This document summarizes a seminar on complex legal and financial challenges related to business succession and family transitions. The agenda includes presentations from Key Bank on business succession strategies, Gallagher, Flynn & Co. on tax planning opportunities, and Dinse, Knapp & McAndrew on the legal aspects. It also includes a lunch presentation from the Mount Family on their business transition experience. The document then provides more details on various succession strategies and considerations, as well as an overview of financial planning processes and tax planning opportunities.

1. Complex Legal and Financial
Challenges (and Opportunities)
to Business Succession and
Family Transitions
Thursday, December 1, 2011
1

2. FOR TODAY
8:00 - Continental breakfast
8:30 - Welcome and introductions
9:00 –
• 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 story
1:30 - Adjourn
2

3. Corporate Banking/Private Banking
Don Baker Steve Gurin Chris Bixby
Sr. Vice President Sr. Vice President Vice President
3

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. 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. 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. SALE TO FAMILY/NEXT GENERATION
• MAXIMIZE RETURN vs. SET UP FOR SUCCESS
• EMOTIONAL CHAINS TO BUSINESS
• INTER-GENERATIONAL EMOTIONAL BAGGAGE
• FINANCING ASSISTANCE
7

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. Financial Planning Process
9

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. Tax Planning Opportunities and the
IRS Voluntary Worker
Reclassification Settlement Program
Rick Wolfish, CPA
Gallagher, Flynn & Company, LLP
11

12. RICHARD G. WOLFISH,
CPA
Tax Partner
12

13. New Voluntary Worker
Classification Settlement Program
Optional
Allows employees to reclassify workers as
employees for future tax periods
Limited federal employment tax liability for
past nonemployee treatment
File form 8952
13

14. New Voluntary Worker
Classification Settlement Program
Payment equal to little over 1% of wages paid
to reclassified employee for past years
Audit insurance
On Nov. 17th, 2011, Vermont announced it
will not piggyback this program. They may
change their mind in the future.
14

15. Tax Planning Opportunities
Accrual basis business can take 2011
deduction for some bonuses not paid until
2012.
Maximize domestic production deduction –
2011 deduction 9% of qualified production
activates income.
Depreciation opportunities
 2011 $5000,000 expensing
 2012 $125,000 expensing
 100% bonus first year depreciation expense
12/31/11
15

16. Tax Planning Opportunities
Research and development credit expires 12/31/11.
If you are an S-Corporation, make sure you have basis
for losses. Consider lending the company money or
making a capital contribution.
File Quick Carrybook refunds for corporations (Form
1139) and Individuals (Form 1045).
Claim deductions for disaster loss in 2010 or 2011.
Make year-end gifts to family members.
16

17. Importance of Business Valuations
Mark Beliveau, CPA CVA CFE
Gallagher, Flynn & Company, LLP
17

18. Mark Beliveau, CPA
CVA CFE
Partner
18

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. 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. 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. Value Defined
Fair Market Value–
―…the price at which property would change hands between a willing buyer
and a willing seller when the former is not under any compulsion to buy and the
latter is not under any compulsion to sell, both parties having reasonable
knowledge 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 involuntarily
deprived of the benefit of his ownership interest where there is neither a willing
buyer nor a willing seller.
22

23. Types of Valuations
Full 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 situation
Calculation Report
 Utilizes single agreed-upon method to determine value
 Not as comprehensive as full appraisal
 Used primarily in non-contentious/friendly situations
Back of the Envelope/Rules of Thumb
23

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. Business Valuation
Professional Organizations
NACVA – CVA or AVA
AICPA - ABV
ASA - ASA
IBA – CBA
Each organization has their own professional business
valuation standards
25

26. ESTIMATING THE VALUE
Valuation Approaches
• Asset Approaches
• Market Approaches
• Income Approaches
26

27. ASSET APPROACH – WHEN TO USE
Appropriate when valuing:
• Marginally profitable companies (better dead than
alive?)
• Asset-heavy companies
• Holding companies and non-profits
• Controlling interests
Generally not useful:
• When significant intangible value exists
• For valuing service companies
• For valuing professional practices
• When considering minority interests
27

28. ASSET APPROACH
Liquidating or Distressed Value
Liquidating – restate value of assets and liabilities
at date of valuation to fair market value, less
costs to dispose
Distressed Value – fair market value does not
apply here
28

29. MARKET APPROACHES:
Guideline Publicly Traded Company Method
Using information from publicly traded, similar companies,
determine “multiples” to apply to the subject company’s
operating results to obtain a value
Completed Transactions Method
Similar to GPTCM – based on sales of business interests in
the market (M&A)
Data Sources
Institute of Business Appraisers
Bizcomps©
Pratt’s Stats©
Mergerstat©
29

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. Guideline Public Companies
Strength:
• Value is based on current market
activity
Weakness:
• Often difficult to find true guideline
companies
• Extensive analysis needed
31

32. The Income Approach
Most commonly used methodology
Strengths
Grounded in finance theory
The most widely recognized approach
Weaknesses
Past isn’t indicative of future – reliance
on historical data
32

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. Present Value
Would you rather
have $10,000 now,
or $14,025 five years
from now?
$14,0
Future
25
Value
2016
$10,0
00
Investment
2011 Yield
5%
Present 7%
Value 10% ?
34

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 to
equity holders (in the form of dividends) after funding operations of
the business enterprise and making necessary capital investments
Discount rate - Rate of return that converts a series of expected
future returns on an investment to a present value
35

36. Time for Some Valuation
Buzz Words
Capitalization rate - Rate of return that
converts a single period of earnings or investment
amount to a present value
Cost of capital - The expected rate of return
that the market requires in order to attract funds
to a particular investment
36

37. ANALYZING THE INFORMATION
Financial Analysis:
• Common-size analysis
• Comparative analysis
• Trends
Non-financial analysis
• Management
• Competition
• Products & Quality
• Customer/supplier concentration
37

38. The Income Approach
Capitalization of Earnings
PV of anticipated benefits =
Economic benefits (cash flow)
Capitalization rate
38

39. The Income Approach
Developing the NUMERATOR…
The approach is forward looking but..
past performance is often foundation for
projecting future economic benefits.
39

40. The Income Approach
Most common methodologies for estimating
future 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. The Income Approach
Our example will use a single amount of tax
-affected cash flow….
Because cash flow and reported earnings or
net income are not the same AND…
Investors purchase the opportunity to
receive cash flow.
41

42. The Income Approach
A proxy for cash flow:
Pre-tax ―normalized‖ earnings
+ Depreciation and amortization expense
Normalized cash flow
42

43. Normalizing Adjustments
Normalization Process– Adjust financial
statements for nonrecurring, non-operating,
or unusual items to eliminate anomalies and
arrive at an indication of the ―economic
reality‖ of the business.
43

44. Normalizing Adjustments
Failure to develop the appropriate
normalizing adjustments may result in a
significant overstatement or understatement
of value
44

45. Normalizing Adjustments
Common income statement adjustments:
Excess compensation or fringe benefits relative to individual’s
role
Above or below market rental payments to related parties
Nonbusiness expenses
Departures from GAAP
Common balance sheet adjustments:
Excess and/or non-operating assets
Related party loans
Economic value of property & equipment
45

46. Relationship Between
Discount Rate and
Capitalization Rate
Discount Rate
Less: Long-term sustainable growth
Equals: Capitalization Rate
46

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. Capitalization of Earnings v.
Discounted Cash Flow
Capitalization of earnings method can be used
where economic benefit (cash flow, earnings
etc.) to owner is steady and increases annually
at the same growth rate.
Discounted Cash Flow method is used where
amount of economic benefit is expected to vary
from year to year and/or growth rate is expected
to change significantly over time.
48

49. The Income Approach
About the DENOMINATOR…
Discount or capitalization rate is function of
risk-free rate of return and real/ perceived
risk premium required to induce buyer
(investor)
In a purchase transaction, discount rate is
the BUYER’S cost of capital
49

50. Example of Income Approach
Capitalization of Earnings method –
information used:
Company’s pretax accounting income = $195,000
Depreciation = $10,000
Grandma on payroll = $20,000
Below market rent paid = $15,000 under market
Tax rate = 40%
50

51. Income Statement
Basics
Revenue: $6,000,000
Less Cost of Goods Sold $4,500,000
Equals: Gross Margin $1,500,000
Less Operating Expenses
Selling Expenses $435,000
General Expenses $435,000
Administrative Expenses $435,000
Equals: Operating Profit $195,000
Plus/minus Other Income/Expenses $0
Pre tax income $195,000
51

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. Example of Income Approach
Pre-tax cash flow to equity 210,000
Income tax (on $200K @40%)
(80,000)
After-tax gross cash flow base 130,000
Less: Additional WC requirements -
Less: Net capital expend required (20,000)
Ongoing after-tax cash flow to equity $110,000
53

54. Example of Income Approach
Using 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 the
Company without discounts
54

55. Discounts
Two biggest issues:
Minority/Lack of Control - reflects the
decreased value of shares that do not convey
control of a closely held business.
Lack of Marketability - reflects no ready
market for shares in a closely held business and
time to turn share into cash
55

56. CONTROL AND MARKETABILITY
Controlling Interest Value
Control Premium Minority Interest Discount
Marketable Minority Interest Value
(“WSJ Listed Price”)
Discount for Lack of Marketability
Nonmarketable Minority
Interest Value
56

57. Discount for Lack of
Marketability
Factors Affecting Marketability
A B C D
Lead to Publicly No Registered Active
smaller traded restrictions securities market
DLOM on sale
Lead to Closely Restrictions Unregistered Thin
larger held on sale securities market
DLOM
57

58. Application of Discounts
and Premiums
Value on a control, marketable basis $583,000
Less discount for lack of control @ 25% 146,000
Value on a minority, marketable basis 437,000
(rounded)
Less marketability discount @ 30% 131,000
Value of minority, non-marketable interest
(rounded) (47.5% overall discount) $306,000
58

59. QUESTIONS…….
59

60. Mark Langan
Tax Attorney
Dinse, Knapp & McAndrew
60