Alternatives to Growth As Usual. Financing

Transcription

1 Alternatives to Growth As Usual Strategy, t Execution and Financing Presenters: Richard K.A. Becker Hogan & Hartson L.L.P. David J. Lundsten, MBA, CPA, CVA Cherry, Bekaert & Holland, L.L.P. Charles A. Neff Hogan & Hartson L.L.P. John T. Schell Altus Associates, LLC

2 Build a Better Machine Presenter: John T. Schell President Altus Associates, LLC 1934 Old Gallows Road Suite 404 Vienna, VA (703)

3 Build a Better Machine Invest in People, Resources and Systems Compete for Larger and Better Contracts, even with a reduction in win rate Improve Earnings as a Team Goal Promote Branding and Marketing (not advertising) Avoid Pitfalls 3

4 Invest in People, Resources and Systems Team: Finders, Minders, Binders and Grinders It s a big jungle, but it only takes a few tigers to keep order Resources: Market analysis, intelligence, outside help Does your team have the skills to fashion solutions, structure proposals and effectively price in all agencies? Systems: An operating and effective business Pipeline Best Practices financial information (Accounting, Pricing, Management Tools) are key to driving earnings 4

5 Stretch Your Team Pipeline is your future use it as a management tool Measure, measure, measure Develop pipeline goals for the Company, each category of business, and each business unit. A % win rate reduces maximum earnings The world is built on a judgment call: incremental costs and incremental benefits. Would you invest $500K to have a 25% chance for a $50M contract with $5M earnings? It will reduce your win rate but raise your earnings. 5

6 Fundamental Challenge: Brand and Market. In a Sea of Sameness How to stand out tin a world of f Gray Boxes? Contractor Contractor Contractor Contractor Contractor Contractor A B C D E F Differentiate t or Die 6

7 Brand and Market to the Customer! Don t Advertise! What is your Point of Difference? Enlightened executives will recognize a fundamental fact - one that most highly competitive industries have discovered... the only way to win is to: Create a Brand. Brands Make Meaningful Promises & Mitigate Perceived Risk 7

8 Avoid Pitfalls Winning new business is a team process and not just the province of a sales team Don t count on miracle workers that t change every year! We call it the Messiah Complex Forget Revenues-Grow Margin! CPFF Out--T&M, FFP In Cutting Costs Can Help, But Not Fully $1 Annual Earnings Worth $5-8 Price Focus on Services in Demand 8

9 Build a Better Machine Presenter: David J. Lundsten, MBA, CPA, CVA Partner Cherry, Bekaert & Holland, L.L.P Old Gallows Road Suite 400 Vienna, VA (703)

10 Invest in Systems and Improve Cashflow Electronic timekeeping Billing within the system, not in spreadsheets Collection person Project reporting Monthly closing process Key metrics 10

11 Funding the Better Machine Investors (Equity Capital) Internal funding (reinvest profit rather than take distributions) Private equity (F&F, Angels, Private equity firms) SBICs SPACS new type of private equity 11

12 Equity Investment Accounting Issues Professional investors often use preferred stock Sometimes see mandatory redemption More often redeemable at option of the investor May result in treating the investment as debt, not as stock May wipe out shareholder equity 12

13 Funding the Better Machine Using Debt Debt free is NOT good Financial leverage is good (within limits) Many middle market companies are under-leveraged Debt is the cheapest type of funding Lessons learned public company data If you meet certain financial criteria, much easier to obtain No dilution of your ownership, no seat on your Board of Directors 13

14 Funding the Better Machine Using Debt Complexity, compliance and accounting issues varies Commercial bank debt is simplest and cheapest Line of Credit, borrowing base or accounts receivable Acquisition debt term debt (if you qualify) Standard structure Standard debt covenants, borrowing base rules Relative easy to comply, no special accounting 14

15 Funding the Better Machine Using Debt Mezzanine debt If commercial banks won t do the deal Complex (often tailored) structure, need expert advisor Involves warrants (potential dilution) Accounting issue with valuation of warrants 15

16 Build a Better Machine Presenter: Richard K.A. Becker Partner Hogan & Hartson LLP 8300 Greensboro Drive Suite 1100 McLean, VA (703)

17 Negotiating Equity Investment Agreements Form of Investment Preferred Returns/Rights Maintaining Control Board Membership Limitation on Actions without Investor Consent Issuance of Securities Operational Limitations Mergers Budget Approval Legal Mechanisms for Valuation (set formulas, selection of appraiser) 17

18 Negotiating Debt Agreements Financial Covenants Transfer Limitations on Equity Limitations on Junior Debt Personal Guarantees When taking an investor is taking equity or debt and equity, If you are a small business, be careful of the SBA s affiliation rules which might affiliate you with the investor and disqualify you as a small business. 18

19 Legal Pitfalls in JV and Teaming Agreements Capitalization (Cash, IP, Sweat Equity) Ownership and Control 50/50 disagreements Minority Rights Dispute Resolution (Good faith provisions, Arbitration, Russian Roulette ) IP/Product Rights outside of JV (Licensing Agreements) 19

20 Motivate Employees with Real Incentives Presenter: John T. Schell President Altus Associates, LLC 1934 Old Gallows Road Suite 404 Vienna, VA (703)

21 Motivate Employees With Real Incentives Tell your Team what you want to achieve Set business and BD goals and constantly refer to them Gain support of your team and increase credibility Is your organization a totem t pole or a pool table? Which h is more effective for your business? Are bonuses motivating or just a gift of appreciation? Who controls next week and next year? Your Team! 21

22 Incentive Compensation A well thought-out and shared set of criteria and awards is the only way to communicate priorities An IC program is of critical importance in professional services a sizable percentage of income for key executives Company should have a comprehensive plan that ties awards to company and individual performance Individual plans for key executives and BD professionals Consider getting some help: especially stock-related awards and tax and regulatory issues 22

23 Motivate Employees with Real Incentives Presenter: David J. Lundsten, MBA, CPA, CVA Partner Cherry, Bekaert t&h Holland, LLP L.L.P Old Gallows Road Suite 400 Vienna, VA (703)

24 Incentive Compensation Carefully consider compensation plan What behavior do you want? Are amounts reasonable? Rules & Regs (allowability) Costs will be significant Check references before hiring Set objective quarterly targets Pipeline: number of leads, targets Win rate (new versus follow-on) Progress review at 9 months 24

25 Incentive Compensation All pricing must be approved by CEO G&A rates will increase in short term Calculate effect if have cost-type contracts Brief main customers if necessary 25

26 Incentive Compensation Make sure the incentives encourage the behavior you want Not as easy as it sounds Plans should specify desired behaviors / outcomes Plans should be subject to adjustment if behaviors not achieved 26

27 Funding new cash incentives at what level in the earnings process? Gross profit level More objective to the employee More within employee s control Few if any corporate charges/allocations, accruals, etc. Less likely to interfere with integration of acquired personnel Operating profit level More subjective to employee Not entirely within employee s control May have disputes over corporate charges/allocations Almost certainly will interfere with integration of acquired personnel 27

28 Funding new equity incentives the good, the bad Stock awards (typically restricted stock) S Corporations watch out! Dilution issues Possible valuation issues If pass through entity, complicates employee shareholder tax returns Blue sky 28

29 Funding new equity incentives the good, the bad Stock options S Corporations REALLY watch out! Potential dilution issues Possible valuation issues New accounting rules FAS 123r went into effect Jan 1, 2006 New cost allowability concerns? 29

30 Funding new equity incentives the good, the bad Phantom stock and stock appreciation rights plans Other names: performance stock units, value appreciation rights Too often overlooked Gives employees the ability to share in increase in company value Doesn t cause dilution No tax headaches to pass-thru entity employees, since not shareholder Accounting rules require expensing, but Since new options must be expensed, phantom plans look better than ever Change of control considerations Vesting rules are significant 30

31 Motivate Employees with Real Incentives Presenter: Richard K.A. Becker Partner Hogan & Hartson LLP 8300 Greensboro Drive Suite 1100 McLean, VA (703)

32 Issuing Equity Any issuance of a security needs an exception under the securities laws and regulations For private companies, people receiving securities are usually receiving them under equity incentive plans or are accredited investors Whether Options, Phantom Stock or Appreciation Rights, or Restricted Shares, written plans or agreements are critical Special issues in S-Corp avoiding two classes of shareholders Executive compensation 32

33 Option Plans Incentive Stock Options or Non-Qualified Stock Options Non-Qualified for employees, consultants, or other people Incentive Stock Options employees only, must have written plan approved by shareholders Other restrictions, not transferable, post termination exercise limitations Documentation and proper approval of options is critical i 33

34 Other Types of Equity Securities Restricted Shares Shares usually subject to vesting and forfeiture f if employment terminated Grant under a plan or a free standing agreement A Stock Appreciation Rights is a contractual right to receive, either in cash or employer stock, the appreciation in the value of the employer's stock over a certain period of time Phantom Stock is a promise to pay the holder a cash bonus at some future point equal to a certain percentage of the company's equity 34

35 SARs and Phantom Stock SARS and Phantom Stock Rights should be issued under equity incentive plans approved by the board and shareholders Plans and agreements with employees should deal with changes of control, termination and death 35

36 Acquire Strategic t Operations Presenter: John T. Schell President Altus Associates, LLC 1934 Old Gallows Road Suite 404 Vienna, VA (703)

37 Acquire Strategic Operations Financial results (earnings not revenues) and forecasts drive valuation Strategic attributes improve valuation metrics How do you identify companies with the right financial i and strategic attributes? Deal terms reduce financing requirements Leverage drives your value 37

38 Buyer Valuation Issues Vertical ( Strategic ) -Core Competencies -Agencies -Federal Market Horizontal ( Bolt-on ) -Earnings -Contracts -People Bottom Line: Supply and Demand 38

39 Risk Higher How Can Leverage Drive Your Value? RISK and COST Cost Higher Risk $2M $2M Equity Equity $3M $3M Debt Earnout Lower Lower 39

40 Given Risk, Leverage Can Lower Cost and Drive Value $5M Purchase Price; $2M Cash, $3M EARNOUT or DEBT Equity and EARNOUT Year 1 Year 2 Year 3 Year 4 Year 5 EBIT $1,100,000 $1,210,000 $1,331,000 $1,464,100 $1,610,510 Payment/ Cost 1,217,500 1,145,000 1,072, Cash Available -129,250 71, ,350 1,610,510 1,771,516 IRR 42% 4.2% Equity and DEBT Year 1 Year 2 Year 3 Year 4 Year 5 EBIT $1,100,000 $1,210,000 $1,331,000 $1,464,100 $1,610,510 Principal/Interest 817, , , , ,500 Cash Available 282, , , , ,010 IRR 13.2% Note: There are many unstated assumptions. 40

41 Acquire Strategic t Operations Presenter: David J. Lundsten, MBA, CPA, CVA Partner Cherry, Bekaert & Holland, L.L.P Old Gallows Road Suite 400 Vienna, VA (703)

42 Funding sources generally the same as for funding growth Commercial banks acquisition senior debt Cashflow based rarely any allowance for borrowing base Term loan Debt covenants Mezzanine debt Equity Private equity firms SPACs 42

43 Acquisition of Companies Accounting Issues Purchase accounting (FAS 141) Valuation of intangible assets Pre-acquisition contingencies: who gets the expense? In general Stay bonuses Purchase price adjustments t Effect of goodwill on debt covenants There are many Terms and Conditions with accounting / financial issues Your accountant must work closely with your counsel in drafting T&Cs 43

44 Acquisition of Companies Tax Issues Fools rush in But you should get an experienced tax expert well in advance of the deal Many possible twists and turns Asset purchase versus stock purchase To novate or not to novate Tax advisor must work closely with your counsel in drafting T&Cs 44

45 Acquisition of Companies Tax Issues If S Corporation is acquired, 338 election usually a good strategy Understand the effect of the election Tax equalization will possibly be required Built-in-gains in tax liability may exist valuation issue 45

46 Acquire Strategic t Operations Presenter: Richard K.A. Becker Partner Hogan & Hartson LLP 8300 Greensboro Drive Suite 1100 McLean, VA (703)

47 Transaction Issues Contracts with preferences Will the preferences continue? Depends on buyer, type of preference and when recertification is required Dealing with foreign investors Costs and risks of acquisitions with regulatory, tax or employee benefit/erisa legal issues Patriot Act, Import Export Compliance, Security Clearances and Facility Security Clearances 47

48 Getting to Closing/Post Closing Issues Closing requirements Dealing with risks found in due diligence indemnification, escrows, earn- outs Public companies buying private companies Governance issues Treatment of Executives Financials Buying the equity means buying the liabilities Private Equity Control, major decisions, what if things go bad 48

49 Alternatives to Growth As Usual Strategy, t Execution and Financing Presenters: Richard K.A. Becker Hogan & Hartson L.L.P. David J. Lundsten, MBA, CPA, CVA Cherry, Bekaert & Holland, L.L.P. Charles A. Neff Hogan & Hartson L.L.P. John T. Schell Altus Associates, LLC 49