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PCE Investment Bankers

ESOP Market Update Winter 2013

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Table of Contents

Market Environment

ESOP Structures

ESOP News

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Market Environment

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Headlines

Approaching record levels on

S&P 500

Job growth

Partial resolution to fiscal

cliff

Debt ceiling fight part II

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Today’s Business Owner(s)

Business is performing

Valuations are at a reasonable level (see stock market)

Tax rates have likely increased – especially in a sale of the

business

Concerned with political climate

Personal diversification important

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Middle-Market M&A

Momentum from 2011 carried into 2012

Valuations for well performing companies remained strong

Volume of transactions compares to 2007

Credit markets were very active

Were 2013 transactions pulled into 2012?

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Quarterly M&A Activity (Q1 2010 – Q4 2012)

Source: CapitalIQ

2010: 6,680 deals 2011: 7,679 deals 2012: 7,783 deals

Q1 '10 Q2 '10 Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12

Transactions - $500MM - $1B 23 41 51 50 51 50 41 41 29 48 37 63

Transactions - $100MM - $500MM 157 175 215 237 210 243 238 221 211 225 198 247

Transactions - < $100MM 1346 1338 1411 1499 1529 1726 1607 1595 1583 1625 1641 1732

-

500

1,000

1,500

2,000

2,500

Transactions - < $100MM Transactions - $100MM - $500MM Transactions - $500MM - $1B

De

al

Vo

lum

e

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Source: CapitalIQ

Private Equity M&A (North America)

Q1 '10 Q2 '10 Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12

PE Value $20 $29 $36 $43 $39 $35 $37 $42 $32 $35 $40 $81

Total PE Transactions (Quarterly) 323 381 402 477 509 561 569 535 550 580 579 623

-

100

200

300

400

500

600

700

$-

$10

$20

$30

$40

$50

$60

$70

$80

$90

$ i

n b

illi

on

s

Deal Volume

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ESOP Market Today

The key factors for ESOP financing are positive

1. Financing is readily available at historically low rates

2. Company performance & valuations have improved

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The ESOP Market

ESOP Market divided into two general types of transactions

1. Shareholders who want liquidity New ESOPs Dividend to ESOPs Buyout of seller paper

2. ESOP Companies looking for capital to refinance or grow

Organic expansion Acquisitions

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Growth Capital

Existing ESOP companies in need of capital to grow are most attractive to capital sources

Experienced borrowers

Seasoned ESOP

Tax advantaged

Should borrow at lowest rates with best terms

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Growth Capital

In 2012 ESOP companies had an increase in institutional capital from private equity and other private funds to support:

Acquisitions

Geographic expansion

Vertical integration

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Liquidity Transactions

2012 was an active year for creation of new ESOPs:

Return of liquidity to the market

Uptick in valuations

Pent-up demand from liquidity crisis

Tax-driven transactions

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Stock sales to ESOP are expected to rise in 2013

Large number of owners sat on sidelines in 2012

Tax rate changes Income

Capital gains

Healthcare premium

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ESOP financing market has become more competitive

More entrants into senior market

Higher level of interest from alternative sources

Historically low rates (3-month LIBOR 0.31%)

Flexible loan structures (longer amortizations, better pricing)

Debt markets transitioning to a borrowers market

Highly dependent on successful track record

The bigger the better

Credit Market Update

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Alternative Lenders / Capital

Institution pools of capital to lend money to ESOPs Secured & unsecured term loans

Grew out of lack of senior debt in market

Debt that acts like equity

Underwriting Criteria Combination of asset based and cash flow

Security Interest Situational

Will take second lien on all assets; junior to the first lien lenders

Current Market Conditions Available to ESOP companies; $3MM+ in EBITDA

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Debt Multiples

Senior Debt Junior Debt Security

< $3MM of EBITDA 1.5-2.5x EBITDA

Less Available

Asset Based / Guarantees

>$3MM of EBITDA 2.0-3.0x 3.0-4.0x Asset Based / Cash-Flow

>$10 MM of EBITDA 3.0-4.0x 4.0-5.0x Cash Flow Based

Pricing Libor + 3-5 Senior +5-10

Debt market continues to be segmented by Company size

EBITDA thresholds have dropped slightly for better advance rates / terms

Additional refinement to pricing / terms & conditions based on industry and company specifics

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Deal Multiples

Median Implied Enterprise Value / EBITDA (North American Targets)

(As of 12/31/2012)

Sector 2010 2011 2012

Consumer Discretionary 11.33x 10.78x 9.60x

Consumer Staples 5.81x 10.79x 8.24x

Energy 10.96x 9.35x 6.21x

Financials 12.18x 13.17x 11.33x

Healthcare 12.03x 11.98x 10.50x

Industrials 6.19x 8.57x 8.08x

Information Technology 11.25x 12.02x 10.30x

Last Twelve Months Ending December 31st of:

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ESOP Structures

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Structure of ESOP Transactions

Accommodating finance markets open up structuring options for stock sales to ESOPs

In Out

1042 Tax Deferral Seller financing

Bank financing Acceleration of seller financing

Alternative financing Personal Guarantees

Partial transactions Redemptions

Non-recourse loans

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Return of the 1042 tax deferral

2012 2013 2013 w. 1042

Gain on Sale $20.0 $20.0 $20.0

Capital Gains Tax

(3.0) (4.0) -

Healthcare Tax - (0.8) -

Net Proceeds $17.0 $15.2 $20.0

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Return of the 1042 tax deferral

2012 2013 2013 w. 1042

Gain on Sale 100% 100% 100%

Capital Gains Tax

(15.0%) (20.0%) 0%

Healthcare Tax 0% (3.8%) 0%

Net Proceeds 85.0% 76.2% 100%

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1042 requirements:

Must be a or convert to C-corporation to qualify

Must sell stock directly to ESOP

ESOP must own at least 30% of company

Owners must have held stock for a minimum of 3 years

Reinvest in Qualified Replacement Property (QRP) – tax deferral for gain

15-month reinvestment window of proceeds

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What does the desire for deferring capital gains mean for ESOP structuring?

Increase in partial sales or staged ESOPs

Multiple classes of stock

Increase in sales to existing C-Corp ESOPs

Simplifies participation for institutional capital

Structuring to maximize tax advantages to Company

Opens up management incentive potential

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Reasons for the staged ESOP :

Allows for preferred class of stock

Management teams concerned about amount of debt

Valuations have room to improve

Partial ESOP provides flexibility into the future

Sell more to ESOP in the future

Sell entire Company in the future

Keep ESOP ownership at a minority position

Owners satisfied with partial diversification

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Terms and Conditions1

1Terms and conditions from HLHZ purchase agreement studies and PCE proprietary data

Strategic Financial ESOP

All Baskets 0.7% 0.8% 0.4%

Cap 12.0% 8.5% 8.0%

Survival Period 18 months 18 months 18 months

Escrow 8.3% 5.2% N/A

Escrow Period 18 15 N/A

Indemnifications as a percentage of purchase price

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Healthy M&A Activity

+ Active Financing Market

Healthy ESOP Market

Structuring options help mitigate tax increases

Fully valued transactions

Seller favorable reps and warranties

Meaningful liquidity & diversification

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Growth Capital

Institutional capital will show increased interest in ESOP companies in 2013

More varieties of capital open to ESOP owned companies

ESOPs have proven to be better investments than non-ESOP owned companies

Private equity has adapted to participate more actively in ESOP companies

All levels of debt active in ESOP companies

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Growth Capital

Different types of institutional investors want different things from investing in ESOPs

Senior debt

• Wants to be repaid • Earn spread over cost of funds

Uni-tranche

• Enhanced return on capital

Mezzanine / sub-debt

• Higher current return • Equity participation

Equity / Structured

Equity

• Growth • Equity returns

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Summary

ESOP market is healthy and active

Capital is available for ESOP company expansion and the creation of new ESOPs

New tax laws expected to drive additional ESOP activity through 2013

Expect capital markets to be more active in ESOP transactions than in 2012

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ESOP News

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ESOP Legislation

The election was mixed for ESOP advocates in Congress

The "Promotion and Expansion of Private Employee Ownership Act of 2011" (H.R. 1244/S. 1512) introduced in the House and the Senate would encourage and support the formation of S corporation ESOPs.

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ESOP Research

July 2012 - An Analysis of the Benefits S ESOPs Provide the U.S. Economy and Workforce (by Alex Brill)

Compliments previous Georgetown (2010) and Penn (2008) studies

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Questions?

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PCE ESOP Practice

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PCE Investment Bankers William A. Stewart, CFA

Will is a key member of PCE’s Employee Stock Ownership Plan (ESOP) practice, with experience in executing sales to ESOPs, ESOP feasibility studies and ESOP trustee & shareholder financial advisory services. Will is engaged in all aspects of PCE’s investment banking practice, including buy-side and sell-side mergers and acquisitions as well as private equity and debt placements.

Will served as a vice president at SunTrust Bank’s private wealth management group, with responsibility for over $300 million of assets, and prior to that, was a SunTrust Bank credit officer underwriting commercial and corporate loan packages with transactions ranging from $5 million to over $100 million in value.

Will received his Economics Bachelor of the Arts degree from Denison University. Will is a Chartered Financial Analyst (CFA) charter holder and member of the CFA Society where he serves on the local Orlando board, a member of the National Center for Employee Ownership, a board member of the New South chapter of the ESOP Association and a series 7 & 24 license holder.

PCE Proprietary and Confidential

P: 407.621.2124 [email protected]

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PCE Valuations Robert Buchanan , J.D., ASA

Robert H. Buchanan brings more than a decade’s worth of valuation experience to PCE. In addition to being a founding principal of PCE Valuations, he is recognized as an industry expert and is frequently invited to speak about valuation topics at industry seminars and professional conferences throughout Florida and the U.S.

Bob’s professional experience encompasses hundreds of valuations for merger & acquisition transactions, business planning, estate & gift planning and filing, financial reporting, ESOPs and litigation support. In addition to overseeing PCE’s business valuation group, he monitors legal developments as well as IRS rulings and pronouncements impacting the valuation industry. Researching and monitoring industry issues enables him to provide timely and targeted analyses for clients.

Bob received a Bachelor's degree in finance from the University of Central Florida, a Juris Doctorate degree from the Washington and Lee University School of Law and is a member of the American Society of Appraisers.

PCE Proprietary and Confidential

P: 407.621.2120 [email protected]

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Representative Transactions

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PCE National and Regional ESOP Speeches

“Advanced Financing: ESOPs in M&A”

2007 National ESOP Association Annual Conference

“Fiduciary Aspects of Raising Money for ESOP Companies”

2008 ESOP Southeast Regional Conference

“Subordinated Financing in Valuation”


“Changing Dynamics of ESOP Financing”

2008 National S-Corp Conference for the ESOP Association

“ESOPs: Exits, Acquisitions & Growth”

2008 ACG Intergrowth National Conference

“Liquidity Strategies for Privately Held Companies”

2008 CFMA National Conference

“Selling your business in a Challenging Economy: The ESOP Alternative”

2008 UBS – MacquireWoods – PCE Conference

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PCE National and Regional ESOP Speeches

“Subordinated Financing & Reasonable Dividends”

2008 Southeast ESOP Chapter Meeting

“Multi-Stage Transactions and Recapitalizations”

2008 National ESOP Association Annual Conference

“Navigating the Sale to an ESOP: A Great Liquidity Option, Even in Stormy Seas”


“Esops Surviving & Thriving – M&A Update and Value Drivers”

2009 New South ESOP Conference

“Strategies for ESOPs”

2009 The McGehee Group Annual Advisors Conference

“ESOPs in the Construction Industry”

2009 FICPA Construction Industry Conference

“ESOP Transactions in Today’s Market”

2010 ESOP Association Tri-Chapter Conference

“Valuation: On Trends and Current Issues”

2011 ESOP Association Tri-Chapter Conference

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PCE Investment Bankers

ESOP Market Update Winter 2013

Download - ESOP Financing Webinar

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