Unlocking Private Company Wealth - Amazon S3...Unlocking Private Company Wealth: Give Me Liberty...

Unlocking Private Company Wealth: Give Me Liberty (and Plenty of Cash)

Z. Christopher Mercer, FASA, CFA, ABAR Mercer Capital [email protected] | 901.685.2120

2016 Spring Symposia, Real Property and Trust & Estate Law Section of the American Bar Association November 17, 2015

Edward F. “Ed” Koren, JD Holland & Knight [email protected] | 813.227.6655

Edward F. Koren, JD

813.227.6655 [email protected]

www.hklaw.com

Holland & Knight

100 North Tampa Street Suite 4100

Tampa, FL 33602

Edward F. Koren is a partner in Holland & Knight's Tampa and Lakeland offices, and serves as the leader of the firm's Private Wealth Services Group. Mr. Koren's practice is focused on wealth planning and protection for entrepreneurs and multi-generational business owners. He serves clients across the country and practices principally in the firm's Tampa and Lakeland offices.

The firm's Private Wealth Services Group is the largest group of trusts and estates lawyers in the United States, with more Fellows in the American College of Trust & Estate Counsel than any other law firm in the country.

Mr. Koren is past chair of the American Bar Association's Real Property, Probate and Trust Law Section; former American College of Trust and Estate Counsel Regent and past chair of its Estate and Gift Tax Committee; and the author of Estate and Personal Financial Planning, a five-volume treatise published by Thomson West that covers planning concepts for asset accumulation and transfer throughout life and through inheritance.

He is a Florida Board Certified Wills, Trusts and Estates Lawyer and is a National Association of Estate Planners & Councils-Accredited Estate Planner® who has received the highest rating assigned by Martindale-Hubbell.

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Z. Christopher Mercer, FASA, CFA, ABAR

901.685.2120 [email protected]

www.MercerCapital.com www.ChrisMercer.net

www.linkedin/in/zchristophermercer

Mercer Capital

5100 Poplar Avenue Suite 2600

Memphis, TN 38137

Chris Mercer is the founder and CEO of Mercer Capital, a national business valuation and financial advisory firm.

Chris began his business valuation career in the 1970s and has been involved with hundreds of valuations for purposes related to mergers & acquisitions, litigation, and estate and gift tax planning, among others. He has extensive experience in litigation engagements including statutory fair value cases, business damages, and lost profits. He is also an expert in buy-sell agreement disputes.

Designations held include Fellow of the College of Fellows (FASA) from the American Society of Appraisers, Chartered Financial Analyst (CFA) from the CFA Institute, and Accredited in Business Appraisal Review (ABAR) from the Institute of Business Appraisers.

Chris has written widely on business valuation-related topics and is a frequent speaker on business valuation issues for national professional associations, other business and professional groups, and business owners.

Recent books authored by Chris include Unlocking Private Company Wealth (Peabody Publishing, LP 2014), Buy-Sell Agreements for Closely Held and Family Business Owners (Peabody Publishing, LP 2010) and Business Valuation: An Integrated Theory, 2nd Edition, with Travis W. Harms (John Wiley and Sons 2008).

For a complete list of the books authored by Chris, as well as further information on his valuation-related experience, view his complete CV at www.mercercapital.com.

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Business Owner Wealth is Concentrated

Private Company Wealth 70-80%

Diversified 20-30%

Focus on risk, returns Pay for professional

management of wealth

Inadequate focus on risk to owners

Little focus on returns Little concept of

managing illiquid wealth

© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net 4

The Road

10,000 per day

76,000,000 Baby Boomers

Own 2/3 of all businesses

Ownership Transfer Matrix Vertical or Horizontal?

See Figure 3 on page 22 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net 6

Partial Sale/Transfer

Total Sale/Transfer

Voluntary Transfer

• Private Equity/PE

• Sales to Insiders/Relatives

• Gifting Programs

• Sale of Business

• ESOP/Management Buyout

• Buy-Sell Agreements

Involuntary Transfer

• Personal Financial Issues

• Divorce

• Death

• Divorce

• Buy-Sell Agreements

Interim Time

Stat

us Q

uo

Bus

ines

s En

d G

ame

The Rest of Your Life

Interim Time is when we set up our business end games and the rest of our lives

Interim Time

Annual Return (No Realized Appreciation)

See page 75 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net

Need approval to calculate return

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The One Percent Solution

$20 million Illiquid

$5 million Liquid

Paying Fees

Create budget based on private illiquid wealth

value

0.5% $100 thousand 1.0% $200 thousand


One Percent Solution Activities

10 See pages 38-41 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net

Wealth Manager Comp

Annual Appraisals & Monitoring of Performance

Buy-Sell Agreement Pricing

Life Insurance Funding

Estate Planning

Ownership & Management Transition Planning

Financial Planning

Annual Legal Review

Outside Board Members

Corporate Finance for Private Businesses

Three Sections

Section 1 Managing Private Company Wealth

Section 2 Tools for Managing Private Company Wealth

Section 3 Perspectives on Managing Private Company Wealth


Fair Market Value

Fair Market Value according to Revenue Ruling 59-60

The price at which the property would change hands between a willing

buyer and a willing seller when the former is not under any compulsion to

buy and the latter is not under any compulsion to sell, both parties having

reasonable knowledge of relevant facts. Court decisions frequently state in

addition that the hypothetical buyer and seller are assumed to be able, as

well as willing, to trade and to be well informed about the property and

concerning the market for such property


The Levels of Value


Creating Liquidity During the Interim Period

See Figure 9 on page 62 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net

Time

14

Net Cash Flow: The Source of Dividends


Four Uses of NCF 1. Dividends 2. Retire debt 3. Reinvest for future growth

4. Reinvest in stagnant assets

15

Market Value Balance Sheet


Two Tools to Create Liquidity

1. Leveraged Dividend Recapitalization

2. Leveraged Share Repurchases


The Situation Acme Company (the Company) has sales for the most recent year of $250 million and manufactures and distributes a wide range of products for the extraction industries. Some of its products are branded. In spite of its significant size for a private business, the Company is a relatively small player in its overall industry

Acme Company is a C corporation, with an EBITDA margin of just under 10% of sales. For perspective, EBITDA is $24.2 million

Return on equity for the last twelve months was 8.6%, and has been trending downward in recent years

The Company has $16.4 million of interest-bearing debt, which is more than offset by $20.5 million in cash

See pages 98-99 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net 19

The Situation

Working capital as a percentage of sales is about 32% (versus 20% for

similar public companies)

The balance sheet reflects $126 million of equity, or 72% of assets

Equity of the Company is valued at $149 million based on an EBITDA

multiple of 6.0x (the median multiple for the group of comparable public

companies)

The Company is currently paying an annual dividend totaling $3.0 million,

reflects a dividend payout ratio (from net income) of 27.5%

Repurchase of 30% of equity (300,000 shares or $44.8 million)


Transaction Assumptions Key Transaction Assumptions Values Comments

1 Number of Shares to be Purchased 300,000 30% of the outstanding shares

2 % of Cash Considered Excess 100.0% Use all cash on balance sheet

3 EBITDA Multiple for Pricing Transaction 6.0 Assumption

4 Dollars of Current Annual Dividends $3,000,000 Factual

5 Given Number of Shares for Example 100,000 10% block

6 Interest Rate on Pro Forma Cash 1.00% Assumption of CFO

7 Interest Rate on Pro Forma Debt 6.00% Assumption per bank discussions

8 Effective Tax Rate 36.20% Factual

9 EBITDA Multiple for Pro Forma #1 Valuation 6.00 No Change in EBITDA Multiple

10 Price/Earnings Multiple for Pro Forma #2 13.7 Proxy for future benefit of recap

21 © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net

Return Analysis


Benefits to Remaining Owners


Financing of Transaction


Pro Forma Analysis

25

Balance Sheet Ratios Before Pro Forma Comments

Current Ratio 4.4 Lots of liquidity

3.5 Adequately liquid

Acid Test Ratio 2.2 1.3 Reasonable

Working Capital % of Sales 31.6% 23.5% Reasonable

Total Liabilities / Assets 28.3% 47.5% Reasonable

Total Liabilities / Equity 39.9% 91.8% Reasonable

Interest Bearing Debt / Equity 13.0% Low leverage

50.2% Moderate leverage

Interest Bearing Debt / Assets 9.2% 26.0% Reasonable

Assets / Equity 1.4 1.9 Reasonable

Debt / MVTC 11.3% 28.0% Reasonable

© Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net

Income Statement Analysis


Valuation Analysis


Observation

In my experience, most owners of successful closely held and

family businesses simply do not think about using reasonable

leverage as a tool to redistribute stock ownership, provide

liquidity for certain shareholders, provide special dividends, or

engage in other transactions designed to provide liquidity for

their owners and to enhance shareholder returns

They should

See page 96 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net 28

Private Equity Minority Investments on the Upswing

During 2013, about 40% of all PE investments involved less than control transactions

Recent statistics indicate that 15% of companies with enterprise values greater than $500 million are owned by private equity funds

With so much investment capacity in the PE world searching for deals, now may be time to consider taking on a PE partner to provide liquidity for aging owners and/or to obtain growth capital to accelerate growth opportunities

See page 125-126 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net 29

1. Satisfy liquidity/diversification needs while retaining a

significant share in a favorable upside outlook

2. Capital and expertise are required to access available

opportunities

3. Outside assistance needed to take the business to the

next level


Three Reasons to Consider Private Equity

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What Are They Supposed to Do?

Require agreement at a point in time

Relate to transactions that will or may occur at future points in time

Define the conditions that “trigger” the buy-sell provision

Determine the price(s) and terms at which specified future transactions will occur


Types of Buy-Sell Agreements Based on how price is determined

• Cross purchase agreements

• Fixed-price agreements

• Formula agreements

• Valuation process agreements


Multiple Appraiser Buy-Sell Agreements

Issues That Can Destroy the Process “As of” date Standard of value Level of value Appraiser qualifications Funding issues Unspecified use of life insurance

See pages 134-135 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net

NOW

THEN

33

RECOMMENDATION

Single Appraiser Agreement

Select Now, Value Now,

Value Annually

See pages 135-136 in Unlocking Private Company Wealth. © Z. Christopher Mercer, 2016 | www.mercercapital.com | www.ChrisMercer.net

NOW

NOW

NOW

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Life Insurance Associated with Buy-Sell Agreements

Funding Vehicle

The life insurance proceeds are intended to be a funding vehicle to

repurchase the shares of a deceased owner. In this case, life insurance

proceeds are not included in value to determine the price for buy-sell

agreement transactions

Corporate Asset

The life insurance is intended to be a corporate asset. The proceeds are,

therefore, included in value to determine the price for buy-sell agreement

transactions


Example 1a: Life Insurance is Funding Vehicle


Company

Estate Harry

Charles

1 Stock Ownership (Shares) 100 50 50

2 Stock Ownership (%) 100% 50% 50%

3 Pre-Life Insurance Value ($000) $10,000 $5,000 $5,000

4 Life Insurance Coverage 120% 120%

5 Life Insurance $6,000 $6,000

6 Life Insurance Proceeds $6,000

7 Repurchase Liability ($5,000)

8 Post-Life Insurance Value $11,000

9 Repurchase Stock ($) ($5,000) $5,000

10 Retire / Sell Stock (50) (50) 0

11 Remaining Shares 50 0 50

12 New Stock Ownership (%) 100.0% 0.0% 100.0%

13 Post-Life Insurance Value of Company $11,000 $0 $11,000

14 Post-Life Insurance Value $5,000 $11,000

15 Net Change in Value from Repurchase $1,000 $0 $6,000

36

Example 1b: Life Insurance is a Corporate Asset


Company

Estate Harry

Charles

1 Stock Ownership (Shares) 100 50 50

2 Stock Ownership (%) 100% 50% 50%

3 Pre-Life Insurance Value ($000) $10,000 $5,000 $5,000

4 Life Insurance Coverage 120% 120%

5 Life Insurance $6,000 $6,000

6 Life Insurance Proceeds $16,000

7 Repurchase Liability ($8,000)

8 Post-Life Insurance Value $8,000

9 Repurchase Stock ($) ($8,000) $8,000

10 Retire / Sell Stock (50) (50) 0

11 Remaining Shares 50 0 50

12 New Stock Ownership (%) 100.0% 0.0% 100.0%

13 Post-Life Insurance Value of Company $8,000 $0 $8,000

14 Post-Life Insurance Value $8,000 $8,000

15 Net Change in Value from Repurchase $2,000 $3,000 $3,000

37

Transferable Business Value

VTransferable = Identifiable Earnings x M

M = f (expected risk and expected growth)


Bad Things Happen to Good Companies

Bad things happen to even good companies, possibly even

yours

If you wait until it is too late to diversify, it will be too late

If you wait until it is too late to refinance, it will be too late


If you wait until it is too late, it is too late

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Key customer loss

Key supplier loss

Key owner/manager loss

Key product is outdated

Key employee loss

Key patent is expiring

Work on them before it is too late

Key location is deteriorating

Key technology reaching obsolescence

Key service line affected by regulation

Key service line affected by competition

And more


Concentrations Can Be Risky and Value Destroying

Is Your Business READY for Sale?

If you don’t sell your business today, you are a buyer of your business

R Risk E Earnings A Activities, Attitudes D Driving Growth Y Year-to-Year Comparisons


READY? So, is your business READY for sale?

Remember we are not talking about your business being up for sale, just READY.

From the viewpoint of managing the wealth in your private company, the concept of READY for sale may be the most important perspective of all


25 Questions for Business Owners

1. How much is your closely held or family business worth?

2. How do you know what your business is worth? Has it been independently valued in the last three years?

3. What portion of your personal net worth is represented by your business ownership interest?

4. What has been your shareholders’ rate of return on their investment over the last one, two, three, four, five years or more?

5. How does this rate of return performance compare with alternative investments, e.g., in the public securities market?


Interim Time

Stat

us Q

uo

Bus

ines

s En

d G

ame

The Rest of Your Life

Interim Time is when we set up our business end games and the rest of our lives

Interim Time

The Road

Unlocking Private Company Wealth

ChrisMercer.net/books

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• Buy-Sell Agreements for Closely Held and Family Business Owners

• The Buy-Sell Agreement Review Checklist

• Checklist for Shareholder Promissory Notes

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