Ownership Transition: Know Your Options ACEC/NC Summer Conference | July 31, 2015

Ownership Transition: Know Your Options ACEC/NC Summer Conference | July 31, 2015

2 ACEC/NC Summer Conference 2015 | July 31, 2015

Presented by

Neil Churman

Principal Consultant

Morrissey Goodale LLC


Agenda

• Two Paths and How to Choose Them• Internal Transition Options• External Transition Options• Case Study of One Seller• Summary


Strategy M&A

Workplace 2020

Research & Publishing

About Morrissey Goodale LLC: AEC Industry Consulting & Research

Buyer AdvisorySeller AdvisoryDeal PricingDeal StructuringIntegration

Market Research & AssessmentScenario PlanningStrategy DevelopmentMarket Research

Executive SearchExecutive CoachingLeadership DevelopmentOwnership Transition

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Events

Houston, TX | October 8, 2015


Morrissey Goodale Locations

Denver

Boston

Houston


The Key is Time

• Everyone who operates a company will reach a point when it’s time to leave

• Start now – Every firm needs a transition plan

• Avoid the three D’s: Death, Disaster or Divorce


Two Paths

Transitions can be either internal or external


So What to Do?

Culture?

Next Tier?

5+ Year Timeline?

Yes

Yes

Yes Yes

No No No No

Risk Tolerance?

External Sale

Internal Sale


Culture

Is an internal transition in our DNA?

• Past history

• Past promises or discussions

• Current owner preferences


Next Tier

Is the next generation capable?• Motivated

• Shared values and belief in the firm’s vision

• Ability to think strategically about the future

• Leadership and team building skills

• Tolerance for and willingness to assume risks

• Trust and integrity

“People who are unable to motivate themselves must be content with mediocrity, no matter how impressive their other talents” – Andrew Carnegie


Risk Tolerance

Are you prepared to wait to get our money out?

• Every transition has risk More time = more risk

Time

Risk

External Transaction

Internal Transition

• External transition yields more money sooner

• Harder to simply walk away with an internal transaction than external


Available Timeline

Now 10 Years

When do we want to be out?

• A shorter timeline limits viability of internal transfer• External transitions still require significant time investment

4 Years 8 Years


Internal Transition (Selling In)


Internal Transition: Options

• Direct Employee Ownership

• ESOP

• Management Buyout


Internal Transition: Direct Employee Ownership

Why direct employee ownership?

• Known players

• Retain and incentivize the next tier

• Arrange for orderly exit


Internal Transition: Mechanics

Defined ownership transition plans will include:

• Valuations: quarterly or annually

• Formulas: book value, tangible net worth, earnings and others

• Generally done by third party advisor

• Schedule: plan the timeframe for share transfer


Internal Transition: ESOP

Why an ESOP?

• Creates a market for closely held shares

• Provides liquidity for shareholders and fund a buy-out with pre-tax dollars

• Provides tax deferral for sale of C-corporation to ESOP

• Creates a tax-advantaged entity with an S-corporation

• Employee recruitment and retention

Source: Wells Fargo Advisors




How it Works

Company

ESOP TrustBuild Employee Equity

Over Time Shareholders

Purchase SharesAt Current FMV



Advantages

• May obtain financing to purchase shares

• Principle and interest payments are tax-deductible

• Tax deferred rollover for seller

• Deferral of taxation for participants

• Employee motivation

• Takeover protection




Disadvantages

• Fiduciary responsibility

• Valuation requirement

• Dilution of ownership

• Operating costs

• Cash flow issues

• Employee impact if stock goes bad

• Repurchase requirement for departing employees



What is a management buyout?

• A company’s management team purchases the assets and operations of their own business

• MBOs are favored exit strategies for private businesses where the current owners wish to retire

• Heavy financing requirement

Internal Transition: Management Buyout


Internal Transition: Keys to Success

• Start early

• Motivate and mentor the future owners

• Establish transparent valuation

• Communication

• Don’t neglect team building

• Remain available as a resource


External Transfer (Selling Out)

ACEC/NC Summer Conference 2015 | July 31, 2015


U.S. M&A Trends

2007 2010 2014 Proj. 2015

100

150

200

250

175

152

203

220+

Reported Annual Domestic A/E/C M&A Activity

# o

f D

eals


2000

2005

2010

Proj.

2015

50

150

250

350

104

303

233

332

291

330+

Reported Annual Global A/E/C M&A Activity

# o

f D

eals

Global M&A Trends


Where the Buyers are


Where the Sellers are


States in Demand

TX

CA

WA

FL

CO

NC

VA

MA

PA

0 5 10 15 20 25 30

25

22

10

9

9

8

8

8

7

Top States for Firm Sales ‒ 2014


External Transition: The Mechanics

• Culture

• What adds value

• What subtracts value

• Valuations can differ

• An accounting moment

• Show me the money


External Transition: Culture

Why is culture so important in the A/E/C world?

• Your staff, your firm and its legacy


External Transition: What Adds Value

• Greater market penetration

• Expand services to current clients

• Augment staff and quality

• Add future leaders

• Increase revenue growth

• Expand backlog


External Transition: What Subtracts Value

• Limited focus or depth

• Owner(s) don’t remain

• Undercapitalization

• Inconsistent financials

• Low growth prospects

• Little backlog


External Transition: Valuations Can Differ

Different Values from Different Buyers

• Strategic value to buyer

• Amount of perceived risk

• Motivations of seller

• Buyer revenue projections

• Future outlook


External Transition: An Accounting Moment

Why do we focus on profitability and EBITDA?

• Profits are a proxy for free cash flow the buyer can expect

• EBITDA excludes expenses that can obscure how a company is actually performing

• EBITDA makes it easier to compare firms


External Transition: Show Me The Money

Payment methods

• Cash

• Promissory note

• Deferred compensation

• Stock in Buyer’s company

• Earn‐outs


External Transition: Options

• Merger

• Sale to strategic buyer

• Sale to financial buyer (private equity)


External Transition: Merger

Why do mergers happen?

• Expansion (new geographies, markets, or services)

• Capital – lower potential capital need

• Industry trend to consolidation

• Fear


External Transition: Sale to Strategic Buyer

What are the issues?

ConsConsProsPros

• More scale and scope• Offload back-office pain and

suffering• Business alignment• Brand recognition and

reputation• Additional opportunities for

staff

• Loss of control• Integration issues• Non-compete agreements

for sellers• Time and resource

investment• Trading one illiquid stock

for another


External Transition: Sale to Financial Buyer

What are the issues?

ConsConsProsPros

• Abundance of capital• Management stays in

place• Maintain existing way of

doing things

• Increased focus on financial performance

• Outsiders on Board• Few precedents in

A/E/C industry• Less industry

knowledge• Eventual “exit”


External Transition: Common Pitfall

• This is flawed thinking: “I can work for three more years and make more money than they are offering me”

• Selling your business today transfers risk to the buyer and compensates you for your years of hard work now


External Transition: Keys To Success

• Strong cultural compatibility

• Provide professional opportunities to key leaders and staff

• Start early and allow enough time

• Know your value proposition and walk away price

• Communication

• Seek outside advice


Case Study


Case Study

Situation

• $6 million in revenue at 12% EBITDA

• Three offices in the US

• Transportation and public works sectors

• Owner doing well after 20 years in business

• Key clients secure, but competitive pressure in specific markets


Case Study

The Decision

1. Culture? Yes, wanted to transfer internally

2. New Tiers? Competent, but none were willing to take second mortgages to make payroll

3. Risk Tolerance? Owner sensed market was peaking, didn’t want to “let it ride”

4. Timeline? Owner wanted out in 3-5 years

Result: Pursue an external sale


Case Study: Potential Outcomes

Internal

• Timeframe: 6-8 years

• Growth: Steady

• Valuation Method: 5x EBITDA

External

• Timeframe: 2-3 Years

• Growth:10%

• Valuation Method: 16% discounted cash flow

Result: $3.6M valuation Result: $4.5M valuation


Case Study

Process

• Engaged three larger firms operating in similar markets

• One local

• One ENR 500

• One ENR 200

• Midsized firm offered $4.2M

• Initial: 20% upfront, 50% over 3 years, 30% earn-out

• Final: 60% upfront, 30% over 3 years, 10% earn-out

Result: Closed transaction within 11 months


Summary

• Whichever option is best for you, start early

• High-quality leaders are a key in the A/E/C industry

• Culture, culture, culture

• More time = more risk


Neil ChurmanPrincipal ConsultantMorrissey Goodale

508-650-0040 ex. 1011

[email protected]

Documents

Ownership Transition: Know Your Options ACEC/NC Summer Conference | July 31, 2015