REALIZING VALUE - BUYING AND SELLING YOUR BUSINESS

Transcription

1 REALIZING VALUE - BUYING AND SELLING YOUR BUSINESS Presented By: Norm Snyder and Jeff Capron November King Farm Boulevard, Suite 300 Rockville, Maryland F

2 Agenda Why this is important (to you!) Business buy/sell transactions overview Due diligence - buyer and seller What is it worth? Transaction type (asset purchase or stock purchase) and related issues Other issues Questions 2

3 Who we are Norm Snyder, CPA Leads the A&C Technology Industry Services Group Over 30 years audit, consulting, due diligence and operating company experience Jeff Capron, CPA/ABV Leads the A&C Diversified Commercial Services Group Over 30 years valuation, tax, audit, consulting and litigation support experience 3

4 Aronson & Company 230 people 48 years old Based in Rockville, MD (serve entire DC area and beyond) Top 50 U.S. CPA firm (Public Accounting Report) Best Places to Work two years in a row (2007, 2008) Variety of industry niches including technology, manufacturing/distributors, professional services, government contractors, construction, real estate, non-profit, employee benefit plans. Variety of service niches including business valuation, due diligence, litigation support, assurance, tax, public companies Member of Praxity (national and international scope) 4

5 Why this is important (to you!) All successful businesses will be sold or transitioned to another ownership group May involve arms length sales/transfers to third parties or transfers to the next generation. Our focus today is arms length transfers. Tremendous opportunities for buyers & sellers to create and realize value Keys to success - long term planning, due diligence and execution. Sellers - long term planning 3 to 5 (or even 10) years Buyers - need well thought out plan 5

6 Why this is important (to you!) Key points - M&A is an art, not a science Value of the business is set by the results of the auction or negotiation (not by the valuation experts or rules of thumb) Terms of fthe deal are as important tas price in determining i the overall value to the buyer/seller Avoid the last minute calls to your CPAs and experts This webinar is designed to give you an overview of the process. Each section can be discussed more in depth in future discussions. 6

7 Business buy/sell transactions overview Key (for both buyer and seller) to maximize value is to be well prepared. Buyer s perspective and process: Identify goals and objectives Identify your team Identify and approach your targets (research & information gathering, LOI, due diligence) Negotiate final agreement 7

8 Business buy/sell transactions overview (continued) Seller s perspective and process: Identify goals and objectives Implement the plan to maximize value (likely will take 2 to 5 years or longer) The seller ss team Identify and approach buyers Negotiate the final agreement 8

9 Due Diligence Seller s preparation (some more aspects of the seller s 2 to 5 year preparation plan) : Verify buyer s ability to finance the acquisition before buyer s due diligence You want no significant surprises to arise during buyer s due diligence. Surprises can kill deals or lead to lower consideration to seller. Accounting issues can especially cause problems since the LOI was based on your numbers (common problem areas include revenue recognition, lack of vacation accruals, warranty accrual issues, inventory accounting and valuation issues, receivable allowances, un-accrued liabilities, including tax liabilities, etc.) Have all important legal and financial documents readily available (legal documents should be current, complete and signed) use electronic data room Consider who of your employees/customers will know about the possible sale Investigate the buyer if not an all cash deal. 9

10 Due Diligence (continued) Buyer s due diligence: Coordinate your team (clarify roles and who is in charge). Due diligence is often broken down into legal, operational, financial, and strategic. Legal generally includes drafting transaction documents, review of contracts & leases, review of organizational documents, risk analysis (what could go wrong?), contingent liabilities, review of significant other seller legal documents, coordination of the closing, etc. Operational includes review of products & services, customers, workforce & management, intellectual property, pricing, marketing, computer systems, industry & competitors, synergies, etc. 10

11 Due Diligence (continued) Buyer s due diligence (continued): Financial includes reviewing financials, budgets, auditor s workpapers, internal controls, support for assets being acquired and liabilities being assumed, revenue recognition and other accounting policies, support for reported revenues and expenses, tax returns, tax audit reports, reserves, contingent liabilities, analytical/trend comparisons, etc. What are the key drivers of financial success & do they appear sustainable (quality of revenues and earnings)? 11

12 Due Diligence (continued) Buyer s due diligence (continued): Strategic includes consideration of key aspects of the target that fit into the buyer s strategic plan. Are they real and achievable? Key reviewing all the documents and information is important, but personal interaction with key players is vital. 12

13 Due Diligence (continued) Some due diligence war stories International company making strategic acquisition of US software company to expand into US market. Seller s management oversold its financial situation and acceptance of software. Financial due diligence revealed revenue recognition overstatement and deteriorating and uncollectible receivables that had not been Seller had been audited, but audited financials proved faulty in revenue recognition. Deal collapsed. Too wide a gap. Turns out seller was on its last legs but management was trying to hide it. Privately held technology products company was buyer in a reverse merger with a public company that had some products & technology of interest to buyer. Seller was to be paid in stock of the resulting company and completed its own detailed due diligence of the buyer. Buyer had its house in order, including well done financials and audit workpapers. Seller had no significant issues & deal closed. 13

14 Due Diligence (continued) Some due diligence war stories (cont.) Contractor buyer wanted to acquire similar, but smaller seller, to expand revenues and customer base. Significant part of the value to the buyer was a pending revenue contract. Due diligence revealed the pending contract was very iffy despite seller s assurances to the contrary. Buyer and seller tried but were unable to agree on contingent consideration so the deal did not close. Postscript - the pending contract was not received - buyer would have substantially ti overpaid if the deal had closed. Seller, a software company, that would give buyer, also a software company strategic new products and IP. During due diligence buyer found some issues with seller s revenue recognition on several contracts (GAAP not followed). Seller restated its numbers. Overall result was not material, but embarrassing. Deal closed with some minor delays. 14

15 What is it worth? Some valuation considerations: Final value determined from good negotiation process. Valuation analyses prepared by professionals may help guide buyer and seller but don t set the final value. Seller should let buyer determine its own value and offer initial pricing to begin negotiations. Seller won t know enough about what is driving buyer and aspects that may be of special value to them. Value of a business will change with time and circumstances and value will differ from buyer to buyer. Deal terms could significantly impact the price. 15

16 What is it worth? (continued) Valuation methods (three primary approaches to valuation): Income approach - discounted cash flows or capitalization of earnings. Two primary drivers of value in this approach: estimate(s) of future cash flows and the discount rate to be used. Market approach - public company guideline method or private company transactions guideline method. Finding comparable data may make this hard to use, but, if such data exists, this approach may provide reliable value indicators. Asset approach not often used for operating companies 16

17 What is it worth? (continued) Other possible valuation considerations Normalized earnings vs. reported historical earnings Adjusting cash flows to reflect cash flow likely available to buyer Control position- impact of any minority ownership Lack of marketability Investment value considerations- valuation issues of interest to the particular buyer Buyer s alternatives Industry rules of thumb- does the deal make sense? Affordability- does the deal make sense to the buyer financially? 17

18 Transaction type Two main transaction types: asset purchase and stock purchase. Asset purchase - buyer buys identified assets and assumes identified liabilities. This could represent substantially all of the assets and liabilities of the target or only some. Stock purchase - buyer buys stock of the target company. This could represent 100% of all stock or less. Asset purchases are more common among smaller companies and stock deals are more common in larger transactions. Tax treatment often is very different ent depending on whether the deal is asset based or stock based. Due diligence considerations will vary based on the transaction type. 18

19 Transaction type (continued) Asset purchase: Potential significant tax problem for seller if C Corporation. Sale of assets and subsequent liquidation of corporation (with in distribution to shareholders) will usually result in double taxation. For C Corporation, gain from sale of assets is taxed at ordinary corporate rates and then shareholders will be taxed at capital gains rates upon liquidation. This may be mitigated by NOLCF. For S Corporation, gain from sale of assets is passed through to shareholder and taxed as ordinary income or capital gains depending d on the nature of the asset sold and the amount of cash distributed. However, S Corporation may be subject to built in gains tax at the corporate level if target has been S Corporation for less than 10 years. Normally a good idea for companies (as potential future sellers) to elect S Corporation status as part of a long range (10 year) plan to sell. 19

20 Transaction type (continued) Asset purchases: (continued) Buyer may want asset based transaction to get increased basis in assets for tax purposes. IRS Form 8594 filed by both buyer & seller to allocate price. Requires buyer and seller to take identical positions and thereby minimize audit risk. Non-tax considerations to seller include: problems with piecemeal sales and what is left, liabilities (contingent and non-contingent) may not be assumed, seller may want to keep certain assets or product lines. Non-tax considerations to buyer include: acquiring only assets they want, limit assumption of liabilities and contingent liabilities, bulk sale laws may bring liability to seller, not assume unfavorable agreements, more difficult to assume valuable contracts, possible higher transaction costs to transfer each asset. 20

21 Transaction type (continued) Stock purchases: In general, tax treatment is better for seller (cap gains/single tax) and worse for buyer (no asset step up). Also, use of NOLCF may be significantly limited to buyer (IRC 382) Non-tax considerations to seller include: liabilities (actual and contingent) passed to buyer, easier to implement, may involve more due diligence and negotiation effort to respond to buyer s concerns. Non-tax considerations to buyer include: favorable agreements and intangible assets more easily acquired (but contract transfer issues in change of control are significant issue), more concern about liabilities (actual and contingent), use of escrows and holdbacks to minimize risk to buyer, due diligence may be more involved. 21

22 Transaction type (continued) Other possible considerations: IRC 338 election - stock purchase treated as asset purchase (rare due to conditions and since buyer may have to pay current tax) IRC 338(h)(10) - buyer get stepped up basis and seller subject to current tax (may work if NOLCF) IRC 1042 tax deferred sale of C Corporation stock to an ESOP IRC 368 tax free reorganizations- exchanges of stock may defer taxes to selling shareholders. IRC 382 limitations on use of NOLCF after certain changes in corporate stock ownership 22

23 Other issues Transaction terms may significantly impact the value of the transaction consideration. Possible terms include: Escrows - longer term (1 to 2 years) to deal with collectibility of A/R, liabilities not recorded, other seller warranties. Specific holdbacks - shorter term to deal with specific issues such as contracts assignment approved. Seller financing. Financial targets - balance sheet or working capital targets which may reduce price paid if not met at closing. Earnouts - part of purchase price contingent on certain events or targets. This is a way to bridge expectation gaps between buyers and sellers. If controlled by seller, perhaps best for buyer if related to gross profit and not just sales. Non-compete agreements for seller. 23

24 Other issues (continued) Types of buyers: Family Management (LBOs) ESOPS Financial buyers (private equity/vcs) Strategic buyers (larger companies in same industry) Overseas buyers IPO 24

25 Other issues (continued) Key issues summarized All businesses should adopt long range plans for sale or transition to new owners. Potential sellers should work to maximize value and minimize surprises (to buyers). Run company in normalized way to build value. Terms are as important as price. Clean financial accounting and financial statements are vital. Outside advisors should be part of the team. A buy/sell transaction is a complex negotiated (or auction) transaction. Seller should under promise and over deliver. 25