Business Exit, The Owner's Perspective - Doug Smith
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Doug Smith, PartnerB2B CFO®
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Business Exit:The Owner’s Perspective
What Is B2B CFO® ?
Established: Founded in 1987
National : 200 Partners in 39 states, 5700 years of experience
Focused: Privately-held companies with sales between $1 - $75M
Affordable: Part-time CFO services, as needed
We are Specialists In:
Banking and Lending Relationships
Profit Improvement
Financial and Strategic Planning
Cash Flow Projections
Working Capital Improvement
Gross Profit Optimization
Expense Reduction
Timely & Accurate Financial Statements
Increased Sales
Exit Strategies
Who Am I?
• 33 Years in Operations, Finance, Administration• COO, CFO, CAO• Government Contracting, IT, Healthcare• M&A experience (seller, buyer)• American Management Systems, MITRE, other
small and mid-market businesses• BS Engineering (Princeton), MBA (Harvard)
Some of Today’s Content is From…
• John Leonetti is the Managing Director of Pinnacle Equity Solutions
• Pinnacle Equity Solutions is a B2B CFO® partner
Copyright 2008 by John M. Leonetti, Published by John Wiley & Sons, Inc.
What We Don’t Have Time for Today
• Details of deal structuring• Asset vs. stock acquisitions• Multiple owner issues (e.g., buy/sell agreements)• Handling the proceeds
– Estate planning– Investment– Tax planning/avoidance
The Exit Environment
• 70% of private business owners report that their business is their primary source of income
• Only 5% of privately-owned businesses successfully sell to an outside buyer– Only 25% of private businesses are offered up for sale– Only 20% of those successfully sell
• 27 million U.S. businesses (2009)– 99.9% have less than 500 employees– 21 million have no employees– 18,000 large businesses
• Firm survival– 70% survive at least 2 years– Half survive at least 5 years– One-third survive at least 10 years– One-fourth survive 15 years Source: SBA
Exit Environment (cont’d)
• Much Baby Boomer wealth tied up in 12 million privately-owned businesses– 70% of these owners will exit in the next 15 years– $3-4 trillion in wealth will change hands
Public vs. Private Markets
Public Markets (Wall Street) Private Markets (Main Street)C Corporation C, S, LLC, etc.
Value established by market at any point in time Value established at a point in time
Ready access to public capital No access to public capitalShareholders have limited liability Shareholder(s) have unlimited liabilityShareholder holdings are diversified Shareholder earnings not diversifiedProfessional management Owner managementCompany has long life Company life typically < one generationLiquid securities, efficiently traded Illiquid securities, inefficiently tradedProfit maximization goal Personal wealth creation goal
©2010, Pinnacle Equity Solutions
10-Year Transfer Cycle
Deal Recession(Buyer’s Market)
Prime Selling Time(Seller’s Market)
Almost Recession(Neutral Market)
1980199020002010
1983199320032013
1988199820082018
1990200020102020
Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 19
Exit ≠ Sale
• Exit definition:
Transferring some or all of your business’ value to someone else, in exchange for more liquid assets
What are the Exit Options?
• Sale to an outsider• Recapitalization (e.g., Private Equity investment)• Employee Stock Ownership Plan (ESOP)• Management Buyout• Gifting (to family, to charity)
What are the Exit Options?
• Sale to an outsider• Recapitalization (e.g., Private Equity investment)• Employee Stock Ownership Plan (ESOP)• Management Buyout• Gifting (to family, to charity)• [Status Quo] Stay and (ideally) grow• Initial Public Offering (IPO)• Close down the business and liquidate assets• Bankruptcy• Death
Why Do Owners Exit Their Business?
Why Do Buyers Acquire A Business?
What Do Exiting Owners Do With Their Proceeds?
• Provide for their own retirement• Provide for loved ones• Share rewards with others who helped them build
their business• Contribute to charity• Invest
– Diversified savings for growth and income– Start another business– Join angel or private equity investment groups
Owner Readiness to Exit
Mental Readiness
FinancialReadiness
High
Low
HighLow
Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 15
Financial Readiness
• How much of my wealth is tied up in the business?• How much of the proceeds do I want/need to keep for
myself?• Do I depend on the business to support my lifestyle?• Am I prepared for the loss of:
– Salary– Benefits– Deductible Perks (travel, auto, meals)
Mental Readiness
• How involved am I in the day-to-day running of the business?– Am I addicted to being a business owner– Will I know what to do with my time when I am no longer
in the business?
• Do I view my business as an investment?– Can I make dispassionate decisions, based on objective
criteria, about the exit process?
• Am I feeling burned out?
Owner Readiness to Exit
Mental Readiness
FinancialReadiness
High
Low
HighLow
Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 15
Four Types of Owners
• Well off, but choose to work• Rich, and ready to go• Can stay and grow the business• Get me out right away at the highest possible price
Owner Type by Readiness
Mental Readiness
FinancialReadiness
High
Low
HighLow
Well off, butchoose to work
Rich, and readyto go
Stay and growGet me out now
at the highestpossible price
Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 15
What are the Exit Options?
• Sale to an outsider• Recapitalization (e.g., Private Equity investment)• Employee Stock Ownership Plan (ESOP)• Management Buyout• Gifting (to family, to charity)• Stay and grow
Exit Options vs. Readiness
Mental Readiness
FinancialReadiness
High
Low
HighLow
Management Buyout, ESOP,
Gift
Gift, ESOP,Sell
Recap, ESOP,Stay and grow
Sell for the highestpossible price
Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 16
Putting It All Together
Mental Readiness
FinancialReadiness
High
Low
HighLow
Management Buyout, ESOP,
Gift
Gift, ESOP,Sell
Recap, ESOP,Stay and grow
Sell for the highestpossible price
Mental Readiness
FinancialReadiness
High
Low
HighLow
Well off, butchoose to work
Rich, and readyto go
Stay and growGet me out now
at the highestpossible price
Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, pp. 15-16
Why Do Owners Exit Their Business?
Why Do Buyers Acquire A Business?
Sources of Capital
RevenueGrowth
Time
Friends &Family
AngelInvestors
VentureCapital
PrivateEquity
IPO
What Do Buyers Buy?
• People (management team, workers)• Reputation/Brand• Future cash stream• Intellectual property• Contracts• Customer/client relationships• Assets and Liabilities on the Balance Sheet
– Cash (usually goes to the seller)– Fixed Assets (buildings, equipment, furniture, computers)– Inventory– Debt Obligations
What Can Prevent a Successful Exit?
• Business cannot survive once the original owner no longer involved
• Keeping family in the business is more important than selling to an outsider
• Potential buyers can’t get the financing needed to acquire the business
• Poor economy has reduced profitability• The owner’s price expectations are unrealistic
What is the Business’ Value?
• Four types of value– Liquidation value (LV)– Fair market value (FMV)– Investment value (IV)– Synergy value (SV)
• FMV may be discounted for partial transfers– Lack of control– Lack of marketability
ESOP,Gift
ManagementBuyout, Recap
StrategicSaleSV
FMV
IV
Discount
LV Liquidation
Synergy Value (from the Buyer’s Perspective)
• Removing competition• Reducing seasonal fluctuations• Critical mass• Expanded geographic reach• Increased prestige• Reduce indirect cost % through consolidation and
elimination of duplication
My Business as an Investment(“Why isn’t it worth what I think it is?”)
• People/organizations with money can invest it different ways– Equities have returned, historically, 10%+ annually– Buying a small business is inherently a risky investment
• Can it prosper without the current owner?• Business will still be illiquid after the sale
– Greater risk = greater expected return– Buyers expect 20-40% annualized return
• Generally speaking, buyers pay for a multiple of company’s cash flow (EBITDA), adjusted for their risk perception
• For given cash flow, higher risk premium → lower price
How Do Owners Determine Their Business’ Value?
• What is needed to sustain (or improve) my personal lifestyle after my exit– Salary– Benefits– Some previously-deductible business expenses now become
personal (travel, meals, cars)
Replacing The Company CarCar Lease $500 Annual Cost $10,200 Insurance $100 Marginal Tax Rate 40%
Fuel $100 Annual Cost (pretax) $17,000
Maintenance $150 Investment Return 6%TOTAL $850
Assets Needed $283,333 Annual Cost $10,200
What is the Business’ Value?
“Owner’sLifestyle
PreservationValue”
ESOP,Gift
ManagementBuyout, Recap
StrategicSaleSV
FMV
IV
Discount
LV Liquidation
What Does the Owner Net?(“How Much Do I Get to Keep?”)
• Sale/Transfer Price• Plus
– Liquid assets pulled out of business• Cash above that needed for Working Capital
• Minus– Payoff of business debt– Transaction Fee (Double Lehman Formula)
• M&A Broker or Investment Bank
– Hourly Fees• Lawyers, Accountant, etc.
– Taxes (Federal, State, Capital Gains, Ordinary Income, Estate)– Earn-Outs
• Replacing non-competitively-won business• Achieving certain milestones (e.g., revenue growth, profitability)
Double Lehman Formula
• 10% of the first $1,000,000 $100,000• 8% of the next $1,000,000 $ 80,000• 6% of the next $1,000,000 $ 60,000• 4% of the next $1,000,000 $ 40,000• 2% of the next $1,000,000 $ 20,000• 2% of each additional $1,000,000
• Sale Price of $20,000,000 $600,000
Total Wealth in a Partial Exit
Assets Removed from the
Business and Reinvested – compound
annual growth
Annual Continuation of Salary, Benefits,
and Perks
Net Proceeds from Final Sale of the Business
+
+
When Should an Owner Start to Plan the Exit?
When Should an Owner Start to Plan Their Exit?
Now!(Even if the exit event is years away)
(Exit Planning is a process, not a milestone)
Exit Strategy Plan
Leonetti: “The written goals for the succession of a business’ ownership and control, derived from a well-thought-out and properly-timed plan that considers all factors, all interested parties, and the personal goals of the owners in a manner and time period that accommodates the business, its shareholders, and potential successors and/or buyers”
• Written goals• Succession of
ownership and control• Detailed plan• Considers needs of all
interested parties
Exiting Your Business, Protecting Your Wealth by John M. Leonetti, ©2008, p. 2
Get Ready to Sell/Transfer
• Increase the value of the business– Increase sales– Improve profit margin– Reduce internal costs through efficiency, streamlining, focus– Strengthen infrastructure (management, people, systems,
process documentation)– “Lock In” key individuals with incentives– Diversify customers and contracts, if concentrated– Document and protect IP– Build a track record of good financial management
(financials reviewed by CPA, correct tax returns)
Get Ready (cont’d)
• Get mentally ready– See your business the way investors will look at it– Make decisions like an investor, not as an emotionally-
invested owner– Be prepared to not live out of your business– Decide what you’ll do with your time after exiting
• Line up advisors
$2M - $5M
BusinessBroker
$5M - $25M
M & ASpecialist
$25M - 100M+
InvestmentBank
Transactional Advisors
CPA Attorney
InsuranceWealth
Valuation Estate
Relationship Advisors
Independent “Quarterback”
Understand Paperwork to be Signed
• Letter of Intent (LOI)– Outlines fundamental deal points– Starts due diligence process– Often has an exclusivity clause
• Purchase and Sale Agreement (a.k.a Definitive Purchase Agreement)– Includes representations and warranties– Include any negatives– Must be in writing, even if discussed verbally during due diligence
• Non-Compete Agreement• Earn-Out Agreement• Seller-Financing Agreement
When Should an Owner Start to Plan Their Exit?
Now!