selling a business: helping your clients with their biggest deal north shore council financial...
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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?
$0
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$0 $100 $200 $300 $400 $500 $600 $700
Annual Gross Revenues in Thousands of $
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Actual Transactions from IBA DatabasePrice/Gross Revenues
Range of Value
$0
$50
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$150
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$0 $100 $200 $300 $400 $500 $600 $700 $800
Annual Gross Revenues in Thousands of $
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Transactions Upper 25% limit Lower 25% limit
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 customersProprietary 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 businessExperienced, knowledgeable managementWork 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 450,000 Multiple X 2
900,000$
Earnings 220,000 Multiple X 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• Sensitivity to
economic environment• Management depth• Capital structure• History of distribution
of earnings• State of the industry
• Financial returns and ratios• Intangible value
• 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 1 2 3 SumEarnings 200,000 230,000 270,000 700,000 Discount Factor 0.86 0.75 0.67 Present Value 172,000 172,500 180,900 525,400
Net Present Value 525,400Plus: Terminal/Residual Value 500,000Estimate of Total Business Value 1,025,400
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 ExampleBook Value Adjustment Fair Market Value
Assets:Accounts Receivable 3,000 (400) 2,600
Fixed Assets 3,000 (2,500) 500 Less: Depreciation (1,000) 1,000 - Net Fixed Assets 2,000 (1,500) 500
Total Assets 5,000 (1,900) 3,100
Liabilities:Current Liabilities 150 0 150 Long-Term Liabilities 200 0 200 Total Liabilities 350 0 350
Owner's Equity 4,650 (1,900) 2,750
Total Liab & Equity 5,000 (1,900) 3,100
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
Perceived Value Today
Explaining the Story
Validating the Business Strategy
Value from Well-Managed Process
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 end-market 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
• Disclose, Disclose, Disclose• Breach of Trust Kills Deals• Better up Front than Later• But not too Early
AVOID SURPRISES!
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 WarrantiesOrganization and Good StandingEnforceability; Authority; No
ConflictCapitalizationFinancial StatementsBooks and RecordsSufficiency of AssetsDescription of Owned Real
PropertyDescription of Leased Real
PropertyTitle to Assets; EncumbrancesCondition of FacilitiesAccounts Receivable InventoriesNo Undisclosed LiabilitiesTaxesNo Material Adverse Change
Employee BenefitsCompliance with Legal
Requirements; Governmental Authorizations
Legal Proceedings; OrdersContracts; No Defaults InsuranceEnvironmental MattersEmployeesLabor Disputes; Compliance Intellectual Property AssetsRelationships with Related
PersonsBrokers or FindersSecurities Law MattersSolvencyDisclosure
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
VENUE
ASSIGNMENTWAIVER
ETC.
DISPUTERESOLUTION
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
Business Valuator
Business Broker/Intermediary
Deal Attorney
Accountant
Financial Advisor
Begin Assembling a Deal Team
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 FridmanAlex 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
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
www.illinois-business-lawyer.com
Jeff Smiejek, CPA, CVA, CEPA
Tom Meyer