WHAT’S YOUR BUSINESS EXIT STRATEGY?

A Road Map to Successful Succession Planning

What We’ll Cover

Overview of the succession planning roadmap

First Stop: Transferring to long-term employees via ESOP

Second Stop: How to perpetuate your business for the next generation

Last Stop: Financial best practices

Today’s Presenters

Bob PedersenVP, Relationship Manger

American River Bank

Kurt GlassmanCo-Founder

Leadership One, The Capital Region Family

Business Center and the Family Business Association

Kevin LongAttorney at Law &

Taxation Law Specialist Chang Ruthenberg & Long

THE ROADMAPAn Overview

A Business Succession Plan provides both an exit strategy and an implementation plan for business owners and their families to ensure the survival of the company with a transition or sale. It plans for unanticipated events – the strategic and tactical options.

An Exit Plan helps secure and solely maximizes the financial future of the business owner, the spouse and family, when the owner chooses to exit the business, becomes disabled, or passes away. Timing is everything; and size matters.

Succession Planning vs. An Exit Plan

Why is it Important?

Ownership Will Transfer: Voluntary or Involuntary

Not “Necessarily” All About the Money Individuals Will Expire, Companies and

Families Can Live Forever. Living Plan Not An Estate Plan

Four Basic Options

Sale or Succession During LifeSell/Gift to Family

or HeirsSell to Employees, Key Management or ESOP

Sell to Outsider- Strategic Investor

Orderly Liquidation or Recap

Minimize Estate Taxes

Alternatives for Divesting Private Company Stock

There are specific benefits and drawbacks to each alternative

Understand your objectives and select the alternative that optimizes them – financial and non-financial – so as to avoid “Seller’s Remorse”

Many times business owners are unaware that an ESOP is even an option!

Benefits of Planning

Clarifies UncertaintyAntidote for AnxietyPromotes CommunicationBuilds TrustFamily Harmony

Obstacles To Planning

The Process

What are you really looking for in an exit?

Option A: $how me the money!

Option B: I want to get a good buyout price, but……I am not ready to retire yet…I want to keep my company independent and perpetuate a legacy…I want to sell only a portion of the company and maintain control…I’m tired of paying taxes!…I don’t want to be beholden to a new owner /investor…The other shareholders are not ready to sell…I want to protect my employees

Questions to Ask Yourself

What Do I Value?Where Am I Going?

What Do I Want To Change?

Challenges

AlignmentOwnership Transfer PlanGovernance StructureManagement Succession Plan

Changing Conditions Relationships Trust

Advisors

Attorney CPA Banker Family Business Advisor

WealthAdviso

r

Appraiser

1ST DESTINATIONIntelligent Succession and Liquidity Strategies for Closely Held Businesses

Background: A Brief History

Most Common Industries

Company Employees

144,000

55,000

18,000

9,200

9,000

8,400

7,000

1,500

400

200

Company Employees

11,500

7,000

4,000

3,000

2,600

2,400

1,500

1,500

600

200

Notable Employee Owned Companies

Myths And Misunderstandings

An ESOP is a giveaway I will lose control of my company You must disclose all financial data to employees My employees cannot pay me what my business is worth My employees are not interested in an ESOP ESOPs are for failing companies ESOPs are too expensive My CPA can advise me on this The ESOP must replace all retirement plans The ESOP's stock repurchase liability will kill the company

General Minimums for an ESOP

$5M in Revenues 20+ employees EBIDA greater than $1.5M/year last five years

• (adding back owners salaries)• Tax Burden is the Driver

Deferral of capital gains tax on sale to ESOP Can create a partial or 100% tax free ESOP company Retain participation or control during the sale Can do partial sales – whenever you are ready A known buyer – with controlled earn out Tax subsidy can cover more that 30% of the cost Doesn't impede a later strategic transaction

ESOP Appeal To The Owner/Seller

ESOP vs. Non-ESOP Transactions Seller’s Perspective

Asset Stock §1042Sale Sale Sale

Gross Sale Proceeds 20,000,000$ 20,000,000$ 20,000,000$ Corporate Taxes Due (6,000,000) - - Individual Taxes Due (4,620,000) (6,600,000) -

Net After Tax Sales Proceeds 9,380,000$ 13,400,000$ 20,000,000$

Note: Assumes $5,000,000 cost basis in corporate assets and no cost basis in stock.in stock. CA & Fed combined corporate tax rate = 40%. CA & federal combined capital gains rate = 33%.

Leveraged Buy-Out Seller Financing

3. Annual Contributions Deducted As Pension Expense

Seller Taxed On Installment Sale Basis

2. Cash And Note

1. Stock

4. Loan Repayment

SellingShareholder

SellingShareholder

Shares Allocated As Loan Is Paid

Pension Expense Matches Loan Amortization

Bank Financing

1. Loan

2. Loan

7. Loan Repayment (Principal & Interest)

6. AnnualContributions

QRP-Stocks &Bonds

QRP-Stocks &Bonds

3. Cash Purchase

4. Stock

5. Reinvest Cash

8. Loan Repayment(Principal & Interest)

Bank / Lender Bank / Lender

Company Company

ESOP TRUSTSuspense Account

Allocation

Participant Accounts

SellingShareholder

SellingShareholder

Tax Deferred "Rollover" ESOPs IRC §1042

Capital gain on sale to the ESOP is deferred Seller must reinvest proceeds within 12 months of

sale date in Qualified Replacement Property (QRP) Can do partial or complete deferral of sales proceeds ESOP must own at least 30% of company

Qualified Replacement Property

• Common Stock• Convertible Bonds• Corporate Fixed Rate

Bonds• Corporate Floating Rate

Notes (FRN)

Eligible1

• Municipal Bonds• U.S. Government Bonds• Mutual Funds• Foreign Securities• REITs• Bank CDs

Not Eligible1

1 Eligible issuer must have: More than 50% of its assets used in the active conduct of a trade or business No more than 25% of its gross income from passive sources

Congress' intention: Incentivize owners of private companies who sell to an ESOP to reinvest into corporate America

S Corp. ESOPs – Generally

S Corps. are pass-through entities ESOP is qualified trust, exempt from taxation Taxable income flows through to ESOP Percentage owned by ESOP is tax exempt ESOP may be minority or up to 100% owner Benefits paid in cash only – not stock

When Is Private Equity A Good Succession Alternative?

Business has solid and consistent cash flow

Business has solid growth prospects

Capable and experienced management team

Limited customer concentration or other business risks

Willingness to sell or recapitalize the business in 5 +- years

SAME

SAME

SAME or can develop over time

SAME

NO! No need to be hemmed in! ESOP allows later sale, but

does not dictate timing!

Private Equity ESOP Pros And Cons

Pros Many flexible structures

Partner with smart, experienced people

Can provide vehicle for immediate or staged liquidity

Can provide owner liquidity, while allowing existing management to maintain management control of the company

Cons More expensive than bank financing

Need to provide liquidity in 5+- years

May have senior class of securities (Preferred Stock) w/ certain rights

Same – over 20 different templates

Bring in outside talent, if you want it

Staged liquidity via financing

ESOP does not control the company –management does

Not as expensive as PE No requirement for a liquidity event – but

it does happen – you control it ESOP will never be superior to your

stock rights

ESOP v. Private Equity The Bottom Line

Private equity is real cash – not debt You are adding someone to your board – can you get

along? Can you replace them? You are selling control – now or in five years Unless you do an ESOP in five years

Description ESOP Company Private Equity Strategic Buyer

Maximize Sale Value

Appraised Fair Market Value

Negotiated Value Negotiated Value

Retain Control Yes Not if a 100% sale; temporary if a minority sale

No

Family Controlled Involvement

Short term Typically not

Legacy Yes No No

Employment Until negotiated to retire

Until company is sold

Short term contracts

Pass Business to Employees

Yes Management kept in place

Consolidation of workforce

Estate Liquidity

Over time Yes; in part or whole

Yes; for cash component of sale

Tax Impact Potential Cap gain deferral

Taxable Taxable (unless merger)

Impact On Shareholder's Goals, Objectives

2ND DESTINATIONPerpetuate your Business for the Next Generation

If What a Business Wants is… 79% of Senior-Generation Members Want Their

Families to Retain the Family Business. 70% of the Next Generation Share These Hopes.

Then Why… Do Only 30% of Family Businesses Make it to the

Second Generation? Do Only 10% of Family Businesses Make it to the

Third Generation?

Breakdown Factors

Traditional Assumptions:– Inadequate Planning– Poor Management

Performance– Estate Tax

Dynamics

Business Transition vs Succession Planning

Multi-dimensional approach that addresses the needs of the business owner

Systematic Approach to Help CEO’s Build “Stakeholder” Value

The Seven Critical Issues

Seven Critical Issues

1. Leadership2. Relationships3. Ownership Transfer4. Business Strategy and Execution5. Management Performance And

Succession6. Financial Performance7. Personal Financial Planning

1. Leadership

Effective Leaders AdaptLeadership is CulturalLeaders ExecuteLeaders Listen

2. Relationships

“How Do We Get Along”Need to Understand and Manage ConflictThe Conduit for Business

3. Ownership Transfer

Can We be Fair and Equitable to All Our Children?

Differences between Ownership and Management

Need to Align Ownership, Governance and Management Succession Plans

4. Business Strategy and Execution

Where Are We Going? (Vision)Why Do I Want To Go There? (Mission)How Do I Measure Success? (Goals)What Are We Going To Do? (Action Plan)

5. Management Performance & Succession

Do My People Know the Plays?Do I Have the Right People on the Bus?No Plan to Recruit, Retain, Reward and Retire

Key Employees

6. Financial Performance

Do You Know Your Key Performance Indicators (“KPI’S”)?

Do Your People Know Their Numbers?Are You Hitting Your Numbers?

7. Personal Financial Planning

Income Continuity All My Eggs Are In One BasketHow Do I Limit My Personal Guarantees?

3RD DESTINATIONFinancial Best Practices

Quality of Financial Reporting

Think like an airline pilot on instruments Treat family like a 3rd Party BuyerAccuracy of Information is Paramount!

– Full Disclosure of your business (w. bad)– Second (first) opinion of your trusted advisors –

CPA/Banker/Attorney– Confidentiality Agreements & Common $

Spreadsheets of Data is NOT boring Create value through ‘event planning’ Three years / year to date data All reports – AR, AP, Backlog, Debts Confidentiality /Sharing Data

– For outside buyers/employees – Share information ‘as needed’ – Use common sense / plan for the worst

Show Me the Money

Business Debt Capacity – A Short List

Liquidity (of company & owners) True Value of Assets Intangible Value – yes and no Leverage and Debt Load Management Quality & Track Record of New

Family Members/Owners is very important

What’s it Really Worth?

Valuation of companies for:– Internal purposes– Tax Purposes– Borrowing/Bank Purposes

The Highest Value is not necessarily the Best value Work with experts – business/equipment/real estate

Financing Options & Taxes

Private Financing – Good & Bad Commercial Bank Lending /Leverage

– ESOP Loans – yes/experience counts– Government Guaranty Programs

Separate Real Estate from the Business Assets– Sale/Leaseback of Property, etc. – Trusts and real estate income

Key Take-Aways

Ownership in your business will transfer: Voluntarily or Involuntarily Your business is the biggest asset and source of income you own – protect it

with “succession planning insurance” Having a written plan is key to successful transfer of control of your company Your family & employees want your legacy to succeed as much as you do ESOP’s and other ownership plans can provide tax advantaged strategies to

the owner/seller There are many options – explore them all with your advisors Most business owners are doer’s – it’s normal to avoid dealing with

succession planning/training There are seven critical issues to confront Others have done this successfully – there is a formula

Let’s Continue The Conversation

Kurt Glassman Kevin LongLeadershipOne Chang Ruthenberg & Long (916) 923-0245 (916) 294-3262 kglassman@leadershipone.net KGL@Seethebenefits.com

Bob PedersenAmerican River Bank(916) 231-6138bpedersen@americanriverbank.com