Selling Your Company June 2012 Howard E. Johnson · Howard E. Johnson . MBA, FCA, FCMA, CBV, CPA, CFA, ASA, CF, C.Dir . Managing Director, Veracap Corporate Finance Limited (416)

M&A International™ – the world's leading M&A alliance

Selling Your Company

June 2012

Howard E. Johnson MBA, FCA, FCMA, CBV, CPA, CFA, ASA, CF, C.DIR

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Speaker

Howard E. Johnson MBA, FCA, FCMA, CBV, CPA, CFA, ASA, CF, C.Dir Managing Director, Veracap Corporate Finance Limited (416) 597-4500; [email protected] Howard is a Managing Director of Veracap Corporate Finance and its affiliate, Campbell Valuation Partners Limited. He advises business owners and executives of mid-sized and large public and private companies on business valuation, acquisitions, divestitures, and value maximization strategies. Howard is the author of several texts on the subjects of business valuation and corporate finance, and has acted as an expert witness on valuation matters before the courts.

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About Veracap

Veracap Corporate Finance Limited helps business owners and executives to maximize shareholder value through acquisitions, divestitures, private equity financing and shareholder value advisory services. Veracap is an affiliate of Campbell Valuation Partners, Canada’s longest established independent business valuation firm. Veracap is a member of M&A International, the world’s leading affiliation of M&A advisors, with over 500 professionals in 41 countries.

www.veracap.com 3


Disclaimer

This material is for educational purposes only. It deals with technical matters which have broad application and may not be applicable to a particular set of circumstances and facts. As well, the course material and references contained therein reflect laws and practices which are subject to change. For these reasons, the course material should not be relied upon as a substitute for specialized advice in connection with any particular matter. Although the course material has been carefully prepared, the author does not accept any legal responsibility for its contents or for any consequences arising from its use. © Howard E. Johnson, 2012

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The Private Company Sale Process 1. Deciding When to Sell 2. Preparing for the Sale 3. Estimating Value & Price 4. Search for Buyers 5. Preliminary Due Diligence 6. Deal Structuring 7. Negotiations 8. Closing

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Deciding When To Sell

Preparing For the Sale

The Search For Buyers

Estimating Value and Price

Preliminary Due Diligence

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Negotiations Deal Structuring Closing

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Building Deal Momentum

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Deciding When to Sell

Situation analysis – owner or parent co. Economic and industry conditions

Company performance and prospects

Key = Time the sale to coincide with favourable personal and business conditions

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VALUE RECEIVED BY THE SELLER

TERMS OF THE DEAL

INTANGIBLE ASPECTS

PURCHASE PRICE

Elements of Value to the Seller

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Timing of the Sale

Revenues & Profitability

Time

Historical Forecast

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Preparing for the Sale

Operational and financial structuring Income tax and estate planning

Transaction advisors

Key = Structure the affairs of the company to increase its attractiveness to buyers

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Operational Matters

•Customer and market analysis –Revenue stability and concentration

•Management and employees –Ability to transition the business –Key employee issues

•General operational matters –Facilities, equipment, inventories, etc. –Company website

•Administrative matters –Minute books, banking agreements, contracts, etc.

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Financial Matters

•The income statement –Revenue recognition –Expense management

•The balance sheet –Working capital management –Capital expenditure management –Redundant assets

• Tax Planning!!

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Valuation

Prospective Cash Flows Valuation Multiples The Balance Sheet

Key = Undertake initiatives to increase or realize

shareholder value before soliciting buyers

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Components of Value & Price

Post-Acquisition Synergies

Intangible Assets & Goodwill

Tangible Net

Worth

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Cash Flow Terms Used in M&A

Income before taxes + Interest expense = earnings before interest and taxes (EBIT) +/- Normalization adjustments = Normalized EBIT + Depreciation and amortization = Norm. earnings before interest, taxes, dep’n, amort. (EBITDA)

- Capital expenditures - Cash income taxes - Incremental working capital requirements = Normalized discretionary cash flow (or “free cash flow”)

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Normalization Adjustments

•Compensation to owners and related parties –Return on labour vs. return on capital

•Discretionary expenses •Rents above/below market •Non-recurring and unusual items •Divisional / common costs

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Multiple of EBITDA Example

Normalized EBITDA $ 10 million Multiplied by EBITDA multiple 5x Equals enterprise value $50 million Deduct interest bearing debt ($10 million) Equals equity value $40 million

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Determinants of Valuation Multiples

•Company size •Revenue stability and concentration •Proprietary products and services •Management and employees •Growth potential •Capital expenditure requirements •Buyer synergy expectations •Terms of the transaction •Comparable transactions

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Rates of Return & Multiples

Return Multiple EBITDA $10,000 20% 5x Depreciation 2,800 EBIT $7,200 14% 7x Income taxes 2,200 After-tax cash flow $5,000 10% 10x All results lead to $50 million (enterprise value)

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What about the Balance Sheet?

•Expectations of buyers as to deliverables –Working capital –Book value

•Normally cash-free, debt free, except as agreed •Redundant assets •Real estate

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Search for Buyers

Identifying prospective buyers Qualifying prospective buyers

Initial buyer contact

Key = Establish a sufficient number of qualified buyers to establish the platform for the effective auction

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Types of Prospective Buyers

•Strategic •Non-strategic •Small corporate / individuals •Financial •Management and employees

Finding the “Platform Buyer”

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The MBO Opportunity

•Availability of capital coupled with a lack of quality opportunities for investment –Financial investors becoming more aggressive

•Speed & confidentiality vs. strategic buyers •Deal structuring opportunities –Tax efficient transaction and availability of cash

•Possible lucrative upside for seller and management

But - beware the conflict of interest

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The Traditional Private Equity Mentality

Leverage x Growth x Multiple Expansion = Huge ROI

Today EBITDA $10 M Multiple 5 x Enterprise Value $50 M Debt $30 M Equity $20 M

ROI = 500%

Exit

$20M 6 x $120 M $ 0 M $120 M

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Preliminary Due Diligence

The Confidential Information Memorandum Initial buyer meetings

Other information and procedures

Key = Control the flow of information to increase the perceived value among buyers

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Transaction Structuring

Assets vs. shares Forms and terms of payment The Management Contract

Key = Evaluate each proposal based on its risk-

reward parameters and income tax efficiency

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Forms of Consideration

•Cash at closing •Holdback •Seller take-back / Promissory Notes •Share exchange •Earn-out

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Negotiations

Preparing for negotiations Negotiating strategies and tactics

The Letter of Intent

Key = Secure a comprehensive letter of intent that offers the best value to the business owner

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Negotiating Principles

•Information is key •Credibility –Information provided –Changes in stated positions

•Alternatives –Number and quality of buyers

•Price and terms are important –When / how paid –Conditions for payment –Tax issues

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The Buyer/Seller Advantage Curve

Management Presentation

Multiple Offers

LOI Negotiations Exclusivity to Buyer Closing

Seller

Buyer

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The LOI is Key


Closing

Detailed due diligence The purchase agreement

Final closing

Key = Stay focused on running the business

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Why Deals Fail to Close

• Buyer and seller have different expectations – Secure a comprehensive, unambiguous LOI / term

sheet • New issues uncovered in detailed due diligence

– Ensure full disclosure of major issues prior to the LOI / term sheet

• Material adverse change in the company’s operations – Adopt a ‘business as usual’ attitude during closing

• External circumstances – Negotiate a relatively short exclusivity period

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The CFO as Quarterback

• Before the Process – Business readiness (financial and operational) – Organizing the transaction team (internal & external) – Tax planning

• During the Process – Coordinating with advisors – Information management – Assessing offers against objectives

• After the Process – Transition management – Integration issues

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Concluding Comments

• Presale planning and preparation are essential • Understand the components of value • Minimize the buyer’s perceived “transition risk” • Stay in control of the process • Terms and price are equally important • The LOI is a critical document • Stay the course through closing

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Resources

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Documents

Selling Your Company June 2012 Howard E. Johnson · Howard E. Johnson . MBA, FCA, FCMA, CBV, CPA, CFA, ASA, CF, C.Dir . Managing Director, Veracap Corporate Finance Limited (416)