Unlocking Private Company Wealth

Unlocking Private Company WealthZ. Christopher Mercer, ASA, CFA, ABARMercer [email protected] | 901.685.2120

Exit Planning, Transaction Advisory Services, and Healthcare Valuation ConferenceNovember 17, 2015

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Baby Boomers Statistics

© Z. Christopher Mercer, 2015 | www.mercercapital.com | www.ChrisMercer.net

There are 76 million baby boomers in the US or approximately

25% of the U.S. population

(2012 US Census data)

66% of all businesses with employees, or

nearly 4 million companies, are owned

by baby boomers(Axial)

Baby boomers started turning 65 in 2011 at a rate of 10,000 a day — a trend that will last for

the next 19 years(Pew Research Center)

The Road

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Ownership Transfer Matrix Vertical or Horizontal?

See Figure 3 on page 22 in Unlocking Private Company Wealth.© Z. Christopher Mercer, 2015 | www.mercercapital.com | www.ChrisMercer.net

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

Busi

ness

End

Gam

e

The Rest of Your Life

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

Interim Time

Keep your eye on the ball

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Managing Private Company Wealth


Investment treatment

Focus on returns and risk

Diversification

Asset Allocation

Management fees

Common Themes of Liquid Wealth Management

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What is the Return on a Portfolio?

See page 29-30 in Unlocking Private Company Wealth.© Z. Christopher Mercer, 2015 | www.mercercapital.com | www.ChrisMercer.net

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Mr. Jones’ $5 Million Portfolio

11.8% Return


Management Fee: $40,000 (80bps)

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Mr. Jones’ $25 Million Portfolio


7.0% Return for Jones Mfg.Management Fee: $0 (0bps)


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Total Portfolio Return

See page 31 in Unlocking Private Company Wealth.© Z. Christopher Mercer, 2015 | www.mercercapital.com | www.ChrisMercer.net

Weighted Return on Jones Mfg + Weighted Return on Liquid Portfolio

(80% x 7% Return) + (20% x 11.8% Return)

= 8.0% Total Portfolio Return

Good? Bad? What to do?

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Idea #1 Rates of Return

Talk to business owners in terms of managing the wealth in their businesses and in terms of achieving reasonable rates of

return on their investments


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An annual budget for managing illiquid private company wealth (defined as an ownership interest in a

company)

Analogous to fees paid to manage liquid wealth (stocks, bonds or other

liquid assets)

It costs money to manage wealth, whether liquid or illiquid


The

Solution

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New themes for Private Wealth Management

Investment treatment

Focus returns and risk

Diversification

Allocation

Management fees (compensation)


The

Solution

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One Percent Solution Activities

See pages 38-41 in Unlocking Private Company Wealth.© Z. Christopher Mercer, 2015 | 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

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The One Percent Solution for Mr. Jones


7.0% Return for Jones Mfg.



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Managing Private Company Wealth

≠Managing Private Companies

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Idea #2The One Percent Solution

Relate the costs of managing private company wealth in terms of the management cost as a percentage of

business value


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Fair Market Value - Hypothetical

Willing Buyers

All Informed

Arm’s Length

Willing Sellers

No Compulsion

Financially Capable

PriceCash

Equivalent Transaction


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Basic Valuation Equations


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The Levels of Value


Interim Time

Stat

us Q

uo

Busi

ness

End

Gam

e

The Rest of Your Life

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

Interim Time

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Tools for Managing Private Company Wealth


Total Revenue minus

Total Cost

Earnings – The Beginning Point for Dividends

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Annual Return (No Realized Appreciation)


Need approval to calculate return

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Net Cash Flow: The Source of Dividends


Four Uses of NCF1. Dividends2. Retire debt3. Reinvest for future growth

4. Reinvest in stagnant assets

Owners don’t think in these terms but all companies have NCF

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Idea #3 Calculate Rates of Return

For recurring clients, calculate the rates of return on their

investment from year to year and compare the results with other, alternative investments


Every company has

a dividend policy

Every company has a dividend policy

Dividend policy is a starting point for portfolio diversification

Special dividends enhance personal liquidity and diversification

Dividend policy matters

Boards of directors need to establish thoughtful dividend policies

Dividends and Dividend Policy for Private Cos

Never pay a dividend One time dividend Special dividend

Constant dollar dividend

Set a dividend payout ratio target

Dividend yield target

Residual dividend policy

Spin-out for spin-off of subsidiaries or

other assets

Leveraged dividend

recapitalization

10 Types of Dividend Policies

Distributions for tax pass-through liabilities

Dividend Policy Influences Return

on Business Investment

Theory – Neutral

Reality – If you run the company well, pay dividends, and maintain normal capital

structure, you may well beat the theoretical

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Leveraged Recapitalizations


Two types of transactions look similar to company

Share Repurchases

Leveraged Dividends

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Look similar to company

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37



Which is best? You decide

Many owners of successful private businesses abhor the use of even prudent

leverage. Others don’t think about it.

They should.

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Idea #4 Basic

Corporate Finance Tools

The “tools” we are discussing are basic corporate finance

tools. Add them to your vocabulary and discuss them

when appropriate with business owners


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Perspectives for Managing Private Company Wealth


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• Value that others are willing to pay for

• Not value to you as an owner

• Related to concept of Identifiable Earnings

• READY

• Visible

• Believable

• Capitalizable

• Projectable

Transferable Business Value

IdentifiableEarnings

7 Ways the Next Investors Will Look at Your Business

Relative to itself over time

Relative to peer groups

Relative to budget or plan

Relative to your unique potential

Relative to strategic or synergistic

opportunities your platform offers

At a point in time

Relative to regulatory expectations or requirements

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Look now at a business like future

investors will look at it


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Idea #5 Future

Investor Analysis

Have a qualified appraisal firm with transactional experience conduct a

valuation analysis of your business that is geared to address the seven perspectives

of future investors in more depth than might be employed in a typical appraisal

That analysis could highlight opportunities to reduce risk, and to enhance expected cash

flow and growth


Bad Things Happen to Good Companies

If you wait until it’s too late, it’s too lateYes, but ...

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Management Transitions

Inevitable

Part of the private company wealth management process

Successful management transitions increase attractiveness to potential future investors


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Ownership Transitions

1. A primary owner dies unexpectedly

2. A key employee leaves

3. The owner gets tired and decides to sell

4. Business reversals happen

5. The primary owner divorces

6. The second (or third or fourth) generation is not up to the task

7. Life changing experiences occur

8. Unexpected offers come along

9. Buy-sell agreement operation

10. Gift and estate tax planning

11. Normal lifetime planning dictates timing

Remember the

Ownership

Transfer Matrix?


Management and ownership transition will occur

Focus now, during interim time, to assure successful transitions

The good things that need to happen will occur (or not) between your current status quo and any ultimate sale or disposition of your business

So, prepare for the unexpected

Observations on Transitions

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Idea #6 Focus on Inevitable

Transitions

During any business valuation process (or any other significant

discussion), ask questions about plans for management and/or ownership transition


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Is Your Business READY for Sale?

If you don’t sell your business today,

you are a buyer of your business


R RiskE EarningsA Activities, AttitudesD Driving GrowthY Year-to-Year Comparisons

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25 Questions for Business Owners

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

2. Is your wealth adequately diversified to avoid the risk of major losses from adverse events with any of your assets, including your business?

3. What is the plan to obtain liquidity from your ownership of your business?

4. Is your business “ready for sale” whether or not you have any interest in selling today?


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Ideas Review

1. Talk to business owners in terms of managing the wealth

and achieving reasonable rates of return

2. Discuss the One Percent Solution to put costs of managing

private wealth in perspective

3. When information is available, calculate your clients’ rates of

return (and discuss)

4. Discuss the tools for managing wealth with your clients


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Ideas Review (cont.)

5. Recommend in depth review of businesses the way next investors will see them

6. Ask questions about plans for ownership and management transition


The Road

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Questions?

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Unlocking Private Company Wealth

ChrisMercer.net/books

Purchase Unlocking Private Company Wealth

When ordering from website, receive a PDF of complimentary resources

• 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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Z. Christopher Mercer, ASA, CFA, ABAR

[email protected]

www.MercerCapital.comwww.ChrisMercer.netlinkedin/in/zchristophermercer

Mercer Capital5100 Poplar Ave., Suite 2600Memphis, 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 Accredited Senior Appraiser (ASA) 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.


Unlocking Private Company Wealth

Economy & Finance

Transcript of Unlocking Private Company Wealth