailing trends. That means buying in the face of optimism, rising prices and therefore an expensive market. And, predictably, it also means bailing out when pessimism reigns and the market is cheap.
Both behaviours go a long way to minimize your potential return or, worse, maximize your losses.

In the words of arguably the world’s great investor Warren Buffett: “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”

So how do you cope with all these strains on your financial emotions?

I believe the only way to invest is for the long term. When you invest, you must understand your return will come over time, and not necessarily in the next month or two. It also means your investment needs to be made with money you won’t need for a number of years to come.

If you’re in it for the long term, you can safely ride out roller coaster drops in the market because you know your grocery budget or rent money aren’t at risk. A useful tip is to have enough savings available to carry you for a few months before you start investing. If your family has problems at work, for example, they can be weathered without
jeopardizing investments.

The notion of investing for the long-term is particularly true for your registered retirement savings plans. The very structure of an RRSP is based on maintaining money for the long term: your retirement. It’s expensive to withdraw monies from the plan as they will be taxed at your marginal tax rate.

If you take money out of the plan, you can’t replace that savings later. (There are exceptions, including the registered home ownership savings plan or the lifelong learning plan.) So you’ll lose the opportunity to have tax deferred income on this savings.

The best thing you can do when you hear the stock market has dropped a thousand points in a day is sit back, watch other people panic and do nothing.

Is it time to become the new owner of an American Dream home? The lead article in a Toronto Star business section last month was titled “We bought an Arizona dream home for 60% off.” The article then describes how they did exactly that, paying $.40 on the dollar for a bank-foreclosed, three-bedroom house in Sedona, Arizona.

The article has a number of tips about estate tax planning and buying real estate long-distance and it lays out some risks. It shows housing prices are down 50% from the 2007 high…but buyer beware: don’t expect an instant profit.

It’s a common thought: US property prices are extraordinarily low right now and represent bargains for Canadians (especially with our dollar at or near par with our stateside buddies). We believe the prices in 2007 were extraordinarily high and unrealistic, thanks to a major American real estate bubble, and that current property prices are more consistent with economic reality. Plus, it’s not certain prices won’t continue to fall in the future, depending on how well the US economy recovers.

So back to our headline. If you’re thinking about buying American property, what should you consider financially?

The starting point (as always) is to figure out your buying objectives. Do you want a vacation home for your family and friends? Is it an investment property you hope to rent out? Or, are you buying because you see extraordinarily low prices now, and a good chance to cash in over the next few years?

You need a different decision-making plan for each objective.

Let’s look at the sunny vacation home option. The price tag may seem attractive, but you need to be careful about the operating costs of maintaining the property. Assuming you won’t be a resident, your property taxes are likely to be twice as high. If you’re buying a condominium with lots of facilities, there’s a hefty monthly maintenance cost. If there are a lot of vacancies in the condo project you may be subject to special assessments to cover the shortfall from the vacant units.

If your family works all year and you only expect to use the property for a few relaxing weeks, you may find renting is cheaper. If you think the property value will stay pretty much the same and not appreciate significantly over the next few years, it may make more financial sense to rent or even stay in hotels and wait until you are closer to retirement to actually buy.

The finances of owning a vacation property make more economic sense after retirement, when you can spend three or four months a year at your vacation home.

If you decide to go ahead and buy, don’t forget to look at the US tax implications. In particular, US estate taxes can be quite onerous and payable at your death (approximately 35% of the value, and not the gain like in Canada). While there is a substantial exemption available, it’s prorated between your US and Canadian assets. That means your estate could owe a lot of dollars to the US government on your death if you don’t plan before you buy.

It’s possible to plan around this by having the property owned in an appropriate name and designing your wills to take US estate tax laws into account. You need to do this with appropriate advice from US tax professionals.

As another article on the same day recommends “don’t buy thinking you’re going to make a killing; buy because you love it and plan to use it for years”.