James Wong, CA, CBV

1
Planning Through The Crisis. A Succession
Planning Perspective.
By James Wong, CA, CBV Director of Succession
Planning BMO Harris Private Banking
2
Agenda

1. Succession process revisited
2. Impact of the current financial crisis/economy
   slowdown on succession planning and planning
   through the crisis
3. Overview of business valuation.

3
Overview

1. 2 of every 3 Canadian entrepreneurs over 50 years
   old have not commence their succession
2. Long-term structural changes in Canadian
   businesses caused by increasing globalization
3. Weak global economy expected to persist through
   2009 and into 2010
4. Generally lower business valuations

4
Succession is a process and not an event

• Set new goals and vision for owners and their
  family. Distinguish between need to have and
  want to have
• Establish open communication amongst stakeholders
  (family members, senior management, etc.)
• Review estate plans in the context of succession
  plans
• Assess the current state of business through a
  SWOT analysis
• Economic landscape
• Business continuity needs in both soft and hard
  capital
• Estimate business value and assess adequacy of
  retirement funds
• Establish target timelines
• Consider tax planning opportunities
• Identify and review succession options
• Select and plan an exit strategy

5
Succession Planning Timeline
6
Impact of Current Economic Crisis on Succession
Planning

• General reduction in business valuation
• Tighter financial markets
• Reduced profitability
• Changes in internal business profile
• Change in future business landscape
• Increase foreign competition
• Consolidation
• Volatile Canadian currency
• Increase dependency
• Redistribution of business resources
• Tighter financing
• Reallocation of business focus.

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Navigating Through Trouble-Waters

• Remain focused on personal and family objectives
• Re-evaluate succession objectives in light of
  external (and internal) business changes
• Revisit timeline based on objectives and overall
  changes in business outlook
• Proactively respond to changes in business
  outlook
• Improve balance sheet (e.g. inventory and AR
  turns)
• Reduce customer/supplier dependency
• Control overhead expenses (operational leverage)
• Reallocate business resources (e.g. from
  manufacturing to distribution)

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Navigating .. (Continued)

• Evaluate net asset value against capitalized
  value of the business
• Maintain and secure lines of credit even if the
  credit is not presently required
• Consider tax planning in light of lower business
  valuation
• Tools
• Increase communication amongst stakeholders
• Assistance from trusted advisors
• Consider succession facilitator

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Importance of Business Valuation

• A business valuation exercise will assist in
  business strategic planning by highlighting key
  business value drivers
• Business valuation provides key input to
• Personal financial planning i.e. an estimate of
  the value of equity in the family business
• Tax planning and
• Insurance planning

10
Valuation Definitions

• Fair market value (FMV)This term is commonly
  used in notional valuations and usually applies
  to the equity of a business. A common definition
  of FMV is The highest price, expressed in terms
  of money or moneys worth, obtainable in an open
  and unrestricted market between informed and
  prudent parties, acting at arms length and under
  no compulsion to transact.
• Enterprise Value (EV)This term is often used
  in sale of business transactions. EV refers to
  the value of the business as supported by all
  sources of financing, including debt financing.
  EV is therefore equal to FMV of equity and debt
  i.e.EV FMV of equity plus debt.

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Business Valuation Essentials

• Value is driven by
• Level of sustainable cash flow
• Level of business risk usually expressed in terms
  of required capitalization rate or multiple.
• Basic valuation models

Cash Flow _________________ Capitalization Rate
- growth
Value
or
Cash Flow X Capitalization Multiple Value
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Business ValuationCapitalization Multiple Model
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Business Valuation DCF Model
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Business Valuation - General Capitalization
Multiples

• Normalized EBITDA Multiple Ranges
• Manufacturing - 4 to 6 times
• Distribution (wholesale) - 3 to 4 times
• Services contracting - 1 to 2 times.
• Reported earnings plus/minus non-economic and
  non-recurring items.
• EBITDA Earnings before interest, taxes,
  depreciation and amortization.

• General factors that influence choice of
  multiple
• Volatility of earnings
• Exclusivity (technology, licenses, contracts,
  etc.)
• Diversification of customer base
• Competitive landscape
• Security of critical supplies (material and
  labour)
• Underlying collateral (TAB)
• General economic conditions.

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Valuation by Industries

• General valuation multiples have weakened by half
  to one-time of EBITDA in the last 12 months
• Global financial crisis in the US has affect
  smaller to medium size private business
  valuations, particularly those dependent on
  leverage
• Select industries are still strong, particularly
  those driven by demographic trends
• The growth in health and healthcare related
  businesses are driving strong multiples 5 times
  for healthcare products distribution company
• Funeral homes 5 to 6 times EBITDA or 7,000 to
  10,000 per call
• Food manufacturing multiples north of 6 times
  EBITDA are common
• Security services 36 times monthly recurring
  revenue
• Auto-parts related businesses continue to
  struggle and multiples remain low
• Professional services (engineering, consulting,
  etc.) have traditionally low multiples (1.5 to 3
  times) and unique transition structures required
  as there is high percentage of personal goodwill
• Increasing trend towards to import and
  distribution versus manufacturing

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Divestiture Process

1. Key is in selecting appropriate intermediary or
   investment banker (IB) to represent the seller
   of the business
2. Fees range between 2 (EV over 50MM) and 10 (EV
   less than 3MM)
3. Approximately 4 to 6 month process see FAS
   timeline. More difficult divestiture could take
   up to 12 months.

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Valuation FAQs (as asked by business owners)

1. What are the main factors considered in a
   business valuation?The main factors considered
   in a business valuation are (i) the estimated
   future sustainable cash flow, (ii) the stability
   of the cash flow, and (iii) the growth prospects
   of the cash flow.
2. How is future cash flow estimated? Future cash
   flow is usually estimated based on the business
   recent historical earnings. Earnings are
   adjusted for non-cash items, such as
   depreciation, and actual cash outflows that are
   not included in earnings such as capital
   expenditure, to estimate cash flow.
3. How far back do valuators look to estimate future
   cash flow? It depends on several factors. If
   earnings are relatively stable and are expected
   to remain stable, then a simple average of the
   last 3 to 5 years would generally suffice. If
   however, earnings are volatile, selection of the
   base period is more complex. A simple average of
   historical earnings may not suffice and therefore
   may require detail analysis and projection of
   future earnings.

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Valuation FAQs - continue

1. What are the most common valuation models that
   are used to value privately held
   business?Models that are based on
   capitalization of cash flow are the most common
   models. Amongst capitalization models, multiple
   of cash flow model is most common because of its
   simplistic and intuitive approach.
2. How reliable are rules of thumb in valuing
   businesses?Rules of thumb should be used with
   caution. Rules of thumb can give a broad
   indication of valuation, however are more
   commonly used to corroborate other mainstream
   valuation models.
3. How are multiples chosen in multiple of cash flow
   models?Multiples are a direct reflection of
   business risk. Higher multiples are generally
   chosen where cash flow is expected to be stable
   and where growth is expected. Where there is
   more uncertainty in future cash flow,
   particularly if cash flow could decline, lower
   multiples are chosen.

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Valuation FAQs - continue

• What is the difference between enterprise value
  and fair market value of equity? Enterprise
  value pertains to the value of the business that
  is supported by both debt-finance and equity.
  Equity is therefore equal to enterprise value
  less debt.
• Why do the ultimate transaction prices of
  business sales sometimes vary significantly from
  their valuations?Valuations are often prepared
  without reference to any specific buyer. Some
  buyers have special or strategic reasons to pay a
  premium, and the price, if negotiated, may
  reflect some of this premium.

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Q A