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The ESOP Solution

We are often asked about Employee Stock Ownership Plans (ESOPs) as an exit strategy. For business owners who are curious about the ESOP exit option, here are links to two recent articles that discuss ESOP basics and some of the pro’s and cons of ESOPs. Both articles are from recent issues of MERGERS & ACQUISITIONS magazine, which is published in partnership with the Association for Corporate Growth, in which I am a member.
Recaps Turn to ESOPs
ESOPs have not been a big part of the M&A discussion for many years, but a confluence of recent factors is changing that.
More sellers are turning to the ESOP as an alternative to a traditional M&A transaction, as baby boomers look to sell their businesses, tax rates continue to increase and bankers become more comfortable with the ESOP option. Also, private equity firms are more frequently willing to invest alongside an ESOP transaction, as they look for ways to  differentiate themselves while buying into high-quality companies.
ESOP Candidates Consider Strategic Buyers
Executing Employee Stock Ownership Plans (ESOPs) may become more difficult because in the current marketplace, sellers can often achieve higher multiples by selling to a strategic buyer.
“I think an ESOP works for the most altruistic of sellers,” says Robert Brown, co-founder and managing director of Chicago investment bank Lincoln International.
“The multiple that an ESOP is able to pay is typically lower than a strategic buyer,” says Jason Bolt, senior associate at Columbia Financial Advisors, which provides business valuation and other financial advisory services.

Is Your Business Prepared for Sale?

Serious potential consequences await owners who neglect to prepare their business, and themselves, for a future sale or transfer. Here are ten exit planning mistakes to avoid:
  1. The business experiences a sudden, catastrophic loss and all of the owner’s financial eggs are in the business.
  2. A perfect buyer suddenly appears and makes a fantastic offer, but the owner cannot consummate the sale due to prohibitive (and avoidable, with planning) tax cost and a lack of sufficient independent retirement income.
  3. An agreement to sell is made with a qualified buyer, but the buyer reduces the offer after finding aged accounts receivable and owner loans on the books.  In short, the company’s books were not in order.
  4. An unanticipated catastrophe hits the business and because the owner failed to have a contingency plan in place, or existing support from legal/financial advisers, the business cannot survive.
  5. The sole owner dies or becomes permanently disabled, without sufficient (or no) life or disability insurance, no business succession plan, and no estate plan.
  6. One of the partners dies or the partners have an irreconcilable falling out and there is no clear buy-sell agreement – either of these situations commonly result in expensive litigation, and value erosion.
  7. The business is struck by a huge, legitimate legal claim with insufficient liability insurance in place thereby irrecoverably impacting the enterprise value and marketability.
  8. One of the company’s key employees quits, taking the best customers and other employees with him because the company has no non-compete agreement or retention plan to prevent this from happening.
  9. The owner wishes to retire and sell the business to a family member but there is insufficient time to make the transfer and pay minimal taxes.
  10. The owner has selected a capable non-family heir apparent, but has no written succession plan in place and the heir apparent cannot realistically fund the transfer.
All of these mistakes can be avoided with a well thought out exit plan developed in advance of a sale and updated frequently.
For more information about preparing to sell and exiting your California-based business successfully, please contact Jim Leonhard at 916-800-2716 or jhleonhard@exitstrategiesgroup.com. 

Ten Commandments of a Successful Exit

The average person doesn’t realize that selling a company is often the most gut-wrenching transaction of a business owner’s life. They’ve just spent their life building the business, it’s their largest asset, and they have no training or experience in selling a business. With that as a backdrop, here are ten practical directives that will help you make better exit strategy decisions and achieve a more successful sale.
1. I shall plan ahead
Why sell? This business may be your life’s work. If you sell, what will you do next? Is your family on board? What type of lifestyle do you want and what will your expenses be? What is the most probable selling price of your business and what are your likely sale proceeds after taxes? Is that enough to fund the next chapter of your life? How will you reinvest the proceeds? The point here is to have your personal needs, goals and plans in focus before you make the final decision to go to market.
2. I shall not depend on miracles
In the privately-held business marketplace, sellers expect full value and buyers require a reasonable return on investment. It’s win-win or no deal. According to the 2014 Pepperdine Private Capital Markets Survey, the number one reason business sale transactions don’t happen is a gap in value expectations. Over-valuing your business leads to mistakes in judgment and poor decisions. So does undervaluing it. Usually there is a market-based price range for similar businesses with comparable financial performance and risk characteristics. A skilled M&A broker can often move price up in the range, but expecting a lot more usually leads to no deal. Before you go to market, spend some time and money with a qualified and objective M&A brokerage professional to assess the market value of your business.
3. I shall prepare my business
A seasoned M&A broker can also objectively evaluate your business from marketability, transferability, finance-ability and deal survivability perspectives. Then take that professional feedback to heart and address the weaknesses. Every business is unique, but here are a few common preparation initiatives:  Have financials reviewed to reduce a buyer’s perception of risk. Embark on a program to diversify the customer base (if concentrated). Delegate more to make yourself less critical to the operation. Put incentives in place to retain key employees who can facilitate a smooth transition. Legally protect intellectual property. Capture growth opportunities in a written business plan with realistic financial projections. Buyers will have their own plans, but this helps them perceive greater value. Think of exit strategy as business strategy with a specific purpose.
4. I shall not wait for perfect timing
It makes sense that the best time to maximize selling price is when business, industry, economic and capital market conditions are strong. Yet, letting go is hard to do when things are good. Don’t make the mistake of waiting too long to make your move. In my experience, owners have a tendency to hold on longer than they should. I could easily cite dozens of examples where an owner held on too long, the business lost its competitive edge, sales and earnings slid, and enterprise value declined severely. Deciding when to go to market requires uncommon objectivity, faith, and courage.
Also keep in mind that the selling process takes 9 months on average. Add time on the front end for go-to-market preparation, and add time on the back end for management transition. Call us if you’re interested in understanding likely time-frames for preparation and transition for your particular circumstances.
5. I shall help buyers buy
I know it sounds simple, yet many owners think playing hard to get and withholding information is the answer. To maximize value, businesses need to be presented with clear, supportable facts. In successful deals, a professional Confidential Information Memorandum (aka “deal book”) is presented to prospective buyers who have signed a confidentiality agreement. A fact-based CIM communicates the essential information that serious buyers need to get a firm grasp on your business, be confident in its prospects, and make solid purchase offers. A CIM presents information in the language of experienced buyers and professional buy-side advisers.
In many years of looking, I have yet to see the perfect business. A significant weakness or risk revealed early in the discovery phase is usually a manageable hurdle or a point to negotiate around, and always a big time saver. That same information revealed during negotiations or later on in due diligence becomes a catalyst for buyers to reexamine every piece of data, lower projections or increase their required rate of return (lower their price), or walk away. Also, appropriately exposing your company’s warts early in the process builds trust and credibility with buyers, which becomes an advantage in negotiations, and helps ensure that you keep your proceeds after the sale.
6. I shall have buyers competing to buy
It can be difficult to achieve full value with just one buyer at the negotiating table. When someone inquires about acquiring a business that is not for sale, that limits the negotiation to one party. Most of these inquirers don’t buy; and when one does, their purchase price is usually lower than what can be achieved in a structured M&A sale process. When an owner decides to exit, it is not uncommon for them to confide in their CPA, attorney or financial advisor. That advisor may mention, “I know a potential buyer, why don’t I introduce you?” This also leads to a negotiation of one. Buyers love exclusivity. This may not be in your best interest if your objective is to maximize selling price. Price is generally maximized in a limited auction process.
7. I shall keep my eye on the ball and my lips sealed
Some owners make the mistake of becoming distracted with selling instead of running their business, resulting in significant value erosion. When sales or earnings slide – so does selling price. There simply isn’t enough time in the day to run a business at peak performance and perform the job of selling it. Do what you do best and hire an M&A professional to run a confidential structured sale process.
Also, it is nearly impossible to maintain confidentiality when an owner attempts to sell on his own. Colleagues gossip. Word spreads fast. Employees may leave and customers may go elsewhere. Bankers and suppliers get nervous. Competitors take advantage. Then the business suffers and goodwill value declines. A competent M&A broker uses systems and procedures to maintain confidentiality and release sensitive information at appropriate times.
8. I shall not do surgery on myself
Selling a business is something you need to do right the first time. For many reasons, you improve your odds of maximizing and holding on to your sale proceeds when you engage an M&A brokerage professional that specializes in selling businesses. Here we can take a lesson from public companies and private equity groups, who wouldn’t consider a sale or divestiture without engaging an investment bank. Why? Better results, and less risk of failure. Engage a professional M&A broker to tip the experience scale in your favor, and manage the entire process for you.
9. I shall use experienced professionals
Your transition team must know the specialized business, legal and tax issues of business transactions, and they must match up against the experience level of a buyer’s advisers. Price is important, but your real goal is to maximize after-tax proceeds. Deal structures that favor you for taxes are often unfavorable to the buyer and vice versa. Are you confident in your tax adviser to help you plan for Uncle Sam, the unwanted stakeholder in any deal? Do you have an experienced transaction attorney who you can trust to negotiate post transaction risks in a commercially reasonable manner? Your end results will be better when you use qualified and seasoned professionals from the very beginning.
10. I shall not let time kill my deal
Time is one of the biggest deal killers, often when due diligence bogs down. Buyer and seller principals are busy running their businesses; attorneys, CPAs and other deal participants can also get distracted. One of the roles of an M&A broker is to establish timelines, keep the deal teams on track, and maintain deal momentum; and not let deal fatigue set in.
During the selling process, never lose sight of why you are selling, whether it is to go fly fishing, travel the world, provide financial security for family members, make charitable contributions, or some other larger purpose. It’s important to keep your big picture future in focus as you encounter the challenges and ride the emotional roller coaster of selling a business. We get it, and we’ll be with you all the way.
If you have questions or want a more complete understanding of any of the above directives, or to schedule a confidential consultation about selling, merging or acquiring a California business, Email Al Statz or call him at (707)778-2040.

Selling a Business Using a CRT

When a business owner decides to sell or transfer ownership, the owner often thinks about achieving the following three post-transaction objectives:
1) being financially independent,
2) taking care of family members, and
3) possibly a donation to a favorite charity.
All three of these objectives can sometimes be met by setting up a Charitable Remainder Trust (CRT) – the subject of a recent article by my friend and colleague Darrell V. Arne, CPA, ASA, CM&AA covering basic CRT concepts and the mechanics involved in using a CRT in a business sale transaction.
CRT Overview
The basic concept of a CRT is that highly appreciated property (e.g. stock in a closely-held company) is donated to a Trust – naming one or more charities as the ultimate beneficiary (remainderman).
Because of the tax-exempt nature of a charitable Trust, when the CRT sells the closely-held stock, no immediate capital gains taxes are paid at the time of sale. Therefore, the trustee of the Trust has more cash proceeds to re-invest in income producing assets for the benefit of the income beneficiaries.
The former selling shareholder and spouse (Donors) become lifetime income beneficiaries of the Trust. The Donors also obtain an immediate charitable deduction (up to 30% of adjusted gross income) at the time of transfer, since the remaining Trust assets are passed to a charity upon the death of the last income beneficiary. Also, assets transferred to the charity do not subject the Donors to estate taxes.

What is an Earn-out?

An earn-out is when part of the consideration received for a business is based on future sales or earnings. Earn-outs usually come in to play in business acquisitions when a business has high risk factors, or when non-linear growth is reasonably expected, or when there is a significant gap in the price expectations between the buyer and seller. In all cases the parties share the risk and reward of future performance.

Bridging a Price Gap

An earnout is often the best way to bridge a gap between what a seller will accept and what a buyer will pay. For example,  a seller may think their company is worth $4 million and the buyer thinks it’s worth $3 million. They can agree on a guaranteed price of $3 million, plus an earn-out over a period of 1-2 years, structured to provide the seller with the potential of receiving the extra $1 million, or more if sales or earnings reach a certain level, based on an agreed upon formula.

Devil in the Details

While simple in concept, earn-outs can become contentious during the measurement and payout phase. It is critical that earn-out parameters be carefully thought out and clearly defined in the purchase agreement. There must be no ambiguity in the accounting practices to be used, for example. Even if you continue to manage the business during the earn-out period, don’t assume anything.

At the same time, remember the K.I.S.S. principle. In my experience, the more complicated an earnout gets, the more likely negotiations will fail.  It is usually (though certainly not always) best to base earn-out calculations on top-line sales or gross profit, not net income. Also, be sure to design the earnout formula to completely align the interests of the parties.

For another perspective on the use of earnouts in M&A transactions, see this recent article on Axial Forum.

For more information on M&A transaction structuring strategies, or if you want help selling a business or developing a winning exit strategy, contact me at 707-778-2040 or alstatz@exitstrategiesgroup.com.

Private Equity Fact and Fiction

Private equity groups are active acquirers of closely-held lower middle market companies here in California. Private equity consists of individuals, families and institutional investors that make passive minority investments in partnerships that invest in, provide debt financing for, and operate private companies.

Republican presidential candidate Mitt Romney’s run for the presidency in 2012 brought sudden attention to the private equity world. Romney, who had been the founder and CEO of private equity firm Bain Capital, didn’t go far out of his way to defend the industry during the election, and this growing and increasingly important source of private capital continues to capture news headlines. Business owners may find it challenging to distinguish facts from fiction.

This article, by advocacy group “The Private Equity Growth Capital Council”, attempts to dispel some of the myths of private equity. Enjoy!

Is it Better to Own or Lease your Business Facility?

For some businesses, specialized building construction is required — hotels, car washes, wineries, some food processing facilities, etc. — making the business and real estate nearly inseparable, and making owning the real estate almost mandatory. However most enterprises need a more generic commercial, industrial or retail property to support business operations, and the decision to own or lease real property is more elective.

Companies that lease their facilities avoid the sizable cash investment associated with ownership. Because a landlord seeks to receive an adequate return on invested capital (debt and equity) the lessee is likely paying a higher rent than just the debt service on a real property investment. But there are numerous financial issues beyond return on investment to consider.   These include the appreciation potential of the facility, how financing the facility will impact financial leverage, tax consequences and even longevity of the business itself.

Looking on the plus side of leasing from a business perspective, growing firms may be wise to invest exclusively in inventory and other working capital assets. In fact, rapidly growing companies may not be able to invest in physical facilities even if they wanted to. Similarly many firms desire the flexibility that leasing provides in terms of expansion potential and having the ability to change locations as market conditions change.

On the plus side of ownership, many firms prefer the control (of rent increases, location, specialized improvements, maintenance, being asked to leave at the expiration of the lease, reducing risk in a sale of the company, etc.) that is only provided through facility ownership. I have seen businesses devastated by losing their location prematurely resulting from landlord actions. In addition, as the mortgage is paid down, an owned facility represents a potential source of collateral in the face of financial challenges to the business. If you determine that your business has long-term viability, cash to invest and will not outgrow the facility; when you sell the company down the road, your lease to the buyer can provide retirement income, especially when the mortgage has been paid down substantially.

Generally, for small to mid-size private companies, real estate is held outside the company, in an entity owned by the same or similar group of shareholders.  The holding entity purchases the real property and leases it to the operating company. Most holding companies are organized as an S-Corporation or LLC with pass-through tax treatment. The facility owner(s) enjoy the tax advantages of depreciation, avoid double taxation, and can reap the benefits of any long-term appreciation of the real property. If the rent is market-based, as it would be in an arm’s-length relationship, which it must be to avoid IRS scrutiny, the valuation impact on the operating company is non-existent.

If you are faced with the choice of owning or leasing real estate, keep in mind it may be difficult to predict the long term future of the enterprise. Understand that your eventual exit from the business could be helped or hindered by owning the real estate. Your best buyer may be a synergistic buyer that already has a facility and would consolidate facilities, leaving you with an empty building to sell or lease.

I’ve really just scratched the surface of this topic. I’m leaving many considerations untouched. There is no single answer to my initial question. Your choice to own or lease should be based on your unique business model, circumstances and objectives, and should be carefully thought out. This can be a complex business question that deserves professional M&A, banking, tax and legal guidance in order to make a final determination.

For advice on selling, acquiring of valuing a California business with or without real property, Email Bob Altieri or call him at 916-905-5706. 

Is it too early to have my business valued?

A potential client has been dragging his feet on having a business valuation done. Most recently, he asked, “Is it too early to have my business valued?” A better question may be, is it too late?

This baby boomer wants to exit his business and retire in the next 2-5 years. He said, if the business isn’t worth much, he would probably hold on to it and transition management of the business to a group of employees over time. If the business is worth a lot, he would sell now and retire as soon as he had transitioned the business to the buyer. Inherent in that discussion is the fact that he really doesn’t know how much his business is worth.

As I pointed out in my blog post of February 26, 2014, “Why Should I Get My Business Valued”, for most business owners, their business in one of their biggest assets (often their biggest). Every month you know what your securities portfolio is worth. You can go to Zillow.com for an estimate of your home’s value. Similarly, you can go to Loop.net to get an idea of the value of your commercial real estate holdings. But where can you find the value of your biggest asset? The only ways are: 1) to market and sell your business or 2) to have your business valued by a qualified valuation expert.

My response to this business owner was:

“No, it is not too early. If you end up deciding to transition the business to your employees, it will take time. Doing it right can take 3-5 years or more. If you want to retire in 3-5 years, you already may be behind the game. And…if the business is worth enough for you to retire now, what are you waiting for?”

Most likely his business is worth somewhere between the two extremes that are occupying his mind. An accurate and well-documented business valuation will help him make better decisions with respect to managing the business and exiting in the right manner and in the appropriate time frame.

  1. Roy Martinez is a Certified Valuation Analyst (CVA) and business broker/M&A adviser. He can be reached at jroymartinez@exitstrategiesgroup.com or 707-778-2040.

Why do business owners hire an M&A broker?

Recent clients “Jane and John Doe” were satisfied with the market value estimate of their manufacturing business, as determined by the independent valuation we prepared.  Armed with this essential piece of information, they were ready to sell the business they had founded and grown with much effort over many years.

John thought they should try to sell the business themselves.  After all, weren’t they the best salespeople for their business? And why should they share a portion of the proceeds with a broker?  Jane was not so sure and began to research whether hiring a business transaction intermediary was warranted.

One article that Jane found contained the results of a poll conducted by Partner On-Call Network LLC in which sellers of small and medium sized businesses were asked why they hire business brokers instead of trying to sell themselves.  The poll identified 62 reasons, including these top eight, in order of frequency cited:

  1. Brokers know how to sell businesses; most sellers don’t
  2. Seller doesn’t want to be distracted from running business
  3. Confidentiality preservation and knowledge of what/when to show buyers
  4. Access broker’s database of potential buyers and investors
  5. Maximize price buyers will pay for the business
  6. Owner does not know how to find buyers
  7. Prepare owner to sell and prepare business for sale
  8. Broker understands and can depersonalize negotiations

After discussing this and other inputs that they had received, the Doe’s decided that hiring an intermediary was the prudent decision if they wanted to maximize proceeds from the sale of their business and reduce the risk of no deal or a flawed deal.

All 62 reasons can be found HERE.

For a certified business valuation or assistance with successfully exiting your California company, you can Email Jim Leonhard or call him at 916-800-2716.

For Historic Mountain Lodge, It’s Not the End of the Rainbow

rainbowThe historic Rainbow Lodge in Soda Springs, California, which was in receivership and non-operational for almost a year, has been acquired. This 33-room lodge on the Sierra’s western slope near Hwy 80 was originally built as a stagecoach stop in the 1800’s. In the 1990’s, the owner of the nearby Royal Gorge Cross Country Ski Resort bought it with the intention of providing lodging for skiers. The building is currently undergoing substantial renovations and the business is expected to re-open in a few weeks.
“There’s so much history. Families have been coming here for decades.”
Craig Mitchell, new owner of Rainbow Lodge
Exit Strategies Group, Inc. represented the buyer in this acquisition; the receiver was Douglas Wilson Companies based in southern California.
Perry Norris, executive director of the Truckee Donner Land Trust, said he was delighted to hear there were new family owners at Rainbow Lodge. The land trust owns about 2,100 of Royal Gorge’s 3,000 acres and is preserving its holdings for skiing, hiking and open space. Rainbow Lodge is one of the few places to stay on the Sierra’s western slope heading up to the ski area eight miles away.
For advice on exiting your company or acquiring a business, please call Bob Altieri at 916-905-5706 or Email boba@exitstrategiesgroup.com.