Transition Planning For Closely Held Businesses: Incorporating The Practical Realities

Transcription

1 Transition Planning For Closely Held Businesses: Incorporating The Practical Realities Mary Ann Spangler Sisco Senior Vice President Director of PFS Client Solutions Daniel R. Barron Senior Vice President and Managing Director of Family Business Services Northern Trust Corporation northerntrust.com 1

2 M&A Market and Economic Environment Update *M&A Market and Economic Environment Update materials provided courtesy of Duff & Phelps, LLC. Reproduction, publication, or dissemination of portions hereof may not be made without prior written consent of Duff & Phelps, LLC. 2

3 Commentary on Middle-Market M&A Environment Although the economy continues to remain volatile, strategic buyers remain confident about undertaking acquisitions The availability and terms for junior and senior debt to support acquisitions are as attractive as they have been since late 2007 Private equity firms are sitting on a record high level of uninvested capital There remains a lack of quality deals in the market so attractive companies are demanding a scarcity premium Valuation multiples in change of control transactions are trending up and at near three year highs A rush to sell is expected in 2012 to avoid the potential capital gains tax rate increase 3

4 M&A Activity Has Picked Up M&A MARKET ENVIRONMENT M&A volume has increased modestly, driven primarily by activity in the middle-market There are many companies and private equity firms looking for acquisition opportunities, but there remains a shortage of quality deals Potential sellers are reluctant to sell having only just recovered ered from the recession Industries that were somewhat recession-resistant have experienced higher levels of M&A activity STRATEGIC BUYER MARKET Increasing confidence in the economy has shifted focus away from cost cutting and towards growth opportunities Limited supply of deals and competition from private equity funds have driven valuations higher Equity markets recovered at the end of 2011 as volatility decreased from highs in October 2011 PRIVATE EQUITY MARKET Large surplus of uninvested capital following successful fund raising efforts in 2007 / 2008 Buyout firms are eager to deploy capital as some face a use it or lose it decision with investment periods nearly over Demand has exceeded the supply of quality deals, pushing valuations up and forcing firms to lower return requirements Financing markets have improved, particularly for larger deals 4

5 Aggregate U.S. Deal Volume M&A deal activity showed strong improvements in 2010 and continued to remain strong in 2011, especially in the first half While M&A deal count in 2011 decreased by 1.5% over 2010, overall deal value increased by 15.9% Middle market M&A activity remained stable with overall deal count decreasing by 1.3% in 2011, and deal value increasing by 1.4% However, middle market M&A deal activity slowed down significantly in the second half of 2011, with deal count falling by 18.5% y o y and deal value decreasing by 17.4% y o y Overall U.S. M&A Activity Middle-Market U.S. M&A Activity $2,500 14,000 $300 3,000 regate Deal Value ($s in billions) Agg $2,000 $1,500 $1,000 $500 12,000 10,000 8,000 6,000 4,000 2,000 Number of Deals Agg gregate Deal Value ($s in billions) $250 $200 $150 $100 $50 2,500 2,000 1,500 1, Number of Deals $0 0 $ H10 H H10 H11 5 Deal Value Source: Thomson Financial as of 12/31/11 Number of Deals Deal Value Number of Deals Source: Thomson Financial as of 12/31/11 Note: Middle-market defined as deals with enterprise values between $20 and $500 million

6 EBITDA Multiples and Deal Volume by Industry In 2011, purchase price multiples continued to improve from their 2009 / 2010 levels across most industries In 2011, deal volume decreased slightly over 2010 levels for most industries Buyers are reluctant to invest in cyclical industries and deal volume and valuations reflects this uncertainty Distressed M&A has driven activity across multiple sectors over the last two years Average EBITDA Multiple by Industry ( ) Deal Volume by Industry ( ) Enterprise Value (m multiple of EBITDA) 12.0x 10.0x 8.0x 60x 6.0x 4.0x 2.0x 0.0x 2011 Average: 9.7x 10.3x 9.1x 9.6x 9.9x 9.4x 8.8x 9.2x 8.8x 9.0x 8.9x 9.1x 8.9x 9.0x 8.7x 8.7x 8.4x 7.9x 7.6x 7.8x 8.0x 7.8x 7.4x 7.3x 7.0x 7.2x 6.8x 6.6x 6.7x 5.9x 5.6x Numbe er of Deals 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, ,838 3,311 2,295 2,385 2,210 2,267 2,059 1,944 1,966 1,840 1,742 1,549 1,302 1, Source: Capital IQ (U.S. announced deals through 12/31/11) Source: Capital IQ (U.S. announced deals through 12/31/11) 6

7 Credit Statistics Have Continued to Improve Leverage multiples have returned to 2005 / 2006 levels and institutions are looking to put money to work Senior debt to EBITDA is now in the 3.3x range, with total leverage of 4.5x for middle market sponsorled deals Private aeequity firms have aenearly $500 billion in uninvested edcapital a and daeagg are aggressively e looking to deploy it Average Debt Multiple of Highly Leveraged Loans Private Equity Capital Raised Multiple of EBITDA x x 4.2x 4.3x 4.3x 4.5x 4.0x x 3.8x 3.9x 3.8x 4.0x 3.9x st Lien/EBITDA 2nd Lien/EBITDA Other Sr. Debt/EBITDA Sub Debt/EBITDA Priv vate Equity Capital Raised by Fund Size ($ B) $350 $315 $280 $245 $210 $550 $313 $307 $436 $440 $217 $330 $175 $138 $139 $140 $220 $105 $87 $79 $70 $110 $35 $0 $ Cumulative Overhang Under $100mm $100mm - $250mm $250mm - $500mm $500mm - $1bn $1bn - $5bn $5bn+ Cumulative Overhang ($B) Source: S&P LCD, as of 12/31/11 Source: PitchBook Private Equity Database 4Q11 (2011 data as of 3Q11) 7

8 U.S. Corporate Liquidity Should Create M&A Activity Balance sheet strength and debt service management became a critical focus across all industries during the recession However, top line organic growth has continued to remain difficult, and input cost pressures are tightening margins Companies have shifted that focus towards acquisitions to increase profitability Measures of Corporate Liquidity Industry Total Debt/EBITDA Current Ratio EBITDA/Interest Exp. Debt/Equity Debt/Total Capital Consumer - Discretionary 2.4x 1.4x 6.7x 65.0% 39.4% Consumer - Staples 1.3x 1.6x 9.8x 43.3% 30.2% Energy 1.7x 1.2x 9.4x 66.0% 39.8% Financial Services 2.9x 1.3x 6.1x 111.8% 51.1% Healthcare 0.9x 2.1x 7.3x 23.3% 18.9% Industrials 3.6x 1.3x 4.0x 93.3% 3% 48.3% Information Technology 1.4x 1.5x 12.8x 42.2% 29.7% Materials 2.7x 1.3x 7.5x 64.6% 39.3% Telecommunications 1.1x 0.8x 12.3x 58.7% 37.0% Utilities 4.0x 1.3x 6.6x 95.4% 48.8% Source: Capital IQ as of 12/31/11 8

9 Transition Planning For The Business Owner 9

10 Transitions Create Wealth Transfer Opportunities TRANSACTION CAPITAL GAINS IMPACT WEALTH TRANSFER OPPORTUNITY Pre Planning Techniques: Gifting Family Limited Partnerships (FLPs) IPO No capital gains tax Grantor Retained Annuity Trusts (GRATs) Installment Sales and Installment Sales to Intentionally Defective Trusts Life Insurance Trusts (ILITs) Privately held business Sale of company Upfront capital gains tax Donation to Charitable Remainder Trust (CRT) Preand post sale sale Income tax planning to minimize the capital gains resulting from the sale ESOP Deferred capital gains tax with proper structure Post ESOP Gifts of stock to children or dynasty trusts Contribution to a GRAT Careful Pre and Post ESOP planning with qualified replacement portfolio to defer capital gains recognition, potentially until death, when a step up in basis may occur 10

11 Pre-Planning is the Key To Successful Transitions TRANSACTION IMPACT WEALTH TRANSFER OPPORTUNITY Privately held business Give to family members Plan correct exit date Reduce gift taxes Equalize estate among heirs Create liquidity to pay estate taxes Planning Techniques: Staggered gifting of ownership interests Grantor retained annuity trust Sale to intentionally defective grantor trust Generation skipping transfer trust Family limited partnership Irrevocable life insurance trust Survivorship insurance policies Sell to family members or business partner Provide continuity during transfer Buy / sell agreement Succession Plan Establish credit relationship with a bank Employee StockOwnership Plan 11

12 How Are Business Owners Preparing For Transitions? PASSING WEALTH TO THE NEXT GENERATION What are your personal feelings about transferring wealth to the next generation: 8% very concerned 42% cautious 10% neutral 25% comfortable 15% very positive TRANSFERRING VOTING CONTROL TO FAMILY At what time would you pass voting control of the company to the next generation? 84% before seniors deaths 12% at seniors deaths 4% never to Trustees STATE OF THE ESTATE % of Business Owners who have: Estate Plan 64% Key person insurance 58% BASIC WEALTH MANAGEMENT PLANNING % of Business Owners who have: formal financial plan 43% formal plan to minimize Buy sell agreement 38% taxes 36% Average # of years last updated: Estate Plan 12.8 years Key person insurance 10.6 years Buy sell agreement 12.4 years Strategy to monetize their business 35% 12 Source: 2005 Grant Thornton International Business Owner Survey: Prince & Associates Survey ; PriceWaterhouseCoopers; VIP Forum research; 2007 Kellogg Family Business Conference

13 How Should Business Owners Be Preparing For Transitions? Preparing the business, owner and family for the inevitable transfer of ownership and management of the business: Financial i planning for the owner, family and business Estate and gift planning for the owner Leadership succession planning Creating and funding a buy sell agreement Tax reduction strategies Structuring for a potential sale A proper succession plan incorporates both the business owner s family objectives and their business concerns 13

14 An Organized Approach Will Ensure A Successful Transition PERSON NAL 1 Establish goals, review will, trusts and insurance plans 5 Identify your investment and planning team 2 Establish trust accounts; critical to transfer assets prior to sale 6 Establish a Brokerage Account 3 Review tax strategies, cash flow, financial plan 7 Determine a short-term asset allocation strategy 4 Create advanced gifting vehicles for family 1 Receive sale proceeds of cash or stock 4 Construct long term portfolio plan 2 Sell shares or allocate portion of proceeds to investment account 5 Fund philanthropic interests 3 Execute transactions to protect equity holdings 6 Retire, maintain current job or begin your next career TODAY BEFORE THE SALE SALE PROCESS SALE PROCESS AFTER THE SALE TOMORROW PROFESSIONAL Sale Process Begins Preparation of Facility tours Management Human resource, Staff meetings Final data Review and analysis of financial statements. Due diligence Participate in negotiations and executive team integration meetings Employment changes Issues with human capital benefits and employment communications planning and rollout and operation integration meetings Stay focused on regular duties to preserve value of the company negotiations and sale closes 14

15 Transitioning A Closely Held Company Impacts Every Aspect of Your Client s Life Northern Trust is positioned to advise on the business and personal areas affected by the sale or transfer of your client s company: Wealth Planning How can wealth transfer planning be incorporated to minimize transfer tax on proceeds? Does the current plan fit with their long term strategic goals? Is there a way to protect assets or interests for generations? Liquidity What are their immediate cash flow needs on day one of the sale? Income tax obligations and options for set aside? Lifestyle considerations? Investment Management How will their investment perspective change upon the transition from a highly illiquid asset to very liquid assets? Creative Financing Alternatives Will they need financing to complete the transaction? If considering an ESOP, who will facilitate obtaining qualified replacement property? Charitable Goals What are the best options to coordinate the transfer of company interests with their long term charitable intentions in order to maximize benefits and minimize tax? 15

16 Incorporating The Practical Realities Into The Plan 16

17 Family Business Team The Family Business Group at Northern Trust Who We Are The Assets More than 1200 assets under management More than 100 control situations S & C corporations, partnerships, LLCs Operating companies Manufacturing Publishing Hospitality & Gaming Service Holding companies Oil & Gas Real Estate Marketable Securities 17

18 Succession Planning Does Not Only Mean Retention Succession Planning for the closely held business owner Retention of the business Sale of the business Whether a business owner wants to sell or retain, it is critical that they have a succession plan in place throughout Elements of The Plan Will Trust Defective Grantor Trusts GRATs ILIT Gifting programs Are we done? Has our business owner done all the planning he needs? 18

19 Managing The Personal Impact As Well As Tax Impact The Family the Realities Who are the beneficiaries of the trusts, GRATs, gifts? Who will own the business? Who will manage the business? What does the business mean to these beneficiaries? How do these beneficiaries feel about one another? 19

20 Business Succession What is the likelihood of success for the business owner who wishes to see the business preserved for future generations? Most surveyed firms in our survey have only existed for one or two generations 1st Generation 31 2nd Generation 36 3rd Generation 19 4th Generation 7 5th Generation 5 Don't know 2 % Source: PwC Family Business Survey 2010/11 20

21 Business Succession Succession Failure 40% Survive to Generation 2 12% Survive to Generation 3 3% Survive to Generation 4 Copyright: Family Business Alliance 21

22 Business Succession What accounts for the high attrition in the survival of family businesses? Owner is too busy to plan. Owner won t cede control (which is eventually resolved by default). Ill advised planning: Ownership divided equally among beneficiaries. No centralized control. Lack of consistent strategy for the company. Inability to make decisions. 22

23 Planning for Practical Realities Lack of planning for family realities. Families tend to be about unconditional i love, equality and caring. Businesses are about performance. Will there be jealousies among the children? Will family members who don t work in the business be in ownership positions? Should the business be run for growth or income? Salaryversus dividend versus capital reinvestment. Little Red Wagon problems. 23

24 Case Study Case Study: Publishing Company Three sons, three family branches Company governance: Key in working with the company and with the family. Northern Trust representative acted as a board member. Constructed an independent board of directors. More professional. Equipped to make good business decisions. Board members not affiliated with family branches. First non family chairman in the 150 year history of the company. Hired a team to construct a family governance structure. Ongoing issue. Key was communication. 24

25 Process For Sale Of The Business Sale of the business To family members To management To an ESOP To a third party Process St Set goals for the sale Maximize price Retain employees Maintain i a tradition of quality Contract for a valuation Prepare the business for sale according to the results of the valuation 25

26 Process For Sale Of The Business, Con t Process (continued) Choose the proper p team Investment banker Transaction attorney Accountant t Due diligence room Set communication structure Periodic conference calls Periodic in person meetings Documents Non disclosure agreements Contracts with team members Purchase/Sale agreement Incentiveplans for top employees Negotiate the deal 26

27 Final Case Study Case Study: Gaming Company Liquidity event Work with the company financials Choose the advisory team. Investment bankers Attorneys Accountants Due diligence room Vet prospective buyers, communicate with family members LTI for management Negotiate the sales document and the price 27

28 Winding Down The Business Don t forget about winding down the business. Litigation: settlements and ongoing litigation Workers compensation Residual insurance claims 28

29 LEGAL, INVESTMENT AND TAX NOTICE: This information is not intended to be and should not be treated as legal advice, investment advice or tax advice. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. For more information about this notice, see 29

30 Thank you Mary Ann Spangler Sisco Senior Vice President Director of PFS Client Solutions Daniel R. Barron Senior Vice President and Managing Director of Family Business Services