M&A Adding Value Through Pre-Sale Planning
Value Drivers That Drive Premium Valuation
3 Value Drivers That Drive Premium Valuation U.S. M&A Activity 2017
4 Value Drivers That Drive Premium Valuation Median U.S. EV/EBITDA Multiples
Value Drivers That Drive Premium Valuation US PE Middle Market Deal Activity $350 2,242 2,245 2,335 75 2,231 2500 $300 1,875 1,913 2000 $250 1,722 $200 1,464 1,313 1,328 1,515 1500 $150 1000 $100 731 $50 500 $0 $225 $272 $164 $75 $183 $202 $237 $231 $326 $307 $284 $312 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017* 0 Deal Value ($B) Estimated Deal Value ($B) # of Deals Closed Estimated # of Deals Closed 5
Value Drivers That Drive Premium Valuation US PE M&A Middle Market transaction multiples 12.0x Debt/EBITDA Equity/EBITDA Valuation/EBITDA 10.0x 8.0x 6.0x 9.7x 3.7x 8.7x 8.8x 3.4x 4.1x 7.0x 8.1x 3.6x 9.2x 4.2x 8.6x 4.3x 9.4x 9.4x 3.9x 3.5x 4.3x 9.9x 4.5x 10.4x 10.4x 5.2x 4.8x 4.0x 2.0x 6.1x 5.3x 4.7x 3.5x 4.4x 5.0x 4.3x 5.5x 5.1x 5.4x 5.2x 5.6x 0.0x 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017* 6
7 Value Drivers That Drive Premium Valuation US PE MM deal flow ($B) by sector and year
Value Drivers That Drive Premium Valuation 7 Value Drivers for Which Buyers will Pay Premium Prices Product Differentiation Specific Taste, Distinctive appearance, recognizable brand Helps to differentiate one products from another and one company from its competitors 8
Value Drivers That Drive Premium Valuation 7 Value Drivers for Which Buyers will Pay Premium Prices Defensible Position Service or Products that can t be easily replicated Access to raw materials or favorable geographic location Economic Castles protected by unbreachable moats 9
Value Drivers That Drive Premium Valuation 7 Value Drivers for Which Buyers will Pay Premium Prices Dominant Market Share Command a position so strong that it has few or ineffective competitors. High switching cost for the customer Network Effect 10
Value Drivers That Drive Premium Valuation 7 Value Drivers for Which Buyers will Pay Premium Prices Technology Proprietary Technology always has value Can also include secretive process, trade secret, etc 11
Value Drivers That Drive Premium Valuation 7 Value Drivers for Which Buyers will Pay Premium Prices Cost Advantage Advantage of low cost producer is obvious Even small companies can have a cost advantage 12
Value Drivers That Drive Premium Valuation 7 Value Drivers for Which Buyers will Pay Premium Prices Recurring Revenue Second most important determination of premium multiples De-risks the business and makes it more transferable 13
Value Drivers That Drive Premium Valuation 7 Value Drivers for Which Buyers will Pay Premium Prices Growth The single most important factor in driving a premium valuation 14
Business and Wealth Transition Strategies
Wealth Transfer Strategies Tax Efficient Transfer Techniques Tactics for Preserving Family Wealth Outright gifts Gifts into irrevocable trusts Leveraged gifts/sales of business interests Family Limited Partnerships (FLP) Irrevocable Trust (IDGT) funded with installment note Combine FLP and IDGT 16 The above represent a small sample of many possible wealth transfer techniques. Business owners are advised to consult experienced tax and legal professionals to determine the best structure for their situation.
Wealth Transfer Strategies Gifts into Irrevocable Trusts Example Contribute $5 million of company stock to trust No gift tax use lifetime exemption When company stock is sold, trustee diversifies investments in trust Annual growth within trust: 6%* Years Future Value of Transfer to Heirs 10 $9 million 20 $16 million 30 $29 million 17 *6% pre-tax growth rate is based on historical rates; used for illustrative purposes only.
Wealth Transfer Strategy Irrevocable (Dynasty) Trust Asset Flow of Generation Skipping Trust Donor 1. Company stock funds trust Trust 3. Income/ principal Beneficiary 2. Company stock sold; trustee invests cash 2 nd Generation Beneficiary Additional Generations 18
Wealth Transfer Strategies Gifts into Irrevocable Trusts Caveats Generally irrevocable changes are limited Lack of control by business owner after completed gift Discounts best if planning done well in advance 19
Wealth Transfer Strategies Leveraged Gifting Typical Structures Outright gift of discounted interest Family limited partnership (FLP) / limited liability company (LLC) Grantor retained annuity trust (GRAT) Irrevocable trust with promissory note (IDGT + note) 20
Wealth Transfer Strategies Leveraged Gifting Family Limited Partnership (FLP) Shares of X Corp Business Owner 99% LP/ 1% GP FLP Gift LP interests to family members Example Contribute $5 million of company stock Gift discounted at 30% due to lack or marketability/minority interest Gift tax on only $3.5 million Annual growth: 6%* Amount to heirs in 10 years is $9 million (undiscounted) Savings of $2.2 million** 21 *6% pre-tax growth rate is based on historical rates; used for illustrative purposes only. **Assumes exemption has already been used. Estate tax rate of 40%.
Wealth Transfer Strategies Leveraged Gifting FLP / LLC Caveats Greater IRS scrutiny than outright/non-discounted gift Must have a strong, defensible valuation Should be business purpose for FLP More complicated structure 22
Wealth Transfer Strategies Intentionally Defective Grantor Trust Interest and balloon payment Bus. Owner/ Seller Business Interest Note (90%) IDGT Beneficiary(s) Gift of seed money (10%) Example Business owner transfers 30% of FLP interest to IDGT. FLP owns $15 million business. $450,000 (10%) is gifted while $4.05 million (90%) is sold in exchange for a note. A 35% discount is assumed for lack of marketability and lack of control. Note has a 9-year term, 2.00% interest only with balloon 1 The business is sold in year 5 and takes on the same growth and income assumptions as outlined in the 5-Year planning scenario. 2 23 1. The 2.00% interest rate is consistent with the IRS mid-year applicable federal rate (AFR) for November of 2017. 2. See endnotes for more details on model assumptions.
Wealth Transfer Strategies Intentionally Defective Grantor Trust Interest and balloon payment Bus. Owner/ Seller Business Interest Note (90%) IDGT Beneficiary(s) Gift of seed money (10%) Year Beginning Balance + Growth on Investments + Income on Investments - Promissory Note (i/o) = Ending Balance 1 $4,500,000 $1,117,500 $300,000 ($52,650) $5,864,850 2 $5,864,850 $1,261,794 $327,184 ($52,650) $7,401,178 3 $7,401,178 $1,420,911 $356,764 ($52,650) $9,126,204 4 $9,126,204 $1,596,216 $388,942 ($52,650) $11,058,712 5 $11,058,712 $1,789,191 $423,932 ($52,650) $13,219,186 6 $13,219,186 $528,767 $330,480 ($52,650) $14,025,783 7 $14,025,783 $561,031 $350,645 ($52,650) $14,884,809 8 $14,884,809 $595,392 $372,120 ($52,650) $15,799,671 9 $15,799,671 $631,987 $394,992 ($2,685,150) $14,141,500 Assets Remaining After Repayment of Note: $14,141,500 24
Wealth Transfer Strategies Sale of Business Interests to Trust Advantages Freezes value of asset in business owner s estate Business Owner may pay income tax on trust income (further reduces estate) Combine with FLP interest for extra discounting benefit Caveats Greater IRS scrutiny than outright/non-discounted gift Relatively complicated structures and rules Difficult to unwind 25
Planning Paralysis Your Plan as Presented To You ADVANTAGES & TAX SAVINGS GRANTOR RETAINED ANNUITY TRUST FAMILY LIMITED PARTNERSHIP COMPREHENSIVE PLAN WILL, TRUST & POWER OF ATTORNEY BRILLIANCE OF ADVICE 26
Planning Paralysis Your Plan as Perceived By You HOW MUCH HASSLE & AGGRAVATION? GRANTOR RETAINED ANNUITY TRUST FAMILY LIMITED PARTNERSHIP COMPREHENSIVE PLAN WILL, TRUST & POWER OF ATTORNEY 27 WHAT IS THIS GOING TO COST ME?
Planning Assumptions and Benefits Income and Estate Tax Planning No Planning 1-Year Plan 3-Year Plan 5-Year Plan Valuation Improve Cashflow 5 years at 5% 1 year @ 7% 3 years @ 7% 5 years @ 7% Derisk Business 3.0 x multiple 3.5 x multiple 4.5 x multiple 5.5 x multiple Transfer to FLP - 25% discount 30% discount 35% discount Sell Interest to IDGT - Gift / Sell 15% at $15.7 MM val. Gift / Sell 25% at $11.9 MM val. Gift / Sell 30% at $9.0 MM val. More Ideas Charitable Giving - Life Insurance in Trust - --- --- --- Consider --- --- --- --- --- --- Consider --- --- --- 28
Planning Assumptions and Benefits Sale to Intentionally Defective Grantor Trust $3.4 $2.7 $7.6 $4.1 $11.6 Growth Outside Estate $4.5 29 1-Year Plan 3-Year Plan 5-Year Plan Though much later starting, the 1-year plan can still use this technique to remove 15% of the business from the taxable estate when the taxable gift is valued at $205,117 Start slightly later: the 3-year plan removes 25% of the business from the taxable estate when the taxable gift is valued at $289,406 Starting early: the 5-year plan removes 30% of the business from the taxable estate when the taxable gift is valued at $292,500
Growth of Wealth Over Time Value of Total Wealth Over Time Millions $100 $90 $80 $70 Value of Total Wealth $60 $50 $40 5 Year 3 Year 1 Year NO PLANNING MODEL $30 $20 $10 30 $0-5 0 5 10 15 20 25 Projection Year (Sale = Year 0)
Growth of Wealth over Time Post-Sale Planning and Estate Planning $ @ Sale $ @ Death $ after Estate Tax 5-Year Plan $39 million $89 million $79 million 3-Year Plan $30 million $64 million $55 million 1-Year Plan $23 million $34 million $29 million No Plan $19 million $12 million $12 million 31