CPA as M&A Advisor for the Middle Market

CPA as M&A Advisor for the Middle Market Chris Blees BiggsKofford 630 Southpointe Ct., Suite 200 Colorado Springs, CO 80906 719-579-9090 blees@biggskofford.com

Today s Webinar I. New Regulatory Environment II. Middle-Market Opportunity III. Private Company Value IV. Transfer / Exit Methods V. Middle Market M&A Process VI. Performing M&A inside CPA firm 2

I. New Regulatory Environment 3

Define a Security Brokers / Dealers / Finders New SEC rule Legislation in Congress Opportunity for CPAs, consultants, etc. 4

Stock of Seller Debt from Seller Longer than 9-months Separate Instrument LLC Membership Interest Buyer s Securities paid as consideration 5

When the sale of a business is a securities transaction: Stock sale vs. an asset sale; Exchange or issuance of stock in a merger; Issuance of buyer s stock for assets; Sale of less than 100% (recapitalization); Sale of stock to an ESOP; The sale generates an instrument of debt; Creating an earn-out might be a security; A Seller s Note might be a security. 6

Securities act of 34 requires SEC license and FINRA registration for anyone charging fees for completing a Security Transaction. You were more than a Finder if: Transaction based compensation Making offering of a security Assisting with Negotiations Recommendations related to the Security Until New Rules 7

History of Regulatory Changes: SEC Country Business No Action Letter Passage of House Bill 2274 Senate Bill 1923 SEC 1/31/14 M&A Broker No Action Letter State laws to follow? 8

II. Middle Market Opportunities 9

Capital Markets Overview Small Companies Middle Market Large Companies P O P U L A T I O N 5.4MM 300,000 2,000 G D P 15% 40% 45% V A L U A T I O N 2-3x 4-11x 12x + 5 150 500 1,000 Revenues ($millions) 10

The Middle Market Buyer Demand There are roughly 8,000 Private equity groups (PEGs) in the US with more than a trillion dollars in spending power PEGs already own around 35,000 middle market companies. Most in the Middle-Middle and Upper Middle-Markets. Large Corporations cut or reduced R&D and organic expansion during the Great Recession, to preserve earnings. Public Companies haven t grown employment organically in 20 years. All growth was through acquisition of Middle- Market companies. 11

The Middle Market Seller Supply Largest demographic of Closely-Held business owners is between 53-57 years old (in 2014). Closely-held company earnings are returning to previous highs. Many owners are risk-averse and comfortable with a lifestyle business. Most owners have their net-worth tied up in their business. 12

Private Market Timing U.S. Ten Year Transfer Cycle Deal Recession Prime Selling Time Uncertainty (Buyer s Market) (Seller s Market) (Neutral Market) 1980 1983 1987 1990 1990 1993 1997 2000 2000 2003 2007 2010 2010 2013 2017 2020 2020 2023 2027 2030 13

Current Private Capital Market Opportunities Private Equity Hunger Strategic Organic Growth Starvation Private Equity life cycle discharge Strategic Division cast-off Lifestyle Owner retirement 14

III. Private Company Value 15

Professional Valuation Today Historic and forensic Compliance-oriented Notional Measured with singular certainty But not the least bit useful in making investment and financing decisions 17

Value Relativity Motive (goal) leads to a reason for an appraisal The reason for an appraisal selects a Value World A private business value is relative to the Value World in which it is viewed Therefore every private company has dozens of correct values at one point in time 18

A Few Value Worlds Market Value what the open market says the business is worth (Asset, Financial, and Synergy Subworlds) Fair Market Value what the IRS/Courts say it is worth Owner Value what the owner says it is worth Investor Value what an investor says it is worth Collateral Value what the bank says it is worth Incremental Business Value returns greater than investment Others: Insurable; Early Equity; Public; Fair Value The 30 second rule 19

Owner Motives Matter PrivateCo s Values Method Value World Value Buy/Sell Asset Market Value $ 2.4 MM MBO Investment Value 7.5 MM ESOP Fair Market Value 9.2 MM Equity Recap Financial Market Value 12.0 MM Negotiated Owner Value 15.8 MM Auction Synergy Market Value 16.6 MM Public Public Value 18.2 MM Business Owners Choose a Transfer Value! 20

Basic Value Formula: PV (Benefit Stream @ Risk Rate) = VALUE Therefore, valuation is easy!! Or not What s the benefit stream (return)? Different in each Value World What s the risk expectation (ROI)? Different in each Value World 21

Benefit Streams (return) Return is defined differently by segment and by world Value World Participants define benefit streams to predict behavior or to meet their needs (investor vs. owner vs. bank vs. insurance vs. corporate buyer, etc.) Benefit Stream variability is infinite 22

Return Expectations (risk) Investor returns are segmented by market and risk is defined differently by world Value World Participants defines how return expectations are viewed (investor vs. owner vs. bank vs. insurance vs. corporate buyer, etc.) Risk is measured differently by each participant even within the Value World. (Value variability is increased) 23

Valuation made simple: PV (Benefit Stream @ Risk Rate) OR Benefit Stream times the Multiple (EBITDA times an acquisition multiple) The Stream is influenced by the presenter The Buyer brings the multiple 24

It s a Recast World Which earnings level do you use to value? Reported EBITDA $1MM Recast EBITDA $2MM Synergized recast EBITDA $3MM Using a 5 multiple, the same company has a $5MM, $10MM, and $15MM market value depending on which earnings level is used 25

Market Value - Conclusion Most private owners want to increase the value of their company Risk acquisition multiple is specific to a buyer and reflects their risk assessment (hurdle rate) Return EBITDA available post-transaction Big opportunity for us to help owners plan and execute 26

IV. Transfer & Exit Channels 27

Business Transfer Business transfer reflects all possible ways or methods to transfer or exchange a private business interest An owner s transfer motive selects a transfer channel (e.g., Related Buyer Channel) Each channel contains numerous transfer methods (e.g., ESOP, PEG financed MBO, Seller Financing) Transfer methods determine the value 28

Exit Channels Strategic Buyers Financial Buyers Related Buyers Pure Product / IP Sale Hybrid PEG Add-On PEG Financed MBO Sale / Merger to Strategic JV to Staged Strategic Sale PEG Platform Buy-out PEG Staged Re-Cap Leveraged MBO (ESOP?) Long- Term Staged MBO 29

Owner Transfer Motives Private owners want to: Create a family legacy Change lifestyle Empower employees Diversify estate Give to charity Use transfer to create liquidity 30

Exit Planning Understand the Options (Exit Channels) Learn what creates value in your Exit Channel Gear the business towards the selected Exit Channel Maximize the Value of the Company, and Leave on your Terms! 31

Exit Planning External Forces (no control): Economy Market for your goods / services Industry forces Competition Barrier to entry 32

Exit Planning Internal Forces (things you can control): Profitability Cash flow Size Intellectual property development (R&D) Management strength Trained employees Sales force Growth rate Operating systems & procedures Diversified customers Premier customers Vendor relations Vendor diversity Industry reputation Geographic coverage Etc., etc., etc Where to start? 33

Example Exit Channel Strategic Buyers Financial Buyers Related Buyers Pure Product / IP Sale Hybrid PEG Add-On PEG Financed MBO Sale / Merger to Strategic JV to Staged Strategic Sale PEG Platform Buy-out PEG Staged Re-Cap Leverage d MBO (ESOP?) Long- Term Staged MBO 34

Example Exit Channel Hybrid PEG Add-On Who: Private Equity owned Competitors, Customers, Industry Complements, Rollups. Pros: Similar value to strategic. May be short transition time. PLUS More choices with multiple PEG platforms looking for add-ons. Cons: Similar to Strategic End of your legacy, Loss to some employees, PLUS Financial owner demands post-closing, Company on a time-line for re-sale. More pressured environment for employees. Value Builders: Sales Growth, Market Share, Profitability, Unique Products & Processes, Key employees, Product R&D. PLUS Presentation. Gearing: Less focus on back-office, More focus on Sales, Products, Market Share, Customer Care, Market Presence, Profits, Key Technical Employee Development. PLUS documented systems and measures, clean records. 35

V. M&A Process 36

SELL SIDE PROCESS 1. The role of the M & A Advisor 2. Discuss Seller Goals 3. What is the Transaction? 4. Obtaining Preliminary Company Data 5. Initial Financial Analysis 6. Discussing Value Range with Seller 7. Reviewing the Process with Seller 8. Importance of Confidentiality with Seller 9. Engagement with Seller 10. Detailed Company Information Gathering 37

SELL SIDE PROCESS 11. Identifying potential buyers 12. Preparing the Offering Document 13. Marketing Seller s Business 14. Negotiating Price & Terms with Buyers 15. Structuring of the Transaction 16. LOI s / Term Sheets from Buyers 17. Responding to Due Diligence of Buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 38

SELL SIDE PROCESS 1. The role of the M & A Advisor for the Seller 2. Discuss Seller Goals 3. What is the Transaction? 4. Obtain Preliminary Company Data 5. Initial Financial Analysis 6. Discuss Value Range with Seller 7. Review the Process with Seller 8. Discuss Importance of Confidentiality with Seller 9. Engagement with Seller 10. Detailed Company Information Gathering 39

Identify the real value drivers for your client Consult on strategy, not tactics for both Identify operating metrics which measure sustainability Identify new products and lines which augment your client s products or services. Be prepared to have a different exit for a seller Ask what s keeping he or she up at nights 40

1. The role of the M & A Advisor for the Seller 2. Discuss Seller Goals 3. What is the Transaction? 4. Obtaining Preliminary Company Data 5. Initial Financial Analysis 6. Discussing Value Range with Seller 7. Reviewing the Process with Seller 8. Importance of Confidentiality with Seller 9. Engagement with Seller 10. Detailed Company Information Gathering 41

PERSONAL BUSINESS MARKET

Identify goals before beginning the Sale process: Do they want to sell? Do they want to continue with the business? Do they want to diversify risk? Do they want to transfer the business to family, or existing management? Each of these goals can mean a different transaction, different buyer, different value, terms, structure, etc. 43

1. The role of the M & A Advisor 2. Discuss Seller Goals 3. What are the options to liquidity? 4. Obtaining Preliminary Company Data 5. Initial Financial Analysis 6. Discussing Value Range with Seller 7. Reviewing the Process with Seller 8. Importance of Confidentiality with Seller 9. Engagement with Seller 10. Detailed Company Information Gathering 44

100% sale with exit of old owner / operator Management Buy-In Management Buy-Out Partner Buy-Out Recapitalization (With Debt only) Minority Recapitalization (Equity) Majority Recapitalization (Equity) Raise Preferred Stock Investment Merger Family Transfer IPO Structured Liquidation 45

I still have lots of ideas and energy for growing this Company, but I don t want to personally guarantee anymore debt.

Solutions Private-Equity Recap Or Strategic Joint-Venture

I love inventing things and coming up with new products, but I can t stand managing employees, so I think I want to sell this business to someone who knows how to manage people. 48

Solution Strategic Buyer (with on-going royalty contract) 55

1. The role of the M & A Advisor 2. Discuss Seller Goals 3. What are the options to liquidity? 4. Steps before the formal engagement 5. Obtaining Preliminary Company Data 6. Initial Financial Analysis 7. Discussing Value Range with Seller 8. Reviewing the Process with Seller 9. Importance of Confidentiality with Seller 10. Engagement with Seller 11. Detailed Company Information Gathering 50

Is there a true commitment to change life style Price expectations THERE MUST BE AN AGREEMENT Timing of the process How is your client going to handle loss of power? 51

1. The role of the M & A Advisor 2. Discuss Seller Goals 3. What are the options to liquidity? 4. Steps to be taken before the formal engagement 5. Obtaining Preliminary Company Data 6. Initial Financial Analysis 7. Discussing Value Range with Seller 8. Reviewing the Process with Seller 9. Importance of Confidentiality with Seller 10. Engagement with Seller 11. Detailed Company Information Gathering 52

Be prepared to sign / deliver a Non-Disclosure Agreement with a potential client (CPA s have an advantage with existing clients) Explain this is a preliminary analysis only. Ask simple questions only to do basic normalizing. Determine what critical information is not available 53

Understand the Transaction Basic Industry Research Who are the active buyers in the sector Review preliminary financial information Understand basic management, operations, and capital structure ESTIMATE valuation range for discussion purposes. 55

THE SELL SIDE PROCESS 1. The role of the M & A Advisor 2. Discuss Seller Goals 3. What are the options to liquidity? 4. Steps to be taken before the formal engagement 5. Obtaining Preliminary Company Data 6. Initial Financial Analysis 7. Discussing Value Range with Seller 8. Reviewing the Process with Seller 9. Importance of Confidentiality with Seller 10. Engagement with Seller 11. Detailed Company Information Gathering 56

Avoid unrealistic expectations of value Do a walk through of the purchase Set a hypothetical value for the business How much cash comes in at closing Possible senior refinancing triggered by the sale Selling notes Hold backs for breach representations Adjustments to the balance sheet Avoid listening to Country Club multiples 57

THE SELL SIDE PROCESS 1. The role of the M & A Advisor 2. Discuss Seller Goals 3. What are the options to liquidity? 4. Steps to be taken before the formal engagement 5. Obtaining Preliminary Company Data 6. Initial Financial Analysis 7. Discussing Value Range with Seller 8. Reviewing the Sale Process with Seller 9. Importance of Confidentiality with Seller 10. Engagement with Seller 11. Detailed Company Information Gathering 58

Create process check-list to review with Seller Generate timelines with key milestones Identify responsibilities and deadlines Use as opportunity to set expectations for Non-price terms Escrows Earn outs Reps & Warranties Indemnifications, etc. 59

THE SELL SIDE PROCESS 1. The role of the M & A Advisor 2. Discuss Seller Goals 3. What are the options to liquidity? 4. Steps to be taken before the formal engagement 5. Obtaining Preliminary Company Data 6. Initial Financial Analysis 7. Discussing Value Range with Seller 8. Reviewing the Sale Process with Seller 9. Importance of Confidentiality 10. Engagement with Seller 11. Detailed Company Information Gathering 60

Discuss your policy on confidentiality. Set ground-rules with your client (Fax numbers, voice mail, email, office visits, etc.) Coach the Seller regarding their friends, customers, employees, vendors. Rehearse the inevitable question: I heard you were selling? The Saturday night tour does not always work. 61

THE SELL SIDE PROCESS 1. The role of the M & A Advisor 2. Discuss Seller Goals 3. What are the options to liquidity? 4. Steps to be taken before the formal engagement 5. Obtaining Preliminary Company Data 6. Initial Financial Analysis 7. Discussing Value Range with Seller 8. Reviewing the Sale Process with Seller 9. Importance of Confidentiality 10.Engagement with Seller 11. Detailed Company Information Gathering 62

Who s your client? Tasks, Responsibilities, Timeline. Fees Milestone Advisory Fees Success fee Termination provisions Tail Provisions 63

Most Middle-Market intermediaries will structure Sell-Side transactions: Retainer or Advisory Fees: Upfront amount Monthly Amounts Milestone Fees Plus Success Fee: Flat dollar amount Flat % Graduated % Value Kicker 64

THE SELL SIDE PROCESS 1. The role of the M & A Advisor 2. Discuss Seller Goals 3. What are the options to liquidity? 4. Steps to be taken before the formal engagement 5. Obtaining Preliminary Company Data 6. Initial Financial Analysis 7. Discussing Value Range with Seller 8. Reviewing the Sale Process with Seller 9. Importance of Confidentiality 10. Engagement with Seller 11.Gathering Company Information 65

At This Stage: Enough Information to create the Marketing Book Need to anticipate PRELIMINARY due diligence questions. Don t gather the detailed due diligence request list YET. 66

THE SELL SIDE PROCESS 11. Research 12. Preparing the Offering Document 13. Marketing the Seller s Business 14. Negotiating Price & Terms with Buyers 15. Structuring of the Transaction 16. Receive LOI s / Term Sheets from Buyers 17. Responding to Due Diligence of Buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 67

Onesource Zephyr (BVD) Capital IQ Pitchbook Private Equity Info EDGAR Online AM&AA List-Serv IBIS World Deal Platforms Basic Internet Searching Trade Association Databases 68

Create list of categories of likely buyer types Competitors Vendors Financial Buyers Roll-ups Employee/Management, etc.). Rank which types of buyers are most likely. Identify likely issues of each buyer These issues will become your outline for the Seller Prospectus / Offering Book. 69

THE SELL SIDE PROCESS 11. Research Industry and Identify Buyer Types 12. Preparing an Offering Document 13. Marketing Seller s Business with the proper due diligence 14. Negotiating Price & Terms with Buyers 15. Structuring of the Transaction 16. LOI s / Term Sheets from Buyers 17. Responding to Due Diligence of Buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 70

Key Positive Points to make: What is the Desired Transaction? Differentiating Qualities of the Business Competitive Advantages Growth Opportunities Profitability All value drivers defined and qualified if possible 71

Negative Points to Explain: Limitations / Gaps in Management Customer Concentrations Lack of Growth Why? Sales Team / Sales Channel Limitations 72

Every M&A Professional has their own preference for assembling The Book. However, many include the following common sections, in roughly a similar order: Exec Summary Business Overview / History Organization Structure (Corporate Structure, Parent/Sub, Brother/Sister) Description of Products, Services, Processes, etc. Sales, Marketing & Growth Opportunities Competitive landscape Risks and Limitations Financial Discussion (Summary & Recast) Proforma Financials Historical Financials Supplemental Information 73

11. Research Industry and Identify Buyer Types 12. Preparing the Offering Document 13. Marketing Seller s Business 14. Negotiating Price & Terms with Buyers 15. Structuring of the Transaction 16. LOI s / Term Sheets from Buyers 17. Responding to Due Diligence of Buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 74

Clear list with Seller Initial Contact with Buyers (Blind Summary). Obtain Signed NDA Distribute Offering Document Follow-up and questions (preliminary due diligence) Management Meetings Negotiate Price & Terms Letter of Intent (LOI) 75

11. Research Industry and Identify Buyer Types 12. Preparing the Offering Document 13. Marketing the Seller s Business 14. Negotiating Price & Terms 15. Structuring of the Transaction 16. LOI s / Term Sheets from Buyers 17. Responding to Due Diligence of Buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 76

NEGOTIATED SALE One buyer at a time. Hand-on-hand combat. LIMITED AUCTION Limited group of buyers compete with knowledge that others are interested. FORMAL AUCTION Uses stages and deadlines to manage large group of potential buyers. 77

11. Research Industry and Identify Buyer Types 12. Preparing the Offering Document 13. Marketing the Seller s Business 14. Negotiating Price & Terms with Buyers 15. Structuring of the Transaction 16. LOI s / Term Sheets from Buyers 17. Responding to Due Diligence of Buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 78

PRIMARY MOTIVATIONS FOR STOCK TRANSACTIONS: Seller s tax motivations Assumption of Seller s contracts, rights, etc. without assignment PRIMARY MOTIVATIONS FOR ASSET TRANSACTIONS: No liability transfer (Except by inclusion) Buyer s tax motivations 79

11. Research Industry and Identify Buyer Types 12. Preparing Offering Document 13. Marketing the Seller s Business 14. Negotiating Price & Terms with Buyers 15. Structuring of the Transaction 16. Letters of Intent / Term Sheets 17. Responding to Due Diligence of Buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 80

LETTER OF INTENT: Establish a written framework and roadmap to the definitive agreements. Can be used by M&A Intermediary to leverage other offers in an auction environment. Generally identifies major deal terms Generally has binding sections confidentiality and exclusivity 81

11. Research Industry and Identify Buyer Types 12. Preparing the Offering Document 13. Marketing Seller s Business 14. Negotiate Price & Terms with Buyers 15. Structuring of the Transaction 16. LOI s / Term Sheets from Buyers 17. Due Diligence from the buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 82

Maintain Data Room for Buyer Make sure Deal Team has read your offering document (CPA, Attorney, CFO, etc.) before responding to DD. Identify and resolve discrepancies ahead of time. 83

11. Research Industry and Identify Buyer Types 12. Preparing the Offering Document 13. Marketing Seller s Business 14. Negotiating Price & Terms with Buyers 15. Structuring of the Transaction 16. LOI s / Term Sheets from Buyers 17. Due Diligence of Buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 84

Purchase Agreement (Asset or Stock) Disclosure Schedules (Start Early) Non-Compete Agreement Employment Agreement Escrow Agreement Promissory Note (Seller Note) Third-Party Consents (Lease, Contract Assignment, etc.) Seller Corporate Consents Buyer Corporate Consents Landlord consents 85

Employment / Consulting Terms for Sellers Escrows & Holdbacks Seller s Representations & Warranties Buyer s Reps & Warranties Seller s Indemnifications (Limitations: Time, Caps & Baskets) Helpful Hint: Use ABA Deal Survey to resolve attorney disputes 86

11. Research Industry and Identify Buyer Types 12. Preparing the Offering Document 13. Marketing the Seller s Business 14. Negotiating Price & Terms with Buyers 15. Structuring of the Transaction 16. LOI s / Term Sheets from Buyers 17. Respond to Due Diligence of Buyer 18. Definitive Agreements 19. Closing Process 20. Post-Sale Integration 87

PRECLOSING MISTAKES Being impatient and indecisive Telling others at the wrong time Leaving loose ends (Buy-out minority shareholders, settle options, bonuses before closing.) Failing to own-up to undisclosed problems or issues. Failing to run your business up to the last day. Failing to disclose intentions to compete or retain certain assets otherwise considered standard 88

Lender approvals needed Governmental approvals needed Lease and contract consents needed Union approvals needed (sometimes) Minority shareholders not aligned Passive and retired ownership Key employee participation issues Game wardens 89

VI. M&A in a CPA Firm 91

These days.anyone can be an M&A Advisor Main Street Business Brokers The M & A Boutique Local/regional Investment Banks CPA Firms Valuation Experts Industry Consultants Your Rabbi, Priest, or Minister Your Yoga Instructor 92

THEN HAS A LARGE ROLODEX KNOWS INDUSTRY PLAYERS DRIVES VALUE BY LEVERAGING RELATIONSHIPS HELPS BUYERS UNDERSTAND FINANCIAL ENGINEERING REMINDS SELLER WHY THEY ARE SELLING

NOW IDENTIFYS THE STRATEGIC ASPECTS OF THE COMPANY ADVISES THE CLIENT OF THE VARIOUS TRANSACTION OPPORTINUTIES USES TECHNOLOGY AND FOLLOWS PROVEN PROCESSES TO CONDUCT A DEAL COACHES THE SELLER THROUGH THE SENSITIVE PARTS BRIDGES THE VALUE GAPS BETWEEN BUYER AND SELLER

CPAs are uniquely positioned to serve as M&A Advisors to their clients: Get educated on the process Use your technical skills Maintain your client relationships Find a Partnering Broker to help with the unfamiliar parts Help your client with the single largest transaction of their life 95

Thank You Chris Blees BiggsKofford 630 Southpointe Ct., Suite 200 Colorado Springs, CO 80906 719-579-9090 blees@biggskofford.com 96