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  • 1. PCE Investment Bankers ESOP Market Update Winter 2013

2. 2 Table of Contents Market Environment ESOP Structures ESOP News 3. 3 Market Environment 4. 4 Headlines Approaching record levels on S&P 500 Job growth Partial resolution to fiscal cliff Debt ceiling fight part II 5. 5 Todays 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 6. 6 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? 7. 7 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 DealVolume 8. 8 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 $inbillions Deal Volume 9. 9 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 10. 10 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 11. 11 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 12. 12 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 13. 13 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 14. 14 Liquidity Transactions 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 15. 15 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 16. 16 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 17. 17 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 18. 18 Deal Multiples Median ImpliedEnterprise 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: 19. 19 ESOP Structures 20. 20 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 21. 21 Liquidity Transactions 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 22. 22 Liquidity Transactions 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% 23. 23 Liquidity Transactions 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 24. 24 Liquidity Transactions 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 25. 25 Liquidity Transactions 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 26. 26 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 27. 27 Liquidity Transactions 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 28. 28 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 29. 29 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 30. 30 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 31. 31 ESOP News 32. 32 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. 33. 33 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 34. 34 Questions? 35. 35 PCE ESOP Practice 36. 36 PCE Investment Bankers William A. Stewart, CFA Will is a key member of PCEs 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 PCEs 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 Banks 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 37. 37 PCE Valuations Robert Buchanan , J.D., ASA Rob


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