Seven Core Principles to Maximize the Value of Your Business During its Life and Upon its Sale

Presented by
Doug Hubert Managing Director, CBIZ Mergers & Acquisitions Group Steve Henley National Tax Practice Leader, CBIZ MHM National Tax Office

Strategic Edge Series

Seven Core Principles to Maximize the Value of Your Business During Its Life and Upon its Sale May 18th Creative Compensation Strategies to Maintain Morale and Retain Talent June 22nd Dont Be Held Captive: Go Captive to Manage Your Risk and Expenses July 20th Federal Incentives That Can Show You the Money August 17th Protecting Your Legacy with Succession Planning September 21st State Tax Nexus: No Physical Presence Required October 26th

All these webinars are from 2:00 3:00 ET. Here is the link for registration for any of these webinars - www.cbiz.com/strategicedge

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Agenda
The Seven Steps to Increase the Value of your Company How is Value Influenced - Pricing How is Value Influenced Transaction Type
Strategic Sale vs Leveraged Recapitalization

How is Valued Influence Tax Considerations

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1. Build a Deep Management Team

Building a deep management team is one of most difficult challenges for business owners. Significant Value Driver: Management depth is the difference between a good and great company. Jack Welch, former CEO of General Electric considered talent development his most important job. Tactic: A formal talent recruitment and development plan should be established. Further, a management retention program should be considered.
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2. Diversify Your Customer Base

Ideally, a companys largest customer should represent no more than approximately 15-20% of revenue & profitability. If any customer becomes too large, then to some degree, the customer owns the business. Like management team depth, customer concentration is a significant value driver. Diversifying customer base may cause short-term sacrifice, but it will create long-term stability and value.
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3. Maintain Quality Financial Information

Lack of quality financial information is a consistent weakness among middle-market companies. Prior to a transaction of any form, a company should transition from their current attest level to a formal audit. Audited statements provide credibility with bankers, insurance companies, and investors (both private and public). In a sale transaction, audited financials reduce chance of purchase price reduction due to lack of certain accruals. An audit is also a powerful management tool.
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4. Develop a Proprietary Product or Service

To thrive in any marketplace, a company must offer unique product or service that isnt easily replicated. While an obvious value driver, few companies are dedicated to creating this distinction. It should be easy for customers, employees, or competitors to quickly describe what makes a company unique? Superior products or services can create pricing advantages (in good times) and customer loyalty (in challenging periods).
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5. Focus on Profitability
Too many business owners measure success on revenue rather than profitability A $30 million revenue company with $5 million in profits is worth more than a $60 million business with $2.5 million in profits Another common mistake is desire to limit profitability to limit taxes
Focus becomes tax avoidance rather than operational efficiency and profit maximization Explore tax efficient strategies such as pass through entities (SCorporation or LLCs)
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6. Prepare and Execute a Business Plan

Establish operational and financial plans and goals for your business in one, three and five year increments and share them with your employees
Plans should take into account various economic, industry and company specific scenarios and how management would react to each Thorough planning creates roadmap for future growth, focuses employees and management on quantifiable goals and allows for better decision making

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7. Seek The Help of Professional Advisors

Qualified advisors can provide valuable advice as you grow your business while also allowing you to avoid disastrous legal, financial and operational mistakes that may have significant financial consequences down the road
Accountants Attorneys Insurance Agents Investment Bankers

Recruit a Board of Directors (or seek counsel from other entrepreneurs)

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Pricing How is Value Influenced?

Review of factors that increase or decrease valuations of businesses
CBIZ M&A handles middle-market assignments generally companies with revenue between $10-300 million Valuation in the middle-market is typically expressed as a multiple of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) A M&A banker will also make adjustments to EBITDA to addback various expenses and personal perks that would not continue under new ownership Adjusted EBITDA

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Pricing How is Value Influenced?

Review of factors that increase or decrease valuations of businesses
To understand how these seven principals affect valuation, we will walk through hypothetical valuation drivers For purposes of this example, based on our experience, please assume that Company A, a healthy middle-market business, has a base valuation multiple of 5x Adjusted EBITDA

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Pricing How is Value Influenced?

1. Size (as expressed in adjusted EBITDA) a larger business is viewed as having more stability (reduced risk), is easier to finance, and generally will attract larger and more financially capable buyers
EBITDA Level > $10 MM $5-10 MM $2-5 MM $1-2 MM < $1 MM Multiple Adjustment add 2x add 1x-2x no change deduct 1x deduct 2x

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Pricing How is Value Influenced?

2. Depth of management does the company have a deep and well-rounded management team?
Factor Deep Management Team One Boss/Limited Team Multiple Adjustment add 1x-2x deduct 1x-2x

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Pricing How is Value Influenced?

3. Customer diversification does the company have any customer concentration issues (i.e. a customer representing more than 20% of revenue/profit)?
Factor Diversified customer base Concentrated customer base Multiple Adjustment add 1x-2x deduct 1x-2x

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Pricing How is Value Influenced?

4. Audited Financials Does the company have audited financials and a strong CFO/financial controls?
Factor Audited Financials/clean records Unaudited Financials/poor records Multiple Adjustment add 1x-2x deduct 1x-2x

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Pricing How is Value Influenced?

5. Proprietary Products/Services Does the company have a proprietary or commodity product/service?
Factor Proprietary Product/Service Commodity Product/Service Multiple Adjustment add 1x-2x deduct 1x-2x

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Pricing How is Value Influenced?

6. Profitability (expressed as a percentage (%) of revenue) What is the companys EBITDA margin?
EBITDA Margin > 20% 15% - 20% 10% - 15% 5% - 10% < 5% Multiple Adjustment add 2x add 1x-2x 0x add 1x deduct 1x-2x deduct 2x

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Pricing How is Value Influenced?

7. Sale Process Is the company only talking to one buyer or has the company hired an investment banking firm to create a controlled auction?
Factor Multiple Buyer Auction One Buyer Process Multiple Adjustment add 1x-2x deduct 1x-2x

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Pricing How is Value Influenced?

Two Strategies
1. Strategic Sale 2. Leveraged Recapitalization

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Strategic Sale - Description

Sale of the stock or assets of the company to a company in the same business line or a similar business line. Sale can either be full or partial. Example: the 1996, $13.3 billion stock for stock merger of Boeing and McDonnell Douglas, creating a larger Boeing.

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Strategic Sale - Advantages

Typically creates highest valuations (at transaction closing) due to the value of synergies. Ideal for business owners who wish to maximize their proceeds at closing and eliminate future risk Reduced post-closing role for selling shareholders.

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Strategic Sale - Disadvantages

After a 100% sale, selling shareholders are unable to take advantage of future growth opportunities. Culture of the company often changes to that of the acquiring company. A strategic sale does not usually create an opportunity for remaining management to obtain any ownership stake.

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Private Equity Sponsored Recapitalization Description

The sale of a portion (usually majority interest) of the stock or assets of a company to a Private Equity Group (PEG). A PEG is a firm that has raised a fund (or funds) to make leveraged investments in privately and publicly held companies. Ideal for business owners who need a financial partner to pursue growth opportunities while reducing a portion of their financial risk

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Private Equity Sponsored Recapitalization Description

General Mechanics of Leveraged Recapitalization
Owner sells 100% of business
Receives cash (and possibly notes) and continuing ownership interest in business
Can be up to 49% as most PEGs wish for majority ownership Continuing Ownership Stake is purchased on a leveraged basis (same equity basis as the PEG)

PEG and Owner work to aggressively grow business Company is typically sold (or recapitalized) four to six years later Attractive option if owner believes future value of business will be materially higher than value at initial sale

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Private Equity Sponsored Recapitalization Advantages

Allows ownership to monetize their investment in the company, often maintaining a substantial (typically minority) ownership stake. Ownership continues to run business PEG funds can materially accelerate growth through organic and acquisition strategies as well as managerial assistance Provides remaining ownership with a second bite of the apple when exiting the company. Post transaction culture of the company typically remains intact. Potential opportunity for management to earn equity.
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Private Equity Sponsored Recapitalization Disadvantages

The post transaction company is typically substantially more leveraged than it was prior to the transaction. Enterprise values (at initial transaction) are typically less than a sale to a strategic acquirer. Unlike a sale to a strategic acquirer, because selling ownership typically reinvests in the new company, cash proceeds at close are typically lower.

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Entity Structure is Important

C Corporation S Corporation LLC Partnership General Limited

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Entity Structure is Important

Stock Sale Buyer Takes entity liabilities and risk exposures No step up in basis of assets (lower depreciation/amortization) absent 338(h)(10) election when eligible Seller Capital gains No continuing liability Transition may be secured by employment continuation May be required by current contracts not being assignable

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Entity Structure is Important

Asset Sale Buyer Avoids entity liabilities and risk exposures Step up in basis of assets (higher depreciation/amortization) Purchase price allocation required Seller Different tax treatment between C corporations and passthroughs No continuing liability Transition may be secured by employment continuation

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Entity Structure is Important

C Corporations
Generally limited to a Stock Sale (if corp gain on assets cant be offset by NOLs); No Basis Step Up for Earnings Pre-Deal; Pre-deal dividend distributions subject to double tax

Pass-Throughs
S Corps, LLCs, Partnerships; Allows Asset Sale; Buyer gets basis step up Seller avoids double tax and basis increase for past earnings Post deal seller tax benefits should drive higher purchase price

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C Corp Conversion to S Corp

Make sure you meet S Corp Eligibility Requirements; Elect S Corp Status 10 Year Built-In Gain Period; BIG Tax Paid on Conversion Date Gain in Assets if Assets disposed within 10 Years; If Company is expected to appreciate substantially over the next 3-5 years prior to sale, this should be beneficial; Option to do a stock sale to avoid BIG tax still exists

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Recapitalization Structure
Recap defined: Seller has a continuing interest Seller participates in future value creation to the extent of this continuing interest

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Recap: S Corporation

Use of LLC structure to facilitate sale can accomplish asset step up for Buyers portion; Seller continues with a continuing interest; Targets shareholders recognize gain (OI or CG) on the asset sale of targets assets; Special allocation of depreciation/amortization to the Buyer group; Be careful to avoid issues with continuing interest and anti-churning rules

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Recap: LLC or Partnership

Seller continuing for a minority share can be accomplished more easily with an LLC or Partnership; More flexibility in percentage interest retained by Seller; Buyer can get basis step up for consideration given to sellers; Special election made to achieve basis step up as a result of purchase of sellers units

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Recap: C Corp
Buyer purchases majority control from seller; Buyer unlikely to achieve basis step up unless a deemed asset election can be made and corporate level tax is sheltered as previously mentioned Seller should receive capital gain on shares sold

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QUESTIONS?

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CBIZ MHM, LLC Contacts

Doug Hubert
Managing Director, CBIZ Mergers & Acquisitions Group 770.858.4491 dhubert@cbiz.com

Steve Henley
National Tax Practice Leader, National Tax Office 770.858.4443 shenley@cbiz.com

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Thank You

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CBIZ Financial Solutions, Inc. Disclosure

CBIZ Mergers & Acquisitions Group is a division of CBIZ Financial Solutions, Inc., which is a wholly-owned subsidiary of CBIZ, Inc. (NYSE:CBZ) Securities & Investment Advisory Services offered through CBIZ Financial Solutions, Inc., member FINRA, SIPC and Registered Investment Adviser

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