exit and succession planning : HOW ORGANIZATIONS ARE PREPARING
Business Exits: Considerations for a Successful Outcome
The Importance of Valuation in Exit Planning
Key Findings from a Global Survey on Succession Planning
Significant Tax Savings Opportunities with the Tangible Property Regulations
TABLE OF CONTENTS
horizons A publication by RubinBrown LLP FALL 2014
1 2 5 6 8
Welcome from the Managing Partner
Chairman James G. Castellano, CPA, CGMA
Remembering Mahlon Rubin
Managing Partner John F. Herber, Jr., CPA, CGMA
Business Exits: Considerations for a Successful Outcome
Denver Managing Partners Michael T. Lewis, CFA Gregory P. Osborn, CPA Kansas City Managing Partner Todd R. Pleimann, CPA
20 24 14 27 68
The Importance of Valuation in Exit Planning
Key Findings from a Global Survey on Succession Planning
Significant Tax Savings Opportunities with the Tangible Property Regulations
Editor Dawn M. Martin
Upcoming RubinBrown Seminars
Art Director Jen Chapman
Horizons , a publication of RubinBrown LLP, is designed to provide general information regarding the subject matters covered. Although prepared by professionals, its contents should not be construed as the rendering of advice regarding specific situations. If accounting, legal or other expert assistance is needed, consult with your professional business advisor. Please call RubinBrown with any questions (contact information is located on the back cover).
life sciences & technology Intellectual Property and Exits: Tips to Maximize and Protect Value
manufacturing & distribution
healthcare Succession Planning for Medical Practices and Physicians
Transitioning Your Business and Knowledge
transportation & dealerships
colleges & universities The Next Generation of Business Officers
Transitioning Your Auto Dealership or Transportation Company
Strategic Buyers and Financial Buyers: One Size Does Not Fit All
Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.
public sector An Aging Public Sector Workforce
real estate Tax Credit Recapture In the Face of Natural Disaster and Casualty Losses
construction Valuation Strategies for Construction Companies
Readers should not act upon information presented without individual professional consultation.
gaming A Post-Acquisition Integration Checklist for Gaming Operators
law firms Proactive Succession Planning for Your Law Firm
not - for - profit Fiduciary Responsibilities of Not-for-Profit Investment Committees
WELCOME FROM THE MANAGING PARTNER
Remembering Mahlon Rubin
It is with sorrow that we remember one of our firm’s founders, Mahlon Rubin.
Mahlon died on September 4, 2014. Please see our story about Mahlon on page 6.
We have received a remarkable number of cards, notes, and other condolences since Mahlon’s passing. It’s abundantly clear that Mahlon not only had a tremendous impact on our firm, but also on the St. Louis community in general and the accounting profession as a whole. Mahlon’s spirited focus on client service, excellence, and managing an effective accounting practice became well known throughout the business community. He shared his business acumen often, whether it be to us internally or to others in the profession and the business community. Mahlon continued to come into our office every day. We all enjoyed his stories about the “old days” and daily visits as he walked our halls and taught us the importance of relationships and integrity. He and co-founder Harvey Brown regularly presented to our interns and new hires about the history of the firm and evolution of our profession. This issue of Horizons is focused on succession planning—a fitting theme as we remember Mahlon and his lessons of managing an accounting practice. The baton may have been passed to the next generation at RubinBrown more than 20 years ago…but we are all living the core values and guiding principles that he and Harvey Brown created for us. We will always remember Mahlon for his tremendous career, his legacy as a family and business man, and, most of all, for the insightful life lessons he taught us all.
John F. Herber Jr., CPA, CGMA Managing Partner
www.RubinBrown.com | page 1
RubinBrown Opens Office in St. Louis Cortex Business District
“We work to help emerging businesses establish successful financial platforms, processes and strategies that will get them to the next level,” said Jason Mannello, CFA, vice chair of RubinBrown’s Life Sciences & Technology Services Group. “Then, down the road, we will be there to assist them with mergers and acquisitions, networking, valuations, and other consulting services as they continue to grow their businesses.” Founded in 1999, CIC is home to more than 600 companies, most of them startups. Since 1999, more than 1,400 companies have chosen CIC as their home. More than $1.8B of venture capital has been invested in companies that were headquartered at CIC. CIC@4240 represents its first expansion outside of Cambridge, Massachusetts.
RubinBrown will open an office suite in St. Louis’ new Cambridge Innovation Center (CIC@4240). Located in the CORTEX innovation district, CIC initially is home to 21 startup,
emerging and industry leading companies.
“This move is a joint initiative of our Life Sciences & Technology and Entrepreneurial Services groups,” said Steven Harris, CPA, partner-in-charge of RubinBrown’s Entrepreneurial Services Group. “We wanted to put valuable resources in the middle of this innovation center as we assist emerging companies build their businesses.”
For more information, visit: http://stl.cic.us .
RubinBrown Sponsors St. Louis Regional Chamber Arcus Awards
RubinBrown will serve as presenting sponsor for the second annual Arcus Awards on November 25, 2014. The Arcus Awards is presented to one company in each of four economic clusters that has demonstrated an exceptional commitment to advancing the St. Louis region’s global strength.
RubinBrown Manager Named St. Louis Business Journal 30 Under 30
Hannah Castellano, CPA, a manager in RubinBrown’s Assurance Services Group was named one of the St. Louis Business Journal’s 30 Under 30. Castellano serves clients in a variety of industries, including gaming, life sciences, colleges and universities, manufacturing and distribution, and not-for-profit.
RubinBrown Manager Selected to AICPA Leadership Academy
Chris Tkach, CPA, manager in RubinBrown’s Assurance Services Group, has been selected as one of 38 young CPAs to participate in the American Institute of CPA’s 6th Annual Leadership Academy. Tkach joins an exclusive group of rising stars in the accounting profession to learn strategic planning techniques and develop personal success skills for handling complex management challenges.
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RubinBrown Talent Promotions Partners Kristin Bettorf is a
Jeff Sackman serves as a partner in RubinBrown’s Assurance Services Group and is vice chair of the Private Equity Services Group. He conducts audit and other assurance-related services for
partner in RubinBrown’s Tax Services Group where she provides tax consulting services. Bettorf specializes in corporate tax, providing tax planning, preparation
companies primarily owned by private equity and family office groups, and has experience providing transaction due diligence services.
and reporting services to clients primarily in the manufacturing and distribution industries.
David Collet is a partner in RubinBrown’s Assurance Services and Manufacturing and Distribution Services Groups. He has vast experience in performing large
With 15 years’ experience working in the financial services industry, Tom Tesar is a partner in RubinBrown Advisors, where he provides investment advisory services and financial planning to high net worth clients. With more than a decade of experience, Ken Van Bree serves as partner in RubinBrown’s Entrepreneurial
multinational audits, audits of internal control over financial reporting, income taxes and revenue recognition.
A partner in RubinBrown’s Assurance Services Group, Matt Finke is also partner- in-charge of the recently formed Law Firms Services Group. Finke provides audit and accounting services
Services Group and vice chair of the Construction Services Group. He specializes in financial and operational audits and provides general business advisory services, including tax planning.
for professional services firms, construction contractors, and colleges and universities.
Robert Cascio works with clients in industries including not-for- profit and the public sector. Cascio specializes in employee
Tim Anderson works in RubinBrown’s Tax and Real Estate Services Groups, providing tax consulting and compliance services to clients. Dan Besmer serves clients in the manufacturing and distribution industries. He provides audit, internal accounting controls, business performance analysis and SEC reporting.
benefits, risk-based audit planning and plan audits.
Ted Clifton serves tax and wealth management clients, specializing in retirement and estate planning, as well as high net worth individual taxation.
www.RubinBrown.com | page 3
RubinBrown Talent Promotions Managers (continued) Susie Dartt serves clients in the public sector and not-for- profit industries and also has experience in payroll, benefit plans, and sales and income tax preparation. Chris Daues works with clients in various industries including construction, manufacturing and distribution, not-for-profit, and public sector. Matt Hartman serves clients through RubinBrown Advisors, an investment advisory firm, providing comprehensive financial planning and investment management services to clients. Dan Healey provides audit, internal accounting controls and business performance analysis services to clients in the manufacturing and distribution, construction and not-for-profit industries. Chris Janis serves in RubinBrown’s Tax Services Group, focusing on clients in the manufacturing and distribution and not-for-profit industries. Donna Krier provides services to clients in the construction and manufacturing and distribution industries.
Grazyna Lewkowicz provides tax compliance and consulting services for real estate, manufacturing and distribution, and professional services industry clients. Ryan Meesey provides clients with business valuation services as well as litigation support, financial modeling, and mergers and acquisitions consulting services. Patrick Miller primarily serves clients in the colleges and universities, construction, and manufacturing and distribution industries. Casey Pohl provides clients in the manufacturing and distribution industry with plan auditing, internal accounting controls, and risk-based audit planning. Chris Tkach serves clients in a variety of industries, including manufacturing and distribution, real estate, and not-for-profit, specializing in SEC reporting and Sarbanes-Oxley compliance testing and reporting. John Zaegel works with clients in a variety of industries including professional services, public sector, real estate, manufacturing and distribution, and construction. Jessica Mueller serves clients in the not-for-profit, public sector and financial institution sectors.
Justin Lee is a member of RubinBrown’s Entrepreneurial Services Group and serves clients in the manufacturing, not-for-profit, real estate, and transportation industries.
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The RubinBrown Succession Story by Jim Castellano, CPA, CGMA
S eptember 4th was a sad day for the RubinBrown family...the day we lost one of our founders, a mentor and friend, Mahlon Rubin. While the theme of succession planning for this issue of Horizons was set months in advance, it seems ever more appropriate now in light of Mahlon’s passing. RubinBrown has grown over the years to become a highly respected, nationally prominent professional services firm, and that, of course, makes me very proud. However, the accomplishments that bring me the most pride are the successful transition of our firm to a third generation of leadership, and the solid plans we have to take it to the fourth generation. Realizing this is a unique accomplishment since so many professional services firms end with the retirement of their founders, I thought our readers might enjoy hearing our story of succession and perhaps inherit a few ideas from the lessons we have learned. Succession begins with a stewardship culture . Our culture of stewardship began with our founders who created a great foundation for us to build upon. As stewards of our firm, we believe in our obligation to leave the firm in a better position for the next generation. Vision is one of our core values at RubinBrown. Read about our core values on our website where we commit to “…invest significant resources in things that will provide benefit to our clients, our team members and ultimately our firm in the future.” Describing our desired future, then building plans to take us from here to there, has long been a powerful planning exercise for us. The clearest vision, however, cannot be achieved without outstanding talent. Our talent planning process is rigorous and disciplined, resulting in a deep and
extraordinarily talented team, quite capable of carrying our firm well into our fourth generation of leadership. Having clear and fair financial arrangements to enable the transition of ownership from one generation to the next is a key factor for succession results. It is a core competency of ours to develop such financial arrangements with clients,
Jim Castellano, CPA, CGMA Chairman
so it’s not surprising that we have long ago created plans for ourselves that have stood the test of time. Finally, a process of orderly transition must be implemented. Culture, vision, talent planning and clear financial arrangements alone will not do the job. Success is achieved in the implementation of the process. Succession planning is not an event, but rather a process requiring ongoing focus and commitment. Ours includes continuous attention to the orderly transition of client relationships, technical capabilities, management responsibilities and community relationships. Starting well in advance of any partner’s retirement has contributed significantly to the sustainability of our firm. If succession planning is on your mind and you would like further guidance or assistance, I invite you to contact your RubinBrown engagement partner who will bring the proper talent and resources to help you through the process.
Thanks for your confidence in us.
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RubinBrown Founder Mahlon Rubin Passes Away
It is with deep sadness that RubinBrown reports the passing of one of our firm’s founders, Mahlon Rubin. Mahlon died on Thursday, September 4, 2014. He was 89 years old. According to Managing Partner, John Herber, CPA, even after retirement, Mahlon remained very engaged in the firm as retired partner of counsel and came into the office every day as he had for the past 62 years. When Mahlon, along with Harvey Brown and Sidney Gornstein formed Rubin, Brown, Gornstein & Co. in St. Louis in 1952, they only dreamed that their firm would evolve into a national leader in the accounting and business consulting profession. Mahlon was steadfast in his dedication to superior client service. It was his passion for totally satisfied clients that built the foundation of RubinBrown and the core values that the firm’s team members live by every day. To honor Mahlon’s leadership and unwavering commitment to client service, RubinBrown created an annual award named after Mahlon several years ago. The Mahlon Rubin Award is given every year to a RubinBrown team member who demonstrates extraordinary client service. In 1996, Mahlon received the gold medal for Distinguished Service from the American Institute of Certified Public Accountants. In 1990, he was awarded Outstanding Businessperson of the Year by the city of Clayton and Outstanding Businessperson of the Year by St. Louis County. Washington University bestowed him with a Distinguished Alumnus Award and St. Louis University with a Distinguished Accounting Award. He also was named the Best Tax Practitioner by Money Magazine and Accounting Advocate of the Year, State of Missouri, by the Small Business Administration.
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He remained active in the profession, serving as a member of the Missouri and New York Societies of Certified Public Accountants and the AICPA. He was a former member of the board of directors and governing council for the AICPA, and a former member of the editorial board of the Journal of Accountancy . He was past president of the St. Louis Chapter of the MSCPA and former chairman of the Mid-America Tax Conference. Mahlon was very active in charitable and community work, serving as a member of the board of directors, Barnes-Jewish Hospital Foundation and as Honorary President, member of the board of directors and past president of the Jewish Center for Aged. He was a former member, board of directors, treasurer and member of the executive committee for Jewish Hospital of St. Louis and served on the board of directors and treasurer of the Jewish Federation of St. Louis. He also was a member of the Washington University Alumni Association Executive Committee; and served on the Accounting Advisory Board for Southern Illinois- Edwardsville University. He was a member of Temple Israel’s board of directors and the Library Board for University City. In 1991, he received the Guardian of the Menorah award from the B’nai Brith Foundation of the USA. Mahlon was also a former Commander of Jewish War Veterans for the State of Missouri. “Mahlon set high values for all of us,” said Herber. “He was steadfast in his dedication to superior client service. It was his passion for totally satisfied clients that built the foundation of our firm and the core values we live by every day. There’s no doubt that we wouldn’t be the firm we are today without him. He will be missed greatly.”
Mahlon Rubin Tribute Fund If you would like to make a tribute in memory of Mahlon, the RubinBrown Charitable Foundation established the Mahlon Rubin Tribute Fund in his honor. Donations can be made at www.RubinBrown.com/Mahlon-Tribute.
Mahlon is survived by his wife Maurine, his sons Larry, Rich and Ken and many other loving family members.
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Business Exits: Considerations for a Successful Outcome by Kyle Murphy, CFA, CPA
For a middle-market business, especially one in the first generation of family ownership, the owner’s exit is often the last item on a lengthy priority list.
And it often remains untouched until advancing age, a health issue, or another inopportune event forces the issue.
This can be a recipe for value destruction. Just as a prudent business executive would not ignore the phone calls of its largest customer, a business owner, who likely has the bulk of his or her net worth tied up in said business, should not put off the necessary planning for his or her eventual exit. Successful exits take discipline, focus, effort, and—perhaps, most of all—time. But all of the dutiful preparation is worth the investment, as being prepared to sell your business when you don’t have to, can put you in a powerful position to dictate the timing and terms of your exit.
Therefore, business owners should begin planning for their exits years ahead of time and, if you have not already begun so, perhaps today is the time to start thinking about your exit strategy.
Build a Capable Management Team (That Can Run the Business Without You) A saleable business is one that can operate independent of its founder/owner, whether now or after a transition period post-exit. Many first generation businesses are highly intertwined with their founders, who maintain the bulk of customer relationships and who can operate the business successfully without many of the checks and balances present in businesses which have changed hands.
These situations often present challenges to prospective buyers. After all, a prospective buyer is not looking to acquire a business in which one person is the key cog keeping it all together.
In the years ahead of a potential exit, it is advisable to entrust employees with increasing responsibilities, such that over time you build a team of trusted employees that can make critical business decisions without you. This does not mean that an owner shouldn’t be involved in the business by the time he or she is ready to sell; rather, it means that he or she has created a business that can succeed on its own merits. Optimize Your Tax Positioning Often, the terms of a sale agreement will dictate how an exit will be taxed. While there is plenty of room for negotiating these finer points, it is advisable to first put the business in an optimal structure for an eventual exit. The legal structure of a business can significantly impact the taxation of a proposed sale transaction. If the business is organized as a C Corporation, the owner may prefer to sell stock in the corporation in lieu of the underlying assets. This is because a sale of C Corporation assets will produce two levels of tax—one level of tax at the C Corporation on the sale of the assets, and another level of tax at the shareholder level when the sale proceeds are distributed.
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can be particularly advantageous if the company’s value is expected to appreciate. Sophisticated strategies using trusts and family limited partnerships can help to maximize the estate tax benefits derived from these types of transfers.
In contrast, a sale of C Corporation stock will only be taxed once at the shareholder level. It is important to note, however, that buyers often prefer asset acquisitions to purchases of stock because it subjects them to less risk after the transaction from pre-existing liabilities, conditions, etc. If the business is organized as a flow-through entity (i.e., an S Corporation), most prefer to sell business assets in lieu of company stock. S Corporations are usually subject to only one level of tax, which is at the shareholder level. In most cases, this can produce significant tax savings versus C Corporation structures by eliminating the corporation level tax. Therefore, if the business is organized as a C Corporation and the sale horizon is still some years from now, it might be worth considering converting from a C Corporation to an S Corporation. It should be noted that any appreciated property transferred at the time of the C to S conversion will be subject to the built-in-gains tax if sold within 10 years of the date of transfer (which preserves some of the entity level tax). Any appreciation on company assets that occurs after the conversion escapes the corporate level tax. Other considerations may include deferral of sale proceeds (and gains) via an installment sale structure. Your company leadership will also want to consider opportunities to reduce future estate tax liabilities through planning in advance and in conjunction with a contemplated sale. Current rules allow each taxpayer to gift, generally tax free, up to $14,000 per year per recipient (the “Annual Exclusion”) and $5,340,000 over the taxpayer’s lifetime (the “Lifetime Exemption”). Future appreciation on gifted assets and proceeds from the future sale of such assets usually escape taxation as part of the estate of their original owner. Business owners often transfer company stock, especially nonvoting stock, utilizing these rules, which
Clean Up Your Business’ Financial Records
If your business is already receiving an audit or review, then you have demonstrated a commitment to enhancing the perceived integrity of your business’ financial records. This is a great step forward in being able to withstand the scrutiny of a prospective buyer’s financial due diligence. Having an audit or review sends a signal to a prospective buyer that your company is keeping orderly financial records and supporting documents (e.g., invoices, receipts, and account statements), the business’ accounting methods are consistent from month-to-month and year-to-year, and that management can articulate why the business’ accounting methods and estimates are reasonable. Having audited or reviewed statements is also a plus from a valuation perspective as anecdotal evidence suggests that a business may lose a half turn to a full turn of EBITDA valuation if a financial statement audit is not available. However, having financial statements audited or reviewed by a third party is not the only step to consider when cleaning up your business’ financial records. Founder/owner-run businesses often contain some level of discretionary, non-operational expenses. While there are ways in which a prospective buyer can get comfortable that certain of these amounts are truly discretionary or non-operational in nature, there are often many questionable amounts for which a prospective buyer may not give you full value.
Examples include higher-than-market wages paid to family members, meals and
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Thus, while middle-market businesses may believe that they lack the resources to make IT investments, when confronted with these types of scenarios (and there are quite a few possibilities) it becomes evident that developing an IT strategy and creating a more robust IT infrastructure will benefit you not only at the time of your exit, but also in the years preceding your exit. IP assets are of increasing importance in the global economy, and as a result, prospective buyers are dedicating greater resources to IP due diligence. For sellers, this is an often overlooked opportunity. Why? For one, getting ahead of (and addressing) potential gaps or weaknesses in your business’ use of IP can provide for a smoother due diligence process and, ultimately, greater exit proceeds. See article on page 28 for more on protecting IP value. Understand What It Will Take to Retain (Key) Employees Post-Exit Transitions create uncertainty, and uncertainty can be perceived negatively by employees. While it may make sense to keep some or most all of your employees in the dark until a transaction is consummated, it is important to a prospective buyer that your key employees understand what is occurring and what it means for them. Recall the first takeaway from this article —build a capable management team (that can run the business without you). As these individuals will likely be the leaders for the business going forward, you need to understand what it will take to have your employees’ buy-in during the sale process (to keep their incentives aligned with your exit objectives) and post-exit (to keep them motivated under new ownership). In fact, a prospective buyer will often want key employees to sign employment agreements as a condition to the Document and Protect Your Intellectual Property (IP)
entertainment, travel expenses, sports tickets, and even vehicle payments and insurance. By eliminating the questionable amounts in the years ahead of potential exit, you can ensure that you capture maximum value for these “add-backs.” Consider Developing an Information Technology (IT) Strategy IT can be a source of competitive advantage for many middle-market businesses. After all, IT is a foundational, value-added resource on which nearly all business functions rely. However, all too often, organizations view resources deployed in IT infrastructure as expenses instead of as investments. By taking the time to develop an IT strategy that provides for a stable, secure, and scalable IT environment, you will demonstrate to a prospective buyer that IT is a core driver of your business’ performance rather than just a “cost of doing business.” Why invest in IT infrastructure? Consider data security. The loss or corruption of critical data, whether through a failed server, unauthorized employee access, or a security breach, can have devastating consequences on your business’ ability to continue as a going concern. Similarly, consider employees that are duplicating efforts at two different locations because they are working on different systems. Surely these human resources could be better deployed. With fewer systems, the IT environment becomes easier to secure and service. These disparate examples quickly show how dependent organizations are on their IT infrastructure. In the first example, the business will likely experience a financial cost to recover from the loss event, while in the second example the business is already incurring a financial cost but does not fully realize it.
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with these agreements. It is not unusual to find outdated agreements, as well as fact patterns indicating companies are in violation of one or more material agreements.
transaction, and may even be willing to offer employment terms post-transaction that are more favorable than their current terms. It is advisable that, if not already in place, you have key employees sign employment agreements with confidentiality, non- competition, and like clauses if for no other reason than to make this a customary process and reduce the surprises to your key employees when your prospective buyer requests such in the weeks prior to closing. Now is also the time to resolve any informal agreements or perks previously agreed to with existing employees and/or family. These issues can disrupt exit processes and scare away a prospective buyer. Document Your Customer, Supplier, and Vendor Relationships Chances are slim that a prospective buyer will want to acquire a business that is operating on a series of handshakes, even if such arrangements represent strong, long- term relationships. It is imperative that you document (and receive executed copies of) all third-party agreements and arrangements so that your prospective buyer is clear on the terms under which it is bound with customers, suppliers, and vendors going forward. After all, these on-going commitments will become your prospective buyer’s commitments, assuming that such agreements are transferable post-transaction. In addition, it is advantageous to have these agreements ready-to-go when the multiple rounds of document requests begin. When negotiating the terms and conditions to these agreements, be aware of how built-in price increases, volume discounts, and unusual termination clauses may be perceived by a prospective buyer. Finally, as you go through this process, make certain that these agreements are current and that your business is in compliance
Organize Your Business’ Corporate Governance Documents A prospective buyer and its legal counsel will want to see your business’ corporate governance documents. These will likely include articles of incorporation, by-laws, operating agreements, filings and certificates of good standing with various federal, state, and local governments, an entity organizational chart, a current capitalization table/evidence of ownership, documents evidencing historical stock and ownership transactions, and board and shareholder meeting minutes, among others. Many organizations spend considerable time during a transaction process locating these documents and, after locating them, struggling to identify whether the versions located are the most current. This is not a situation you want to be dealing with while managing your business and being responsive to your prospective buyer’s other requests. While it is always a best practice to keep corporate governance documents organized and accessible, it is especially important to keep ahead of this task in the months and years leading up to a potential exit. Ensure the Business Is Properly Licensed and Current On Its Regulatory Filings No prospective buyer wants to walk into a situation in which the business they have just acquired is lacking the proper regulatory, environmental, or other permits it requires for its operations. This is a sure way to sell your business at a discount, if you can sell it at all. But, these situations are more common than you think. Most often, the proper licenses or filings have
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mouth, a professional service provider, or another source? A business owner should know that there are a number of factors in every transaction which can impact the sales price, and that comparable transactions—while relevant—should be used only as guides and not direct indications of what can be achieved in any given situation. Having a realistic value in mind, knowing the absolute minimum proceeds you are willing to accept, and keeping top of mind your key negotiating points will allow you to better respond to the offers received, and help you quickly decide whether to move forward with a prospective buyer. Lastly, a knowledgeable team of financial, tax, and legal advisors, as well as a reputable business broker or investment banker, can improve the outcome of any exit.
lapsed and the business can re-obtain its good standing after some effort, additional cost, and perhaps rounds of inspection. It goes without saying that your exit process is not the time to find about shortcomings in your business’ licensing and permitting. Therefore, as you prepare for the exit, it is advisable to ensure that the business is properly licensed and current on its regulatory filings. Know Your Value According to the International Business Brokers Association, the greatest hurdle to deal completion is a seller’s value expectations, so it is worth examining the basis of your expectations.
Have you arrived at your value from an independent appraisal, research, word-of-
RubinBrown’s Mergers & Acquisitions Services Group RubinBrown’s team of Mergers & Acquisitions professionals has the experience to help your organization successfully navigate the transaction process. From the initial thought of buying or selling to the critical post-closing and integration activities that must occur, our comprehensive approach will provide you with superior quality and service.
Ben Barnes, CPA — St. Louis Partner-In-Charge Mergers & Acquisitions Services Group 314.678.3531 firstname.lastname@example.org
Sunti Wathanacharoen — Kansas City Partner Mergers & Acquisitions Services Group 913.499.4462 email@example.com
Tim Farquhar, CFA, CPA — St. Louis Partner Mergers & Acquisitions Services Group 314.290.3281 firstname.lastname@example.org
Jason McAdamis, CPA — St. Louis Manager Mergers & Acquisitions Services Group 314.290.3227 email@example.com
Dale Lash, CFA — Denver Partner Mergers & Acquisitions Services Group 303.952.1261 firstname.lastname@example.org
Kyle Murphy, CFA, CPA — St. Louis Manager Mergers & Acquisitions Services Group 314.678.3511 email@example.com
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The Importance of Valuation in Exit Planning by Tim Farquhar, CFA, CPA
A common mistake that business owners often make is not fully understanding the value of their company. Business owners tend to rely on anecdotal information, such as what their neighbor sold his business for or what a competitor was sold for recently, to determine the value of their business. Sometimes, business owners don’t even engage in that limited level of “research” and, instead, allow the amount that they need to sell their business for to bias their opinion of what their company is actually worth. A poor understanding of the valuation of a business can lead to disappointment at the exit or even the late realization that an exit is not even possible given the inability to fund one’s retirement with the lower than expected proceeds from an exit. These are all reasons why it’s critically important to regularly value your business. In fact, it is strongly recommended that you consider having an independent valuation performed on your business prior to marketing your business for sale. It is an unfortunate situation when business owners enter the sale process, incur significant attorney and investment banker fees, and then discover that the value they thought the business had (and what they had been told by the investment banker) was nowhere close to what the market was willing to offer.
At that point, the business owner has two choices:
∙ Sell for significantly less than he thought entering the process OR ∙ Continue to run the business and lose any potential benefit from the sunk attorney and investment banker costs
Neither choice is desired and could be avoided by having an independent valuation performed prior to entering the sale process.
While RubinBrown can’t provide a set of hard and fast rules that you can use to value your business, this information is an overview of the methodologies most commonly used in practice. If you decide to have an independent valuation performed, this information will help you more fully understand the process. You can also benefit from exploring these common methodologies if you make the decision to forgo a valuation.
The three primary approaches to valuing a business are described in the following pages.
Income Approach The income approach determines the value of a business by capitalizing its future cash flows.
The basic premise of this approach is that the price a willing buyer would pay is based on the economic benefits of ownership that are available to the buyer, namely, the cash flows which the business generates.
The cash flows in this context are defined as net operating income after tax, plus depreciation, less capital expenditures and working capital needs. These are the cash flows available to all
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stocks is based on historical returns of the S&P 500 Composite, with dividends reinvested.
stakeholders (i.e. equity and debt holders), as they are before any payments on debt or dividends.
The risk premium for size is an incremental addition to the cost of equity to reflect additional returns to stocks of companies smaller than those included in the S&P 500. The risk premium for the subject company is a judgmental factor that recognizes the general risks associated with an investment in a closely held business and the specific risks related to the subject company. General risks inherent in a closely held business include a lack of diversification, access to capital, management depth, and supplier pricing leverage. Specific risks include the company’s financial structure, earnings stability, competitive position, and future growth prospects. The cost of debt is the rate at which the company can borrow money from a bank or in the open market. The optimal capital structure considers factors such as the amount of assets the company has to borrow against and the company’s cash flow.
The value of the business is determined by computing the present value of:
∙ Forecasted future net cash flows over an appropriate period, normally 5 to 10 years AND ∙ Forecasted value of the business at the end of that period A discount rate (present value factor) is selected that is commensurate with the risk involved in receiving the future cash flows. Typically, the discount rate used is the company’s weighted average cost of capital (WACC), which represents the cost of equity and debt financing. The WACC is calculated by determining the company’s cost of equity and after-tax cost of debt and then estimating the company’s optimal capital structure. The cost of equity can be developed using a technique called the build-up or summation method. This method involves adding rates of return and return premiums based on market factors and a qualitative risk analysis of the subject company.
The formula for a discounted cash flow calculation is shown in Figure 1 on page 17.
Market Approach In using the market approach, the value of a business is determined by using one or more methods that compare the subject company to either similar businesses or to securities of similar businesses that have been sold.
The cost of equity is calculated using the formula shown below.
Risk free rate
Risk premium for large company common stocks
This approach examines factors such as:
∙ Guideline businesses which have recently been sold
Risk premium for size
Risk premium for subject company
∙ Publicly traded stocks of companies which participate in the same general line of business The company or security used for comparison must have a reasonable basis for the comparison. Factors that are considered
COST OF EQUITY
The risk-free rate is typically based on the current yield of a 20-year treasury bond. The risk premium for large company common
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DISCOUNTED CASH FLOW CALCULATION
For instance, companies in the same industry can still have significantly different levels of debt (and thus different levels of interest expense), different effective tax rates (based on tax jurisdiction), and different levels of asset intensity (and thus different levels of depreciation and/or amortization expense). EBITDA removes all of these potential differences by focusing on earnings before interest, taxes, and depreciation / amortization. Figure 2 on the following page is a chart that shows historical EV/Revenue and EV/ EBITDA multiples for all middle market M&A transactions since 2009. Middle market is defined as businesses with values between $1 million and $1 billion. Asset Approach In using the asset approach, the value of a business is determined by considering the value of the business’ individual assets and liabilities. Under this approach, each component of the business is valued separately. The values are totaled and reduced by outstanding liabilities to determine the net asset value of the company.
when assessing comparability include the industries in which the company operates, its size, capital structure, profitability, growth prospects, and risk factors. When employing the market approach, the ratios commonly used for comparison are Enterprise Value (“EV” or the sum of a company’s equity and net debt) to revenue and EV to EBITDA (earnings before interest, taxes, depreciation, and amortization). The EV/Revenue and EV/EBITDA multiples of recent transactions and publicly traded companies are used to determine what the appropriate multiples for the subject company should be. EV/Revenue multiples are typically used as they are more generally available than EV/EBITDA multiples, particularly for transactions. However, there are usually large ranges in EV/Revenue multiples within an industry, and small changes to the multiple applied to the subject company can cause large changes in the resulting value. In this case, EV/EBITDA multiples are more commonly used and most transactions are referred to in terms of the EV/EBITDA multiple. The main reason that EBTIDA multiples are commonly used is that EBITDA is a measure that removes many of the differences between comparable companies.
In the most commonly used method, the company’s balance sheet is adjusted to
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MIDDLE MARKET M&A TRANSACTIONS
Source: S&P Capital IQ
the period of liquidation, represent the liquidation value of the business.
reflect differences between book value and known or estimated market values.
In liquidation, assets are typically sold for less than the value determined on a going concern basis. While the liquidation value is not applicable in many cases, it is often used to determine the minimum value of a business. Factors That Can Increase Value Regardless of the approach used, there are several factors that can cause an increase in the resulting value of a company: Growth – Companies that have consistently achieved higher growth or are expected to achieve higher growth will typically enjoy a premium valuation. Profitability – Companies that enjoy higher profitability will also achieve a higher valuation. Size – Larger companies will typically receive higher valuations as larger size tends to be correlated with lower risk.
Adjustments are also made for assets and liabilities that may, for one reason or another, not be recorded on the company’s books.
Under this approach, assets can be valued under two fundamental bases:
∙ Going concern value
∙ Liquidation value
Going concern value assumes the company remains in business and is able to realize the full fair market value of its assets in the normal course of business. Going concern value is based on the cost concept (i.e., the cost of replacing the individual assets and liabilities of the business given their age, condition, and use). Liquidation value assumes that all assets are sold off individually or in bulk in an orderly liquidation. The net proceeds available after the payment of all liabilities and expenses of sale, including administrative costs during
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Lower Volatility – Companies with consistent operating performance and low volatility will typically enjoy higher valuations. Synergies – When several potential buyers can achieve synergistic benefits from the purchase of a company, the company will achieve a higher valuation, all else equal. Interest Rate Environment – In a low interest rate environment, potential alternative investments such as fixed income investments are less attractive, and this causes equity or company valuations to increase. RubinBrown typically employs an income and a market approach when valuing a business, and the asset approach is only used when the resulting values of the first two approaches are low and approaching the valuation “floor” provided by the asset approach (i.e. the company is worth more “dead” than “alive”).
The advantages of a market approach are that it is fairly quick to employ, is easily understood, and is based on observable market data. The primary limitation of the market approach is that it can be difficult to find information on relevant, comparable companies and transactions to help one understand the differences between the subject company and the comparable companies. The advantages of the income approach are that it can give a business owner insight into what specific factors in his business are driving value. The limitations are that the income approach is only as good as its underlying assumptions, and to the extent that the assumptions prove to be incorrect, the resulting value can also be incorrect. Because of the positive and negative attributes of the various approaches, we generally prescribe the use of more than one.
RubinBrown’s Valuation Services Group The valuation professionals at RubinBrown are specialists that focus on the valuation of public and private businesses and business interests as well as intangible assets.
Dale Lash, CFA — Denver Partner Valuation Services Group 303.952.1261 firstname.lastname@example.org
Michael T. Lewis, CFA — Denver Partner Valuation Services Group 303.698.1883 email@example.com
Tim Farquhar, CFA, CPA — St. Louis Partner Valuation Services Group 314.290.3281 firstname.lastname@example.org
Sunti Wathanacharoen — Kansas City Partner Valuation Services Group 913.499.4462 email@example.com
www.RubinBrown.com | page 19
Key Findings from a Global Survey on Succession Planning by Steven Harris, CPA
As many organizations begin the process to establish their visions and strategies for 2020 and beyond, a major revelation in the transition of leadership is becoming increasingly apparent. It’s believed that by 2020, a significant number of the baby boomer generation who owned businesses will have or be in the process of transitioning ownership and leadership of their respective businesses. For those companies that have an already established succession plan, this change will serve as an opportunity. For those that don’t, they could experience significant risk. Succession is a journey that preferably commences the day you start your business, but often only begins when a business owner decides it is time to sell or transfer control of the business. As many owners are contemplating the next phase of their involvement with their respective companies, it is important to understand that succession does not equal retirement, but instead it equals business evolution. Many owners have trodden the path of business succession and discovered the hard way that improper planning can foul the journey, and in some instances, even inflict significant costs, both financial and personal. Through our membership in Baker Tilly International, RubinBrown LLP has participated in a global research study that has taken a closer look as both the sociological and economic implications of the family business succession process. The results from 1,650 business owners across 55 countries provide businesses with a common sense, practical guide on how you should view and conduct your succession process. To address the structures of family businesses, the findings of the research have been condensed into eight principles of succession which are intended to be a practical guide to how family businesses should view and conduct their succession process. Key findings from the research include: Principle 1: Succession Is Not Retirement If you believe succession is about retirement, growing old or stepping down, then you have lost the process before you have commenced. Succession is truly about growth, opportunity and building the future while you are there today. It is about future proofing the capital value of your business by ensuring its continuity and evolution.
Baker Tilly International Global Succession Research Study The survey focused solely on the issue of succession and is not part of a general family business survey. It is structured to focus on the dynamics, barriers and success strategies experienced in a succession process. The findings in the November 2013 survey are interim results and will continue to be refined and explored as this survey continues. To access the interim findings, as well as find other succession planning resources, please visit RubinBrown.com/BTI-Survey