Unlocking Private Company Wealth:
Unlocking Private Company Wealth: Give Me Liberty (and Plenty of Cash)
Edward F. “Ed” Koren, JD
Z. Christopher Mercer, FASA, CFA, ABAR
Holland & Knight [email protected] | 813.227.6655
Mercer Capital [email protected] | 901.685.2120
2016 Spring Symposia, Real Property and Trust & Estate Law Section of the American Bar Association November 17, 2015
Edward F. Koren, JD Edward F. Koren is a partner in Holland & Knight's Tampa and Lakeland offices, and serves as the leader of the firm's Private Wealth Services Group. Mr. Koren's practice is focused on wealth planning and protection for entrepreneurs and multi-generational business owners. He serves clients across the country and practices principally in the firm's Tampa and Lakeland offices. The firm's Private Wealth Services Group is the largest group of trusts and estates lawyers in the United States, with more Fellows in the American College of Trust & Estate Counsel than any other law firm in the country. 813.227.6655 [email protected] www.hklaw.com
Holland & Knight 100 North Tampa Street Suite 4100 Tampa, FL 33602
Mr. Koren is past chair of the American Bar Association's Real Property, Probate and Trust Law Section; former American College of Trust and Estate Counsel Regent and past chair of its Estate and Gift Tax Committee; and the author of Estate and Personal Financial Planning, a five-volume treatise published by Thomson West that covers planning concepts for asset accumulation and transfer throughout life and through inheritance. He is a Florida Board Certified Wills, Trusts and Estates Lawyer and is a National Association of Estate Planners & Councils-Accredited Estate Planner® who has received the highest rating assigned by Martindale-Hubbell.
2
Z. Christopher Mercer, FASA, CFA, ABAR Chris Mercer is the founder and CEO of Mercer Capital, a national business valuation and financial advisory firm. Chris began his business valuation career in the 1970s and has been involved with hundreds of valuations for purposes related to mergers & acquisitions, litigation, and estate and gift tax planning, among others. He has extensive experience in litigation engagements including statutory fair value cases, business damages, and lost profits. He is also an expert in buy-sell agreement disputes. 901.685.2120 [email protected] www.MercerCapital.com www.ChrisMercer.net www.linkedin/in/zchristophermercer
Mercer Capital 5100 Poplar Avenue Suite 2600 Memphis, TN 38137
Designations held include Fellow of the College of Fellows (FASA) from the American Society of Appraisers, Chartered Financial Analyst (CFA) from the CFA Institute, and Accredited in Business Appraisal Review (ABAR) from the Institute of Business Appraisers. Chris has written widely on business valuation-related topics and is a frequent speaker on business valuation issues for national professional associations, other business and professional groups, and business owners. Recent books authored by Chris include Unlocking Private Company Wealth (Peabody Publishing, LP 2014), Buy-Sell Agreements for Closely Held and Family Business Owners (Peabody Publishing, LP 2010) and Business Valuation: An Integrated Theory, 2nd Edition, with Travis W. Harms (John Wiley and Sons 2008). For a complete list of the books authored by Chris, as well as further information on his valuation-related experience, view his complete CV at www.mercercapital.com.
3
Business Owner Wealth is Concentrated Focus on risk, returns Diversified 20-30%
Pay for professional management of wealth
Inadequate focus on risk to owners Private Company Wealth 70-80%
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
Little focus on returns Little concept of managing illiquid wealth
4
The Road
10,000 per day 76,000,000 Baby Boomers Own 2/3 of all businesses
Ownership Transfer Matrix Vertical or Horizontal? Partial Sale/Transfer
Total Sale/Transfer
Voluntary Transfer
• Private Equity/PE
• Sale of Business
Involuntary Transfer
• Personal Financial Issues
• Death
• Divorce
• Divorce
• Sales to Insiders/Relatives • ESOP/Management Buyout • Gifting Programs • Buy-Sell Agreements
• Buy-Sell Agreements
See Figure 3 on page 22 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
6
Interim Time
Business End Game
Status Quo
Interim Time
The Rest of Your Life
Interim Time is when we set up our business end games and the rest of our lives
Annual Return (No Realized Appreciation)
Need approval to calculate return
See page 75 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
8
The One Percent Solution Paying Fees $5 million Liquid Create budget based on private illiquid wealth value $20 million Illiquid
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
0.5%
$100 thousand
1.0%
$200 thousand
9
One Percent Solution Activities Annual Appraisals & Monitoring of Performance
Buy-Sell Agreement Pricing
Estate Planning
Ownership & Management Transition Planning
Corporate Finance for Private Businesses
Wealth Manager Comp
Life Insurance Funding
Financial Planning
Annual Legal Review
Outside Board Members
See pages 38-41 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
10
Three Sections Section 1 Managing Private Company Wealth Section 2 Tools for Managing Private Company Wealth Section 3 Perspectives on Managing Private Company Wealth
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
11
Fair Market Value Fair Market Value according to Revenue Ruling 59-60 The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
12
The Levels of Value
See Figure 7 on page 46 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
13
Creating Liquidity During the Interim Period Time
See Figure 9 on page 62 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
14
Net Cash Flow: The Source of Dividends Four Uses of NCF 1. Dividends 2. Retire debt 3. Reinvest for future growth 4. Reinvest in stagnant assets
See Figure 11 on page 72 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
15
Market Value Balance Sheet
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
16
Market Value Balance Sheet
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
17
Two Tools to Create Liquidity 1. Leveraged Dividend Recapitalization 2. Leveraged Share Repurchases
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
18
The Situation Acme Company (the Company) has sales for the most recent year of $250 million and manufactures and distributes a wide range of products for the extraction industries. Some of its products are branded. In spite of its significant size for a private business, the Company is a relatively small player in its overall industry Acme Company is a C corporation, with an EBITDA margin of just under 10% of sales. For perspective, EBITDA is $24.2 million Return on equity for the last twelve months was 8.6%, and has been trending downward in recent years The Company has $16.4 million of interest-bearing debt, which is more than offset by $20.5 million in cash See pages 98-99 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
19
The Situation Working capital as a percentage of sales is about 32% (versus 20% for similar public companies) The balance sheet reflects $126 million of equity, or 72% of assets Equity of the Company is valued at $149 million based on an EBITDA multiple of 6.0x (the median multiple for the group of comparable public companies) The Company is currently paying an annual dividend totaling $3.0 million, reflects a dividend payout ratio (from net income) of 27.5% Repurchase of 30% of equity (300,000 shares or $44.8 million) See pages 98-99 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
20
Transaction Assumptions Key Transaction Assumptions
Values
Comments
1
Number of Shares to be Purchased
300,000
30% of the outstanding shares
2
% of Cash Considered Excess
100.0%
Use all cash on balance sheet
3
EBITDA Multiple for Pricing Transaction
4
Dollars of Current Annual Dividends
5
Given Number of Shares for Example
6
Interest Rate on Pro Forma Cash
1.00%
Assumption of CFO
7
Interest Rate on Pro Forma Debt
6.00%
Assumption per bank discussions
8
Effective Tax Rate
36.20%
Factual
9
EBITDA Multiple for Pro Forma #1 Valuation
6.00
No Change in EBITDA Multiple
10
Price/Earnings Multiple for Pro Forma #2
13.7
Proxy for future benefit of recap
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
6.0 $3,000,000 100,000
Assumption Factual 10% block
21
Return Analysis
See Figure 18 on page 107 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
22
Benefits to Remaining Owners
See Figure 19 on page 108 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
23
Financing of Transaction
See Figure 14 on page 103 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
24
Pro Forma Analysis Balance Sheet Ratios
Before
Pro Forma
Comments
4.4 Lots of liquidity
3.5
2.2
1.3
Reasonable
Working Capital % of Sales
31.6%
23.5%
Reasonable
Total Liabilities / Assets
28.3%
47.5%
Reasonable
Total Liabilities / Equity
39.9%
91.8%
Reasonable
Interest Bearing Debt / Equity
13.0% Low leverage
50.2%
Interest Bearing Debt / Assets
9.2%
26.0%
Reasonable
1.4
1.9
Reasonable
11.3%
28.0%
Reasonable
Current Ratio Acid Test Ratio
Assets / Equity Debt / MVTC
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
Adequately liquid
Moderate leverage
25
Income Statement Analysis
See Figure 16 on page 105 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
26
Valuation Analysis
See Figure 17 on page 105 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
27
Observation In my experience, most owners of successful closely held and family businesses simply do not think about using reasonable leverage as a tool to redistribute stock ownership, provide liquidity for certain shareholders, provide special dividends, or engage in other transactions designed to provide liquidity for their owners and to enhance shareholder returns They should
See page 96 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
28
Private Equity Minority Investments on the Upswing During 2013, about 40% of all PE investments involved less than control transactions Recent statistics indicate that 15% of companies with enterprise values greater than $500 million are owned by private equity funds With so much investment capacity in the PE world searching for deals, now may be time to consider taking on a PE partner to provide liquidity for aging owners and/or to obtain growth capital to accelerate growth opportunities See page 125-126 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
29
Three Reasons to Consider Private Equity 1. Satisfy liquidity/diversification needs while retaining a significant share in a favorable upside outlook 2. Capital and expertise are required to access available opportunities 3. Outside assistance needed to take the business to the next level See page 127 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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What Are They Supposed to Do? Require agreement at a point in time Relate to transactions that will or may occur at future points in time Define the conditions that “trigger” the buy-sell provision Determine the price(s) and terms at which specified future transactions will occur
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
31
Types of Buy-Sell Agreements Based on how price is determined • Cross purchase agreements • Fixed-price agreements • Formula agreements • Valuation process agreements
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
32
Multiple Appraiser Buy-Sell Agreements Issues That Can Destroy the Process
NOW
“As of” date Standard of value Level of value Appraiser qualifications Funding issues Unspecified use of life insurance THEN
See pages 134-135 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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RECOMMENDATION NOW
Single Appraiser Agreement
NOW
Select Now, Value Now, Value Annually
NOW
See pages 135-136 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
34
Life Insurance Associated with Buy-Sell Agreements Funding Vehicle The life insurance proceeds are intended to be a funding vehicle to repurchase the shares of a deceased owner. In this case, life insurance proceeds are not included in value to determine the price for buy-sell agreement transactions
Corporate Asset The life insurance is intended to be a corporate asset. The proceeds are, therefore, included in value to determine the price for buy-sell agreement transactions See pages 136-137 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
35
Example 1a: Life Insurance is Funding Vehicle Company
Estate Harry
Charles
1
Stock Ownership (Shares)
2
Stock Ownership (%)
3
Pre-Life Insurance Value ($000)
4
Life Insurance Coverage
5
Life Insurance
6
Life Insurance Proceeds
7
Repurchase Liability
($5,000)
8
Post-Life Insurance Value
$11,000
9
Repurchase Stock ($)
($5,000)
$5,000
10
Retire / Sell Stock
(50)
(50)
0
11
Remaining Shares
50
0
50
12
New Stock Ownership (%)
100.0%
0.0%
100.0%
13
Post-Life Insurance Value of Company
$11,000
$0
$11,000
14
Post-Life Insurance Value
$5,000
$11,000
15
Net Change in Value from Repurchase
$0
$6,000
See Figure 21 on page 139 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
100
50
50
100%
50%
50%
$10,000
$5,000
$5,000
120%
120%
$6,000
$6,000
$6,000
$1,000
36
Example 1b: Life Insurance is a Corporate Asset Company 1
Stock Ownership (Shares)
2
Stock Ownership (%)
3
Pre-Life Insurance Value ($000)
4
Life Insurance Coverage
5
Life Insurance
6
Life Insurance Proceeds
$16,000
7
Repurchase Liability
($8,000)
8
Post-Life Insurance Value
9
Repurchase Stock ($)
10
Estate Harry
Charles
100
50
50
100%
50%
50%
$10,000
$5,000
$5,000
120%
120%
$6,000
$6,000
$8,000
($8,000)
$8,000
Retire / Sell Stock
(50)
(50)
0
11
Remaining Shares
50
0
50
12
New Stock Ownership (%)
100.0%
0.0%
100.0%
13
Post-Life Insurance Value of Company
$8,000
$0
$8,000
14
Post-Life Insurance Value
$8,000
$8,000
15
Net Change in Value from Repurchase
$3,000
$3,000
See Figure 21 on page 139 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
$2,000
37
Transferable Business Value
VTransferable = Identifiable Earnings x M M = f (expected risk and expected growth)
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
38
Bad Things Happen to Good Companies Bad things happen to even good companies, possibly even yours If you wait until it is too late to diversify, it will be too late If you wait until it is too late to refinance, it will be too late If you wait until it is too late, it is too late
See page 171 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
39
Concentrations Can Be Risky and Value Destroying Key customer loss
Key location is deteriorating
Key supplier loss
Key technology reaching obsolescence
Key owner/manager loss
Key service line affected by regulation
Key product is outdated
Key service line affected by competition
Key employee loss
And more
Key patent is expiring
Work on them before it is too late
See pages 172-173 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
40
Is Your Business READY for Sale? If you don’t sell your business today, you are a buyer of your business R E A D Y
Risk Earnings Activities, Attitudes Driving Growth Year-to-Year Comparisons
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
41
READY? So, is your business READY for sale? Remember we are not talking about your business being up for sale, just READY. From the viewpoint of managing the wealth in your private company, the concept of READY for sale may be the most important perspective of all
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
42
25 Questions for Business Owners 1. How much is your closely held or family business worth? 2. How do you know what your business is worth? Has it been independently valued in the last three years? 3. What portion of your personal net worth is represented by your business ownership interest? 4. What has been your shareholders’ rate of return on their investment over the last one, two, three, four, five years or more? 5. How does this rate of return performance compare with alternative investments, e.g., in the public securities market? See pages 197-206 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
43
Interim Time
Business End Game
Status Quo
Interim Time
The Rest of Your Life
Interim Time is when we set up our business end games and the rest of our lives
The Road
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© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
46
Edward F. “Ed” Koren, JD
Z. Christopher Mercer, FASA, CFA, ABAR
Holland & Knight [email protected] | 813.227.6655
Mercer Capital [email protected] | 901.685.2120
2016 Spring Symposia, Real Property and Trust & Estate Law Section of the American Bar Association November 17, 2015
Edward F. Koren, JD Edward F. Koren is a partner in Holland & Knight's Tampa and Lakeland offices, and serves as the leader of the firm's Private Wealth Services Group. Mr. Koren's practice is focused on wealth planning and protection for entrepreneurs and multi-generational business owners. He serves clients across the country and practices principally in the firm's Tampa and Lakeland offices. The firm's Private Wealth Services Group is the largest group of trusts and estates lawyers in the United States, with more Fellows in the American College of Trust & Estate Counsel than any other law firm in the country. 813.227.6655 [email protected] www.hklaw.com
Holland & Knight 100 North Tampa Street Suite 4100 Tampa, FL 33602
Mr. Koren is past chair of the American Bar Association's Real Property, Probate and Trust Law Section; former American College of Trust and Estate Counsel Regent and past chair of its Estate and Gift Tax Committee; and the author of Estate and Personal Financial Planning, a five-volume treatise published by Thomson West that covers planning concepts for asset accumulation and transfer throughout life and through inheritance. He is a Florida Board Certified Wills, Trusts and Estates Lawyer and is a National Association of Estate Planners & Councils-Accredited Estate Planner® who has received the highest rating assigned by Martindale-Hubbell.
2
Z. Christopher Mercer, FASA, CFA, ABAR Chris Mercer is the founder and CEO of Mercer Capital, a national business valuation and financial advisory firm. Chris began his business valuation career in the 1970s and has been involved with hundreds of valuations for purposes related to mergers & acquisitions, litigation, and estate and gift tax planning, among others. He has extensive experience in litigation engagements including statutory fair value cases, business damages, and lost profits. He is also an expert in buy-sell agreement disputes. 901.685.2120 [email protected] www.MercerCapital.com www.ChrisMercer.net www.linkedin/in/zchristophermercer
Mercer Capital 5100 Poplar Avenue Suite 2600 Memphis, TN 38137
Designations held include Fellow of the College of Fellows (FASA) from the American Society of Appraisers, Chartered Financial Analyst (CFA) from the CFA Institute, and Accredited in Business Appraisal Review (ABAR) from the Institute of Business Appraisers. Chris has written widely on business valuation-related topics and is a frequent speaker on business valuation issues for national professional associations, other business and professional groups, and business owners. Recent books authored by Chris include Unlocking Private Company Wealth (Peabody Publishing, LP 2014), Buy-Sell Agreements for Closely Held and Family Business Owners (Peabody Publishing, LP 2010) and Business Valuation: An Integrated Theory, 2nd Edition, with Travis W. Harms (John Wiley and Sons 2008). For a complete list of the books authored by Chris, as well as further information on his valuation-related experience, view his complete CV at www.mercercapital.com.
3
Business Owner Wealth is Concentrated Focus on risk, returns Diversified 20-30%
Pay for professional management of wealth
Inadequate focus on risk to owners Private Company Wealth 70-80%
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
Little focus on returns Little concept of managing illiquid wealth
4
The Road
10,000 per day 76,000,000 Baby Boomers Own 2/3 of all businesses
Ownership Transfer Matrix Vertical or Horizontal? Partial Sale/Transfer
Total Sale/Transfer
Voluntary Transfer
• Private Equity/PE
• Sale of Business
Involuntary Transfer
• Personal Financial Issues
• Death
• Divorce
• Divorce
• Sales to Insiders/Relatives • ESOP/Management Buyout • Gifting Programs • Buy-Sell Agreements
• Buy-Sell Agreements
See Figure 3 on page 22 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
6
Interim Time
Business End Game
Status Quo
Interim Time
The Rest of Your Life
Interim Time is when we set up our business end games and the rest of our lives
Annual Return (No Realized Appreciation)
Need approval to calculate return
See page 75 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
8
The One Percent Solution Paying Fees $5 million Liquid Create budget based on private illiquid wealth value $20 million Illiquid
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
0.5%
$100 thousand
1.0%
$200 thousand
9
One Percent Solution Activities Annual Appraisals & Monitoring of Performance
Buy-Sell Agreement Pricing
Estate Planning
Ownership & Management Transition Planning
Corporate Finance for Private Businesses
Wealth Manager Comp
Life Insurance Funding
Financial Planning
Annual Legal Review
Outside Board Members
See pages 38-41 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
10
Three Sections Section 1 Managing Private Company Wealth Section 2 Tools for Managing Private Company Wealth Section 3 Perspectives on Managing Private Company Wealth
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
11
Fair Market Value Fair Market Value according to Revenue Ruling 59-60 The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
12
The Levels of Value
See Figure 7 on page 46 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
13
Creating Liquidity During the Interim Period Time
See Figure 9 on page 62 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
14
Net Cash Flow: The Source of Dividends Four Uses of NCF 1. Dividends 2. Retire debt 3. Reinvest for future growth 4. Reinvest in stagnant assets
See Figure 11 on page 72 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
15
Market Value Balance Sheet
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
16
Market Value Balance Sheet
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
17
Two Tools to Create Liquidity 1. Leveraged Dividend Recapitalization 2. Leveraged Share Repurchases
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
18
The Situation Acme Company (the Company) has sales for the most recent year of $250 million and manufactures and distributes a wide range of products for the extraction industries. Some of its products are branded. In spite of its significant size for a private business, the Company is a relatively small player in its overall industry Acme Company is a C corporation, with an EBITDA margin of just under 10% of sales. For perspective, EBITDA is $24.2 million Return on equity for the last twelve months was 8.6%, and has been trending downward in recent years The Company has $16.4 million of interest-bearing debt, which is more than offset by $20.5 million in cash See pages 98-99 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
19
The Situation Working capital as a percentage of sales is about 32% (versus 20% for similar public companies) The balance sheet reflects $126 million of equity, or 72% of assets Equity of the Company is valued at $149 million based on an EBITDA multiple of 6.0x (the median multiple for the group of comparable public companies) The Company is currently paying an annual dividend totaling $3.0 million, reflects a dividend payout ratio (from net income) of 27.5% Repurchase of 30% of equity (300,000 shares or $44.8 million) See pages 98-99 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
20
Transaction Assumptions Key Transaction Assumptions
Values
Comments
1
Number of Shares to be Purchased
300,000
30% of the outstanding shares
2
% of Cash Considered Excess
100.0%
Use all cash on balance sheet
3
EBITDA Multiple for Pricing Transaction
4
Dollars of Current Annual Dividends
5
Given Number of Shares for Example
6
Interest Rate on Pro Forma Cash
1.00%
Assumption of CFO
7
Interest Rate on Pro Forma Debt
6.00%
Assumption per bank discussions
8
Effective Tax Rate
36.20%
Factual
9
EBITDA Multiple for Pro Forma #1 Valuation
6.00
No Change in EBITDA Multiple
10
Price/Earnings Multiple for Pro Forma #2
13.7
Proxy for future benefit of recap
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
6.0 $3,000,000 100,000
Assumption Factual 10% block
21
Return Analysis
See Figure 18 on page 107 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
22
Benefits to Remaining Owners
See Figure 19 on page 108 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
23
Financing of Transaction
See Figure 14 on page 103 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
24
Pro Forma Analysis Balance Sheet Ratios
Before
Pro Forma
Comments
4.4 Lots of liquidity
3.5
2.2
1.3
Reasonable
Working Capital % of Sales
31.6%
23.5%
Reasonable
Total Liabilities / Assets
28.3%
47.5%
Reasonable
Total Liabilities / Equity
39.9%
91.8%
Reasonable
Interest Bearing Debt / Equity
13.0% Low leverage
50.2%
Interest Bearing Debt / Assets
9.2%
26.0%
Reasonable
1.4
1.9
Reasonable
11.3%
28.0%
Reasonable
Current Ratio Acid Test Ratio
Assets / Equity Debt / MVTC
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
Adequately liquid
Moderate leverage
25
Income Statement Analysis
See Figure 16 on page 105 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
26
Valuation Analysis
See Figure 17 on page 105 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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Observation In my experience, most owners of successful closely held and family businesses simply do not think about using reasonable leverage as a tool to redistribute stock ownership, provide liquidity for certain shareholders, provide special dividends, or engage in other transactions designed to provide liquidity for their owners and to enhance shareholder returns They should
See page 96 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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Private Equity Minority Investments on the Upswing During 2013, about 40% of all PE investments involved less than control transactions Recent statistics indicate that 15% of companies with enterprise values greater than $500 million are owned by private equity funds With so much investment capacity in the PE world searching for deals, now may be time to consider taking on a PE partner to provide liquidity for aging owners and/or to obtain growth capital to accelerate growth opportunities See page 125-126 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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Three Reasons to Consider Private Equity 1. Satisfy liquidity/diversification needs while retaining a significant share in a favorable upside outlook 2. Capital and expertise are required to access available opportunities 3. Outside assistance needed to take the business to the next level See page 127 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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What Are They Supposed to Do? Require agreement at a point in time Relate to transactions that will or may occur at future points in time Define the conditions that “trigger” the buy-sell provision Determine the price(s) and terms at which specified future transactions will occur
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
31
Types of Buy-Sell Agreements Based on how price is determined • Cross purchase agreements • Fixed-price agreements • Formula agreements • Valuation process agreements
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
32
Multiple Appraiser Buy-Sell Agreements Issues That Can Destroy the Process
NOW
“As of” date Standard of value Level of value Appraiser qualifications Funding issues Unspecified use of life insurance THEN
See pages 134-135 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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RECOMMENDATION NOW
Single Appraiser Agreement
NOW
Select Now, Value Now, Value Annually
NOW
See pages 135-136 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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Life Insurance Associated with Buy-Sell Agreements Funding Vehicle The life insurance proceeds are intended to be a funding vehicle to repurchase the shares of a deceased owner. In this case, life insurance proceeds are not included in value to determine the price for buy-sell agreement transactions
Corporate Asset The life insurance is intended to be a corporate asset. The proceeds are, therefore, included in value to determine the price for buy-sell agreement transactions See pages 136-137 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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Example 1a: Life Insurance is Funding Vehicle Company
Estate Harry
Charles
1
Stock Ownership (Shares)
2
Stock Ownership (%)
3
Pre-Life Insurance Value ($000)
4
Life Insurance Coverage
5
Life Insurance
6
Life Insurance Proceeds
7
Repurchase Liability
($5,000)
8
Post-Life Insurance Value
$11,000
9
Repurchase Stock ($)
($5,000)
$5,000
10
Retire / Sell Stock
(50)
(50)
0
11
Remaining Shares
50
0
50
12
New Stock Ownership (%)
100.0%
0.0%
100.0%
13
Post-Life Insurance Value of Company
$11,000
$0
$11,000
14
Post-Life Insurance Value
$5,000
$11,000
15
Net Change in Value from Repurchase
$0
$6,000
See Figure 21 on page 139 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
100
50
50
100%
50%
50%
$10,000
$5,000
$5,000
120%
120%
$6,000
$6,000
$6,000
$1,000
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Example 1b: Life Insurance is a Corporate Asset Company 1
Stock Ownership (Shares)
2
Stock Ownership (%)
3
Pre-Life Insurance Value ($000)
4
Life Insurance Coverage
5
Life Insurance
6
Life Insurance Proceeds
$16,000
7
Repurchase Liability
($8,000)
8
Post-Life Insurance Value
9
Repurchase Stock ($)
10
Estate Harry
Charles
100
50
50
100%
50%
50%
$10,000
$5,000
$5,000
120%
120%
$6,000
$6,000
$8,000
($8,000)
$8,000
Retire / Sell Stock
(50)
(50)
0
11
Remaining Shares
50
0
50
12
New Stock Ownership (%)
100.0%
0.0%
100.0%
13
Post-Life Insurance Value of Company
$8,000
$0
$8,000
14
Post-Life Insurance Value
$8,000
$8,000
15
Net Change in Value from Repurchase
$3,000
$3,000
See Figure 21 on page 139 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
$2,000
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Transferable Business Value
VTransferable = Identifiable Earnings x M M = f (expected risk and expected growth)
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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Bad Things Happen to Good Companies Bad things happen to even good companies, possibly even yours If you wait until it is too late to diversify, it will be too late If you wait until it is too late to refinance, it will be too late If you wait until it is too late, it is too late
See page 171 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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Concentrations Can Be Risky and Value Destroying Key customer loss
Key location is deteriorating
Key supplier loss
Key technology reaching obsolescence
Key owner/manager loss
Key service line affected by regulation
Key product is outdated
Key service line affected by competition
Key employee loss
And more
Key patent is expiring
Work on them before it is too late
See pages 172-173 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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Is Your Business READY for Sale? If you don’t sell your business today, you are a buyer of your business R E A D Y
Risk Earnings Activities, Attitudes Driving Growth Year-to-Year Comparisons
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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READY? So, is your business READY for sale? Remember we are not talking about your business being up for sale, just READY. From the viewpoint of managing the wealth in your private company, the concept of READY for sale may be the most important perspective of all
© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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25 Questions for Business Owners 1. How much is your closely held or family business worth? 2. How do you know what your business is worth? Has it been independently valued in the last three years? 3. What portion of your personal net worth is represented by your business ownership interest? 4. What has been your shareholders’ rate of return on their investment over the last one, two, three, four, five years or more? 5. How does this rate of return performance compare with alternative investments, e.g., in the public securities market? See pages 197-206 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net
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Interim Time
Business End Game
Status Quo
Interim Time
The Rest of Your Life
Interim Time is when we set up our business end games and the rest of our lives
The Road
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