Spring 2006 issue of Horizons

The toughest part of getting to closure is agreeing on the details of the definitive purchase agreement. Agreements are long, complex and critically important to the seller's chances of keeping all of the proceeds received at close. These documents are fundamental and critical to the deal and, until they are done and agreed to, there is real exposure to the seller. Representation and warranty issues are critical because they determine whether or not the buyer can come back to the seller for indemnification after the sale. Due dili- gence and access to employees and customers are critical. Solutions must be designed to satisfy the buyer's need for

information without risking the seller's base business stabili- ty. The deal is never closed until it is closed, and the risk of non-completion is always present. The most costly mistake sellers commonly make is in either not getting enough competition - or the right competition - into the process. Often there is such fear of a confidentiality breach and such discomfort with the whole process that sell- ers cost themselves enormous lost value in pricing by mis- takenly limiting talks to one or two buyers - and often the wrong one or two. Competition pays off in a big way. It's worth the time and effort.

Valuation and Succession Planning

Dale Lash, CFA

In the life cycle of any closely held business, there comes a time when current owners desire to transition ownership of the company. The value of the company is often an important factor in the decision of how or when to transition ownership. The decision to retain ownership of the busi- ness in the family or sell to an outside buyer will be in part dependent upon the value of the business to the family ver- sus the market value to an outside buyer. Understanding the basics of what drives value in this context can be criti- cal to good decision-making. On a very simple level, the value of any operating business is based on the ongoing income from operations. In consid- ering ongoing operating income, the company's historical expenses should be adjusted to eliminate non-recurring or extraordinary expenses. Compensation paid to sharehold- ers should be adjusted to what it would cost the company to hire employees to fill these positions. Also adjust for any assets such as real estate that are rented to the company at above or below market rates. Once the ongoing operating profit has been established, a common method of developing an indication of value is to apply a multiple to the ongoing operating profit. This multi- ple is typically based on recent sales of similar companies. This value indication represents the “intrinsic” value of the business to the family. It also represents the value of the company to the so-called “financial buyer,” a buyer such as a private equity group that is a passive investor. But that's not the end of the line, because there may be buyers in the

same industry that would pay a greater price, based on strategic considerations.

Strategic value is what a buyer in the same or similar industry might pay for the business, and it can be signifi- cantly higher than the value to the existing owners. This is because strategic buyers can achieve greater levels of operating profit by reducing operating costs or increasing revenues. If the buyer has similar operations, eliminating redundant overhead expenses could yield significant profit increases for which a buyer might pay a premium price. Likewise, if the buyer has a complementary product line, it might be possible to increase revenues by offering the buyer's products to the company's existing customer base. If the decision is made to retain the business within the family, minimizing the tax impact of transfer is critical. By transferring minority interests in the company, the value for tax purposes can be reduced to reflect the lack of control and marketability inherent in a minority interest in a close- ly held company. Whether the decision is to retain the business within the family or sell to an outside buyer, a thorough understand- ing of the alternatives from a valuation perspective is a key ingredient to sound decision-making. Questions? Contact Dale Lash, Partner-in-Charge, Business Valuations Services Group 314-290-3261 dale.lash@rubinbrown.com

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