Complex Legal and FinancialChallenges (and Opportunities)to Business Succession andFamily TransitionsThursday, December 1,...
FOR TODAY8:00 - Continental breakfast8:30 - Welcome and introductions9:00 –• Key Bank - Business succession and exit strat...
Corporate Banking/Private BankingDon Baker            Steve Gurin          Chris BixbySr. Vice President   Sr. Vice Presid...
Business Succession/Exit Strategies • OUTRIGHT SALE TO A 3RD PARTY • SALE TO EMPLOYEES    • Management Buy-out    • Employ...
ISSUES THAT ARE CONSISTENT    REGARDLESS OF STRATEGY• SELLER’S FINANCIAL OBJECTIVES• SELLER’S PERSONAL OBJECTIVES• PRIORIT...
Business Succession/Exit Strategies• OUTRIGHT SALE TO A 3RD PARTY• SALE TO EMPLOYEES   • Management Buy-out   • Employee S...
SALE TO FAMILY/NEXT GENERATION• MAXIMIZE RETURN vs. SET UP FOR SUCCESS• EMOTIONAL CHAINS TO BUSINESS• INTER-GENERATIONAL E...
FINANCING ISSUES• STOCK SALE vs. ASSET SALE• BUSINESS VALUATION vs. BALANCE SHEET VALUE• HISTORICAL/PREDICTABLE CASH FLOW•...
Financial Planning Process                             9
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Complex Legal and Financial Challenges (and Opportunities) to Business Succession

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Complex Legal and Financial Challenges (and Opportunities) to Business Succession

  1. 1. Complex Legal and FinancialChallenges (and Opportunities)to Business Succession andFamily TransitionsThursday, December 1, 2011 1
  2. 2. FOR TODAY8:00 - Continental breakfast8:30 - Welcome and introductions9:00 –• Key Bank - Business succession and exit strategies• Gallagher, Flynn & Co. - Tax planning opportunities & business valuation• Dinse, Knapp & McAndrew - Legally, what you need to know.12:30 – Lunch & the Mount Family Business story1:30 - Adjourn 2
  3. 3. Corporate Banking/Private BankingDon Baker Steve Gurin Chris BixbySr. Vice President Sr. Vice President Vice President 3
  4. 4. Business Succession/Exit Strategies • OUTRIGHT SALE TO A 3RD PARTY • SALE TO EMPLOYEES • Management Buy-out • Employee Stock Ownership Plan • BRING IN A NEW INVESTOR • SALE TO FAMILY/NEXT GENERATION 4
  5. 5. ISSUES THAT ARE CONSISTENT REGARDLESS OF STRATEGY• SELLER’S FINANCIAL OBJECTIVES• SELLER’S PERSONAL OBJECTIVES• PRIORITIES• WHO IS THE RIGHT BUYER?• BUYER’S ABILITY TO OBTAIN FINANCING/CLOSE THE DEAL 5
  6. 6. Business Succession/Exit Strategies• OUTRIGHT SALE TO A 3RD PARTY• SALE TO EMPLOYEES • Management Buy-out • Employee Stock Ownership Plan• BRING IN A NEW INVESTOR• SALE TO FAMILY/NEXT GENERATION 6
  7. 7. SALE TO FAMILY/NEXT GENERATION• MAXIMIZE RETURN vs. SET UP FOR SUCCESS• EMOTIONAL CHAINS TO BUSINESS• INTER-GENERATIONAL EMOTIONAL BAGGAGE• FINANCING ASSISTANCE 7
  8. 8. FINANCING ISSUES• STOCK SALE vs. ASSET SALE• BUSINESS VALUATION vs. BALANCE SHEET VALUE• HISTORICAL/PREDICTABLE CASH FLOW• BUYER EQUITY CONTRIBUTION• BUYER MANAGEMENT EXPERIENCE• OTHER CREDIT ENHANCEMENTS AVAILABLE 8
  9. 9. Financial Planning Process 9
  10. 10. Financial Planning Process• Cash Flow Management • Risk Mitigation – Budgeting – Insurance – Debt Strategy – Emergency Savings – Retirement Withdrawal – Estate Planning Plan • Psychological Overlay• Resource Allocation – Goals and Assumptions – Investments – Risk Profile – Real Estate – Business Assets 10
  11. 11. Tax Planning Opportunities and the IRS Voluntary WorkerReclassification Settlement Program Rick Wolfish, CPA Gallagher, Flynn & Company, LLP 11
  12. 12. RICHARD G. WOLFISH,CPATax Partner 12
  13. 13. New Voluntary WorkerClassification Settlement ProgramOptionalAllows employees to reclassify workers asemployees for future tax periodsLimited federal employment tax liability forpast nonemployee treatmentFile form 8952 13
  14. 14. New Voluntary WorkerClassification Settlement ProgramPayment equal to little over 1% of wages paidto reclassified employee for past yearsAudit insuranceOn Nov. 17th, 2011, Vermont announced itwill not piggyback this program. They maychange their mind in the future. 14
  15. 15. Tax Planning OpportunitiesAccrual basis business can take 2011deduction for some bonuses not paid until2012.Maximize domestic production deduction –2011 deduction 9% of qualified productionactivates income. Depreciation opportunities  2011 $5000,000 expensing  2012 $125,000 expensing  100% bonus first year depreciation expense 12/31/11 15
  16. 16. Tax Planning OpportunitiesResearch and development credit expires 12/31/11.If you are an S-Corporation, make sure you have basisfor losses. Consider lending the company money ormaking a capital contribution.File Quick Carrybook refunds for corporations (Form1139) and Individuals (Form 1045).Claim deductions for disaster loss in 2010 or 2011.Make year-end gifts to family members. 16
  17. 17. Importance of Business Valuations Mark Beliveau, CPA CVA CFE Gallagher, Flynn & Company, LLP 17
  18. 18. Mark Beliveau, CPACVA CFEPartner 18
  19. 19. Why a Valuation?• Succession Planning/Buy Sell Agreements Insurance or other funding needs• For estate planning, gifting and estate filing• To evaluate potential sale/purchase of a business (or joint venture)• Shareholder Disputes & Oppression (minority shareholder suit) 19
  20. 20. Why a Valuation?• Determine economic damages (before/after event)• Marital dissolution – value of interest to be included in the marital estate• Management – assessment of enterprise value and indicators that impact value of company• ESOP – employee stock ownership 20
  21. 21. Basic Valuation Questions to be asked• Who is the client? Stockholder or Company• What is the specific interest being appraised?• What is the valuation date? Maybe dictated by factors causing need for valuation.• What is the purpose of the appraisal? See Why(s) above• What is the standard of value? Fair Market Value, Fair Value• What type of report is needed? See next slide. 21
  22. 22. Value DefinedFair Market Value– ―…the price at which property would change hands between a willing buyerand a willing seller when the former is not under any compulsion to buy and thelatter is not under any compulsion to sell, both parties having reasonableknowledge of the relevant facts.(Article 20.2031-1(b) of the Estate Tax Regulations and Revenue Ruling 59-60,1959-1 C.B. 237)Fair Value— The price that fairly compensates an owner who was involuntarilydeprived of the benefit of his ownership interest where there is neither a willingbuyer nor a willing seller. 22
  23. 23. Types of ValuationsFull Appraisal  Takes in to account the 3 major methods (to be discussed a bit later) to determine value  Used primarily for: Litigation Filings with governmental agencies Contentious situationCalculation Report  Utilizes single agreed-upon method to determine value  Not as comprehensive as full appraisal  Used primarily in non-contentious/friendly situationsBack of the Envelope/Rules of Thumb 23
  24. 24. Professionals Involved in Process• Attorney – usually. If litigation-based may want to have Valuator engaged by Attorney• Valuation Professional  Appraiser Skills, Knowledge, Certification, Objectivity & Bias• May need to involve real estate or machinery and equipment appraiser 24
  25. 25. Business Valuation Professional OrganizationsNACVA – CVA or AVAAICPA - ABVASA - ASAIBA – CBAEach organization has their own professional businessvaluation standards 25
  26. 26. ESTIMATING THE VALUE Valuation Approaches • Asset Approaches • Market Approaches • Income Approaches 26
  27. 27. ASSET APPROACH – WHEN TO USEAppropriate when valuing: • Marginally profitable companies (better dead than alive?) • Asset-heavy companies • Holding companies and non-profits • Controlling interestsGenerally not useful: • When significant intangible value exists • For valuing service companies • For valuing professional practices • When considering minority interests 27
  28. 28. ASSET APPROACHLiquidating or Distressed ValueLiquidating – restate value of assets and liabilities at date of valuation to fair market value, less costs to disposeDistressed Value – fair market value does not apply here 28
  29. 29. MARKET APPROACHES:Guideline Publicly Traded Company MethodUsing information from publicly traded, similar companies,determine “multiples” to apply to the subject company’soperating results to obtain a valueCompleted Transactions MethodSimilar to GPTCM – based on sales of business interests inthe market (M&A)Data Sources Institute of Business Appraisers Bizcomps© Pratt’s Stats© Mergerstat© 29
  30. 30. Market (continued)Guideline public companies• Search databases for ―comparable‖ publicly traded companies• Multiple (price to earnings, price to sales, etc.) applied to same measures of subject company 30
  31. 31. Guideline Public CompaniesStrength:• Value is based on current market activityWeakness:• Often difficult to find true guideline companies• Extensive analysis needed 31
  32. 32. The Income ApproachMost commonly used methodologyStrengthsGrounded in finance theoryThe most widely recognized approachWeaknessesPast isn’t indicative of future – relianceon historical data 32
  33. 33. The Income Approach…• Value today is the Present Value of future benefits• Considers time value of money and risk• Use history to project future cash flows• Cash flows are converted to PV using capitalization rate or discount rate 33
  34. 34. Present ValueWould you ratherhave $10,000 now,or $14,025 five yearsfrom now? $14,0 Future 25 Value 2016 $10,0 00 Investment 2011 Yield 5% Present 7% Value 10% ? 34
  35. 35. Time for Some Valuation Buzz WordsEquity - Also called ―net book value,‖ ―net asset value,‖ or―shareholder’s/owner’s equity.‖ Assets less Liabilities = EquityCash flows to equity – those cash flows available to pay out toequity holders (in the form of dividends) after funding operations ofthe business enterprise and making necessary capital investmentsDiscount rate - Rate of return that converts a series of expectedfuture returns on an investment to a present value 35
  36. 36. Time for Some Valuation Buzz WordsCapitalization rate - Rate of return thatconverts a single period of earnings or investmentamount to a present valueCost of capital - The expected rate of returnthat the market requires in order to attract fundsto a particular investment 36
  37. 37. ANALYZING THE INFORMATIONFinancial Analysis: • Common-size analysis • Comparative analysis • TrendsNon-financial analysis • Management • Competition • Products & Quality • Customer/supplier concentration 37
  38. 38. The Income ApproachCapitalization of EarningsPV of anticipated benefits = Economic benefits (cash flow) Capitalization rate 38
  39. 39. The Income ApproachDeveloping the NUMERATOR…The approach is forward looking but.. past performance is often foundation forprojecting future economic benefits. 39
  40. 40. The Income ApproachMost common methodologies for estimatingfuture economic benefits from historical data  Current earnings method – used in example  Simple average method – averaging the benefits provided during the study period  Weighted average method – applying a weighting to benefits provided during the study period 40
  41. 41. The Income ApproachOur example will use a single amount of tax-affected cash flow….Because cash flow and reported earnings ornet income are not the same AND…Investors purchase the opportunity toreceive cash flow. 41
  42. 42. The Income ApproachA proxy for cash flow: Pre-tax ―normalized‖ earnings+ Depreciation and amortization expense Normalized cash flow 42
  43. 43. Normalizing AdjustmentsNormalization Process– Adjust financialstatements for nonrecurring, non-operating,or unusual items to eliminate anomalies andarrive at an indication of the ―economicreality‖ of the business. 43
  44. 44. Normalizing Adjustments Failure to develop the appropriatenormalizing adjustments may result in asignificant overstatement or understatementof value 44
  45. 45. Normalizing AdjustmentsCommon income statement adjustments:Excess compensation or fringe benefits relative to individual’sroleAbove or below market rental payments to related partiesNonbusiness expensesDepartures from GAAPCommon balance sheet adjustments:Excess and/or non-operating assetsRelated party loansEconomic value of property & equipment 45
  46. 46. Relationship Between Discount Rate and Capitalization Rate Discount RateLess: Long-term sustainable growthEquals: Capitalization Rate 46
  47. 47. Quantitative “build-up” method Risk-free long-term U.S. government bond rate 4.6% Add: Equity risk premium 6.3% Size risk premium 9.8% Equals: Expected total return-small publicly traded stocks 20.7% Add: Company specific risk premium 3.0% Equals: After-tax discount rate 23.7% Less: Long-term sustainable growth rate 4.0% Equals: After-tax capitalization rate for next year 19.7% Divide by: 1 + growth rate 104% Equals: After tax capitalization rate for current year 18.9% Capitalization factor (1/.189) 5.3 47
  48. 48. Capitalization of Earnings v. Discounted Cash FlowCapitalization of earnings method can be usedwhere economic benefit (cash flow, earningsetc.) to owner is steady and increases annuallyat the same growth rate.Discounted Cash Flow method is used whereamount of economic benefit is expected to varyfrom year to year and/or growth rate is expectedto change significantly over time. 48
  49. 49. The Income ApproachAbout the DENOMINATOR…Discount or capitalization rate is function ofrisk-free rate of return and real/ perceivedrisk premium required to induce buyer(investor)In a purchase transaction, discount rate isthe BUYER’S cost of capital 49
  50. 50. Example of Income ApproachCapitalization of Earnings method –information used:Company’s pretax accounting income = $195,000Depreciation = $10,000Grandma on payroll = $20,000Below market rent paid = $15,000 under marketTax rate = 40% 50
  51. 51. Income Statement BasicsRevenue: $6,000,000 Less Cost of Goods Sold $4,500,000Equals: Gross Margin $1,500,000 Less Operating Expenses Selling Expenses $435,000 General Expenses $435,000 Administrative Expenses $435,000Equals: Operating Profit $195,000Plus/minus Other Income/Expenses $0Pre tax income $195,000 51
  52. 52. Example of Income Approach Pretax income $195,000 Normalizing Adjustments: Remove Grandma 20,000 Rent to market (15,000) Normalized pre-tax net inc $200,000 Add: Depreciation 10,000 Pre-tax cash flow to equity $210,000 Keep going….there’s more……… 52
  53. 53. Example of Income ApproachPre-tax cash flow to equity 210,000Income tax (on $200K @40%) (80,000)After-tax gross cash flow base 130,000Less: Additional WC requirements -Less: Net capital expend required (20,000)Ongoing after-tax cash flow to equity $110,000 53
  54. 54. Example of Income ApproachUsing cap rate computed earlier:After-tax cash flow to equity $110,000 /.189 = $582,000 -or-Using capitalization factor: $110,000 x 5.3 = $583,000(Difference is due to rounding)This is the value of a 100% interest in theCompany without discounts 54
  55. 55. DiscountsTwo biggest issues:Minority/Lack of Control - reflects thedecreased value of shares that do not conveycontrol of a closely held business.Lack of Marketability - reflects no readymarket for shares in a closely held business andtime to turn share into cash 55
  56. 56. CONTROL AND MARKETABILITY Controlling Interest ValueControl Premium Minority Interest Discount Marketable Minority Interest Value (“WSJ Listed Price”) Discount for Lack of Marketability Nonmarketable Minority Interest Value 56
  57. 57. Discount for Lack of Marketability Factors Affecting Marketability A B C DLead to Publicly No Registered Activesmaller traded restrictions securities marketDLOM on saleLead to Closely Restrictions Unregistered Thinlarger held on sale securities marketDLOM 57
  58. 58. Application of Discounts and PremiumsValue on a control, marketable basis $583,000Less discount for lack of control @ 25% 146,000Value on a minority, marketable basis 437,000(rounded)Less marketability discount @ 30% 131,000Value of minority, non-marketable interest(rounded) (47.5% overall discount) $306,000 58
  59. 59. QUESTIONS……. 59
  60. 60. Mark Langan Tax AttorneyDinse, Knapp & McAndrew 60

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