ESOPs: Basics and Beyond Twin Cities FSP

Transcription

1 s: Basics and Beyond Twin Cities FSP Kelly O. Finnell, J.D., CLU, AIF Executive Financial Services, Inc. (901) The $10 Trillion Opportunity Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning in the next 5-6 Years Source: waterhousecoopers, Trendsetter Barometer The $10 Trillion Opportunity Baby Boomer Business Owners Source: White Horse Advisors, Survey of Closely-Held Business Owners 1

2 Monetization Planning Strategies Traditional Exit Paths: Sale to Third Party Strategic Buyer Private Equity Group Lifetime Gift to Family Member Management Buy-Out Leveraged Re-cap Monetization Planning Strategies Traditional Exit Paths: Sale to Third Party Strategic Buyer Private Equity Group Lifetime Gift to Family Member Management Buy-Out Leveraged Re-cap Sale to Employee Stock Ownership Plan () Presentation Overview Technical Practical 2

3 What is an? Qualified Retirement Plan 2½ times Greater Contribution What is an? Tax-Efficient Liquidity Keep Control Retain Legacy What is an? Pre-Tax LBO Tax-Exempt 3

4 What is an? Qualified Retirement Plan, but An can borrow money An can transact with parties in interest An invests in the stock of sponsoring company How Does an Work? Creates & Trust 4

5 How Does an Work? Outside Loan How Does an Work? Outside Loan Inside Loan How Does an Work? Outside Loan Selling Shareholder Stock Cash + Seller Note Inside Loan 5

6 How Does an Work? Contribution/ Dividend How Does an Work? Contribution/ Dividend Inside Loan Payment How Does an Work? Contribution/ Dividend Inside Loan Payment Stock Allocations 6

7 How Does an Work? Outside Loan Payments Seller Note Payments Selling Shareholder Contribution/ Dividend Inside Loan Payment Stock Allocations Tax Advantages s were designed by Congress to provide unique tax advantages to owners, companies and employees, advantages no other approach can replicate. Corey Rosen, Ph.D. Former Executive Director, NCEO Tax Advantages Corporate Pre-Tax Debt Payment Tax-Deductible Dividends Tax-Free Stock Sale Tax-Exempt Corporation 7

8 Tax Advantages Contributions Dividends Tax- Deductible Corporate Expense Loan Interest AND Principal Tax Benefits: Tax-Free Stock Sale Only Available to C Corporation Shareholders Like-Kind Exchange Requirements: 30% Rule Qualified Replacement Property (QRP) 15-Month Rule Tax Benefits: QRP Eligible Common Stock Not Eligible Preferred Stock Corporate Fixed Rate Bonds Corporate Floating Rate Notes 8

9 Tax Benefits: QRP Eligible Common Stock Preferred Stock Corporate Fixed Rate Bonds Corporate Floating Rate Notes Not Eligible U.S. Gov t Bonds Municipal Bonds Foreign Securities REITs CDs Mutual Funds Tax Benefits $10M Sale of Stock MBO or Redemption Tax Savings Proceeds to Shareholders $7.62M 1 $10.0M $2.38M Cost to $10.0M $6.6M 2 $3.4M 1 Assumes 23.8% federal tax on sales proceeds 2 Assumes 34% federal corporate tax rate $5.78M (57.8%) Tax Benefits: Tax-Free Sale Capital Gain (Taxed at 23.8%) Sale $10,000,000 Taxable Sale $13,123,359 Net to Seller $10,000,000 9

10 Tax Benefits: Tax-Free Sale Capital Gain (Taxed at 23.8%) Sale $10,000,000 Taxable Sale $13,123,359 C Corporation Asset Sale (Taxed at 35%) Sale $10,000,000 Taxable Sale $15,384,615 Net to Seller $10,000,000 Net to Seller $10,000,000 Tax Benefits: Tax-Free Sale Tax-Affected AEBITDA Multiples Multiple Tax Rate 0.0% 23.8% 35.0% Tax Benefits: Tax-Exempt Corporation Only Available to S Corporations No tax at corporate level Trust is tax-exempt To extent of s ownership, S Corporation will not pay income tax 10

11 Tax Benefits: 100% -Owned S Corporation NO TAX ON CORPORATE INCOME! Tax Benefits: Tax-Exempt Corporation $10M Sale of Stock MBO/ Redemption Tax Savings Tax on s Income 1 $792,000 2 $0M 3 $7.92MM 4 1 Annual corporate earnings of $2MM % tax rate 3 operates as 100% -owned S Corporation 4 $792,000 per year for 10 years Tax Benefits: Tax-Exempt Corporation 11

12 Major Issues Valuation Financing Control Valuation Independent Trustee Responsibility Qualified Independent Appraiser Range of Value Report Negotiate Terms Fairness Opinion Annual Valuation Sample Multiples Defense Contractor Manufacturing Collection Agency Revenue $266MM $10MM $25MM AEBITDA $25.18MM $923k $2.42MM 100% Valuation AEBITDA Multiple $180MM $6MM $18.5MM $4MM Excess Cash Tax Status C Corporation C Corporation C Corporation 12

13 Sample Multiples Environmental Consulting Third-Party Logistics Mortgage Revenue $50MM $213MM $50MM AEBITDA $7.01MM $5MM $10.38MM 100% Valuation AEBITDA Multiple $50.17MM $45.34MM $61.76MM $4.6MM Excess Cash 9.61 $4MM Debt $4MM Excess Cash Tax Status C Corporation C Corporation C Corporation Financing: Basic Structure Bank Loan Excess + + Cash Seller Note = Total Financing: Basic Structure Bank Loan Excess + + Cash Seller Note = Total $2MM + $4MM + $4MM = $10MM 13

14 Financing: Basic Structure Bank Loan Excess + + Cash Seller Note = Total $2MM + $4MM + $4MM = $10MM $6MM Cash at Closing $320,000 per year (8% Interest + Warrants) Financing: Advanced Structure Bank Loan Mezzanine Debt Excess + + Cash + Cash Flow Lender + Seller Note 401(k) Lateral Transfer Total Financing Sources of Cash for Debt Service Tax Savings 401(k) Match Owner s Adjusted Salary, Bonuses, and Perks Corporate Earnings 14

15 Financing Control in Companies Stock Ownership Directed Trustee has legal title have beneficial interest Trustee directed by Board Seller Note Provisions Limited Pass-Through Voting 15

16 Characteristics of Good Candidates For a Owners accustomed to dealing with complexity Previous transaction experience Sophisticated advisor team Strong successor management team Characteristics of Good Candidates Specific Tax Motivated Legacy Motivated AEBITDA of $1M + Payroll (excluding Owner) of $1M+ Characteristics of Good Candidates Specific Low level of debt Commitment to employees/community Mother Theresa/Gordon Gekko 16

17 Recent EFS s Tax Status Revenue AEBITDA Payroll Gov t Contractor & Logistics Services S Corporation $10.8M $2.1M $6.1M Uniquely unsophisticated company Credit union Owner s HELOC was company s LOC Outsourced CFO Didn t know what an audit was No outside CPA firm No corporate counsel 70 $3M (49%) We recommended that the company hire IBG Recent EFS s Tax Status Revenue AEBITDA Payroll Gov t Contractor & Logistics Services S Corporation $10.8M $2.1M $6.1M Financing (New Bank) $2M Bank Debt No personal guaranty $1M Seller Note brought CFO in house Seller took less value in order to reward employees 70 $3M (49%) Retained flexibility for future transaction Reflections Just met minimum transaction size ($3M) Very smart Owner, but very low level of business knowledge and experience Outsourced CFO Credit Union HELOC as LOC Audit 17

18 Reflections Owner felt like transaction was difficult Wanted everything to move in straight line (i.e., cookie-cutter process) We referred to local CPA firm and banker Recent EFS s Tax Status Manufacturing C Corporation Revenue $10M Owner (age 70) came in late, took a long lunch, left early received LOI from strategic buyer, but plant would close AEBITDA $1M Payroll $3.2M 75 2 children employed, but not capable of leading the 2 long-term employees tapped as successor management team $6M (100%) Attractive collateral base Property, Plant, and Equipment Recent EFS s Tax Status Manufacturing C Corporation Revenue $10M Financing (New Bank) $5M Bank Debt No personal guaranty $1M Seller Note AEBITDA $1M Payroll $3.2M 75 Incentives for successor management Increased salary Accounts SAR Plan (20%) $6M (100%) 18

19 Recent EFS s Tax Status Manufacturing C Corporation Revenue $10M Children kept their jobs Plant remained open AEBITDA $1M Seller made 1042 election Payroll $3.2M 75 S election $6M (100%) Reflections Successor management team negotiated very hard for increased pay and benefits Recognized they were in strong position Owner had transaction experience (LOI) Ruled out sale to third party Many great financing offers resulted from competitive process Recent EFS s Tax Status Logistics Services C Corporation Owner (age 68) diagnosed with multiple myloma Revenue $213M AEBITDA $5M hired IBG to sell IBG brought stalking horse with LOI Owner walked out of meeting Payroll $10M 145 Strong successor management team President and CFO ran process $22.5M (49%) 19

20 Recent EFS s Logistics Services 9.61 Multiple Tax Status C Corporation Revenue $213M 49% sale of CPS AEBITDA $5M Payroll $10M 145 Financing (Existing Bank) $6M Bank Debt No personal guaranty $16.5M Seller Notes + Warrants $22.5M (49%) Recent EFS s Incentives for successor management Logistics Services Increased salary and bonus pool Tax Status C Corporation SAR Plan (15%) Revenue $213M AEBITDA $5M Payroll $10M 145 Owner did NOT make 1042 election Age and health 15% rate on Capital Gains $22.5M (49%) Reflections can pay as much as any financial buyer Used convertible preferred stock to mitigate impact of minority interest discount Owner entrusted transaction process to successor management team Issues with lender counsel 20

21 Recent EFS s Tax Status Plant Automation & Information Systems S Corporation Revenue $25M AEBITDA Payroll $3.8M $17.6M 55 Shareholders (all employees) Sophisticated company and employees Great CFO Very involved President and Benefits Manager 150 $23.7M (100%) Won t take a penny less than $25 per share Recent EFS s Tax Status Plant Automation & Information Systems S Corporation Revenue $25M AEBITDA $3.8M Purchase : $27.50 per share Financing (Existing Bank) $5M Bank Debt No personal guaranty $18.7M Seller Notes Payroll $17.6M 150 $23.7M (100%) Incentives for executive team Increased salary and bonus pool SAR Plan (40%): Sellers accepted less than FMV for stock in exchange for richer SAR package Reflections was very well prepared for Fired first consultant and hired us Purchased 22 copies of my book Had internal education session led by CFO Great attitudes CFO viewed financial due diligence process as a learning opportunity 21

22 Recent EFS s Tax Status Missile Defense Contractor C Corporation Revenue $266M 200 Shareholders Extremely well-educated workforce 200 employees hold Ph.D. in engineering or physics AEBITDA $25.2M Payroll $105M 1,200 Virtually unlimited opportunities to sell to strategic buyer Board committed to maintaining company s independence $84M (51%) $120M in 401(k) Plan Assets Recent EFS s Tax Status Missile Defense Contractor C Corporation Revenue $266M Financing $10M Bank Debt ($25MM committed) $47M Seller Notes (7% interest) $27M Lateral Transfer AEBITDA $25.2M Payroll $105M Virtually no incremental cost 1,200 $84M (51%) Recent EFS s Tax Status Missile Defense Contractor C Corporation Revenue $266M S election $10M annual tax savings Government contractor, redirected PSP contribution AEBITDA $25.2M Payroll $105M 1,200 Gifts to local community foundation of $5M purchased shares from foundation $84M (51%) 22

23 Reflections Many shareholders preferred a Seller Note to cash at Closing Despite transaction complexity, process completed in 6 months $2M+ in fees Committee/Successor Management Team Co-op most challenging employee Consider an Minority Interest Buyout minority shareholder Take Chips off the Table Owner Insists on Control Post- Over the Process Consider an Liquidity Event Plus Family Succession Committed to Independence No Market for the as Stalking Horse 23

24 Consider an Don t Repay Employee Loyalty with Betrayal Mergers and Executions Maintain Culture My is an Integral Part of my Identity Consider an Government Contractors Private Utilities Contra-Indicated Hot Target for Strategic Buyer Niche Industry Segment IP Exceptional Financial Performance Gordon Gekko Type Owner Highly Leveraged Want to Take the Money and Run 24

25 Cost-Benefit Analysis Projected Implementation Fees Total Consultant $200,000 Valuation Trustee $35,000 $35,000 Projected Tax Benefit 2 over the next 10 years Selling Shareholders $4,760,000 (23.8% Capital Gains Rate) $8,000,000 (40% Corporate Tax Tax Rate) Trustee Counsel Other Total Cost $50,000 $10,000 $330,000* 2.59% $12,760,000 % of Fees 1.65% * Does not include fees for corporate counsel or accountant of $20,000,000 25