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Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
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Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning

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This fall 2009 presentation discussed valuation issues in buy-sell agreements as well as how the economic downturn impacted business value.

This fall 2009 presentation discussed valuation issues in buy-sell agreements as well as how the economic downturn impacted business value.

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  • 1. Timothy R. Lee, ASA Birmingham Estate Planning Council » September 3, 2009 Buy-Sell Agreements Convergence of Business Succession & Shareholder Planning
  • 2. Who We Are MERCER CAPITAL Among the largest business valuation offices in the nation and the largest in the Southeast serving a national and international clientele MERCER CAPITAL INVESTMENT BANKING M&A and transaction advisory services for buyers and sellers, focusing on mid-market corporate development and divesture activities, reorganizations, fairness opinions, and strategic alternatives assessment
  • 3. Overview of Services <ul><li>Valuation </li></ul><ul><ul><li>Tax compliance </li></ul></ul><ul><ul><li>Employee Stock Ownership Plan valuation </li></ul></ul><ul><ul><li>Corporate valuation services </li></ul></ul><ul><li>Transaction advisory services </li></ul><ul><ul><li>Fairness and solvency opinions </li></ul></ul><ul><ul><li>Buy-sell agreements and private company transactions </li></ul></ul><ul><li>Litigation support and expert testimony </li></ul><ul><ul><li>Business Damages </li></ul></ul><ul><ul><li>Shareholder Disputes </li></ul></ul><ul><ul><li>Divorce </li></ul></ul><ul><li>Public and private company financial reporting </li></ul><ul><ul><li>Purchase Price Allocation </li></ul></ul><ul><ul><li>Impairment Testing Services </li></ul></ul><ul><ul><li>Alternative Investment Portfolio Valuation Services </li></ul></ul><ul><li>M&A and investment banking </li></ul>
  • 4. Economic Review – History
  • 5. Economic Review – Where Are We?
  • 6. Economic Review – Where Are We?
  • 7. Economic Review – Where Are We?
  • 8. Economic Review – Where Are We?
  • 9. Economic Review – EESA, Now ARRA Graphics courtesy of Wikipedia.com
  • 10. Economic Review – What’s Next? <ul><li>High unemployment recovery </li></ul><ul><li>High inventories and weak income suggest slow recovery with limited push from consumers </li></ul><ul><li>Low capacity utilization suggests significant capacity to increase output without new capital spend and hiring </li></ul><ul><li>High deficits foreshadow increasing inflation in the long-run </li></ul><ul><li>Energy and commodity issues still loom from emerging world demand and geopolitical instability </li></ul><ul><li>Taxation issues still murky </li></ul><ul><li>Consensus WSJ economist poll suggests +/- 1% growth in real GDP for 2009-Q3 (deceleration of bad trends, trend inversion) </li></ul>
  • 11. Valuation Issues Abound <ul><li>Valuations at the peak or trough of the business cycle are difficult </li></ul><ul><li>Valuations in an environment of financial distress and unknown paradigms are even more difficult </li></ul><ul><li>Some practitioners struggling with the most basic element of present value mechanics – the discount rate </li></ul><ul><ul><li>Equity market returns distorting historical data </li></ul></ul><ul><ul><li>Treasury yields extraordinarily low </li></ul></ul><ul><ul><li>Increasingly difficult to support equity premiums </li></ul></ul><ul><li>Growth assessments require more scrutiny </li></ul><ul><li>Financing constraints and loan-to-value ratios suggest compromised valuations for many assets and businesses </li></ul>
  • 12. The Segue » New Realties = Revised BSAs <ul><li>Old formulas are likely meaningless </li></ul><ul><li>Old fixed price agreements are likely stale </li></ul><ul><li>Multi-appraiser processes are more costly than ever and likely to lead to greater conflicts on value </li></ul><ul><li>Legal and valuation professionals have more obligation than ever to bring these matters to our clients’ attention </li></ul><ul><li>Client resistance to fees and challenging discussions reflect tendencies of fear and procrastination – “things will eventually get better and then we’ll fix it” </li></ul><ul><li>Nobody getting younger – likelihood of trigger events rising </li></ul>
  • 13. Buy-Sell Agreements - Trigger Events <ul><li>Q Quits </li></ul><ul><li>F Fired </li></ul><ul><li>R Retires </li></ul><ul><li>D Disabled </li></ul><ul><li>D Dies </li></ul><ul><li>D Divorced (?) </li></ul><ul><li>O Others </li></ul>
  • 14. Categories of Buy-Sell Agreements <ul><li>Cross-Purchase Agreements </li></ul><ul><ul><li>Between shareholders </li></ul></ul><ul><li>Entity-Purchase Agreements </li></ul><ul><ul><li>Where the entity does the purchasing </li></ul></ul><ul><li>Hybrid Agreements </li></ul><ul><ul><li>Where there may be interplay between the rights of the shareholders to purchase and those of the company </li></ul></ul>
  • 15. Types of Buy-Sell Agreements Fixed Price Agreements Formula Agreements Process Agreements
  • 16. Fixed Price Agreements <ul><li>Have fixed prices </li></ul><ul><ul><li>Shareholders agree on a price </li></ul></ul><ul><ul><li>Price is written into the agreement </li></ul></ul><ul><ul><li>Usually, parties to agreement state in the agreement that they will update the price each year </li></ul></ul>
  • 17. Fixed Price Agreements - Disadvantages <ul><li>Parties seldom update the fixed prices, even over periods of many years </li></ul><ul><ul><li>Real life examples abound </li></ul></ul><ul><li>Inequities are almost certainly a result of out-of-date fixed price agreements </li></ul><ul><ul><li>Real life examples abound </li></ul></ul>
  • 18. Formula Agreements <ul><li>State a single formula to be applied to balance sheet and/or income statement metrics </li></ul><ul><li>Examples </li></ul><ul><ul><li>Multiple of EBITDA </li></ul></ul><ul><ul><li>Multiple of Pre-tax Income </li></ul></ul><ul><ul><li>Book Value </li></ul></ul><ul><ul><li>Multiple of Book Value </li></ul></ul><ul><li>No formula can withstand changes in circumstances </li></ul><ul><ul><li>Valuation metrics can change with time </li></ul></ul><ul><ul><li>Non-recurring items </li></ul></ul><ul><ul><li>Often too backward-looking </li></ul></ul>
  • 19. Types of Process Agreements Multiple Appraiser Agreements Single Appraiser Agreements
  • 20. Multiple Appraiser Agreements <ul><li>Advantages </li></ul><ul><li>Provide a defined structure </li></ul><ul><li>All parties know, at least generally, what the process will be in advance </li></ul><ul><li>Fairly commonly known and generally understood by attorneys (who know the problems with fixed price and formula agreements) </li></ul><ul><li>Illusory Benefit – False sense that “my appraiser” will protect “my interests” </li></ul><ul><li>Disadvantages </li></ul><ul><li>Price not determined now </li></ul><ul><li>Potential for dissatisfaction with the process for all parties </li></ul><ul><li>Danger of advocacy </li></ul><ul><li>Uncertainty over what happens at trigger event </li></ul><ul><li>Uncertainty over final price if the process is invoked </li></ul><ul><li>Problems with any other aspect of the operation of the agreements are deferred until a trigger event </li></ul><ul><li>Expensive </li></ul><ul><li>Time-consuming </li></ul><ul><li>Distracting for management </li></ul><ul><li>Potentially devastating for affected shareholders and their families </li></ul>
  • 21. <ul><li>Advantages </li></ul><ul><li>Selected appraiser viewed as independent </li></ul><ul><li>Appraiser’s valuation process is seen by all parties at the outset </li></ul><ul><li>Appraiser’s conclusion is known at outset and has established a baseline price for the agreement </li></ul><ul><li>Because process is observed at the outset, all parties know what will happen when trigger event occurs </li></ul><ul><li>Because the appraiser must interpret the “words on the pages” in conducting the initial appraisal, any issues regarding lack of clarity of valuation-defining terms will be resolved </li></ul><ul><li>Selected appraiser must maintain independence with respect to process and render future valuations consistent with terms of agreement and with prior reports </li></ul>Single Appraiser Agreements Select Now & Value Now
  • 22. <ul><li>Advantages (continued) </li></ul><ul><li>Subsequent appraisals, either annually or at trigger events, should be less time-consuming and expensive than other alternatives </li></ul><ul><li>Parties should gain confidence in the process </li></ul><ul><li>Parties will always know the current value for the buy-sell agreement (helpful for planning all-around) </li></ul><ul><li>Appraisers’ knowledge of the company and its industry will grow over time, enhancing confidence for all parties with the process </li></ul><ul><li>Creates a means of maintaining pricing for other transactions, thereby enhancing “the market” for a company’s shares </li></ul>Single Appraiser Agreements Select Now & Value Now
  • 23. Single Appraiser Agreements Disadvantages
  • 24. Six Defining Elements of a Process Agreement Standard of Value Level of Value “ As of” Date Appraiser Qualifications Appraisal Standards Funding Mechanism
  • 25. <ul><li>Standard of Value </li></ul><ul><ul><li>Normally fair market value </li></ul></ul><ul><ul><li>“ The value” is not operative </li></ul></ul>Six Defining Elements of a Process Agreement
  • 26. <ul><li>Level of Value </li></ul><ul><ul><li>Which level, specifically? </li></ul></ul><ul><ul><li>Second source of confusion </li></ul></ul><ul><ul><li>The value of my business is often control </li></ul></ul>Six Defining Elements of a Process Agreement
  • 27. Six Defining Elements of a Process Agreement
  • 28. Six Defining Elements of a Process Agreement Price we hope to get if we sell the company together Price the rest of us can reasonably pay if we have to buy out someone else “ Fair market value of the (minority) interest”
  • 29. Six Defining Elements of a Process Agreement $100 Per Share $100 Per Share $60 Per Share $140 Per Share
  • 30. <ul><li>The “as of” Date of the Appraisal </li></ul><ul><ul><li>Defines the situation at the Company, within the Industry and National Economy, and the pricing from guideline companies and comparable transactions </li></ul></ul><ul><li>Appraiser Qualifications </li></ul><ul><ul><li>■ Credentials ■ Industry experience </li></ul></ul><ul><ul><li>■ Experience in appraisal ■ Reputation </li></ul></ul><ul><li>Appraisal standards to be followed </li></ul><ul><ul><li>■ ASA Business Valuation Standards </li></ul></ul><ul><ul><li>■ Principals of Appraisal Practice and Code of Ethics of the ASA </li></ul></ul><ul><ul><li>■ Uniform Standards of Professional Appraisal Practice </li></ul></ul>Six Defining Elements of a Process Agreement
  • 31. <ul><li>Who buys? </li></ul><ul><ul><li>Other shareholders </li></ul></ul><ul><ul><li>Company </li></ul></ul><ul><ul><li>Other shareholders and/or company </li></ul></ul><ul><li>Life insurance </li></ul><ul><li>Adequacy of funding </li></ul><ul><li>Nature of mechanism </li></ul><ul><ul><li>Cash (is there a sinking fund?) </li></ul></ul><ul><ul><li>Notes </li></ul></ul><ul><ul><ul><li>Down payment </li></ul></ul></ul><ul><ul><ul><li>Terms </li></ul></ul></ul><ul><ul><ul><li>Interest rate </li></ul></ul></ul><ul><ul><ul><li>Security </li></ul></ul></ul>Six Defining Elements of a Process Agreement What does your client’s buy-sell agreement say about the treatment of life insurance proceeds in the event of the death of a shareholder subject to it?
  • 32. Six Defining Elements of a Process Agreement Proceeds are a Funding Vehicle Proceeds are a Corporate Asset
  • 33. Buy-Sell Agreement Legal & Valuation Audit TM <ul><li>Review the buy-sell agreement from a legal and business perspective (attorneys and owners) </li></ul><ul><ul><li>Based on the business today, does the buy-sell agreement say what it should say (clients may resist talking about the issues, but it is critical that they do so before interests are adverse? </li></ul></ul><ul><ul><li>Do the trigger events reflect the business reality of today? </li></ul></ul><ul><ul><li>Do all parties to the agreement understand how the agreement will operate? </li></ul></ul><ul><ul><li>Determine appraisal issues in advance </li></ul></ul><ul><ul><li>Are the valuation terms clear and applicable in light of current terminology? </li></ul></ul>
  • 34. Buy-Sell Agreement Legal & Valuation Audit TM <ul><li>Review the buy-sell agreement from a valuation perspective (appraisers) </li></ul><ul><ul><li>Are the five key defining elements of a buy-sell valuation present? </li></ul></ul><ul><ul><li>What do the “words on the page” say to an appraiser about the kind of value per the agreement? </li></ul></ul><ul><ul><li>Explain how the agreement would operate from a valuation perspective </li></ul></ul><ul><ul><li>Is there a current value for the buy-sell agreement? </li></ul></ul>
  • 35. Helpful Resources <ul><li>Mercer Capital resources </li></ul><ul><ul><li>www.mercercapital.com </li></ul></ul><ul><li>Uniform Standards of Professional Appraisal Practice (USPAP) </li></ul><ul><ul><li>www.appraisalfoundation.org/uspap </li></ul></ul><ul><li>American Society of Appraisers (ASA) </li></ul><ul><ul><li>www.appraisers.org </li></ul></ul>
  • 36. Other Resources
  • 37. MERCER CAPTIAL 5860 Ridgeway Center Parkway, Suite 400 • Memphis, TN 38120 901.685.2120 (P) • 901.685.2199 (F) www.mercercapital.com Z. Christopher Mercer, ASA, CFA [email_address] Andrew K. Gibbs, CFA, CPA/ABV [email_address] James E. Graves, ASA, CFA [email_address] Timothy R. Lee, ASA [email_address] Travis W. Harms, CFA, CPA/ABV [email_address] Jean E. Harris, CFA [email_address] Questions? Matthew R. Crow, ASA, CFA [email_address] Wendy S. Ingalls, CPA/ABV, CBA, ASA [email_address] Nicholas J. Heinz [email_address] For further information, feel free to contact any of our senior professionals listed below:
  • 38. Mercer Capital’s M&A Overview 2 nd Quarter, 2009 Prepared by Timothy R. Lee, ASA & Nicholas J. Heinz, ASA 901.685.2120 MERCER CAPITAL www.mercercapital.com
  • 39. M&A Deal Volume <ul><li>Transaction volume declined in 2008 and has weakened further in 2009 </li></ul>
  • 40. M&A Middle Market Deal Volume <ul><li>Middle market activity has followed that of the broader market </li></ul>
  • 41. M&A Transaction Types <ul><li>Approximately 50% of all deals involve privately owned sellers </li></ul>
  • 42. M&A Transaction Size <ul><li>Most deals are below $100 million (approx. 80%) </li></ul>
  • 43. M&A Pricing Report <ul><li>Not surprisingly, P/E multiples were low in 2008 </li></ul>
  • 44. M&A Pricing Report <ul><li>Average P/E multiples showed some recovery during first Q1 2009 </li></ul>
  • 45. M&A Pricing Report <ul><li>The disparity in multiples was large in 2008 across deal sizes </li></ul><ul><li>Size clearly matters in deal pricing </li></ul>
  • 46. M&A Middle Market Pricing Report <ul><li>Middle-market multiples remain low compared to 2007 and 2008 but have increased relative to Q1 2009 </li></ul>
  • 47. Private Equity Overview <ul><li>Private equity firms are still experiencing difficulty </li></ul><ul><ul><li>The number of PE deals in the last twelve months is down 43% from the prior year </li></ul></ul><ul><ul><li>The average P/E on a private equity deal was 17.8, whereas strategic buyers were able to pay an average P/E of 22.2 </li></ul></ul><ul><ul><li>Credit markets remain tight </li></ul></ul><ul><ul><li>The capital raising environment is still difficult for private equity </li></ul></ul>Source: Merger Stat Flashwire Monthly.
  • 48. M&A Market Summary <ul><li>Deal volume remains low but some strategic buyers are finding attractive pricing </li></ul><ul><li>Debt markets continue to hobble private equity </li></ul><ul><li>Privately owned sellers continue to produce a considerable portion of the deal activity </li></ul><ul><li>Smaller deals are transacting at particularly low prices on a multiples basis </li></ul><ul><li>Middle market volumes and multiples have shown some signs of recovery in the last quarter – still a long way to go </li></ul>
  • 49.  

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