Unlocking efficiency: How DOE grants can transform your operations

Early-stage startups must often contemplate the most practical way to raise capital for their business. If traditional debt and equity methods are not available, different avenues to raising capital must be considered. Here are four alternatives to traditional debt and equity transactions:

Simple Agreement for Future Equity (SAFE)

A SAFE provides rights to an investor for future equity in a company without determining a specific price per share at the time of the initial investment (date of agreement), nor does it provide for interest or a maturity date. A SAFE investor receives future equity shares when a priced round or investment event occurs (e.g., a Series A preferred stock financing round), typically at a discounted rate. SAFEs are intended to provide a simpler mechanism for startups to seek initial funding.

Convertible note

A convertible note is a hybrid security containing components of both debt and equity. The loan can be converted into either a predetermined or a variable number of equity shares at a later date, usually upon the occurrence of an event such as a financing round or liquidity event. In some cases, these are complex agreements that require more involvement from legal counsel.

Keep It Simple Security (KISS)

A KISS can be structured as either a debt or equity agreement. An investor provides funding to the company in exchange for the right to convert the instrument to equity upon a future event when an equity round is raised and preferred shares are issued. Like a SAFE, KISS agreements delay the need for a valuation and can minimize legal expenses. Unlike SAFEs, KISS notes do provide for an interest rate and a maturity date. KISS securities frequently include a Most Favored Nation clause, which provides that should a better deal be provided to new investors at a later date, they would need to revise the terms of the KISS investments to match the new preferable terms. These are sometimes seen in SAFEs and convertible notes as well. A KISS is generally viewed as more investor-friendly because of the protections it provides.

Redeemable preferred stock

A type of preferred stock that allows the issuer (the company) to buy back (call) the stock at a certain share price and retire it. The call feature can be beneficial for the company, as it can eliminate equity if it becomes too expensive. Aside from the redemption feature, it sometimes contains common provisions of preferred stock such as fixed dividends to the holder ahead of payments to holders of common stock. Another version of this, mandatorily redeemable preferred stock, includes a put feature that allows the investor to request the funds back at a specific date including a return. Depending on the provisions in the contract, mandatorily redeemable preferred stock may be classified as debt on a company’s balance sheet.

This is not an all-inclusive list. There are other non-traditional methods of financing, including, but not limited to, peer-to-peer lending, crowdfunding, and government grants. Selecting the appropriate methods of raising capital for your business involves the consideration of numerous factors. Current macroeconomic trends, the company’s industry, and long-term strategic objectives are examples of factors you may want to consider.

If you have questions about raising capital and the related business, accounting, and tax implications, please contact our professionals. We can also provide guidance on other alternatives to raising capital.

Read this if you are considering debt financing for your business.

“Give me a lever and a place to stand and I’ll move the world.”

Since Archimedes, the idea of a force multiplier (or lever) has been applied to many areas, including finance. Most businesses will explore increased leverage (taking on debt) to help finance operations at some point during their life cycle. There are important risks and rewards to be mindful of when determining whether debt financing is right for your business.

The rewards of leverage

There are advantages to taking on debt in order to fund operations and growth, including:

• Generally, adding debt to the capital structure will result in a lower cost of capital compared to using only equity, due to the higher return equity investors seek.
• Interest expense is tax deductible for income tax purposes (subject to certain limitations), whereas dividends (or distributions) to equity holders are not.
• Leverage increases the return on equity, improving investors' return on capital invested; investors have fewer funds at risk and their ownership percentages do not get diluted (debt financing does not reduce their control of the entity or profit allocation).

The risks of leverage

However, leverage can also pose some risks and other financial disadvantages, including:

• Increased financial risk resulting from the cash flow that will be required to service the debt. This additional pressure on cash flow can lead to an increased risk of insolvency and bankruptcy during a downturn. It also reduces future funds available to re-invest in operations or distribute to investors.
• If the loan includes a covenant that the borrower doesn't meet, the lender could call the debt and demand repayment.
• The interest on the debt is an ongoing cost over the term of the debt, lowering net income.
• Any business assets used for collateral will be at risk.
• When an owner personally guarantees a loan, they’re putting their own individual assets at risk, not just the business.

Balancing the pros and cons of leverage

Determining the appropriate amount of leverage for your business is a calculated decision that involves the consideration of many factors, including those stated above. Current macroeconomic trends such as periods of rising or declining borrowing rates, and the company's industry are examples of other factors that may play into the decision-making process.

If you have questions about your capital structure and the related business, accounting, and tax implications, please contact our professionals. We can also provide guidance on the debt-raising process and other alternatives to raising capital.

BerryDunn’s Commercial Practice Group partners with clients to provide insights that inform effective growth strategies, help them assess and manage risk, and optimize return strategies for better profitability. 

Read this if you are a business owner or an advisor to business owners.

In times of uncertainty, exit planning can be a strong reason to focus on the opportunity in front of you. Instead of waiting for conditions to improve, business owners are often best served by staying active, involved, and focusing their efforts on improving their business. Consider what opportunities you can take advantage of and be ready to succeed when the climate improves.

Assessing risks and strengthening operations

In periods of uncertainty, the landscape shifts—revealing weaknesses, threats, and hidden hazards. How these challenges are navigated can shape long-term outcomes. Will this moment be used to identify, assess, and address these risks? 

It is important to view challenging times in the context of a larger, long-term perspective. It presents the perfect opportunity to focus on building resiliency, redundancy, and strength. Unsettled times allow business owners to discover and understand: 

• What broke first and why? 
• How can you shore it up for better operations in the days ahead?
• What weak spots you didn’t know about are now apparent?
• How can you address those weaknesses?
• How can you leverage existing resources differently to chart a path forward?

Models of priority: The progress of a business

There are various stages or hierarchies of priority in thinking about the progress of a business. Each priority model features bases and pinnacles. The pinnacles of each model are realized in a long-term setting, after the remaining bases have been solidified. While continued development of a clear vision for your business is paramount, dynamic shifts in the landscape call for reassessment of the bases. In the long-term, self-fulfillment manifests from properly executed strategy, but in the near- and mid-term, these various frameworks force strategic planning back to assess and address the base components.  

The bases of each model should serve as safe havens for reversion. When facing uncertainty and failure, have you made your base strong enough to redirect your efforts into an actionable plan for the long-term? 

Action Planning Pyramid and Value Maturity Index

The Value Maturity Index, broken into five stages, is a stepwise assessment of active exit and business strategy. Inherent in the value acceleration framework are the concepts of resiliency, redundancy, disaster recovery, and actionable planning. 

While we may have been fully entrenched in the build phase, setbacks due to dynamic changes in the landscape force us back to protect mode—the assessment and methodical shoring up of weaker points of the operation to protect against future downside risks.

Though this stepwise progression is linear in nature, flexibility and adaptability are paramount in changing course to address the needs of your current state. 

When we look at action planning, parallels can be drawn to the various models. Certainly, we are focused on continuing sales, marketing, and customer relationships, but it becomes a question of reversion to meeting the basic needs and serving a client’s pain points rather than beginning ground-breaking efforts.  

An uncertain climate forces us to the base, where the focus is on solidifying any exposed areas that have emerged, and likely compounded, by the current challenges. Concerns related to management, metrics, core values, and priorities are the bases in need of coverage. 

Maslow’s Hierarchy of Needs
 

Maslow’s Hierarchy of Needs¹ is a well-known motivational theory in psychology that comprises a five-tiered model of human needs, whereby each successive tier must be fulfilled (beginning at the base) before rising to the next tier. It can be used to view similar information from a psychological perspective.

Value acceleration and creating successful outcomes are largely tied to a clear long-term vision. We typically reside in the self-actualization level of the hierarchy of needs when undertaking the high-level view of the framework.

In periods of uncertainty, the emphasis is on adaptability, so there will be less concern with the top levels. Those levels remain available but are not the pressing issue of the moment. If we think about shoring up bases (the protect stage) when viewing this psychological model, our focus is on the “basic needs” level. That is, keeping people (i.e., self, family, and employees) safe and remaining connected for immediate continuity.

McKinsey & Company Event Horizons

Many others in related fields view uncertain times in similar terms. In the McKinsey & Company Events Horizon view²:

• Resolve addresses those immediate hurdles and challenges a business is currently facing.
• Resilience focuses on near-term items to be addressed once the initial base is covered. 
• Return views the mid-term horizon in understanding how to return to scale by focusing on understanding metrics and increasing the frequency of measurements for informed decision-making. 
• Reimagination and reform typically go hand in hand, but without covering bases of needs, crafting a dynamic shift in operations to incorporate new environments may be counterproductive. 

Once these bases have been clearly assessed and addressed, the path forward may appear dramatically different. This is when creative solutions to enhance opportunity should begin to take shape. Examples may include newly emerged revenue streams and opportunities, fully integrated systems and dashboards to capture timely decision-making data points, or strategic pivots in your business model to improve navigation in changing environments. 

Discover and control in uncertain times

Consider what the period of uncertainty has revealed and ask yourself: 

• What existing challenges became more apparent?  
• How can these areas be addressed? 
• Is this the time to make large investments in the company or the right investments? 

Taking stock of your company’s future through the incorporation of lessons learned will bolster value in the long-term by de-risking and developing new opportunities, methods, work, shifts in productivity, and shifts in mentality. That approach also brings lots of questions: 

• If there are no early warning signs, why not?  
• What should your indicators be?  
• What metrics are crucial in identifying the pulse of your current situation?  
• What is your business reliant on?  
• How can you build information and indicators for rapid shifts in decision-making?  
• How strong are your current controls and how integrated are your management and information systems? 

To answer these questions, you need to quantify and develop metrics that will aid in the early identification of future challenges, thus increasing your responsiveness with data-driven decision mechanisms. Having your fingers on the pulse of your company and understanding the impact of each input on your strategy will focus your attention on the information that matters most. This allows you to understand, position, and adapt to changes in your business and community environment in a proactive and agile manner. Measurements, forecasts, and dashboards should provide you with regular, valid, and relevant information you can use to take informed action in decision-making. 

The importance of look-backs

Historical look-backs during various points of time will allow you to key in on pivotal data indicators and inflection points. When looking at this from an operational view, industry and economic factors impacting your company can serve as corroborating pieces of evidence to further support data metrics analyzed.

• It's best practice to regularly study and update development, pipeline, and reliance metrics for feedback and information discovery with data integrated throughout your operations. This helps avoid lag time in reporting on stale information towards real-time actionable data points.  
• Each metric is specific to your business and can be directly mapped back to increases in shareholder value. Understanding these business value drivers will focus your attention and intention on improving in the right areas, while avoiding distracting and less impactful pain points. 
• Instead of focusing on precision, build in flexibility and adaptability with scenario- and sensitivity-based criteria to understand changes, implications, and reliance of each input. Understanding these relationships in a broader scheme aids you in quick, impactful decision-making, guiding you toward enhanced value. 

Remaining resilient in challenging times 

This approach allows an opportunity to fully assess the known and unknown problem areas, weaknesses, perils, and hazards your business may be facing. From that base, you can begin to address these issues to scale effectively with lower overall risk when activity picks up. 

Management metrics, core values, and priorities drive resilience for long-term continuity by shoring up the foundation to build for the future. Assembling evidence in troubled times provides an opportunity to capitalize on and fulfill core values. Documenting these decisions and improvements memorializes your decision-making and impact on value enhancement, and serves as a playbook for future events. 

What you make of difficult periods through identification, assessment, and addressing newly emerged risk areas provides the opportunity to increase success as the climate rebounds.

Key takeaways

• Stay active during uncertainty: Improve the business now rather than waiting for conditions to recover. 
• Identify and mitigate newly exposed risks: Examine what broke first, what weak spots surfaced, and how to shore up operations. 
• Reinforce the “base” of the business: Prioritize management practices, core values, metrics, controls, and near-term continuity. 
• Measure what matters more often: Build timely dashboards, forecasts, and early-warning indicators to support faster, data-driven decisions. 
• Document lessons learned and improvements: Create a repeatable playbook that reduces future downside risk and supports long-term value. 

BerryDunn can help 

Our credentialed business valuation specialists bring clarity to the complexities of valuation while adhering to strict development and reporting standards. Through our assessments, risk profiling, and benchmarking analyses, we help business owners discover the largest gaps across the company, prioritize the most impactful problem areas to address, and implement changes to enhance business value through continuous improvement. We render an independent, objective opinion of your company’s value in a reporting format tailored to meet your needs. If you have questions about your unique situation, or would like more information, please contact the business valuation consulting team.

¹Maslow’s Hierarchy of Needs, Saul McLeod, updated March 20, 2020. SimplyPsychology. www.simplypsychology.org/maslow.html.
²Beyond coronavirus: The path to the next normal, Kevin Sneader and Shubham Singhal, McKinsey & Company, March 23, 2020.  www.mckinsey.com/industries/healthcare-systems-and-services/our-insights/beyond-coronavirus-the-path-to-the-next-normal. COVID-19: Briefing note, March 30, 2020, Our latest perspectives on the coronavirus pandemic. Matt Craven, Mihir Mysore, Shubham Singhal, Sven Smit, and Matt Wilson. McKinsey & Company. www.mckinsey.com/business-functions/risk/our-insights/covid-19-implications-for-business.

Read this if you are a business owner or an advisor to business owners.

This article is part three of a three-part series. 

With continued uncertainty in the business environment—driven by shifting economic conditions, market volatility, and evolving tax policy—now may be a good time to utilize trust, gift, and estate strategies in the transfer of privately held business interests. Periods of uncertainty can create an opportunity to free up considerable portions of lifetime gift and estate tax exemption amounts through transfers, particularly as uncertainty and increased risk serve to reduce business valuations. 

An element to consider is the ability to transfer noncontrolling interests in a business. These interests are potentially subject to discounts for lack of control and lack of marketability. This may further reduce the overall value transferred through a given strategy, potentially offloading a larger percentage of ownership in a business while retaining large portions of the gift and estate lifetime exemption. Part one of this series focused on the discount for lack of control (DLOC) and part two focused on the discount for lack of marketability (DLOM). In part three, we’ll focus on the application of discounts. 

Application of discounts

One area that often challenges those unfamiliar with business valuations is the application of the DLOC and DLOM. These discounts are multiplicative, not additive. The combined effect of a 10% DLOC and a 30% DLOM is not an additive result of 40%, rather a multiplicative result of 37% (mathematically, 1 – [(1 – DLOC) x (1 – DLOM)]). Consider the following example:

A business owner has a 10% minority, nonmarketable interest in a business. The equity of the business is worth $1,000,000. Their interest has a pro-rata value of $100,000 (10% of $1,000,000). They retained a qualified valuation analyst, who estimated that a 10% discount for lack of control and a 30% discount for lack of marketability were appropriate for the valuation of the business owner’s interest. The difference in applying these discounts correctly through a multiplicative process and incorrectly through an additive process is demonstrated in the following chart: 

It does not matter the order in which a DLOC and a DLOM are applied. Because these discounts are multiplicative, applying either one first will not affect the concluded minority, nonmarketable value.

What this means for business owners 

Business owners are knowledgeable of the facts and circumstances surrounding a business interest. They take a close look at what they are buying before they make an offer. Like most owners, they prefer to maintain control and invest in assets that are readily convertible to cash. Therefore, they are generally not willing to pay the pro-rata value for a minority interest in a business that lacks control and marketability. To assess appropriate discounts for lack of control and discounts for lack of marketability, consider resources such as those referred to in part one and part two of this series, then ensure the selected discounts are appropriate based on the factors specific to the company and interest being valued. From there, the application of the DLOC and DLOM is multiplicative, not additive, as noted in the example above. 

Given the current environment, using trust, gift, and estate strategies that take advantage of discounts for lack of control and marketability offers the opportunity to transfer a higher percentage of interest in a privately held company at a lower value. This potentially frees up additional amounts of remaining thresholds of the lifetime gift and estate tax exemptions. 

Key takeaways

• Watch for market and tax uncertainty that can create transfer opportunities. 
• Identify noncontrolling interests that may qualify for valuation discounts. 
• Distinguish discounts for lack of control from discounts for lack of marketability. 
• Apply the two discounts multiplicatively rather than adding the percentages. 

BerryDunn can help 

BerryDunn’s credentialed business valuation specialists bring clarity to the complexities of valuation while adhering to strict development and reporting standards. We render an independent, objective opinion of your company’s value in a reporting format tailored to meet your needs. If you have questions about your unique situation, or would like more information, please contact the business valuation consulting team. 

Read this if you are a business owner or an advisor to business owners.

This article is part two of a three-part series. 

With continued uncertainty in the business environment—driven by shifting economic conditions, market volatility, and evolving tax policy—now may be a good time to utilize trust, gift, and estate strategies in the transfer of privately held business interests. Periods of uncertainty can create an opportunity to free up considerable portions of lifetime gift and estate tax exemption amounts through transfers, particularly as uncertainty and increased risk serve to reduce business valuations. 

An element to consider is the ability to transfer noncontrolling interests in a business. These interests are potentially subject to discounts for lack of control and lack of marketability. This may further reduce the overall value transferred through a given strategy, potentially offloading a larger percentage of ownership in a business while retaining large portions of the gift and estate lifetime exemption. Part one of this series focused on the discount for lack of control. For part two, we'll focus on the discount for lack of marketability. 

Discount for lack of marketability

In the context of a hypothetical willing buyer and willing seller, the buyer may place a greater value on an ownership interest in an investment that is “marketable.” Marketable investments can be bought and sold easily and offer the ability to extract liquidity compared to an interest where transferability and marketability are limited. 

Simply put, buyers would rather own investments they can sell easily and will pay less for the investment if it lacks this ability. Noncontrolling interests in private businesses lack marketability—few people are interested in investing in a business where control rests in someone else’s hands. Discounts for lack of control commonly reduce the value of the transferred interest by 5% to 15%, while discounts for lack of marketability can drop the value of the business by 25% to 35%. 

Market-based evidence of proxies for discounts for lack of marketability can be found within the following resources, studies, and methods (including but not limited to): 

• Various restricted stock studies 
• The Quantitative Marketability Discount Model (QMDM) developed by Z. Christopher Mercer 
• Various pre-initial public offering studies 
• Option pricing models 
• Other discounted cash flow models 

In addition to these resources, to fully assess the degree of discount applicable to a subject interest, consider company-specific factors when estimating the discount for lack of marketability. The degree of marketability is dependent upon a wide range of factors, such as the payment of dividends, the existence of a pool of prospective buyers, the size of the interest, any restrictions on transfer, and other factors. 

Assessing discount for lack of marketability

To establish a comprehensive view on the applicable degree of discount, here are more things to consider. In a ruling on the case Mandelbaum v. Commissioner¹, Judge David Laro outlined the primary company-specific factors affecting the discount for lack of marketability, including:

1. Restrictions on transferability and withdrawal
2. Financial statement analysis
3. Dividend policy
4. The size and nature of the interest
5. Management decisions
6. Amount of control in the transferred shares

Business owners are knowledgeable of the facts and circumstances surrounding a business interest. They take a close look at what they are buying before they make an offer. Like most owners, they prefer investments they can readily convert into cash and are generally not willing to pay the pro-rata value for a minority interest in a business that lacks marketability. To assess an appropriate discount for lack of marketability, consider resources such as those referred to above, then ensure selected discounts are appropriate based on the factors specific to the company and interest being valued. 

Key takeaways

• Use periods of uncertainty to consider trust, gift, and estate strategies for transferring privately held business interests.  
• Recognize that noncontrolling interests may qualify for discounts for lack of marketability, reducing reported transfer value.  
• Expect marketability discounts to be materially larger than control discounts in many cases, potentially reducing value by roughly 25% to 35%. 
• Reference market-based studies and valuation models when estimating the discount. 
• Evaluate company-specific factors when determining the discount. 

BerryDunn can help 

Our credentialed business valuation specialists bring clarity to the complexities of valuation while adhering to strict development and reporting standards. We render an independent, objective opinion of your company’s value in a reporting format tailored to meet your needs. If you have questions about your unique situation, or would like more information, please contact the business valuation consulting team. 

¹Mandelbaum v. Commissioner, T.C. Memo 1995-255 (June 13, 1995).

Read this if you are a business owner or an advisor to business owners.

This article is part one of a three-part series. 

With continued uncertainty in the business environment—driven by shifting economic conditions, market volatility, and evolving tax policy—now may be a good time to utilize trust, gift, and estate strategies in the transfer of privately held business interests. Periods of uncertainty can create an opportunity to free up considerable portions of lifetime gift and estate tax exemption amounts through transfers, particularly as uncertainty and increased risk serve to reduce business valuations.  

An element to consider is the ability to transfer noncontrolling interests in a business. These interests are potentially subject to Discounts for Lack of Control (DLOC) and lack of marketability. This may further reduce the overall value transferred through a given strategy, potentially offloading a larger percentage of ownership in a business while retaining large portions of the gift and estate lifetime exemption. For the first part of this series, we’ll focus on the DLOC.

What is discount for lack of control?

In the context of a hypothetical willing buyer and willing seller, the buyer may place a greater value on an ownership interest with the ability to make changes at their discretion, compared to an alternative ownership interest lacking control. Simply put, buyers like to be in control, and they will pay less for the investment if the interest lacks these characteristics.  

When valuing noncontrolling business interests, there is an inherent discount to full value recognized to reflect the fact that the subject interest does not hold a controlling position. As a result of this discount, the value of a noncontrolling interest in a company will differ from the pro-rata value per share of the entire company. DLOCs alone commonly reduce the value of the transferred interest by 5% to 15%. 

All else being equal, a noncontrolling ownership position is less desirable (valuable) than a controlling position. This is because of the majority owner’s right to control any or all of the following activities:

• Managing the assets or selecting agents for this purpose 
• Controlling major business decisions, asset allocation choices, setting salary levels, admitting new investors, acquiring assets, selling the company, and declaring/paying distributions

Market-based evidence of proxies for DLOCs can be found within the following subscription-based databases, including but not limited to: 

• Control premium studies published in the Mergerstat^® Review series by FactSet Mergerstat/Business Valuation Resources
• Closed-end fund data
• The Partnership Profiles, Inc. Minority Interest Database and Executive Summary Report on Re-Sale Discounts for applicable entity types

In addition to these resources, to fully assess the degree of discount applicable to a subject interest, consider company-specific factors when estimating the DLOC. The degree of control for a subject interest may be impacted by relevant state statutes and the governing documents of the subject company. These factors are analyzed in conjunction with the current operational and financial policies established and implemented in practice by management to establish a comprehensive view on the applicable degree of discount.

Hypothetical business owners are knowledgeable of the facts and circumstances surrounding a business interest. They take a close look at what they are buying before they make an offer. Like most owners, they prefer to be in control and are generally unwilling to pay the pro-rata value for a minority interest in a business that lacks control. To assess an appropriate discount for lack of control, consider resources such as those referred to above, then ensure the selected discounts are appropriate based on the factors specific to the company and interest being valued. 

Key takeaways

• Use periods of uncertainty to consider trust, gift, and estate strategies for transferring privately held business interests. 
• Recognize that noncontrolling interests may qualify for discounts for lack of control, reducing reported transfer value. 
• Define a DLOC as the price reduction buyers apply when an ownership stake cannot influence decisions or change operations. 
• Expect DLOCs alone to commonly reduce transferred-interest value by 5%–15%, making minority value differ from pro‑rata value. 
• Support a DLOC with market evidence (control premium studies, closed-end fund data, minority interest databases) and company-specific factors (state statutes, governing documents, operating policies). 

BerryDunn can help 

BerryDunn’s credentialed business valuation specialists bring clarity to the complexities of valuation while adhering to strict development and reporting standards. We render an independent, objective opinion of your company’s value in a reporting format tailored to meet your needs. If you have questions about your unique situation, or would like more information, please contact the business valuation consulting team. 

Read this if your company is considering financing through a sale leaseback.

In today’s economic climate, some companies are looking for financing alternatives to traditional senior or mezzanine debt with financial institutions. As such, more companies are considering entering into sale leaseback arrangements. Depending on your company’s situation and goals, a sale leaseback may be a good option. Before you decide, here are some advantages and disadvantages that you should consider.

What is a sale leaseback?

A sale leaseback is when a company sells an asset and simultaneously enters into a lease contract with the buyer for the same asset. This transaction can be used as a method of financing, as the company is able to retrieve cash from the sale of the asset while still being able to use the asset through the lease term. Sale leaseback arrangements can be a viable alternative to traditional financing for a company that owns significant “hard assets” and has a need for liquidity with limited borrowing capacity from traditional financial institutions, or when the company is looking to supplement its financing mix.

Below are notable advantages, disadvantages, and other considerations for companies to consider when contemplating a sale leaseback transaction:

Advantages of using a sale leaseback

Sale leasebacks may be able to help your company: 

• Increase working capital to deploy at a greater rate of return, if opportunities exist
• Maintain control of the asset during the lease term
• Avoid restrictive covenants associated with traditional financing
• Capitalize on market conditions, if the fair value of an asset has increased dramatically
• Reduce financing fees
• Receive sale proceeds equal to or greater than the fair value of the asset, which generally is contingent on the company’s ability to fund future lease commitments

Disadvantages of using a sale leaseback

On the other hand, a sale leaseback may:

• Create a current tax obligation for capital gains; however, the company will be able to deduct future lease payments.
• Cause loss of right to receive any future appreciation in the fair value of the asset
• Cause a lack of control of the asset at the end of the lease term
• Require long-term financial commitments with fixed payments
• Create loss of operational flexibility (e.g., ability to move from a leased facility in the future)
• Create a lost opportunity to diversify risk by owning the asset

Other considerations in assessing if a sale leaseback is right for you

Here are some questions you should ask before deciding if a sale leaseback is the right course of action for your company: 

• What are the length and terms of the lease?
• Are the owners considering a sale of the company in the near future?
• Is the asset core to the company’s operations?
• Is entering into the transaction fulfilling your fiduciary duty to shareholders and investors?
• What is the volatility in the fair value of the asset?
• Does the transaction create any other tax opportunities, obligations, or exposures?

Accounting for sale leaseback transactions under Accounting Standards Codification (ASC) Topic 842, Leases, can be very complex with varying outcomes depending on the structure of the transaction. It is important to determine if a sale has occurred, based on guidance provided by ASC Topic 842, as it will determine the initial and subsequent accounting treatment.

The structure of a sale leaseback transactions can also significantly impact a company’s tax position and tax attributes. If you’re contemplating a sale leaseback transaction, reach out to our team of experts to discuss whether this is the right path for you.

Read this if you received State and Local Fiscal Recovery Funds.

Picture this: Your organization has received millions of dollars from the federal government to help you steer your community through the aftermath of the COVID-19 pandemic. These funds are designed to enhance capacity, bolster resilience, and fortify your community against future challenges, ultimately elevating services for your constituents. But there's a catch. The clock is ticking, and every decision you make has a deadline attached.

In January 2022, the US Treasury unveiled a final rule to streamline the implementation of the State and Local Fiscal Recovery Funds (SLFRF) program pursuant to the American Rescue Plan Act (ARPA) and address public feedback. This rule stipulates that recipients must fully obligate their SLFRF funds by December 31, 2024. However, the obligation requirement lacked detailed information, prompting numerous recipients to seek further clarification. Responding to this need, the Treasury introduced the Obligation Interim Final Rule (Obligation IFR) in November 2023, aiming to provide recipients with a clearer understanding of the "obligation" concept within the SLFRF program under ARPA. Here, we present a concise overview of key points outlined in the new Obligation IFR.

Section 1.0: Key points and December 31 deadline

• Definition of obligation: The Obligation IFR definition means  placing an order for goods or services and entering into a contract, subaward, or similar transaction that requires payment. 
• Application of obligation deadline (December 31, 2024) to recipients: The critical date of December 31, 2024, pertains to when the primary recipient of SLFRF funds enters into an executed contract of subaward. Subrecipients aren't bound by the December 31, 2024, obligation deadline. 
• Amending or replacing contracts and subawards after the deadline: While recipients can't obligate more funds after December 31, 2024, they can replace contracts or subawards and use up to the remaining funds from the original agreement to provide the same services under specific circumstances, such as the termination of an agreement due to default, mutual agreement, or for convenience if the original award was improper.
• No changes to eligible use categories, including "Revenue Replacement" (Expenditure Category 6.1), and obligation and expenditure deadlines for the SLFRF program.

Section 2.0: Crucial clarification

To use SLFRF funds, recipients must have placed orders or entered into contracts by December 31, 2024. This means if a recipient hasn't spent the funds or entered into a contract for goods or services by this date, they can't use SLFRF funds, even if claimed under the Revenue Replacement Expenditure Category.

Exception: Funds are considered obligated if they cover costs associated with complying with federal law or regulation or SLFRF award terms and conditions. A recipient may use SLFRF funds, without a formal agreement, to cover obligation costs related to:

1. Reporting and compliance requirements, including subrecipient monitoring
2. Single Audit costs
3. Record retention and internal control requirements
4. Property standards
5. Environmental compliance requirements
6. Civil rights and nondiscrimination requirements

Please feel free to contact our team for more detailed information on this exception.

Section 3.0: Next steps

In order to help ensure you are compliant with the requirements under the Obligation IFR, we recommend that you take the following steps:

1. Review all projects using SLFRF funds and assess whether you have a contract or subaward with a contractor or subrecipient to provide the goods and services to be delivered under each project.
2. For projects where you do not have a contract or subaward (e.g., projects where you were planning to use your own internal staff to implement or operate the project), assess whether those services can be contracted or subawarded to an outside entity (i.e., a community-based organization or contractor).
3. Develop and execute a contract, subaward, or similar document that records the obligation to pay for goods and services after the December 31, 2024, deadline.
4. Prepare an estimate of the amount of SLFRF funds you will use to meet one of the compliance related activities described above in Section 2.0, provide a justification for these compliance related costs and how you calculated these costs, and provide this documentation to the US Treasury during the April 30, 2024, quarterly Project and Expenditure Report.

BerryDunn's ARPA Consulting team is available to help in performing these tasks and providing advice on how best to comply with the requirements under the Obligation IFR.

We encourage you to review these examples issued by the US Treasury that illustrate how the requirements under the Obligation IFR should be applied.

Read this if you are interested in grant compliance in healthcare. 

This is a companion article to the podcast, Mitigating the compliance and revenue integrity risk of grant funded healthcare programs.

The BerryDunn Healthcare Practice Group boasts professionals who have expertise all across the spectrum of healthcare, including regulatory, revenue, integrity, general compliance, and risk management issues. This article covers the very specific arena of grant compliance affecting many of BerryDunn’s healthcare, not-for-profit, and government clients.

After starting as a newly minted MBA financial analyst with an academic medical center in Northern New England, I (Markes) worked my way into the world of grants and contracts supported by my interest in federal regulations and the non-clinical revenue streams. Fascinated to navigate through waters where it seemed no one was the expert, or really had the time or patience to figure things out, I worked to stand up a grant office in finance on the hospital side, separate from the medical school which was the usual repository for grant funding. We moved this direction because hospital leadership realized grant funding was tipping toward the clinical setting and was less focused on bench or clinical research. Put another way, less NIH and more CDC, HRSA, and CMS.

BerryDunn Senior Manager Regina Mathieson advises, “wherever there is complexity, there is compliance risk.” Whether from a federal agency like HHS, HRSA, NIH, or CDC, a state Medicaid program, foundation, or private source, grants always come with requirements, typically very specific requirements. Because the dollars are being ‘given’, those requirements for how the funds are used may be much more restrictive than loans.

Like other areas of regulatory compliance, it is reasonable to assume that grant programs often have compliance gaps that go unnoticed. For many of our clients, both in healthcare and not-for-profit, and in the government space, grant revenue has become a significant source of funding. Any kind of healthcare delivery organization, including academic medical centers, federally qualified health centers, community hospitals, behavioral health service organizations, home health providers, visiting nurse associations, and others can end up with significant portions of their income for the year being sourced by federal grants.

Grant compliance categories

We all can’t be experts in every domain of regulatory compliance, and grant compliance has a lot of breadth. Thankfully, at BerryDunn, we have a team of grant experts who work collaboratively across practice groups. When I was working on setting up the grant office and establishing a proprietary clinical FTE reporting process and system earlier in my career, I would have greatly benefited from the perspectives of other experts at the table.

When we think about grant compliance, four categories are helpful to keep in mind:

1. Restricted funding
2. Single audit
3. Indirect rate
4. Time and effort

Restricted funding

Firstly, and most universally understood and applied is that grant monies are, pretty much by definition, restricted. Aside from very specific and rare instances of monies being granted to beneficiaries who have no responsibility, all grant funding is awarded with the expectation that the funds will be expended in a specific way. 

Any funder, from the federal government to your local community organization like the Lions Club or the VFW, will likely require individuals and entities awarded a grant must promise to use the funds only for the purpose laid out in the award and proposal. Compliance with grant terms typically includes following the requested reporting requirements of that funder as well. Though this category may sound obvious, it's actually pretty far-reaching, as it usually affects sub-recipients (those entities who are partnered with the direct recipient to accomplish the grant purpose). For example, where the money goes after the initial awardee receives it, or rules about who can do the work, what type of organization, how you choose a vendor, etc.—all sorts of categories.

It should be noted that many of these grant award requirements are not dissimilar from work we already do in the healthcare compliance space to assist our clients in avoiding anti-kickback statutes and Stark risks. This is because grant compliance is grounded in the same basic concepts—no favoritism, no bribes or shady deals, and avoiding fraud, waste, and abuse. Especially if you're spending federal monies, you need to prove that you choose the vendor based on verifiable best practices, and consideration was afforded to organizations owned by women, veterans, and minorities.

Single audit 

The second category, Single Audit, is applicable to all federal funding of $750,000 or more annually. My colleague from BerryDunn’s Not-for-Profit practice group, Katie Balukas, explains: 

"The federal Single Audit Act is a requirement for entities to undergo an independent financial and compliance audit when the entity has expended over $750,000 in federal awards. These audits are conducted following guidance issued through the Governmental Auditing Standards and the United States Office of Management and Budgets' Uniform Guidance. The main focus of the compliance audit is to assess the entity's compliance with the requirements set forth by the federal agency that administered the grant funds. That includes, but is not limited to determining if the funds were utilized for allowable costs and activities and expanded within the proper grant period and that the reporting and performance objectives were met."

It is important to note that adequate, appropriately scaled internal resources are essential for any organization receiving grants and even more so with larger grants. Though the phrase has been overused, it really does “take a village”. Grant management isn't something an organization should do on the side, assigning grant accounting to someone who already has a full-time role, but unfortunately this is common and also unfortunate because under resourcing tends to lead to compliance concerns, as well as just plain old poor funding management. 

Indirect rate

Speaking of funding, the third type of grant compliance is very focused on a component of the grant world that really has a life of its own: The indirect rate. Though there is an accounting definition of ‘indirect’, the way it is defined regarding grant funding is pretty specific, and there is an entire body of work organizations undertake to get a federally approved indirect rate.

There's an awful lot to think about with the indirect rate. On the one hand, you could say it's pretty simple. For example, a lot of foundation funders and even some federal funders will offer you a 5% or 10% indirect rate without any need to make a calculation. That's because they know that if you take time to do the math, you'll come up with a number much higher than 5% or 10%. When it comes to federal grants and healthcare services organizations, the indirect rate is dependent on how an organization measures costs. For hospitals, of course, the method of measurement is driven by the Medicare cost report, and that's where we would do the fancy math to derive the indirect rate. But the reality is far from simple or straightforward. 

Time and effort

The fourth and final area of grant compliance, time and effort, is also the one I'm actually most passionate about and is probably the most minimized, or at the very least, misapplied. 

In one way, “time & effort” is exactly what it sounds like. Much of granted dollars, especially from the federal government, get appropriately spent on program staff. The challenge is to match time and effort to those dollars, but that isn't as clear as it sounds, because the standard way of measuring staff time is usually in a payroll system of some sort, which can't prove how time was spent.

Most payroll systems can be programmed to account for FTE (full-time equivalent) allocations; however, there is often a breakdown between theory and practice. Putting allocations into payroll, usually done without employee interaction, may show how an employee “should” spend their time, but it is really no guarantee that that's actually how they're spending their time.

So how does the organization typically go about assuring that? Now, I don't want to speak for everyone, but let's just say I happen to know that there's a place for two or three (or maybe 10,000) that basically put allocations into payroll, and then, unfortunately, often well after the fact and/or more than once, send that allocation to the employee to sign off on without really any option to disagree, or even to modify. We all know that is not compliant…but in the organization's defense, there really haven't been very good alternatives to that kind of woeful and frustrating process, at least none that have been widely shared or understood.

As often is the case in the compliance world, rules are not followed because there is no perceived risk, but that is not a winning strategy.

Though many people involved in grant management do not have any experience or even knowledge of time and effort violations meeting with any consequences, organization interest and grant compliance have more implications than just preventing front page news. What I find in the conversations with organizations, both large and small, is that loose time and effort management costs the organization in two major ways. 

Firstly, it is inefficient to scramble around at the close of each federal grant to fix time and effort allocations. The extra time spent by grant staff, project coordinators, managers, and the finance team to sort things out because they didn't get them right the first time is the worst kind of inefficient—poor use of time with an equally poor outcome. 

Secondly, loose time and effort is costly in direct salary dollars. Most grant staff are not dedicated to one project, so we need to consider the value of their other work. Whether that is on other grants or, for example, seeing patients in the clinic as many principal investigators in healthcare do, having inaccurate or fluctuating understandings of their ability costs the organization directly in wasted salary dollars or indirectly as the opportunity cost of those providers (or other roles in other organizations). 

Digging in and fixing these issues is the work I really enjoy. It's relatively simple to build a compliant model, whether that requires very little payroll redo and is just a simple recurring attestation process in built in Excel, or more complex integrated models with triggered attestations in PDF format in a database that manages the overall FTE of principal investigators. It might even drive the available clinical provider time. It can all be done. We just need to know what the goal is. 

Working in this space so rewarding, because like so much of compliance, it's about doing something better—not just being compliant—but setting organizations up to better meet their goals and fulfill their mission.

The compliance or accounting professional might still ask, “But why aren’t payroll allocations sufficient for meeting Uniform Guidance?” The truth is, when UG came into effect and superseded the A-110, 122, 133, and others, the bar was effectively lowered. Historically, organizations abiding by the old OMB circulars had to make an attestation at least twice a year, which doesn’t really seem helpful, as who can accurately allocate their time from 5 or 6 months ago? So UG did away with the timeframe reference, relying on the idea that the payroll allocations and distributions would be all that would be needed, and in the absence of those, a monthly ‘look back’ by professional staff would be in order.

I say all this, because as a result, the interpretation of ‘payroll allocations’ then becomes the standard and we have forgotten about the other elements spoken of in the regulation. Remember, for anyone salaried (the vast majority of physicians and most of the higher level grant personnel), the ‘payroll allocation’ doesn’t pass muster. It is a static allocation that has no mooring in actual activity. This is why UG calls for monthly “current and reasonable estimates” of time and effort.

So what can organizations do in response? They need to seek a solution, a process, and a method that will both pass audit muster, as well as help the organization properly manage their resources. Almost every organization manages their productivity and finances on a regular basis: monthly! That’s why the same standard should apply to grant time and effort management. It's much more reasonable to ask you how you spent your effort this month, asking you to make a reasonable estimate of your time allocations to the different efforts you worked on.

So to summarize, the four key areas of grant compliance are (1) grants are restricted funding, (2) single audit requirement for federal funding over $750,000 annually, (3) the indirect rate and related agreement, and (4) time and effort.

Of course, I would be remiss to not point out that undergirding all this is the organization’s approach to policy. Any organization that considers grant funding a regular piece of their annual income needs to have dedicated grant management policies, covering all of the above topics, with particular focus on those arenas that are unique to the world of federal funding, and being mindful to follow or otherwise update for changes in processes and/or regulations.

Final takeaways: 

• First, what grant focused infrastructure do you have in place? If you are subject to a single audit, there should be dedicated administrative grant staff. And I don’t mean the programmatic people actually working on the grant, but people outside the grant funding—also why you have an indirect rate. 
• Second, how are you handling time and effort? If the process relies on any long after-the-fact attestations or payroll-generated reporting, it is unlikely to be truly following the spirit…or the letter…of Uniform Guidance. 
• Third, review your policies regarding grants. You may not actually have policies focused on grant activities, leaving them under ‘general finance’. That isn’t sufficient to cover federal funding requirements. Many have grant policies in place, but are they actually being followed through the lifecycle of your grant programs? 
• Lastly, the grant world is a whole ball game unto itself. BerryDunn has some great resources internally to offer assistance in all phases of grant management and administration.