Transcript PREPARING A BUSINESS FOR SALE OR CAPITAL RAISES

SELLING A BUSINESS: HELPING YOUR
CLIENTS WITH THEIR BIGGEST DEAL
North Shore Council
Financial Planning Association of Illinois
Markus May, Esq.
Jeff Smiejek, CPA, CVA, CEPA
Tom Meyer
Alex Fridman
Enterprise Value
Who is Purchasing?
• Outsider
• Insider
• Family Member
Outsider Sales – Pros and Cons
• Price is higher, but higher taxes
• No longer need to be involved long term in business –
will have will training component
• Can will/gift the proceeds to children
• A way to distribute estate proportionately among children when
business = major asset
• Lose the legacy
Insider Sales – Pros and Cons
• Buyer knows the business
• Maybe a lower price, but have a person who can run the business
well
• Seller financing is more likely to be paid
• Less post-closing disputes
• Reward loyal employees
Family Member Sales –
Pros and Cons
• Good if want to leave a family legacy and all children treated
•
•
•
•
equally
Probably bad result if child has no experience
Valuation is subjective: can leave more to the children with less
estate or income taxes
Issues if children are co-owners
Issues if all children are not all owners
The Concept of Value
• Why valuations are performed
and who performs them
• Effectively communicating an
overview of the valuation
process to your clients
The Concept of Value
• Oldest known appraisal—Genesis 23, Verse
15
• “The land is worth 400 shekels”
• Modern Valuation Theory—ARM 34—1920
• A result of the 18th Amendment (Prohibition)
• First attempt at valuing goodwill associated with
breweries and distilleries
Value?
 “Value…[is an] attitude of persons toward that thing
in view of its estimated capacity to perform a
service.”
 “…certainly…property has no value unless there is a
prospect that it can be exploited by human beings.”
- James C. Bonbright
Financial Value
• “The value of any financial asset is the net present
value of all future cash flows discounted at the
appropriate rate of return.”
• Brealey & Meyers—Principles of Corporate Finance
Principal of Substitution
• A prudent buyer will pay no more for property than it
would cost to acquire an equally desirable
substitute with the same utility.
Valuation: Art or Science?
• Valuation applies both quantitative analysis and
qualitative (subjective) analysis to derive an opinion
of value
• Training, experience and common sense are key
elements in a supportable opinion of value
Value to Whom?
Selling Price in Thousands of $
$350
Actual Transactions from IBA Database
Price/Gross Revenues
$300
$250
$200
$150
$100
$50
$0
$0
$100
$200
$300
$400
$500
Annual Gross Revenues in Thousands of $
$600
$700
Range of Value
Selling Price in Thousands of $
Transactions
Upper 25% limit
Lower 25% limit
$400
$350
$300
$250
$200
$150
$100
$50
$0
$0
$100
$200
$300
$400
$500
Annual Gross Revenues in Thousands of $
$600
$700
$800
Why Have a Valuation Performed?
• Tax purposes
• Estate Tax Form 706
• Gift Tax Form 709
• S-Election—net unrealized built-in gains
Why Have a Valuation Performed?
• Non-tax purposes
• Business sale/merger/acquisition
• Buy/sell agreements
• Obtaining financing
• Strategic planning and consulting
• Dissolution of marriage
• Dissident shareholder action
• Litigation support
• Damages/lost profits/business interruption
Who Performs Valuations?
• Business brokers/intermediaries and investment
•
•
•
•
bankers
CPAs
Professors
Financial analysts
Professional business valuators
The Valuation Process
• Define the engagement and discuss
expectations with the client
• Gather and review all necessary information
that may impact the value of the subject
company
• Analyze all information and make adjustments
to “normalize” financial statements
• Apply valuation approaches and methods to
estimate the value of the enterprise
• Consider application of premiums and
discounts*
• Communicate the results
Types (Standards) of Value
• Market value
• Asset
• Financial
• Synergistic
• Fair market value
• Fair value
• Economic value
• Book value
• Owner value
• Collateral value
Identification of Value Drivers
• Value driver – n : an important factor that determines
or causes an increase in value of a business, as viewed
by investors
Source: Go Big Dictionary
• It is important to identify value drivers and their
relationships to increasing cash flow, decreasing risk
and increasing the growth of the business
• Value drivers are critical to the ongoing viability and
success of a business!
Value Drivers - Operations
 Customer list, repeat customers
 Proprietary products: patents, copyrights
 Large market share
 Diversified: industry, products, customers,
geographic locations
Value Drivers – Company Investment
 Commitment to employees – training,
benefits, etc.
 Keep current with technology/equipment
 Additional capacity for growth
 Capital budgeting processes in place
 Improve facility appearance
Value Drivers - Intangibles
 A solid purpose and vision for business
 Experienced, knowledgeable management
 Work force is motivated, dependable
 Key employees have employment/
non-compete agreements
 Departing owner dispensable
 Well-trained management team
Have Good Records
• The “Numbers” affect value
• Cash flow: Positive, growing, sustainable
• Generally Accepted Accounting Principles
• Accounting firm report
• Importance of credibility
Corporate Value Drivers
• Corporate Structure
• Corporate Formalities
• Issue Stock if not already issued
• Create By-Laws
• Minutes regarding Officers/Directors and Past Actions
• Operating Agreement or Buy/Sell Agreement
• Piercing the Corporate Veil
• Run the business to avoid personal liability
Contractual Value Drivers
• Contracts
• Vendors
• Customers
• Leases
• Terms and Conditions, etc.
Intellectual and Property Value Drivers
• Review Key Licenses
• Review Intellectual Property Ownership
Copyrights
Trademarks
Patents
Intellectual and Property Value Drivers
• Review Ownership of Property
• Works Made for Hire
• Computer Software
• Advertising
• Art Work
Common Approaches to Valuation
• Market Approach
• Income Approach
• Asset Approach
Market Approaches
• Rule-of-thumb method
• Quick and dirty method based on industry
averages
• Guideline publicly traded company method
• Based on similar and relevant comparable public
companies
• Comparative or private transaction method
• Based on actual transactions of similar entities
Market Approach
• Apply a multiple to derive a value
• Price to earnings (P/E ratio)
• Price to EBIT or EBITDA
• Price to seller’s discretionary earnings (SDE)
• Price to gross revenues
• Price to book value
Market Example
Gross Revenues
Multiple
Earnings
Multiple
X
450,000
2
$ 900,000
X
220,000
4
$ 880,000
Income Approach
• Capitalization of earnings method
• Discounted earnings method
• Dividend pay-out method
• Excess earnings method
Variables That Affect the Discount or
Capitalization Rate
• Operating history
• Financial returns and ratios
• Sensitivity to
• Intangible value
•
•
•
•
economic environment
Management depth
Capital structure
History of distribution
of earnings
State of the industry
• Patents/trademarks etc.
• Trade secrets
• Processes, formulas etc.
• Location
Capitalized Earnings Method Example
V=
__I__
R-G
I
= Earnings
$100,000
R
= Business risks
25%
G
= Growth
5%
(R-G = Capitalization Rate)
Example:
$100,000 = $500,000
25%-5%
Discounted Earnings Example
Future Periods
Earnings
Discount Factor
Present Value
1
200,000
0.86
172,000
2
230,000
0.75
172,500
Net Present Value
Plus: Terminal/Residual Value
Estimate of Total Business Value
3
270,000
0.67
180,900
525,400
500,000
1,025,400
Sum
700,000
525,400
Asset Approach
• Net asset value method
• Liquidation value method
Asset Approach
• Useful for
• Asset-intensive businesses
• Real estate holding companies
• Entities that hold mostly securities (or cash)
• Some contracting businesses that bid for work
Adjusted Asset Example
Book Value
Assets:
Accounts Receivable
Fair Market Value
(400)
2,600
3,000
(1,000)
2,000
(2,500)
1,000
(1,500)
500
500
5,000
(1,900)
3,100
150
200
350
0
0
0
150
200
350
Owner's Equity
4,650
(1,900)
2,750
Total Liab & Equity
5,000
(1,900)
3,100
Fixed Assets
Less: Depreciation
Net Fixed Assets
Total Assets
Liabilities:
Current Liabilities
Long-Term Liabilities
Total Liabilities
3,000
Adjustment
Walking Buyer(s) Up To A Full
Valuation
 M&A Advisor will do the “heavy lifting” to allow the Company to focus on running the business
 M&A Advisor will emphasize the Company’s growth strategy and focus Buyer(s) on the appropriate financial metrics
o Educate Buyer(s) to focus on run-rate or forward metrics to reflect current growth profile and business momentum
o Adjust for potential non-recurring and one-time adjustments
Value from WellManaged Process
Validating the Business
Strategy
Explaining the Story

Perceived Value Today

Established and
proven business today
Stable base business
with attractive growth
opportunity

Unique defensible
market position

Significant investment
in assets and
employees

Proven management
team with established
track record

EBITDA adjustments

Top-line growth secured
by sustainability of endmarket demand

EBITDA margin expansion
from scalable operating
platform and attractive
new markets

Minimize potential buyer
concerns

Organic and acquisition
growth opportunities

Unique asset creating
significant scarcity value

Validation of financial
model will provide comfort
that business can sustain
growth and cash flow
profile

Attractive financing
markets

Buyer(s) actively seeking
investments to deploy
capital

Well run process will
further drive value and
minimize transaction risk
BREAK
15 Minutes
AUDIENCE
DISCUSSION
Preparing to Sell the Business
• Advise Client about the sale process and what to expect
• Time Frame: 3 months to 2 years between going to
market and sitting down at the closing table
• The well prepared business sells faster
Sale Process
• Broker Agreement
• Market Business
• Confidentiality Agreement
• Letter of Intent
• Due Diligence
• Purchase Agreement
• Closing
Sale Process
AVOID SURPRISES!
• Disclose, Disclose, Disclose
• Breach of Trust Kills Deals
• Better up Front than Later
• But not too Early
Letter of Intent / Term Sheet
• Initial Draft by Buyer Usually
• Sets the Terms of the Deal
• Get Attorney Involved in Negotiating
 Deal Killer if Change Terms Later
Letter of Intent
• Should be Non-Binding Except Certain Items
• Takes Business off the Market
• Allows Due Diligence
 Make sure you get what you think you are getting
 Adjustments to Deal
 Seller’s Due Diligence on the Buyer
Purchase Agreement
• Identify the Parties
• Identify What is Being Sold
 Stock v. Assets
 Accounts Receivable
 Liabilities
 Exclusions from Sale
 Some Liabilities Follow
Purchase Price
• Payment Terms
• Seller Financing
• Security from Buyer
 Security Agreement – pledging stock or assets
 UCC Filing / Mortgage
 Letter of Credit
• Earn Out
Purchase Price
• Working Capital
 Cash + A/R + Inventory = Current Assets
 A/P + Other Liabilities = Current Liabilities
 Net Operating Assets (Assets – Liabilities)
• Pro Rations
Representations and Warranties
 Organization and Good Standing
 Enforceability; Authority; No
Conflict
 Capitalization
 Financial Statements
 Books and Records
 Sufficiency of Assets
 Description of Owned Real
Property
 Description of Leased Real
Property
 Title to Assets; Encumbrances
 Condition of Facilities
 Accounts Receivable
 Inventories
 No Undisclosed Liabilities
 Taxes
 No Material Adverse Change
 Employee Benefits
 Compliance with Legal
Requirements; Governmental
Authorizations
 Legal Proceedings; Orders
 Contracts; No Defaults
 Insurance
 Environmental Matters
 Employees
 Labor Disputes; Compliance
 Intellectual Property Assets
 Relationships with Related
Persons
 Brokers or Finders
 Securities Law Matters
 Solvency
 Disclosure
Conditions to Closing
• Accurate Reps and Warranties
• Compliance with Agreement
• No Adverse Changes
• Buyer Financing
• Satisfactory Lease
• Key Customers/Employee Retention
• Satisfied with Due Diligence?
• Etc.
Indemnification
• Generally breach of Reps and Warranties / Agreement
• Add Deal Specific items – e.g. litigation
• Personal or Corporate?
• Set Off
• Baskets (deductible or tipping?)
• Dollar Limit
• Duration
General Provisions
DISPUTE
RESOLUTION
VENUE
ETC.
WAIVER
ASSIGNMENT
Ancillary Documents
• Employment Agreements
 Seller/Owner
 Key Employees
• Non-Compete
• Promissory Note/Security Agreement
• Escrow Agreement
• Bill of Sale and Assignment
Post Closing
• Training
• Working Capital Adjustments
• Taxes
• Investment of Income
• On the Beach….
Assembling the Deal Team
Financial Advisor
Business Valuator
Accountant
Begin Assembling
a Deal Team
Business Broker/
Intermediary
Deal
Attorney
Conclusion
• Identify Client and Potential Purchaser
• Prepare Client for Sale by getting business operations
and legal documents in place
• Assemble Good Advisors
• Prepare Client by informing about the sale process to
avoid a disgruntled client
QUESTIONS ??
Alex Fridman
Alex Fridman is a Co-Founder of The Peakstone Group, a middle market
investment banking and direct investing firm. Mr. Fridman has executed over
30 investment banking and principal transactions across numerous industries
including general industrial, consumer and retail, distribution, healthcare and
business services. Mr. Fridman previously held senior investment banking
positions with Lehman Brothers and previously worked at Banc of America
Securities. He has his series 24, 79, 82 and 63 licenses and graduated from
Indiana University's Honors Business Program.
Alex Fridman
The Peakstone Group
150 N. Wacker Drive, Suite 2500
Chicago, IL 60606
(312) 346-7303
[email protected]
Markus May, Esq.
Markus May is a client focused and service oriented business attorney at May
Law Firm Ltd. with knowledge in a broad range of industries. Mr. May has
represented numerous clients with respect to M&A transactions and spoken
to numerous professional and business organizations on the topic of helping
to prepare a business for sale. Mr. May is a prior or current Chairman of the:
Securities & Business Law Section Council of the Illinois State Bar, Chicago
Bar Association (CBA) Business Law Committee, and CBA Mergers and
Acquisitions Committee and a member of the American Bar Association. He
served six years on the MBBI board of directors.
Markus May
May Law Firm Ltd.
400 E. Diehl Rd. Suite 130
Naperville, IL 60563
630-864-1003
[email protected]
www.illinois-business-lawyer.com
Jeff Smiejek, CPA, CVA, CEPA
Tom Meyer