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MERGERS & ACQUISITIONS
                                                                            CORPORATE FINANCE
                                                                           MARKET INTELLIGENCE
                                                                            BUSINESS VALUATION
                                                                                  EXIT PLANNING

                                                                         MERGERS AND ACQUISITIONS
                                                                               CORPORATE FINANCE
                                                                              MARKET INTELLIGENCE
Investment Bankers To The Middle Market
                                                                              BUSINESS VALUATION
                    Investment Bankers to the Middle Market                         EXIT PLANNING
                                                                     




                                                              What’s your Business Worth?
                                                               
                                                               
    HARRY WARD
    HAMPTON ROADS OFFICE
                                                               
    757.613.0476
    hward@mcleanllc.com                                        
     

                                                               
Introduction to The McLean Group

  Middle-market investment bank with extensive reach and experience.
        Private Company M&A, Capital Formation
        Business Valuation
        Market Intelligence 
        Exit Planning

  Broker/dealer serving the middle-market ($5M to $500M in revenue)
        McLean Securities, a wholly-owned affiliate, is a registered broker/dealer with 
         FINRA; Member, Securities Investor Protection Corporation (SIPC) 1

  Headquartered in the Northern Virginia technology corridor near
   Washington, D.C. with 30 North American offices.

  International desk with network of 200 close affiliates in 35 countries.




            1.   All advisors are fully-licensed to facilitate securities transactions as mandated and actively enforced by government regulatory bodies with unique
                 technical depth – CPAs, CFAs, MBAs, certified negotiators, M&A and valuation experts.


                                                                                                                                     Confidential and Proprietary      2
Objectives:



   •   Define the Middle Market
   •   Discuss Types of Buyers
   •   Show How Buyers Value a Company
   •   Contrast Seller’s Approach to Value
   •   Discuss the M&A Process




                                             Confidential and Proprietary
Defining Our Middle Market:


Revenues from $5 million to $500 million
      Less than $5 million: “Mom and Pop” - best served by business
       brokers;
       Greater than $500 million: best served by Wall Street and some
       regional I-banks.




                                                        Confidential and Proprietary
Buyer Types Help Drive Business Value:


 Buyer Type                           Generates value through…

 Strategic – Industry Consolidators   Operational means: economies of
                                      scale, new markets, market
                                      share, “synergies”

 Financial – Private Equity           Financial engineering and
                                      operational efficiencies

 Roll-up groups                       Financial engineering

 Industry (non-strategic)             Bottom-fishers (opportunistic)

 Individual Buyers                    Last ditch effort, very rare in MM




                                                           Confidential and Proprietary
Another View of the Buyers




           Source: Mergerstat Review



                                       Confidential and Proprietary
Business Valuation Basics




                            Confidential and Proprietary   7
Formal vs. “Street” Valuations


• Formal (Report)                      • M&A (The street)
    Appraisals  of Equity for               Always Investment Value 
     legal purposes                           of whole enterprise
    Several Measures: FMV,                  Real-world transaction 
     Investor Value, Fair Value               comparables
    Assumes Symmetric                       Asymmetric Knowledge is 
     knowledge                                reality
    Cash/Non-contingent                     Mixed Consideration, 
     Consideration                            often Contingent


      ** Appraisals are of little value to a seller: each buyer
                      drives a different value **

                                                             Confidential and Proprietary
M&A Valuation Dynamics:



                Buyers                                 Sellers
          Detalied Calculations                 Preliminary Calculations

    1.DCF / Capitalized Cash Flows     1.Comparable Transactions
    2.Comparable Transactions          2.DCF / Capitalized Cash Flows
        • Unavoidable!                      •     Understand Buyer’s view




                          Negotiated Agreement
                Buyer’s investment value and synergies
                balanced with market influences in auction

              Key Issue: Who gets the value of buyer’s synergies?


                                                                 Confidential and Proprietary
Buy Side: Discounted Cash Flows (DCF)




                                 Confidential and Proprietary   10
EBITDA: Pre-Tax Cash Flow


• What? Earnings before interest, taxes, depreciation and 
  amortization (EBITDA);
• Why? EBITDA is a close approximation to cash flow; removes 
  the effects of financing and cap investment decisions
• Who cares? Buyers care because cash-flow comparisons allow 
  them to evaluate alternative investment vehicles that provide 
  cash flows 
   –   Bonds 5% (20 times multiple)
   –   Real Estate (commercial) 9% to 11% (11 to 9 times multiple)
   –   Large cap stocks 12% (8 times multiple)
   –   Small cap stocks 21% (4.8 times multiple)




                                                               Confidential and Proprietary
Normalize for “Real” EBITDA
                      Or Pre-tax Cash Flow


   Reported net taxable income                     500,000
   Adjustments:
   Add back owner salary > $200K              $     400,000
   Add back interest long term debt                  50,000
   Add non-recurring expenses                 $     250,000
   Add back depreciation                      $.     50,000
   Normalized net (EBITDA)                    $    1,450,00




                                                      Confidential and Proprietary
Cash Flow to the Firm


                       • EBIT = Earnings before Interest and Taxes
 Standard for seller
 market multiples >
                       • EBITDA = add depreciation and amortization 
                         (and normalize)

                       • EBITDA minus Capital Expenditures 
                          – Buyer estimates CAPEX to sustain operations
  Standard used by     • EBITDA minus CAPEX & Changes in Working 
   most buyers for
       DCF >             Capital (aka Cash Flow to the Firm)
                          – Need more WC to execute plans?  Must reduce cash 
                            flow as a buyer




                                                             Confidential and Proprietary   13
Basic DCF


   1. Buyer calculates Cost of Capital *
   2. Forecast 3 – 5 years cash flows and terminal value
   3. Discount each year and terminal value by cost of capital


                                  EXAMPLE
                               Year 1   Year 2   Year 3   Terminal

    Forecast cash flow         2,200    2,500    2,900     30,000
    Present value at 12%       1,964    1,993    2,064     21,353

    Sum all DCF’s for Total Enterprise Value:              $27,374




            * Various Flavors: WACC, Discount Rate, Cap Rate, IRR

                                                                 Confidential and Proprietary   14
Sell Side: EBITDA Multiples




                              Confidential and Proprietary   15
Multiple Realities in the Middle Market:


• Usual range 4.5x – 5.5x EBITDA
• Possible range 1x - 12x 
• Higher ranges may be justifiable in hot industries
  with high growth rates, and
• Lower ranges are more likely in professional 
  services, resellers, commodity and “buggy whip” 
  businesses).




                                              Confidential and Proprietary
Value Driver Considerations


    Growth
    Size
    Proprietary Assets/Differentiation
    Customer/Supplier concentration
    Ratio Comparisons
    Cyclicality (e.g. construction)
    Professional goodwill/key management dependence
    In gov’t contracting: transferability of contracts



                                                    Confidential and Proprietary
Summing Up: Calculating Preliminary Value

                           (in the Marketplace)

    Normalized net income (EBITDA)             $ 6,000,000
    Preliminary multiple                              6X

    Value of earnings                          $36,000,000

    Excess balance sheet value                        $ 2,000,000
    Value of enterprise
    $38,000,000
    Minus Liabilities assumed by buyer, e.g.          $      8,000,000

    Value of Equity                                $30,000,000
    In the auction – who knows?


                                                             Confidential and Proprietary
Owners – Keep an Eye on Your Exit


    Always pursue growth (top and bottom line)
    Hire, train, incentivize solid people
    Keep balance sheet and business entities clean
     (consider housing non-core assets in separate entities)
    Diversify customer and supplier bases
    Shift from tax optimization to value optimization
    View your company through eyes of potential suitors
     (e.g. build a complementary niche market)




                                                         Confidential and Proprietary
Middle Market M&A Process




                            Confidential and Proprietary
The M&A Process, Step by Step:


 1.  Identify and locate prospective buyers;
 2.  Prepare confidential information memorandum and acquisition
     profile;
 3. Distribute acquisition profiles to prospective buyers;
 4. Secure non-disclosure agreements from interested prospects;
 5. Distribute the confidential information memorandum;
 6. Negotiate Indications of Interest (IOIs), hold meetings
 7. Secure letters of intent;
 8. Conduct due diligence (by buyer);
 9. Negotiate and prepare the definitive agreement;
 10. Closing (sounds easy, but “every deal dies a thousand deaths!”)




                                                            Confidential and Proprietary
Timing the Sale: A Big Mistake!




                         Maximum
                          Value
 $ Sales




                            Time


                                   Confidential and Proprietary
Beware the Single Offer!
A typical single offeror:




                            Confidential and Proprietary
Don’t Hide Problems/Issues:

   Letters of Intent Are Not Invitations to Further Negotiation

                  The Seller’s Advantage Curve
Seller




Buyer


         Management     Multiple   LOI Negotiations Exclusivity to Buyer Closin
         Presentation   Offers                                           g




                                                                       Confidential and Proprietary
Buyer research & effective Auctions:

                      Don’t Assume
             The “Likely” Identity of the Buyer

30 Transactions: were “Most Likely” Buyers the final acquirer?




                                              Source: Goldsmith Agio Helms




                                                     Confidential and Proprietary
M&A Consideration:

                   Types and Ranges

• Principal elements:
   – Cash (usually 40% to 80%);
   – Seller take-back notes (20% to 40%);
   – Stock (if any, then 20% to 80%), and
   – Contingent vs. non-contingent consideration
      •  If any, then 20% to 25% contingent, and
      •  Comfort vs. incentive earn-outs.



                                            Confidential and Proprietary
The Top 14 Seller Mistakes:


 1. Selling it without            8. Being represented by an
    representation                    unlicensed broker
 2. Selling to a single offeror   9. Communicating your asking
 3. The poorly constructed            price inappropriately
    earn-out                      10. Eliminating offshore buyers
 4. Disclosing an insufficient    11. Assuming the type of buyer
    amount of information in      12. Waiting until management is
    Offering Memo                     ready to retire
 5. LOI not thorough              13. Waiting for next year’s growth
 6. Focusing on history and       14. Ignoring or over-emphasizing
    numbers instead of future         timing
    opportunity
 7. Mismanaging team, end
    runs


                                                       Confidential and Proprietary
National Office Locations

 Headquartered in McLean, VA, The McLean Group has built a national presence in middle market investment banking
 with offices in 30 cities nationwide. Each of The McLean Group’s investment bankers brings a unique breadth of
 experience and expertise to the firm.

                                             National Offices

                            McLean, VA – Headquarters         Halifax, Nova Scotia
                            Anchorage, AK                     Lafayette, LA
                            Asheville, NC                     Miami, FL
                            Atlanta, GA                       Milwaukee, WI
                            Austin, TX                        Norfolk, VA
                            Baltimore, MD                     Phoenix, AZ
                            Boston, MA                        Reno, NV
                            Bozeman, MT                       Sacramento, CA
                            Buffalo, NY                       San Diego, CA
                            Chicago, IL                       San Francisco, CA
                            Cleveland, OH                     Silicon Valley, CA
                            Columbus, OH                      St. Louis, MO
                            Erie, PA                          Tallahassee, FL
                            Green Bay, WI                     Tampa, FL
                            Hartford, CT                      Tulsa, OK


                                                                                        Confidential and Proprietary   28
The McLean Group Hampton Roads, VA
                                        The McLean Group, LLC
         Harry Ward, Director
                                     7900 Westpark Drive, Suite A320
           3181 Shore Drive
                                           McLean, VA 22102
       Virginia Beach, VA 23451
                                             703.827.0200
             757.613.0476




                                                          Confidential and Proprietary    29

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HatchConf Business Value and M&A Process

  • 1. MERGERS & ACQUISITIONS CORPORATE FINANCE MARKET INTELLIGENCE BUSINESS VALUATION EXIT PLANNING MERGERS AND ACQUISITIONS CORPORATE FINANCE MARKET INTELLIGENCE Investment Bankers To The Middle Market BUSINESS VALUATION             Investment Bankers to the Middle Market EXIT PLANNING   What’s your Business Worth?     HARRY WARD HAMPTON ROADS OFFICE   757.613.0476 hward@mcleanllc.com      
  • 2. Introduction to The McLean Group  Middle-market investment bank with extensive reach and experience.  Private Company M&A, Capital Formation  Business Valuation  Market Intelligence   Exit Planning  Broker/dealer serving the middle-market ($5M to $500M in revenue)  McLean Securities, a wholly-owned affiliate, is a registered broker/dealer with  FINRA; Member, Securities Investor Protection Corporation (SIPC) 1  Headquartered in the Northern Virginia technology corridor near Washington, D.C. with 30 North American offices.  International desk with network of 200 close affiliates in 35 countries. 1. All advisors are fully-licensed to facilitate securities transactions as mandated and actively enforced by government regulatory bodies with unique technical depth – CPAs, CFAs, MBAs, certified negotiators, M&A and valuation experts. Confidential and Proprietary 2
  • 3. Objectives: • Define the Middle Market • Discuss Types of Buyers • Show How Buyers Value a Company • Contrast Seller’s Approach to Value • Discuss the M&A Process Confidential and Proprietary
  • 4. Defining Our Middle Market: Revenues from $5 million to $500 million  Less than $5 million: “Mom and Pop” - best served by business brokers; Greater than $500 million: best served by Wall Street and some regional I-banks. Confidential and Proprietary
  • 5. Buyer Types Help Drive Business Value: Buyer Type Generates value through… Strategic – Industry Consolidators Operational means: economies of scale, new markets, market share, “synergies” Financial – Private Equity Financial engineering and operational efficiencies Roll-up groups Financial engineering Industry (non-strategic) Bottom-fishers (opportunistic) Individual Buyers Last ditch effort, very rare in MM Confidential and Proprietary
  • 6. Another View of the Buyers Source: Mergerstat Review Confidential and Proprietary
  • 7. Business Valuation Basics Confidential and Proprietary 7
  • 8. Formal vs. “Street” Valuations • Formal (Report) • M&A (The street)  Appraisals  of Equity for   Always Investment Value  legal purposes of whole enterprise  Several Measures: FMV,   Real-world transaction  Investor Value, Fair Value comparables  Assumes Symmetric   Asymmetric Knowledge is  knowledge reality  Cash/Non-contingent   Mixed Consideration,  Consideration often Contingent ** Appraisals are of little value to a seller: each buyer drives a different value ** Confidential and Proprietary
  • 9. M&A Valuation Dynamics: Buyers Sellers Detalied Calculations Preliminary Calculations 1.DCF / Capitalized Cash Flows 1.Comparable Transactions 2.Comparable Transactions 2.DCF / Capitalized Cash Flows • Unavoidable! • Understand Buyer’s view Negotiated Agreement Buyer’s investment value and synergies balanced with market influences in auction Key Issue: Who gets the value of buyer’s synergies? Confidential and Proprietary
  • 10. Buy Side: Discounted Cash Flows (DCF) Confidential and Proprietary 10
  • 11. EBITDA: Pre-Tax Cash Flow • What? Earnings before interest, taxes, depreciation and  amortization (EBITDA); • Why? EBITDA is a close approximation to cash flow; removes  the effects of financing and cap investment decisions • Who cares? Buyers care because cash-flow comparisons allow  them to evaluate alternative investment vehicles that provide  cash flows  – Bonds 5% (20 times multiple) – Real Estate (commercial) 9% to 11% (11 to 9 times multiple) – Large cap stocks 12% (8 times multiple) – Small cap stocks 21% (4.8 times multiple) Confidential and Proprietary
  • 12. Normalize for “Real” EBITDA Or Pre-tax Cash Flow Reported net taxable income 500,000 Adjustments: Add back owner salary > $200K  $ 400,000 Add back interest long term debt      50,000 Add non-recurring expenses         $ 250,000 Add back depreciation        $. 50,000 Normalized net (EBITDA)         $ 1,450,00 Confidential and Proprietary
  • 13. Cash Flow to the Firm • EBIT = Earnings before Interest and Taxes Standard for seller market multiples > • EBITDA = add depreciation and amortization  (and normalize) • EBITDA minus Capital Expenditures  – Buyer estimates CAPEX to sustain operations Standard used by • EBITDA minus CAPEX & Changes in Working  most buyers for DCF > Capital (aka Cash Flow to the Firm) – Need more WC to execute plans?  Must reduce cash  flow as a buyer Confidential and Proprietary 13
  • 14. Basic DCF 1. Buyer calculates Cost of Capital * 2. Forecast 3 – 5 years cash flows and terminal value 3. Discount each year and terminal value by cost of capital EXAMPLE Year 1 Year 2 Year 3 Terminal Forecast cash flow 2,200 2,500 2,900 30,000 Present value at 12% 1,964 1,993 2,064 21,353 Sum all DCF’s for Total Enterprise Value: $27,374 * Various Flavors: WACC, Discount Rate, Cap Rate, IRR Confidential and Proprietary 14
  • 15. Sell Side: EBITDA Multiples Confidential and Proprietary 15
  • 16. Multiple Realities in the Middle Market: • Usual range 4.5x – 5.5x EBITDA • Possible range 1x - 12x  • Higher ranges may be justifiable in hot industries with high growth rates, and • Lower ranges are more likely in professional  services, resellers, commodity and “buggy whip”  businesses). Confidential and Proprietary
  • 17. Value Driver Considerations  Growth  Size  Proprietary Assets/Differentiation  Customer/Supplier concentration  Ratio Comparisons  Cyclicality (e.g. construction)  Professional goodwill/key management dependence  In gov’t contracting: transferability of contracts Confidential and Proprietary
  • 18. Summing Up: Calculating Preliminary Value (in the Marketplace) Normalized net income (EBITDA) $ 6,000,000 Preliminary multiple 6X Value of earnings $36,000,000 Excess balance sheet value $ 2,000,000 Value of enterprise $38,000,000 Minus Liabilities assumed by buyer, e.g. $ 8,000,000 Value of Equity $30,000,000 In the auction – who knows? Confidential and Proprietary
  • 19. Owners – Keep an Eye on Your Exit  Always pursue growth (top and bottom line)  Hire, train, incentivize solid people  Keep balance sheet and business entities clean (consider housing non-core assets in separate entities)  Diversify customer and supplier bases  Shift from tax optimization to value optimization  View your company through eyes of potential suitors (e.g. build a complementary niche market) Confidential and Proprietary
  • 20. Middle Market M&A Process Confidential and Proprietary
  • 21. The M&A Process, Step by Step: 1. Identify and locate prospective buyers; 2. Prepare confidential information memorandum and acquisition profile; 3. Distribute acquisition profiles to prospective buyers; 4. Secure non-disclosure agreements from interested prospects; 5. Distribute the confidential information memorandum; 6. Negotiate Indications of Interest (IOIs), hold meetings 7. Secure letters of intent; 8. Conduct due diligence (by buyer); 9. Negotiate and prepare the definitive agreement; 10. Closing (sounds easy, but “every deal dies a thousand deaths!”) Confidential and Proprietary
  • 22. Timing the Sale: A Big Mistake! Maximum Value $ Sales Time Confidential and Proprietary
  • 23. Beware the Single Offer! A typical single offeror: Confidential and Proprietary
  • 24. Don’t Hide Problems/Issues: Letters of Intent Are Not Invitations to Further Negotiation The Seller’s Advantage Curve Seller Buyer Management Multiple LOI Negotiations Exclusivity to Buyer Closin Presentation Offers g Confidential and Proprietary
  • 25. Buyer research & effective Auctions: Don’t Assume The “Likely” Identity of the Buyer 30 Transactions: were “Most Likely” Buyers the final acquirer? Source: Goldsmith Agio Helms Confidential and Proprietary
  • 26. M&A Consideration: Types and Ranges • Principal elements: – Cash (usually 40% to 80%); – Seller take-back notes (20% to 40%); – Stock (if any, then 20% to 80%), and – Contingent vs. non-contingent consideration •  If any, then 20% to 25% contingent, and •  Comfort vs. incentive earn-outs. Confidential and Proprietary
  • 27. The Top 14 Seller Mistakes: 1. Selling it without 8. Being represented by an representation unlicensed broker 2. Selling to a single offeror 9. Communicating your asking 3. The poorly constructed price inappropriately earn-out 10. Eliminating offshore buyers 4. Disclosing an insufficient 11. Assuming the type of buyer amount of information in 12. Waiting until management is Offering Memo ready to retire 5. LOI not thorough 13. Waiting for next year’s growth 6. Focusing on history and 14. Ignoring or over-emphasizing numbers instead of future timing opportunity 7. Mismanaging team, end runs Confidential and Proprietary
  • 28. National Office Locations Headquartered in McLean, VA, The McLean Group has built a national presence in middle market investment banking with offices in 30 cities nationwide. Each of The McLean Group’s investment bankers brings a unique breadth of experience and expertise to the firm. National Offices  McLean, VA – Headquarters  Halifax, Nova Scotia  Anchorage, AK  Lafayette, LA  Asheville, NC  Miami, FL  Atlanta, GA  Milwaukee, WI  Austin, TX  Norfolk, VA  Baltimore, MD  Phoenix, AZ  Boston, MA  Reno, NV  Bozeman, MT  Sacramento, CA  Buffalo, NY  San Diego, CA  Chicago, IL  San Francisco, CA  Cleveland, OH  Silicon Valley, CA  Columbus, OH  St. Louis, MO  Erie, PA  Tallahassee, FL  Green Bay, WI  Tampa, FL  Hartford, CT  Tulsa, OK Confidential and Proprietary 28
  • 29. The McLean Group Hampton Roads, VA The McLean Group, LLC Harry Ward, Director 7900 Westpark Drive, Suite A320 3181 Shore Drive McLean, VA 22102 Virginia Beach, VA 23451 703.827.0200 757.613.0476 Confidential and Proprietary  29