Preparing Your Company for SaleMarch 23, 2010

Agenda• 7:15 – 7:45 – Breakfast and Networking

• 7:45 – Introduction and Welcome▫ Merritt Green, Managing Partner, General Counsel, P.C.

• 7:50 – 8:45 – Program Panel▫ Braun Jones, Partner, WWC Capital Group, LLC▫ Kevin Learned, Chair, Corporate Practice Group,

General Counsel, P.C.

• 8:45 – 9:00 – Q&A

I. The Essence of Value

II. Maximizing Value

III. Preparing for Due Diligence

IV. M&A Process

Contents

I. The Essence of Value

Four Primary Valuation Methods• Asset-Based Methods

▫ (unusual in M&A, unless liquidation)

• Marketplace Methods▫ M&A methods (comparable transactions) ▫ Guideline public companies

• Income Methods▫ Discounted (or capitalization of) cash flows

• Rules of Thumb

The Essence of Value Value Defined

Value can be defined as a risk-adjusted benefit

ValueBenefit

Risk=

The Essence of Value Value Defined (cont.)

Time Value of Money plus Risk

ValueCash Flows

Expected Return

=

Forward looking

The Essence of Value Value Creation

The key to value creation is to identify those strategies that most effectively:

• improve net cash flows and/or • reduce risk

Value creation is a function of the company’s growth potential (revenues, profits, and capital base) and its ability to earn a return on invested capital above its cost of capital

The Essence of Value Multiples, ROI, and Risk

Risk quantifies the likelihood of achieving less than expected returns.It can also be thought of as the time you are willing to wait to get your investment back

Return on Investment Multiple Years

12.5% 8.0X 8.0

20% 5.0X 5.0

40% 2.5X 2.5

The Essence of Value Buyer’s Perspective

Buyers evaluate businesses as to their risk factors and expectations of future earnings

• Historical earnings• Growth prospects for business and industry• Depth of management• Employee stability• Terms of sale• Competition• Location and facilities

Perspectives on Value• Fair Market Value: An

appraiser’s formal valuation (normally for legal or IRS purposes)

• Investment or strategic value (beauty is in the eye of the beholder)

• Dynamic valuation (effective auctions)

$0

$10

$20

$30

$40

$50

$60

$70

$80

Total AcquisitionValuation (millions)

Dynamic

Strategic

Fair Market

Normalization Adjustments• Track adjustments and present them clearly

• Main types of normalization adjustments:▫ Non-recurring revenues/expenses▫ Discretionary/personal expenses▫ Owners salaries (if not indicative of market rates)▫ Unusual accounting methods▫ Rent (if not indicative of market rates)

• Have back-up schedules where needed

How Do You Normalize Earnings?

Reported net taxable income 1,000,000$

Adjustements:

Add back excess owner's salary 600,000$

Add back interest expense 50,000$

Add non-recurring expenses 350,000$

Normalized EBIT 2,000,000$

5x multiple on earnings = $10M valuation

What about the Balance Sheet?

Company A▫ $10M Revenue▫ $1M Earnings▫ 5x Earnings Multiple▫ $5M Valuation▫ No Debt▫ Sales Price = $5M▫ Equity Value = $5M

Company B▫ $10M Revenue▫ $1M Earnings▫ 5x Earnings Multiple▫ $5M Valuation▫ $1M Debt▫ Sales Price = $4M▫ Equity Value = $4M

“Enterprise Value” is $5 million for both

II. How to Maximize Value

Value Drivers What Drives Business Value?

• Quality of Revenues• Financial Performance • A Strong Balance Sheet• Management Team’s Depth and Experience• Quality of Assets (tangible and intangible)• Intellectual Property• Proprietary Information and Processes (competitive

advantage)• Growth History and Potential (business / market)• Quality and Uniqueness of People, Products, & Services• Favorable Economic & Industry Conditions

Risk Drivers What Drives Business Risk?

• Lack of Customer Diversification

• Contingent Liabilities• Inexperienced

Management Team• Lack of Management

Depth• Poorly Maintained Assets• High Operating Costs• Frequent Contract

Renewals (bidding)

• High employee turnover• High Financing Costs• Weak Accounting

Systems, Record Keeping, and Controls

• Poor Visibility, Small Backlog

• Litigation Exposure (Health Hazards, Environmental, Tax, Compliance, etc.)

The Value Enhancement ProcessValue Building Map

Principals Plans People Processes Metrics Improvements Rewards Average

Top Management 9 4 9 4 2 2 8 5.4

Sales 5 6 4 5 3 3 8 4.9

Marketing 6 7 7 7 7 6 7 6.7

Engineering 10 10 9 9 9 8 8 9.0

Operations 8 7 7 7 6 7 3 6.4

Human Resources 6 6 6 6 3 3 3 4.7

Finance 6 6 6 8 2 3 3 4.9

Average 7.1 6.6 6.9 6.6 4.6 4.6 5.7

Ratings 1-2 Real problems here 3-4 Performing below par 5-6 Acceptable, but not stellar 7-8 Good, with room for improvement 9-10 Performing well

Sales• Sales lead and pipeline tracking• Improve customer satisfaction• CRM or other automation• Proprietary methods (e.g., training

programs, follow-up, etc.)• Order processing automation• Problem resolution• Supervision

Marketing• ROI analysis• Customer surveys• Market driven product development,

refinement• Build corporate identity/brand• Public relations• Social network marketing initiatives• Proposal development• Market segmentation or other

research 

Finance• Improve reporting systems• Financial dashboard• Improve cash flow, liquidity• Reduce operating, overhead costs• Detailed projections with backlog and

pipeline• Improve collections• Proprietary procurement procedures• Improve ROIC Human Resources• Lower turnover• Develop job descriptions• Conduct regular performance reviews• Create effective incentive programs• Proprietary recruiting methods• Training• Compensation reviews, committees• Formal grievance process

The Value Enhancement ProcessStrategic and Process Initiatives – Track and Improve

Business Owner Considerations

• Plan for exit• How important is the CEO/owner• Who are the key employees – are they properly incentivized• Who has the key relationships with customers• Are there management gaps• Value-based strategy• Insurance, risk exposure• Tax, investment, and estate planning (business and personal)

What else is important to enhance value?

Top 10 Seller Mistakes

1. Overestimating or underestimating value

2. Trying to time the market or selling at the peak

3. Failing to plan for taxes and estate

4. Focusing on price and not terms

5. Failing to take a buyer’s perspective

6. Failing to lock-in key personnel

7. Keeping poor accounting records

8. Failing to seek professional assistance

9. Underestimating the required time and complexity of issues

10.Waiting too long – not selling into positive momentum

IV. Preparing for Due Diligence

Preparing for Due DiligenceDon’t Wait for the Buyer

• Accounting• Taxes• State Registrations• Ownership• Governance• Contracts• Affiliated Transactions• Employees/Contractors• Intellectual Property• Contingent Liabilities

AccountingBalance the Books

• Accounting Systems and Controls

• Audited Financials

▫ Buyers Will Require

▫ Identify and Resolve Issues

▫ Through Recent Calendar Quarter

▫ Consider Auditing Up to Three Years Back

• Be Prepared for Recent Financials to be Reviewed

• Track Normalization Adjustments

TaxesGet Current with Uncle Sam

• Income• Sales and Use• Employee/Payroll• Property• Franchise

State RegistrationsAre You Qualified?

• Obtain a Good Standing Certificate

▫ Place of Formation

▫ Other States Where Qualified• Qualify Where Doing Business

▫ Location of Contract Performance

▫ Generating Sales/Income

▫ Generally, Not Mere Solicitation

OwnershipAvoid Loose Ends

• Update Stock Ledger and Capitalization Table• Document All Equity Issuances and Transfers• Document All Incentive Compensation• Clean-up Unwanted Transactions

▫ Transfers in Violation of S Corp Restrictions

▫ Issuances with Negative Tax Implications

▫ Transfers/Issuances in Violation of 51% Ownership Requirements

GovernanceYou are Selling a Real Company

• Make Sure Your Organizational Documents are Updated• Conduct Regular Board Meetings• Conduct Annual Shareholder Meetings• Adopt Current Resolutions Appointing Directors and

Officers

ContractsIs Everything Updated?

• Are Expired Contracts Continuing?• Amendments, Work Orders, etc.• Identify Contracts That Require Notice or Consent• Identify Contracts with Other Transfer Restrictions

▫ Set-aside Restrictions• Contracts Currently Being Negotiated

▫ Look Ahead to a Sale

• Terminated Contracts

Affiliated TransactionsKeep Everything Separate

• Document Agreements Between the Company and Owners or Affiliates

▫ Loans

▫ Leases/Subleases

▫ Shared Services

▫ Intercompany Transfers• De-Personalize the Company

Employees/ContractorsLock Down Your Team

• Employment Agreements with Key Employees

▫ Non-competition and Non-solicitation provisions

▫ Change of Control Bonuses• Incentivize Employees to Stay with the Company

▫ Limit Concerns with Transition

▫ Keep Focus on Business Operations• Well-drafted Independent Contractor Agreements• Human Resources/Immigration Audit

Intellectual PropertyDo You Own It?

• Work for Hire• Assignment of Inventions• Patents• Trademarks• IP Audit

Contingent LiabilitiesResolve Disputes

• Pending or Threatened Litigation• Engage Competent Counsel• Determine Amount in Dispute

IV. The M&A Process

Assembling the Team• Owners and key managers

• Attorneys (w/ specific M&A experience)

• Accountants (before-the-fact clean-up and after-the-fact compliance, tax specialists)

• Investment bankers (valuation, marketing, process, and negotiation experts)

• Estate planning and/or financial planning professionals

The M&A Deal ProcessPhase I

PreparationPhase II

MarketingPhase III

EvaluationPhase IV

Consummation

Establish transaction objectives and parameters

Create a potential

acquirer/partner list

Draft Confidential

Information Memorandum

Preparing for Due Diligence

Contact prospective acquirers/ partners

Narrow the potential acquirer/ partner list

Answer initial information requests

Schedule management presentations

Solicit 1st round indications of interest

Preliminary due diligence deliveries

Provide additional financial and operational information, as appropriate

Request best and final offers

Evaluate offers and select acquirer / partner

Negotiate letters of intent

Complete due diligence deliveries

Facilitate completion of the documentation

Close transaction

Assist with financial risk minimization

Seller’s Advantage Curve

Buyer

Seller

ManagementPresentation

Multiple Offers LOI Negotiations Exclusivity to Buyer Closing

Kevin R. LearnedGeneral Counsel, P.C.6862 Elm Street, Suite 800McLean, Virginia 22101p: (703) 226-2713e: klearned@generalcounsellaw.com

Questions?

Wm. Braun Jones, IIIWWC Capital Group, LLC 11911 Freedom Drive, Suite 1010 Reston, Virginia 20190 p: (703) 995 2175 e: bjones@wwccapital.com