Exit Strategies Sells Aldetec, Inc. to Private Equity Backed Strategic Buyer

/in , /by Jim Leonhard

Sacramento, California – Exit Strategies is pleased to announce the acquisition of microwave electronics manufacturer Aldetec, Inc. by U.S. Technologies, a portfolio company of Cornerstone Capital Holdings.

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Sold To:

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Aldetec, Inc. designs and manufactures integrated microwave assemblies and RF amplifiers for the commercial, military and space flight industry sectors. US Technologies (UST), of Fair Lawn, New Jersey, provides quality electronics design, manufacturing, engineering, testing, repair and refurbishment services, from complete finished units down to the component level. Cornerstone Capital Holdings, which owns UST, is a private investment firm that seeks to acquire niche manufacturing and industrial service companies with enterprise value ranging from $5 to $50 million.

Exit Strategies (ESGI) represented the sellers on an exclusive basis in this transaction. In the course of our sale engagement, we prepared a business valuation, composed the offering memorandum, marketed the company confidentially, negotiated on behalf of our client, managed the sale process and advised the sellers throughout the transaction. Deal terms are of course confidential.

For further information or for advice and representation in the sale, merger or acquisition of a company, contact Al Statz at 707-781-8580 or alstatz@exitstrategiesgroup.com.

About Exit Strategies

Exit Strategies Group, Inc. is a respected lower middle-market mergers and acquisitions advisory and business valuation firm based in California. ESGI brings M&A experience, proven processes and meticulous attention to detail to help private business owners sell, merge and acquire companies, as well as partner with private equity groups to grow and maximize value in an eventual exit. Our advisors have more than 100 years of combined experience in business merger and acquisition transactions in a variety of industries including sophisticated electronics manufacturing.

Don’t Forget the Net Investment Income Tax when Selling a Business

/in , /by Al Statz

The Net Investment Income Tax, which our friends at the IRS put into effect in 2013, takes an extra toll on business owners who sell their businesses; and for that matter, on most higher income taxpayers and any moderate income taxpayer whose income increases suddenly in a given tax year.

What is the Net Investment Income Tax?

The Net Investment Income Tax (“NIIT”) is a 3.8 percent federal tax on certain income of individuals, estates and trusts whose modified adjusted gross income or “MAGI” exceeds certain threshold amounts. Common forms of investment income are interest, dividends, capital gains and passive business activities such as rental income or income derived from royalties. Generally, wages and income from an operating business are NOT considered net investment income.

For individuals, the MAGI threshold is $250,000 (married filing jointly) and $200,000 for single filers. Taxpayers with MAGI over the threshold are taxed at a flat rate of 3.8 percent on all net investment income, in addition to other taxes!

When you sell a business of any significant value, NIIT will likely affect your tax liability in the tax year(s) in which you receive payment. Individuals report (and pay) net investment income tax on IRS Form 1040; while estates and trusts use Form 1041.

So, what should business owners do?

If you are considering the sale of a business or business interest, it is important that you fully understand the tax implications of a sale beforehand. There are strategies that you can use to minimize your tax liability if you take action early enough and/or structure the sale in certain ways. Contact your tax advisor to estimate your tax liability and find out what can be done to maximize your after-tax proceeds.

 

Exit Strategies are not tax professionals, and we do not provide tax advice. However, tax issues arise in nearly all of our exit planning, valuation and M&A brokerage engagements, so we are well aware of them. If you are looking for an experienced CPA or tax advisor to analyze the various federal and state tax issues related to a business transaction and recommend appropriate tax minimization strategies, we can recommend one or two. Feel free to Email Al Statz or call him at 707-781-8580 for help.

Selling an Ecommerce Business in the Lower Middle Market

/in , /by Exit Strategies

With continuing growth in consumer online spending and many high-profile public acquisitions this year, it seems like a great time to sell your online retail business. But things are never quite as simple as they appear.

Over the past few months, several impressive acquisitions have been announced in the public markets. Walmart has purchased Jet.com at a jaw dropping $3.3 billion; a move that is presumably Walmart’s effort to narrow Amazon’s ever-increasing dominance. Consumer brands company, Unilever, acquired Dollar Shave Club earlier this year, another massive $1 billion deal. And the Unilever acquisition machine is still hungry, rumored to be purchasing Jessica Alba’s The Honest Company, also for $1 billion.

Other well-known emerging ecommerce companies have raised impressive sums of money, suggesting incredible valuations. Take Ipsy for example, which raised $100 million in 2015 for their subscription-based make up service.

The above examples all have one or more of the following characteristics in common: Strong intellectual property, unique business model, extreme differentiation, and larger than life CEOs.

Most online stores do not have a Hollywood-famous CEO or an R&D budget to reinvent the consumer shopping experience. How do these companies create acquisition value? In the lower middle market, we often explore exit strategies with CEOs of ecommerce companies; in the process, we’ve discovered two differing models that are both attractive to prospective buyers in their own unique ways.

On one hand, there are many niche-oriented “efficient online stores” – where a majority of sales are generated through channels, and where most products are drop-shipped directly to customers. These companies have narrow, unique product lines – simple enough to manage with a basic ecommerce platform. Such an ecommerce business requires few employees, little or no office space, and virtually no inventory. An online business with these characteristics, and $1 – $2 million in revenues, can be attractive to individual and financial buyers.

On the other hand, many “mature ecommerce businesses” reached an inflection point – where it became mandatory to invest heavily in underlying platforms and technologies, to make difficult decisions about sales channels (and related margins), and to bear the overhead of specialized marketing staff and warehousing. When revenues exceed $5 million with consistent growth and profitability, such online retailers can become attractive to strategic buyers.

Online businesses have become far more competitive and challenging in today’s business landscape. Large players like Amazon increasingly sell virtually every product category, breaking through the old fortress walls of niche-based differentiation. Large players are investing billions in technologies – such as Chatbots and drone delivery – simultaneously creating simplicity for consumers and barriers to entry for smaller online retailers.

It’s always important to consider your exit strategy, while focusing on growth and fundamentals. Are you building an efficient online store or a mature ecommerce business? These strategic decisions prepare your company for eventual exit, and create appeal for the right kind of buyer when the time comes.

Why is That Information Needed?!?

/in , /by Exit Strategies

When we begin a business valuation project the first thing we do is provide an extensive document request list. A week or two into the analysis, we send a customized questionnaire to help us understand the business in appropriate depth. Our questions are designed to understand the facts and circumstances of your business well enough to develop a reliable opinion of value. To the extent we can, we try to streamline and tailor our requests so as not to overwhelm the client.

Most clients trust that we have a method to our madness and dutifully respond to each request and question. Sometimes however we get comments like: You asked for that before! Why do you need that? What does that have to do with value? So and so didn’t ask for that.

It’s an investigation, not an interrogation.

A key fact in most privately held businesses is that owners run personal expenses through the business. We ask about these for several reasons. For starters, a buyer would want to know the core expenses and cash flow of the business; they aren’t usually interested in paying for your kid’s health and auto insurance and cell phone bill. Second, when we add these expenses back, it increases the value of the business. Lastly, and very often overlooked, when owners evaluate post-exit income they often use flawed inputs to forecast income needs.

Case in Point:

On a recent exit plan an owner told me he thought his business was expensing $30,000 in perquisites annually. After we investigated, the actual amount turned out to be closer to $80,000. And that’s pre-tax. To replace that $80,000 after he exits the business, he would need around $120,000 in pre-tax income. That’s a $90,000 annual difference from his guesstimate. Inflation adjust for a 25-year retirement plan, and it produces a very large spending shortfall – or a big change in lifestyle. Isn’t that worth discovering today rather than when you run out of money 5 or 10 years into retirement?

And, no, we are not IRS agents!

This example illustrates why we ask a lot of questions. There are many more areas of your business that we need to investigate. Short-circuiting the valuation process only compromises the result and leads to poor decisions. A reasonably thorough analysis by a qualified valuation expert on the other hand produces a result that can be relied upon to make the best decisions for you, your shareholders and your family.

The Zen Art of Cooperative Negotiation

/in /by Don Ross

zen-negotiationThe common image of an M&A negotiation between a buyer and a seller is that of a rugby scrum: two masses of interlocked muscled bodies scheming and bulldozing their collective strengths in opposing directions in an effort to secure the prize without compromise and ultimately yield one winner and one loser.

In contrast, what I call the “Zen Art of Cooperative Negotiation” is a playing field where the players (the principals and their attorney, M&A broker, and other advisors and stakeholders) become more collaborative and the outcome rewards everyone. The goal is win-win. There are no losers.

Below is a list of strategies that support a cooperative negotiation of business acquisitions, mergers, sales and other business transactions.

  1. Patience. Find a tempo that both can live with. A relaxed, easy swing usually gets more distance and greater accuracy. Set a realistic time frame checklist that keeps everyone on task but allows flexibility.
  2. Accept the personalities that are in the negotiation. Suspend judgment, keeping in mind that the end game is a successful transaction, not a personality contest.
  3. Share your objectives and listen. If you know what your end games are, you can be more mindful of the elements that will get you there. A “give and take” philosophy preserves self respect and encourages cooperation.
  4. Don’t burn bridges. Visualize the negotiation process as a cross country hike, not a tip toe through a minefield. You will encounter obstructions on the journey but with time and effort, most can be resolved. . . .but only if you leave the door open.
  5. Concentrate with your mind and stay loose with your spirit. A clear headed approach tempered with occasional humor can alleviate the stress and tension and optimize performance.
  6. Be honest. Full disclosure is always the best policy, and that applies equally to what you don’t know.

You can connect with Don Ross at 707-778-0210 or donross@exitstrategiesgroup.com.

Using Retention Bonuses to Enable an M&A Transaction

/in , /by Al Statz

Assurance of business continuity is essential to most business acquisitions, and for small to mid-size companies, this often translates to retaining key employees. This blog looks at using a simple tool, called a stay bonus or retention bonus, to keep your key people on board through a sale or merger of your company.

Bonuses are commonly used in business to reward employees for performance, such as hitting a sales target, implementing a new system, or boosting manufacturing productivity. Bonuses can also be used to incentivize a key employee to stay with your company for a specified period of time after a sale or merger.

How much are we talking about here?

sbimageStay bonus amounts are customarily based on the key person’s annual compensation, determined in accordance with the risk and effect of losing them. According to Mercer’s Survey of M&A Retention and Transaction Programs, median stay bonuses paid by U.S. companies range from 25 to 95 percent of base salary depending on the position (see graphic). The way we see this at Exit Strategies is that the stay bonus amount has to be personally meaningful to the key employee. In many of our deals this number is half to two-thirds of a person’s annual compensation.

But isn’t retention a buyer’s concern?

Remember that what gives your business value is the expectation of future earnings, adjusted for risk. As you reduce risk for buyers, your business value and probable selling price go up. From a buyer perspective, the cost of acquiring a business is more than just the purchase price. Other line items on their investment ledger include, for example, legal and professional transaction fees, loan fees and other closing costs, working capital injection (if you retain cash or AR) and any extra compensation paid to employees to ensure their continued employment and performance.

Stay bonuses can come from either side of the table—the seller or the company acquiring—or both. When retention bonuses are paid out of your proceeds, buyers can afford to pay a higher purchase price. So, in the end, it really doesn’t matter which side the bonus comes from.

When is the bonus offered?

Stay bonus agreements (a.k.a. stay-put agreements) are usually offered to (negotiated with) key employees when the owner is preparing to sell the company. Actual timing normally varies by employee and circumstances. Someone who you don’t identify as key to your company’s future may be offered a financial incentive during due diligence to ensure their participation in the short-term post-sale integration process. Integration bonuses are typically offered to CFOs, controllers or IT specialists.

Offering a stay bonus early on arises when an employee is critical to future performance and would be difficult to replace (e.g. a top design engineer or salesperson). Or when you need to involve them in the selling process. It may be compensation for the extra work involved. A third situation is when the employee is aware that you plan to sell the company, and you need them to stay put. When employees become aware that their employer is for sale, they understandably get nervous and may begin seeking alternative employment or become more open to offers of employment. When competitors find out that a company is for sale, key employees are likely to be approached and offered signing bonuses to jump ship. You can mitigate that risk by putting a retention bonus in place early on.

When is a stay bonus paid?

Stay bonuses should be paid out a specified number of months AFTER your deal has closed, not before and not at closing. Remember, you need them to stay on with the new owner. Most retention incentive bonuses are payable within 3 to 12 months after a deal closes. For key-employees who are critical to long-term success, it may be 24 to 36 months. Stay bonus agreements can also have an acceleration provision where they become payable if employment is terminated by the buyer.

How much should I budget for this?

The budget for stay bonuses will depend on several facts and circumstances. It’s a wide range in practice, and in many cases its zero. As a general rule, the larger the company, the smaller this budget is relative to the sale price. Unfortunately for small service businesses with few employees, it can be a significant percentage of the sale price. Some sellers elect to pay bonuses to loyal employees simply to acknowledge their contribution to the company’s goodwill value—unrelated to retention.

Stay Bonus Limitations

Clearly stay bonuses have limitations as a long term retention tool. Ultimately the buyer will need to provide rewarding work, a desirable culture, competitive compensation, growth opportunities and strong leadership. They do however enable transactions by reducing business risk during the critical months before and after an acquisition or merger. And of course there are other forms of financial incentives that can be used to align the interests of owners and employees, such as stock options, stock appreciation rights and phantom stock —a subject for another day.

In closing; retaining key staff affects the overall success of most M&A deals. Key employees drive customer retention, product and service quality levels, and in some cases business survival. Bonusing key employees to facilitate a business sale, merger or acquisition isn’t always necessary, but should always be considered when developing your exit strategy.

California-based Exit Strategies Groiup has been helping company owners plan for and exit their businesses successfully since 2002. Stay bonuses are just one tool in the M&A toolkit. If you have questions or are considering selling your company, Email Al Statz or call him at 707-781-8580 for a confidential consultation.

Can You Sell a Contracting Business to a Buyer Without a License?

/in , /by Adam Wiskind

Solar Installers, General Contractors, Electricians and Plumbers in California have something in common when it comes to selling their businesses. All of these businesses require a Contractors State Licensing Board (CSLB) license to operate. This can be an additional burden to the process of transitioning a business to a new owner. What if a potential buyer doesn’t have the necessary licenses? The easiest solution to this issue is to target investors that already have the Licenses needed to operate the business but this obviously limits the pool of potential buyers.

It is possible to sell a contracting business to an individual without a CSLB license but it requires some negotiation, trust and planning between the seller and buyer. To maintain their Contractor’s License a contracting business must employ or associate with a “Qualifying Individual” or “Qualifier”. A Qualifier has demonstrated knowledge and experience in the construction industry and can either be a Responsible Managing Officer (RMO) or a Responsible Managing Employee (RME) of the company.

An RMO/RME is according to California Law permanently employed by the applicant and is actively engaged in the operation of the applicant’s contracting business for at least 32 hours or 80 percent of the total hours per week such business is in operation, whichever is less. An RMO and RME may have different duties within the company but their responsibilities and liabilities with respect to the license are the same.

A contracting business can be sold to a buyer without a contractor’s license as long as the Qualifying Individual for the company is willing to continue to be employed by the business until the buyer is able to obtain the necessary licenses or hire a new Qualifying Individual. Under this approach managerial control will inherently be divided as the Seller’s Qualifying Individual will want to maintain close oversight of the contracting work being performed. Typically these situations are transitional because the new business owner will want to obtain the necessary licenses themselves or hire their own Qualifying Individual.

Exit Strategies Group has sold many California contracting businesses; some to investors who did not have the necessary CSLB licenses prior to the sale/acquisition transaction. With legal consultation, careful planning and development of trust between parties we help our clients to navigate this obstacle and successfully exit their contracting businesses.

Please contact Adam Wiskind at (707) 781-8744 or awiskind@exitstrategiesgroup.com about selling a Solar Installation Company, Construction Company or any other company requiring a California Contractor’s License.

Add-On Acquisitions are on the Rise

/in , /by Jim Leonhard

When developing an exit strategy for your company, we will consider whether Private Equity Groups (PEG’s) would want to acquire it as either a new platform company or as an add-on (also “bolt-on”) to one of their existing portfolio companies. Most small companies are too small or don’t have strong enough management teams to be attractive platform opportunities, however many are strong add-on candidates. According to PitchBook, which tracks the PEG M&A activity in the middle market, the number of add-ons as a percentage of all acquisitions grew from 43% in 2006 to over 60% in 2015 — and Q1 data showed a continuing increase to 68%.

buyoutactivityWhat has caused this trend? A number of reasons are generally cited, including:

  • Larger companies typically trade at higher valuation multiples, and this gap has risen in recent years
  • It has become increasingly harder to find good platform companies making add-ons more appealing
  • Add-ons are easier to assimilate because the PEG already knows and understands the industry
  • The increasingly shorter holding periods for platform companies makes a buy and build with add-ons a favored strategy
  • An add-on can increase a platform company’s competitive position in its industry by providing synergies or access to a new niche market
  • PEG’s can often use more debt to buy an add-on and invest less equity

As a potential seller of an add-on company, you might consider these questions, among others:

  • How does your company align with and how could it be integrated into a platform company?
  • In addition to a good strategic fit, PEG’s look for strong profit margins, a defensible market niche and revenue “stickiness”. Does your business have these qualities?
  • Business continuity will be important to the buyer. Will you consider providing ongoing leadership and retaining some equity for a future sale at a potentially higher price per share?
  • PEG due diligence can be exhaustive, as they are experienced and disciplined investors and typically require multiple approvals from lenders and investors. How will your company fare in such a deal environment?

If you are interested in understanding PEG investing activity in your industry and whether your company is a strong add-on or platform acquisition candidate, contact Jim Leonhard, CVA MBA at 916-800-2716 or jhleonhard@exitstrategiesgroup.com.

A Tax Saving Strategy for C-Corp Sellers

/in , /by Jim Leonhard

When selling a C-Corporation, most sellers will want to sell stock while most buyers will want to buy the assets.  Selling the stock minimizes the built-in gains (BIG) for sellers that carries a hefty double taxation first at the corporate level and second individually.  Buyers wish to buy assets for a number of reasons including loss of future depreciable expenses and potential increased liability.

One method to possibly reduce the impact of BIG for some businesses is allocation of a portion of the transaction to personal goodwill, defined as the value from an individual’s service to the business.

To qualify for personal goodwill, the tax authorities will need to find some of these key attributes for the business owner, including:

  • Personal relationships with customers and/or suppliers that exist with or without a contractual agreement
  • Industry reputation that gives an intangible benefit to the company
  • Technical expertise that provides identifiable economic benefit to the business
  • The absence of an employment agreement or a covenant not to compete

If a tax advisor believes this is an appropriate strategy, a valuation can be performed to estimate the value of personal goodwill.

For additional information on this subject see the article, “Personal Goodwill Avoids Corporate Tax Exposure” on Forbes.com.  (https://www.forbes.com/sites/peterjreilly/2014/06/13/personal-goodwill-avoids-corporate-tax-exposure/#3d1cbf0c21b4)

Disclaimer: Exit Strategies Group, Inc. is not qualified to provide tax advice to others.  Readers should not rely on the information in this blog for any specific transaction and should seek the advice of a qualified tax advisor.

For more information about M&A transaction structuring and business valuation, you may contact Jim Leonhard, CVA MBA at 916-800-2716 or jhleonhard@exitstrategiesgroup.com

Risk and its Effect on Enterprise Value

/in , /by Exit Strategies

Investors have choices in how to allocate their investment dollars across the risk and return spectrum. Whether it be bonds, public company equity, or private company equity, an astute investor will evaluate the risk of return and expect to be compensated according to this risk.

Business valuation, whether for public or private companies, has three key variables: growth, profit margins, and risk.

Growth and profit margins are more easily understood by most business owners and generally receive the most attention. Growth and margins drive cash flow which is what a buyer is ultimately looking for when investing in a business. That is, what cash flow return can they expect on their investment. In the ubiquitous Gordon Growth valuation model, cash flow is the numerator; risk is in the denominator.

“The path of least resistance to increasing enterprise value is often to reduce business risk.”

Yet risk is often overlooked and under appreciated. Business risk can have many dimensions ranging from concentration of customers, reliance on a single product line, owner dependence, reliance on a key individual, sub-par financial reporting, competitive threats, and outdated technology, systems or equipment to name just a few.

Before attempting to sell a business or attract investors, an owner should consider ways to make their business more attractive to buyers/investors. Increasing growth and margins often requires the most time and capital. An owner thinking of an exit may not want to put more capital into the business. The path of least resistance to increasing enterprise value is often to reduce business risk. Examples of this include cleaning up the books, creating retention incentives for key employees, obtaining long term contracts with vendors or customers, and other measures.

Having a business appraised by an independent expert in advance of going to market helps the owner clearly understand existing risk factors that are penalizing business value. This helps the owner identify strategies and objectives to de-risk the business and enhance value for current and future shareholders.

For further information on buy-sell agreement business valuation or to discuss a potential need, confidentially, please one of our senior business appraisers.