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Capital Strategies: Liquidity Events

Capital Strategies: Liquidity Events

Timothy Shea

March 22, 2014
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  1. Working with Founders: Liquidity Events Financing, Structures, Requirements and Case

    Studies Capital Strategies Wells Fargo Advisors Financial Network New York Office 200 Park Avenue, 17th Floor New York, NY 10166 San Francisco Office 220 Montgomery Street, Suite 942 San Francisco, CA 94104 Silicon Valley Office 3900 New Park Mall Road, Suite 339 Newark, CA 94560
  2. Table of Contents • Working with Founders • Lending &

    Liquidity Overview • Transactional Lending: SBA for M&A, Partner Buyouts
  3. Capital Strategies: Outsourced CFO Model Capital Strategies Team Client Personal

    Planning Investment Consulting Wealth Preservation Investment Management Charitable Giving Executive Stock Planning Wealth Transfer & Planning Wealth Protection • Debt Management • Income Replacement • Liability Protection Other Investments • Alternative Investments • Real Estate • Closely Held Businesses Lending & Advisory Corporate Lending SBA & Specialized Lending Small Co. Advisory • Small Co. M&A • Company Valuations • Strategic Advisory Private Banking & Lending External Advisory Services Boutique M&A Growth Equity Corporate Strategy Individual Needs Corporate Needs Attorney & Accountants The Capital Strategies team addresses the needs of the business owner segment, delivering advisory services and capital solutions designed to address the often overlapping needs of the owner and the company. Specifically, we help clients: • Leverage their relationship across platforms and the entire firm • Navigate complex service paths to achieve best outcomes • Using our scale to their advantage (pricing, availability, execution)
  4. Exits and Liquidity Events - Comparison MBO Leveraged Recapitalization ESOP

    Outright Sale Private Equity IPO Description Sale to management team Add debt to capital structure to fund dividend to owners Sell a portion or all of the outstanding stock to an employee stock ownership plan Stock or asset sale to a third party Sell a portion of the company to a financial, non-strategic investor Sell a percentage in a public offering Control Result Seller generally cedes control No loss of equity for seller Seller can preserve control Seller cedes control Buyer generally takes control Seller/Management generally maintains control Liquidity Result Low cash component, primarily financed from cashflow Entirely dependent on debt capacity Entirely dependent on debt capacity Cash component can range from 30% to 100%, with balance in notes or earn out Private equity investment is usually all cash to the owners Owners are rarely allowed to sell a significant portion of their stake in the initial offering Negotiation Type Semi Adversarial (management) Cooperative Cooperative Adversarial Adversarial (private investors) Adversarial (public investors) Ongoing Legal Liability Company responsible for indemnification in purchase agreement Company responsible for indemnification in purchase agreement Limited indemnification by seller Seller responsible for indemnifications in purchase agreement Seller responsible for indemnifications in purchase agreement Company responsible for indemnification in purchase agreement Ongoing Commitment Generally a short employment contract Unchanged Varies Usually a one year employment contract Usually requires a longer tem employment arrangement Responsibility increases Initial Execution Risk Limited initial execution risk Execution risk is limited to availability of leverage Execution risk is limited to availability of leverage and Second most risky to execute, behind an IPO Almost as risky as a sale Riskiest route to liquidity Leverage Impact Leverage is not a necessary element of the deal structure Company will be levered Company will be levered Leverage is not a necessary element of the deal structure Leverage is not a necessary element of the deal structure Leverage is not a necessary element of the deal structure Tax Impact Long Term Capital Gains tax Long Term Capital Gains Tax Taxes can be deferred indiefinitely Long term capital gains for a large portion of the purchase price Long Term Capital Gains Long Term Capital Gains Value Creation Low to Mid No loss of equity for seller Average Mid to High Mid to High Highest Timeline 3-9 months 2-3 months 3-6 months 3 to 6 months 6-12 months 12 months to 2 years Well in advance of initiating a specific liquidity strategy, we review all the alternatives with clients to ensure an informed decision is reached. Every strategy has a unique set of requirements and outcomes.
  5. Working with Founders: Advisory Services Working alongside of our Business

    Advisory Team, we have developed an analytical framework designed to identify the critical alternatives when selling a business. Generating the most value from a transaction is not necessarily tied to finding the highest sale price. Often, the maximum benefit can be gained by making a few critical decisions in advance. These decisions include: • Weighing the safety of cash against the tax deferral and greater return potential of a stock transaction. A stock deal may seem more lucrative, but its additional risks need to be factored in, including exposure to price fluctuations before the deal is consummated and the imposition of a lockup period. – Evaluating key estate-planning strategies, which often yield maximum benefit if implemented before rather than after the transaction. A careful evaluation of the owner’s goals and anticipated sale proceeds can help determine the types of family or charitable trusts to establish— whether to use a GRAT, a CRT, or both, for example—and the amounts to allocate. – Considering various exit or liquidity strategies other than a straight 100% sale—such as the sale of a minority stake in one’s business, a leveraged recapitalization, or sale to an employee stock ownership plan. Key financial-planning questions arise with these strategies, including how much of the owner’s stake to sell. Business Advisory Group: How We Manage Complexity to Achieve Results
  6. Working with Founders: Liquidity Event Lifecycle Business Planning •Monitor trends

    •Fine tune model •Appoint trusted advisors – M&A advisor, accountant, lawyer, lenders Personal Planning •Prioritize needs, goals and wishes. •Formalize roles of family members and clarify goals Financial Planning •Reduce oversight responsibilities for financial assets. •Evaluate transfer strategies and asset protection structures Preparation Stage Business Planning •Focus on deal execution •Manage employee expectations carefully and have a communications game plan in place Personal Planning •Establish goals and objectives for next phase of career Financial Planning •Maintain a conservative investment plan to keep focus on deal execution. Execution Stage Business Planning •Do not interfere with new management if you still occupy a position within the firm. •Reassess work/career aspirations. Personal Planning •Vacations, charitable goals etc. •Settle into your new role and pursue lifetime goals. Financial Planning •Separate accounts for taxes, consumption and investments. •Educate yourself about wealth management. Post Execution Stage At the Capital Solutions Group, we adhere to a three part planning process at each stage of the liquidity event process that encompasses business, personal and financial planning objectives. At Wells Fargo FINET and within New York Capital Strategies, we bring a team of professionals together to move from one stage to the next without missing key steps.
  7. Working with Founders: Liquidity Event Modeling Annual Withdrawal Rate 100%

    Bonds 75% Bonds, 25% Equities 50% Bonds, 50% Equities 25% Bonds, 75% Equities 100% Equities 4% Rate (example above: $240k) 86% 97% 96% 93% 90% 5% Rate (example above: $300k) 32% 70% 79% 80% 77% 6% Rate (example above: $360k) 3% 25% 51% 61% 63% 7% Rate (example above: $420k) 0% 4% 26% 42% 49% 8% Rate (example above: $480k) 0% 0% 11% 26% 36% Will this sale meet my spending goals? Case Study: Successful Software Entrepreneur After tax proceeds from transaction: $5,000,000 Existing Investments and Retirement Accounts: $1,000,000 Assumed spend-down period: 25 years Desired Confidence Level: 80% Appetite for Investment Return Volatility: Moderate Target Withdrawal Rate and Allocation: 5% withdrawal rate, 50/50 Allocation Withdrawal Rates at Certain Investment Allocation Ratios
  8. Working with Founders: Liquidity Event Modeling Perhaps the most important

    step of our process is the modeling stage: will this event accomplish what you want from a financial standpoint? We use the Envision system from Wells Fargo to model various outcomes and create a picture of probabilistic financial outcomes. • Using Monte Carlo simulation, Envision simulates one thousand different potential outcomes over a lifetime of investing. • This graph reflects the range of results of the simulated trials based on your Recommended Investment Plan. It graphically displays every tenth trial, (from the 5th through the 95th), and also identifies which "target" trial simulated the minimum ending value needed for the plan to achieve its stated goals. • While this diagram depicts a wide range of possible outcomes, there is no assurance that your actual investment plan will fall within this range.
  9. Working with Founders: Business Valuations Determining the true value of

    your business, stock or partnership interest Determining the value of a private company for estate planning or potential sale can be challenging. Access to accurate data on the value or market transactions of comparable businesses can be restricted or hard to find. Why get a valuation? Our Business Advisory Services specialists offer a complete range of valuation services required to: • Determine the value of a business enterprise, fractional stock interest or partnership interests taking into account any appropriate discounts relating to control or marketability • Identify options for sale or transfer • Coordinate with your legal and tax advisors • Support your tax advisor with valuation before the IRS, tax court or other entity, where appropriate · Estate planning · Sales, mergers and acquisitions · Gifting of company stock · Buy/sell agreements · Stock option plans · “S” Corporation election · ESOP valuations · Fairness opinions · Leveraged buyouts · Partnership dissolution · Shareholder buy-out · Strategic management planning
  10. Credit Decision Path for Owners Sector & Financial Performance Desired

    Use of Proceeds Appropriate Capital Solution Primary screening questions Does the Company: • have earnings challenges; • have one year cash flow profitability; or • have three years net income profitability Does the company/sector have: • a cash conversion cycle • inventory and receivables • real estate or other tangible assets Is the use of proceeds for: • capital expenditures and projects • equipment • business real estate • working capital Are you capital constrained? Looking to take advantage of low rates to purchase property? How do you decide which capital solution is appropriate? We begin by asking a few basic questions that will then inform us as to which credit solutions are likely to be available and provide a cost effective and practical solution for the client.
  11. Credit: Determining Debt Service Capacity Generally, in analyzing debt capacity,

    the measurement lenders will focus on is cash flow available for debt service, which is usually Net Ordinary Income plus: • Income Tax • Interest Expense (unless debt will remain) • Depreciation and Amortization • Non operating income or expenses • Rent (future rent expense will be added back later) • Any rents paid to owner • Pension and profit share for owner • Any insurance paid for owner • Owner’s excess compensation • Other payroll benefits • Capital replacement or maintenance reserves • Non essential and non recurring expenses For most loans, a margin of approximately 1.2-1.4x current cash flow available for debt service is a good target. As an example, the charts here show monthly debt amortization for 5, 7 and 10 year loans with interest rates of 4.5%, 5% and 6% respectively. $5,572 $4,223 $3,314 $7,244 $5,489 $4,308 5 Y E A R T E RM 7 Y E A R T E RM 10 Y E A R T E RM $300K LOAN - CASHFLOW AND COVERAGE NEEDED Monthly Debt Service Target Monthly Cashflow Needed (1.3x) $18,573 $14,075 $11,047 $24,145 $18,298 $14,361 5 Y E A R T E RM 7 Y E A R T E RM 10 Y E A R T E RM $1MM LOAN - CASHFLOW AND COVERAGE NEEDED Monthly Debt Service Target Monthly Cashflow Needed (1.3x)
  12. Early Stage Credit Solutions (up to $100k) Wells Fargo Capital

    Finance (via Business Credit unit) provides asset-based financing to companies with initial credit needs ranging from $5 million to $35 million. Their monitoring of both credit and collateral allows us them to underwrite loans that are outside the typical lending criteria of most traditional lenders. Business Platinum Credit Card or Corporate Card BusinessLine or SBA Line of Credit Business PrimeLoan Equipment Express Typical Client Platinum Card - newer businesses, up to 99 cards Corporate Card - seasoned businesses, up to 200 cards for employees BusinessLine: established businesses – min. of 4 years in business. SBA Line: newer businesses between 2-4 years in business Established small business owners who require funds for their business; customers in business 2 years or more (or 3 years for non-customers) Established businesses – 2 years for existing Wells Fargo customers and 3 years for non- customers Any business owner who plan to purchase a specific new or used business equipment or vehicle Suggested Use of Funds • Office supplies • Online purchases • Travel & Entertainment • Vehicle Maintenance • Manage cash flow • Seasonal expenses • Inventory • Payroll & Taxes • Capital improvements • Working capital • Business expansion • Finance the purchase of new or used business equipment and vehicles within one- month from approval • Reimbursement for cash purchases of business equipment and vehicles made one month prior to approval Loan/Line Amount up to $50k for Platinum, and $100k for Corporate Card Up to $100k Up to $100k Up to $100k Term or Structure Revolving without a fixed term Revolving; SBA has 5-year term • 2, 3, 4 and 5-year terms • Monthly repayment of principal and interest • 2, 3, 4, 5 and 6-year terms • Available credit converts to term loan which amortizes with fixed monthly payments of principal and interest Collateral None None A UCC is filed for all equipment purchases • Secured by the equipment or vehicle purchased or refinanced • A dealer invoice validating purchase price must be provided to fund the loan Interest Rate Variable rate: Prime + 5.99% to 14.99% credit score dependent Variable rate Fixed or Variable rate Fixed, determined at time of purchase Fees • No annual fee • $150-$250 upfront fee depending on amount • $150 annual fee beginning year 2 • SBA Line: One-time SBA guaranty fee of 1% of credit line (no opening or origination fee) • Opening fee of 1% of the loan amount (minimum $150) • No annual fee • Pre-payment penalty may apply to fixed- rate option only • One-time $150 documentation fee when customers finance their first purchase • No annual fee • No pre-payment penalty
  13. Securities-Based Credit Solutions Secured PrimeLine (Revolving Line of Credit) Custom

    Line of Credit Secured Term Loan Target Borrow Amount $100,000 to $5 million; $2 million minimum, though loans typically start at $5 million $100,000 to $5 million; Fees and Accessibility No set up, non-usage or cancellation fees; Check, online transfer and wire transfer Wire Transfer No set up, non-usage or cancellation fees; Check, online transfer and wire transfer Eligible Use of Proceeds Virtually any use other than the purchase of securities or paying off a margin account Virtually any use other than the purchase of securities or paying off a margin account Virtually any use other than the purchase of securities or paying off a margin account Borrowing Capacity 50%-90% based on the asset class 50%-90% based on the asset class 50%-90% based on the asset class Term Revolving line of credit with 36-month term Varies 36 month term Index/Rate and Payments Variable rate based on Prime or LIBOR; monthly interest only payments Variable rate based on LIBOR; monthly interest only payments Fixed rate based on Prime; monthly interest only payments Benefits Access funds all at once or over time or use as standby liquidity Can be established in individual or business name, and can have higher advance rates Predictable payments, one-time disbursement of full amount of funds Securities-based lending lets you borrow money using your eligible marketable securities as collateral. Funds you borrow can be used toward a wide range of purchases, such as home improvements, real estate purchase, medical costs or unplanned expenses. Leveraging your assets in this manner may be more cost-effective than other alternatives and may be a good fit for your long-term investment plan. Benefits • Offers lower rates than other forms of financing, including relationship pricing • Funds can be used to meet virtually any need • Provides alternative to asset liquidation
  14. Business Real Estate Financing Wells Fargo Purchase Advantage Wells Fargo

    Express Refi Loan Wells Fargo Express Equity Loan & Line of Credit Target Audience • Business owners and real estate investors who need financing for any business purpose including the purchase of commercial property • Property owned 1 year, in business for 2 years (investors – no 2-year requirement for business) • Maximum property value $3,000,000 Suggested Use of Proceeds Purchase of commercial or investment property Refinance commercial mortgage Leverage equity in commercial property for: Renovations, To purchase supplies, inventory and/or large equipment, Reserve funds for unexpected opportunities, Working capital Line or Loan Amount $50,000 to $500,000 Collateral Secured by commercial/investor property valued up to $3,000,000 Interest Rate Loans: Fixed or Prime-based Lines of Credit: Prime-based Repayment Term Variety of fixed and prime-based loan terms: • 5, 10,15-year terms • 10-year balloon/ 25-year amortization • 5-year balloon/ 30-year amortization • 3-year balloon/ 30-year amortization (only available for fixed rates) • Line of Credit: Revolving Note: Balloon rates not available on Special Purpose Properties for Wells Fargo Purchase Advantage product. • Loan origination fee is 1% of loan amount, due at closing ($2,500 minimum). • $1,000 non-refundable deposit due at selection of terms and will be applied at closing to loan origination and other fees due at closing. • Lines of credit: Annual fee of 25 basis points of the line amount (minimum of $250, maximum of $1,000) waived the first year. $1,500 early closure fee applies to lines of credit if closed within 3 years. • Pre-payment fee applies to fixed rate loans. Amount depends on year the pre-payment is made. • Variable loans, prime-based, are subject to a $3,000 early closure fee if closed within the first 3 years following booking. • Prime-based loans may be converted to an amortizing fixed-rate loan with BREF at then current fixed rates for a conversion fee of $500. Restrictions may apply. With rates at historic lows, now may be the right time to make your move and take advantage of: • Purchase new property at today’s low rates • Refinance to get a lower monthly payment on an existing commercial mortgage • Access available equity in your commercial property
  15. Asset-Based Lending: By Industry Benefits • Accelerate cash flow by

    converting accounts receivable to cash • Advance rates up to 90% on accounts receivable and up to 60% on inventory • Outsource customer collections • Off-balance sheet financing available • More aggressive financing than traditional banking lines • Simple documentation, quick closing and online reporting Industries Trade Capital Receivables Funding Government Services Staffing Services Transportation Services Taget client Apparel, textiles, furniture, action sports, carpet, toys, electronics, selected other industries and most consumer products companies Service providers, manufacturers, distributors and wholesalers Government contractors Staffing companies Trucking and transportation companies Company Size 10 million+ 4 million+ 4 million+ 4 million+ 4 million+ Typical Facility Size $1,000,000 - $100,000,000 $500,000 - $100,000,000 $1,000,000 - $100,000,000 $1,000,000 - $100,000,000 $500,000 - $100,000,000 Credit Protection Yes No No No No Inventory Yes No No No No Covenants Deal Specific Not Usually Not Usually Not Usually Not Usually Typical Uses • Working capital • Expansion/growth • Refinancing • Turnarounds Wells Fargo Capital Finance (via Business Credit unit) provides asset-based financing to companies with initial credit needs ranging from $5 million to $35 million.
  16. SBA Lending: Overview Although SBA has grown and evolved in

    the years since it was established in 1953, the bottom line mission remains the same: the SBA helps Americans start, build and grow businesses. Generally, the SBA does not provide grants or direct loans. Instead, the SBA guarantees against default certain portions of business loans made by banks like Wells Fargo and other lenders that conform to its guidelines. For the fifth straight year, Wells Fargo is America’s top SBA lender in dollar volume, approving a record $1.47 billion in SBA 7(a) loans for small businesses in federal fiscal year 2013 (Oct. 1, 2012 – Sept. 30, 2013). Benefits Considerations & Requirements • Lower down payment (as low as 10%) – keeps personal liquidity accessible for new business owner • Not collateral focused, since loan decisions are not collateral dependent if none is available, so many “asset light” sectors become bankable (software, professional services etc.) • Working Capital Available - Can now be used to fund working capital needs via the CapLines program • Better structures - blended amortization period (up to 25 years on CRE & 10 years on business acquisition) – preserves cash flow with lower monthly payments • Typically no cash required for partner buyout with pledge of existing equity reflected on balance sheet • Can be used for acquisitions, since SBA now allows lenders to finance substantial “goodwill” in accordance with SBA SOP guidelines • Expansion financing available to start/buy second/third location • Must be a for-profit business with less than $15MM in book equity and less than an average of $5MM of net income over the last two years • Debt Service Coverage current year, interim and / or projected ranges from 1.25 to 1.4 to 1 depending on existence of collateral • Stand alone working capital lines require a cash conversion cycle and don’t work for retail, non-profit, contractors etc. • Personal Guaranty’s from all owners with > 20% ownership required with minimum of 51% ownership required to guaranty • Personal liquid assets of each principal/guarantor not to exceed the total project costs of the proposed loan. • Business revenue/cash flow trends should be stable, should be profitable and leverage should be reasonable (generally should have at least one year and one quarter of cash flow profitability) • At least 51% ownership must be in hands of U.S. citizen or resident aliens, individual FICO Score > 640, and no bankruptcy in the last 7 years and no unsatisfied judgments, • All 7A loan structures will limit the unsecured exposure to < $1,200,000
  17. SBA Lending: By Program SBA Express SBA CapLine SBA 7(a)

    Term Loan SBA 504 Term Loan Amount $5,000 to $350,000 $350k to $5MM; Total borrowing should not exceed 10-20% of revenue $350k to $5MM; Debt service ratio should exceed 1.3x $150,000 to $6,000,000 Maximum SBA Loan $5 million for public policy (Up to $5,500,000 for small manufacturers). Structure & Term Line of Credit — up to 3 years. Term Loan — Up to 5 years. 2 yr terms, renewable every 2 years for 8 more years, for a total of 10 years Working Capital: up to 7 years. Equipment: up to 10 yrs (or useful life). Real Estate: up to 25 years. Real Estate – 25 yrs Purpose Working Capital Larger working capital needs for companies with a cash conversion cycle Fund capex, projects, business start-up, business acquisitions, partner buyouts and owner-occupied commercial real estate. Longer term financing loans for businesses to purchase commercial real estate, buy machinery, or to expand their existing operations; Advantage to conventional Loan Streamlined loan application process to access funding Longer maturity for newer businesses with less stable cash flow, higher leverage, or inconsistent earnings. Not collateral focused, longer terms and ability to lend with less earnings history Larger loans available using a two-tiered structure of conventional (senior) + SBA- backed loans (sub) Considerations Borrowing amounts capped Must have cash conversion cycle which generate A/R Primarily used to fund discrete projects More complex structure Rates Under $50,000: NY Prime + 6.5%. Greater than $50,000: NY Prime + 4.5%. Prime + 25 to 225 bps Fixed or Variable. Under 7 years: Prime + 2.25%. Over 7 years: Prime + 2.75%. Wells Fargo Loan: Fixed or variable rate SBA Loan: Below market fixed interest payment. Fees SBA Guarantee Fee for Lines of Credit and Term Loans Loans up to $150,000 — 2% of the guaranteed portion of the loan. Loans from $150,001 to $350,000 — 3% of the guaranteed portion of the loan. $350k to $700k: 3% of guaranteed portion $700k to $5MM – 3.5% of guaranteed portion to $1MM, then 3.75% of the guaranteed portion above $1MM Loans up to $150,000 — 2% of the guaranteed portion of the loan. Thereafter same as CapLine fees for amounts above $150k Wells Fargo Packaging Fee: $1,000. Filing Fees: Minimum of $50. Generally 3.5% of SBA debenture amount and this fee may be financed in the loan. Wells Fargo utilizes four primary SBA programs to address borrower’s needs
  18. SBA Lending: by Use of Proceeds Deciding which lending program

    to access depends largely on the use of proceeds: Business Acquisition or Expansion •Term loan for the purpose of purchasing or expanding an existing business. •$25,000 to $2,000,000. •Minimum of 10% cash down-payment. •Up to 10 years depending on the collateral type. •Principal and interest monthly, fully amortized. •Fixed and adjustable rates available. •Collateral: All of the business assets along with some owners’ personal assets if needed. Business Real Estate •Term loan to purchase owner/user commercial real estate. •$50,000 to $5,200,000. •Up to 90% LTV available. •Up to 25 years. •Fixed and adjustable rates. •Principal and interest monthly, fully amortized. •Minimum of 10% cash down payment. •Collateral: First deed of trust on commercial, office, industrial properties, and other assets as needed. Construction Loans •Loans for ground up construction and/or leasehold improvements of commercial real estate (owner/user). •$50,000 to $5,200,000. •Up to 80% LTV available. •Up to 12 months/adjustable rates. •Interest monthly, principal at maturity. •Collateral: First deed of trust on commercial, office, or industrial property(s) being constructed, other assets as needed. Equipment Loans •Term loans to purchase new or used equipment. •$25,000 to $3,000,000. •Up to 100% financing available. •Up to 10 years depending on the collateral type. •Principal and interest monthly, fully amortized. •Fixed and adjustable rates available. •Collateral: Existing or purchased business equipment, other assets as needed. New Business Development Loans •Term loan for the purpose of starting a new business. •$25,000 to $2,000,000. •Minimum of 30% cash down payment. •Up to 10 years depending on the collateral type. •Principal and interest monthly, fully amortized. •Fixed and adjustable rates available. •Collateral: All of the business assets along with some owners’ personal assets if needed. Working Capital or Debt Consolidation Loans •Term loan for working capital/debt consolidation. •$25,000 to $2,000,000. •Working capital — Up to 7 years. •Debt consolidation — Up to 10 years depending on the collateral type. •Principal and interest monthly, fully amortized. •Fixed and adjustable rates available. •Collateral: Real property, equipment, deposit accounts, and other business assets.
  19. SBA for M&A: What’s Changed? October 2009 - Change to

    SBA SOP regarding Goodwill Financing • No more limits on financing goodwill: Under the old SBA guidelines, lenders were prohibited from financing more than $250,000 of goodwill. Under the new SBA guidelines, there is no technical limit on the amount of intangible assets that can be financed. If the value of the intangible assets purchased exceeds $500,000, the borrower and the seller must combine to provide an equity injection of at least 25% of the purchase price of the business. Small Business Jobs Act of 2010 – Funding Increases • Increased the maximum loan size for 7(a) loans from $2 million to $5 million; Increased the maximum loan size for the 504/CDC loans from $1.5 million to $5 million for regular projects, from $2 million to $5 million for projects meeting one of the program’s specified public policy goals, and from $4 million to $5.5 million for manufacturers; • Authorized the SBA to use maximum tangible net worth and average net income as an alternative to the use of industry standards and established an interim size standard of a maximum tangible net worth of not more than $15 million and an average net income after federal taxes (excluding any carryover losses) for the preceding two fiscal years of not more than $5 million; and • Allowed 504/CDC loans to be used to refinance up to $7.5 billion in short-term commercial real estate debt each fiscal year for two years after enactment (through September 27, 2012) into long-term fixed rate loans
  20. SBA for M&A: M&A Funding Rules & Requirements Summary of

    Rules Regarding Acquisitions • “Goodwill” of $500,000 or more = 25% down payment • “Goodwill” of less than $500,000 =10% down payment • Business Valuation required on all deals $250,000 or more • Down Payment must be non-borrowed funds • If loan is under secured, SBA may require outside collateral • Business with tax liens are not eligible • Earn out provisions are not eligible • Seller cannot remain with company more than 1 year • Seller note cannot pay interest for two years • Seller debt must seasoned 24 Months before SBA refinance
  21. SBA Loans for M&A: Financing Goodwill Rules regarding the Funding

    of Goodwill Acquisitions An SBA-guaranteed loan may be used to finance a change of ownership that includes intangible assets (goodwill, client/customer lists, patents, copyrights, trademarks and agreements not to compete) ; • If the purchase price of the business includes intangible assets in excess of $500,000: – Borrower and/or seller must provide an equity injection of at least 25% of the purchase price – Note - Seller equity is defined as seller take-back financing that is on full standby (principal and interest) for a minimum of 2 years. The borrower and seller will agree how much equity each will provide. • If the purchase price of the business includes intangible assets of $500,000 or less, 25% equity does not apply. The purchase price of the business includes all assets being acquired such as real estate, machinery and equipment, and intangible assets. Real estate may not be removed from the transaction and financed separately to avoid the 25% equity injection requirement. *Goodwill = Total Purchase Price - Real Estate at FMV - Cash and Equivalents - A/R at NBV - Inventory at Cost - Fixed or Other Assets at NBV) + Any Assumed Liabilities at NBV
  22. SBA Loans for M&A: Must be 100% Purchase M&A Change

    in Ownership Requirements: • Eligible - The Small Business Applicant is purchasing 100% of the ownership interest in a business (either an asset purchase or a stock purchase), though the business must be the borrower; or • Eligible - One or more existing owners are purchasing the stock of a selling owner or owners resulting in 100% ownership by the purchasing owners. – The seller is not remaining as an officer, director, stockholder or key employee of the business. (If a short transitional period is needed, the small business may contract with the seller as a consultant for a period not to exceed 12 months including any extensions.) – If there is business real estate as part of the change of ownership, the real estate cannot be financed separately by a non-SBA guaranteed loan unless the SBA loan receives a shared lien position (pari passu) on the real estate with the non-SBA guaranteed loan. This provision does not apply if the business real estate is being financed as part of a 504 project. • Not eligible - A non-owner who is purchasing only a portion of the ownership of the business from a selling owner; or an existing owner who is purchasing the ownership of another existing owner that will not result in 100% ownership by the purchaser.
  23. SBA for M&A: Sample Transaction Structure Sample Transaction: Purchase Price

    $1,000,000 - Tangible Assets (Net Book Value) $175,000 = Intangible Assets (“Goodwill”) $825,000 + Soft Costs Working Capital $100,000 Closing Costs & SBA Fees $40,000 Total Project $1,140,000 Possible Structures: • Equity Injection (25%) $285,000 • Seller Carry (0%) $0 • Wells Fargo SBA Loan (75%) $855,000 Or • Equity Injection (15%) $171,000 • Seller Note (10% ) $114,000 • Wells Fargo SBA Loan (75%) $855,000
  24. SBA for M&A: Cash Flow for Debt Service The measurement

    lenders will focus on is cash flow available for debt service, which is usually Net Ordinary Income plus: • Income Tax • Interest Expense (unless debt will remain) • Depreciation and Amortization • Non operating income or expenses • Rent (future rent expense will be added back later) • Any rents paid to owner • Pension and profit share for owner • Any insurance paid for owner • Owner’s excess compensation • Other payroll benefits • Capital replacement or maintenance reserves • Non essential and non recurring expenses
  25. SBA for M&A: Documents Needed Needed for prescreening: • Three

    years of company tax returns, including all schedules • Interim Financials with previous year comparison • Interim Balance Sheet • Owner three year personal tax returns and personal financial statement Needed for loan commitment • W2’s and Payroll detail for all Owners
  26. SBA for M&A: Calculating Enterprise Value • Determining the value

    of a business (not including real estate which is separately valued through an appraisal) is the key component to the analysis of any loan application for a change of ownership. Note: Any amount in excess of the business valuation may not be financed with the SBA guaranteed loan. • An accurate business valuation is required because the change in ownership will result in new debt unrelated to business operations and create an intangible asset. • A business valuation assists the buyer in making a determination that the seller’s asking price is supported by historic operations and permits the buyer to make a reasonable return on his or her investment. • Lender Verification of Business Valuation Financial Data - Lender must obtain a copy of the financial information relied upon by the individual who performed the business valuation and verify that information against the seller’s IRS transcripts to ensure the accuracy of the information.
  27. SBA for M&A: Collateral Valuation Rates Note: SBA Loans are

    not collateral dependent until borrowing exceeds $1.2MM • 50% on A/R & 20% on INV for 504 loans ( 0% for both on 7A loans) • Up to 85% on general purpose medical office R/E • Up to 80% on general purpose R/E, 60-70% for special purpose R/E • Up to 80% on Personal Residence • Up to 60% for hospitality / Up to 55% for c-store/gas station • Up to 50% - 90% on Marketable Securities, depending on investment grade • Up to 80% on New Equipment (60% on loans > $2MM) • Up to 70% of 3rd party invoice on Used Equipment, or • Up to 100% of Orderly Liquidation value on purchased Equipment • Up to 100% of Forced Liquidation value on Equipment for debt refinance