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Presented by
Neil Churman
Principal Consultant
Morrissey Goodale LLC
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Agenda
• Two Paths and How to Choose Them• Internal Transition Options• External Transition Options• Case Study of One Seller• Summary
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Strategy M&A
Workplace 2020
Research & Publishing
About Morrissey Goodale LLC: AEC Industry Consulting & Research
Buyer AdvisorySeller AdvisoryDeal PricingDeal StructuringIntegration
Market Research & AssessmentScenario PlanningStrategy DevelopmentMarket Research
Executive SearchExecutive CoachingLeadership DevelopmentOwnership Transition
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The Key is Time
• Everyone who operates a company will reach a point when it’s time to leave
• Start now – Every firm needs a transition plan
• Avoid the three D’s: Death, Disaster or Divorce
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Two Paths
Transitions can be either internal or external
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So What to Do?
Culture?
Next Tier?
5+ Year Timeline?
Yes
Yes
Yes Yes
No No No No
Risk Tolerance?
External Sale
Internal Sale
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Culture
Is an internal transition in our DNA?
• Past history
• Past promises or discussions
• Current owner preferences
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Next Tier
Is the next generation capable?• Motivated
• Shared values and belief in the firm’s vision
• Ability to think strategically about the future
• Leadership and team building skills
• Tolerance for and willingness to assume risks
• Trust and integrity
“People who are unable to motivate themselves must be content with mediocrity, no matter how impressive their other talents” – Andrew Carnegie
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Risk Tolerance
Are you prepared to wait to get our money out?
• Every transition has risk More time = more risk
Time
Risk
External Transaction
Internal Transition
• External transition yields more money sooner
• Harder to simply walk away with an internal transaction than external
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Available Timeline
Now 10 Years
When do we want to be out?
• A shorter timeline limits viability of internal transfer• External transitions still require significant time investment
4 Years 8 Years
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Internal Transition: Options
• Direct Employee Ownership
• ESOP
• Management Buyout
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Internal Transition: Direct Employee Ownership
Why direct employee ownership?
• Known players
• Retain and incentivize the next tier
• Arrange for orderly exit
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Internal Transition: Mechanics
Defined ownership transition plans will include:
• Valuations: quarterly or annually
• Formulas: book value, tangible net worth, earnings and others
• Generally done by third party advisor
• Schedule: plan the timeframe for share transfer
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Internal Transition: ESOP
Why an ESOP?
• Creates a market for closely held shares
• Provides liquidity for shareholders and fund a buy-out with pre-tax dollars
• Provides tax deferral for sale of C-corporation to ESOP
• Creates a tax-advantaged entity with an S-corporation
• Employee recruitment and retention
Source: Wells Fargo Advisors
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Internal Transition: ESOP
Source: Wells Fargo Advisors
How it Works
Company
ESOP TrustBuild Employee Equity
Over Time Shareholders
Purchase SharesAt Current FMV
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Internal Transition: ESOP
Advantages
• May obtain financing to purchase shares
• Principle and interest payments are tax-deductible
• Tax deferred rollover for seller
• Deferral of taxation for participants
• Employee motivation
• Takeover protection
Source: Wells Fargo Advisors
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Internal Transition: ESOP
Disadvantages
• Fiduciary responsibility
• Valuation requirement
• Dilution of ownership
• Operating costs
• Cash flow issues
• Employee impact if stock goes bad
• Repurchase requirement for departing employees
Source: Wells Fargo Advisors
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What is a management buyout?
• A company’s management team purchases the assets and operations of their own business
• MBOs are favored exit strategies for private businesses where the current owners wish to retire
• Heavy financing requirement
Internal Transition: Management Buyout
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Internal Transition: Keys to Success
• Start early
• Motivate and mentor the future owners
• Establish transparent valuation
• Communication
• Don’t neglect team building
• Remain available as a resource
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U.S. M&A Trends
2007 2010 2014 Proj. 2015
100
150
200
250
175
152
203
220+
Reported Annual Domestic A/E/C M&A Activity
# o
f D
eals
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2000
2005
2010
Proj.
2015
50
150
250
350
104
303
233
332
291
330+
Reported Annual Global A/E/C M&A Activity
# o
f D
eals
Global M&A Trends
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States in Demand
TX
CA
WA
FL
CO
NC
VA
MA
PA
0 5 10 15 20 25 30
25
22
10
9
9
8
8
8
7
Top States for Firm Sales ‒ 2014
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External Transition: The Mechanics
• Culture
• What adds value
• What subtracts value
• Valuations can differ
• An accounting moment
• Show me the money
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External Transition: Culture
Why is culture so important in the A/E/C world?
• Your staff, your firm and its legacy
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External Transition: What Adds Value
• Greater market penetration
• Expand services to current clients
• Augment staff and quality
• Add future leaders
• Increase revenue growth
• Expand backlog
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External Transition: What Subtracts Value
• Limited focus or depth
• Owner(s) don’t remain
• Undercapitalization
• Inconsistent financials
• Low growth prospects
• Little backlog
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External Transition: Valuations Can Differ
Different Values from Different Buyers
• Strategic value to buyer
• Amount of perceived risk
• Motivations of seller
• Buyer revenue projections
• Future outlook
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External Transition: An Accounting Moment
Why do we focus on profitability and EBITDA?
• Profits are a proxy for free cash flow the buyer can expect
• EBITDA excludes expenses that can obscure how a company is actually performing
• EBITDA makes it easier to compare firms
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External Transition: Show Me The Money
Payment methods
• Cash
• Promissory note
• Deferred compensation
• Stock in Buyer’s company
• Earn‐outs
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External Transition: Options
• Merger
• Sale to strategic buyer
• Sale to financial buyer (private equity)
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External Transition: Merger
Why do mergers happen?
• Expansion (new geographies, markets, or services)
• Capital – lower potential capital need
• Industry trend to consolidation
• Fear
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External Transition: Sale to Strategic Buyer
What are the issues?
ConsConsProsPros
• More scale and scope• Offload back-office pain and
suffering• Business alignment• Brand recognition and
reputation• Additional opportunities for
staff
• Loss of control• Integration issues• Non-compete agreements
for sellers• Time and resource
investment• Trading one illiquid stock
for another
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External Transition: Sale to Financial Buyer
What are the issues?
ConsConsProsPros
• Abundance of capital• Management stays in
place• Maintain existing way of
doing things
• Increased focus on financial performance
• Outsiders on Board• Few precedents in
A/E/C industry• Less industry
knowledge• Eventual “exit”
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External Transition: Common Pitfall
• This is flawed thinking: “I can work for three more years and make more money than they are offering me”
• Selling your business today transfers risk to the buyer and compensates you for your years of hard work now
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External Transition: Keys To Success
• Strong cultural compatibility
• Provide professional opportunities to key leaders and staff
• Start early and allow enough time
• Know your value proposition and walk away price
• Communication
• Seek outside advice
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Case Study
Situation
• $6 million in revenue at 12% EBITDA
• Three offices in the US
• Transportation and public works sectors
• Owner doing well after 20 years in business
• Key clients secure, but competitive pressure in specific markets
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Case Study
The Decision
1. Culture? Yes, wanted to transfer internally
2. New Tiers? Competent, but none were willing to take second mortgages to make payroll
3. Risk Tolerance? Owner sensed market was peaking, didn’t want to “let it ride”
4. Timeline? Owner wanted out in 3-5 years
Result: Pursue an external sale
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Case Study: Potential Outcomes
Internal
• Timeframe: 6-8 years
• Growth: Steady
• Valuation Method: 5x EBITDA
External
• Timeframe: 2-3 Years
• Growth:10%
• Valuation Method: 16% discounted cash flow
Result: $3.6M valuation Result: $4.5M valuation
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Case Study
Process
• Engaged three larger firms operating in similar markets
• One local
• One ENR 500
• One ENR 200
• Midsized firm offered $4.2M
• Initial: 20% upfront, 50% over 3 years, 30% earn-out
• Final: 60% upfront, 30% over 3 years, 10% earn-out
Result: Closed transaction within 11 months
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Summary
• Whichever option is best for you, start early
• High-quality leaders are a key in the A/E/C industry
• Culture, culture, culture
• More time = more risk
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Neil ChurmanPrincipal ConsultantMorrissey Goodale
508-650-0040 ex. 1011
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