BUSINESS SUCCESSION PLANNING Don t throw your business under the bus, if you get hit by one

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1 BUSINESS SUCCESSION PLANNING Don t throw your business under the bus, if you get hit by one Presented by: Mike Gracik, CPA Managing Partner, Keiter Business Succession & Exit Planning Overview What is Business Succession Planning? Why is it Important? What are the Principal Challenges? Thesis Business and Personal Considerations are Intertwined and must be Addressed Together

2 Generational Business and Wealth Transfer Trends In a normal year approximately 250,000 private U.S. businesses exchange hands Over the next years, during the maturing of the age wave bubble, it is estimated that this number will exceed 500,000 per year The need for exit planning advisory services for post WWII and Baby Boomer generations will increase dramatically over the next two decades It is estimated that over 7.7 million business owners will be seeking to exit their companies and liquefy business net worth s over the next years No. of companies for sale 600, , , , ,000 It is estimated that the generational transfer of wealth from the age wave bubble will approach $10 trillion with a 100,000 majority of this wealth stemming from the sale of privately owned businesses The need for investment advice, legal 0 representation, accounting services, estate planning and investment banking services created by this Baby Boomers Post WWII Combined phenomena will be unprecedented Derived from studies by Family Firm Institute and Cornell University Team of Expert Advisors Strategy Planning & Execution is an Integrated Process Involving Trusted Advisors Business Owner Evaluates alternatives Helps identify potential buyers Assists in providing due diligence materials Leads management presentations Other Lender, Insurance representative, environmentalist, etc. Legal Counsel Evaluates sale process and transaction Structure Prepares & reviews acquisition documents Identifies regulatory issues Assists in negotiations Accountant Examines and refines transaction structure Identifies all tax implications Provides materials for due diligence Personal Financial Advisor Provides advice to owner on investment alternatives Helps prepare options for minimizing taxes Investment Banker Performs valuation of business Prepares buyers list and materials on company Conducts the sales process and assists with Experience Knowledge negotiations Relationships Insight Evaluates proposals

3 Five Levels to a Business Succession Plan 1. Determine the Owner s Goals and Objectives 2. The Financial Needs of the Owner and Their Spouse 3. Determine and Develop the Future Management of the Business 4. Transition the Ownership 5. Plan for Estate, Gift, and Income Tax Minimization 1. Determine the Owner s Goals and Objectives Helps establish an appropriate blueprint for transitioning the business Compare present situation with owner s goals and objectives Involves financial planning, retirement planning, tax planning, and estate planning Determine the present situation related to family dynamics How to handle inactive family members Short term vs. long term consideration

4 2. The Financial Needs of the Owner and Their Spouse Many family business owners are dependent on the business to meet their current and future financial needs Will the business be able to support them after the transition? Can the business also support the new owners? Is the owner s expectation of the value of the business realistic? Consider having a valuation performed What steps need to be taken to increase the value of the business? 3. Determine and Develop the Future Management of the Business It can take many years to develop the management team so that the owner can transition out of the day to day operations Are any family members likely candidates? If no family members, are there any key employees that are likely candidates for the plan Determine key, non-family employees-address methods to retain key employees through and after the transition Key tools: Employment agreements, Incentive compensation, Deferred comp plans, Stock options, change of control agreements, non-compete agreements

5 4. Transition the Ownership Family members Key employees Sell the business Take money off the table 5. Plan for Estate, Gift, and Income Tax Minimization Make use of annual gift tax exclusions Plan for use of gift tax exemption Life insurance planning Voting and non-voting shares Sales to IDGT

6 Building Business Value (slide 1 of 2) Addressing the following issues will improve shareholder value and probabilities of success Most owners have not formally weighed or considered the implications of and their priorities related to value, employees, legacy, business continuity, etc. Value of the business reliant on one, or few key individuals Majority of owners personal net worth tied up in their companies Limited knowledge of the cyclicality of capital markets and their implications on value and timing No strategic business planning No budgets, forecasts, or variance analysis Inappropriate, or a incomplete set of skilled advisors necessary to provide input on and strategic plans Building Business Value (slide 2 of 2) Addressing the following issues will improve shareholder value and probabilities of success Insufficient management, systems, operations, or financial reporting to support growth Under-estimating typical planning and transaction lead times Not aware of the various alternatives and options available for exiting Making the decision to exit only after there is a personal, business or market crisis Responding to a single offer without realizing the value of engaging in a formal sales process Inappropriate legal and tax structures for maximizing shareholder value Not having financial statements reviewed or audited by professional 3rd parties

7 External Value Drivers Availability of debt capital and related terms Industry trends and Competition Economic Environment Political Environment Consolidation Trends Public market values General investor confidence Buyers access to capital and appetite for deals Company performance relative to competitors and economy Strategic Buyers appetite for acquisitions Internal Value Drivers Normalized earnings (managing for tax efficiency or for profits) Efficient legal corporate structure Functional board Formal business plan Management information systems Financial reporting & disciplines (audits or reviews; projections, forecasts, etc.) Financial trends Sales backlog Capital requirements Market position Management depth Distribution channels Customer concentrations Geographic coverage Environmental or legal risks Proprietary assets (patents, trademarks, brands, intellectual property, etc.)

8 Fiscal Year-End Outline I. Review of Business Income Tax Status a) Initial determination of income tax liability b) Existing methods of reducing income tax liability c) Consideration of new methods to reduce income tax liability as appropriate II. Additional Corporate Considerations a) Business Value b) Business Continuity c) Business Expansion/Contraction d) Employee considerations including key employee perks and incentive plans e) Business contracts, including liability insurance contracts f) Banking Considerations g) Exit Planning and Strategies h) Miscellaneous III. Individual Planning Considerations a) Current income tax status and methods to reduce income tax liability b) Financial Planning Considerations c) Estate Planning Considerations IV. Review of Owner Based Goals Primary purpose of the meeting is communication: coordination of your legal, tax, and financial planning objectives. This meeting also allows you to obtain input from all of your advisors on specific topics--- rather than trying to reach each individually for their views not an effective use of their time or your money. The Sales Process Courtesy of Steve Howell and Barry Johnson at Windward Advisors Stages and Timeline Potential Deal Spoilers

9 Stages and Timeline in a Typical Sales Process Stage 1 (1-2 months) Stage 2 (2-3 months) Stage 3 (1-2 month) Stage 4 (3-5 months) Information Gathering Initial Marketing Solicit LOI s Negotiations & Closing Determine Seller s goals and objectives Prepare potential buyers list Management Presentations Commence due diligence and respond to questions Review preliminary due diligence information (financials, industry, etc.) & prepare SWOT analysis Determine strategy to prepare company for sale and value enhancement Prepare Confidentiality Agreement Analyze legal, accounting and tax considerations Prepare Financial Forecasts & Business Plan Prepare & Distribute Teaser to potential buyers Execute Confidentiality Agreements Prepare & Distribute Confidential Business Memorandum Solicit Preliminary Indications of Interest Prepare & Practice Management Presentations Respond to additional requests for information Solicit Letters of Intent Negotiate Letters of Intent Review Final LOI s with Management Select Final Party Negotiate with Final Party any remaining terms Prepare for On-site Due diligence (Data Room) Prepare and negotiate Definitive Purchase Agreement Complete and Negotiate Final Legal Documents and Schedules Submit to Applicable Regulatory Authorities Communicate with Employees, Customers, and Suppliers Close Transaction Select Parties to be Invited for Management Meetings Potential Deal Spoilers Industry Trends Lack of Sufficient Documentation Finance-ability Timing Unqualified Professional Representation Economic Shift Unrealistic Expectations Seller s Remorse Buyer s Ability to Execute Management Transition Representations and Warranties Escrow Arrangements Due Diligence Problems Environmental Issues Integrity of Financial Statements Tax Issues Information System Issues Sales Process Distractions Performance Shortfalls Deal Fatigue

10 LIQUIDITY / EXIT ALTERNATIVES Liquidity/Exit Alternatives Dividend Recapitalization Company borrows funds which are distributed to the shareholders Loan is not non-recourse (i.e. is personally guaranteed by shareholders) Strategy achieves liquidity and wealth diversification, but additional company debt leverage increases specific company risks

11 Liquidity/Exit Alternatives Minority Recapitalization Company generally sells equity to a new investor, with all or a portion of the proceeds being distributed to the incumbent owners Proceeds could be all equity or a combination of equity and debt Prior ownership group maintains board control Governance provisions vary but generally a change of control transaction or an acquisition requires both founders and investors approval Investors generally have put provision to sell their stock to the company in five to seven years Level of debt used to fund the recapitalization is important because of possible future dilution if an acquisition requiring additional equity is made Liquidity/Exit Alternatives Control Recapitalization Similar to minority recapitalization in structure, but the investor acquires control Due to control, put provisions are not required

12 Liquidity/Exit Alternatives Buy-Out by Strategic or Financial Buyer 1. Buyer acquires all of the equity interests held by the ownership group prior to the transaction 2. The transaction could include employment agreements for some of the prior ownership group members 3. Earn-out and bonus provisions 4. Escrows and holdbacks 5. Seller-financed notes, normally subordinated to senior debt Liquidity/Exit Alternatives Management Buy-Out 1. Purchase of all or a portion of the company by members of the company s management team 2. Low transition risk due to retention of key employees 3. Limited risk of breach of confidentiality and nondisclosure provisions 4. Potentially less than maximum valuation because of the lack of a competitive bidding process 5. Potentially higher levels of contingent payments including seller note which will likely be subordinated to senior debt

13 Liquidity/Exit Alternatives Employee Stock Ownership Plan (ESOP) may be an alternative to a traditional sale 1. Over 11,000 active ESOPs 2. Allows employees to acquire Company from seller utilizing a qualified Plan Vehicle 3. Tax favored alternative to Seller through income tax gain deferral 4. Leveraged ESOP provides Company with tax deduction for debt repayment 5. S Corporation ESOPs pay no income tax on company income 6. Attractive when business in not highly marketable 7. Incentive for existing employees 8. ERISA/Fiduciary considerations