Increasing Shareholder Value Through Transaction Preparation PRESENTED BY: CHRIS DALTON, NATIONAL TRANSACTION SERVICES LEADER & KEN HIRSCH, MANAGING DIRECTOR, BKD CORPORATE FINANCE TO RECEIVE CPE CREDIT Participate in entire webinar Answer polls when they are provided If you are viewing this webinar in a group Complete group attendance form with Title & date of live webinar Your company name Your printed name, signature & email address All group attendance sheets must be submitted to training@bkd.com within 24 hours of live webinar Answer polls when they are provided If all eligibility requirements are met, each participant will be emailed their CPE certificates within 15 business days of live webinar
INTRODUCTION Current state & general market conditions Steps & considerations to help become market-ready & enhance transferable value Importance & key components of sell-side due diligence VALUE DRIVERS Thoughtful approach to preparing for sale of your business is the single most important factor in creating optimal outcome Bankers & buyers refer to the process as professionalizing the business Companies with strong value drivers & ability to communicate those value drivers to buyers receive premium sale prices
VALUE DRIVERS Key value drivers include Demonstrated financial performance & sustainability Strength & depth of management Operating systems & processes; quality, reliability & consistency of information Customer & supplier relationships, branding Access to new products, technologies, best practices Growth opportunities U.S. M&A ACTIVITY Although off record levels, M&A market remains strong, driven by high levels of liquidity in capital markets & key secular trends Overall, 2017 deal volume is projected to match 2016 Private equity funds have over $1 trillion dollars of buying power With more domestic cash sitting on corporate balance sheets than ever before ($1.68 trillion), corporate buyers are looking to expand footprints & diversify via acquisitions Baby boomers currently own about twothirds of businesses in U.S., approximately 5 million companies. As they begin retiring, an estimated 210,000 businesses will hit the market each year until 2030 Number of Deals 25,000 20,000 15,000 10,000 5,000 U.S. M&A Deal Activity 0 2012 2013 2014 2015 2016 YTD June 2017 > $1B 172 165 229 247 250 115 $500MM - $1B 161 159 179 174 172 86 $250MM - $500MM 270 273 325 308 292 109 $100MM - $250MM 554 586 776 714 595 280 $10MM - $100MM 3,203 3,230 3,692 3,825 3,067 1,356 < $10MM 3,176 3,262 3,446 3,238 2,614 1,103 Undisclosed 9,413 9,165 10,190 10,689 10,221 5,488 Deal Value ($ trillions) $0.91 $1.07 $1.48 $2.05 $1.73 $0.60 $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 Total Deal Value ($ in trillions)
PRIVATE EQUITY MARKET DYNAMICS Private equity has become an important capital source for middle-market companies over the last decade A. Growth in capital available to private equity firms has been driven by institutional investors, such as endowments, pension funds & insurance companies, embracing private equity as an alternative asset class B. At the same time, higher valuation multiples & greater equity contributions in deals has caused expected returns on the funds to decline C. The $546 billion of uninvested capital currently available to PE firms represents over $1 trillion in purchasing power $400 $300 $200 $100 $- PE Capital Invested & Closed Transactions 2,916 $180 2,672 $245 3,431 $236 3,594 $332 3,412 $365 2012 2013 2014 2015 2016 4,000 3,000 2,000 1,000 0 $150 $100 $50 $0 119 ($ in Billions) $600 $500 $400 $300 $200 $100 169 $- $440 $487 $516 $554 $546 2012 2013 2014 2015 2016 177 Uninvested Private Equity Capital PE Capital Raised & Funds Closed 165 164 $90 $108 $133 $125 $110 2012 2013 2014 2015 2016 Capital Raised # Funds Closed 200 150 100 50 0 STRATEGIC BUYER DYNAMICS Strategic buyers continue to view acquisitions as an important component of their growth strategy & they have substantial capital available to pursue acquisitions A. Nearly $1.7 trillion in cash on the balance sheets of U.S. nonfinancial companies rated by Moody s $504 billion (30%) of cash is held by five tech giants: Apple, Microsoft, Alphabet, Cisco & Oracle Top four cash-heavy industries include technology, health care/pharmaceuticals, consumer products & energy; all of which are the most active industry sectors in the M&A market B. In addition to domestic cash on balance sheets, about 72% of S&P 500 companies were holding approximately $2.5 trillion in offshore tax havens in 2015 $ in trillions $ in trillions $2.0 $1.5 $1.0 $0.5 Domestic Cash on Corporate Balance Sheets $0.0 2010 2011 2012 2013 2014 2015 2016 $4.0 $2.0 $0.0 Source: SEC Filings, Audit Analytics, Capital Economics Foreign Cash Held by U.S. Companies Overseas 2010 2011 2012 2013 2014 2015
MIDDLE-MARKET M&A METRICS Middle-market M&A is robust Middle-market deal multiples remain strong, although somewhat off record levels There is a distinct valuation bias to larger companies Low interest rates, substantial available capital & stable economic outlook has resulted in lenders increasing acceptable levels of leverage As valuation multiples have moved up, private equity firms have had to increase the amount of equity invested in transactions U.S. Middle-Market Deal Stats by Enterprise Value 2011 2012 2013 2014 2015 2016 $10 - $25 MM 5.3x 5.8x 6.0x 5.6x 5.8x 6.0x $25 - $50 MM 6.4x 6.2x 6.8x 6.6x 6.6x 6.4x $50 - $100 MM 7.5x 6.7x 6.8x 8.4x 7.8x 7.3x $100 - $250 MM 7.7x 7.4x 7.5x 7.8x 9.0x 9.0x Historical Leverage Multiples 2011 2012 2013 2014 2015 2016 Sub Debt/EBITDA 1.0x 1.1x 0.8x 1.0x 0.9x 0.8x Sr. Debt/EBITDA 2.4x 2.4x 2.6x 2.7x 3.0x 3.1x Total Debt/EBITDA 3.4x 3.5x 3.4x 3.7x 3.9x 3.9x Equity & Debt Contribution 2011 2012 2013 2014 2015 2016 Equity 49.6% 46.6% 49.8% 46.5% 43.1% 45.4% Sub Debt 14.3% 16.5% 12.1% 14.7% 13.4% 11.4% Senior Debt 36.1% 36.9% 38.1% 38.4% 43.5% 43.1% Source: GF Data Resources CHARACTERISTICS THAT ATTRACT FINANCIAL SPONSORS Financial sponsors seek well-managed companies that generate sufficient cash flow, support a levered capital structure & possess achievable growth plans with logical exit opportunities in three to seven years Steady Cash Flow Consistent operating cash flow required to meet debt payments High margins, defensible position & strong customer relationships Limited working capital & capital expenditure requirements Leveragable Asset Base A/R, inventory & PP&E quality determines available leverage Asset-light businesses must generate strong recurring cash flow Strong Management Owner/operators will continue running the business for three to seven years Complementary operating team with proven industry track record Compelling Growth & Exit Strategies Achievable & profitable opportunities that use limited cash Product development, market expansion or add-on acquisitions Logical strategic buyer or initial public offering opportunity
WHAT TO EXPECT IN A SALE PROCESS Buyers are willing to pay top dollar for a business but they are unwilling to make mistakes Number one sin a buyer can commit is to overlook an issue that stringent due diligence would have uncovered; the look stupid effect Confidence on the part of the buyer in the representations made during transaction process is critical. A fail in due diligence can have significant impact on valuation, process & quite possibly, ultimate success of transaction Sale processes are taking longer. Bulk of this added time has been driven by added due diligence & legal documentation As a result, due diligence process can be an overwhelming exercise if not properly planned for & managed PREPARING TO GO TO MARKET Align shareholder & management interests Develop strong management team capable of running the business Evaluate benefit of an advisory board & establish discipline of reporting quarterly results Develop a sophisticated financial reporting process Identify & track financial add-backs & keep documentation readily available Regularly develop & monitor a business plan, competitive landscape, industry trends
PREPARING TO GO TO MARKET Understand the strategic fit with potential buyers Hire reputable law firm with significant M&A & tax expertise Consider spinning off unattractive/nonstrategic assets Obtain proper contracts with employees, customers & vendors, register all intellectual property Resolve any material outstanding litigation Evaluate personal financial matters with a wealth advisor to maximize proceeds post-transaction TRANSACTION PREPARATION DIAGNOSTIC Shareholder alignment Management team & advisors Financial reporting capabilities Business strategy Legal & regulatory
SHAREHOLDER ALIGNMENT Shareholder alignment Are your shareholders aligned with objectives? Valuation expectations Do your company shareholders have valuation expectations in line with what third-party advisors deem to be fair market value? Management alignment Are your company executives aligned with shareholders? Shareholder advisors Has your ownership group been engaged in a review of your company s strategic alternatives? MANAGEMENT TEAM & ADVISORS Management strength Are there any weak spots in your team that need to be filled or replaced? Are others being groomed to eventually run the business? Finance team How well prepared is your company lead finance executive to execute on tasks required in a transaction? Do they have past transaction experience? Transaction advisory team Have you engaged professional transaction advisors? Have you engaged an investment bank? Transaction experience Do your shareholders & managers have experience with control sale transactions? Have any previously sold a business to a strategic or financial buyer? Have any worked for a private equity-owned business?
FINANCIAL REPORTING CAPABILITIES Financial review status To what extent do you have your financial statements analyzed by a third-party accounting firm? Do you receive audited financials? Reviewed financials? Compilations? Only internal reporting? Financial analysis reporting How frequently does your financial team create the following financial analyses? Consolidated financial statements Forecasts & budgets Adjusted EBITDA Product contribution analyses Working capital needs Capital expenditure requirements Tax matters (federal, state) BUSINESS STRATEGY Business plan Do you have a formal business plan that articulates your current market strategy & growth opportunities? How often is it updated? How well can that plan be articulated to potential buyers? Strategic analysis Do you formally analyze & report on the following strategic analyses? Do you have any formal presentations on these topics? Does management informally discuss these issues? Are any of these issues not formally addressed? Company s value proposition S.W.O.T. analysis Customer concentration Competitive analysis Industry trends Acquisition opportunities
LEGAL/REGULATORY Potential liabilities How would you assess your company s exposure to potential threats in the following areas? Are records updated? Have you reviewed these issues with legal counsel? Are the records organized & easy to distribute? Environmental tests Lawsuits (current, threatened) Intellectual property Employee contracts Customer contracts Supplier contracts Facility contracts Labor agreements Contingent liabilities A SIGNIFICANT EVENT FOR ANY BUSINESS A transaction can be the single largest financial transaction of a private business owner s life For private equity, a successful exit is critical to generate required returns The transaction should not be taken lightly & consideration should be given to the exit strategy far in advance of Selling the entire company Recapitalizing the business Divesting a division or subsidiary Spinning off a division or product to Family member Other shareholders Management External investor Investing a subsidiary or division to form a joint venture
CONFLICTING AGENDAS & COMMON GOALS Avoid surprises from bidders due diligence Meet timetables & manage expectations Control information release Limit reps, warranties, indemnifications Optimize structure Maximize valuation Preserve value Reduce uncertainty Design efficient tax structure Minimize distractions Maintain credibility Enhance reputation Smooth separation Minimize post-closing disputes Highlight liabilities & risks Challenge run rates & forecasts Understand sustainability Maximize reps, warranties, indemnifications Develop advantage vs. other bidders Reduce price & uncertainty Control sales process SELL-SIDE DUE DILIGENCE TRENDS & PRIMARY OBJECTIVES Sell-side due diligence has become common The objective of sell-side due diligence is to contribute to success by Preserving your company s value throughout the process Reduce uncertainties & diminish bidder ability to renegotiate Proactively position opportunities & address exposures Keep bidders engaged longer to enhance competitive landscape Enhance net proceeds that will be received
PRIMARY OBJECTIVES OF SELL-SIDE DUE DILIGENCE As a result of sell-side due diligence, companies should be enabled to proactively manage the sales process by Understanding financial & tax exposures, consequences & opportunities Identifying & addressing issues before bidders Assembling a complete & transparent data room Providing bidders information that is Complete Accurate Credible COMPLEMENTARY TO YOUR OTHER PROVIDERS Sell-side is complementary to services provided by Investment bankers Attorneys Independent auditors
BUYERS OFTEN HAVE AN ALTERNATIVE VIEW Sell-side due diligence looks at your business through the eyes of a potential buyer Quality of information Quality of earnings Operating trends & drivers Quality of net assets Tax planning & analysis HR IT Contracts Questions?
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Thank You! Chris Dalton cdalton@bkd.com Ken Hirsch khirsch@bkd.com BKD Thoughtware Sign up for articles & event announcements based on your specific industry or service needs Sign up at bkd.com/subscribe