In addition to teaching a “How to Value a Business” continuing education course each year, I am also asked to speak to various groups of CEOs, entrepreneurs and business owners on the same subject.  Regardless of the audience, invariably, someone will ask, “Jim, this valuation stuff is all well and good, but what is a simple multiple of earnings or formula to use to value a business?”

Face it, we all love shortcuts. We learn at an early age the benefits of shortcuts: whether we cut through our neighbor’s yard on our walk to school, clean our room by stuffing our messes into our closets, or even feed our unwanted vegetables to our dog (surreptitiously under the table, of course) so we can get the dessert our mothers’ promised if we clean our plates, who can resist a good shortcut?

Today, I still use the shortcuts my high school mathematics teacher taught us to check our addition and how to quickly multiply by 25. I doubt any of us can get through the day without utilizing at least one shortcut we learned as kids. For business buyers and sellers, multiples are simply shortcuts to the valuation and/or negotiation process.

When applied properly, multiples can be used effectively as sanity or temperature checks/gauges. However, I personally would not want to buy or sell a business based strictly upon a multiple. There are always so many variables to consider when acquiring or selling a business; basing such an important decision on a simple multiple does not make sense. Take a look at the following, admittedly simple, example as a way of illustrating my point. Read more »

Suppose you owned a valuable asset that does not earn any income or it earns very little income.  Let us assume that this property has substantially appreciated in value such that, if you sold it today, you would realize a substantial gain and resulting tax on the gain.  So how can you turn this valuable property into an income producing source without erosion to principal due to taxation?

Answer:  By conveying the property to a Charitable Remainder Trust (CRT).

Here’s how it works:  After the trustor/donor transfers property to the CRT, the property is sold by the trustee.  There is no tax on the sale since the CRT is exempt from income tax under Section 664(c)(1) of the Internal Revenue Code.  The proceeds from the sale are invested into income producing property.  The trustee distributes income to the trustor during his or her lifetime.  Upon death of the trustor, the remaining property (corpus) is transferred to a designated charity.

Besides the benefit of avoiding tax from a taxable sale, in the year of transfer to the CRT, the trustor receives a charitable contribution deduction for the computed value of the charitable remainder interest.  The charitable remainder interest computation is based upon the value of the property transferred to the trust, the type of trust, the payout rate, frequency of payments each year, the mortality table, the applicable federal interest rate, and the age of the trustor.

There are two types of charitable remainder trusts Read more »

Part 3 of 7

We have been looking at the two-fold challenge faced by Business Owners wishing to “extract themselves and their wealth” from their businesses in the next decade.  Firstly, that the economic recovery may be slow, and, secondly, that the retirement of the Baby Boomers will put “10 million” businesses on the market in this period.

From this perspective, we recognize that many companies will not sell without careful planning and preparation.  The point of considering possible “Positioning Strategies” is that most business are not being run with a mind to “selling”, and are typically not optimally prepared for an exit because:

1. the ownership and management roles are not properly separated, and
2. the key determinants of value, namely growth and risk, are not calibrated to the expectations and desires of market buyers (investors)

Exiting through a sale, recapitalization or merger generally involves investors and may involve lenders. Management is pivotal.  Exiting through a transfer of the business to family, management or employees, or through a gifting strategy, may or may not involve lenders but, once again, management is a pivotal issue.  Exiting through liquidation, on the other hand, does not depend on management to the same extent.

Generally, the different Exit Strategies depend on key considerations as follows: Read more »

Although sales price and terms are important components of any stock sale transaction, the structure of such a transaction can have a major effect upon what the seller is left with after taxes are paid on the resulting capital gain.  In the case of a management buyout transaction, a structure worthy of consideration involves the use of a leveraged ESOP.

ESOP is an acronym for Employee Stock Ownership Plan, which is a special type of qualified employee benefit plan.  An ESOP is a defined contribution plan that can emulate either a money purchase pension plan or a profit sharing plan.  An ESOP is similar to a stock bonus plan except that, unlike a stock bonus plan, it can utilize the credit of the company, borrow funds from outside sources, and use the funds to purchase company stock from existing stockholders.  The fact that an ESOP can enter into this type of leveraged transaction is what makes it different from all other qualified employee benefit plans.  The act of borrowing funds through the credit of the company and buying company shares is considered a prohibited transaction for all other employee benefit plans under the Employee Retirement Income Security Act of 1974 (“ERISA”).

As with other employee benefit plans, the ESOP operates as a trust.  Therefore, an Employee Stock Ownership Trust (“ESOT”) is created and a designated trustee or trustees serve in a fiduciary capacity on behalf of the employee beneficiaries of the trust.  The trustee or trustees for the ESOT are appointed by the company’s board of directors. Read more »

While working on a recent transaction where we represented a seller who was looking to complete a Management Buyout sponsored by private equity groups, one of the potential equity sponsors told us,  “We will only invest in this transaction if there is another investor group who invests along side us.”  “Is that to minimize your risk,” I asked.  “No, it is our requirement to have a co-investor because it validates our investment philosophy.”

In other words, like sheep who flock together, this investor group was satisfied with an investment so long as someone else came to the same conclusion.  “But what if you like the opportunity but do not find a co-investor,” I inquired of the group.  “Then we walk away from the opportunity,” I was told.

This group, and many others with same investment criteria, are not willing to trust their own instincts but need validation from others.  Ultimately, this is a sheep mentality… following others at all costs.

Eagles, on the other hand, hunt and soar alone.  They find their prey and seize the moment.  Eagles have the courage and temerity to make their own decisions based on their own standards and criteria and seize the moment regardless of what others around them are doing. Read more »

Part 2 of 7: The Solution – Know the Endgame

The Issue is how to Extract yourself and your Wealth

We’re looking at how business owners can most successfully extract themselves and their wealth from the company they own and, typically, run, recognizing that the success of this critical process will have a direct and significant impact on their family, associates, employees and, of course, themselves. Business owners want to know that their legacy is assured and that a wealth transfer can be effected to assure their life-after-business goals, including the protection of their loved ones.

In Part 1 I noted that my Business Owner clients are encountering a challenging and demanding market, partly because credit has been tight, and partly because buyers are already anticipating the boomer exit era which will give them multiple acquisition options and the ability to be selective, pursuing only quality opportunities. I also noted that this “oversupply” does not appear to have an end in sight, which means that business owners expecting to exit in the next decade need to be systematic, employ a professional team, plan, prepare and execute a selected “optimal” exit strategy.

It will take a Military Campaign to engage and overcome this Market Condition

Not a single day goes by without someone in the media asking how it is that we’re engaged in Iraq or Afghanistan without an Exit Strategy. i.e. without knowing when, why and how we will ensure an endgame.

Don’t be reactive or opportunistic about selling your business! Be proactive, methodical and in control! Read more »

Singing In the Rain

No doubt, for the past 18 months, the current economic crisis has hung over our heads like a summer storm over the Great Plains.  We are certain it will pass, but its rains and winds can produce lasting damage for all in its path.  In times such as these, we can either seek the comfort and security of shelter, or, more aggressively, we can learn to sing and dance in the rain.

Recently, I was invited to attend a recent summit of CEOs of mid-market companies.  I heard many CEOs who literally shouted: “Now is not the time to seek acquisitions because we do not know if we have hit bottom yet,” “Banks are not lending like they once did,” “How can we consider an acquisition now when we have our own business challenges?”  These were common themes and common statements during presentations, around the lunch table, and at the bar during cocktail hour.

However, a few of CEOs, those who I will call the “enlightened elite” embraced an alternative approach, exclaiming for all who would listen: “There has never been a better time than now to make acquisitions. Read more »

Part 1 of 7: The Challenge

In advising business owners during this past year, I have seen, firsthand, how unforgiving the market has become. In one case, rather than wait to sign an LOI, a seller invested in audited financial statements simply to increase the odds of being shortlisted. In another, a business owner accepted the buyer’s premise that a full-price deal required that he stand behind his projections in the form of a significant contingent payment.

Is the “unforgiving market” just the recession, or a reflection of a long term reality?

Boom-er Bust

I read daily about the challenges facing boomer business owners expecting to sell in the coming years. Frankly, it’s not just boomer business owners, it’s ALL business owners who are affected by this extraordinary situation. My clients are finding that it takes perfect planning and execution to reach the finals of the beauty contest. Good enough just doesn’t cut it any more … and won’t, for the foreseeable future!

According to an article published by Robert Avery of Cornell University in February 2006, “the majority of boomer wealth is held in 12 million privately owned businesses, of which more than 70% are expected to change hands in the next 10 to 15 years.” Read more »

Mezzanine Debt

Today’s economy has put many private companies in a tight spot.  Companies end up with too much bank debt as business volume and profits contract.  But lower earnings mean that company owners who would have been ready to sell their companies now can’t do it because they end up with too little after paying off their banks.

So, how can you reduce your bank debt, improve your cash flow, and stay tough while you wait for the outside economy and your earnings to recover?  One answer is mezzanine debt.

Mezza-what?  Mezzanine debt gets the name because it’s half way between senior bank debt and equity.  Because it’s kind of both, it serves really well in the right situation.  Mezzanine is semi-permanent capital, like equity, so the company does not have to make monthly or quarterly payments of principal.  It usually has a 5 to 7 year term. Read more »

Not Just For Big Companies

Recently, I was asked to speak to a group of CEOs of mid-sized companies regarding EBITDA and its importance to them as business owners. Several questions from the group centered on what I will loosely call “tax avoidance” and “tax deferral” practices commonly employed by owners of privately held companies. The questions focused upon the impact of these practices on the value of a business. The common theme from the audience was, “buyers understand owners do not want to pay taxes and they are willing to adjust for these practices.”

I reminded the group that buyers, or anyone who is reviewing the performance of their companies, will only be able to evaluate what they can see. If you are writing off inventory, expensing personal items, or employing any of the myriad other “tax avoidance” practices, you do a nice job of lowering your tax burden, but you may not be able to get a return on this “investment” when you look to “withdraw” these funds. All of these practices impact your cash flow positively for you, but not necessarily for those evaluating your company. Read more »