How to Build Value in Your Company

Presented by Rob Slee, CBA, CM&AA, MA, MBA

. Capital Markets Overview

Sales ($millions) 5 150 500 1,000

Small Lower Middle Upper Large Businesses M I d d l e M a r k e t Companies

5.4MM 300,000 2,000

15% 40% 45%

2-3x 4-7x 8-9x 10-11x >12x

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. Creating a More Valuable View

1. Focus on the business model 2. Develop a recurring revenue/income stream 3. Institutionalize the business (mgmt, systems, etc.) 4. Create transparency on all fronts 5. Rationalize the process chain

. End Result: Better/cheaper access to capital plus a higher acquisition multiple

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. The Middle Market – What’s Happening? • The US middle market is one of the largest economies in the world • There are roughly 8,000 Private equity groups (PEGs) in the US – with several trillion dollars in spending power • PEGs own around 35,000 middle market companies (12%) – but this represents about 30% of the market equity…moving to more than 40% of equity by 2012 • Hedge Funds are newer to private investments – but they have raised more than $1 trillion in the past 2 years • Realized returns are dropping like a rock

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. Intermediated Value Gap

Middle Market Investments Expected versus Realized Returns* Investments Expected Realized Returns Returns** 5 Year 10 Year 20 Year Venture capital 38% 4.6% -1.5% 17.8% Mezzanine capital 21% 2.7% 2.3% 6.7% Private equity 30% 5.8% 2.8% 11.3%

*Thomson Reuters US Private Equity Performance Index (PEPI) **Realized returns are net to investors after management fees and carried interest.

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. Owner Value Gap • Most lower middle market companies have a cost of capital of 25-30% • Yet 80-90% of owners do not generate returns on investment to cover this cost of capital • This means that over time, a value gap occurs (the difference between what the owner wants/needs the value to be…versus what the market says it is worth) • The value gap shows-up in a number of negative ways (lack of job creation; diminished GDP; lower loan demand, etc.)

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. Middle Market Finance Theory T R I A N Capital Transfer G Middle U Market Finance L Theory A T I O Valuation N

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. Middle Market Finance • The study of how managers of private middle market companies make investment and financing decisions • Value Relativity: Value is relative to the reason for an appraisal • The Bizarre Bazaar: Private capital is allocated in a bazaar • Transfer Spectrum: Business transfer comprises a spectrum of alternatives • You are lost until you understand the integrated structure of private finance

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. Value World Theory • Motive leads to a purpose (reason) for an appraisal • The purpose for an appraisal selects a value world • A private business value is relative to the value world in which it is viewed • Therefore every private company has dozens of correct values at one point in time • Why is there value relativity? Because I say so…NOT!

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. A Few Value Worlds • Market Value – what the open market says the business is worth (Asset, Financial, and Synergy Subworlds) • Fair Market Value – what the IRS/Courts say it is worth • Owner Value – what the owner says it is worth • Investor Value – what an investor says it is worth • Collateral Value – what the bank says it is worth • Incremental Business Value – returns greater than investment • Others: Insurable; Early Equity; Public; Fair Value • The 30 second rule

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. Value Worlds Planning

ACTION ENTER EXIT

CRTs FMV MV Acquisitions BRuptcy Synergy MV MBOs Investment Owner Go Public FMV / MV Public

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. The Bizarre Bazaar of Private Capital • Why a bazaar and not a supermarket? • There is a structure and rules • Be prepared for financial hand-to-hand combat • Realize that capital providers constantly move their tents • Need to create capital solutions one deal at a time

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. Structure of the Bazaar • Private capital owner motives include a desire: for few shareholders; to stretch equity; to eliminate personal guarantees; to manage business – not balance sheet • Capital is allocated based on the credit requirements of the providers (credit box) • Capital providers have unique return expectations • Return expectations are all-in rates (not just stated interest rates) • Return expectations can be graphed

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Pepperdine Private Capital Market Line Lower Middle Market Expected Returns ($5-10M)

45% 41.8% 37.5% 40% 35% 30.0% 30% 25% 21.0% 20% 15% 8.0%

10% 5.0% ExpectedReturns(%) 5% 0% Banks ABL Mezzanine Private Venture Factoring Equity Capital

Capital Types

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. Business Transfer • Business transfer reflects all possible ways or methods to transfer or exchange a private business interest • An owner’s transfer motive selects a transfer channel (e.g., Employee channel) • Each channel contains numerous transfer methods (e.g., ESOP or MBO) • Transfer methods select value worlds!

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. Business Transfer Spectrum

T R A N S F E R M O T I V E S

T R A N S F E R C H A N N E L S

Charitable Outside Outside Employees Family Co-Owners [Retire] [Continue] Public Trusts

T R A N S F E R M E T H O D S

ESOPs Charitable Outright Buy/Sell Negotiated Consolidate Initial Public Management Remainder Gifts Russian One-Step Roll-ups Offerings Buyouts/Ins Trusts SCINs Roulette Private Buy and Direct Public Phantom Charitable Annuities Auctions Dutch Build Offerings Stock Lead Trusts GRATs Auction Two-Step Recapitali- Reverse

Stock Appre- FLPs Right of Private zations Mergers ciation Rights IDGTs First Auctions Going Private Refusal

INTERNAL EXTERNAL

TRANSFERS TRANSFERS

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. Owner Motives Matter – PrivateCo’s Values

Method Value World Value

Buy/Sell Asset Market Value $ 2.4 MM MBO Investment Value 7.5 MM ESOP Fair Market Value 9.2 MM Equity Recap Financial Market Value 12.0 MM Negotiated Owner Value 15.8 MM Auction Synergy Market Value 16.6 MM Public Public Value 18.2 MM

Business Owners Choose a Transfer Value!

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. Private Market Timing

U.S. Ten Year Transfer Cycle

Deal Recession Prime Selling Time Uncertainty (Buyer’s Market) (Seller’s Market) (Neutral Market)

1980 1983 1988 1990 1990 1993 1998 2000 2000 2003 2008 2010 2011 2013 2018 2020

. How to play this cycle?

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. Value Architecture • Tradespeople - mechanics; fingerprints on everything; low leverage (less than 2:1); earning a living; probably small businessperson for life • General Contractor - still fingerprinting; some leverage (less than 5:1); earning a lifestyle; may or may not realize financial independence • Value Architect - fingers on pulse; substantial leverage (more than 10:1); creating value/wealth; is or has realized financial independence

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. Becoming a Niche-aholic in Your Business • Incrementalism versus departurism…do the math • Steps:

1. Complete a physical inventory of your intellectual capital 2. Describe the needs/wants/behavior of your current markets 3. Determine several niches that you can exploit 4. Use an Aggregation Model 5. Rinse, lather, repeat

• Create a niche conglomerate?

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. Niche Conglomerate

Seminars Advise Preach Write Create Own / Mentor Books Engr. Mentor

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. Where Do We Go From Here? • Clarify your goals … how important is financial independence to you? • Do you want to become a Value Architect? • Join MidasNation.com • What else can you do?

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. Thank You

BiggsKofford, P.C. 630 Southpointe Court, Suite 200 Colorado Springs, CO 80906 (719) 579-9090 www.biggskofford.com