Investors took a wait and see attitude throughout much of 2012. While new job creation remained weak, layoffs and the unemployment rate stabilized during the second half of the year. The general election is now over and the business community did not get what it wanted most: clarity regarding future tax rates and the regulatory environment. The country will continue with a strongly divided government and the status quo for at least the next two years. Unresolved uncertainties in the aftermath of the election, including the looming ‘fiscal cliff’, seem to be quickly changing from a concern into action. In the short time since the election, the number of public companies announcing layoffs has surged.
What will be the likely impact on the demand for executive talent given significant unresolved uncertainties? How can lower and middle market enterprises leverage executive talent in the current market to reduce risk? Read our article to find out.
Large corporations are reacting to the political stalemate by quickly implementing plans to tighten their belts in the expectation of higher taxes, increased operating costs, and a potentially weaker economy. One day after the election, Boeing announced plans to close two plants in California and cut 30% of its management jobs. While insisting it was not related to the potential drastic cuts in defense which would be enacted under a ‘fiscal cliff’ scenario, the company would have been derelict in serving its shareholders not to have considered that as a central consideration. The business community is quickly becoming resigned to the fact that the Affordable Healthcare Act will become fully implemented in its existing form. Some companies which are specifically referencing the Affordable Care Act as a reason for layoffs include Dana Holding Corp, Stryker, Boston Scientific, Medtronic, and Abbott Labs.
Beyond company or industry specific uncertainties and challenges, the stalemate in Washington also clouds the overall macroeconomic outlook. There is great concern in the business community that any level of individual or corporate tax increases could throw our fragile economy back into recession. President Obama and Congressional Democrats insist on tax increases on at least some taxpayers, while Republicans insist the current tax rates be extended for all. If a compromise cannot be reached, then we face the worst case scenario of tax rates increasing for all income brackets. States such as California, New York, and New Jersey have either already raised taxes or voiced their intent to do so in the near future. Regardless of what ultimately plays out, some of the most populous states are increasing taxes and some level of federal income tax rate increase is probable. An MBA is not required to understand that less disposable income in the hands of consumers translates into lower consumption and economic activity. Tax increases do not spur economic growth, but they certainly can hamper it.
All things considered, the level of risk involved in expanding or starting a business in the current environment appears quite high (in my humble opinion as a small business owner). I would anticipate an unusually large number of deals in December as investors rush to cash out their gains since the capital gains tax rate is likely to increase in 2013. Investors will enter 2013 with access to a enormous level of liquidity to finance acquisitions and start-ups. However, it is difficult to sell investors or bankers on a project when there is a unacceptably wide range in the expected rates of returns on an investment based on various macroeconomic factors beyond their control. And if the tax rate on capital gains is increased, then every investment opportunity in the market instantly becomes less attractive. Until there is clarity regarding future tax policy and the cost of new regulations, expect existing companies to continue belt tightening and investments in new businesses to slow.
What does all this mean for the outlook of executives who serve lower and middle market companies?
While uncertainty remains significant, there are a few things which are now known or probable. The U.S. economy remains weak, operating costs are surging (eg. fuel, benefits), and taxes are almost certain to rise. There will be an agreement between the Democrats and Republicans to avoid going over the ‘fiscal cliff’ because all sides have too much to lose. Even before considering the bitter medicine resulting from such an agreement, factors which are already known will make 2013 a tough year for growth and new investments within the lower and middle market.
Over the coming months, anticipate executive opportunities and new hire compensation levels in the lower and middle market to remain relatively unchanged. While there appears little economic upside in 2013 to drive the demand for experienced executives, there are meaningful downside risks which could soften the employment market for senior level professionals.
A number of companies have announced significant layoffs in the last month, many of which included senior level positions. However, these have been predominantly larger and/or publicly traded companies. In general, smaller enterprises and private equity investors exercised caution throughout 2012. They had already made decisions to delay on-boarding new executives and cut administrative overhead at existing companies when possible, while no small number of contemplated expansions and start-ups were placed on hold or cancelled as expenses, costs, and uncertainty increased. As a result, the current political impasse and pending new taxes should have a muted impact on executive staffing decisions within lower and middle market companies.
Assuming the economy remains relatively static, the demand for experienced executives in the lower and middle market should remain relatively unchanged. Government regulations and taxes are going to increase business costs and negatively impact the economy in 2013. The million dollar question is “Will these push the economy back into a recession”? And if so, how deep and how long? Recessions tend to have a disproportionate impact on small businesses, so a shrinking economy would be expected to negatively impact the demand and compensation of executive level professionals. Eerily, the initial jobless report after the election showed a dramatic jump in new jobless claim. While some of the increase was attributable to Sandy, Ohio and Pennsylvania accounted for a meaningful portion of the new claims. Adding to the bad news, it was revealed Thursday that the Euro Zone is now officially back in recession. At best, the prospects for executives entering 2013 appear unchanged from 2012 with a reasonable possibility things could deteriorate.
How can businesses leverage executives in the current market environment to reduce risk?
The seemingly limitless permutations of costs attributable to inflation and government legislation, tax policy in 2013 and beyond, and the resulting impact on general economic conditions makes dependable financial projections difficult. In the face of uncertainty throughout 2012, private enterprises moved to cut costs and defer incremental discretionary expenses. Plans to add new executive talent continue to be shelved and searches to replace previously departed executives are being delayed to conserve cash when possible.
Assuming a defensive posture in the current environment is prudent. However, delaying executive hiring decisions or reducing the senior management team to conserve cash is a double edged sword. Many are choosing to forgo senior level professionals at the very time when the need for such leadership is at its greatest. While the hesitancy to add overhead in turbulent times is understandable, market conditions have created opportunities to engage contract based executives at historically low hourly rates.
While opportunities for permanent ‘for hire’ CFOs in the lower and middle market have remained relatively stable, the demand for interim and fractional executives has weakened. This makes intuitive sense since those who make their living consulting as interim CFOs or fractional CFOs typically provide CFO services to startups and smaller sized companies. As start-ups and small business expansions have slowed, the result has been a decrease in the utilization rate of CFO consultants. I have no official employment index which would serve to validate my assessment. Regardless, dozens of long time CFO consultants with whom I maintain regular contact continue to communicate their schedules have never been lighter. The under-utilization of contract based executive talent currently presents a cost effective opportunity for business owners.
The average contract rate for CFO level expertise has long held in the range of $175 to $200/hour. Given the under-utilization of senior level consulting professionals in the market, world class talent can be engaged at unusually competitive rates whether on a full time, part time, or project basis. And there has never been a time when contract based partner, as opposed to a permanent hire, made more sense.
Contract based professionals come without the commitments (eg. salary, benefits, stock options, bonuses, etc.) and legal entanglements (severance and employment agreements) of statutory employees. This benefit will continue to become more important as legislatively mandated programs such as the Affordable Care Act drive up the cost of traditional employees. Consultants are available for assignment on a temporary, long-term, full-time, or part-time basis. Interim or fractional professionals allow small and mid-market enterprises to acquire the expertise their business demands in the midst of a difficult environment while maintaining maximum flexibility.
Now more than ever, interim executives are an economical, flexible, and relatively low risk investment which can guide small businesses and start-ups through a murky and risk-laden economic environment.
Christopher Tiesman
