Valuation and Exit Planning - dhg.com · – Business planning – Valuation – Estate planning...

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Valuation and Exit Planning Strategies to Enhance and Protect Business Value

Brian Burns, CPA/ABV/CFF, ASA, MAFFDirector, Forensics & Valuation


Agenda

• Potential Exit Options and Strategies• Transaction Lifecycle• Business Valuation Concepts• Exit Planning

Exit Strategies and Valuation

• Shareholder Oppression and Rights• Common Techniques of Oppression• FMV v. Fair Value• Practices and Techniques to Avoid Disputes

Shareholder Disputes

• Evolution of Owner Characteristics• Purpose and Types of Agreements• Key Provisions to Understand• Red Flags and Pitfalls

Buy-Sell Agreements


Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code.


Exit Strategies and Valuation


Potential Options and Exit Strategies

• Buyers– Financial and Strategic

• Recapitalization– Partial or staged exit for active owners– Increase debt to generate growth capital, fund shareholder

dividends and / or repurchase equity• Internal Succession

– Transferring (or selling) ownership within the family and / or employee group

– Employee Stock Ownership Plan (ESOP)• Divestiture

– Leverage buyout– Strategic M&A sell


Transaction Lifecycle

Planning Pre-Transaction

Transaction Execution

Post-Transaction

• Defining Potential Options and Exit Strategies• Valuation Analysis and Retirement Planning• Pre-Letter of Intent Due Diligence• Buyer and Market Research

Planning

•Marketing Materials and Sell-Side Due Diligence•Letter of Intent and Negotiation with Buyers•Transaction and Tax Structuring•Information Collection

Pre-Transaction

•Purchase Agreement •Financial, Accounting, and Tax Due Diligence•Information Technology Due Diligence•Operations, Human Resources or Other Due Diligence

Transaction Execution

•Audit and Tax•Post-Closing Integration Support•Purchase Price Allocation and Earn-Out/Purchase Price Calculations•Former Owner Retirement Planning

Post-Transaction


Functions of Professional Advisorsby Practice Area

• Certified Public Accountants– Due diligence– Business planning– Valuation– Estate planning– Tax planning and deal structure– Assurance services

• Attorneys– Transaction agreements – Transfer of contracts– Negotiators– Employment law– Corporate governance

• Investment Bankers– Brokerage function– Identify buyers– Industry expertise– Make the pitch– Negotiations

• Financial Advisors– Investment of sale proceeds– Retirement planning and long-

term financial needs– Insurance products


Valuation Basics

Does the Balance Sheet Present the Fair Market Value of

Stockholders’ Equity?Answer: Typically No

– Balance Sheet = Financial Snapshot– Tax Returns– Financial statements

– Asset Reporting– Cost v. market value

– Where are intangible assets?– Workforce– Customer and supplier

relationships– Contracts– Proprietary technology/processes– Intellectual property

• Trade names• Patents• Copyrights• Trade secrets

– Goodwill= Stockholders’ Equity

Minus Liabilities

Assets


Fundamental Factors Influencing Value

ValueGrowth Profile

Future Shareholder

Dividends/Cash Flow

Risk Profile

Transferability


Common Valuation Approaches

• Income Approach– Capitalized and Discounted Cash Flow Methods– Rates of return of return of public companies

• Market Approach– Valuation Multiples– Guideline Merger and Acquisition Transaction Method– Guideline Public Company Method

• Asset Approach– Book value– Adjusted book value– Liquidation value

• Rules of thumb– Not a primary valuation method– Reasonableness check


Risk and Value

Investors Are Compensated for Risk Requiring Varying Levels of Rates of Return

Rates of Return

Value

Typical RangeForm of Capital/Investment Rates of Return

Bank financing - Cash Flow Loan 3.5% 5.5%Bank financing - Asset Based Loan 6.1% 8.3%Publicly Traded Companies 8.7% 15.1%Mezzanine Financing 8.5% 21.0%Private Equity Groups 19.2% 28.3%Venture/Angel Capital 35.0% 70.0%


Applying Valuation Multiples

• How to apply Valuation Multiples….

• Examples– Revenue – 1.0X Revenue– EBITDA Multiple – 6.0X EBITDA

Earnings Stream

•Revenue , EBITDA, etc.

X Multiple

• [Rate of Return – Growth]

= Value


Buyers Seek Synergies

• Revenue Enhancement– Cross selling of complimentary product offerings– Geographic expansion– Elimination of competition– Diversification of product/service/customers

• Cost savings– Economies of scale– Vertical integration of supply chain

Manufacturer Distributor Retailer


Exit Planning


Importance of Planning

Assessment of Historical

Performance and Market Positioning

Future Performance=

Value


Planning to Enhance Value

Value Enhancement

Customer Relationships

Product/Service Mix and

Differentiation

Intellectual Property

Competitive Positioning and Market Share

Executive Management

Infrastructure and Systems

Legal Agreements

HR Policies

Financial Compliance

Tax and Regulatory Compliance


Shareholder Oppression


Shareholder Oppression

• Controlling Shareholders who vote themselves as directors and “run” the company often:– Believe the company is “their” company.– Believe they can do whatever they desire with

“their” company.– Are frequently tempted to take actions to

enhance their own (or their family’s) financial advantage at the expense of the minority


Legal Remedies

• Shareholder oppression occurs when the majority shareholders in a corporation take action that unfairly prejudices the minority.

• The courts sometimes make oppression remedies available. An oppressed minority shareholder can ask the court to dissolve the corporation or to hold the corporation’s leaders accountable for their fiduciary responsibilities.

• Another remedy sometimes used is court-ordered purchase of shares or the sale of its assets.

- 2 -


Common Techniques of Oppression

– Removal of minority shareholders from the board– Removal of minority shareholders as officers– Terminate employment of minority shareholders or reduce

compensation– Increase compensation of controlling shareholders or reduce

compensation– Reduce or terminate dividends (flow-through income tax

liability concerns)– Diversion of corporate funds for various personal benefits

flowing only to controlling shareholders– Use of corporate assets for personal reasons– Withholding information from minority shareholders and

minority directors– Goal: Squeeze Out

• Through these actions, controlling shareholder may seek to purchase the stock at an artificially deflated price below market value.


Fair Market Value

• Internal Revenue Service (“IRS”) definition of fair market value in Revenue Ruling 59-60:– Price at which a property would change hands– Willing buyer– Willing seller– Neither being under any compulsion– Both having reasonable knowledge of the relevant facts– Valuation date and use of subsequent events

• Tax-Related Valuation Purposes– Gift tax reporting– Estate tax reporting– Income tax reporting– Charitable contribution

reporting– Stock-based compensation

409(a)

• Other Valuation Purposes– ESOPs– Succession planning– Shareholder/Buy-Sell

Agreements– Shareholder transactions– Divorce – jurisdictional

considerations


Statutory Fair Value

• Legal Concept - shareholder should be paid for the value that was taken from him/ her.

– Dissenting shareholder matters– Oppressed shareholder matters (focus of our presentation)

• State mandated concept that varies by jurisdiction (not a federal statute). • American Bar Association and the American Law Institute developed model

statutes (RMBCA and Principles of Corporate Governance)– Most states adopted– States may modify – Case law

• Most states (but not all) have accepted the position that what has been taken from the shareholder is pro rata share of the value of the company as a whole.

• How is it different than fair market value?– Minority interest = proportionate share of a company’s value on a controlling basis– Typically results in the elimination of any discounts at the shareholder level


What should you do?

• High functioning firms have leadership teams that assess markets, develop strategies and execute decisions with relative ease, speed and success. These firms seem to share these attributes:– Build Trust,– Treat each other with respect,– Encourage people to take responsibility,– Value Humility,– Place the needs of the company, the team, its

customer/client ahead of individual ambitions,– Strive to be positive,– Value communication,– Operate with vision


What should you do?(continued)

• Common Sense applications– Avoid conflicts of interest– Apply “best” corporate practices– Importance of following corporate formalities

• Meeting Minutes• Detailed corporate records• Action and approval of important transactions• Compensation studies and basis for and documentation of

bonuses• Dividend policy and related plans to support important

changes therein• Think through and document family business plans and

succession plans


Buy-Sell Agreements


Types of Organizational Document by Entity

Type of Entity Organizational Documents Filed with State*

Common Ownership Agreements

Corporation Articles of Incorporation 1. Bylaws,2. Buy-Sell Agreements, 3. Shareholder

Agreements

Limited Liability Company Articles of Organization Operating Agreement

Limited Partnership Certificate of Limited Partnership

Limited Partnership Agreement

Partnership Partnership Certificate Partnership Agreement

For purposes of this presentation, we use the term, Buy-Sell Agreements, to be inclusive of the common ownership agreements listed above.

* The list above is not all inclusive; filing requirements and organizational documents vary by state.


Can’t We all Just Get Along?

• Potential Differences in Owner Characteristics

– Level of Ownership - Control v. Minority Percentage of Outstanding Ownership Interests

– Operational Involvement - Active v. Passive Investor in Management

– Personal Characteristics - Age, Retirement Plans, Personal Guarantees, Business Outlook/Perspective

– Investment Characteristics – Amount of Investment Relative to Personal Wealth


Purpose of Buy-Sell Agreements

• Protect the interests of the business and owners and may establish provisions relating to:– Owners’ rights and relationships– Management of the company– Transfer of ownership interests– Privileges and protections of owners

• Mitigate a variety of risk areas relating to– Anticipated changes in the interests, objectives, and

circumstances of business owners – Unanticipated events and changes


Types of Buy-Sell Agreements

• Third-Party Purchases– Terms set forth the manner by which transactions among

owners and third parties are consummated or restricted (“cross-purchase”)

• Business Purchases– Terms set forth a purchase obligation or option for the

business upon the occurrence of certain triggering events (“redemption”)

• Combination of Third-Party and Business– Terms address both cross-purchase and redemption

arrangements and may provide right of first refusal provisions for the remaining owners and the business


Key Provisions

• Purchase price determination– Fixed Price– Agreed-Upon Formula (e.g. Multiple of Earnings)– Agreed-Upon Methodology (e.g. Market Derived)– Valuation Performed by Qualified Business Appraiser

• Restrictions on transfer and right of first refusal• Employment and non-compete• Call and put options• Funding and terms of purchase• Preferred returns, conversion rights, and

participation rights


Selecting the Method to Determine the Purchase Price

• Assess– Nature of the subject company– Goals and characteristics of ownership– Application of valuation theory and accounting principles

• Potential Considerations– Cost-benefit– Clarity– Understandability– Credibility– Fairness– Protection and preservation of owner rights and business value– Punitive or Restrictive– Business Factors: profitability, stage of development, expected

growth, risk, etc.


Ambiguity of Essential Appraisal Elements

• Standard of Value• Level of Value• Valuation Date• Appraiser Qualifications• Governing Standards• Scope of Valuation and Type of Report


Buy-Sell Agreement Disputes

• Evolution of Differences in Owner Characteristics– Level of Ownership– Operational Involvement– Personal Characteristics– Investment Characteristics

• Ongoing maintenance may be afterthought– Set it and forget it

• Owner relationship and nature of purchase/sale negotiation– Conflicting objectives– Opposing interpretations of vague or inequitable

provisions


Case Examples - Guidance

• Court Rulings– Tended to provide a strict interpretation of the

agreements’ provisions absent apparent ambiguity– Operated within the four corners of the agreements

finding that book value was a defined term to be utilized despite any perceived, and even apparent, inequities

• Emphasize the importance of establishing Buy-Sell Agreements consistent with the current objectives of ownership to facilitate the transfer of ownership in a manner agreeable to the owners

• Buy-Sell Agreement “check-up” – Operations, ownership, management, and industry of a

business evolve over time


Questions?


Brian Burns, CPA/ABV/CFF, ASA, MAFF

Licenses & Certifications• Certified Public

Accountant, VA (CPA)• Accredited in Business

Valuation (ABV)• Certified in Financial

Forensics (CFF)• Accredited Senior

Appraiser in Business Valuation (ASA)

• Master Analyst in Financial Forensics( MAFF)

Industry/Service Focus

• Valuation services• Commercial Matters

• Economic damages• Business Interruption

• Family law• Asset/income valuation

and classification• Fraud and Forensics

Accounting

ExperienceBrian leads the DHG Forensics and Valuation practices in Virginia and serves clients across the Mid‐Atlantic region. He practices inthe areas of valuation and forensic accounting, including financial investigations and litigation support and consulting services. Hehas been designated as an expert witness and qualified to testify by report, deposition, and/or trial testimony in various venues incommercial and domestic matters. Brian frequently presents to professional and trade organizations and has presented at venuessuch as the AICPA's National Forensic and Valuation Services conference, state CPA society conferences, and a national webinar.

Brian has also authored articles on forensics and valuation presented in various professional publications. Brian assists businessesand individuals with valuation services in the areas of family law, financial reporting, stock‐based compensation, litigation andshareholder disputes, transaction consulting, tax matters, and employee stock ownership plans. The focus areas of his forensicaccounting services include consulting services in commercial and family law matters involving matters such as shareholderdisputes, breach of contract, breach of warranties, misappropriation of trade secrets, post‐acquisition disputes, tortious interference,statutory conspiracy, business interruption claims, employee embezzlement, investment scams, and fraud.

Brian has served both public and private businesses in industries including, but not limited to: real estate, construction, healthcare,technology, food service, auto dealerships, manufacturing, distribution, government contracting, retail, insurance, and banking.

Professional & Civic Organizations• AICPA, Business Valuation Committee and Former Task Force Member • American Society of Appraisers, Former Richmond Chapter President• VSCPA, Top 5 Under 35 Award, Past Recipient• VSCPA, Annual BVFLS Former Conference Task Force Member• Junior Achievement Worldwide, Past volunteer and presenter

Director, Forensics & Valuation804.474.1240 [email protected] E. Cary Street, Suite 1000 | Richmond, VA 23219

EducationVirginia Tech• Bachelor of Science, Magna Cum Laude

Virginia Commonwealth University• Post Baccalaureate Certificate in Accounting

Valuation and Exit Planning - dhg.com · – Business planning – Valuation – Estate planning...

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