Selling Your Company. June 2012 Howard E. Johnson

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1 Selling Your Company June 2012 Howard E. Johnson MBA, FCA, FCMA, CBV, CPA, CFA, ASA, CF, C.DIR 1

2 Speaker Howard E. Johnson MBA, FCA, FCMA, CBV, CPA, CFA, ASA, CF, C.Dir Managing Director, Veracap Corporate Finance Limited (416) ; 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. 2

3 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. 3

4 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,

5 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 5

6 Building Deal Momentum V A L U E E N H A N C E M E N T PLANNING PHASE EXECUTION PHASE Deciding When To Sell Preparing For the Sale Estimating Value and Price The Search For Buyers Preliminary Due Diligence Deal Structuring Negotiations Closing 6

7 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 7

8 Elements of Value to the Seller PURCHASE PRICE VALUE RECEIVED BY THE SELLER TERMS OF THE DEAL INTANGIBLE ASPECTS 8

9 Timing of the Sale Revenues & Profitability Historical Forecast Time 9

10 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 10

11 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. 11

12 Financial Matters The income statement Revenue recognition Expense management The balance sheet Working capital management Capital expenditure management Redundant assets Tax Planning!! 12

13 Valuation Prospective Cash Flows Valuation Multiples The Balance Sheet Key = Undertake initiatives to increase or realize shareholder value before soliciting buyers 13

14 Components of Value & Price Post- Acquisition Synergies Intangible Assets & Goodwill Tangible Net Worth 14

15 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 ) 15

16 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 16

17 Multiple of EBITDA Example Normalized EBITDA Multiplied by EBITDA multiple Equals enterprise value Deduct interest bearing debt Equals equity value $ 10 million 5x $50 million ($10 million) $40 million 17

18 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 18

19 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) 19

20 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 20

21 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 21

22 Types of Prospective Buyers Strategic Non-strategic Small corporate / individuals Financial Management and employees Finding the Platform Buyer 22

23 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 23

24 The Traditional Private Equity Mentality Leverage x Growth x Multiple Expansion = Huge ROI Today Exit EBITDA Multiple Enterprise Value Debt Equity $10 M 5 x $50 M $30 M $20 M $20M 6 x $120 M $ 0 M $120 M ROI = 500% 24

25 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 25

26 Transaction Structuring Assets vs. shares Forms and terms of payment The Management Contract Key = Evaluate each proposal based on its riskreward parameters and income tax efficiency 26

27 Forms of Consideration Cash at closing Holdback Seller take-back / Promissory Notes Share exchange Earn-out 27

28 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 28

29 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 29

30 The Buyer/Seller Advantage Curve Seller Buyer Management Presentation Multiple Offers LOI Negotiations Exclusivity to Buyer Closing The LOI is Key 30

31 Closing Detailed due diligence The purchase agreement Final closing Key = Stay focused on running the business 31

32 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 32

33 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 33

34 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 34

35 Resources 35

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