Alternatives to “Growth As Usual ... - Altus Associates · Altus Associates, LLC. B ild B tt M hiBuild a Better Machine Presenter: John T. Schell President Altus Associates, LLC

Alternatives to “Growth As Usual” St t E ti d – Strategy, Execution and

Financing

Richard K.A. BeckerHogan & Hartson L.L.P.

Charles A. NeffHogan & Hartson L.L.P.

Presenters:

David J. Lundsten, MBA, CPA, CVACherry, Bekaert & Holland, L.L.P.

John T. SchellAltus Associates, LLC

B ild B tt M hiBuild a Better MachinePresenter:

John T. SchellPresident

Altus Associates, LLC1934 Old Gallo s Road1934 Old Gallows Road

Suite 404Vienna, VA 22102(703) 893-6403

2www.altus-associates.com

Build a Better Machine

– Invest in People, Resources and Systems

– Compete for Larger and Better Contracts, even with a reduction in win rate

Improve Earnings as a Team Goal– Improve Earnings as a Team Goal

– Promote Branding and Marketing (not advertising)

A id Pi f ll– Avoid Pitfalls

3

Invest in People, Resources and Systems

• Team: Finders, Minders, Binders and Grinders

– ‘It’s a big jungle, but it only takes a few tigers to keep order’

• Resources: Market analysis, intelligence, outside help

– Does your team have the skills to fashion solutions, structure proposals and effectively price in all agencies?proposals and effectively price in all agencies?

• Systems:

– An operating and effective business Pipeline– An operating and effective business Pipeline

– Best Practices financial information (Accounting, Pricing, Management Tools) are key to driving earnings

4

Pipeline is your future use it as a management tool

Stretch Your Team– Pipeline is your future– use it as a management tool

• Measure, measure, measure…

f C f• Develop pipeline goals for the Company, each category of business, and each business unit.

– A 50-100% “win rate” reduces maximum earningsg

• The world is built on a judgment call: incremental costs and incremental benefits.

• Would you invest $500K to have a 25% chance for a $50M contract with $5M earnings? It will reduce your “win rate” but raise your earnings.

5

Fundamental Challenge: Brand and MarketBrand and Market….

In a Sea of Sameness…

H t t d t i ld f ‘G B ’?How to stand out in a world of ‘Gray Boxes’?

Contractor Contractor Contractor Contractor Contractor ContractorA B C D E F

Diff ti t DiDifferentiate or Die

6

Brand and Market to the Customer! Don’t Advertise!

Enlightened executives will recognize a fundamental fact‘What is your Point of Difference?’

Enlightened executives will recognize a fundamental fact -one that most highly competitive industries have discovered...

the only way to win is to: y yCreate a Brand.

Brands Make Meaningful Promises & Mitigate Perceived Risk

7

Avoid Pitfalls• Winning new business is a team process and not just the

province of a sales team

D ’t t i l k th t h !– Don’t count on miracle workers that change every year!

• We call it the “Messiah Complex”

G• Forget Revenues-Grow Margin!

– CPFF Out--T&M, FFP In

• Cutting Costs Can Help, But Not Fully

– $1 Annual Earnings Worth $5-8 Price

8

• Focus on Services in Demand


David J. Lundsten, MBA, CPA, CVAPartner

Cherry, Bekaert & Holland, L.L.P.1934 Old Gallo s Road1934 Old Gallows Road

Suite 400Vienna, VA 22182(703) 506-4440

9www.cbh.com

Invest in Systems and Improve Cashflow

• Electronic timekeeping

• Billing within the system, not in spreadsheetsg y , p

• Collection person

• Project reportingj p g

• Monthly closing process

• Key metricsy

10

Funding the Better Machine – Investors (Equity Capital)Capital)

• Internal funding (reinvest profit rather than take distributions)

• Private equity (F&F, Angels, Private equity firms)

• SBICs

• SPACS – new type of private equity

11

Equity Investment Accounting Issues

• Professional investors often use preferred stock

– Sometimes see mandatory redemptiony p

– More often redeemable at option of the investor

– May result in treating the investment as debt, not as stock

– May wipe out shareholder equity

12

Funding the Better Machine – Using Debt

• “Debt free” is NOT “good”

– Financial leverage is good (within limits)g g ( )

– Many middle market companies are under-leveraged

– Debt is the cheapest type of funding

• Lessons learned – public company data

– If you meet certain financial criteria, much easier to obtain

N dil ti f hi t B d f– No dilution of your ownership, no seat on your Board of Directors

13


• Complexity, compliance and accounting issues varies

– Commercial bank debt is simplest and cheapestp p

• Line of Credit, borrowing base or accounts receivable

• Acquisition debt – term debt (if you qualify)

• Standard structure

• Standard debt covenants, borrowing base rules

• Relative easy to comply, no special accountingy p y, p g

14


– Mezzanine debt

• If commercial banks won’t do the deal

• Complex (often tailored) structure, need expert advisor

• Involves warrants (potential dilution)

• Accounting issue with valuation of warrants

15


Richard K.A. BeckerPartner

Hogan & Hartson LLP8300 Greensboro Dri e8300 Greensboro Drive

Suite 1100McLean, VA 22102

(703) 610-6100

16www.hhlaw.com

Negotiating Equity Investment Agreements• Form of Investment

– Preferred Returns/Rights

– Maintaining ControlMaintaining Control

• Board Membership

• Limitation on Actions without Investor Consent

– Issuance of Securities

– Operational Limitations

– Mergers

– Budget Approval

• Legal Mechanisms for Valuation (set formulas, selection of appraiser)

17

Negotiating Debt Agreements

• Financial Covenants

• Transfer Limitations on Equity

• Limitations on Junior Debt

• Personal Guarantees

• When taking an investor is taking equity or debt and g g q yequity, If you are a small business, be careful of the SBA’s affiliation rules which might affiliate you with the investor and disqualify you as a small business.

18

Legal Pitfalls in JV and Teaming Agreements

• Capitalization (Cash, IP, Sweat Equity)

• Ownership and Control

– 50/50 disagreements

– Minority Rights

• Dispute Resolution (Good faith provisions, Arbitration, p ( p“Russian Roulette”)

• IP/Product Rights outside of JV (Licensing Agreements)

19

Motivate Employees with Motivate Employees with Real Incentives

Presenter:


Alt A i t LLCAltus Associates, LLC1934 Old Gallows Road

Suite 404Vienna, VA 22102(703) 893 6403(703) 893-6403


Motivate Employees With Real Incentives

• Tell your Team what you want to achieve –

– Set business and BD goals and constantly refer to them

– Gain support of your team and increase credibility

I i ti t t l l t bl ? Whi h i• Is your organization a totem pole or a pool table? Which is more effective for your business?

• Are bonuses motivating or just a gift of appreciation?

• Who controls next week and next year? Your Team!

21

Incentive Compensation

• A well thought-out and shared set of criteria and awards is the only way to communicate priorities

• An IC program is of critical importance in professional services – a sizable percentage of income for key executives

• Company should have a comprehensive plan that ties awards to company and individual performance

• Individual plans for key executives and BD professionals

• Consider getting some help: especially stock-related awards and tax and regulatory issues

22


Presenter:


Ch B k t & H ll d L L PCherry, Bekaert & Holland, L.L.P.1934 Old Gallows Road

Suite 400Vienna, VA 22182(703) 506 4440(703) 506-4440

23www.cbh.com


• Carefully consider compensation plan

– What behavior do you want?

– Are amounts reasonable?

– Rules & Regs… (allowability)

Costs will be significant• Costs will be significant

– Check references before hiring

– Set objective quarterly targets

• Pipeline: number of leads, targets

• Win rate (new versus follow-on)

P i t 9 th

24

– Progress review at 9 months


• All pricing must be approved by CEO

• G&A rates will increase in short term

– Calculate effect if have cost-type contracts

– Brief main customers if necessary

25


• Make sure the incentives encourage the behavior you want

Not as eas as it so nds– Not as easy as it sounds

– Plans should specify desired behaviors / outcomes

– Plans should be subject to adjustment if behaviors notPlans should be subject to adjustment if behaviors not achieved

26

Funding new cash incentives – at what level in the earnings process?earnings process?

• Gross profit level

– More “objective” to the employee– More objective to the employee

– More within employee’s control

– Few if any “corporate” charges/allocations, accruals, etc.

– Less likely to interfere with integration of acquired personnel

• Operating profit level

More subjective to employee– More subjective to employee

– Not entirely within employee’s control

– May have disputes over corporate charges/allocations

27

– Almost certainly will interfere with integration of acquired personnel

Funding new equity incentives – the good, the bad…

• Stock awards (typically restricted stock)

– S Corporations – watch out!p

– Dilution issues

– Possible valuation issues

– If pass through entity, complicates employee shareholder tax returns

– Blue skyy

28


• Stock options

– S Corporations – REALLY watch out!p

– Potential dilution issues

– Possible valuation issues

– New accounting rules – FAS 123r went into effect Jan 1, 2006

– New cost allowability concerns?

29


• “Phantom” stock and stock appreciation rights plans

– Other names: performance stock units, value appreciation rights

– Too often overlooked

– Gives employees the ability to share in increase in company value

Doesn’t cause dilution– Doesn’t cause dilution

– No tax headaches to pass-thru entity employees, since not shareholder

Accounting rules require expensing but– Accounting rules require expensing, but…

– Since new options must be expensed, phantom plans look better than ever

• Change of control considerations

30

• Change of control considerations

– Vesting rules are significant


Presenter:


H & H t LLPHogan & Hartson LLP8300 Greensboro Drive


(703) 610 6100(703) 610-6100

31www.hhlaw.com

Issuing Equity

• Any issuance of a “security” needs an exception under the securities laws and regulationsg

• For private companies, people receiving securities are usually receiving them under equity incentive plans or are accredited investorsinvestors

• Whether Options, Phantom Stock or Appreciation Rights, or Restricted Shares, written plans or agreements are critical

• Special issues in S-Corp—avoiding two classes of shareholders

• Executive compensation

32

Option Plans

Incentive Stock Options or Non-Qualified Stock Options

• Non-Qualified for employees, consultants, or other people

• Incentive Stock Options

– employees only, must have written plan approved by shareholdersshareholders

– Other restrictions, not transferable, post termination exercise limitations

D i d l f i i i i l• Documentation and proper approval of options is critical

33

Other Types of Equity “Securities”

• Restricted Shares

Sh ll bj t t ti d f f it if– Shares usually subject to vesting and forfeiture if employment terminated

– Grant under a plan or a free standing agreement

• A Stock Appreciation Rights is a contractual right to receive, either in cash or employer stock, the appreciation in the value of the employer's stock over a certain period of time

• Phantom Stock is a promise to pay the holder a cash bonus at some future point equal to a certain percentage of the company's equity

34

SARs and Phantom Stock

• SARS and Phantom Stock Rights should be issued under equity incentive plans approved by the board andequity incentive plans approved by the board and shareholders

• Plans and agreements with employees should deal with changes of control, termination and death

35

A i St t i O tiAcquire Strategic OperationsPresenter:


Altus Associates, LLC1934 Old Gallo s Road1934 Old Gallows Road

Suite 404Vienna, VA 22102(703) 893-6403


Acquire Strategic Operations

• Financial results (earnings not revenues) and forecasts drive valuationdrive valuation

• Strategic attributes improve valuation metrics

H d id tif i ith th i ht fi i l d• How do you identify companies with the right financial and strategic attributes?

• Deal terms reduce financing requirements g q

• Leverage drives your value

37

Buyer Valuation Issues

• Vertical (“Strategic”)

-Core Competencies

-Agencies

-Federal Market

• Horizontal (“Bolt-on”)

-Earnings

-Contracts

-People

38• Bottom Line: Supply and Demand

How Can Leverage Drive Your Value?RISK and COST

Risk Risk

Higher Higher

Risk RiskCost

Equity$2M $2M

EquityEquity

$3M $3M

Equity

Debt$3M $3M

Earnout

Lower

39

LowerLower

Given Risk, Leverage Can Lower Cost and Drive Value

Equity and EARNOUT Year 1 Year 2 Year 3 Year 4 Year 5

$5M Purchase Price; $2M Cash, $3M EARNOUT or DEBT

EBIT $1,100,000 $1,210,000 $1,331,000 $1,464,100 $1,610,510

Payment/ Cost 1,217,500 1,145,000 1,072,500 0 0

Cash Available -129,250 71,500 284,350 1,610,510 1,771,516

IRR 4 2%IRR 4.2%

Equity and DEBT Year 1 Year 2 Year 3 Year 4 Year 5

EBIT $1,100,000 $1,210,000 $1,331,000 $1,464,100 $1,610,510

Principal/Interest 817,500 774,000 730,500 687,000 643,500

Cash Available 282,500 436,000 600,500 777,100 967,010

IRR 13.2%

40

Note: There are many unstated assumptions.



Cherry, Bekaert & Holland, L.L.P.1934 Old Gallo s Road1934 Old Gallows Road

Suite 400Vienna, VA 22182(703) 506-4440

41www.cbh.com

Funding sources – generally the same as for funding growthgrowth

• Commercial banks – acquisition senior debt

– Cashflow based – rarely any allowance for borrowing base

– Term loan

– Debt covenants

Mezzanine debt• Mezzanine debt

• Equity

– Private equity firmsq y

– SPACs

42

Acquisition of Companies – Accounting Issues

• Purchase accounting (FAS 141)

– Valuation of intangible assets

– Pre-acquisition contingencies: who gets the expense?

• In general

• Stay bonuses

P h i dj t t– Purchase price adjustments

– Effect of goodwill on debt covenants

• There are many Terms and Conditions with accounting / financial issues

• Your accountant must work closely with your counsel in drafting T&Cs

43

Acquisition of Companies – Tax Issues

• Fools rush in…

• But you should get an experienced tax expert well in y g p padvance of the deal

• Many possible twists and turns

– Asset purchase versus stock purchase

– To novate or not to novate

Tax advisor must work closely with your counsel in drafting• Tax advisor must work closely with your counsel in drafting T&Cs

44

Acquisition of Companies – Tax Issues

• If S Corporation is acquired, 338 election usually a good strategy

– Understand the effect of the election

– Tax equalization will possibly be required

Built in gains tax liability may exist valuation issue– Built-in-gains tax liability may exist – valuation issue

45



Hogan & Hartson LLP8300 Greensboro Dri e8300 Greensboro Drive


(703) 610-6100

46www.hhlaw.com

Transaction Issues

• Contracts with preferences

• Will the preferences continue? Depends on buyer, type of preference and when recertification is required

D li ith f i i t• Dealing with foreign investors

• Costs and risks of acquisitions with regulatory, tax or employee benefit/ERISA legal issuesemployee benefit/ERISA legal issues

• Patriot Act, Import Export Compliance, Security Clearances and Facility Security Clearances

47

Getting to Closing/Post Closing Issues

• Closing requirements

• Dealing with risks found in due diligence—indemnification, escrows, earn-outsouts

• Public companies buying private companies

– Governance issues

– Treatment of Executives

– Financials

• Buying the equity means buying the liabilities

• Private Equity

– Control, major decisions, what if things go bad

48

Alternatives to “Growth As Usual” St t E ti d – Strategy, Execution and

Financing

Richard K.A. BeckerHogan & Hartson L.L.P.

Charles A. NeffHogan & Hartson L.L.P.

Presenters:

David J. Lundsten, MBA, CPA, CVACherry, Bekaert & Holland, L.L.P.

John T. SchellAltus Associates, LLC

49

Alternatives to “Growth As Usual ... - Altus Associates · Altus Associates, LLC. B ild B tt M hiBuild a Better Machine Presenter: John T. Schell President Altus Associates, LLC

Documents