Capital Budgeting, Capital Structure and Working Capital Management Activities at the Richardson Tree Farm

The Richards Family’s Capital Budgeting Investment Decisions

The Richards family’s decisions and activities contain elements of capital budgeting investment. Capital budgeting decisions, in general, require the commitment of a large sum of money today/now in exchange for some future anticipated advantages in the form of cash inflows. Additional significant characteristics of this type of investment include: a risk item linked to benefit realization because the future is intrinsically unknown; irreversibility of the decision; time lag before cash flows begin to be realized; and the likelihood of a lack of second-hand market (Riahi-Belkaoui, 2001).

The Capital Budgeting Process and Jake’s Investment

The capital budgeting process begins with the generation of a concept. From the given case, Jake developed an idea of how he would use the family’s piece of land in a beneficial manner. He planted trees in a few acres, hoping to sell in the future as Christmas trees, before realizing that these trees would be used in a more profitable manner in his landscaping business and sell them to the neighboring nurseries and other landscapers. The addition of other popular landscape trees, including the ornamental crabapple, pear, arborvitae, red maple, yew, dogwood, and cherry, is also a huge investment (capital in nature).

Financing the Capital Investment Projects

As noted by Chandra (2014) the manager must also think of how he will finance the capital investment projects. It is through this decision that the capital structure is determined. In other words, the finance manager evaluates the various sources of funding and makes a decision on the proportionate financing from each. In most cases, an entity finances its capital investment using debts and owners’ contribution. The project undertaken by Jake fits these features as he borrowed $600,000 from the bank and added other funds from his wife’s income and by disposing the dairy herd (owner’s contribution).

Working Capital Decisions

The working capital decisions are those linked to the short-term management of operations (Chandra, 2014). These decisions can be seen from the successful management of the workforce and the daily activities by Jake.

Choice of the Corporation Type

The Richards family should register their business as an S corporation. This is a form of corporation formed through the election of an IRS tax. As noted by Wood (2012) the Richards family will first register the traditional corporation, but file for the S election with the IRS within 75 days. After this registration, they will acquire business license and permits to start operating an S corporation and enjoy the associated benefits. First, there will be tax savings benefits for both the company and the family (US Small Business Administration, 2017). Unlike the C or LLC corporations that are taxed twice (at the corporate level and individual level when distributions are made), S corporation’s tax is paid once by the shareholders. The profits or losses of the S corporation pass through to the shareholder’s tax return. Second, like other corporations, S has limited liability and independent life of its owners (Wood, 2012). This implies that an exit of any shareholder will not affect the performance of the business. In addition, this status will protect the Richards family and other shareholders of the business activities. Third, there will be business expense tax credits. The US Small Business Administration (2017) noted that there are some expenses incurred by the employees or the shareholders that can be considered business costs and written off. However, there are some cons associated with the S corporation such as stricter operational processes and the shareholders’ compensation requirements, which must be high.

Transfer of Ownership by Richards Family to their Children

The S corporation has several restrictions, especially in relation to who can own shares and their transferability (The Motley Fool, 2017). First the number of shareholders cannot exceed 100, and any attempt to go against this restriction threatens the entity’s tax-favored status. The laws also require that only individual shareholders, deceased shareholder’s estates, and designated charitable and trust organizations can own S corporation’s shares. In the case of the Richards family, they will not have any difficulties transferring their ownership to the descendants. The Motley Fool (2017) noted that the tax legislation allows all family members to be regarded as a single shareholder as it pertains to the 100-shareholder rule. Therefore, the ownership is easily transferable up to the 6th generations.

Hiring Professional Management

Bloom, Sadun and Van Reenen (2011) noted that family businesses were faced with several problems including the reduction in the pool from which a manager can be chosen because the eldest son is automatically taken as the CEO; and it depression of the talented managers. Katz (2013) noted that there reaches a point when the entrepreneur find it necessary to seek the services of professionals to run his firm. The author noted two main instances when the professional management is needed. First, is when the entrepreneur cannot manage to do what he used to execute better. Whereas in the beginning the entrepreneur focused on innovations to keep the firm growing and expanding its market share, one could get trapped in other areas such as managing the workforce. However, with the professional managers, they undertake these duties while the entrepreneur focuses his strength in improving the company. Second, professional managers are required when the firm has outgrown the owner’s ability to handle it on his own. The professional can bring new skills and best practices gained from other engagements. In addition, he can analyze the company’s strengths, other opportunities, weaknesses and threats that the founder could not manage. From these backgrounds, Jake needs the services of professional management. His tree business has continued to expand, which made him give up his other activities. In addition to the tree farming activities, he runs the leasing business, all which have rapidly grown.

Effects of Incorporation on Richards Family’s Ability Protect the Environment

By incorporating the business into an S corporation will not deter the Richards family from giving up a portion of the profit in exchange for environment protection. Instead, the company will engage in the environmental protection activities through the corporate social responsibility practices. The CSR is all about doing that which is good where the business maximizes the shareholders’ wealth while abiding by the basic societal rules among the sustainable development and philanthropy.

Raising Capital Finance by S Corporation

The S corporation’s ability to raise funds, especially the external financing is restricted. The firm has only one class of stock, thereby eliminating other avenues used by other companies desiring to issue cheaply priced shares. The S corporation will only raise funds by issuing the common shares to the investors (Seidenfeld, 2017). Since S corporation and in this case the Richardson’ Tree Farm is a family business will also raise capital from individual shareholders. In addition, it will be able to borrow from outside sources through the stockholders. Therefore, the management should be careful since capitalizing an S corporation is really a difficult task.

References

Bloom, N., Sadun, R., & Van Reenen, J. (2011). Family firms need professional management. Harvard Business Review, https://hbr.org/2011/03/family-firms-need-professional.

Chandra. (2014). Fundamentals of financial management. McGraw Hill Education (India).

Katz, L. N. (2013, October 29). When an entrepreneur needs to hire a professional manager. Retrieved March 30, 2017, from The Turnaround Authority: https://theturnaroundauthority.com/2013/10/29/when-an-entrepreneur-needs-to-hire-a-professional-manager/

Riahi-Belkaoui, A. (2001). Evaluating capital projects. Santa Barbara, California: Greenwood Publishing Group.

Seidenfeld, J. (2017). S corporations: The basics. Retrieved March 30, 2017, from Cooley LLP: https://www.cooleygo.com/s-corporations-basics/

The Motley Fool. (2017). How to transfer ownership of stock in an S corporation. Retrieved March 30, 2017, from The Motley Fool: https://www.fool.com/knowledge-center/how-to-transfer-ownership-of-stock-in-an-s-corpora.aspx

US Small Business Administration. (2017). Starting and managing S corporation. Retrieved March 30, 2017, from the US Small Business Administration: https://www.sba.gov/starting-business/choose-your-business-structure/s-corporation

Wood, R. W. (2012, May 3). C or S corporation choice is critical for small business. Retrieved March 30, 2017, from Forbes: https://www.forbes.com/sites/robertwood/2012/05/03/c-or-s-corporation-choice-is-critical-for-small-business/#1f5bd1721ba3