investment banking deal process

FOUNDERSINVESTMENTBANKING

APRIMERONHOWMIDDLEMARKETCOMPANIESARE

BOUGHTANDSOLD

~FROMTHEPERSPECTIVEOFASELLER~

FoundersInvestmentBanking Page12012

INTRODUCTION

Thesteps tosellingamiddlemarketcompany1aregenerallynotall thatwellknown,butthere isaprovenmethodologythat,whenfollowed, increasesthelikelihoodofafirmobtainingapremiumvalueandgettingadealdone.Thereisa large universe of potential buyers and investors. Owners of companiestypicallyseetheiruniverseofbuyersconsistingoffellowpartners,employees,competitors, key customers, major suppliers, and perhaps local investors.Whiletheseareallvalidoptions,professionaladvisorsarealsoabletotapintoa vastly larger universe consisting of domestic and international public andprivatecompaniesaswellasprivateequityfirms.Thechallenge isnotfindingpotentialbuyers,butfindingtherightbuyerorinvestor.Attheoutset,itisnotalwaysobviouswho thebestbuyermightbe,and there isahighprobabilitythattheownerhasnevermetthebuyerbefore.Ittakesasystematicapproachtoidentifyandconnectwiththebestcandidates.Letsfaceit.Mostofusareamateurswhenitcomestosellingourbusinesses,sincewe tend todo itonlyonceor twice. Institutionalbuyers2,on theotherhand,buyand investfora living.Consequently,theyhavea lotofexperiencegettingdealsdone thataremore in their favor.Financialbuyersexist tobuybusinesses for institutional and high networth investors, and these shrewdbuyershaveinvestedover$2trillionbuyingcompanies.Strategicbuyershaveapreference for acquiring small to mediumsize firms and while these dealshappeneveryday,itisachallengefortheuninitiatedtogetintothismarket.Ifyou already know potential buyers because they are a customer, partner,familymember,orcompetitor,youshouldaskyourself iftheyarewillingandabletopayfairmarketvalue.How is fairmarketvaluedetermined? Lets first lookat thedefinitionof thisterm.Fairmarketvalueisthemostlikelypriceatwhichabusinesswillchangehandswithinareasonableperiodoftimebetweenawillingbuyerandawillingseller in an arms length transactionwhere both parties aremotivated butneither isunderanyparticular compulsion toact.While thisdefinitionhelpssomewhat, itdoesnotshedmuch lightonhowprice isdetermined.Nordoesthis definition givemuch guidance on how owners can exert leveragewhendealing with professional institutional buyers and investors. The solution todetermining fairmarket value inamanner thatalsoprovides the sellerwithleverage lies inmaking amarket.Howdo youmake amarket? Youmake amarket by creating a competitive deal environment consisting of multiplebuyersandinvestors.1Middlemarketcompaniesaretypicallydefinedashavingannualrevenuesbetween$10millionand$500million.2Institutionalbuyersandinvestorsconsistofprivateequityfirms(i.e.,financialbuyers)andlargercorporations(i.e.,strategicbuyers").


FIVEMAJORPHASES

Therearefivemajorphasestocreatingacompetitivedealenvironment:I. PREPARATION&PACKAGINGII. BUYERRESEARCH&DEVELOPMENTIII. MARKETING&INVESTORCOMMUNICATIONSIV. ECONOMICNEGOTIATIONS&LETTEROFINTENTV. DUEDILIGENCE&CLOSING

The PREPARATION & PACKAGING phase starts with an indepth analysis of thecompanys business model, historical financial performance, and futureoutlook. This information is then packaged into a set of documents thatconciselyandauthenticallytellsthecompanysstoryandformsthethesiswhythe company would be a good acquisition orinvestment.The BUYER RESEARCH & DEVELOPMENT phasesystematically researches, identifies, and targetspotential buyers and investors culminating in aspecific listofqualifiedbuyersandthe individualstocontact.The MARKETING& INVESTOR COMMUNICATIONS phasedirectly engages potential buyers and obtainsindications of interest from the subset of firmsexpressingastronginterestinthecompany.The ECONOMIC NEGOTIATIONS & LETTER OF INTENTphasestructuresandframesthedealculminatinginaLetterofIntent.The DUE DILIGENCE & CLOSING phase allows the buyer to verify all therepresentationsmadebytheseller,finalizesthedealstructure,andexecutesadefinitivepurchaseagreement.Now letsdive intoeachof thesephases indetail from the vantagepointofowners and CEOswho seek both a premium price and a high probability ofcompletingadealandarewillingtodowhatittakestoputtheircompaniesinthebestpositiontoaccomplishthesetwinobjectives.


PHASEI:PREPARATION&PACKAGING

BUSINESSREVIEW

HISTORICALFINANCIALANALYSIS

Phase I startswithan indepthanalysisofyour company.The first step is toconduct a thorough review of the business and to begin constructing acompany profile. An assessment of market and industry drivers reveals thesource of revenues and profits and the potential for future growth. Acomparisontoindustryandcompetitorbenchmarksassessesthesustainabilityof the companys competitive advantage. The areas that distinguish thecompanyfrom itspeersare identified,aswellasthoseareasthatmay inhibitfuture performance, by candidly appraising the companys strengths,weaknesses,opportunities,andthreats.Thecompanyshistoricalperformance isassessedby reviewingandanalyzingfinancial statements (income statements/profit & loss statements, balancesheets,statementsofcashflows)forthepast35years.Auditedfinancialsareadefiniteplus,but theyarenot required.While it is commonplace forprivatecompanies to seek to minimize taxes and maximize personal benefits, thisapproach tends to understate the earning potential of a firm. Historicalfinancial statements, consequently, often have several limitations when itcomes toportraying a firm in itsbest light. For instance, earningsmayhavebeen suppressed due to tax minimization strategies and since financialstatementsonlydealwith thepast, they seldomdoagood job illustratingacompanys potential going forward. Furthermore, the structure of financialstatementsmakes itdifficult to spot trendsandmine salientdata.A singleoffyear or an unusual onetime event may disproportionately distort thecompanysperformance.Understandingthesepatternsandtheimplicationsofkeyfinancialandmarketratiosisanessentialsteptodocumentingthehistoryofthefirmandestablishingthecompanysfoundationofvalue.


RECASTINGFINANCIALS

Publicly held companies like to please shareholders by showing the largestbottom linepossible.Privatecompanies,ontheotherhand,wanttomakeallthe money they can while showing the smallest amount of income that istaxable.Tohelpbuyersand investorsbetterunderstandtheearningpotentialof the company, the next step is to recast financial statements as if yourcompanywasasubsidiaryofapubliccompany.ByadjustingtheP&Lstatementto compensate for extraordinary spending or nonstandard accountingpractices,itisoftenpossibletoillustratehigherearningscomparedtohistoricalfinancialreports.Caremustbetaken,however,toensurethatalladjustmentsarecredible,defensible,andproperlydocumented.Recastingisnotanexercisein fantasy, but rather shows how your companys earningswould appear ifwidelyusedmanagementandaccountingpracticesofpubliccompanieswereemployed.Forexample,excess compensation that iswellabove the industryaverage could be restated by reducing salaries to bemore in linewith theindustry. Likewise, country club dues, leases for highend automobiles, andcompany loans at very favorable interest rates could be eliminated, whichwouldlowerexpensesandboostearnings.Recastingcutsbothways,however.Ifacompanyhasunfundedorunderfundedobligations,insufficientinventorylevels,or inadequatecapitalexpenditurestokeeppacewiththecompetition,then these savings shouldbe recasted,whichwould increaseexpendituresanddetrimentallyimpactearnings.CommonadjustmentstoProfit&Lossstatementsare: Sales: Eliminateintercompany&relatedthirdpartytransactions Cashtoaccrualbasedaccounting GAAPrevenuerecognition CostofGoodsSold: Costofsuppliesforinventoryitems LIFOvs.FIFOaccountingadjustments Depreciationandamortizationreclassification Removenonperformingassets Reclassifydepreciation&amortization Operatingexpenses: Adjustsalariestoindustrystandard Familymembersonthepayroll Nonrecurring(onetime/extraordinary)expenses Discretionaryexpenses Nonworkingfamilymembers'salaries Perquisites(cars,clubs,insurance) Flexibletravelandentertainmentpolicy Adjustinterestexpense: Interestexpense:relatedtodifferentcostofcapital Removeinterestrelatedtononoperationalassets Reclassifyinterestexpense/removefromoperatingexpense


CommonadjustmentstoBalanceSheetsinclude: Assets: Removenoncoreassets Excesscashandinvestments Aircraft Boats Luxuryautomobiles Automobilesprovidedtoselectpersonnelasperks Realestate Lifeinsurancecashvalue Nontransferableintangibleassets(brandnames, patents) Inventory Lowerofcostormarket Inventorynotonbooks Adjustfixedassetstofairmarketvalue Equivalentreplacement/currentbookvalue Liabilities: Removedebttoshareholdersadditionalequity Fairmarketvalueofdebt Longtermdebtsettlementperiodamortization Optimizedebtincapitalstructure Optimizeinternalgrowthcapabilities Toomuch/notenoughdebt

Inmanycases,theoutcomeofrecastingincreasesacompanysvaluationcomparedtoexaminingfinancialstatementsbasedsolelyontaxreturns.


MULTIYEAR PROFORMA&VALUATIONRANGE

Thenextstepbuildsuponrecastedfinancialsbyconstructingaproformathatprojectsrevenuesandexpenses,aswellasassetsand liabilities,overthenextthree to five years. The pro forma places the company in its best light andreflects managements expectations for the future. As was the case whenrecastingfinancialstatements,itisessentialtokeepassumptionsconservativeandcredibleandtoprovideindependentthirdpartyevidencewhenpossibletodocumenttherationalebehindanassumption.Sincetheindustryisthesourceofallprofits, it isalso important to forecast thegrowth rate for the industryand to substantiate the companys relativeperformance in the industry (i.e.,outperforms the industry, inline with industry performance, underperformstheindustry)byanalyzingindustryperformanceratios.The pro forma provides the mechanism to quantify growth opportunitiesresultingfromstrategic initiativesavailabletothecompany.Examplesofsuchinitiatives include expanding into new markets and geographies, rolling outnewproducts,andacquisitions.

The pro forma produces an integrated financial model for the company byquantifying assumptions for future earnings. The Profit & Loss Statementcaptures thepricingmodelandsalesassumptionsdrivingrevenuesaswellasthe corresponding cost structure necessary to develop, deliver, and supportproductsandservices.TheBalanceSheetdocumentstheassetsusedtocreateandsupportproducts,theworkingcapitalnecessarytoconductbusinessinanorderlymanner,andthecapitalstructureofthefirm.TheCashFlowStatementcapturescapitalexpendituresanddemonstrates thecompanysability topayitsbills.The pro forma also provides the foundation for estimating your companysvaluation, knownalsoasanenterprise value.Many factorsand variablesaretaken into consideration when determining a companys valuation. It isimportantnottorelyonsimpleformulasortouseindustryrulesofthumbtovalueyourcompany.Formiddlemarketcompanies,acombinationofvaluation


HIGHIMPACTMARKETINGMATERIALS

methods are usedwith eachmethod producing a valuation range. The fourmostcommonmethodsare:

1. DiscountedCashFlow2. FinancialReturnModel3. ComparableCompany4. PrecedentTransactions

By estimating themost likely valuation rangeusing eachmethod,while alsotaking into consideration industry conditions, the macroeconomicenvironment,andothertimingfactors,itispossibletoderiveavaluationrangeforyourcompanybyevaluatingwheretherangesintersect.Thefinalstep inPhase I iscomposingandproducingmarketingmaterialsthatauthentically and succinctly tell the companys story with a high degree ofimpact. Phase IIIwill use thesematerials to solicit interest from buyers andinvestors.

The Anonymous Profile is a one page overview ofthe company sent to prospective buyers andinvestors togauge their initial interest.Thisprofileprovides a brief description of the company, itsindustry and product offerings, points of keydifferentiation, and highlights of compellingaccomplishments. A financial recap and pro formaalsomaybeincluded.Thecompanysidentityisnotdisclosedinthisdocument.


The Confidential Information Memorandumsummarizes the companys strategy, operations,industry trends and conditions, and investmentconsiderations. The CIM communicates whom thecompany serves, theproblem the company solves,howthecompanymakesmoneydoingso,andhowthe company will grow. Key sections of a CIMinclude an overview of the company, its history,management team, market assessment (industrysize, drivers, trends, and growth estimates),competitive environment, products and services,

customerbase,marketshare,compellingpointsofdifferentiation(proprietarytechnology and methods, patents, source code, engineering, R&D) and afinancial recap analyzing historical performance and projecting futureperformanceintheformofaproforma.

TheManagementPresentationisadynamic,hardhittingpresentationrecappingthemost importantfactorsforbuyerstoconsider.Thestructureofthepresentationreflectsmanagementsapproachandstyle and complements the ConfidentialInformationMemorandum.


PHASEII:BUYERRESEARCH&DEVELOPMENT

PROSPECTLISTS

Phase IIfocuseson identifyingasubsetoffinancialbuyers(i.e.,privateequityfirms)andstrategicbuyers(i.e., largercorporations)thathavean interestandthe financialmeans tocompletea transaction.Theprocessstartswithaverylargeuniverseofpotentialbuyersandinvestors.

The number of domestic and international public and private companies,including andprivate equity firms, totalover 700,000.Byusing a systematicandsurgicalprocess,itispossibletowinnowthislistdowntoasmallsubsetoffirmsmost likely to express an interest to learnmore about your company.Analysisperformed inPhase I istappedto identifythe industrysegmentsandplayerswho form thebusinessecosystemandvaluechains surroundingyourcompany. Identifyingcurrentparticipants in the industry,however, is just thestartingpoint.Itisalsoimportanttoidentifycorporationswhomaybeseekingtoenteran industry segment.On theprivateequity front, firms specialize incertain industriesandseekcompaniesofacertainsizeandsetofcapabilities.The initial screening is critical.Casting toobroadofnet results inapooruseeverybodystime filteringoutunqualifiedcandidates.Castingtoonarrowofanet,on theotherhand,riskspotentiallyexcludingthebestbuyeror investor.


FINANCIALBUYERPROFILES

Themethod forscreeningprivateequity firms isdifferent from theapproachused to screen strategic buyers. The initial screening concentrates on buyermandates, industry focus, company size in terms of revenue and EBITDA,investmentsize,andgeographicpreference.

PrivateEquityGroups(PEGs)raisemoneyfrom institutional investors,suchaspension funds, and qualified high net worth individuals and form a fundstructured as a limited partnership. These funds typically have a tenyearhorizon to give PEGs the opportunity to identify, acquire, grow, and sellcompanies. Companies purchased by PEGs are referred to as portfoliocompanies. In certain situations, PEGs will create platform companies andacquire smallersized companiesasaddons toexpand the capabilitiesof theplatform company as a whole. PEGs typically target the lifecycle stage ofcompanies inwhich theyprefer to invest. For instance, somePEGs focusonproviding growth capital to early stage firms, others specialize in providingexpansion financing to established firms,while others target acquiringmorematurefirms.PEGsalsoliketotargetspecificindustriesgiventheirexperienceandexpertise.Finally,PEGsestablishguidelinesgoverninghowmuchtheyareprepared to invest and theminimum sizeof company they are interested inbasedon revenue andEBITDA.These criteria areused toperform the initialscreening. The next step is to peermore deeply into each PEG passing theinitialscreeningand isolatethose firmsthatarethebest fitbasedoncurrentinvestments (i.e., portfolio and platform companies already in the fund),geographicpreferences, investment size, industry focus,and track record for


successfullygrowingandexitingsimilarcompanies.From thisevaluation, it ispossibletosegregatepotentialbuyersandinvestorsintotwocategories,TierAandTierB.TierA firmshave thestrongestmatchbasedonpubliclyavailableguidelines,proprietary research databases, and prior knowledge of the firm.Tier B buyers and investors could still be viable candidates, but there areseveral criterion that are not as strongly aligned when compared to Tier Afirms.ThefinalstepistouseatenpointscaletorankeachTierAfirmbasedonoverall fitand toprovideasynopsisdescribingwhy the firm isagood fit.BysortingTierAfirmsbasedon itsrank, it iseasyto identifythefirmsprovidingthebestfit.

STRATEGICBUYERPROFILES

Searchingforstrategicbuyersrequiresdiligenceandcreativity.Employinga4step iterative process is the best approach to systematically identify andevaluatetargetcompanies.

Step 1: Evaluate forward and backward supply chain andvaluechainintegration.

Step2:Reviewmacrolevelacquisitionsacrossthebusinessecosystem.

Step3:Examinebusinessmodels forcorporationsappearingtobeagoodfittoidentifypotentialsynergies.

Step4:Compiletieredlistsandranktopcandidates.Thesearchprocess isan iterative,ongoingprocessthatcontinuesthroughouttheMarketingPhase.Itisimportanttounderstandeachcandidatecorporationfrombothyourcompanysperspectiveaswellasfromthemarketsperspectivebefore finalizing the gotomarket list. Strong candidates are not alwaysreadilyapparentbecause theymaynotbe inyour industry segment,butarelooking for a company to acquire as the means to enter your segment.Likewise,acorporationmaybe interested inemployingyouruniqueassetsortechnology inadifferent industry than theoneyouare currently in.For thisreason,itisimportanttoincorporatefeedbackcontinuouslyfromallcontactedparties.Atthispointintheprocess,itisessentialtoguardagainstprematurelydisclosingthatyourcompanyisconsideringamarkettransaction.Toachieveoptimalresults,thesearchprocessiscustomizedforeachcorporatetarget. This customization requiresdeveloping an investment thesis for eachbuyercategoryandincorporatingmicroeconomictrendsthatarefavorabletoyour companys products, services, and capabilities. Researching andunderstanding each corporations growth strategy and business model iscentral to identifying potential synergies, which form the basis forcommunications in the form of personal calls, tailored letters, customizedpresentations,webinars,andfacetofacemeetings.


TARGETEDLISTOFQUALIFIEDBUYERS

The objective of this extensive screening process is to narrow down thenumberofqualifiedbuyersandinvestorstoamanageablelistcontainingbothfinancialandstrategicbuyerswithahigh likelihoodofwanting to learnmoreabout your company and who also have the wherewithal and resources tocomplete a transaction in a timely manner. To ensure that competitivesensitivities are given proper consideration, the final gotomarket list isreviewed and approved by you before contacting any potential buyer orinvestor.


PHASEIII:MARKETING&INVESTORSCOMMUNICATIONS

INITIALCONTACTCAMPAIGNCONFIDENTIALITYAGREEMENT

PhaseIIIdirectlyengagespotentialbuyers.Itstartswithanintensivecampaigntargetingspecificindividualsineachprivateequityfirmandcorporationonthegotomarketlist.Identifyingtherightpersontocontactataprivateequityfirmis straightforward. For corporations,however, thepreferredpointof contactmaynotbe readilyapparentand if theyare, itstillcanbeachallenge togetthem to engage. It is crucial to know what to say during the initial call tostimulatetheir interestandtoqualifyfurtherthatthefirmorcorporation isastrong candidate. Tracking all communications (phone calls, emails,correspondence)inaCustomerRelationshipManagementsystemisimportant.Using a CRM ensures every potential buyer or investor is contacted and allfollow up requests are responded to and documented in a timely manner.Following a methodical process helps build deal momentum, establishes asense of competitive urgency, and conveys to buyers and investors that thesearchisbeingconductedinaprofessionalmanner.Duringtheinitialcontact,yourcompanysnameisnotdisclosed.TheonepageAnonymousProfile isused todepictyour companys characteristics. Indepthdiscussions are only conducted after a Confidentiality Agreement has beenexecuted.Executing a confidentiality agreement reduces the chance that customers,competitors, and employees prematurely discover you are considering amarket transaction. Confidentiality agreements are legal instruments andshouldbedraftedbyanattorney.Atminimum, theagreementshoulddefinethemeaningofconfidential information,howconfidential informationmaybeused,whohasaccess toconfidential information, restrictionsonattempts toreverseengineerorcopymaterialsforanypurposeotherthanevaluatingyourcompany,andremediesintheeventofabreachofconfidentiality.


INDEPTHDISCUSSIONS

INDICATIONOFINTEREST

MANAGEMENTMEETINGS

After executing the confidentiality agreement, thenameof your company isdisclosedandtheConfidential InformationMemorandum isshared.ThebuyerprofilesdevelopedinPhaseIIsteerinitialdiscussions,soitpossibletohighlightquickly important facets of your company that should be appealing to thespecificbuyerorinvestor.Thecombinationoftargetingtherightfirmsfromtheoutset,craftingacompellingCIM,anddiscussingonpointthesalientfactorsofhigh interest to a given PEG or corporation motivates them to pursue thetransactionandtoengage internalteams.Thesediscussionscanbeextensive,butyouandyourmanagementteamareshelteredfromthesecallssoyoucanconcentrate on running your business. The objective of these indepthdiscussionsistoprovidesufficientdetailsandguidancesothebuyerorinvestorcanmake an informed decision if there is strong fit betweenwhat they areseekingandwhatyourcompanycanprovide.An indication of interest is a nonbinding letter submitted by buyers orinvestors who have a high degree of interest in seriously considering atransaction. Indicationsof interest state thepercentageofownership soughtalongwithapreliminaryvaluation,expressedasarange,theyarepreparedtopay subject to further discussions, negotiations, and due diligence. Theobjective is to obtain multiple indications of interest as this is the path toattainingnegotiatingleverageonbehalfoftheseller.

Thestage isnowset foryou tomeetwithpotentialbuyersand investors.Byemployingasystematicprocesstoreachthispoint,youenterthesemeetingsunderstandingthemotivationsdrivingeachinterestedpartyandapreliminaryassessmentofhowyourcompanystacksupwithwhattheyarelookingfor.Themanagement presentation developed in Phase I is used to underscore yourcompanysgrowthpotentialandoperatingstrengthswhilealsomitigatinganyperceived weaknesses. These management meetings help to create anenvironment forparties toget comfortablewitheachotherand toestablishgroundsforevaluatingafutureworkingrelationship.


PHASEIV:ECONOMICNEGOTIATIONS&LETTEROFINTENTBUSINESSTERMS

The purchase price for which a company is sold represents a composite ofseveral factors, terms,andconditions.Someof these factorsareeconomic innaturedealing, for instance,with thepresentvalueof future cash flows, fairmarket value of assets and inventory, and the perception of the economicvalueforintangiblessuchaspatents,sourcecode,brands,andgoodwill.Otherfactors are legalistic and deal with indemnification, warranties, contingentliabilities, and the like. Operational and organizational factors also weigh inconcerning, for example, specifying which employees remain with thecompany,divestingordiscontinuingproductlines,andrelocatingoperationstoadifferentofficeor city.Manyof these termsand conditionsarenegotiableandtheirrelativeimportancewillvarywitheachbuyerorinvestor.Taxeswill play abig part dependingonwhat is beingboughtor sold. If thetransaction is a stock sale, then the seller potentially may realize severaladvantages:

Proceedsaretaxedatlongtermcapitalgainsrates Seller is not responsible for the companys liabilities going

forward Taxes may be deferred depending on the structure of the

dealThebuyer,ontheotherhand,facessomedisadvantages:

Assetscannotbewrittenuptofairmarketvalue Buyerassumescontingentandunknownliabilities Goodwillisnotdeductablefortaxes

Anotherwayofstructuringatransactionisasanassetsale.Thereareseveraladvantagesforbuyerswithassetsales:

Goodwillisdeductibleforincometaxpurposes Assets arewrittenup to fairmarket value,which increases

cashflow Contingentandunknownliabilitiesarenotassumed


DEALSTRUCTURE

Theseller,however,facessomedisadvantages:

Proceeds may be taxed at ordinary income tax ratesdependingonthelegalstructureofthecompany

ForCcorpsthereisthepotentialofdoubletaxation Sellerretainsliabilitiesandcontractsnotspecificallyassumed

Matterscangetcomplicatednegotiatingwhichmethodologies,standards,andpractices touse fordetermining the finalpurchaseprice.This is the realmofexperts and specialists, and it requires a multidisciplinary team of M&Aadvisors, attorneys, and accountants who specialize in middlemarkettransactions toguideyou through thedealprocess.Forexample,negotiatingwhichliabilitiesareincludedorexcludedfromadeal,themethodusedtovalueassets and remaining depreciation, providing sufficient funding for bonus,profitsharing,andpensionplans,andappropriatelyvaluing futurecash flowsbased on current customers are all examples of business terms that have adirecteconomicimpactonprice.TheintegratedfinancialmodelconstructedinPhaseIprovidesthefacilitytoquantitativelyanalyzetheeconomiceffectthesevariousbusinesstermswillhaveonyourcompanysvaluation.Howadealisstructurediscritical.Itisnotjusthowmuchyougetpaidforyourcompany that counts; its how much you ultimately put in the bank thatmattersthemost.Whichofthefollowingtwoscenariosisabetterdeal?

Option#1:sellfor$40milliono $25millionincasho $7millioninrestrictedstockwithalockupperiodo $5millionsellernoteo $2millionearnout

Option#2:sellfor$33milliono $33millionallcashupfronto 3yearemployment/consultingagreement

Atfirstglance,option#1lookstobethewaytogo.Afterall,$40millionbeats$33 million and you also get the bragging rights that go with the highernumber.But if the acquiring company falls out of favor and the stock priceplummets,andpaymentson the sellernote are suspended topreserve cashbecauselinesofcreditaredryingup,andinternalaccountingtransferscreatedan operating loss eliminating the earnout since itwas tied to profits versusrevenue,thenoption#2wouldstartto lookverygood.Ofcourse, itcouldgothe otherway: the stock could appreciate in valuewhile also providing taxbenefits because gains are taxed at the capital gains rate, the


interestrateonthesellernotecouldexceedwhatyouwouldreceiveinvestinginfixed incomesecuritiesprovidinganicestreamofmonthly income,andthecompany gladlypays the earnout because the acquisition exceeded revenuetargets.Three broad categories can be used to influence the structure of a deal.Recasting focuses on adjustments to EBITDA, valuing goodwill, employingaccounting standards, adopting realistic forecasts, addressing tax issues, andotheritemsdirectlyaffectingfinancialstatements.Sharing future risks allocates risk between both parties and addresses theextentofprotectioneachpartyseeks.Trust,chemistry,flexibility,believability,sharedvalues,andthedegreeandnatureofthepartiesinvolvementafterthesaleallinfluencecredibilityandtheperceptionofthelikelihoodcertaineventscouldtranspireinthefuture.Compensation concentrates on how you get paid. Several methods ofcompensatingasellerareusedtosealadeal.

Cash:As the saying goes, Cash is king. The benefits are readilyevident:zerorisk,instantliquidity,andtotalflexibilitywhenitcomes to structuring an investment portfolio. Withoutplanning,however,theordinaryversuscapitalgainstaxbitemaybedouble.Cashalsoeliminatesdeferredcompensationstrategies.

Gettingpaidtoworkafterthedeal:There are two basic methods of getting paid to continueworkingafterthedealclosesemploymentagreementsandearnouts.Employmentagreementstypicallylastthreetofiveyears,buttheycanbeforshorterdurations.Compensationisusuallyinthe form of a base salary, incentive bonus, and companybenefits.Typicalprovisionsincludenoncompeteclausesthatsurvive post termination, specific language addressingconditions for termination, and perks beyond standardcompany benefits. Compensation is taxed as ordinaryincome.Earnoutsareoftenusedtoclosethevaluationgapbetweenbuyer and seller and typically span one to three years.Compensationisbasedonperformanceandcanbeladdered.Earnout targets can be indexed or structured as all ornothing.Targetsshouldbetiedtorevenueinsteadofprofits.Taxtreatmentcanbeeithercapitalgainsorordinaryincomedependingonhowthedealisstructured.


Gettingpaidnottocompete:Anoncompeteagreementprotectsboth thebuyerand theseller.Ifthenoncompeteisnotproperlydocumented,itrunsthe risk of judicial interpretation in the event of a conflict.Fourelementsmakeanoncompeteagreementvalid:

1. Itmustbeinthesametypeofbusiness.2. There must be some form of paid

compensation or consideration, which istreatedasordinaryincome.

3. Reasonablelimitsongeography.4. Reasonableperiodoftime.

Gettingpaidwithstock:

Therearedifferent typesof stockwithvarious featuresandrestrictions: common or preferred; voting or nonvoting,convertible or nonconvertible. If the stock is issued by apubliccorporationandisregistered,taxesmaybedeferrableuntil the stock is sold. If the stock isunregistered,Rule144appliesrequiringthestocktobeheldforoneyearor longer(in thisevent, it is important to requestpiggyback rights).To guard against a substantial drop in market value,protectivemeasuresusingstockcollars,puts,andcallscanbeemployed.Private company stock ismoredifficult to value,notasliquid,andhypothecation,transfer,sale,orassignmentmaybeprohibited.

Otherformsofpayment:Seller notes help buyers fill financing gaps,which can drivehighervaluations.Typical termsare1260monthnotesatadefinedinterestrateusingapredeterminedamortizationandpaymentschedule.Thesenotesareusuallysubordinatedandare not collateralized by specific assets. Principal paymentsare taxedat capitalgains rateswhile interestpaymentsaretaxedasordinaryincome.Royalties are typically best suited for productdrivenbusinessesandcanbeusedduringnegotiationsasatradeofffor goodwill. Royalties may qualify for favorable taxtreatments.Warrantsgranttherighttobuystockfromanissueratapreagreed upon price and are an effective tool to alignincentives.


LEGALTERMS

GOODFAITHTERMS

LETTEROFINTENT

Afterframingthebusinesstermsanddealstructure,itistimetodelveintothevarious legal issues associated with the transaction. The legal focus in thisphaseisondraftingandexecutingaLetterofIntent(LOI).TheLOIwillserveasthefoundationfortheDefinitivePurchaseAgreement,whichisdraftedduringPhaseV and covers standard covenants, representations,warranties, closingconditions,andprovisionsforindemnificationandsurvival.Atthisjuncture,thepartiesconcentrateondefiningthelegalaspectsofthedealandresolvinganyunusualorextraordinaryitemswhichmaysurfaceduringduediligence.Good faith terms formabondof trustbetween thebuyerand seller thatallpartieswillrepresentfairlyandaccuratelywhat isbeingboughtandsoldand,baring unusual and unforeseen circumstances, the parties commit tocompletingthetransaction inareasonableperiodoftimeconsistentwiththetermsoftheLOI.TheLOIdocumentsthebusinesstermsthathavebeenagreedto,describesthetransaction, states thepurchaseprice and compensation structure,and citesotherkey termsandconditions,suchasconfidentialityprovisions,continuingto operate the company inmuch the samemanner as it has been, and thesellermakingavailableallinformationnecessaryforthebuyertocompleteduediligence.An importantprovisionoftheLOI isgrantingaperiodofexclusivityduringwhichtimetheselleragreestodiscontinuenegotiationsandnotenterinto any agreementwith another party. It is imperative at this point in theprocess to have available quantitative and qualitative analyses to equipshareholderstomakea fully informeddecisiononwhichbuyeror investortochoose for negotiating the Letter of Intent. It is important to maintaincompetitivepressurebykeepingother interestedpartiesasstalkinghorsestoassistinnegotiatingfavorabletermsandconditionsBy implementing awellstructured competitivedealprocess, it ispossible tomovesystematicallyfromthemanytothemostinterestedtotheone.


PHASEV: DUEDILIGENCE&CLOSING

DUEDILIGENCE

Throughout the deal process, the seller makes representations and setsexpectations about the nature of the company. Due diligence provides thebuyer the opportunity to verify all that has been communicated, clarify anypointsofconfusion,andvalidatethattheoperationsofthecompanyareinlinewithwhatthebuyerisexpecting.Duediligenceevaluatesboththebenefitsandtherisksoftheacquisitionor investmentbyexaminingthepast,present,andpredictablefuture.SellersshouldstartpreparingforduediligenceinPhaseI.Duediligencetypicallycoversfourbroadareas:

1. FinancialStatementsreview:examinestheassetsandliabilitiesonthebalancesheetbyverifyingtheirexistenceandcurrentvalue;assessesthe incomestatement toappraise thegeneralhealthandsoundnessofthecompanysoperations.

2. Management and Operations review: evaluates the companyspractices, procedures, and controls; assesses key staff memberscritical to ongoing success; analyzes revenue streams, customerconcentration, and health of customer relationships; analyzesproducts,services,andkeytechnologiesandmethods;reviewsqualityandstabilityofkeysuppliers.

3. Legal,HumanResources,andRegulatory&EnvironmentalCompliancereview: examines pending or potential litigation or other legalproblems; identifies current or potential human resources issues;verifiescompany is incompliancewithregulatoryandenvironmentallawsandregulations.

4. Transaction review: verifies all documentation associated with thetransactionisinorder.

The scope of due diligence varies depending on the size and scale of thecompany. Experienced buyerswill agree to complete due diligencewithin aspecifiedtimeperiodandwillprovidethesellerwithachecklistof itemstheywant to review. Many of these items are standard requests and can be


prepared inadvancetoexpeditecompletingtheduediligencestep.Examplesoftheseitemsinclude:

Documentso Corporatedocuments

Certificateofincorporation Bylaws Minutes

o Financialstatements Taxreturns Assets Receivables Pension ESOP

o Environmentalreportso Marketstudieso Productdescriptionsandplanso Keyintangibleso Keytangibles

Mortgages Titledocuments

o Insurancepolicies Companymanagement

o Relativeprofitabilityofproductsandserviceso Ownershipofcompanyo Governanceinformationo Litigation

Contractso Supplyandsalesagreementso Employmentandconsultingagreementso Leaseso Licenseandfranchiseagreementso Loanagreementso Shareholderagreementso Sponsorshipagreementso Laboragreementso Goldenparachuteso Deferredcompensationo Poisonpillso Securityagreementso Salesandproductwarranties

Outsidesourceso Marketandcapitalinformationo Liensearcho Creditcheckso Backgroundcheckso Patentandtrademarksearcheso Assetappraisals

These documents are typically stored in a virtual data room, whichfacilitates 24/7 access and reduces the amount ofwork that has to beperformedatthecompanyslocation.


FINALIZEDEALSTRUCTUREDEFINITIVEPURCHASEAGREEMENTEXECUTEAGREEMENTDISBURSEFUNDS

Any remainingadjustments to structuring thedealare finalizedat thispoint.Common adjustments include balances for working capital, receivables,payables, and other current assets and liabilities. Resolving any materialfindings or surprises emerging out of due diligence may also affect thestructureofthedeal.TheDefinitivePurchaseAgreement is thebinding legalcontractspecifyingallterms and conditions of the transaction. All the elements in the LOI areincorporatedaswellas the legal clausesandprovisionsattorneys frombothsidesbelievearenecessaryforthedeal.The deal is not complete until both parties execute the Definitive PurchaseAgreement. All hands remain on deck until financing is secure and theDefinitivePurchaseAgreementissigned.Thebestpartof theprocess isdisbursing theproceeds from the transactionaccordingtothetermsoftheDefinitivePurchaseAgreement. Proceeds fromthesaleofmiddlemarketcompaniestypicallyareintheseventoninefigures.Prudentownersprepareforthisdaywell inadvancebyworkingwithamultidisciplinary team of wealth management advisors consisting of certifiedfinancialplanners, trustandestateattorneys, taxattorneysandaccountants,chartered financial analysts and portfolio managers, and insurance andphilanthropicspecialists.Planning forandaddressingyourpersonalobjectivesareofequalimportancetoplanningandaddressingyourcorporateobjectives.Somesituationsaremorecomplexthanothersareandnotwocasesarealike.Succession planning inparticular requires careful forethought, consideration,and coordination.Managing this levelofwealth requiresboth customizing aplantoyourspecificsituationandformingateamoftrustedadvisorswhowillcontinuously place your interests ahead of theirs when the time comes forimplementingtheplanandmanagingyourwellearnedwealthfortheyearstocome.Thedealisnotcomplete,however,untiltheinkisdryandthemoneyisinthebank.Followingthroughtothecloseisessential.


THESTEPSOFACOMPETITIVEDEALPROCESS

It takes a lot of work, energy, and skill to plan and execute a successfultransaction.Itisfairtoask ifallthesestepsarenecessary.Butwhichofthesecanyouafford toskip?Unlocking theeconomicvalueofyourcompanywhileensuringasmoothandorderlytransitiontoaqualifiedbuyeror investorthatyouselectbasedonbothyourcorporateandpersonalpreferencesisaneventfewpeopleearntheprivilegetoperform.Givenallthatisatstake,followingaproven methodology managed by a team of experienced advisors whospecializeinmiddlemarketcompaniesmakesalotofsense.

Workingwiththerightteamofadvisorsisthebestapproachtoaccomplishingthe twin objectives of obtaining a premium price with a high probability ofgettingadealdone.


ABOUTFOUNDERSINVESTMENTBANKING

Founders Investment Banking is an independent investment banking firm,headquartered in Birmingham, Alabama, that is committed to providingcustomized corporate finance solutions for our clients. Our comprehensiverangeof complementary, valueadded services includemerger& acquisition,capital market, strategic financial, and real estate investment advisory. Wecontinue to build our reputation by delivering creative and sophisticatedsolutions, providing a superior level of customer service and personalattention, producing a track record of successful results, and conductingourselves every day with the highest degree of personal and professionalintegrity.Atour core,ourprofessionalsarededicated to connectingour clients to thebroadercapitalmarkets,bothdomesticallyand internationally, toaccomplishtheirpersonalandstrategicobjectives,withanemphasison:

o AchievingGrowtho BuildingValueo RealizingLiquidity

To learnmoreaboutFoundersordiscusswayswemightbeofservice,pleasecontact:

DuaneDonnerat2059492043([email protected])GeorgeMyersat2058217437([email protected])ZaneTarenceat2055034013([email protected])orvisitourwebsiteatwww.FoundersIB.com.

FoundersInvestmentBanking,LLCLakeshoreParkPlaza

2204LakeshoreDrive,Suite425Birmingham,Alabama35209

205.949.2043(office)205.871.0010(fax)

www.FoundersIB.com