Transcript ESOP POWER - Ahrens Technologies

TRANSFERRING A BUSINESS
TO KEY EMPLOYEES
For
Privately Held Business
Presented by:
Sam G. Torolopoulos
ATI Capital Group, Inc.
ATICG © 2010
ATI Capital Group, Inc.
BUSINESS TRANSFER
SPECTRUM
TRANSFER MOTIVES
TRANSFER
Employees
Charitable
Trusts
Family
Co-Owners
T R A N S F E R
 ESOPs
 Management
Buyout/Ins
 Options
 Phantom Stock
 Stock
Appreciation
Rights
CRTs
CRATS
CRUTs
CLTs
CLATs
CLUTs
INTERNAL
TRANSFERS
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Gifts
SCINs
Annuities
GRATs
FLPs
IDGTs
CHANNELS
Outside
Outside
(Retire)
(Continue)
Public
M E T H O D S
 Buy/Sell
 Russian
Roulette
 Dutch
Auction
 Right of
First
Refusal
 Negotiated
One-Step
Private
Auctions
 Two-Step
Public
Auctions
ATI Capital Group, Inc.
 Consolidated
Roll-ups
 Buy and Build
Recaps
EXTERNAL
TRANSFERS
 Initial Public
Offerings
 Direct Public
Offerings
 Reverse
Mergers
 Going Private
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For Financial Professional Use Only
PUBLIC CAPITAL
MARKETS
Large Publicly Traded Companies
• Have unlimited access to capital
• Are focused on profit maximization
• Are not concerned about Tax minimization
• Are Strategic minded
• Are not concerned with creating personal
wealth for the “owner” of the business.
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PRIVATE CAPITAL
MARKETS
Privately Held Companies
• Capital is limited to the owner’s guarantee
• Are concerned about Tax minimization
• Are primarily concerned with creating
personal wealth for the “owner” of the
business.
• Are tactical not strategic (wear many hats)
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DIFFERENCES
THEREIN
• Very few if any privately held “C” corporations
pay double tax.
• All/most “S” Corporations pay income tax.
• Owner of a private company is obsessed with
minimizing or eliminating income taxes.
• Public companies do NOT pay income tax
therefore, CEO could care less about the
amount or rate of corporate taxation.
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DIFFERENCES
THEREIN
• Officers of a publicly traded company can sell
some, most, or all of their stock or vested
options before retirement, at retirement or
after retirement….there is a ready market for
the stock.
• Officers of a privately traded company have no
such ready market for their stock.
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DIFFERENCES
THEREIN
• Owner of a private company seeks to grow
family wealth (starting with himself)
• CEO of a public company seeks to grow share
value and\or pay dividends
• Board of directors of a private company (if
any) are reluctant to make changes to
management
• Board of directors of a public company will act
quickly to remove non-performing Mgt.
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DIFFERENCES
THEREIN
• CFO of a public company strives to obtain
capital at the lowest possible cost (WACC)
• Owner of a privately held business has VERY
limited access to capital (will take what he can
get)
• CEOs of privately owned companies think
tactical
• CEOs of publicly traded companies think
strategic
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POTENTIAL BUYERS
• An Individual\Individuals
• A Corporation
• A Qualified Plan
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HUMAN CAPITAL
Every corporation has three basic
categories of human capital
• Legacy Generation
 Current owner or founder
• Next Generation or Senior Mgt.
• Rank and file employees
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BUSINESS OWNER’S
MOTIVES
• Most business owners want to:
 “leave a legacy” behind in their business
 extract VALUE in an efficient manner that will
not negatively impact the Company’s legacy
 remain in control for a period of time
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MANAGEMENT’S
MOTIVES
• Management wants to:
 grow the business\take more risk.
 to create VALUE that will first pay off the seller, and
second increase their personal wealth.
 See to it that control passes in an efficient but
determinable manner.
 Extract the value that they have paid for and created in
order to enhance their personal wealth.
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BUSINESS OWNER’S
UNKNOWNS
• Very few business owners:
 know what their options are
 understand how their motives impact the
decision process
 understand the opportunity cost of one option
over the other
 understand that their business has multiple
values on the same day
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TRANSFER TO
MANAGEMENT
Making It Work For Everyone!
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For Financial Professional Use Only
MOTIVATING THE
SELLER
• Transition is a process not an event
• Quicker and more confidential than 3rd
party sale
• Deal structure can be more flexible
• Legacy of the Company continues
• Personal sentiment of the owner
 “Mgt. has earned it”
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MOTIVATING THE
SELLER
• Upside growth potential for both seller
and management
• Can provide continued service to the
Company as officer and\or director
• Control over “control”
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SELLER CONCERNS
• Deal structure
 Cash, debt, earn-out
• Mgt. generally has no capital or “skin in
the game”
• Loss of control
• Contingent liabilities
• Maintaining Mgt. enthusiasm
 “Who gets what percentage?”
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SELLER CONCERNS
• Should a private equity firm be involved?




Control\Minority
What is P.E. exit strategy?
Where will that money come from?
Will management be willing to work that
hard and stay that long?
 Impact of P.E. representative on the board?
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MGT. BUY OUT EXAMPLE
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ASSUMPTIONS
•
•
•
•
•
•
Gross revenue = $50MM
EBITDA = 10% of revenue
Annual Growth = 10%
Depreciation = Cap Ex at 2% of revenue
Taxes = 34%
Working Capital increases at 12% of revenue
growth
• No existing debt
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ASSUMPTIONS
•
•
•
•
•
•
•
Value @ 5X EBITDA
$10MM bank debt
Mgt. can raise $1MM
P.E. infuses $14MM
Annual Growth = 10%
100% of excess cash to pay down bank debt
EBITDA value multiple @ 6X after three years
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MBO EXAMPLE
In thousands
Current
Yr. 1
Yr. 2
Yr. 3
Exit
Revenue
10%
$50,000
$55,000
$60,500
$66,550
$66,550
EBITDA
10%
5,000
5,500
6,050
6,655
6,655
Depr.\Cap Ex.
2%
1,100
1,210
1,331
Interest Exp.
7%
700
568
413
3,700
4,272
4,911
Pre-tax income
Taxes
34%
1,258
1,453
1,670
Working Cap. Incr.
10%
550
605
666
1,892
2,215
2,576
Principal Pmt.
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MBO EXAMPLE CONT.
Valuation
Current
Yr. 1
Yr. 2
Yr. 3
Exit
EBITDA
$5,000
$6,655
Multiple
X5
X6
25,000
39,930
Value
Financed
Bank Debt
10,000
Mgt. Equity
1,000
2,442
P.E. Equity
14,000
34,171
$25,000
$39,930
Totals
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(1,892)
(2,215)
ATI Capital Group, Inc.
(2,576)
3,317
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SELLER’S RESULTS
•
•
•
•
“Cashes out” and receives $25,000
Remains on the board of directors
Remains as an officer
Possible incentives for growing the
company
• Maintains privacy of the transaction
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FOR THE P.E. GROUP
• Purchased 93.33% of the equity
$14MM/$15MM for 56% of the purchase
price $14MM/$25MM.
• Value of P.E. equity went from $14MM to
$34MM representing a 244% increase over
three years.
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FOR MANAGEMENT
• Only came up with $1MM
• Mgt. equity went from $1MM to $2.442MM
representing a 244% increase over three
years
• Didn’t guarantee the $10MM loan
• $10MM loan reduced to $3.317MM
• Continuity of Mgt. position\board
representation
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CONCERNS FOR ALL
• 100% of excess cash flow is used to pay
debt not grow the Company.
• Where is Mgt. going to get the money to
buy-out P.E. group?
• P.E. realizes lion’s share of actual equity
growth.
• Undo emphasis on short-term results.
• Shareholders’ Agreements?
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CONCERNS FOR ALL
• Mgt. conflict of interest.
• Mgt. ongoing appetite for new Majority
owners when P.E. sells.
• Owner motives outweigh Management
motives.
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EMPLOYEE STOCK
OWNERSHIP PLAN
A Pre-tax Management Buyout?
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WHAT IS AN ESOP
• ESOP = Employee Stock Ownership Plan
• An ESOP is a QUALIFIED PLAN under
the Employees’ Retirement Income
Security Act of 1974 (ERISA)
• See Sections 401(a), 4975(e)(7), and
501(a) of the Internal Revenue Code of
1986, as amended, and Section 407(d)(6)
of ERISA, 1974
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UNIQUE FEATURES OF
AN ESOP
An ESOP trust “ESOT” has three very unique
features:
1. ESOT must own “principally” stock in its
sponsor company.
2. An ESOT is the ONLY qualified plan under
ERISA allowed to BORROW MONEY!!
3. The trust can purchase the Company in
“Stages” (multiple transactions).
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TAX ADVANTAGES OF
AN ESOP
ESOP structures have the following tax
advantages:
• Seller can defer tax on sale indefinitely

•
30% or more for “C” corporations only
Seller can be a participant in the ESOP

•
Only if tax deferral on sale is not elected
Company tax deducts the principal and
interest on ESOP buyout loan

Available for “C” and “S” Corporation ESOPs
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TAX ADVANTAGES OF
AN ESOP
•
“S” Corporation ESOP pays no tax on
pre-tax income for the percent owned
by the ESOP.

If 100% “S” Corporation ESOP, then
100% of pre-tax income free from tax.
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ESOP EXAMPLE
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ASSUMPTIONS
•
•
•
•
•
•
Gross revenue = $50MM
EBITDA = 10% of revenue
Annual Growth = 10%
Depreciation = Cap Ex at 2% of revenue
Taxes = 0%
Working Capital increases at 12% of revenue
growth
• No existing debt
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ASSUMPTIONS
•
•
•
•
•
•
•
Value @ 5X EBITDA
$25MM Seller Note
Five year vs. three year horizon for MBO
Mgt. need not raise ANY capital
Annual Growth = 10%
100% of excess cash to pay down bank debt
EBITDA value multiple @ 6X after five years
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ESOP EXAMPLE
Current
Revenue
Growth
10%
EBITDA
10%
Yr. 1
Yr. 2
Yr. 3
Yr. 4
Yr. 5
Exit
50,000
55,000
60,500
66,550
73,205
80,526
66,550
5,000
5,500
6,050
6,655
7,321
8,053
8,053
Depr.\Cap Ex.
2%
1,100
1,210
1,331
1,464
1,611
Interest Exp.
7%
1,750
1,603
1,419
1,192
1,064
2,650
3,237
3,905
4,664
5,378
550
605
666
732
805
2,100
2,632
3,240
3,932
4,573
Pre-tax income
Working Cap.
Debt Repayment
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10%
ATI Capital Group, Inc.
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ESOP EXAMPLE CONT.
Valuation
EBITDA
Current
Yr. 1
Yr. 2
Yr. 3
Yr. 4
Yr. 5
5,000
Multiple
Exit
8,053
X5
X6
25,000
48,318
Equity
N/A
39,795
Seller Debt
25,000
Value
Financed
Debt Balance
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(2,100)
(2,632)
(3,240)
(3,932)
22,900
20,268
17,028
13,096
ATI Capital Group, Inc.
(4,573)
Totals
8,523
48,318
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SELLER’S RESULTS
• “Sells” for $25MM plus interest (over $7MM in
interest in our example buy yr. 5).
• Does not have to pay tax on sale.
• Can receive lump sum for balance at time of
bank refinancing during year three or four.
• Remains on the board of directors.
• Remains as an officer.
• Possible incentives for growing the company
via cash based incentives.
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SELLER’S RESULTS
• Can be paid more quickly due to Company
paying less tax for “C” corporation or NO tax
for “S” Corporation.
• Continuity of transition.
• Has Mgt. buy-in from day one.
• No P.E. involvement.
• Seller is a more flexible lender in case of
economic downturn.
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FOR MANAGEMENT
•
•
•
•
•
•
•
No down payment, no guarantee on loan.
Ownership in the ESOP as participants.
No P.E. group on board of directors.
Continuity of Mgt. position\board representation.
Clear understanding of process on day one.
Can earn additional equity via synthetic equity.
Increased compensation under “cash-based”
incentive plans.
• Will accumulate more equity value in the ESOP
than with MBO.
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CONCERNS FOR ALL
• 100% of excess cash flow is used to pay
debt not grow the Company.
• Company must set aside money to meet
repurchase obligation on ESOP stock
• Seller in control longer 5 yrs. vs. 3 yrs.
• At the end of 5 yrs. Company still has
$17MM in total debt.
• Shareholders’ Agreements?
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CONCERNS FOR ALL
• Owner motives outweigh Management
motives.
• Stock in ESOP allocated based on payroll
(no extra management incentive).
• Administrative requirements of
managing ESOP.
• Trustee of ESOP has some say in Mgt.
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Contact Information
Web Site:
www.aticg.com
Sam G. Torolopoulos, CPA/ABV, ASA
 1674 Keller Parkway, Suite #140. Keller, Texas. 76248
 214-920-1616, fax 214-920-1617
 [email protected]
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