Chris Kramer - Your Exit is Coming - Will You Be Ready? (D0518)

Welcome to the Exit Coach Radio show, the show for baby boomer business owners who are looking for cutting edge information as they plan their 3 to 10 year business succession and exit. Every week we interview top professional advisors for their best tips, strategies, and precautions so you can be well planned. And don't miss our one minute exit. tip of the day on exit coachradio.com. And now here's your host, the exit coach, Bill Black. We're going to talk with Chris Kramer, who's here with Strategic Equity Group. He's the managing director and Chris, welcome to the show. Thanks, Bill, appreciate it. What we're going to be talking about is, uh, how you can get your business ready for sale and how you I help business owners do that, Chris, but before we get into that, we always like to ask our guests for a little bit of your background and how you, uh, got into this business. Yeah, no, sure, I appreciate that, Bill, and thanks again. Um, you know, in many ways I'm kind of, um, the epitome of the American dream in the sense that I was actually born in Germany of immigrant parents. We came over here when I was a baby and, uh, I've lived in Southern California most of my life, but I ended up having to kind of work my way through college and, um, spent my twenties kind of doing that and getting, you know, educated professional. Designations and the like and essentially kind of fell into the business when I was in college. I needed. A job like a lot of college kids and uh started off as a research analyst and just kind of took a shine to the business and um you know been working in the industry ever since. At what point did you decide that you wanted to get into helping business owners or you know work towards building strategic equity group? Well, it was interesting. I started off really in the valuation business where we were rendering valuation opinions for various purposes, primarily at that time litigation and employee stock ownership plans or ESOPs. And I recognized pretty quickly that business owners didn't just necessarily need or want a valuation for its own sake, but really we're trying to accomplish a goal, typically some kind of an ownership transition. So as I evolved my career, I migrated more towards investment banking and different types of transactions that were actually impacting the ownership. And at what point did the strategic Equity Group get started? Yeah, it's an interesting story. I met my business partner in 1995 and we were actually on opposite sides of a litigation matter. And we ended up coming up with the value of the company within about 10% of each other, and we're on opposite sides of the litigation, so it was kind of remarkable. We developed a pretty close friendship and an in, you know, kind of an instant respect for each other. And uh I joined, uh, I joined a little bit later and uh we've been doing it ever since. That's a great story. So it came out of actually being on the opposite sides, but you respected each other and saw that you were coming up with some uh valuations, at least in that instance, right? Exactly right. So what do you do? What does Strategic Equity Group do out and who do you do it for? So we're an investment banking and business valuation firm, which really means we help business owners in the middle market. So let's say. Typically, uh, 10 to 100 million in valuation, although we have some larger clients so I won't bore you with those details, but, um, typically what we do is we help where there's some kind of an ownership transition, so that could be a sale of a business, that could be an acquisition of a business, or that could be uh different things that happen to the equity that are not an actual transaction like state planning where someone's doing a gift or somebody passes away. People are entering into buy sell agreements. Uh, companies are making selections to lower the potential tax and a sale down the road. Um, often times we get involved in bringing in partners or or even putting in, um, employee retention plans. So all things that basically would require at least initially an understanding of what the business is worth. And each of those things could come up with a, I've always heard, you know, depending on what your valuation is for, uh, you can shade it one way or the other for a business owner if they're trying to create a, a minority interest gifting dis uh, situation, then they can use discounts and things like that. So tell us a little bit about the art of valuing a company, Chris. Yeah, so the, I guess what I would say is, you know, sort of, you know, investment banking kind of, kind of starts where valuation leaves on. Because most transactions center around a price, but that's not generally the, the end, the end, um, issue if you will, lots of other issues arise, but in terms of value, you really have the, the notion of market value, which is this concept of a willing buyer and a willing seller, which is really driven by what the tax code dictates. Now when you have a minority interest. You'll typically be able to apply discounts because if you don't control the company, you can't generally sell the interest very readily. There's not usually a market for the stock. You can't control the future outlook, etc. On the other hand, when we're looking at selling a company, we try to look at what would be referred to as a strategic value. What is your best buyer willing to pay for the assets that you have? And oftentimes that can be significantly more than what Bill Black or Chris Kramer would pay for. XYZ widget manufacturer where we don't have any anything to necessarily gain by the acquisition other than, you know, just cash flows, let's say, because they're gonna bolt you on your your business onto their business and hit the ground running and probably get rid of a lot of unnecessary expenses and duplicate, uh, administrative expenses and things like that. That's exactly right and I have an example that we can get to. OK, OK, we'll get to that after the break. Tell me something because I, I hear this, uh, uh, from a lot of people are confused about. Is a 50/50 ownership considered a minority valuation? Uh, is it, is it considered something that you could apply a minority uh valuation to? Well, I think the answer, the answer is yes, although it would be mitigated by the fact that you, you don't, you, you don't lack control, but you don't have control, right? So you're in essentially a standoff position. So the, the way we try to measure it is if you were gonna sell half the company to somebody. Would they require some discount from the perceived value for the fact that they don't have the controlling interest? I think the answer is yes. Little technical question there for our listeners, but thanks for answering that because I, I hear that's a point of confusion for a lot of people. So Chris, we have about 2 minutes till our break. What are some of the options available to business owners that are considering an exit other than an outright sale? Yeah, so depending on the size of the company and, and, um, other factors, obviously, uh, business can can be sold to a third party that's sort of option one. Option two might be a sale to a management team which oftentimes will happen where it's a very concentrated, uh, group of folks and, and maybe it's difficult to transfer their knowledge with a larger company, um, sometimes you can look at a recapitalization which would be where a private equity fund would. By a significant portion of the company, but let the ownership or the management team or the owners retain some amount and then get what they call a second bite at the apple as they help grow the company. But another option that a lot of people have sort of heard about but maybe don't know much about is an ESOP or an employee stock ownership plan. And this is a tax advantaged way for a business owner to sell all or part of the company to a trust for the benefit of the owners. So in essence you end up having. The workforce of your company having an ownership stake which should lead to better productivity and enhanced performance. That's a great overview of an ESOP, Chris. I appreciate it. We're going to take a quick break and when we come back, we're going to ask Chris to share some stories and, uh, uh, a few tips, ideas and precautions that you can use so that you can be well prepared. We'll be right back. Are you thinking about selling your company? Have you been approached by a buyer? Are you curious as to what your business might be worth? If so, call the trusted advisors at Strategic Equity Group. They've been providing sound, unbiased, honest advice to business owners just like you since 1989. Don't wait to start planning for your exit. Call them today at 714-380-3300. That's 714-380-3300. If you came back from lunch today and there was a resignation letter on your desk, which employee would you really, really not want it to be from? More importantly, what are you doing to prevent the situation from happening in the first place? We work with business owners like you every day to design plans that attract, motivate, retain, and reward key employees. Don't wait until it's too late. Contact Bill Black, the exit coach at 866-370-3774 for a free consultation on how to retain and reward your key employees. That's 866-370-3774. Call today. Welcome back friends. Just a reminder that we've interviewed dozens of advisors on a wide variety of topics, and you'll find all of their interviews and highlights online at exacoachradio.com or on iTunes. I'm talking with Chris Kramer of the Strategic Equity Group, and Chris, before the break, you gave us some great overviews on some different ways for business owners to exit. Could you share a couple stories with us, uh, that, that illustrate some of those examples? Yeah, I'd be happy to you, Bill. Thanks. So, so one transaction we worked on recently involved a couple of brothers that were 50/50 shareholders in a manufacturing company where they had outsourced all the manufacturing to China some years ago, but they had essentially a distribution company that that had manufacturing company margins, so it was a great business unfortunately. They really hadn't developed a second tier management team. There were no family members in the business, and they were in their late 60s, so it was kind of time to exit the business, and they came to us to find the right buyer, help them structure, negotiate the transaction, and bring it to a successful close. We identified a uh strategic buyer that happened to be owned by a private equity group that basically was in their business and they didn't see any detriment to not having a management team or any real infrastructure. Basically they wanted to buy the product line. So it was almost a match made in heaven in some respects, and had they not um found that buyer, they would have struggled to get the valuation, you know, with any other buyer. So we really got them a pretty significant premium and it ended up being, um, essentially an all cash deal with very little in terms of holdbacks or contingencies. And it was a win-win for all the parties. Sounds like they were really lucky they found you and you found that strategic buyer, Chris. Don't try this at home, right? to walk on a tightrope for a lot of business owners. What else do you have? Well, there was another transaction we just completed at the end of the year, and it was a local, uh, service company that already had an ESOP in place, and what had happened there was the owner, um, had decided a number of years ago that he wanted to exit the business and he wanted to reward his employees. He saw the tax advantages of the ESOP. And he sold about 35% to the ESOP. Unfortunately, he, uh, he, he died and, um, and it was a bit of a shock. He was, he was still a fairly young and robust individual and so his wife and the family were left with stock in the company that they really couldn't manage very well and they really didn't know, you know, sort of what to do with, but they did know that that his goal was always to end up having the ESOP own 100%. So we worked with them to bring about that second transaction where they ended up, uh, selling the remaining 65 or so to the ESOP and so now you have a company that's um run by a management team that has an ownership stake. You have a family in an estate that got cash and other proceeds, uh, where they really didn't need or want the stock, so to speak, and again, you're gonna see this company, um, basically thrive in the future because they're in control of their own destiny. That sounds like a great outcome for that particular situation. Could you walk us through that? Just, I think a lot of our listeners might be confused about the ESOP and the fact that you can do a partial sale versus a full sale. When, when should they think about, maybe I should call Chris and ask him about this. What's a good time for them to call you if, if they think that might be a good way to go? Yeah, I think, you know, obviously earlier in the process is better, and we, we'll always talk to a business owner about options and, and what makes the most sense. And what I would say about ESOPs is they're certainly not right for every situation. Um, as an investment banking and valuation firm, we're what I call structure agnostic, so we're not out there pitching a particular strategy we're pitching that we're gonna help you find and execute the right strategy, and it might be an ESO and frankly it might not. So typically if you have multiple shareholders, uh, ESOPs can be a good option, um, if you have already built into the organizational structure what I call a participatory management style, uh, consulting firms, uh, service businesses, engineering, architects, those types of folks, they tend to lend themselves better to ESOPs because the owners are usually, uh, recognizing that the workforce is really what got them where, you know, where they are. As opposed to let's say a company that has a specific brand or a or a piece of intellectual property that another buyer would pay a big premium for or a sole shareholder that wants to exit totally and basically just try to command the largest price. Now, if a company has a, an older workforce, key employee workforce, let's say they're the same age as the owner, uh, is that one of those things where you tread, tread with caution as far as an ESOP because you might have to buy those people right back. You don't have to buy their shares right back. Yeah, well, the good news about an ESOP, the way it's structured is that um you don't have to buy the shares back for some period of time, and even if you do, you have the option, um, that the company can do it over time. So in other words, um, well, let me back up. So there's a couple of ways to finance an ESOP. One of them is by building up cash in the trust vis a vis contributions. The other way is to borrow money primarily from a bank. To fund the purchase of shares, and the third way is a is a hybrid and or having the seller finance some of it. So some people would say, well, in an ESO I don't, I'm not out, right? I can't just walk away and there's some truth to that, but you get some tax benefits and you get some other advantages to to structuring it that way. But the point of all that being that if there's leverage involved, you're not obligated to buy the stock back until that leverage has been paid. OK, so there are some potential ways to defer the potential buyback and things like that. uh, uh, just spell a myth for us. Um, a lot of owners say, you know, uh, I don't want to sell to an outsider, but I, I, I have key people and, and they don't have any money. And what I always hear is it sounds like I've got to buy myself out of this company. Is that, is that true for an insider sale? I mean, there is no source of capital outside, so it's really, is it all about the cash flow of the company at that point and preserving that? Well, yeah, whether it's a whether it's a management buyout or whether it's an ESO at the, at the end of the day, the company is the source of the of the debt repayment. There's no question, but it depends on in part on what the owner's goals and objectives are. What we see a lot of, and this is a great strategy using an ESOP is you start off with a partial sale. Maybe it's 30% and there's some tax advantages that that that are that are, um, you know, part of that and what happens is the owner will get some amount of money, excuse me, and or take back a loan, but at the same time the workforce is now getting the benefits of the ownership, so you see some increased productivity and theoretically that value is gonna rise such that 3457 years later when the rest of the stock gets sold to the ESOP, it's going to be at a higher valuation. It's not that different than, uh, the, the thought behind a recapitalization where a private equity fund comes in and says, look, I'm gonna buy 80% of the company and give you a bunch of cash, but to keep you motivated because guess what, when people get a whole lot of cash, sometimes their motivation wanes, they say you're gonna keep 20% and by the way with our plan and our capital and our strategy. We're gonna grow this company to the point where that 20% might be worth all of what you got on the first transaction. Chris, your wealth of knowledge on this topic or really, uh, wish we had more time with you today. We have a couple of minutes. Could you give us a couple tips or ideas for our listeners? Yeah, absolutely. The, the thing I always say is, uh, is that, um, as Stephen Covey once said, you got to begin with the end in mind. I mean, none of us as as advisors can help clients until we have some sense of what their plans are. So really I always ask business owners to visualize what life is gonna be like after this transaction, whether it's an ESOP or a third party sale. Why are they doing it and what is life gonna look like when they're done? That'll help us structure the right transaction and help them achieve the goals that they have. The second thing I would say is you got to start the planning process early. Especially in a third party sale, there are any number of things that that can be done. We can help with some of those, but other advisors can help where you can either enhance the value or you can increase the chances of actually closing a transaction. And then lastly, I always tell people to assemble the best team of advisors that you can. We're, I think, very knowledgeable and very effective, but we don't know everything. We don't know tax laws as well as a tax advisor. We're not lawyers, so we need legal counsel. We might have other advisors that have to weigh in on a transaction. Getting the right team and, and, and the best team you can, I think will pay, uh, pay big dividends. I've been talking with, uh, Chris Kramer of Strategic Equity Group, and Chris, how do people get a hold of you? What's your website address? Yeah, in fact, we have a new look, uh, we just launched a new look website. We'll be working on it, um, over the coming months and years, but, uh, it's got a fresh look. It's www.sco.comEco.com. SEGCO.com. I've been talking with Chris Kramer of Strategic Equity Group. We're going to take a short break, so please stay tuned. What can you do in a minute? At Exitoachradio.com, you can listen to a daily tip, idea, or precaution from over 100 top advisors about how to prepare your business for the future. We upload new one minute tips at 6 a.m. and 10 p.m. daily. Exitcoachradio.com. Come listen for a minute. Thank you for listening to Exit Coach Radio. Time is precious and so are our pets, so time with our pets is extra precious. 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