Exit Planning - Maximizing Value Through Pre-Transaction Readiness


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According to numerous surveys, more than half of business owners intend to transition ownership of their business during the next 10 years. Yet most business owners do not have a formal strategic or financial plan, and many are unaware of the possible tax and estate implications. As a result, there is a real need for business exit planning. A robust exit plan will help chart a course toward extracting maximum value from the company to reach the seller’s goals.

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Exit Planning - Maximizing Value Through Pre-Transaction Readiness

  1. 1.  Understand the drivers and need for business exit planning  Understand the components of a robust exit plan  Understand the roles that professional service firms can play in business exit planning Capitalize on the Succession Bubble! 2
  2. 2. There are over 6 million small and medium sized businesses (SMBs) in the U.S.1, 90% of which are family owned. Many of these SMBs are owned by Baby Boomers. A significant number of SMB owners will look to exit their business during the next decade in preparation for retirement. 1. U.S. Census Bureau 2. AARP Demographic Bubble There are over 80 million baby boomers and 8,000 will be turning 65 every day for the next two decades.2 Census Bureau projects that Americans 65 and older will make up 19% of the population by 2030. 1 3
  3. 3.  How many are going to sell? • 75% of business owners ultimately plan to sell or pass along their business.1 • One out of every two company owners plan to sell their business within the next 10 years.2 • Demand may outstrip supply  potentially lower sale prices.  How many are ready to sell? • Some have delayed a sale due to the ‘08-’09 recession, while others have re-evaluated their lifestyles and may be more likely to sell earlier than was the case 10+ years ago. • Most (many estimate 70%+) do not have any plan for what will be the most significant event of their lives. 1 1. Northwestern Mutual 2. PricewaterhouseCoopers 4
  4. 4. Other Facts  Of the family owned businesses, only 30% of such companies succeed in the second generation and just 15% make it to the third generation = Sale > Transfer  Most will seek advice on the sale of their business = Opportunity  According to SunTrust Bank, 42% indicated that maximizing their business’s value is the most important part of an exit1 = ironic since most do not have a plan to chart a course toward increasing value  To maintain a sustainable business, scale is becoming increasingly important. Technology is allowing larger businesses to drive down into smaller segments, thereby increasing competition = Growth through acquisitions 1. SunTrust Bank 5
  5. 5. Opportunity Estimate Number of SMBs 6,000,000 % Family Owned 90% # Family Owned SMBs 5,400,000 % That Will Sell 50% # That Will Sell 2,700,000 Average Revenue $5,000,000 Total Average Revenue Sold $13.5 Trillion Estimated Sales Multiple 0.5x Business Value Transferred $6.75T Annual Opportunity (Est. 10 Yrs.) $675 Billion Assuming a 2% variable fee, a $13.5 billion annual revenue opportunity exists for service providers in this space!! 6
  6. 6.  For many business owners, the business is a significant contributor toward retirement capital. For those with limited retirement savings they may have to stay in the business longer than planned or accept a significant reduction in their standard of living. A robust exit plan can help chart a course towards extracting maximum value. An Exit Plan Can Help Bridge the Gap “How much does my business produce (income)?” “How much is my business worth (value)?” Potential Disconnect 7 $350k Annually $5M revenue @ 0.5x sales = $2.5M Reinvest $2.5M @ 10% (aggressive) = $250k < $350k
  7. 7.  Succession planning is important for owners transferring leadership from one generation to the next and/or to management • Focuses on business continuity, skills of next generation/management, relational issues, family dynamics, etc.  Exit planning focuses on transferring ownership • Succession planning can be a part of exit planning, since a “self sustaining” business (i.e., doesn’t require the owner to assure it generates the level of profit desired) is worth more than one with key man risks (owner wears a lot of “hats”). • A plan should be initiated at least a year or more in advance of a potential sale process. 8
  8. 8.  Understand The Owner’s Objectives  Assemble a Team  Understand Your Business’ Worth 9  Make the Business Look Desirable to Buyers  Improve Business Operations and Profitability
  9. 9.  Understand the owner’s personal and financial goals • How much money is needed to sustain retirement? • Is that feasible? If an owner wants $10 million on an exit but the business is likely worth $7 million, significant business and market improvements may be needed in order to increase profits and the exit multiple; or the owner’s expectations will need to change. • When does the owner want to retire? • Certain buyers may require the owner to transition the business over a period of time (18 months +/-). In addition, the sale process can take up to 12 months. As such, planning should begin at least 3 years before the owner wants to retire. • Who does the owner want to sell to? • Strategic buyers can pay premiums due to synergies. However, some sellers prefer to take a lower price in order to ensure status quo – same culture, name, people, etc. 10
  10. 10.  Before initiating a sale process, a team of experts with diverse skill sets should be assembled to help steer a sale to a positive end. • A deal team should include attorneys, accountants and an investment banker or business broker, all of whom can help navigate the tax and deal landscape. No one professional has all the answers. 11 • Post-transaction estate and retirement needs should also be addressed (such as an estate attorney, insurance planner and/or wealth manager). A good team allows the owner to continue to focus on growing the business throughout the sale process, thereby maximizing the sale price and minimizing business disruption.
  11. 11.  Establishing parameters on business value is an important step in the process.  A formal valuation gives a realistic idea of what a business is worth and help assess financial and non-financial status, including current industry dynamics and market position. 12
  12. 12. Traditional Valuation Methodologies Income Method Discounted Cash Flow Approach Capitalization of Cash Flow Approach Market Method Comparable Public Company Approach Precedent Transaction Approach Asset Method Net Asset Value Approach Leveraged Buyout Approach
  13. 13.  Working capital considerations - examine efficiency  Tangible assets – quality of assets or deferred capex  Contract backlog – confidence to near-term projections  Customer relationships – repeat customers with low concentration  Proprietary, patented technology/formulations/process  Brand name  Proven management team and skilled assembled workforce – employee retention  Supplier relationships  Growth strategy – scalable growth at sustainable margins  Tax attributes 14
  14. 14. Strategic Control Premium Financial Control Premium Lack of Control Discount Lack of Marketability Discount Strategic Control Value Financial Control Value Marketable Minority Nonmarketable Minority Strategic value is the highest level of value related to potential synergies. The next level, financial control, is value expected from a financial buyer. Oftentimes, financial control and marketable minority levels of value converge in efficiently run businesses.
  15. 15. Strategic Control Benefits Reduction in competition Revenue or profit enhancement through synergies Cost savings or economies of scale Financial Control Benefits Ability to change management or compensation Ability to sell or acquire assets Ability to change capital structure Ability to make distributions Ability to control capex decisions
  16. 16.  Goal is to “measure up” and realize a higher “price per square foot” for the business • Physical assets should be clean and attractive • Companies sell for more that also present an attractive story with supporting documentation • Is there remaining upside runway? • Are the financial records well maintained? • Is there a history of financial forecasting/budgeting? • Do the reported financials provide an incomplete picture of how profitable the Company really is or have you prepared and justified appropriate earnings adjustments? • How strong are the external and internal agreements? • Do you have well documented policies and processes? • Have you mitigated litigation or environmental issues? • Are you complying with all necessary regulations? 17
  17. 17.  It is key to focus on the business’ core operations and underlying profitability  There are many things an owner can do to legitimately make his/her business more profitable/valuable/less risky to a new owner including: • Diversifying the customer base • Filling management holes • Upgrading systems/processes • Closing down less profitable business lines • Culling unprofitable customers • Keeping the work force lean 18
  18. 18.  Sale to a strategic buyer (typically highest valuation due to synergies)  Sale to a financial buyer  Sale to management (buy/sell agreements)  Transfer/sale to family members/trust (potential discounts for lack of control and marketability)  Sale to employees (ESOP – Fair Market Value)  IPO (at least > $100 million revenue)  Shut down 19 Exit alternative will impact taxes, timing, and cash considerations
  19. 19. Financing Expansion / Recap 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Jul-12 Jul-13 # of Transactions – Middle-Market 3,692 3,956 3,848 3,867 3,640 3,604 3,322 5,401 4,561 4,427 2,618 1,728 # of Transactions – $500M - $1B 106 134 143 178 227 120 78 173 152 169 91 80 # of Transactions – $100M – $499M 620 781 796 864 853 600 432 691 760 719 413 357 # of Transactions – <$100M 2,966 3,041 2,909 2,825 2,560 2,884 2,812 4,537 3,649 3,539 2,114 1,291 Deal Value (In Billions) 270$ 338$ 350$ 401$ 423$ 278$ 196$ 342$ 346$ 346$ 195$ 162$ U.S. Middle Market M&A Activity $- $50 $100 $150 $200 $250 $300 $350 $400 $450 - 1,000 2,000 3,000 4,000 5,000 6,000 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Jul-12 Jul-13 # of Transactions – <$100M # of Transactions – $100M – $499M # of Transactions – $500M - $1B Deal Value (In Billions)  2011: Fewer deals versus 2010, but the value of these transactions trended higher  2012: Essentially flat with 2011 related to political uncertainty (fiscal cliff) and a U.S. economy entrenched in low growth mode  2013: Meager M&A volume despite easy debt and giant corporate balance sheets due in part to risk adverse CEOs & boards  Going forward M&A drivers: cash on corporate balance sheets, ongoing recovery, pent-up demand, robust credit markets • Cash levels of S&P 500 >$1 trillion • Private equity buyout funds are sitting on nearly $400 billion of cash 20
  20. 20. Financing Expansion / Recap  Valuation multiples hovering in the range of 5-8x EBITDA for most mid- sized companies, with higher outliers seen in unique, niche markets  Positive trend: strategics and financial sponsors are willing to pay significant values for firms that show scale, growth and a prominent position in the marketplace; S&P 500 up 18% since the beginning of the year LTM Transaction Size 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 <$100M 6.8x 7.6x 9.2x 8.1x 8.5x 7.8x 7.0x 7.0x 8.3x 7.1x 7.4x $100M-$499M 8.2x 9.0x 9.9x 9.2x 11.2x 11.1x 8.1x 10.1x 9.3x 9.1x 9.1x $500M-$1B 9.6x 10.3x 10.1x 12.0x 10.8x 10.6x 7.8x 9.0x 9.9x 8.7x 8.6x Middle-Market 7.5x 8.6x 9.7x 9.2x 9.9x 9.5x 7.6x 8.6x 9.2x 8.1x 8.5x Middle Market EV / EBITDA Multiples 21
  21. 21. Financing Expansion / Recap Low interest rate environment • Lower cost of capital (e.g., “cheap debt”) that may lend itself to higher prices • Reinvestment risk More predictable estate planning environment (e.g., continuation of the $5.25 million lifetime gift tax exemption) • Presents more opportunities to make informed decisions 22
  22. 22. 23 Company A Company B • Light Manufacturing • Light Manufacturing • Revenue at $20M, growing 3%/yr. • Revenue at $18M, growing 8.5%/yr. • $2M EBITDA • $2.5M EBITDA • Older equipment needing frequent maintenance • Equipment in good condition • $1M inventory • (poor controls) • $500K inventory • Good controls • Loyal employees • Loyal employees • Limited management team • Good management team Valued at 5.0x EBITDA, or $10M Valued at 6x EBITDA, or $15M Two businesses, similar size, similar industry. However Company B performed exit planning and executed on areas of improvement including culling unprofitable customers, improving working capital efficiency and filling management holes. Company B also presented an exciting growth story to potential buyers (i.e., better packaging). As such, Company B realized a higher multiple on higher earnings at exit, resulting in a 50% higher sale price.
  23. 23.  Carleton McKenna advised a company in a sale process that did not perform exit planning  Discovered capital structure issues as company had an “underwater” class of common shareholders • Certain shareholders would receive nothing in the sale due to a heavy liquidation preference from preferred shareholders • Added time and uncertainty to the deal as the buyer was hesitant to structure the transaction as a merger and common shareholders could dissent and elect appraisal rights • Added cost as a fairness opinion was needed • Issue could have been resolved via exit planning as the shares could have been redeemed for some nominal amount 24
  24. 24.  Carleton McKenna advised a company in a sale process that did not perform exit planning  Discovered issue with contracts of a large customer • Company had a customer with multiple contracts that represented over 20% of profits (customer concentration) • Only one contract was structured appropriately regarding economic terms • Buyer wanted the contracts restructured to reflect economic reality • Customer had leverage and was able to negotiate better terms in exchange for shifting contract compensation • Issue could have been resolved via exit planning as the contracts could have been modified in the normal course of operations 25
  25. 25.  Carleton McKenna advised a company in a sale process that did not perform exit planning  Key employees did not have non-competes in place • Company had several key regional managers that maintained customer relationships but did not have non-compete agreements • Buyer wanted non-competes • Key managers held significant bargaining power since they knew they could hold the deal hostage; owner agreed to pay the managers a significant sum to sign the non-competes • Issue could have been resolved via exit planning as the non-competes could have been obtained in prior years and tied to bonuses 26
  26. 26. Paul H. Carleton MANAGING PARTNER phc@carletonmckenna.com Christopher J. McKenna MANAGING DIRECTOR cjm@carletonmckenna.com Dominic M. Brault MANAGING DIRECTOR dmb@carletonmckenna.com For more information please contact: 1801 East Ninth Street, Suite 1425 Cleveland, OH 44114 Phone: 216.523.1962 Fax:216.523.1322 www.carletonmckenna.com 27