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Explore best practices for business perpetuation.
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suc·ces·sion the process by which this happens: the act of getting a title or right after the person who had that title or right before they died or is no longer able or allowed to have it
to make or cause to last indefinitely.
per·pet·u·ate
Why does this matter? at some point the ownership is going to change to somebody …
Why is this hot ?
We’ve been
Hunkered down
There’s cash Buyers out there
You’re more confident
your future
Nobody said it was easy.
But why does it have to
be so hard?
wicked[ real ]ONLY PROBLEMS ARE4
PROBLEMS
• It’s emotional • It’s private • It’s change • It’s risky • It’s scary
Opportunity Exciting Rewarding
What would you like to
get out of today?
SUCCESSION PLANNING & BUSINESS VALUATION POST RECESSION
2014
HOUSEKEEPING
• Slide deck will be posted on hni.com
• Moderated Q&A at the end, but feel free to ask questions throughout
• Tweet @HNIRisk or using the
hashtag #hniu to win some HNI swag!
Thanks to our sponsors!
GUEST SPEAKERS
JOHN SIKORAPartner at Weiss Berzowski Brady LLP
TOM BAYERPartner at Sikich LLP
CATHY DURHAMShareholder at Capitol Valuation Group
GUEST SPEAKERS
JOHN SIKORAPartner at Weiss Berzowski Brady LLP
TOM BAYERPartner at Sikich LLP
CATHY DURHAMShareholder at Capitol Valuation Group
In Sheboygan:(920) 452-8250
In Green Bay:(920) 437-3702
6In Madison:
(608) 257-2757
Succession Planning & Business Planning Post-Recession
--Understanding and Increasing Business Value--
Cathy J. Durham, ASA
HNI
June 16, 2014
In Sheboygan:(920) 452-8250
In Green Bay:(920) 437-3702
7In Madison:
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Just Thinking……
• Baby Boomers—1946 to 1964• Business Owner’s Thoughts on Business
Value• Consider employment but not investment• Value typically overstated• Opportunity to impact value• Not driven by outside data
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Is it Transferrable?
vs.
Year 1 Year 15
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The Transferable Business Has Two Key Characteristics
• It is not dependent on a specific individual with skills or relationships that cannot be transferred.
• The business generates sufficient cash flow for BOTH market compensation and return on investment.
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S So….what’s my value?
Every business has more than one value based on:
– Valuation Date– Valuation Purpose– Characterization of the Buyer
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11In Madison:
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Prospect Ranking ChartBuyers of a Business Enterprise
Highest Enterprise Value9 Strategically Positioned Businesses8 Diversifying Businesses7 Competing Businesses6 ESOPs5 Outside Investors/Managers4 Insider Management Group3 Diversified Passive Investors2 Investor/Job Seeker1 Undiversified Passive Investors
Lowest Enterprise Value
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What about……
• Those handy rules of thumb?–Multiple of Revenue?–Multiple of EBIT?–Multiple of EBITDA?
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ABC v. XYZ Company4.35 x EBITDA
• ABC Company– High employee turnover– 26% of revenues from one
customer– No contracts for future
work– Facilities at capacity– Contracts do not allow for
surcharges– New competitor just came
to town
• XYZ Company– Low-no employee turnover– 4% of revenues from one
customer– Contracts in place for
future work– Facilities at 60% of
capacity– Contracts do allow for
surcharges– Competitive landscape
unchanged
In Sheboygan:(920) 452-8250
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14In Madison:
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What is “value”?
Value today is the present value of future economic benefits
Need history and current business plan to project future cash flows
Need to understand risks and opportunities the business faces Discount rate
Cash flows are converted to present value using capitalization rate or discount rate
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Analyzing the Business Enterprise
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Business Valuation Approaches
Income Approach
Market Approach
Asset Approach
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Balance Sheet Adjustment To RestatedAs Reported Market Value Balance Sheet
Cash 50,000$ 50,000$ Accounts Receivable 200,000 (25,000) 175,000 Inventory 450,000 (50,000) 400,000
Plant & Equipment 750,000 1,000,000 1,750,000
Land 250,000 1,000,000 1,250,000
TOTAL ASSETS 1,700,000 1,925,000 3,625,000
Accounts Payable 100,000 100,000
Interest-Bearing Debt 500,000 500,000
Built-In Capital Gain Tax 350,000 350,000 -
TOTAL LIABILITIES 600,000 950,000 -
NET EQUITY 1,100,000$ 1,575,000$ 2,675,000$
Asset Approach to ValueAsset Approach to Value
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Market ApproachAre there any comparable transactions whose data we could apply to our subject company?
Guideline public companies
Comparable private transactions
Prior transactions in the subject company
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Income ApproachTwo methods—
• Capitalization of earnings—only if future will look like most recent year(s)
• Discounted future cash flows—most detailed method for reflecting the specific company’s expected future
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Income Approach
Capitalization of Earnings
• Involves a numerator– A single number intended to represent the future economic
benefit
• Involves a denominator– Represents the rate of return required by the investor
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Step 1
• Identify the numerator….
ONE number that represents the future economic benefit for a business
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Normalizing the Income Statement
As Reported Adjustments Normalized
Revenues 7,600,000$ 7,600,000$
Cost of Goods Sold 6,080,000 6,080,000
Gross Profit 1,520,000 1,520,000
Operating Expenses Payroll 860,000 (100,000) 760,000 Payroll Taxes 77,400 (9,000) 68,400 Rent 68,000 (30,000) 38,000 Utilities 12,000 12,000 Telephone 12,000 12,000 Professional Fees 62,000 (28,000) 34,000 Interest Expense 12,000 12,000 Depreciation 24,000 24,000Total Operating Expenses 1,127,400 (167,000) 960,400
Net Income 392,600$ 559,600$ EBITDA 428,600$ 595,600$
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Step 2
• Determine the denominator….
Represents rate of return required by the investor for the particular investment
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Developing Equity Capitalization Rate
Risk Free Rate 3.00Equity Risk Premium 5.73Industry Risk Premium .59Size Premium 9.53Specific Company Risk 4.00Total Expected Return 22.85
Less long-term growth (3.00)
Capitalization Rate 19.85
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Capitalizing Historical Earnings
As Reported Adjustments Normalized
Revenues 7,600,000$ 7,600,000$
Cost of Goods Sold 6,080,000 6,080,000
Gross Profit 1,520,000 1,520,000
Operating Expenses Payroll 860,000 (100,000) 760,000 Payroll Taxes 77,400 (9,000) 68,400 Rent 68,000 (30,000) 38,000 Utilities 12,000 12,000 Telephone 12,000 12,000 Professional Fees 62,000 (28,000) 34,000 Interest Expense 12,000 12,000 Depreciation 24,000 24,000Total Operating Expenses 1,127,400 (167,000) 960,400
Net Income 392,600$ 559,600$ EBITDA 428,600$ 595,600$
Capitalization of Net IncomeAdjusted Net Income 559,600$ Divided by Capitalization Rate 19.85%Equity Value 2,819,144$
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Discounted Cash Flow Method
Where the rubber meets the road in business valuation
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Discounted Cash Flow ProjectionsProjections
Normalized Year 1 Year 2 Year 3Base
Revenues 7,600,000$ 7,828,000 8,162,840 8,407,725Cost of Goods Sold 6,080,000 6,262,400 6,450,272 6,643,780Gross Profit 1,520,000 1,565,600 1,712,568 1,763,945
Operating ExpensesPayroll 760,000 782,800 856,284 881,973Payroll Taxes 68,400 70,452 77,066 79,378Rent 38,000 39,140 40,314 61,524Utilities 12,000 12,360 12,731 13,113Telephone 12,000 12,360 12,731 13,113Professional Fees 34,000 35,020 36,071 37,153Interest Expense 12,000 12,360 12,731 13,113Depreciation 24,000 24,720 25,462 26,225
Total Operating Expenses 960,400 989,212 1,073,388 1,125,590
Net Income 559,600$ 576,388$ 639,180$ 638,355$ Change from Prior Year 3.00% 10.89% -0.13%EBIT 571,600$ 588,748$ 651,910$ 651,468$
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The Conclusion: Discounted Cash Flow Projections
ProjectionsYear 1 Year 2 Year 3
Calculation of Cash FlowEBIT 588,748 651,910 651,468Plus Depreciation 24,720 25,462 26,225Change in Working Cap. (35,000) (35,000) (35,000)
Cash Flows from Operations 578,468 642,372 642,693
Capital Expenditures (20,000) (20,000) (20,000)Cash Flow to Investors 558,468 622,372 622,693Change 11.4%
WACC 16.51%479,331$ 458,483$ 393,717$
PV of CF to D&E Investors 1,331,531$
Perpetuity 4,747,402Present Value of Perpetuity 3,001,694
Total PV of Invested Capital 4,333,225Less Interest Bearing Debt ( 900,000)
Equity Value 3,433,225$
In Sheboygan:(920) 452-8250
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29In Madison:
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So Why Doesn’t…..
Value = Price???
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Bargaining Position: The Fulcrum of Price
• Value does not equal price• What is the motivation of the buyer?• What is the motivation of the seller?
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How You’ll Leave Your Business1. Transfer the company to a family member
2. Sell the business to one or more key employees
3. Sell to key employees using an Employee Stock Ownership Plan (ESOP)
4. Sell the business to one or more co-owners
5. Sell to an outside third party
6. Engage in an Initial Public Offering
7. Retain ownership but become a passive owner
8. Liquidate
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Increasing Value
Must Either….»increase cash flows»decrease risk»increase future opportunity
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Pay Attention to Gross Profit Margin
• Impact of 1% improvement in Gross Profit
• Understanding why the margin is changing and manage to protect margin:
• Increased material costs? • Change in company’s product mix?• Changing labor expense?• Changing freight expense?• Negotiated lower costs (or favorable terms) for products?
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Credible and Consistent Financial Statements
Buyers need to have confidence in the company’s financial reporting
• Settle on a chart of accounts and keep it consistent for 3-5 years• Market Rent and Market Compensation• Hire an outside accounting firm—compiled, reviewed, audited• Income Statement provides evidence of a company’s ongoing flow
of business• Balance Sheet is the foundation upon which most companies stand
– it should be solid (no Non-Operating Assets)
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Top 10 Items NOT to have on a Balance Sheet
1. The Family Farm2. Timberlands & Wetlands3. Unrelated Businesses4. Private Equity Investments5. Vacation Homes6. Historical Resorts7. Rental Houses8. Apartment buildings, Strip Shopping Centers and Office Buildings9. Art10.Loans to Shareholders
In Madison:(608) 257-2757
In Sheboygan:(920) 452-8250
In Green Bay:(920) 437-3702
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Get Problems Resolved
• Litigation
• Problem Projects/Jobs
• Environmental Concerns
• Employee Issues
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Stop Tax Planning
• Report all revenues and expenses when they occur
• Business vs. Personal Expenses»Tax experts estimate you will lose $3-6 in a
sale for every dollar claimed as a Business Expense
• Eliminate owner perks
In Madison:(608) 257-2757
In Sheboygan:(920) 452-8250
In Green Bay:(920) 437-3702
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Workforce Development
Buyers look for companies where employees are knowledgeable and committed to the strategic direction outlined by management
• Hire the best talent• Train, document, train• Delegate, delegate, delegate• Determine what that talent wants• Healthy culture – the intangible asset of “good attitudes” can be
surprisingly valuable • Put verbal contracts with key employees in writing
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In Sheboygan:(920) 452-8250
In Green Bay:(920) 437-3702
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Keep Re-investing
• Invest in R&D to continually update and improve product and service lines (to gain additional or new markets share)
• Invest in Technology
• Invest in Capital Expenditures
• Consumable products – possible repeat customers
• Extending/Continuing existing customer relationships—extending maintenance contracts/warranty
In Madison:(608) 257-2757
In Sheboygan:(920) 452-8250
In Green Bay:(920) 437-3702
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Owner’s Exit Exam
1. Are the company’s processes documented?2. What is the quality of the company’s books and
records?3. What is the condition of the company’s
facilities?4. Has the company’s strategic vision been
adopted by staff?5. Does the company have customer or supplier
concentrations?
In Madison:(608) 257-2757
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41In Madison:
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“If you don’t know the value of your company, I’ll steal it from you and it will be ethical, legal and moral.
If you know the value of your company and can justify it, I’ll be perfectly happy to pay every nickel of it.”
--Warren Buffett
In Sheboygan:(920) 452-8250
In Green Bay:(920) 437-3702
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Cathy J. DurhamPresident
Capital Valuation Group, [email protected]
608-257-2757Website: www.capvalgroup.com
In Madison:(608) 257-2757
GUEST SPEAKERS
JOHN SIKORAPartner at Weiss Berzowski Brady LLP
TOM BAYERPartner at Sikich LLP
CATHY DURHAMShareholder at Capitol Valuation Group
Identifying and Vetting Buyers for Your Business
Presented By Tom Bayer, CPA, CExPPartner, Springfield, Illinois Office
4 Topics Today
» Selling to Internal Management Group
» Transitioning Away From Family Ownership
» Pros and Cons of an ESOP
» Loss of a Key Employee
Selling to an Internal Management Group»An “insider” sale answers one of the Big
3 questions we always ask:1. Who – who is the Buyer?2. How Much – How much do you need
in retirement?3. When – What is your timeframe?
Selling to an Internal Management Group
»General attributes of an internal management group»Lack financial resources»Lack understanding of risk»Lack understanding of cash flow »Expect more
Selling to an Internal Management Group»General attributes of current ownership»Quality of life is increasingly more important»Standard of living is high»Significant portion of their current cash flow is
from business assets»Significant portion of their personal wealth is
tied up in business assets»They have taken a lot of risk
» Software sales – represented technology used in professional services, government
» 3 key employees given opportunity to own business» Owner Age 65
STRATEGY EMPLOYED:» 3 key employees offered deferred compensation plans with rolling
vesting.» Convertible to equity after 5 years.» Growth in deferred comp based on increase in value – determined
by formula» Corporate Owned Life Insurance (COLI) purchased as a funding
mechanism for deferred comp as well as to create liquidity for family in event of death
Selling to an Internal Management Group – Case Study
Selling to an Internal Management Group – 5 keys to success
»Sustainable revenue stream for exiting owners
»Necessary skill sets must remain
»Legal protections – noncompetes, compensation agreements, real estate leases
»New owners must be financially responsible and credit worthy for vendors, bank, other stakeholders
»Tax efficiency – find ways to make purchase price tax deductible for both parties
Transitioning Away from Family Ownership – Case Study
» Large Construction Company
» 3 key employees purchased some ownership – nonvoting stock
» Current majority owners both had different ideas for their children’s involvement – discovered during our initial assessment process
» Key employees expected to eventually have majority ownership and control – family members were not part of majority
» Nepotism issue became front and center and has now altered the path.
Transitioning Away from Family Ownership – common issues
» Family ownership includes both active family members and inactive family members
» Family legacy interferes with sound business decision making
» Next generation has enjoyed the spoils without the sweat –impacts their level of engagement in many cases
» Unwillingness to hire outside management team with appropriate qualifications
» Board of Directors is not separate from Family Council –these 2 entities are combined
Transitioning Away from Family Ownership – case study» Large Agribusiness – services and products to agriculture producers
in Iowa and Illinois
» Family owners – 1st generation owners split the business 5 ways –each brother and sister owned 20%.
» Each family unit would pass ownership down to next generation
» No plan for consolidating ownership.
» S Corp dividends of $3 mm per year
» 2nd generation – 21. 3rd generation – 70.
» Patriarch was content with status quo and assumed next generation would
» Son of patriarch believed that sale of the business would be his exit path, but didn’t want that legacy.
Transitioning away from family business - takeaway points» Develop a process to educate next generation on
protecting family wealth
» Seriously consider ceding management control through legal agreement, or, selling business
» Always segregate inactive family members from having voting control or indirect control through other legal agreement such as real estate lease or debt agreements
» Protect key non-family employees with golden parachute or other compensatory agreements
Pros and Cons of Employee Stock Ownership Plans» ESOP basics»Qualified Plan under ERISA – 401k plans are also
Qualified Plans» Investments within ESOP are primarily employer
securities» ESOP Trust purchase stock from stockholders – cash
proceeds to shareholders financed from business or debt» Tax benefits exist for owner and Company
Why do an ESOP – pros?» In certain fact pattern, ownership can transfer tax-free by following
rules» ESOP can provide additional rewards to employees and serve as a
retention and recruitment tool» Employee owners are more conscientious and focused on
increasing company value» Many studies have been done to prove that ESOP owned
companies are more profitable and increase in value at a faster rate
» Market for company stock created» Keeps ownership local » Fits best where revenue stream is consistent and there is not a lot of
volatility in business» S Corp owned by ESOP can be very powerful
» Percent of company owned by ESOP creates a permanent liability» Eg: Company with value of $10mm is 40% ESOP owned.
ESOP value is $4,000,000. Shares in ESOP are redeemed by retiring employees and recycled. ESOP continues to own 40%. As Company value grows, obligation of ESOP grows.
» Complex rules and laws create administrative costs and risk» Year end administration and valuation
» Business volatility creates value fluctuation which can impact morale» Retiring employees may suffer significant wealth loss if timing of
retirement is in a time of economic downturn» ESOP contributions can be burdensome on cash flow» Bankers and investment bankers are generally leery of ESOPs» Does not solve leadership issues – purely a financial strategy.
Why not an ESOP - cons?
Managing the Loss of a Key Person» What is the reason for the loss?» Death of key employee» Disability or other event that precludes them from working
(arrest, other health event, etc.)» Termination for whatever reason» Resignation
» What key skills or relationships need to be fulfilled?» In the case of an owner, is their a financial burden to the family?» In the case of an owner, are their vendors or customers or
financial backers such as banks or bonding companies that will be at risk?
» In the case of a key skill set that cannot be replaced internally, is there a contingency plan in place?
Managing the Loss of a Key Person» In the case of a resignation, understanding the Why» Is there recognition that key employees need to be compensated
for current efforts but also for future retirement security?» Are there family business issues?» Case Study: » Construction Company» $10mm in Revenue» Well compensated family members left business and started
up their own construction company using year-end bonuses to capitalize startup» Orchestrated exit over the course of 3 months and took
customers and jobs with them.» Why – family resentment for owner who was taking longer
vacations in winter; belief they could earn more on their own
Managing the Loss of a Key Person» Planning issues to consider for key employees» Compensation plans that include long-term compensation with
vesting schedules to encourage retention» Legal agreements to protect trade secrets, customers,
employees in the case of a hostile exit» Legal agreements to define other issues such as repurchase of
stock or other property from key employee» Consider financial burdens of various scenarios such as death,
disability and the need to repurchase stock, pay final settlements on deferred comp plans, or fund replacement costs such as search fees or signing bonuses for replacement employees
» Consider funding stay bonuses or other costs related to protecting the business value in time of transition
Summary – Identifying and Vetting Buyers for Your Business
» Remember we are focused on the “Who” – who is your Buyer?» General rules of thumb I have found» Businesses need to review the risks around key employees and
ensure they protect themselves to retain key employees» Larger businesses – measured in terms of transaction size – will
generally need outside investment to allow for an internal transfer in a reasonable timeframe.
» ESOPs need to be carefully vetted – get a feasibility study and find competent advisors that will provide the true pros and cons
» Family businesses need to develop transparency about their succession plans and build protections to ensure family issues do not interfere with sound business practices
» Succession planning is a process that requires periodic review and adjustment!
Thomas E. Bayer, CPA, CExP, CSPMPartner, Sikich LLP
3201 West White Oaks Drive, Suite 102Springfield, Illinois 62704
Phone: 217-862-1704Email: [email protected]
GUEST SPEAKERS
JOHN SIKORAPartner at Weiss Berzowski Brady LLP
TOM BAYERPartner at Sikich LLP
CATHY DURHAMShareholder at Capitol Valuation Group
Succession Planning & Business Valuation
Post-Recession
John A. Sikora
HNI UniversityJune 16, 2014
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• What is it?
• Agreement that controls the transfer of ownership interests upon the occurrence of potential, uncertain events affecting or relating to a member of the ownership group, although on occasion the applicable event might be one affecting or relating to others
• Sometimes referred to as redemption or cross-purchase agreement, which is descriptive of type
66
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• “Triggering events”; common examples:
• Owner desire to sell
• Death
• Disability
• Retirement
• Termination of employment
• Tailored
• So, agreement identifies potential or actual buyer for business interests in (for the most part) “unplanned” situations
67
Identifying Buyers for Your Business-
The Buy-Sell Agreement• Big picture
• Closely held environment – important part of any succession plan
• Key – It is an agreement• Thus, as among significant owners, its typically
negotiated; for new owners, often not, and becoming a party is frequently a condition of invitation to ownership
• Like a will or other personal succession instrument, buy-sell agreement requires periodic attention, and potential modification in light of changing circumstances
68
Identifying Buyers for Your Business-
The Buy-Sell Agreement• “Watch outs”; Buy-sell terms residing in:
• Organizational documents
• Bylaws or like documents
• Minutes
• Title instruments
• Employment agreements
• Subscription agreements
• Other documents/statutory provisions
69
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Importance/purpose of buy-sell agreement – to “protect”:
• Triggering event owner and his/her/its successors
• Other owners
• Business
• All of the above
• Valuable ancillary benefit of process can be to bring focus to long term goals and objectives of owners and prompt business planning discussions
70
Identifying Buyers for Your Business-
The Buy-Sell Agreement• Protects the “triggering event” owner and his/her/its
successors - continued
• Provides equitable outcome for owner or successor at time at which leverage likely lacking
• Creates market for ownership interest
▫ There is usually no ready market for the closely held business interest
▫ Even if such a market exists, the occurrence of the applicable triggering event may adversely affect the ability or leverage to sell or to sell at acceptable price
71
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Protects the “triggering event” owner and his/her/its successors - continued
• Provides certainty
▫ Imposes contractual obligations to sell and to purchase
▫ Imposes contractual conditions to sale and time parameters for sale
▫ Establishes price or mechanism for establishing price
▫ Establishes payment terms
▫ Provides instruments under which closing of transaction will occur
72
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Protects the “triggering event” owner and his/her/its successors - continued
• Promotes fairness and perception of fairness
▫ Triggering event owner will have been party to negotiation resulting in buy-sell agreement
▫ Such negotiation will have occurred when parties not adverse (or at least not as adverse as at time of a triggering event)
▫ Such negotiation will have been “deliberate”
73
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Protects triggering event owner and his/her/its successors - continued
• Provides opportunity to educate successors regarding financial expectations/burdens
• Provides opportunity for planning regarding tax treatment of buy out
74
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Protects the other owners
• Provides obstacle to potentially “unwanted” ownership
▫ Strangers
▫ Successors (e.g., family members; estates; trusts)
▫ “Disqualifiers” (e.g., parties that cannot be owners with respect to certain entities)
▫ Other
75
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Protects the other owners – continued
• Promotes perception of fairness/confidence in organization/retention
▫ Direct or indirect purchaser will have been party to “non-adverse” negotiation resulting in buy-sell obligations arising upon triggering event
▫ Or, if not party to negotiations, because owner is newer owner, he/she/it had opportunity to evaluate buy-sell agreement at the time he/she/it acquired interests
76
Identifying Buyers for Your Business-
The Buy-Sell Agreement• Protects the other owners - continued
• Provides certainty ▫ Imposes contractual obligations to sell and to
purchase▫ Imposes contractual conditions to sale and
time parameters for sale▫ Establishes price or mechanism for
establishing price▫ Establishes payment terms▫ Provides instruments under which closing of
transaction will occur▫ Provides contractual enforcement mechanism
77
Identifying Buyers for Your Business-
The Buy-Sell Agreement• Protects the other owners – continued
• Promotes planning by others with respect to buy out of ownership interests, with respect to:
▫ Cash needs
▫ Potential insurance
▫ Banking/restrictive covenants/other documents to which potential parties are bound
▫ Tax treatment of buy out
▫ Other
78
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Promotes the business or enterprise• At the front end, satisfactory agreement is a
factor that facilitates business acquisitions and combinations
• Example - deals in which seller leaves part of its equity in the enterprise are not uncommon; such sellers, having lost control of business enterprise, want buy-sell protection
• Example – constituents participating in formation of new enterprise by contribution of property or services typically want buy-sell protection
79
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Protects the business• Reduces risk of “forced” sale
• Promotes orderly disposition/discourages disruption at potentially difficult time
• Promotes planning regarding “mechanics” of potential purchase transactions – e.g., funding, including insurance arrangements; tax treatment
• Promotes management continuity, succession planning
80
Identifying Buyers for Your Business-
The Buy-Sell Agreement• Protects some or all of the above; agreements may
include other provisions such as:
• Solomon’s choice trigger
• Come along rights
• Bring along rights
• Inclusion of governance provisions
• Modification of statutory provisions
• Distribution rights
• Other
81
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Protects some or all of the above – continued
• Often vehicle that promotes business planning discussion among owners regarding related and unrelated issues
• Because consideration of triggering events promotes wearing hat of business seller or buyer; promotes looking at future; promotes consideration of variety of things that may follow if any of the triggering events occurs; promotes examination of goals and objectives
82
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Some common issues relating to sale/purchase provisions - continued
• Should the buy out be mandatory or optional?; if optional, in favor of which party?
• Death usually mandatory
• Others typically negotiable
83
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Some common issues relating to sale/purchase provisions – continued
• Purchase price▫ Book value▫ Book value with adjustments▫ Formula▫ Annual agreement (with appraisal or other
method if no agreement)▫ Appraisal▫ Adjustments/hybrids, perhaps based on trigger▫ Other
84
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Some common issues relating to sale/purchase provisions – continued
• Appraisal provision
• Selection terms
• Guidance
▫ Meaning of fair market value
▫ Share of enterprise value?
▫ Discounts, premiums, adjustments?
85
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Some common issues relating to sale/purchase provisions – continued
• Valuation date
• End of a year
• End of a month
• Date of triggering event
• Other
• Interim income/interim distribution rights
86
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Some common issues relating to sale/purchase provisions – continued
• Tax treatment of payments (typically pass throughs)
• Pass through entity cut offs
• Pass through entity tax treatment
87
Identifying Buyers for Your Business-
The Buy-Sell Agreement• Some common issues relating to sale/purchase
provisions – continued
• Often overlooked issue, or not adequately addressed - dealing with multiple entity structure or non-entity ownership of business assets
• Horizontal entity structures/various asset ownership situations common
• Should interest in all entities be purchased upon trigger?; if so, should basis for terms be same or different?; should options, other agreements be in effect?
88
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Some common issues relating to sale/purchase provisions – continued
• Parties – less than all an option?
• Non buy-sell matters may reside in documents
▫ Governance
▫ Employment/effort related matters
▫ Noncompetition/confidentiality matters
▫ Other
89
Identifying Buyers for Your Business-
The Buy-Sell Agreement
• Summary
• It is an important part of any succession plan in the closely held environment
• It is an agreement
• Its purpose may be to protect the interests of selling owners, buying owners, the entity, the business or some or all of the above
• It should receive periodic attention
90
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• Sale to external buyer – desired exit strategy for some• Particularly when there is:
• No natural (co-owner, employee, etc.) successor
• Or, lack of confidence in natural successor
• Or, lack of sufficient investment capital held by natural successor
• Or, desire to diversify investments
• Or, desire to otherwise reduce risk
• Or, desire to liquidate investment
• Or, desire to relocate
• Or, …
91
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• Isn’t any business “transferable”?; are those that are not
common?
• Aside from the unique personal service provider enterprise, businesses in which property, rights, seller promises or capital is or could be an income producing factor will be transferable, at some price, in some “structure” and on some terms
• Question will be whether that price, that structure and those terms are acceptable
92
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• What can be done to make a truly “nontransferable”
business “transferable”?
• Little or some
• Depends on whether the unique service provider is willing to be employed by the buyer
• Does an owner of such a business really expect to make is transferable?
93
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• Finding external buyers requires evaluation of the
business with respect to areas, issues and factors that affect buyer interest
• Helpful to discuss those areas, issues and factors in the context of the common characterization of buyers as either financial buyers or strategic ones (though the line often blurs)
• The matters all potential buyers consider overlap, but the points of emphasis of these two categories of buyers differ
94
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• For the financial buyer, its about earnings and
projections
• What do the historical financials look like?
• What do projections look like?
• What can buyer do or cause to positively affect financial performance of the business, and improve projected return?
• Can that be accomplished in a relatively short period of time?
95
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• And, for it, can the business operate on its own to meet
those objectives?; how strong are:
• Management team
• Sales, customer service and related functions
• Support functions
• Production abilities
• Other
96
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• And, for it, what factors make achieving those objectives possible
or a risk? E.g.:
• Industry outlook
• Regional outlook
• Whether business enjoys competitive advantages in its industry, whether those will continue and whether those can be enhanced
• Customer issues (concentration, customer contracts, etc.)
• Supplier/vendor issues
• Employee issues
• Other
97
In Sheboygan:(920) 452-8250
In Green Bay:(920) 437-3702
98In Madison:
(608) 257-2757
STOP
Is the business actually a transferable entity, or is it a career with the
“tools of the trade”?
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• Private equity
• Purchase of entire business
• Transaction in which it becomes majority owner of business
• Common structures
• The debt issue
• What the future may hold for those who remain involved in business after closing
99
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• For the strategic buyer, the analysis asks how the target will
integrate into and improve its current company/business; its about “synergies”; will the acquisition:
• Provide product or service lines that would be attractive to buyer’s customers?
• Provide access to additional customers for buyer’s products and services?
• Provide entry to new regions?
• Provide increased production capabilities?; produce production or other economies of scale?; allow use of buyer excess capacity?
100
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• For the strategic buyer, the analysis asks how the target
will integrate into and improve its current company/business; its all about “synergies”; will the acquisition:
• Provide access to desirable IP?
• Eliminate or inhibit competition?
• Provide easier access to needed, desirable labor pool?
• Bring some function “in house”?
101
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers
• Strategic buyer somewhat less concerned than financial buyer regarding:
• What the historical financials look like
• What seller projections look like
• Whether the business can effectively operate as a stand alone, as some part of various functions likely to be eliminated upon or shortly after closing
102
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• Strategic buyers may include:
• Competitors
• Same industry participants
• Related industry participants
• Customers
• Suppliers/vendors
103
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• Nature of potential buyers matter when planning for the
potential sale of the business and solicitation of potential buyers
• Because it affects current behavior if external sale is objective
• Examples/how will the following affect sale opportunities:
• New product development/R&D expenditures• Equipment and other purchases• Hiring plans and decisions• Expansion• Other
104
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• What will all potential buyers examine (each of which has
important implications for sale planning)?
• Financial statements; and “trustworthiness” of F/S; accounting methods and practices
• Organizational and governance instruments; compliance with same
• Legal qualifications to conduct the business
• Service/vendor contracts; length, dollar amount, benefit, market competitiveness, assignability, enforceability
• Customer contracts; length, dollar amount, benefit, market competitiveness, assignability, enforceability
• Working capital requirements
105
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• What will all potential buyers examine (each of which has
important implications for sale planning)?
• Applicable laws/permits/compliance with laws
• Litigation/potential litigation/potential disputes
• Product or service warranties/product liability issues
• Insurance coverages/sufficiency/survival
• Employee benefits/legal compliance
• Environmental laws/compliance
• Regulatory environment/compliance
• Intellectual property/compliance/potential disputes
106
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• What will all potential buyers examine (each of which has
important implications for sale planning)?
• Tax matters/compliance/surviving and successor liabilities
• Intellectual property/compliance/potential disputes
• Ownership of property
• Sufficiency of assets for business operation
• IP/ownership/rights
• Related party arrangements/contracts
107
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• What will all potential buyers examine (each of which
has important implications for sale planning)?
• Control of essential business assets/licenses/leases
• Inventory/levels/condition
• Equipment/condition
• Customer/identity/concentration/contracts
• Supplier/vendor matters
• Other
108
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• “Preparation” for potential external sale should start early;
sometimes influences business judgment in period long before transaction; E.g.:
• What contract terms should we be willing to accept?• How should we handle controversies?• How should our financial statements be prepared?• What employee benefits should we provide?• Should we expand?; add employees?• What steps should we take to protect our IP and trade
secrets?• What tax elections should we make?• Other
109
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• Expectation of external sale and desired time also has
implications regarding decisions such as:• Invitations to ownership
• Buy-sell agreement terms
• Lending matters
• Entity form – new products/new assets
• Tax affected “decisions”
▫ Entity form
▫ S elections
▫ Residency
• Other
110
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• If sale to external buyer is potential, wearing the
potential buyer’s “hat” and considering matters buyers will find of interest puts business in better position to address/capitalize on unanticipated/surprise event or opportunity; E.g.:
• Ownership death, disability, etc.• Unsolicited merger, acquisition (sale), acquisition
(purchase), expansion opportunity• Investor/lender situations• Other
111
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers
• Selling the business in parts or selling part of the business
• Sometimes best solution
• Sometimes only solution
• Sometimes effective part of long term succession plan
112
Identifying Buyers for Your Business-
What if business isn’t transferable?/
finding external buyers• Sources of sale opportunities/external parties:
• Competitor interactions
• Industry interactions
• Supplier/customer interactions
• Business broker community
• Other advisor “disciplines”
• Other
• Process• Strategic buyers
• Taking the business to market
113
John A. Sikora
Weiss Berzowski Brady LLP
400 Genesee Street, Delafield, WI 53018
700 North Water Street, Milwaukee, WI 53202
262-646-1528 (direct dial)
114
Q&A PANEL
JOHN SIKORAPartner at Weiss Berzowski Brady LLP
TOM BAYERPartner at Sikich LLP
CATHY DURHAMShareholder at Capitol Valuation Group
UPCOMING EVENTS
Recruiting the Next Generation of Talent in Transportation
July 16, 2014 - 10 AM CDT - Webinar
This HNI University workshop will explore challenges and opportunities with generational differences in the workplace and discuss strategies to become an employer of choice for Generation Y.