Buy

Article Dean Dorton

When planning for the future, business owners often are engaged in forecasting, reflecting on past performance, and setting goals. While budgets, financial statements, and tax returns may be part of this process, it is equally important to devote attention to your business’s organizational structure, corporate governance, and potential sale considerations. Often overlooked, these elements can significantly impact your business’s success and long-term viability.

It is important to begin this process early often years in advance if possible.

In this article, we emphasize the importance of revisiting your organizational structure, delve into the types of buy-sell agreements, and explore considerations for a potential sale of your business.

1. The Importance of Revisiting Organizational Structure

Your business’s organizational structure serves as the foundation for its operations, decision-making processes, and growth trajectory. Outdated structures can impede progress, hinder adaptability, and limit your ability to attract potential buyers. By reviewing and updating your organizational structure, you can:

  • Streamline operations: Assess whether your current structure aligns with your business goals and objectives. Clearly define decision-making authority and accountability within your organizational structure to limit exposure to a key-man discount.
  • Attract potential buyers: A clean corporate structure and buy-sell agreement can make future exits much simpler. Messy ownership structures can scare away potential buyers. If you believe selling to an outside party is a likely exit, planning this process earlier is paramount to ensure you maximize value.

2. Types of Buy-Sell Agreements

Buy-sell agreements are essential for privately-held businesses, especially during ownership transitions or potential sales. Good agreements safeguard the interests of owners and their families, ensuring a fair and orderly process. Poorly structured agreements can create headaches and strip value from your business. In his book, Buy-Sell Agreements for Closely Held and Family Business Owners, Chris Mercer identifies commonly used buy-sell agreements:

  1. Valuation agreements — The business value is determined by one or multiple valuation appraisers. The buy-sell agreement defines key aspects of the valuation process such as the standard of value, level of value, application of discounts for lack of marketability and control, etc.
  2. Fixed-price agreements — Owners agree on a fixed price for the business value. Price remains static over time which may or may not represent a fair and
    reasonable price depending on changes in the business, industry, and economic environment.
  3. Formula agreements — A formula agreed upon by the owners will determine the business value typically based on financial metrics (e.g. stated multiple of earnings or book equity value). Similar to a fixed-price agreement, the formula may or may not result in a fair and reasonable price over time due to the changes in facts and circumstances of the business.
  4. Shotgun agreements — A triggering event results in an owner tendering a price to buy or sell an ownership interest in the business. The owner receiving the offer has the option to buy at the offered price or sell at the same price. A “fair and reasonable price” is anticipated as each owner could be the buyer or seller. However, the financial circumstances and personal employment status of each owner and their family can influence the offering price and related decisions or implications.

Each type of buy-sell agreement has many nuances, advantages, and disadvantages. The “right” type of buy-sell agreement often depends upon the circumstances of the business, owners, and the owner family dynamics.

3. Considerations for a Potential Sale

In addition to reviewing your organizational structure and buy-sell agreements, it is crucial to consider the potential sale of your business. Factors to evaluate may include:

  • Business valuation: Assess the current value of your business, taking into account its assets, revenue, market position, and growth potential
  • Market analysis: Understand the market conditions, industry trends, and potential buyer profiles that may influence the sale process. Identify opportunities to position your business strategically to maximize its attractiveness to potential buyers.
  • Exit strategy planning: Develop a robust exit strategy that aligns with your personal and financial goals. Consider the timing, succession planning, and potential tax implications of the sale. Who is your target buyer? A family member, someone interested in your business’ legacy, or private equity?

Conclusion

Remember to allocate time and resources to review your business’s organizational structure, buy-sell agreements, and potential sale considerations.

Dean Dorton’s business advisory and valuation group has assisted many business owners with transitions and structuring their buy-sell agreements. Let us become part of your advisory team to review your business organizational and governance and help you ensure a smooth and rewarding journey as you navigate the future of your business.

Article Dean Dorton

In our last newsletter, Determining and Increasing Business Value, we discussed the three primary approaches to valuing a business. We described how value hinges on projected cash flows and risks associated with achieving them. And, we explained that a business owner can increase value by increasing cash flows and lowering risks. In this article we focus on the various levels of value associated with a business (or business interest), and we discuss strategies for maximizing value.

Though we often think that value means one specific amount, various levels of value are associated with business interests. These levels of value reflect varying degrees of control, marketability, and synergies with other enterprises. The levels of value, from highest to lowest, are illustrated in the following example:

$12 per share Synergistic (or Strategic) Value (reflects a 20% strategic premium)
$10 per share Control Value (reflects control and liquidity)
$7 per share Noncontrol, Marketable Value (reflects a 30% discount for lack of control)
$5 per share Noncontrol, Nonmarketable Value (reflects combined discounts for both lack of control and liquidity of 50%)

In arms-length business acquisitions lacking strategic or synergistic features, buyers and sellers tend to negotiate a purchase price that approximates the control value of the business. A buyer seeks to maximize value by identifying a target with strategic or synergistic potential. If the buyer is able to purchase the business at control value, but operate it at a level consistent with strategic value, the buyer has effectively purchased the business at a “bargain.” By capitalizing on synergies or other strategic advantages, the buyer’s return on investment will be enhanced. A buyer tries to negotiate a purchase price without paying for synergies or other strategic value that the buyer brings to the deal, while recognizing that if multiple potential buyers who recognize synergistic or strategic potential are involved, the purchase price may get “bid-up” to an amount approaching strategic value.

One of the ways to realize strategic value is by buying a competing company. By eliminating a competitor, the buyer is able to capture a greater share of the market, providing opportunities for increasing revenues and reducing costs. Similarly, a buyer can purchase a supplier or distributor to create vertical integration. This will enable the buyer to save the “mark-up” in supply or distribution costs, resulting in greater profits. Other strategic acquisition value can result from purchasing one or more companies, enabling the buyer to generate economies of scale, leverage existing expertise and know-how, provide for “one-stop” shopping, or create a level of “critical mass” that provides an advantage in the marketplace.

We have approached the idea of maximizing value from a buyer’s perspective, but a seller can also maximize price by marketing and selling to a strategic buyer that can create synergies between its existing business and the targeted business. The seller, though, often needs multiple potential buyers in order to realize a price that reflects strategic value.

If you have any questions or would like to discuss your business, please contact one of the members of our forensic accounting and business valuation group.

David Parks, dparks@deandorton.com

John Herring, jherring@deandorton.com

David Angelucci, dangelucci@deandorton.com

Missy DeArk, mdeark@deandorton.com

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Article Dean Dorton

Merger and acquisition (M&A) transaction volume in the healthcare industry is off to a fast start in 2015, continuing the robust trend from 2014.  Many analysts and executives believe M&A activity will continue its strong momentum and may accelerate at an even faster pace for the remainder of 2015.

Participants in the marketplace, both buyers and sellers, are assessing whether future transactions meet their organization’s goals and operational strategies.  Furthermore, management teams are assessing the value of the subject entity to ensure the transaction price reflects the current market and maximizes their long-term return on capital.  Understanding the marketplace of the subject entity can be a daunting task and determining whether the assessed value will enable the organization to meet its objectives can be challenging.  To further complicate the analysis, Stark Law requirements and other regulatory concerns must be addressed.

The approaches to valuation are often implicitly known and performed, but often not formally outlined. The three primary approaches to valuing a healthcare entity (or any closely-held business) are the asset, market, and income approaches.  The asset approach looks to the subject entity’s tangible equity on the balance sheet, but often ignores the intangible assets (e.g. customer relationships, assembled workforce, and goodwill).  The market approach uses known transactions in the marketplace for entities that are comparable to the subject entity to arrive at valuation multiples (often reflected as multiples of revenue or earnings) which are applied to the subject entity’s financial metrics.  The income approach derives value by converting the subject entity’s forecasted future cash flows to present value using a discount rate adjusted for the risks of the forecast, industry, and inherent characteristics of the subject entity.

Dean Dorton’s valuation expertise and experience, combined with its healthcare industry knowledge, has contributed to the success of many M&A transactions.  From guidance in strategy to valuation, Dean Dorton can assist with the challenges involved with M&A transactions.

For more information, contact Adam Shewmaker at 502.566.1054 or ashewmaker@deandorton.com or David Angelucci at 859.425.7695 or dangelucci@deandorton.com.

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