Unlocking Private Company Wealth

Unlocking Private
Company Wealth
Z. Christopher Mercer, ASA, CFA, ABAR
Mercer Capital
mercerc@mercercapital.com | 901.685.2120
Exit Planning, Transaction Advisory Services, and Healthcare Valuation Conference
November 17, 2015

Baby Boomers Statistics
© Z. Christopher Mercer, 2015 | www.mercercapital.com | www.ChrisMercer.net 3
There are 76 million
baby boomers in the
US or approximately
25% of the U.S.
population
(2012 US Census data)
66% of all businesses
with employees, or
nearly 4 million
companies, are owned
by baby boomers
(Axial)
Baby boomers started
turning 65 in 2011 at a
rate of 10,000 a day —
a trend that will last for
the next 19 years
(Pew Research Center)

Ownership Transfer Matrix
Vertical or Horizontal?
See Figure 3 on page 22 in Unlocking Private Company Wealth.
Partial
Sale/Transfer
Total
Sale/Transfer
Voluntary
Transfer
• Private Equity/PE
• Sales to Insiders/Relatives
• Gifting Programs
• Sale of Business
• ESOP/Management
Buyout
• Buy-Sell Agreements
Involuntary
Transfer
• Personal Financial Issues
• Divorce
• Death
• Divorce
• Buy-Sell Agreements

Interim Time
StatusQuo
BusinessEndGame
The Rest of Your Life
Interim Time is when we set up our business end games and the rest of our lives
Interim Time

Managing Private Company Wealth
8© Z. Christopher Mercer, 2015 | www.mercercapital.com | www.ChrisMercer.net

Investment treatment
Focus on returns and risk
Diversification
Asset Allocation
Management fees
Common Themes of Liquid Wealth Management

What is the Return on a Portfolio?
See page 29-30 in Unlocking Private Company Wealth.

Mr. Jones’ $5 Million Portfolio
11.8% Return
Management Fee: $40,000 (80bps)

Mr. Jones’ $25 Million Portfolio
© Z. Christopher Mercer, 2015 | www.mercercapital.com | www.ChrisMercer.net
7.0% Return for Jones Mfg.
12
Management Fee: $0 (0bps)

Total Portfolio Return
See page 31 in Unlocking Private Company Wealth.
Weighted Return on Jones Mfg + Weighted Return on Liquid Portfolio
(80% x 7% Return) + (20% x 11.8% Return)
= 8.0% Total Portfolio Return
Good? Bad?
What
to do?

Idea #1
Rates of
Return
Talk to business owners in
terms of managing the wealth
in their businesses and in
terms of achieving
reasonable rates of return on
their investments

15
An annual budget for managing
illiquid private company wealth
(defined as an ownership interest in a
company)
Analogous to fees paid to manage
liquid wealth (stocks, bonds or other
liquid assets)
It costs money to manage wealth,
whether liquid or illiquid
The
Solution

16
New themes for
Private Wealth Management
Investment treatment
Focus returns and risk
Diversification
Allocation
Management fees (compensation)
The
Solution

One Percent Solution Activities
17
See pages 38-41 in Unlocking Private Company Wealth.
Wealth
Manager
Comp
Annual
Appraisals &
Monitoring of
Performance
Buy-Sell
Agreement
Pricing
Life
Insurance
Funding
Estate
Planning
Ownership &
Management
Transition
Planning
Financial
Planning
Annual
Legal
Review
Outside
Board
Members
Corporate
Finance for
Private
Businesses

The One Percent Solution for Mr. Jones
7.0% Return for Jones Mfg.
18

19
Managing Private Company Wealth
≠
Managing Private Companies

Idea #2
The One
Percent
Solution
Relate the costs of managing
private company wealth in
terms of the management
cost as a percentage of
business value

Fair Market Value - Hypothetical
21
Willing Buyers
All Informed
Arm’s Length
Willing Sellers
No
Compulsion
Financially
Capable
Price
Cash
Equivalent
Transaction

Basic Valuation Equations

The Levels of Value

Tools for Managing
Private Company Wealth

Total Revenue
minus
Total Cost
Earnings – The Beginning Point for Dividends

Annual Return
(No Realized Appreciation)
Need approval to calculate return
27

Net Cash Flow:
The Source of Dividends
Four Uses of NCF
1. Dividends
2. Retire debt
3. Reinvest for future growth
4. Reinvest in stagnant
assets
28
Owners don’t think in these terms but all companies have NCF

Idea #3
Calculate
Rates of
Return
For recurring clients,
calculate the rates of return
on their investment from year
to year and compare the
results with other, alternative
investments

Every
company has
a dividend
policy

Every company has a dividend policy
Dividend policy is a starting point for portfolio diversification
Special dividends enhance personal liquidity and diversification
Dividend policy matters
Boards of directors need to establish thoughtful dividend policies
Dividends and Dividend Policy for Private Cos

Never pay a
dividend
One time dividend Special dividend
Constant dollar
dividend
Set a dividend
payout ratio target
Dividend yield
target
Residual dividend
policy
Spin-out for spin-off
of subsidiaries or
other assets
Leveraged
dividend
recapitalization
10 Types of Dividend Policies
Distributions for tax pass-through liabilities

Dividend Policy
Influences Return
on Business Investment
Theory – Neutral
Reality – If you run the
company well, pay dividends,
and maintain normal capital
structure, you may well beat the
theoretical

Leveraged Recapitalizations
Leveraged Share Leveraged Dividend
Before Repurchase Recapitalization
1. Transactional Assumptions Transactions Change Pro Forma % Change Change Pro Forma % Change
1 Number of Shares to be Purchased 400,000 -
2 Number of Shares Outstanding 1,000,000 (400,000) 600,000 -40.0% - 1,000,000 0.0%
3 Amount of Repurchase / Dividend $30,800,000 $30,800,000 $30,800,000
4 Percentage of Shares Repurchased 40.0% 0.0%
5 Less Cash ($2,000,000) ($2,000,000) ($2,000,000)
6 Amount to be Borrowed $28,800,000 $28,800,000 $28,800,000
7 Interest Rate on New Debt 6.0%
8 Blended Tax Rate 40.0%
Two types of transactions look similar to company
Share
Repurchases
Leveraged
Dividends

2. Income Statements Transactions Change Pro Forma % Change Change Pro Forma % Change
1 Sales $50,000,000 $50,000,000 0.0% $50,000,000 0.0%
2 EBITDA Margin 26.0% 26.0% 0.0% 26.0% 0.0%
3 EBITDA $13,000,000 $13,000,000 0.0% $13,000,000 0.0%
4 Depreciation $1,000,000 $1,000,000 $1,000,000
5 EBIT $12,000,000 $12,000,000 $12,000,000
5 Interest Expense $0 ($1,728,000) (1,728,000) ($1,728,000) ($1,728,000)
6 Pre-Tax Income $12,000,000 $10,272,000 -14.4% $11,272,000 -6.1%
7 Taxes ($4,800,000) ($4,108,800) -14.4% ($4,508,800) -6.1%
8 Net Income $7,200,000 $6,163,200 -14.4% $6,763,200 -6.1%
9 Net Margin 14.4% 12.3% -14.4% 13.5% -6.1%
10 Current Dividends $1,000,000 1,000,000 0.0% 1,000,000 0.0%
3. Key Balance Sheet Items
11 Cash $2,000,000 ($2,000,000) $0 -100.0% ($2,000,000) $0 -100.0%
12 Debt $0 28,800,000 $28,800,000 nm 28,800,000 $28,800,000 nm
13 Book Value of Equity $70,000,000 (30,800,000) $39,200,000 -44.0% (30,800,000) $39,200,000 -44.0%
Look similar to company

4. Valuation and Leverage Transactions Change Pro Forma % Change Change Pro Forma % Change
1 Market Value of Total Capital (MVTC) 6.0 $77,000,000 $77,000,000 0.0% $77,000,000 0.0%
2 Enterprise Value (MVTC - Cash) $75,000,000 $77,000,000 2.7% $77,000,000 2.7%
3 Less Debt - 28,800,000 nm 28,800,000 nm
4 Plus Cash $2,000,000 $0 $0
5 Market Value of Equity $77,000,000 $48,200,000 -37.4% $48,200,000 -37.4%
6 Interest Bearing Debt/Equity 0.0% 73.5% 73.5%
7 Debt to Enterprise Value 0.0% 37.4% 37.4%
8 EBITDA/Interest Expense nm 7.5 7.5
9 Debt/EBITDA 0.0% 2.2 2.2
10 Net Income - Expected Dividend $6,200,000 $5,163,200 $5,763,200 -7.0%
11 Years to Amortize Debt Principal na 5.6 5.0

5. Shareholder Results Transactions Change Pro Forma % Change Change Pro Forma % Change
1 Shares Outstanding 1,000,000 600,000 -40.0% 1,000,000 0.0%
2 Earnings Per Share $7.20 $10.27 42.7% $6.76 -6.1%
3 Value Per Share $77.00 $80.33 4.3% $48.20 -37.4%
4 Price/Earnings Multiple 10.7 7.8 7.1
5 Dividends Per Share $1.00 $1.67 66.7% $1.00 0.0%
6 Dividend Yield 1.3% 2.1% 59.8% 2.1% 59.8%
7 Dividend Payout Ratio 13.9% 16.2% 16.8% 14.8% 6.5%
8 Book V alue Per Share $77.00 $65.33 -15.2% $39.20 -49.1%
9 Price/Book Value 110.0% 123.0% 11.8% 123.0% 11.8%
10 Return on Equity 10.3% 15.7% 52.9% 17.3% 67.7%
Which is best? You decide

Many owners of successful private
businesses abhor the use of even prudent
leverage. Others don’t think about it.
They should.

Idea #4
Basic
Corporate
Finance Tools
The “tools” we are discussing
are basic corporate finance
tools. Add them to your
vocabulary and discuss them
when appropriate with
business owners

Perspectives for Managing
Private Company Wealth

41
• Value that others are
willing to pay for
• Not value to you as an
owner
• Related to concept of
Identifiable Earnings
• READY
• Visible
• Believable
• Capitalizable
• Projectable
Transferable
Business Value
Identifiable
Earnings

7 Ways the Next Investors Will Look at Your Business
Relative to itself
over time
Relative to peer
groups
Relative to budget
or plan
Relative to your
unique potential
Relative to strategic
or synergistic
opportunities your
platform offers
At a point in time
Relative to regulatory
expectations or
requirements

43
Look now at a
business like future
investors will
look at it

Idea #5
Future
Investor
Analysis
Have a qualified appraisal firm with
transactional experience conduct a
valuation analysis of your business that is
geared to address the seven perspectives
of future investors in more depth than
might be employed in a typical appraisal
That analysis could highlight opportunities to
reduce risk, and to enhance expected cash
flow and growth

Bad Things Happen to
Good Companies
If you wait until it’s too late, it’s too late
Yes, but ...

Management Transitions
Inevitable
Part of the private company wealth management process
Successful management transitions increase
attractiveness to potential future investors

Ownership Transitions
1. A primary owner dies unexpectedly
2. A key employee leaves
3. The owner gets tired and decides to sell
4. Business reversals happen
5. The primary owner divorces
6. The second (or third or fourth) generation is not up to the task
7. Life changing experiences occur
8. Unexpected offers come along
9. Buy-sell agreement operation
10. Gift and estate tax planning
11. Normal lifetime planning dictates timing
Remember the
Ownership
Transfer Matrix?

Management and ownership transition will occur
Focus now, during interim time, to assure
successful transitions
The good things that need to happen will occur
(or not) between your current status quo and any
ultimate sale or disposition of your business
So, prepare for the unexpected
Observations on Transitions

Idea #6
Focus on
Inevitable
Transitions
During any business valuation
process (or any other significant
discussion), ask questions
about plans for management
and/or ownership transition

Is Your Business READY for Sale?
If you don’t sell your business today,
you are a buyer of your business
R Risk
E Earnings
A Activities, Attitudes
D Driving Growth
Y Year-to-Year Comparisons

25 Questions for Business Owners
1. How much is your closely held or family business worth?
2. Is your wealth adequately diversified to avoid the risk of major
losses from adverse events with any of your assets, including your
business?
3. What is the plan to obtain liquidity from your ownership of your
business?
4. Is your business “ready for sale” whether or not you have any
interest in selling today?

Ideas Review
1. Talk to business owners in terms of managing the wealth
and achieving reasonable rates of return
2. Discuss the One Percent Solution to put costs of managing
private wealth in perspective
3. When information is available, calculate your clients’ rates of
return (and discuss)
4. Discuss the tools for managing wealth with your clients

Ideas Review (cont.)
5. Recommend in depth review of businesses the way next
investors will see them
6. Ask questions about plans for ownership and management
transition

Unlocking Private Company Wealth
ChrisMercer.net/books
Purchase Unlocking Private Company Wealth
When ordering from website, receive a PDF of
complimentary resources
• Buy-Sell Agreements for Closely
Held and Family Business Owners
• The Buy-Sell Agreement
Review Checklist
• Checklist for Shareholder
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Z. Christopher Mercer, ASA, CFA, ABAR
901.685.2120
mercerc@mercercapital.com
www.MercerCapital.com
www.ChrisMercer.net
linkedin/in/zchristophermercer
Mercer Capital
5100 Poplar Ave., Suite 2600
Memphis, TN 38137
Chris Mercer is the founder and CEO of Mercer Capital, a national business valuation and
financial advisory firm.
Chris began his business valuation career in the 1970s and has been involved with hundreds
of valuations for purposes related to mergers & acquisitions, litigation, and estate and gift tax
planning, among others. He has extensive experience in litigation engagements including
statutory fair value cases, business damages, and lost profits. He is also an expert in buy-sell
agreement disputes.
Designations held include Accredited Senior Appraiser (ASA) from the American Society of
Appraisers, Chartered Financial Analyst (CFA) from the CFA Institute, and Accredited in
Business Appraisal Review (ABAR) from the Institute of Business Appraisers.
Chris has written widely on business valuation-related topics and is a frequent speaker on
business valuation issues for national professional associations, other business and
professional groups, and business owners.
Recent books authored by Chris include Unlocking Private Company Wealth (Peabody
Publishing, LP 2014), Buy-Sell Agreements for Closely Held and Family Business Owners
(Peabody Publishing, LP 2010) and Business Valuation: An Integrated Theory, 2nd Edition,
with Travis W. Harms (John Wiley and Sons 2008).
For a complete list of the books authored by Chris, as well as further information on his
valuation-related experience, view his complete CV at www.mercercapital.com.

Unlocking Private Company Wealth

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