The Zen Art of Cooperative Negotiation

/in /by Don Ross

zen-negotiationThe common image of an M&A negotiation between a buyer and a seller is that of a rugby scrum: two masses of interlocked muscled bodies scheming and bulldozing their collective strengths in opposing directions in an effort to secure the prize without compromise and ultimately yield one winner and one loser.

In contrast, what I call the “Zen Art of Cooperative Negotiation” is a playing field where the players (the principals and their attorney, M&A broker, and other advisors and stakeholders) become more collaborative and the outcome rewards everyone. The goal is win-win. There are no losers.

Below is a list of strategies that support a cooperative negotiation of business acquisitions, mergers, sales and other business transactions.

  1. Patience. Find a tempo that both can live with. A relaxed, easy swing usually gets more distance and greater accuracy. Set a realistic time frame checklist that keeps everyone on task but allows flexibility.
  2. Accept the personalities that are in the negotiation. Suspend judgment, keeping in mind that the end game is a successful transaction, not a personality contest.
  3. Share your objectives and listen. If you know what your end games are, you can be more mindful of the elements that will get you there. A “give and take” philosophy preserves self respect and encourages cooperation.
  4. Don’t burn bridges. Visualize the negotiation process as a cross country hike, not a tip toe through a minefield. You will encounter obstructions on the journey but with time and effort, most can be resolved. . . .but only if you leave the door open.
  5. Concentrate with your mind and stay loose with your spirit. A clear headed approach tempered with occasional humor can alleviate the stress and tension and optimize performance.
  6. Be honest. Full disclosure is always the best policy, and that applies equally to what you don’t know.

You can connect with Don Ross at 707-778-0210 or donross@exitstrategiesgroup.com.

Using Retention Bonuses to Enable an M&A Transaction

/in , /by Al Statz

Assurance of business continuity is essential to most business acquisitions, and for small to mid-size companies, this often translates to retaining key employees. This blog looks at using a simple tool, called a stay bonus or retention bonus, to keep your key people on board through a sale or merger of your company.

Bonuses are commonly used in business to reward employees for performance, such as hitting a sales target, implementing a new system, or boosting manufacturing productivity. Bonuses can also be used to incentivize a key employee to stay with your company for a specified period of time after a sale or merger.

How much are we talking about here?

sbimageStay bonus amounts are customarily based on the key person’s annual compensation, determined in accordance with the risk and effect of losing them. According to Mercer’s Survey of M&A Retention and Transaction Programs, median stay bonuses paid by U.S. companies range from 25 to 95 percent of base salary depending on the position (see graphic). The way we see this at Exit Strategies is that the stay bonus amount has to be personally meaningful to the key employee. In many of our deals this number is half to two-thirds of a person’s annual compensation.

But isn’t retention a buyer’s concern?

Remember that what gives your business value is the expectation of future earnings, adjusted for risk. As you reduce risk for buyers, your business value and probable selling price go up. From a buyer perspective, the cost of acquiring a business is more than just the purchase price. Other line items on their investment ledger include, for example, legal and professional transaction fees, loan fees and other closing costs, working capital injection (if you retain cash or AR) and any extra compensation paid to employees to ensure their continued employment and performance.

Stay bonuses can come from either side of the table—the seller or the company acquiring—or both. When retention bonuses are paid out of your proceeds, buyers can afford to pay a higher purchase price. So, in the end, it really doesn’t matter which side the bonus comes from.

When is the bonus offered?

Stay bonus agreements (a.k.a. stay-put agreements) are usually offered to (negotiated with) key employees when the owner is preparing to sell the company. Actual timing normally varies by employee and circumstances. Someone who you don’t identify as key to your company’s future may be offered a financial incentive during due diligence to ensure their participation in the short-term post-sale integration process. Integration bonuses are typically offered to CFOs, controllers or IT specialists.

Offering a stay bonus early on arises when an employee is critical to future performance and would be difficult to replace (e.g. a top design engineer or salesperson). Or when you need to involve them in the selling process. It may be compensation for the extra work involved. A third situation is when the employee is aware that you plan to sell the company, and you need them to stay put. When employees become aware that their employer is for sale, they understandably get nervous and may begin seeking alternative employment or become more open to offers of employment. When competitors find out that a company is for sale, key employees are likely to be approached and offered signing bonuses to jump ship. You can mitigate that risk by putting a retention bonus in place early on.

When is a stay bonus paid?

Stay bonuses should be paid out a specified number of months AFTER your deal has closed, not before and not at closing. Remember, you need them to stay on with the new owner. Most retention incentive bonuses are payable within 3 to 12 months after a deal closes. For key-employees who are critical to long-term success, it may be 24 to 36 months. Stay bonus agreements can also have an acceleration provision where they become payable if employment is terminated by the buyer.

How much should I budget for this?

The budget for stay bonuses will depend on several facts and circumstances. It’s a wide range in practice, and in many cases its zero. As a general rule, the larger the company, the smaller this budget is relative to the sale price. Unfortunately for small service businesses with few employees, it can be a significant percentage of the sale price. Some sellers elect to pay bonuses to loyal employees simply to acknowledge their contribution to the company’s goodwill value—unrelated to retention.

Stay Bonus Limitations

Clearly stay bonuses have limitations as a long term retention tool. Ultimately the buyer will need to provide rewarding work, a desirable culture, competitive compensation, growth opportunities and strong leadership. They do however enable transactions by reducing business risk during the critical months before and after an acquisition or merger. And of course there are other forms of financial incentives that can be used to align the interests of owners and employees, such as stock options, stock appreciation rights and phantom stock —a subject for another day.

In closing; retaining key staff affects the overall success of most M&A deals. Key employees drive customer retention, product and service quality levels, and in some cases business survival. Bonusing key employees to facilitate a business sale, merger or acquisition isn’t always necessary, but should always be considered when developing your exit strategy.

California-based Exit Strategies Groiup has been helping company owners plan for and exit their businesses successfully since 2002. Stay bonuses are just one tool in the M&A toolkit. If you have questions or are considering selling your company, Email Al Statz or call him at 707-781-8580 for a confidential consultation.

Can You Sell a Contracting Business to a Buyer Without a License?

/in , /by Adam Wiskind

Solar Installers, General Contractors, Electricians and Plumbers in California have something in common when it comes to selling their businesses. All of these businesses require a Contractors State Licensing Board (CSLB) license to operate. This can be an additional burden to the process of transitioning a business to a new owner. What if a potential buyer doesn’t have the necessary licenses? The easiest solution to this issue is to target investors that already have the Licenses needed to operate the business but this obviously limits the pool of potential buyers.

It is possible to sell a contracting business to an individual without a CSLB license but it requires some negotiation, trust and planning between the seller and buyer. To maintain their Contractor’s License a contracting business must employ or associate with a “Qualifying Individual” or “Qualifier”. A Qualifier has demonstrated knowledge and experience in the construction industry and can either be a Responsible Managing Officer (RMO) or a Responsible Managing Employee (RME) of the company.

An RMO/RME is according to California Law permanently employed by the applicant and is actively engaged in the operation of the applicant’s contracting business for at least 32 hours or 80 percent of the total hours per week such business is in operation, whichever is less. An RMO and RME may have different duties within the company but their responsibilities and liabilities with respect to the license are the same.

A contracting business can be sold to a buyer without a contractor’s license as long as the Qualifying Individual for the company is willing to continue to be employed by the business until the buyer is able to obtain the necessary licenses or hire a new Qualifying Individual. Under this approach managerial control will inherently be divided as the Seller’s Qualifying Individual will want to maintain close oversight of the contracting work being performed. Typically these situations are transitional because the new business owner will want to obtain the necessary licenses themselves or hire their own Qualifying Individual.

Exit Strategies Group has sold many California contracting businesses; some to investors who did not have the necessary CSLB licenses prior to the sale/acquisition transaction. With legal consultation, careful planning and development of trust between parties we help our clients to navigate this obstacle and successfully exit their contracting businesses.

Please contact Adam Wiskind at (707) 781-8744 or awiskind@exitstrategiesgroup.com about selling a Solar Installation Company, Construction Company or any other company requiring a California Contractor’s License.

Add-On Acquisitions are on the Rise

/in , /by Jim Leonhard

When developing an exit strategy for your company, we will consider whether Private Equity Groups (PEG’s) would want to acquire it as either a new platform company or as an add-on (also “bolt-on”) to one of their existing portfolio companies. Most small companies are too small or don’t have strong enough management teams to be attractive platform opportunities, however many are strong add-on candidates. According to PitchBook, which tracks the PEG M&A activity in the middle market, the number of add-ons as a percentage of all acquisitions grew from 43% in 2006 to over 60% in 2015 — and Q1 data showed a continuing increase to 68%.

buyoutactivityWhat has caused this trend? A number of reasons are generally cited, including:

  • Larger companies typically trade at higher valuation multiples, and this gap has risen in recent years
  • It has become increasingly harder to find good platform companies making add-ons more appealing
  • Add-ons are easier to assimilate because the PEG already knows and understands the industry
  • The increasingly shorter holding periods for platform companies makes a buy and build with add-ons a favored strategy
  • An add-on can increase a platform company’s competitive position in its industry by providing synergies or access to a new niche market
  • PEG’s can often use more debt to buy an add-on and invest less equity

As a potential seller of an add-on company, you might consider these questions, among others:

  • How does your company align with and how could it be integrated into a platform company?
  • In addition to a good strategic fit, PEG’s look for strong profit margins, a defensible market niche and revenue “stickiness”. Does your business have these qualities?
  • Business continuity will be important to the buyer. Will you consider providing ongoing leadership and retaining some equity for a future sale at a potentially higher price per share?
  • PEG due diligence can be exhaustive, as they are experienced and disciplined investors and typically require multiple approvals from lenders and investors. How will your company fare in such a deal environment?

If you are interested in understanding PEG investing activity in your industry and whether your company is a strong add-on or platform acquisition candidate, contact Jim Leonhard, CVA MBA at 916-800-2716 or jhleonhard@exitstrategiesgroup.com.

A Tax Saving Strategy for C-Corp Sellers

/in , /by Jim Leonhard

When selling a C-Corporation, most sellers will want to sell stock while most buyers will want to buy the assets.  Selling the stock minimizes the built-in gains (BIG) for sellers that carries a hefty double taxation first at the corporate level and second individually.  Buyers wish to buy assets for a number of reasons including loss of future depreciable expenses and potential increased liability.

One method to possibly reduce the impact of BIG for some businesses is allocation of a portion of the transaction to personal goodwill, defined as the value from an individual’s service to the business.

To qualify for personal goodwill, the tax authorities will need to find some of these key attributes for the business owner, including:

  • Personal relationships with customers and/or suppliers that exist with or without a contractual agreement
  • Industry reputation that gives an intangible benefit to the company
  • Technical expertise that provides identifiable economic benefit to the business
  • The absence of an employment agreement or a covenant not to compete

If a tax advisor believes this is an appropriate strategy, a valuation can be performed to estimate the value of personal goodwill.

For additional information on this subject see the article, “Personal Goodwill Avoids Corporate Tax Exposure” on Forbes.com.  (https://www.forbes.com/sites/peterjreilly/2014/06/13/personal-goodwill-avoids-corporate-tax-exposure/#3d1cbf0c21b4)

Disclaimer: Exit Strategies Group, Inc. is not qualified to provide tax advice to others.  Readers should not rely on the information in this blog for any specific transaction and should seek the advice of a qualified tax advisor.

For more information about M&A transaction structuring and business valuation, you may contact Jim Leonhard, CVA MBA at 916-800-2716 or jhleonhard@exitstrategiesgroup.com

Risk and its Effect on Enterprise Value

/in , /by Exit Strategies

Investors have choices in how to allocate their investment dollars across the risk and return spectrum. Whether it be bonds, public company equity, or private company equity, an astute investor will evaluate the risk of return and expect to be compensated according to this risk.

Business valuation, whether for public or private companies, has three key variables: growth, profit margins, and risk.

Growth and profit margins are more easily understood by most business owners and generally receive the most attention. Growth and margins drive cash flow which is what a buyer is ultimately looking for when investing in a business. That is, what cash flow return can they expect on their investment. In the ubiquitous Gordon Growth valuation model, cash flow is the numerator; risk is in the denominator.

“The path of least resistance to increasing enterprise value is often to reduce business risk.”

Yet risk is often overlooked and under appreciated. Business risk can have many dimensions ranging from concentration of customers, reliance on a single product line, owner dependence, reliance on a key individual, sub-par financial reporting, competitive threats, and outdated technology, systems or equipment to name just a few.

Before attempting to sell a business or attract investors, an owner should consider ways to make their business more attractive to buyers/investors. Increasing growth and margins often requires the most time and capital. An owner thinking of an exit may not want to put more capital into the business. The path of least resistance to increasing enterprise value is often to reduce business risk. Examples of this include cleaning up the books, creating retention incentives for key employees, obtaining long term contracts with vendors or customers, and other measures.

Having a business appraised by an independent expert in advance of going to market helps the owner clearly understand existing risk factors that are penalizing business value. This helps the owner identify strategies and objectives to de-risk the business and enhance value for current and future shareholders.

For further information on buy-sell agreement business valuation or to discuss a potential need, confidentially, please one of our senior business appraisers.

Business Valuation and M&A Services for Estates and Trusts

/in , /by Al Statz

Al StatzThis article takes a look at the various situations in which trusts and estates (those that hold private business interests) need business valuation or M&A brokerage services.

Business Valuation Services

Our firm, Exit Strategies Group, regularly provides fair market value appraisals (a.k.a. valuations) of closely-held corporations, FLPs and LLCs for estate planning, gifting, estate tax, charitable donations, buy-sell transactions and succession planning. We value fractional interests in operating companies and asset holding companies using appropriate discounts. We also value intangible assets such as patents, trademarks and copyrights.

For estates containing closely held business interests, we can determine the value of a decedent’s interest, and we can provide input to the estate attorney or CPA on whether an alternative valuation date should be considered.

For trust administration, when a privately held business interest is placed in trust, our business valuation can help the fiduciary or trustee establish a baseline value and enhance their understanding of the asset’s prospects and marketability. Subsequent valuations may be ordered to assess the investment’s performance over time. An independent business valuation can also avoid potential conflict of interest, when trustee fees are based upon the value of assets managed.

When an owner gifts shares in a business, we determine value as of the date of gift. When closely held business interests are donated to a Charitable Remainder Trust, our business valuation can support the charitable deduction by the donor taxpayer.

In estate planning where a family business is one of the owner’s major assets, a valuation is often the starting point for estate planning professionals as they consider various estate planning techniques. Valuations provide a basis for the owner to evaluate potential ownership transfers and gifts; and can safeguard against future IRS challenges.

Our appraisers adhere to professional valuation standards, perform appropriate due diligence, and meet or exceed accepted reporting requirements. We are prepared to defend our work in the unlikely event of an IRS audit. Between us, we hold all major U.S. business valuation credentials (ASA, CBA, CVA and ABV).

When drafting entity agreement terms, attorneys have to balance flexibility and efficiency of operation with restricting control and marketability. During this stage, we can identify problem valuation situations or problem assets, identify the effects of estate planning alternatives on fair market value, and make recommendations on operating, shareholder and buy-sell agreement terms that impact valuation.

Part of estate planning  is business succession planning, which is emotionally charged and usually meets with resistance. Business valuation provides an objective look at many aspects of a business, including its management, marketability, inherent risks, and future prospects. The very act of going through the business valuation process with an experienced, knowledgeable and independent appraiser often provides the catalyst that owners and their families need to embark on developing succession and wealth transfer plans.

M&A Brokerage Services

In many instances, an inter-generational transfer or management buyout of a business is not the best option for business owners and their families. In some cases the children aren’t qualified or they simply aren’t interested. In others, the industry may be consolidating or an opportunity exists to sell the business for significantly more than fair market value and/or create substantial liquidity for the family to reinvest or use to pursue other interests.

Accordingly, Exit Strategies markets and sells businesses. Our professionals advise owners throughout the evaluation, prospectus preparation, confidential strategic marketing, negotiation and due diligence phases. We lead the M&A sale process and work alongside our client’s tax, legal and financial advisors to maximize proceeds and preserve wealth.

Feel free to contact us for more information on business valuation and M&A brokerage services for estates and trusts, or to discuss a current need.

Welcome News for Business Owners: Five-Year Built-in Gains Tax Recognition Period Permanently Extended

/in , /by Al Statz
The Protecting Americans from Tax Hikes Act (PATH), enacted in December, makes selling a business easier for some.
Since most sales of SME’s will be asset (versus stock) sales, double tax for C-corp owners and built-in gain tax (currently 35 percent federal) for owners of recently converted S-corps are very real impediments to selling a business.
C-corporation owners face a “double tax”, where gains on a sale of assets are taxed at the corporate level and subsequent liquidating dividends are taxed at the shareholder level; whereas in an S-corp there is no federal corporate level tax. However, when a C-corp converts to an S-corp, a “built-in gain” is determined, based on the Fair Market Value of the corporation’s assets (both tangible and intangible) less the tax basis in the assets on the date of conversion.  Essentially, built-in gain is the gain that would have been taxed had the C-corp sold its assets on the conversion date. A sale of assets by an S corporation during the “recognition period” triggers the built-in gains tax, as does a sale of stock in a deemed asset sale under Section 338(h)(10). Congress’ enactment of built-in gains (a.k.a. “BIG”) tax back in 1986 was intended in part to prevent C-corp owners from making an S election just before selling their companies’ assets to avoid corporate-level taxes.
From 1986 until 2009, the BIG recognition period was 10 years. Then between 2009 and 2014, Congress acted sporadically to reduce it to between five and seven years on a temporary basis. This uncertain tax environment made sale planning for C-corp and recently converted S-corp owners difficult.
The Protecting Americans from Tax Hikes Act (PATH), enacted on December 18, 2015, made permanent the five-year recognition period for S corporations. This is welcome news for owners of C-corps, and S-corps that recently converted from C Corp status, who are considering selling their companies.
Whether you expect to sell your business now or five or ten years from now, I urge you to work with a competent and objective CPA to assess and clearly understand the tax implications of a sale of your company. And then reevaluate your entity structure from an overall tax efficiency perspective.
Begin with the end in mind. Exit right, retire well!
 
For further information on this topic or to discuss a current business valuation, sale, merger or acquisition need, Email or call Al Statz 707-781-8580 at Exit Strategies Group, Inc.

Think Like a Buyer

/in , /by Roy Martinez
Entrepreneurs spend their entire career thinking like an owner. They don’t need to pay any attention to the value of their business. They may have a vague notion of its value based on anecdotal industry revenue or profit multiples that they heard bandied about at an industry conference they went to years ago in Orlando. But, at the end of the day, during the operating years, what is important to an entrepreneur is the bottom line: how much cash can I take home and/or invest in the business for future profitability?
Then, when they are ready to exit, they flip a switch and start to think like a seller. They ask: how much my business is worth? Or more precisely, how much cash can I get out of selling the business?
That is when they come to us. They are ready to sell. They remember those multiples they heard, and they ask us to sell their business, with those multiples in mind. Typically, our first job is to advise the client on how to price the company. We look at ACTUAL market comps based on ACTUAL transactions. We look at the market value of their hard assets. And we analyze the business cash flows, growth prospects and business risk — from the point of view of a BUYER.
But, how is a buyer’s perspective different?  Thinking like a buyer means considering what their risks are if they buy your company, what their synergistic opportunities are, and what their investment alternatives are.
An industry buyer may have synergies with the company they are targeting, and they may be willing to pay more than the asking price. We recently helped a building services company sell to an industry strategic buyer at an incredible market multiple. On the other hand, a buyer may be scared about client retention when the seller leaves. A dentist selling her practice may think she is selling a business with $2 million in revenue. But, dental practice buyers know that up to 20% or more dental patients leave upon a practice transition. So, from their perspective, they are buying a business with $1.6 million in revenue or even less.  (Source: “Retaining Patients Following a Dental Practice Sale”; DentalTown; Adams, Bill DDS)  Or, the industry buyer may believe that they can duplicate the target company (or whatever part of it they are interested in) and get a better return on investment.
Basically, buyers are concerned not just with revenue and profitability, but also about risk. There are many, many sources of risk. Client retention is only one example. Business owners tend to downplay risk. They downplay risk to themselves, and inevitably to business brokers, buyers and lenders. And since most buyers enter a business with substantial debt financing, their ability to withstand risk and volatility is usually less than that of the seller. Rather than downplay business risk, an owner is far better off facing facts or setting to work on reducing it.
As business brokers, we ask seller clients to not only think like owners and sellers, but also to start thinking like a buyer!
For more information on thinking like a buyer when planning a business sale or when engaging in a sale process, contact Roy Martinez.

Build, Transfer, or Protect

/in , /by Exit Strategies

Research indicates that most business owners have 60-80% of their wealth tied up in their businesses. Yet in our experience few owners have a clear idea about the value of their business and few have done much thinking or strategizing about how to build, transfer, or protect years of hard-earned wealth. Let’s examine these options.

Build means to invest for growth.

This involves time and money. As you near retirement, it may be less prudent to invest in the business and time to think about diversifying assets to lessen your overall risk. Personal considerations are often in play so they must also be assessed. This transition period requires a shift in mindset. Owners often have a hard time distinguishing between accumulation (growth) and distribution (preservation) years. Failure to recognize this transition can leave you exposed to untimely risks that have real consequences for your lifestyle and how long your money may last.

Transfer options depend on several factors — some within your control, some not.

A few considerations include the marketability of the business; the current market for privately held businesses; is there a key employee(s) or family member(s) with the skills, motivation, and capital to be successors? A third party buyer, if an option, may allow for a larger payout with more cash down in the deal structure, or perhaps a full payout. Each of these options involve different risk, return, and timing. Getting your tax and legal advisers involved early is always advised so more proceeds remain in your pocket.

Protect means preserving what you have built so that it can fund your lifestyle or next venture.

The question is will it be enough? De-risking may involve altering the business model or operations. Examining the various contingent risks that could destroy years of wealth accumulation is something every owner needs to be aware of. The potential for high liability, low probability events needs to be examined.

These strategies aren’t mutually exclusive. They require deliberate thought and a process to ensure that you strike the right balance so you can meet your goals without undue risk. We can help you quantify the tradeoffs and design an effective long-term strategy consistent with your goals.

To confidentially discuss your business valuation needs or exit strategy, please contact one of Exit Strategies’ senior advisors.