Business Exit, The Owner's Perspective - Doug Smith

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Presentation to[list audience here]

Doug Smith, PartnerB2B CFO®

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Business Exit:The Owner’s Perspective

What Is B2B CFO® ?

Established: Founded in 1987

National : 200 Partners in 39 states, 5700 years of experience

Focused: Privately-held companies with sales between $1 - $75M

Affordable: Part-time CFO services, as needed

We are Specialists In:

Banking and Lending Relationships

Profit Improvement

Financial and Strategic Planning

Cash Flow Projections

Working Capital Improvement

Gross Profit Optimization

Expense Reduction

Timely & Accurate Financial Statements

Increased Sales

Exit Strategies

Who Am I?

• 33 Years in Operations, Finance, Administration• COO, CFO, CAO• Government Contracting, IT, Healthcare• M&A experience (seller, buyer)• American Management Systems, MITRE, other

small and mid-market businesses• BS Engineering (Princeton), MBA (Harvard)

Some of Today’s Content is From…

• John Leonetti is the Managing Director of Pinnacle Equity Solutions

• Pinnacle Equity Solutions is a B2B CFO® partner

What We Don’t Have Time for Today

• Details of deal structuring• Asset vs. stock acquisitions• Multiple owner issues (e.g., buy/sell agreements)• Handling the proceeds

– Estate planning– Investment– Tax planning/avoidance

The Exit Environment

• 70% of private business owners report that their business is their primary source of income

• Only 5% of privately-owned businesses successfully sell to an outside buyer– Only 25% of private businesses are offered up for sale– Only 20% of those successfully sell

• 27 million U.S. businesses (2009)– 99.9% have less than 500 employees– 21 million have no employees– 18,000 large businesses

• Firm survival– 70% survive at least 2 years– Half survive at least 5 years– One-third survive at least 10 years– One-fourth survive 15 years Source: SBA

Exit Environment (cont’d)

• Much Baby Boomer wealth tied up in 12 million privately-owned businesses– 70% of these owners will exit in the next 15 years– $3-4 trillion in wealth will change hands

Public vs. Private Markets

Public Markets (Wall Street) Private Markets (Main Street)C Corporation C, S, LLC, etc.

Value established by market at any point in time Value established at a point in time

Ready access to public capital No access to public capitalShareholders have limited liability Shareholder(s) have unlimited liabilityShareholder holdings are diversified Shareholder earnings not diversifiedProfessional management Owner managementCompany has long life Company life typically < one generationLiquid securities, efficiently traded Illiquid securities, inefficiently tradedProfit maximization goal Personal wealth creation goal

10-Year Transfer Cycle

Deal Recession(Buyer’s Market)

Prime Selling Time(Seller’s Market)

Almost Recession(Neutral Market)

1980199020002010

1983199320032013

1988199820082018

1990200020102020

Exit ≠ Sale

• Exit definition:

Transferring some or all of your business’ value to someone else, in exchange for more liquid assets

What are the Exit Options?

• Sale to an outsider• Recapitalization (e.g., Private Equity investment)• Employee Stock Ownership Plan (ESOP)• Management Buyout• Gifting (to family, to charity)

• Sale to an outsider• Recapitalization (e.g., Private Equity investment)• Employee Stock Ownership Plan (ESOP)• Management Buyout• Gifting (to family, to charity)• [Status Quo] Stay and (ideally) grow• Initial Public Offering (IPO)• Close down the business and liquidate assets• Bankruptcy• Death

Why Do Owners Exit Their Business?

Why Do Buyers Acquire A Business?

What Do Exiting Owners Do With Their Proceeds?

• Provide for their own retirement• Provide for loved ones• Share rewards with others who helped them build

their business• Contribute to charity• Invest

– Diversified savings for growth and income– Start another business– Join angel or private equity investment groups

Owner Readiness to Exit

Mental Readiness

FinancialReadiness

HighLow

Financial Readiness

• How much of my wealth is tied up in the business?• How much of the proceeds do I want/need to keep for

myself?• Do I depend on the business to support my lifestyle?• Am I prepared for the loss of:

– Salary– Benefits– Deductible Perks (travel, auto, meals)

Mental Readiness

• How involved am I in the day-to-day running of the business?– Am I addicted to being a business owner– Will I know what to do with my time when I am no longer

in the business?

• Do I view my business as an investment?– Can I make dispassionate decisions, based on objective

criteria, about the exit process?

• Am I feeling burned out?

Owner Readiness to Exit

Mental Readiness

FinancialReadiness

HighLow

Four Types of Owners

• Well off, but choose to work• Rich, and ready to go• Can stay and grow the business• Get me out right away at the highest possible price

Owner Type by Readiness

Mental Readiness

FinancialReadiness

HighLow

Well off, butchoose to work

Rich, and readyto go

Stay and growGet me out now

at the highestpossible price

• Sale to an outsider• Recapitalization (e.g., Private Equity investment)• Employee Stock Ownership Plan (ESOP)• Management Buyout• Gifting (to family, to charity)• Stay and grow

Exit Options vs. Readiness

Mental Readiness

FinancialReadiness

HighLow

Management Buyout, ESOP,

Gift, ESOP,Sell

Recap, ESOP,Stay and grow

Sell for the highestpossible price

Putting It All Together

Mental Readiness

FinancialReadiness

HighLow

Management Buyout, ESOP,

Gift, ESOP,Sell

Recap, ESOP,Stay and grow

Sell for the highestpossible price

Mental Readiness

FinancialReadiness

HighLow

Well off, butchoose to work

Rich, and readyto go

Stay and growGet me out now

at the highestpossible price

Why Do Owners Exit Their Business?

Why Do Buyers Acquire A Business?

Sources of Capital

RevenueGrowth

Friends &Family

AngelInvestors

VentureCapital

PrivateEquity

What Do Buyers Buy?

• People (management team, workers)• Reputation/Brand• Future cash stream• Intellectual property• Contracts• Customer/client relationships• Assets and Liabilities on the Balance Sheet

– Cash (usually goes to the seller)– Fixed Assets (buildings, equipment, furniture, computers)– Inventory– Debt Obligations

What Can Prevent a Successful Exit?

• Business cannot survive once the original owner no longer involved

• Keeping family in the business is more important than selling to an outsider

• Potential buyers can’t get the financing needed to acquire the business

• Poor economy has reduced profitability• The owner’s price expectations are unrealistic

What is the Business’ Value?

• Four types of value– Liquidation value (LV)– Fair market value (FMV)– Investment value (IV)– Synergy value (SV)

• FMV may be discounted for partial transfers– Lack of control– Lack of marketability

ESOP,Gift

ManagementBuyout, Recap

StrategicSaleSV

Discount

LV Liquidation

Synergy Value (from the Buyer’s Perspective)

• Removing competition• Reducing seasonal fluctuations• Critical mass• Expanded geographic reach• Increased prestige• Reduce indirect cost % through consolidation and

elimination of duplication

My Business as an Investment(“Why isn’t it worth what I think it is?”)

• People/organizations with money can invest it different ways– Equities have returned, historically, 10%+ annually– Buying a small business is inherently a risky investment

• Can it prosper without the current owner?• Business will still be illiquid after the sale

– Greater risk = greater expected return– Buyers expect 20-40% annualized return

• Generally speaking, buyers pay for a multiple of company’s cash flow (EBITDA), adjusted for their risk perception

• For given cash flow, higher risk premium → lower price

How Do Owners Determine Their Business’ Value?

• What is needed to sustain (or improve) my personal lifestyle after my exit– Salary– Benefits– Some previously-deductible business expenses now become

personal (travel, meals, cars)

Replacing The Company CarCar Lease $500 Annual Cost $10,200 Insurance $100 Marginal Tax Rate 40%

Fuel $100 Annual Cost (pretax) $17,000

Maintenance $150 Investment Return 6%TOTAL $850

Assets Needed $283,333 Annual Cost $10,200

What is the Business’ Value?

“Owner’sLifestyle

PreservationValue”

ESOP,Gift

ManagementBuyout, Recap

StrategicSaleSV

Discount

LV Liquidation

What Does the Owner Net?(“How Much Do I Get to Keep?”)

• Sale/Transfer Price• Plus

– Liquid assets pulled out of business• Cash above that needed for Working Capital

• Minus– Payoff of business debt– Transaction Fee (Double Lehman Formula)

• M&A Broker or Investment Bank

– Hourly Fees• Lawyers, Accountant, etc.

– Taxes (Federal, State, Capital Gains, Ordinary Income, Estate)– Earn-Outs

• Replacing non-competitively-won business• Achieving certain milestones (e.g., revenue growth, profitability)

Double Lehman Formula

• 10% of the first $1,000,000 $100,000• 8% of the next $1,000,000 $ 80,000• 6% of the next $1,000,000 $ 60,000• 4% of the next $1,000,000 $ 40,000• 2% of the next $1,000,000 $ 20,000• 2% of each additional $1,000,000

• Sale Price of $20,000,000 $600,000

Total Wealth in a Partial Exit

Assets Removed from the

Business and Reinvested – compound

annual growth

Annual Continuation of Salary, Benefits,

and Perks

Net Proceeds from Final Sale of the Business

When Should an Owner Start to Plan the Exit?

When Should an Owner Start to Plan Their Exit?

Now!(Even if the exit event is years away)

(Exit Planning is a process, not a milestone)

Exit Strategy Plan

Leonetti: “The written goals for the succession of a business’ ownership and control, derived from a well-thought-out and properly-timed plan that considers all factors, all interested parties, and the personal goals of the owners in a manner and time period that accommodates the business, its shareholders, and potential successors and/or buyers”

• Written goals• Succession of

ownership and control• Detailed plan• Considers needs of all

interested parties

Get Ready to Sell/Transfer

• Increase the value of the business– Increase sales– Improve profit margin– Reduce internal costs through efficiency, streamlining, focus– Strengthen infrastructure (management, people, systems,

process documentation)– “Lock In” key individuals with incentives– Diversify customers and contracts, if concentrated– Document and protect IP– Build a track record of good financial management

(financials reviewed by CPA, correct tax returns)

Get Ready (cont’d)

• Get mentally ready– See your business the way investors will look at it– Make decisions like an investor, not as an emotionally-

invested owner– Be prepared to not live out of your business– Decide what you’ll do with your time after exiting

• Line up advisors

$2M - $5M

BusinessBroker

$5M - $25M

M & ASpecialist

$25M - 100M+

InvestmentBank

Transactional Advisors

CPA Attorney

InsuranceWealth

Valuation Estate

Relationship Advisors

Independent “Quarterback”

Understand Paperwork to be Signed

• Letter of Intent (LOI)– Outlines fundamental deal points– Starts due diligence process– Often has an exclusivity clause

• Purchase and Sale Agreement (a.k.a Definitive Purchase Agreement)– Includes representations and warranties– Include any negatives– Must be in writing, even if discussed verbally during due diligence

• Non-Compete Agreement• Earn-Out Agreement• Seller-Financing Agreement

When Should an Owner Start to Plan Their Exit?

Questions? Comments?

Doug Smith, Partner, B2B CFO®

e-mail: dougsmith@b2bcfo.comphone: 703.927.9823

Business Exit, The Owner's Perspective - Doug Smith

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