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The Leveraged Capital Newsletter,
sponsored by Graham Financial Corporation
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August and our summer are quickly drawing to a close. We just returned from a long overdue holiday to the Azores in Portugal so this months edition is out a little later than usual. Any one who is interested in a golfers paradise may want to try the handicap humbling Furnas Golf and Country Club on the island of Sao Miguel. If you don't golf, the island offers outstanding food, wines, excellent beaches that our kids loved and a great cultural and historical experience. The capitalist in me still marvels that some restaurants and businesses still close at lunch! But, I digress. Back to business, literally. With our July edition, some of our readers experienced delivery problems, which should be fixed in this August edition. Thanks for your support and interest in Leveraged Capital. DPG. In this months issue:
========================================================= ========================================================= Welcome to the Leveraged Capital Newsletter. Our goal is to provide you with timely and informative articles about growth and strategy issues effecting entrepreneurs and small to medium sized companies. Each month Leveraged Capital will deal with issues affecting your business. You will be able to read topics ranging from finance, human resources, buying companies, selling your company, and technology. In coming months you will read profiles about other entrepreneurs and current decision makers. We will keep timely content levels high, advertising content low, and welcome your feedback. Are you interested in contributing articles?
Or, do you have an interesting and unique story to tell about your
company? We would like to interview you. ========================================================= Selling Your Company. Part Two - The
Steak and The Sizzle. This multipart series will take you through the sale process from start to finish. Part One - Is It
Time? See the Jul01 Issue of
Leveraged Capital. SELLING YOUR
BUSINESS – PART TWO: THE
SIZZLE AND THE STEAK. In part one of our series we explored pre-sale considerations to selling your company. To borrow from an overused marketing metaphor, the sale of your company will involve selling both the steak and the sizzle. In this second of a four-part series, focus on these key areas as requisites to the effective packaging and marketing your company for sale: 1) Assembling Your Team; Assembling Your Team. External advisors that you need to consider will vary depending upon the size of your company, the complexity of the deal, and the internal management depth that you have in your company. At a minimum, you should have these experts as part of your team. A Tax Accountant. Not only to address financial questions that may be raised during the negotiations, but perhaps even more importantly, to help you plan for the post-sale use of cash that you and your estate will receive when you sell. We have been very surprised how few owners of SME's consider the financial and tax issues of the next phase of their lives after selling a company. A Corporate Lawyer, especially one experienced in mergers and acquisitions. Selling your company will involve significant levels of documentation. The confidentiality agreement, letters of intent, due diligence issues, the agreement of purchase and sale, purchase price allocations, and representations and warrants that will affect you and survive closing will require the input of a corporate lawyer. A Deal Intermediary. Our experience shows that sales values are 10% to 20% higher when an owner uses an intermediary to act as a "broker" to sell a company. As you will see through this series of articles, selling your company takes a tremendous amount of time, not only in preparing documentation, but also in the marketing of the company to generate serious interested purchasers who are able to close the deal. An intermediary will be skilled in packaging your company for sale, know the most effective way to generate information and approach the most likely buyers for your company, will provide a level of confidentiality during the early stages of marketing your company for sale, and will be an effective buffer from your emotional ties to your business during negotiations. Internal advisors that you should involve in this process should include your partner(s), your spouse and family, key management such as your accountant, controller, CFO or general manager, and your most trusted friends or family members that can give you a personal perspective to what you face during the selling process. Selling your company is not something that you can do on your own. You simply cannot continue to focus on day-to-day issues of your company and sell the company effectively. In fact, we advise our clients not to assume that sale will be completed. Many factors come into play when selling the company, many of which are external issues that you may not have control over. Rather, continue to run your company as if it is not for sale with a focus and attitude of making the company better every day. By using a skilled and trusted team of advisors, you can focus on your company today and make the best decisions possible from the issues that will develop during the sale process to maximize the sale price. Housekeeping Issues. i. Review your organizational management structure and
individual participants; If a sale is not completed at this time, you have a better understand of the management of your company as a result of this "house cleaning" process. Preparing Your Marketing Package. Initial information provided for the marketing package should include the
following contents: This initial package will help serious buyers to assess their level of interest and should lead to a letter of intent that will define proposed parameters of the deal and allow for more detailed examination of information by the potential purchaser. Determining The Most Likely Buyers. Strategic Buyers will likely be direct competitors, a company that is attempting to have a strategic alignment with your business and industry, or add a logical addition to their current activities and business model. Reasons for acquiring your company could be improved distribution channels, elimination of competitors, diversification of product or business lines, leveling a cyclical nature of business or industry, increasing size for capital market interests, or a consolidation within an industry. Strategic buyers are more likely to pay a premium price over a financial buyer given their understanding of your business and the industry. Financial buyers will be much more focused on the leverage of your company, cash flow from your operations, their targeted Internal Rate of Return (IRR), and are likely attempting to add to the diversification of their investment portfolio. They may also be semi-strategic buyers in that they may own or control a one of your competitors. Financial buyers may not recognize the valuation of intangible assets that a strategic buyer may place on certain aspects of your business. One other buyer group exists. Your management group may approach you to undertake a management buyout (MBO). Even though this may seem to be the easiest group to approach, there are a number or reasons and evidence that exists that point out that MBO's may not generate the maximum value that you can achieve from the market place. We plan on covering MBO's in a future edition of Leveraged Capital. Understanding your potential buyers will assist you in developing an appropriate sales strategy. An effective strategy will identify the most likely buyers, detail the most logical and effective approach to these buyers and will define a process to attract the buyers to increase your ability to close a deal with maximum value for your company. Additionally, a well thought out sales strategy will be the first step in assessing valuation and pricing expectations, which we discuss next month. ==========================================================
Unique Insurance Solutions For Potential Corporate Liabilities. Today, newly formed private and public companies, including those formed as a result of mergers and acquisitions may find themselves exposed to potential balance sheet losses for which insurance was never available within these "standard" policies. New insurance products however have been recently introduced that will both facilitate deal making and reduce the possibility of future "surprises" that result in unbudgeted financial loss. In addition, insurance is now available to cover risks that were historically considered as pure "business" risk and thus not insurable at any cost. The purpose of this article is to outline some of these new products and how they may be employed in specific situations. It should also be noted that many traditional forms of insurance (i.e. Directors & Officers Liability) have been modified to provide much broader coverage. If your policies have remained unchanged in scope for a few years you likely have an inferior product and should seek an immediate review of your policies (and pricing). Mergers & Acquisitions: These issues not only relate to problems which may have occurred in the past (and are known but may not be properly recorded or funded) but also to problems that may occur in the future. The concern is: How does one properly account for or quantify these exposures. Another important factor is that traditional solutions for disputes (holdbacks or vendor financing) may in themselves be difficult, if not impossible, for parties to reach agreement. If resolved, both parties may still suffer financial loss if the quantification of the problem has been underestimated (or even over-estimated). Solutions: Directors and Officers Liability: (D&O) Standard policy exclusions or restrictions included any claims related to joint ventures, affiliated companies (those which were less than 51% owned), foreign subsidiaries, pollution, employment practice, punitive damages, acquisitions, outside entities, fines and penalties, or "oppressive conduct". Further, securities claims were excluded as were statutory claims relating to the handling of wages, UIC, pensions or tax. Policies only covered directors and officers and thus claims made against the Corporation, in whole or in part, were not covered, and limitations were placed on reimbursement for defense costs. In the past D&O insurance was not available to partnerships, limited partnerships or private companies and insurance for non-profit organizations was limited. As often as not, newly formed corporations were not eligible for insurance coverage or were offered very limited coverage at inflated premiums. Insurers routinely responded to D&O claims by denying coverage. For
example, coverage was narrow as mentioned above and older policies only covered
the directors and officers and not the Corporation itself. Furthermore, the
allocation of defense costs were difficult to determine when the costs of a
lawsuit were allocated between insured or uninsured claims and/or between
insured and uninsured parties (i.e. the corporation). Most companies, whether private or public, new or old, can now purchase broad
form D&O insurance to include all or most of these coverage extensions, the
importance of which would be absolutely crucial in any merger or acquisition
situation. One major concern for most companies and particularly for those that acquire or merge with another is the impact of poor collection of accounts receivable, bad debts or the creditworthiness of customers. Credit Insurance will guarantee payment of accounts receivable and thus reduce the size of delinquent or non-collectable accounts (or in the case of a merger or acquisition, reduce the risk of an inflated A/R declared asset). Insurers can also provide the technology to do credit analyses of customers and monitor their on-going financial stability, and will take responsibility for collection of customer defaults. This form of protection is particularly useful for middle market companies from a management perspective and can also remove accounts receivable and bad debt items from the balance sheet, thus freeing up capital for growth. Litigation Expense: a) Plaintiff's Cost Indemnity: Will indemnify a plaintiff for legal costs resulting from unexpected court judgments i.e. where cases are lost by surprise verdicts. (This insurance insures the plaintiff; it is also available for law firms - Litigation Cost Indemnity Insurance or as Litigation Disbursements Indemnity which only covers disbursements). b) Opponents Cost Indemnity: Insures the plaintiff for the potential award of costs in favor of the defendant. c) Defendant's Commercial Litigation Indemnity: Insures the defendant for the award or settlement, interest, disbursements and legal fees that result from unfavorable or unexpected court decisions. The insurance basically allows a company to ignore the impact of such decisions and costs relating to same. d) Contingent Liabilities Indemnity: Allows for the transfer of contingency funds on the balance sheet to an insurance policy. These liability issues may relate to settlement of existing lawsuits, uninsured or under-insured claims, unknown and unreported claims reserves, insolvency etc. e) Contingent Asset Liability: Will pay a plaintiff Extended Reporting Insurance: The insurance can provide higher limits or broader coverage, retrospectively, for future claims against the acquired company, isolate exposure for discontinued product lines, replace the insurance formerly held by bankrupt insurance companies and even provide higher policy limits for known claims. Pollution Liability Insurance: a) Cost Cap Liability: will allow parties to cap or limit the maximum cost that they will incur for remediation of any known contamination. b) Post Remediation Liability: will provide coverage after a cleanup should liability be incurred that results from a recurrence of the contamination or if government guidelines were changed such that further cleanup is necessary. The insurance will also provide Third Party protection for bodily injury or costs of cleanup resulting from migration of contaminants to adjoining properties. c) Pollution Liability: will provide third party liability coverage and first party cleanup cover for costs resulting from unknown contaminants. In any land transfer of contaminated property these insurance coverage's may be purchased in a package to offer complete protection from unknown costs, or they may be purchased individually. Employment Practice Liability: These exposures are not insured under standard "general" liability policies but new forms of Directors and Officers Liability Insurance and stand-alone Employment Practice Liability policies will provide coverage for these perils. In mergers and acquisitions the coverage would appear to be of great importance to the buyer to avoid heavy costs that may result from layoffs, dismissals Other New Innovative Insurance Coverage: In terms of protection of one's bottom line, two new products that come to mind are ECommerce Insurance and Electronic Maintenance Expense Insurance. Ecommerce Insurance allows for the transfer and control of cyber risks. The insurance covers financial loss caused by fraudulent acts by employees or outsiders to computer systems, loss of intellectual property, extortion, libel and slander, invasion of privacy, copyright infringement etc. It covers the costs related to suits by third parties and the cost of replacing damaged EDP equipment and software. It will also provide for lost income and the extra expense incurred during those periods when a system is shut down. No company that deals on the Webb should be without this form of insurance - as recent events have demonstrated (the Love Bug virus resulted in damages in the hundreds of millions dollars). Electronic Maintenance Expense Insurance is a new product that should have great appeal to any company that incurs significant annual expense for the regular and unexpected expense for the maintenance of electronic machinery - computers, printers, fax machines, copiers, postal machines, cash registers etc. Retail store and hotel chains, high tech companies, large offices, banks and
insurance companies would be ideal candidates for this insurance. All of the above noted innovative insurance products illustrate the changing nature of the insurance industry and it's willingness to accept new challenges. For business, they provide solutions which not only allow for the better management of business expense but also promote higher profitability. Lloyd
R. Brown is a Senior Account Manager responsible for Business Development Further information about the KRG Insurance Group can be found at www.krg.com. ========================================================= Quick Stuff: Pitfalls and Traps To Avoid For Owners Of SME's. Entrepreneurs and Owners of SMEs are faced with many challenges when running a company. Take a moment to see if you are falling into one (or more) of these pitfalls and traps that lead to serious problems and failure of many businesses. Graham Financial Corporation can help you assess and deal with these issues.
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