Maximizing Value Through Pre-Transaction Readiness

Goal for Today Understand the drivers and need for business exit

planning Understand the components of a robust exit plan Understand the roles that professional service firms

can play in business exit planning

Capitalize on the Succession Bubble!

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Business Transition Bubble Background

There are over 6 million small and medium sized businesses (SMBs) in the U.S.1, 90% of which are family owned. Many of these SMBs are owned by Baby Boomers.A significant number of SMB owners will look to exit their business during the next decade in preparation for retirement.

1. U.S. Census Bureau2. AARP

Demographic BubbleThere are over 80 million baby boomers and 8,000 will be turning 65 every day for the next two decades.2 Census Bureau projects that Americans 65 and older will make up 19% of the population by 2030. 1

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How many are going to sell?• 75% of business owners ultimately plan to sell or pass along their

business.1

• One out of every two company owners plan to sell their business within the next 10 years.2

• Demand may outstrip supply potentially lower sale prices.

How many are ready to sell?• Some have delayed a sale due to the ‘08-’09 recession, while others

have re-evaluated their lifestyles and may be more likely to sell earlier than was the case 10+ years ago.

• Most (many estimate 70%+) do not have any plan for what will be the most significant event of their lives. 1

1. Northwestern Mutual2. PricewaterhouseCoopers

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Business Transition Bubble Market Need

Other Facts Of the family owned businesses, only 30% of such companies

succeed in the second generation and just 15% make it to the third generation = Sale > Transfer

Most will seek advice on the sale of their business = Opportunity According to SunTrust Bank, 42% indicated that maximizing their

business’s value is the most important part of an exit1 = ironic since most do not have a plan to chart a course toward increasing value

To maintain a sustainable business, scale is becoming increasingly important. Technology is allowing larger businesses to drive down into smaller segments, thereby increasing competition = Growth through acquisitions

1. SunTrust Bank

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Business Transition Bubble Overview

Opportunity EstimateNumber of SMBs 6,000,000

% Family Owned 90%

# Family Owned SMBs 5,400,000

% That Will Sell 50%

# That Will Sell 2,700,000

Average Revenue $5,000,000

Total Average Revenue Sold $13.5 Trillion

Estimated Sales Multiple 0.5x

Business Value Transferred $6.75T

Annual Opportunity (Est. 10 Yrs.) $675 Billion

Assuming a 2% variable fee, a $13.5 billion

annual revenue opportunity

exists for service

providers in this space!!

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Business Transition Bubble Market Opportunity

Exit Planning is Key!

For many business owners, the business is a significant contributor toward retirement capital. For those with limited retirement savings they may have to stay in the business longer than planned or accept a significant reduction in their standard of living. A robust exit plan can help chart a course towards extracting maximum value.

An Exit Plan Can Help Bridge the Gap

“How much does my business

produce (income)?”

“How much is my business

worth (value)?”

Potential Disconnect

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$350k Annually $5M revenue @ 0.5x sales =

$2.5M

Reinvest $2.5M @ 10%

(aggressive) = $250k < $350k

Succession Versus Exit Planning

Succession planning is important for owners transferring leadership from one generation to the next and/or to management• Focuses on business continuity, skills of next generation/management, relational

issues, family dynamics, etc. Exit planning focuses on transferring ownership

• Succession planning can be a part of exit planning, since a “self sustaining” business (i.e., doesn’t require the owner to assure it generates the level of profit desired) is worth more than one with key man risks (owner wears a lot of “hats”).

• A plan should be initiated at least a year or more in advance of a potential sale process.

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Exit Planning Components

Understand The Owner’s Objectives

Assemble a Team Understand Your Business’

Worth

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Make the Business Look Desirable to Buyers Improve Business Operations and Profitability

Owner Objectives

Understand the owner’s personal and financial goals• How much money is needed to sustain retirement?

• Is that feasible? If an owner wants $10 million on an exit but the business is likely worth $7 million, significant business and market improvements may be needed in order to increase profits and the exit multiple; or the owner’s expectations will need to change.

• When does the owner want to retire?• Certain buyers may require the owner to transition the business over a

period of time (18 months +/-). In addition, the sale process can take up to 12 months. As such, planning should begin at least 3 years before the owner wants to retire.

• Who does the owner want to sell to?• Strategic buyers can pay premiums due to synergies. However, some sellers

prefer to take a lower price in order to ensure status quo – same culture, name, people, etc.

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Assemble a Team Before initiating a sale process, a team of experts with

diverse skill sets should be assembled to help steer a sale to a positive end.• A deal team should include attorneys, accountants and an investment banker or

business broker, all of whom can help navigate the tax and deal landscape. No one professional has all the answers.

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• Post-transaction estate and retirement needs should also be addressed (such as an estate attorney, insurance planner and/or wealth manager).

A good team allows the owner to continue to focus on growing the business throughout the sale process, thereby maximizing the sale price and minimizing business disruption.

Understand Business Valuation

Establishing parameters on business value is an important step in the process.

A formal valuation gives a realistic idea of what a business is worth and help assess financial and non-financial status, including current industry dynamics and market position.

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Accepted Valuation Methods

Traditional Valuation Methodologies

Income Method

Discounted Cash Flow

Approach

Capitalization of Cash

Flow Approach

Market Method

Comparable Public

Company Approach

Precedent Transactio

n Approach

Asset Method

Net Asset Value Approach

Leveraged Buyout

Approach

Value Drivers

Working capital considerations - examine efficiency Tangible assets – quality of assets or deferred capex Contract backlog – confidence to near-term projections Customer relationships – repeat customers with low

concentration Proprietary, patented technology/formulations/process Brand name Proven management team and skilled assembled workforce –

employee retention Supplier relationships Growth strategy – scalable growth at sustainable margins Tax attributes

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Levels of Value

Strategic Control Premium

Financial Control Premium Lack of Control Discount

Lack of Marketability Discount

Strategic Control Value

Financial Control Value

Marketable Minority

Nonmarketable Minority

Strategic value is the highest level of value related to potential synergies. The next

level, financial control, is value expected from

a financial buyer. Oftentimes, financial

control and marketable minority

levels of value converge in efficiently

run businesses.

Strategic Versus Financial Control

Strategic Control Benefits

Reduction in competition

Revenue or profit enhancement through synergies

Cost savings or economies of scale

Make Business Look Desirable

Goal is to “measure up” and realize a higher “price per square foot” for the business• Physical assets should be clean and attractive• Companies sell for more that also present an attractive story with

supporting documentation• Is there remaining upside runway?• Are the financial records well maintained?• Is there a history of financial forecasting/budgeting?• Do the reported financials provide an incomplete picture of how

profitable the Company really is or have you prepared and justified appropriate earnings adjustments?

• How strong are the external and internal agreements?• Do you have well documented policies and processes?• Have you mitigated litigation or environmental issues?• Are you complying with all necessary regulations?

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Improve Business Operations/Profitability

It is key to focus on the business’ core operations and underlying profitability

There are many things an owner can do to legitimately make his/her business more profitable/valuable/less risky to a new owner including:

• Diversifying the customer base• Filling management holes• Upgrading systems/processes• Closing down less profitable business lines• Culling unprofitable customers• Keeping the work force lean

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Exit Alternatives Sale to a strategic buyer (typically highest valuation due to

synergies) Sale to a financial buyer Sale to management (buy/sell agreements) Transfer/sale to family members/trust (potential discounts for

lack of control and marketability) Sale to employees (ESOP – Fair Market Value) IPO (at least > $100 million revenue) Shut down

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Exit alternative will impact taxes, timing, and cash considerations

Current Exit Environment U.S. Middle Market M&A Activity

Financing Expansion

/ RecapSource: Robert W. Baird, Inc.

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Jul-12 Jul-13# of Transactions – Middle-Market 3,692 3,956 3,848 3,867 3,640 3,604 3,322 5,401 4,561 4,427 2,618 1,728 # of Transactions – $500M - $1B 106 134 143 178 227 120 78 173 152 169 91 80 # of Transactions – $100M – $499M 620 781 796 864 853 600 432 691 760 719 413 357 # of Transactions – <$100M 2,966 3,041 2,909 2,825 2,560 2,884 2,812 4,537 3,649 3,539 2,114 1,291 Deal Value (In Billions) 270$ 338$ 350$ 401$ 423$ 278$ 196$ 342$ 346$ 346$ 195$ 162$

U.S. Middle Market M&A Activity

$-

$50

$100

$150

$200

$250

$300

$350

$400

$450

-

1,000

2,000

3,000

4,000

5,000

6,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Jul-12 Jul-13

# of Transactions – <$100M # of Transactions – $100M – $499M # of Transactions – $500M - $1B Deal Value (In Billions)

2011: Fewer deals versus 2010, but the value of these transactions trended higher 2012: Essentially flat with 2011 related to political uncertainty (fiscal cliff) and a U.S. economy entrenched in low

growth mode 2013: Meager M&A volume despite easy debt and giant corporate balance sheets due in part to risk adverse CEOs &

boards Going forward M&A drivers: cash on corporate balance sheets, ongoing recovery, pent-up demand, robust credit

markets• Cash levels of S&P 500 >$1 trillion • Private equity buyout funds are sitting on nearly $400 billion of cash

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Current Exit Environment U.S. Middle Market M&A Multiples

Financing Expansion

/ Recap

Source: Robert W. Baird, Inc.

Valuation multiples hovering in the range of 5-8x EBITDA for most mid-sized companies, with higher outliers seen in unique, niche markets

Positive trend: strategics and financial sponsors are willing to pay significant values for firms that show scale, growth and a prominent position in the marketplace; S&P 500 up 18% since the beginning of the year

LTMTransaction Size 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

<$100M 6.8x 7.6x 9.2x 8.1x 8.5x 7.8x 7.0x 7.0x 8.3x 7.1x 7.4x$100M-$499M 8.2x 9.0x 9.9x 9.2x 11.2x 11.1x 8.1x 10.1x 9.3x 9.1x 9.1x$500M-$1B 9.6x 10.3x 10.1x 12.0x 10.8x 10.6x 7.8x 9.0x 9.9x 8.7x 8.6xMiddle-Market 7.5x 8.6x 9.7x 9.2x 9.9x 9.5x 7.6x 8.6x 9.2x 8.1x 8.5x

Middle Market EV / EBITDA Multiples

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Current Exit Environment Other

Financing Expansion

/ Recap

22Proprietary & Confidential

Low interest rate environment• Lower cost of capital (e.g., “cheap debt”) that may lend itself to higher

prices• Reinvestment risk

More predictable estate planning environment (e.g., continuation of the $5.25 million lifetime gift tax exemption)

• Presents more opportunities to make informed decisions

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Exit Planning ValueExample

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Company A Company B• Light Manufacturing • Light Manufacturing

• Revenue at $20M, growing 3%/yr.

• Revenue at $18M, growing 8.5%/yr.

• $2M EBITDA • $2.5M EBITDA

• Older equipment needing frequent maintenance

• Equipment in good condition

• $1M inventory• (poor controls)

• $500K inventory • Good controls

• Loyal employees• Loyal employees

• Limited management team • Good management team

Valued at 5.0x EBITDA, or $10M

Valued at 6x EBITDA, or $15M

Two businesses, similar size, similar

industry. However Company B

performed exit planning and

executed on areas of improvement

including culling unprofitable

customers, improving working

capital efficiency and filling

management holes. Company B also

presented an exciting growth story

to potential buyers (i.e., better

packaging). As such, Company B

realized a higher multiple on higher

earnings at exit, resulting in a 50%

higher sale price.

Exit Planning - Case Study 1

Carleton McKenna advised a company in a sale process that did not perform exit planning

Discovered capital structure issues as company had an “underwater” class of common shareholders

• Certain shareholders would receive nothing in the sale due to a heavy liquidation preference from preferred shareholders

• Added time and uncertainty to the deal as the buyer was hesitant to structure the transaction as a merger and common shareholders could dissent and elect appraisal rights

• Added cost as a fairness opinion was needed• Issue could have been resolved via exit planning as the shares could have

been redeemed for some nominal amount

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Exit Planning - Case Study 2

Carleton McKenna advised a company in a sale process that did not perform exit planning

Discovered issue with contracts of a large customer• Company had a customer with multiple contracts that represented over

20% of profits (customer concentration)• Only one contract was structured appropriately regarding economic

terms• Buyer wanted the contracts restructured to reflect economic reality• Customer had leverage and was able to negotiate better terms in

exchange for shifting contract compensation• Issue could have been resolved via exit planning as the contracts could

have been modified in the normal course of operations

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Exit Planning - Case Study 3

Carleton McKenna advised a company in a sale process that did not perform exit planning

Key employees did not have non-competes in place• Company had several key regional managers that maintained customer

relationships but did not have non-compete agreements• Buyer wanted non-competes• Key managers held significant bargaining power since they knew they

could hold the deal hostage; owner agreed to pay the managers a significant sum to sign the non-competes

• Issue could have been resolved via exit planning as the non-competes could have been obtained in prior years and tied to bonuses

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Thank you

Paul H. Carleton MANAGING PARTNERphc@carletonmckenna.com

Christopher J. McKenna MANAGING DIRECTORcjm@carletonmckenna.com

Dominic M. Brault MANAGING DIRECTORdmb@carletonmckenna.com

For more information please contact:

1801 East Ninth Street, Suite 1425Cleveland, OH 44114

Phone: 216.523.1962 Fax:216.523.1322www.carletonmckenna.com

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