Suppose you own 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 the rest of this entry »

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 the rest of this entry »

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 the rest of this entry »

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 the rest of this entry »

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 the rest of this entry »

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 the rest of this entry »

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 the rest of this entry »

Middle Market investment banking activities felt the effects of the financial crisis.  M&A deal volume for the middle market fell 39 percent in 2008 compared to 2007 and has fallen even further into 2009.  The harsh credit markets have left their mark on the middle market.  The average deal value in Q1 2009 was $64.1 million, down from $93.4 million in the fourth quarter of 2007.  The decrease in average deal size can be accredited to conservative valuations due to the added risk and limited debt funds available.  The incentive for an owner or principals to sell their business has sharply decreased and left many waiting for a more optimal, but indefinite exit timeline.

Traditional business models and financial investments have lost effectiveness, allowing a higher demand for alternative strategies and investments.  Private Equity groups are tentative to invest because of the risk coupled with difficultly accessing debt to leverage the scale of their investments.  An alternative investment like a Management Buyout (MBO) presents an appealing opportunity to private equity. Why? Read the rest of this entry »

When selling a business there are many layers of confidentiality and they are all a major concern to business sellers. More often than not, when we hear a seller express concern about confidentiality they are primarily focused on the possible damage competitors might cause should they learn that the business is for sale. This is a real concern about which many articles have been written; however, another layer of confidentiality which has received less attention is that which relates to employees.

Sound working relations with employees are an important component of every business. While confidentiality can be a far greater perceived problem with regard to employees than an actual problem, with proper planning it is possible to minimize the risk of untimely disclosures. Read the rest of this entry »

As Investment Bankers, we are often asked, “What kills most deals?” This is an especially critical concern in uncertain economic times like those we are in now. Unequivocally, our answer, regardless of the economic situation, is always the same, “Time is not your friend in deals; it is the ultimate deal killer.”

When we reflect upon our deals that did not get done, or those that died between Letter of Intent and Closing, regardless of the specific reason, time killed all of these deals in some why or another.

Once a seller of a business makes his/her decision to sell the business, time does not move fast enough. Sellers imagine the worst: customers or employees learning of the sale; declining revenues; problems with the business; all these events happening the longer a deal takes to get done. Some of these fears are justified, others are not. Read the rest of this entry »