M&A International™ – the world's leading M&A alliance

Getting Top Dollar for a Family Business

CREATING SHAREHOLDER VALUE February 2012

Howard E. Johnson

MBA, FCA, FCMA, CBV, CPA, CFA, ASA, CF, C.DIR

M&A International™ – the world's leading M&A alliance

Speaker

Howard E. Johnson MBA, FCA, FCMA, CBV, CPA, CFA, ASA, C.Dir Managing Director, Veracap Corporate Finance Limited (416) 597-4500; hjohnson@veracap.com Howard is a Managing Director of Veracap Corporate Finance and its affiliate, Campbell Valuation Partners Limited. Howard has been involved in business valuation, acquisition, divestiture, and related assignments for corporations throughout North America. He is the author of several texts on the subjects of business valuation and corporate finance, and has acted as an expert witness on complex valuation matters before the courts.

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M&A International™ – the world's leading M&A alliance

About Veracap

Veracap Corporate Finance Limited helps business owners and executives to maximize shareholder value through acquisitions, divestitures, private equity financing and strategic value advisory services. Veracap is an affiliate of Campbell Valuation Partners, Canada’s longest established independent business valuation firm. Veracap is a member of M&A International, the world’s leading affiliation of M&A advisors, with over 500 professionals in 40 countries.

www.veracap.com 3

M&A International™ – the world's leading M&A alliance

Disclaimer

This material is for educational purposes only. It deals with technical matters which have broad application and may not be applicable to a particular set of circumstances and facts. As well, the course material and references contained therein reflect laws and practices which are subject to change. For these reasons, the course material should not be relied upon as a substitute for specialized advice in connection with any particular matter. Although the course material has been carefully prepared, the author does not accept any legal responsibility for its contents or for any consequences arising from its use. © Howard E. Johnson, 2012

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M&A International™ – the world's leading M&A alliance

The Shareholder Value Curve™

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Value Realization

Intangible Value

Value MeasurementTangible Net Worth

Time

Sh

areh

old

er V

alu

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M&A International™ – the world's leading M&A alliance

Shareholder Value and Beyond

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EBITDA 10,000$

Multiple 5.0x

Enterprise Value 50,000$

Debt 20,000$

Shareholder Value 30,000$

Tangible Net Worth 30,000$ 10,000$

Intangible Value -$ 20,000$

M&A International™ – the world's leading M&A alliance

The Determinants of Shareholder Value

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Cash RiskFlow Profile

Deduct: Debt Outstanding

Equals: Shareholder Value

Deduct: Tangible Net Worth

Equals Intangible Value

Enterprise Value

InvestedCapital

M&A International™ – the world's leading M&A alliance

Drivers of Shareholder Value

• Cash Flow – Discretionary cash flow

• Risk Profile – Differentiated product and service offerings – Diverse base of repeat customers – Strong and committed management team

• Invested Capital – Capital investment and working capital – Management compensation considerations

Creating a Competitive Advantage

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M&A International™ – the world's leading M&A alliance

Competitive Advantage Examples

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Value Driver Competitive Advantage

Increase Cash Flow • Premium pricing • Cost advantage

Reduced risk • Customer exit barriers • Diversification

Capital efficiency • Working capital mgmt • Capacity utilization

M&A International™ – the world's leading M&A alliance

Creating a Competitive Advantage

• Must be sustainable and transferable • Sustainability requires continuous innovation

and adaptability – Company culture and business philosophy

• Transferability – Legal rights – Customers & employees

• Must result in return on capital > cost of capital

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M&A International™ – the world's leading M&A alliance

Cost of Capital

• Why Important? – Value is created where return on capital > cost of capital

• Cost of Capital for public companies – Determinable based on market prices, analyst reports – Possible issues for small-cap public companies

• Cost of Capital for private companies – More subjective – “Build-up” approach is common

• Liquidity is a key driver • Segregate 2 Components – Operating risk (unlevered return on equity) – Financial risk (capital structure)

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M&A International™ – the world's leading M&A alliance

Competitive Advantage & Intangible Value

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Competitive Advantage

Cash Flow Risk Profile Invested Capital

Return on InvestedCapital Cost of Capital

Intangible Value

M&A International™ – the world's leading M&A alliance

Value vs. Growth

• Growth only leads to value where the return on

capital exceeds the cost of capital • One of Three Avenues – Operating efficiencies (cash flow) – Risk reduction – Capital efficiency

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M&A International™ – the world's leading M&A alliance

Value vs. Growth

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BeforeExpansion No added Operating Risk Capital

Value Efficiency Reduction Efficiency

EBITDA 10,000$ 12,000$ 13,000$ 12,000$ 12,000$

Multiple 5.0x 5.0x 5.0x 5.5x 5.0x

Enterprise Value 50,000$ 60,000$ 65,000$ 66,000$ 60,000$

Expansion Cost 10,000-$ 10,000-$ 10,000-$ 5,000-$

Net Value 50,000$ 55,000$ 56,000$ 55,000$

Value Created -$ 5,000$ 6,000$ 5,000$

After Expansion

M&A International™ – the world's leading M&A alliance

Acquisitions and Shareholder Value

• Growth vs. value (again) • 3 Ways to Create Value: - Realize more synergies than what are paid for - Effective negotiation - Deal structuring

• Importance of strategic fit • Integration is key • Due diligence requirements • Beware “Transition Risk”

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M&A International™ – the world's leading M&A alliance

The Magic of Financial Leverage

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No ModerateLeverage Leverage

Earnings Before Interest and Taxes (EBIT) 10,000$ 10,000$

Interest expense (5%) -$ 1,000$ Pretax income 10,000$ 9,000$

Income taxes (25%) 2,500$ 2,160$ After-tax income 7,500$ 6,840$

Invested CapitalDebt -$ 20,000$ Equity 50,000$ 30,000$

50,000$ 50,000$

Return on Equity 15.0% 22.8%

M&A International™ – the world's leading M&A alliance

Financial Risk

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0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0:100 10:90 20:80 30:70 40:60 50:50 60:40 70:30 80:20

Leve

red

Cos

t of

Eq

uit

y

Debt to Equity Ratio

Financial Risk Premium

Unlevered Cost of Equity

Levered Cost of Equity

Conclusion: Using debt MAY lead to a higher return on equity BUT the shareholder is exposed to higher risk

M&A International™ – the world's leading M&A alliance

Avenues to Value Realization

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Initial Public Offering

Strategic BuyerPotential Reward Financial Buyer

Management Buyout

Family Succession

Transactions with Existing Shareholders

Recapitalization

Dividends / Share Buyback

Liquidation

Risk

ShareholderDistributions

Related PartyTransactions

Transactions withThird Parties

M&A International™ – the world's leading M&A alliance

Deciding When To Sell

Preparing For the Sale

The Search For Buyers

Estimating Value and Price

Preliminary Due Diligence

PLA

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PH

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UTI

ON

PH

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Negotiations Deal Structuring Closing

V A

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H A

N C

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Building Deal Momentum

M&A International™ – the world's leading M&A alliance

Keys to Realizing Maximum Value

• Create alternatives – Liquidity is key

• The “Platform Buyer” – Leveraging your people, products, customers

• Pre-transaction planning – 3 parties to every deal

• More than a numbers game – Negotiations and deal structuring are key

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M&A International™ – the world's leading M&A alliance

Final Thoughts

• Value Measurement – Knowing your cost of capital – Measuring intangible value

• Value Creation – Cash flow, risk, invested capital – Competitive advantage (sustainable, transferable) – Return on capital > cost of capital – Focus on building intangible value

• Value Realization – Process management – Alternatives – Liquidity

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M&A International™ – the world's leading M&A alliance

Resources available at www.veracap.com

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