Meet Todays Economic ChallengesExplore Two Sides of the Coin... "Growth through Acquisition vs. Exit Strategies for your Business" November 14, 2012 Elk Grove Village, Illinois
Presented by:• The Private Bank Thomas J. Doherty• The Peakstone Group Mark Horita• Querrey & Harrow, Ltd. Peter E. Converse• Corbett, Duncan & Hubly PC Ryan P. Giolitto Moderated by: Bruce H. Schoumacher Querrey & Harrow, Ltd.
How Your Bank Can Helpin an Acquisition Thomas J. Doherty The Private Bank
How Your Bank Can Help in an Acquisition Commercial Bank’s Role in Acquisitions Include early as an advisor Leverage network for assistance Not an equity partner
Debt EquityMust be repaid or refinanced. Can usually be kept permanently.Requires regular interest payments; company must No payment requirements. May provide dividends, butgenerate cash flow. only out of retained earnings.Collateral assets must usually be available. No collateral required.Debt providers are conservative. They cannot share any Equity investors are aggressive. They can acceptupside or profits, and wish to eliminate all possible loss downside risk because they fully share in upside as well.or risks.Interest payments are tax deductible. Dividend payments are not tax deductible.Debt covenants may impose some restrictions on some Shared equity may lead to shared control anddecisions made by existing management. management over the day-to-day operations of the company.Debt allows leverage of equity. Equity holders share the company profits.May impose restrictions on the compensation of owners Investors are consulted or can determine compensationand officers as terms of loan. of owners and officers.Restrictions on the sale of assets that have been used as Investors share in ownership of all assets.collateral for a loan, or taking on of additional debt tofinance the purchase of assets.Regular timely reporting of financial results to lenders. Investors usually have access to financial results at any time.Restrictions on transfer of ownership. As either majority or minority owners, investors participate in all ownership issues.
Debt Financing Debt financing can be either short term or long-term. In either case common lending principles apply. Lenders typically consider the risk of lending to borrowers on the basis of: • Credit history • Cash flow history and projections • Collateral available to secure a loan • Character of the borrower • Loan documentation: financial statements, tax returns, business plan Long-term Short-termPurchase, improve, or expand fixed assets such Raising cash for working capital, inventoryas a company’s facilities and major equipment. needs, or for accounts payable.Requires the borrower to secure the loan by Commonly secured by collateral, but may beproviding collateral and thereby reducing the available unsecured if the lender is willing tolender’s risk to non-payment of the loan. rely on the creditworthiness and reputation of the borrower to repay the loan.
How Your Bank Can Help in an Acquisition Small Business Administration (SBA) Loans 7A vs. 504 Programs Extended Term Lack of Equity Into Project Collateral Shortfall
U.S. Small Business Administration(SBA) 7(a) Loan Program This is the SBA’s primary loan program where the SBA guarantees major portions of loans made to small businesses by private lenders. ◦ Eligibility: For-profit businesses with: good character, fair credit record; sufficient management expertise; a feasible business plan; adequate equity in the business – typically a minimum of 20%; sufficient collateral; and adequate cash flow to repay debt from historical or projected cash flow. ◦ Use of Funds: Business acquisition or start-up, purchase or remodeling of real estate, leasehold improvements, equipment purchases, long and short-term working capital, inventory, and the refinancing of existing business indebtedness that is not already structured with reasonable terms and conditions. ◦ Financing: Private lenders provide the loan. Typically, the Small Business Administration (SBA) will guarantee up to 75% of loans (or up to 85% for loans less than $150,000).
Terms and ConditionsLoan Size Maximum loan amount is $5 million. SBA’s maximum guarantee is $3,750,000 or 75% of loan amount.Term Twenty-five years for real estate and equipment. Generally, up to ten years for working capital.Interest Rate Lenders set rates which may be variable within the following limits: Loans of $50,000: Prime or Libor + 300bps, plus 2.25% if the maturity is less than 7 years, and Prime or Libor + 300bps plus 2.75% if the maturity is 7 years or more. Loans of $25,000 -$50.000: Prime or Libor + 300bps, plus 3.25% if the maturity is less than 7 ears, and Prime or Libor + 300bps, plus 3.75% if the maturity is 7 years or more. Loans of $25,000 or less: Prime Plus 4.25% if the maturity is less than 7 years, and Prime Plus 4.75%, if the maturity is 7 years or more. NOTE: There is a prepayment penalty owed to SBA for loans with a maturity of 15 years or longer.Loan Fee 2.0% of guaranteed portion up to $150,000. 3.0% of guaranteed portion up to $700,000. 3.5% of guaranteed portion up to $1,000,000. For loans greater than $1,000,000, an additional 0.25% guaranty fee will be charged for the portion greater than $1,000,000.Collateral Assets purchased with loan proceeds. SBA and lender may require additional personal and business assets as collateral.Other Conditions For real estate loans, borrower must occupy 51% of an existing building and must occupy 60% of new construction.Additional Info Contact your current lender or www.sba.gov; http://www.sba.gov/services/financialassistance/7alenderprograms/index.html , or http://www.naggl.org/AM/template.cfm
How Your Bank Can Help in an Acquisition Bank Financing Terms Typical Terms and Advance Rates Accounts Receivable Inventory Equipment Commercial Real Estate Fees
Completing a Successful Acquisitionor Disposition Mark Horita The Peakstone Group
Economic Landscape …Mixed Signals Still forecasting growth Though choppy and differing by industry Fundamentals are there…but trend is slow But uncertainty coming from several areas China GDP European sovereign debt US uncertainty (election, taxes) Changes are occurring quickly Making it harder to develop forecasts and committed plans
Economic Landscape GDP …but slow Unempl /empl. …but slow Housing starts …but slow Purch mgr index …but slow Auto consum/prodn …moderating Chicago Fed National Activity Index China GDP mid 2013 Standard deviation from trend, 3-month average. 3 Dry bulk index mid 2013 2 1 0 -1 -2 -3 -4 -5 1967 1972 1977 1982 1987 1992 1997 2002 2007 Shading corresponds with recessions. Source: Chicago Fed
M&A: What We’re Seeing… Capital Overhang for US-Focused Funds Raised by US InvestorsDeal volume and valuations moderate $160 $146.54 $466B However “Dry Powder” is driving market $140 $500 $120 PE firms: $450B $96.23 $93.61 $400 $100 Corporations: $1.5T $80 $67.34 $300 Banks: $1.5T $60 $41.64 $200 $40 $20.63 $100 Highly competitive for “good deals” $20 $0 $0 Conservatism…deals are taking longer 2005 2006 2007 2008 2009 2010 Source: PitchBookFinancing is competitive 8 U.S. Middle Market Deal Activity 70 Has been moving down market 7.5 60 7 50 Most recently, seeing some tightening on 6.5 6.2X 6.2X 6.5X 6.0X 6.1X 6.1X 40 5.9X larger deals 6 5.5 5.6X 5.6X 5.3X 5.5X 5.7X 30 5.1X 5.2X 20 5 4.5 10 4 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2008 2008 2008 2008 2009 2009 2009 2009 2010 2010 2010 2010 2011 2011 TEV/Adj. EBITDA Deals/Quarter Reported deals with values from $10-250m. Source: GF Data Resources
Valuations – Rules of Thumb Typical Valuations EBITDA Comments (EBITDA multiple) > $10 8-12X • Headline grabbing transactions • Ultra-competitive, efficient market • 3-6X total leverage $5-10 4-9X • Competitive • Commercial banks returning in a big way • 2-4X leverage $3-5 3-6X • Equity market somewhat inefficient • Debt markets somewhat dislocated • Significant deal structuring < $3 3-5X • Debt financing challenging • Owners more challenged by deal process
Strategic Alternatives for Business Owners Which path maximizes value? Managing Risk Sell / Equity Set realistic expectations Value to the seller vs buyer A business is worth whatever a buyer will pay for it Focus on Core Acquisition Business Strategy Understand options Structure vs price Earnouts, notes, rollover equity Debt Restructuring Cash: Need vs. Want Emotional Considerations Your staff and/or family Continued Involvement
Strategic Alternatives for Business Owners Tax-Driven Exits Offense v. Defense Counter-Cyclical Plays EBITDA Multiple Math
A well-run process includes 4 essential steps: < handout details > Preparation Marketing Negotiating ClosingActions Pitfalls Analyze business Fail to consider full range of options Analyze markets Fail to anticipate and address what investors care about Identify key issues and develop strategies to address them Fail to calibrate interests and expectations of multiple shareholders Identify list of potential and preferred investors (equity and/or debt) Fail to understand real value (high or low) Recast financial statements Under-market a company based on poor positioning and documents Determine valuation range Evaluate deal structuring alternatives Develop compelling marketing materials (teaser, CIM, presentation) Many middle market sales have significant gaps in either expertise or effort in at least one of these stages.
Preparation/Marketing: Sell-Side Preparation Marketing Negotiating Closing Preparation Recast financial statements Pitfall: Fail to anticipate and address what investors care about Marketing Positioning Pitfall: Improperly position the business or conversely “List and hope” Positioning
Negotiating/Structuring: Sell-Side Preparation Marketing Negotiating Closing Negotiating Using competitive process techniques to drive behavior ◦ IOI’s, management presentations, LOI’s Pitfalls: “High ball” offers, unsophisticated buyers Closing Due diligence Managing fatigue Actively managing the process
Having a good process: Buy-Side Strategy Deal Creation Execution Capital / FinancingPreparation Crisp target profile leads to better and quicker outcomes What is objective for acquisition? …Product line, channel coverage, geography, skill setsExecution Viewing the deal from both sides Why is the seller selling? Commercial realities, buyer risk, valuation expectations, TTM performance Compare funding organic growth Senior vs. Junior Debt vs. Equity. More options today: minority equity, strategic partners, etc.
Overall Process Considerations Time and distraction to core business Efficient marketing Targeting in a highly fragmented market Financing implications Experience in negotiating/structuring Getting the right help beforehand… Building a team of advisors
Project LINK Background Integrated logistics company with unique value added capabilities, excellent facilities and equipment $180M revenue, $22M adjusted EBITDA Very strong management team capable of supporting $500M company Growth in recent years driven by supply chain optimization and integration Reason for selling: seller planning for retirement, other interests Process Listed company with NYC, “bulge bracket” investment banker Well connected to high visibility PE firms. Very good “book”. Targeted mostly PE firms Several interested strategic and financial buyers found What was outcome?
Project LINK …the rest of the story Reality Complex, asset intensive business, with unique combination of value added manufacturing and with high customer concentration Investment banker had elevated earnings expectations…business actually shrank Very little interaction with management team…”small deal” Only resulted in 1 indication of interest by “bottom feeder” PE firm Business has found another investment banker and is now back in the market Key Lessons Poorly positioned for buyers comfortable with asset intensive businesses should have targeted strategics with prior experience and internal mechanisms to accommodate Seller’s process dragged out as business performance deteriorated, destroying value Investment banker had distant relationship with sellers and didn’t serve role as trusted advisor
Understanding the Acquisition Process Peter E. Converse
Consider Alternatives to Acquisition or Disposition Alternatives to Acquisitions Organic Growth Disposition Alternatives to Dispositions Management Buy-Out Transfer to Family Members Acquisitions Windup of Operations/Sale of Assets
Understanding the Acquisition Process Basic Steps in Completing an Acquisition Preparing for the Acquisition Identifying the Target Seller (or Buyer) Negotiating a Preliminary Deal (Letter of Intent) Preliminary Due Diligence Negotiating Definitive Binding Agreements
Understanding the Acquisition Process Basic Steps in Completing an Acquisition (continued) Final Due Diligence Satisfying Pre-Closing Conditions Closing Satisfying Post-Closing Conditions
Understanding the Acquisition Process Preparing for the Acquisition-Buyer Financial Issues Operational Issues Which employees to retain? Integration of new business with old Acquisition vs. Organic Growth
Understanding the Acquisition Process Preparing for the Disposition-Seller Is the timing right? Other exit options (transfer or sale to family, long-term employees) What are tax and estate planning issues? What due diligence issues may arise? Example: key lease about to expire Example: are proper software licenses in place?
Understanding the Acquisition Process Identifying the Target Seller (or Buyer) Seller or Buyer May Initiate Discussions Good Team of Advisors is Important Try to Understand the Other Side’s Goals, Motives and Constraints Reality About What the Other Side is Offering- Good and Bad Doing the “Disclosure Dance”-NDAs
Understanding the Acquisition Process Negotiating a Preliminary Deal (LOI) Goal: Letter of Intent (LOI) also called Memorandum of Understanding (MOU) LOI is non-binding, sets forth major terms Playing “Chess” and “Bridge” What Really Matters to You? Look for Win-Win Opportunities More “Disclosure Dance”
Understanding the Acquisition Process Typical Deal Terms in an LOI Sale of Assets or Shares/Equity Interests? Purchase Price (Cash and Non-Cash) Assumed Liabilities/Excluded Liabilities Closing Date and Pre-Closing Milestones Broad Conditions to Closing Subsequent Employment/Non-Competes Non-Binding Statement of Intent
Understanding the Acquisition Process Preliminary Due Diligence Prior to Executing Definitive Agreements, Some Additional Information Usually Provided How Much: Usually Basic Financials, Not Customer-Specific Information
Understanding the Acquisition Process Executing Definitive Binding Agreements Attempts to Cover All Significant Deal Terms This Stage Often Brings Hidden Issues to the Surface- Examples: • Post-closing employment/consulting by selling individual • Employment for Seller’s Mgmt/Labor Force • Allocating Purchase Price Among Assets
Understanding the Acquisition Process Final Due Diligence- Microscopic-Examples: Schedules of Assets Schedules of A/R and A/P Customer Lists and Agreements Copies of Leases-Property and Equipment Intellectual Property (Patents, TMs, etc.) Pension/Profit-sharing Plans
Understanding the Acquisition Process Satisfying Pre-Closing Conditions- Examples: Financing Approvals by Government Agencies Other Third-Party Approvals Execution of Employment Agreements by Key Employees
Understanding the Acquisition Process Closing- Break Out the Champagne! Post-Closing Conditions
Tax Issues in Acquisitionsand Dispositions Ryan P. Giolitto
Tax Considerations in Acquisitions Form of Assets Acquired Form of Acquired Company Purchase Price Allocations
Form of Assets Acquired Stock/Units or Assets? Buyers prefer to acquire assets while sellers prefer to sell stock Competing interests often drive negotiation
Form of Assets Acquired - Comparison Acquisition Consideration Assets Stock Risk of Past Liabilities Seller Buyer Write Off Purchase Price Buyer None Title Transfer Complex Simple Potential Double Tax Seller No
338(g) Election 338(g) election Allows purchaser to treat stock acquisition as asset acquisition Purchaser pays tax on deemed asset sale Buyer and seller must be C corporation Seller must not be part of consolidated group (freestanding) Foreign targets eligible Beneficial to use target NOL’s or for foreign target
338(h)(10) Election 338(h)(10) election Allows purchaser and seller to treat stock acquisition as asset acquisition Seller pays tax on deemed asset sale Seller must be a subsidiary or S corporation Foreign targets not eligible States do not treat election uniformly
Form of Assets Acquired Tips 1. Consult with a CPA regarding default tax implications of asset/stock sale 2. Analyze the deal from both buyer/seller perspective 3. Analyze potential 338(g)/(h)(10) elections on sale 4. Negotiate based on findings of analysis
Legal Form of Target – Why It Matters Buyer indifferent to type of target Legal form of target matters more to sellers • Subchapter C corporations Potential double tax (tax on asset sale followed by tax on dividend distribution) • Subchapter S Corporations Potential built in gain tax (previous C corporations) • Limited Liability Companies (LLCs) Potential for hot assets
Double Tax on C Corporations One level of tax when assets are sold (15-35%) One more level of tax when sale proceeds are distributed to shareholders (15-39%) Tax on Assets Sale Proceeds C Corp Received Tax on Shareholder Dividend
Built In Gains Tax If previously a C corporation, appreciation in assets occurring before conversion to S corporation are taxed at C corporation tax rates Look back period runs up to 10 years
Hot Assets Taxed as ordinary income instead of capital gains Would be ordinary income if realized by partnership prior to sale Can exist even when selling for a loss Buyers can make a section 754 election to step up basis of hot assets sold
Identifying Hot Assets Unrealized receivables Cash basis receivables Depreciation recapture Inventory Redemption by partnership – substantially appreciated only Sale of interest – all inventory
Legal Form of Target Tips1. Know the legal form of your target2. If a C corporation, assess double tax exposure3. If an S corporation, assess built in gains tax exposure4. If an LLC/partnership, assess hot assets exposure5. Understand the effects on the seller for optimal negotiations
Purchase Price Allocations May or may not be agreed on in advance Goodwill Cash Drives tax treatment of asset sale (buyers/sellers) Intangibles Investments Must be agreed upon mutually Fixed Accounts Assets Receivable by both buyer and seller Inventory Buyers – depreciation/ amortization of assets purchased Sellers – gain/loss on sale of assets
Effects of Purchase Price Allocations Determines tax effects Seller prefers allocation to capital assets Buyer prefer allocation to short-term assets C corporations - consider allocations to personal goodwill
Purchase Price Allocation SummaryAsset Type Buyer Amortization Period Seller Income TypeFixed Assets 3-39 years based on type Capital Gain/Ordinary IncomeGoodwill 15 years Capital GainNon-Compete Agreements Useful life or 15 years based Ordinary Income on type
Purchase Price Allocations Tips1. Assess allocation to assets vs. intangibles2. Assess viability of allocating purchase price to personal goodwill in C corporation context3. Agree up front to purchase price allocations to minimize post-closing headaches4. Analyze the tax effects of your purchase price allocations
Summary of Tax Tips1. Know the form and character of acquired assets2. Know the legal/tax status of the target company3. Know the effects of your purchase price allocation
Thank you.Ryan P. Giolitto Peter E. Converse Bruce H. Schoumacher Thomas J. Doherty Mark Horita November 14, 2012 Belvedere Banquets Elk Grove Village, IL