Post on 20-Jul-2020
transcript
Alternatives to “Growth As Usual” St t E ti d – Strategy, Execution and
Financing
Richard K.A. BeckerHogan & Hartson L.L.P.
Charles A. NeffHogan & Hartson L.L.P.
Presenters:
David J. Lundsten, MBA, CPA, CVACherry, Bekaert & Holland, L.L.P.
John T. SchellAltus Associates, LLC
B ild B tt M hiBuild a Better MachinePresenter:
John T. SchellPresident
Altus Associates, LLC1934 Old Gallo s Road1934 Old Gallows Road
Suite 404Vienna, VA 22102(703) 893-6403
2www.altus-associates.com
Build a Better Machine
– Invest in People, Resources and Systems
– Compete for Larger and Better Contracts, even with a reduction in win rate
Improve Earnings as a Team Goal– Improve Earnings as a Team Goal
– Promote Branding and Marketing (not advertising)
A id Pi f ll– Avoid Pitfalls
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Invest in People, Resources and Systems
• Team: Finders, Minders, Binders and Grinders
– ‘It’s a big jungle, but it only takes a few tigers to keep order’
• Resources: Market analysis, intelligence, outside help
– Does your team have the skills to fashion solutions, structure proposals and effectively price in all agencies?proposals and effectively price in all agencies?
• Systems:
– An operating and effective business Pipeline– An operating and effective business Pipeline
– Best Practices financial information (Accounting, Pricing, Management Tools) are key to driving earnings
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Pipeline is your future use it as a management tool
Stretch Your Team– Pipeline is your future– use it as a management tool
• Measure, measure, measure…
f C f• Develop pipeline goals for the Company, each category of business, and each business unit.
– A 50-100% “win rate” reduces maximum earningsg
• The world is built on a judgment call: incremental costs and incremental benefits.
• Would you invest $500K to have a 25% chance for a $50M contract with $5M earnings? It will reduce your “win rate” but raise your earnings.
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Fundamental Challenge: Brand and MarketBrand and Market….
In a Sea of Sameness…
H t t d t i ld f ‘G B ’?How to stand out in a world of ‘Gray Boxes’?
Contractor Contractor Contractor Contractor Contractor ContractorA B C D E F
Diff ti t DiDifferentiate or Die
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Brand and Market to the Customer! Don’t Advertise!
Enlightened executives will recognize a fundamental fact‘What is your Point of Difference?’
Enlightened executives will recognize a fundamental fact -one that most highly competitive industries have discovered...
the only way to win is to: y yCreate a Brand.
Brands Make Meaningful Promises & Mitigate Perceived Risk
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Avoid Pitfalls• Winning new business is a team process and not just the
province of a sales team
D ’t t i l k th t h !– Don’t count on miracle workers that change every year!
• We call it the “Messiah Complex”
G• Forget Revenues-Grow Margin!
– CPFF Out--T&M, FFP In
• Cutting Costs Can Help, But Not Fully
– $1 Annual Earnings Worth $5-8 Price
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• Focus on Services in Demand
B ild B tt M hiBuild a Better MachinePresenter:
David J. Lundsten, MBA, CPA, CVAPartner
Cherry, Bekaert & Holland, L.L.P.1934 Old Gallo s Road1934 Old Gallows Road
Suite 400Vienna, VA 22182(703) 506-4440
9www.cbh.com
Invest in Systems and Improve Cashflow
• Electronic timekeeping
• Billing within the system, not in spreadsheetsg y , p
• Collection person
• Project reportingj p g
• Monthly closing process
• Key metricsy
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Funding the Better Machine – Investors (Equity Capital)Capital)
• Internal funding (reinvest profit rather than take distributions)
• Private equity (F&F, Angels, Private equity firms)
• SBICs
• SPACS – new type of private equity
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Equity Investment Accounting Issues
• Professional investors often use preferred stock
– Sometimes see mandatory redemptiony p
– More often redeemable at option of the investor
– May result in treating the investment as debt, not as stock
– May wipe out shareholder equity
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Funding the Better Machine – Using Debt
• “Debt free” is NOT “good”
– Financial leverage is good (within limits)g g ( )
– Many middle market companies are under-leveraged
– Debt is the cheapest type of funding
• Lessons learned – public company data
– If you meet certain financial criteria, much easier to obtain
N dil ti f hi t B d f– No dilution of your ownership, no seat on your Board of Directors
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Funding the Better Machine – Using Debt
• Complexity, compliance and accounting issues varies
– Commercial bank debt is simplest and cheapestp p
• Line of Credit, borrowing base or accounts receivable
• Acquisition debt – term debt (if you qualify)
• Standard structure
• Standard debt covenants, borrowing base rules
• Relative easy to comply, no special accountingy p y, p g
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Funding the Better Machine – Using Debt
– Mezzanine debt
• If commercial banks won’t do the deal
• Complex (often tailored) structure, need expert advisor
• Involves warrants (potential dilution)
• Accounting issue with valuation of warrants
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B ild B tt M hiBuild a Better MachinePresenter:
Richard K.A. BeckerPartner
Hogan & Hartson LLP8300 Greensboro Dri e8300 Greensboro Drive
Suite 1100McLean, VA 22102
(703) 610-6100
16www.hhlaw.com
Negotiating Equity Investment Agreements• Form of Investment
– Preferred Returns/Rights
– Maintaining ControlMaintaining Control
• Board Membership
• Limitation on Actions without Investor Consent
– Issuance of Securities
– Operational Limitations
– Mergers
– Budget Approval
• Legal Mechanisms for Valuation (set formulas, selection of appraiser)
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Negotiating Debt Agreements
• Financial Covenants
• Transfer Limitations on Equity
• Limitations on Junior Debt
• Personal Guarantees
• When taking an investor is taking equity or debt and g g q yequity, If you are a small business, be careful of the SBA’s affiliation rules which might affiliate you with the investor and disqualify you as a small business.
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Legal Pitfalls in JV and Teaming Agreements
• Capitalization (Cash, IP, Sweat Equity)
• Ownership and Control
– 50/50 disagreements
– Minority Rights
• Dispute Resolution (Good faith provisions, Arbitration, p ( p“Russian Roulette”)
• IP/Product Rights outside of JV (Licensing Agreements)
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Motivate Employees with Motivate Employees with Real Incentives
Presenter:
John T. SchellPresident
Alt A i t LLCAltus Associates, LLC1934 Old Gallows Road
Suite 404Vienna, VA 22102(703) 893 6403(703) 893-6403
20www.altus-associates.com
Motivate Employees With Real Incentives
• Tell your Team what you want to achieve –
– Set business and BD goals and constantly refer to them
– Gain support of your team and increase credibility
I i ti t t l l t bl ? Whi h i• Is your organization a totem pole or a pool table? Which is more effective for your business?
• Are bonuses motivating or just a gift of appreciation?
• Who controls next week and next year? Your Team!
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Incentive Compensation
• A well thought-out and shared set of criteria and awards is the only way to communicate priorities
• An IC program is of critical importance in professional services – a sizable percentage of income for key executives
• Company should have a comprehensive plan that ties awards to company and individual performance
• Individual plans for key executives and BD professionals
• Consider getting some help: especially stock-related awards and tax and regulatory issues
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Motivate Employees with Motivate Employees with Real Incentives
Presenter:
David J. Lundsten, MBA, CPA, CVAPartner
Ch B k t & H ll d L L PCherry, Bekaert & Holland, L.L.P.1934 Old Gallows Road
Suite 400Vienna, VA 22182(703) 506 4440(703) 506-4440
23www.cbh.com
Incentive Compensation
• Carefully consider compensation plan
– What behavior do you want?
– Are amounts reasonable?
– Rules & Regs… (allowability)
Costs will be significant• Costs will be significant
– Check references before hiring
– Set objective quarterly targets
• Pipeline: number of leads, targets
• Win rate (new versus follow-on)
P i t 9 th
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– Progress review at 9 months
Incentive Compensation
• All pricing must be approved by CEO
• G&A rates will increase in short term
– Calculate effect if have cost-type contracts
– Brief main customers if necessary
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Incentive Compensation
• Make sure the incentives encourage the behavior you want
Not as eas as it so nds– Not as easy as it sounds
– Plans should specify desired behaviors / outcomes
– Plans should be subject to adjustment if behaviors notPlans should be subject to adjustment if behaviors not achieved
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Funding new cash incentives – at what level in the earnings process?earnings process?
• Gross profit level
– More “objective” to the employee– More objective to the employee
– More within employee’s control
– Few if any “corporate” charges/allocations, accruals, etc.
– Less likely to interfere with integration of acquired personnel
• Operating profit level
More subjective to employee– More subjective to employee
– Not entirely within employee’s control
– May have disputes over corporate charges/allocations
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– Almost certainly will interfere with integration of acquired personnel
Funding new equity incentives – the good, the bad…
• Stock awards (typically restricted stock)
– S Corporations – watch out!p
– Dilution issues
– Possible valuation issues
– If pass through entity, complicates employee shareholder tax returns
– Blue skyy
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Funding new equity incentives – the good, the bad…
• Stock options
– S Corporations – REALLY watch out!p
– Potential dilution issues
– Possible valuation issues
– New accounting rules – FAS 123r went into effect Jan 1, 2006
– New cost allowability concerns?
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Funding new equity incentives – the good, the bad…
• “Phantom” stock and stock appreciation rights plans
– Other names: performance stock units, value appreciation rights
– Too often overlooked
– Gives employees the ability to share in increase in company value
Doesn’t cause dilution– Doesn’t cause dilution
– No tax headaches to pass-thru entity employees, since not shareholder
Accounting rules require expensing but– Accounting rules require expensing, but…
– Since new options must be expensed, phantom plans look better than ever
• Change of control considerations
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• Change of control considerations
– Vesting rules are significant
Motivate Employees with Motivate Employees with Real Incentives
Presenter:
Richard K.A. BeckerPartner
H & H t LLPHogan & Hartson LLP8300 Greensboro Drive
Suite 1100McLean, VA 22102
(703) 610 6100(703) 610-6100
31www.hhlaw.com
Issuing Equity
• Any issuance of a “security” needs an exception under the securities laws and regulationsg
• For private companies, people receiving securities are usually receiving them under equity incentive plans or are accredited investorsinvestors
• Whether Options, Phantom Stock or Appreciation Rights, or Restricted Shares, written plans or agreements are critical
• Special issues in S-Corp—avoiding two classes of shareholders
• Executive compensation
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Option Plans
Incentive Stock Options or Non-Qualified Stock Options
• Non-Qualified for employees, consultants, or other people
• Incentive Stock Options
– employees only, must have written plan approved by shareholdersshareholders
– Other restrictions, not transferable, post termination exercise limitations
D i d l f i i i i l• Documentation and proper approval of options is critical
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Other Types of Equity “Securities”
• Restricted Shares
Sh ll bj t t ti d f f it if– Shares usually subject to vesting and forfeiture if employment terminated
– Grant under a plan or a free standing agreement
• A Stock Appreciation Rights is a contractual right to receive, either in cash or employer stock, the appreciation in the value of the employer's stock over a certain period of time
• Phantom Stock is a promise to pay the holder a cash bonus at some future point equal to a certain percentage of the company's equity
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SARs and Phantom Stock
• SARS and Phantom Stock Rights should be issued under equity incentive plans approved by the board andequity incentive plans approved by the board and shareholders
• Plans and agreements with employees should deal with changes of control, termination and death
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A i St t i O tiAcquire Strategic OperationsPresenter:
John T. SchellPresident
Altus Associates, LLC1934 Old Gallo s Road1934 Old Gallows Road
Suite 404Vienna, VA 22102(703) 893-6403
36www.altus-associates.com
Acquire Strategic Operations
• Financial results (earnings not revenues) and forecasts drive valuationdrive valuation
• Strategic attributes improve valuation metrics
H d id tif i ith th i ht fi i l d• How do you identify companies with the right financial and strategic attributes?
• Deal terms reduce financing requirements g q
• Leverage drives your value
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Buyer Valuation Issues
• Vertical (“Strategic”)
-Core Competencies
-Agencies
-Federal Market
• Horizontal (“Bolt-on”)
-Earnings
-Contracts
-People
38• Bottom Line: Supply and Demand
How Can Leverage Drive Your Value?RISK and COST
Risk Risk
Higher Higher
Risk RiskCost
Equity$2M $2M
EquityEquity
$3M $3M
Equity
Debt$3M $3M
Earnout
Lower
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LowerLower
Given Risk, Leverage Can Lower Cost and Drive Value
Equity and EARNOUT Year 1 Year 2 Year 3 Year 4 Year 5
$5M Purchase Price; $2M Cash, $3M EARNOUT or DEBT
EBIT $1,100,000 $1,210,000 $1,331,000 $1,464,100 $1,610,510
Payment/ Cost 1,217,500 1,145,000 1,072,500 0 0
Cash Available -129,250 71,500 284,350 1,610,510 1,771,516
IRR 4 2%IRR 4.2%
Equity and DEBT Year 1 Year 2 Year 3 Year 4 Year 5
EBIT $1,100,000 $1,210,000 $1,331,000 $1,464,100 $1,610,510
Principal/Interest 817,500 774,000 730,500 687,000 643,500
Cash Available 282,500 436,000 600,500 777,100 967,010
IRR 13.2%
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Note: There are many unstated assumptions.
A i St t i O tiAcquire Strategic OperationsPresenter:
David J. Lundsten, MBA, CPA, CVAPartner
Cherry, Bekaert & Holland, L.L.P.1934 Old Gallo s Road1934 Old Gallows Road
Suite 400Vienna, VA 22182(703) 506-4440
41www.cbh.com
Funding sources – generally the same as for funding growthgrowth
• Commercial banks – acquisition senior debt
– Cashflow based – rarely any allowance for borrowing base
– Term loan
– Debt covenants
Mezzanine debt• Mezzanine debt
• Equity
– Private equity firmsq y
– SPACs
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Acquisition of Companies – Accounting Issues
• Purchase accounting (FAS 141)
– Valuation of intangible assets
– Pre-acquisition contingencies: who gets the expense?
• In general
• Stay bonuses
P h i dj t t– Purchase price adjustments
– Effect of goodwill on debt covenants
• There are many Terms and Conditions with accounting / financial issues
• Your accountant must work closely with your counsel in drafting T&Cs
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Acquisition of Companies – Tax Issues
• Fools rush in…
• But you should get an experienced tax expert well in y g p padvance of the deal
• Many possible twists and turns
– Asset purchase versus stock purchase
– To novate or not to novate
Tax advisor must work closely with your counsel in drafting• Tax advisor must work closely with your counsel in drafting T&Cs
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Acquisition of Companies – Tax Issues
• If S Corporation is acquired, 338 election usually a good strategy
– Understand the effect of the election
– Tax equalization will possibly be required
Built in gains tax liability may exist valuation issue– Built-in-gains tax liability may exist – valuation issue
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A i St t i O tiAcquire Strategic OperationsPresenter:
Richard K.A. BeckerPartner
Hogan & Hartson LLP8300 Greensboro Dri e8300 Greensboro Drive
Suite 1100McLean, VA 22102
(703) 610-6100
46www.hhlaw.com
Transaction Issues
• Contracts with preferences
• Will the preferences continue? Depends on buyer, type of preference and when recertification is required
D li ith f i i t• Dealing with foreign investors
• Costs and risks of acquisitions with regulatory, tax or employee benefit/ERISA legal issuesemployee benefit/ERISA legal issues
• Patriot Act, Import Export Compliance, Security Clearances and Facility Security Clearances
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Getting to Closing/Post Closing Issues
• Closing requirements
• Dealing with risks found in due diligence—indemnification, escrows, earn-outsouts
• Public companies buying private companies
– Governance issues
– Treatment of Executives
– Financials
• Buying the equity means buying the liabilities
• Private Equity
– Control, major decisions, what if things go bad
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Alternatives to “Growth As Usual” St t E ti d – Strategy, Execution and
Financing
Richard K.A. BeckerHogan & Hartson L.L.P.
Charles A. NeffHogan & Hartson L.L.P.
Presenters:
David J. Lundsten, MBA, CPA, CVACherry, Bekaert & Holland, L.L.P.
John T. SchellAltus Associates, LLC
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