While any Covid impact on recent business performance will have to be addressed, buyers are still looking for growth through acquisition, private equity funds with plenty of “dry powder” continue to aggressively seek out quality companies to buy, and transactions are getting done. Chris Kramer looks at the big picture and three options for business owners.
If you are like many of our clients, recent events have caused you to think even more acutely about what the future holds. If you own a business, those thoughts naturally turn to questions around future direction, strategy, and potential exit.
Clients often ask me “Is now a good time to sell my Company?” My response is always the same, “The best time to sell your company is when you are ready.” That said, if you have been thinking about selling, the current climate, despite Covid, remains one of the best climates in recent history to maximize the value you have built through a sale.
While Covid, PPP forgiveness, shutdowns and general uncertainty have not made things any easier, buyers continue to seek growth through acquisition and transactions are getting done. That means your company is likely to be an attractive candidate to the right buyer, especially given the relative shortage of high quality, private companies available for purchase.
PRIVATE EQUITY BUYERS WITH MONEY TO SPEND
While private equity funds have been very active over the last 5 years as evidenced by the graph, the amount of “dry powder,” or committed capital seeking out acquisitions, remains at an all-time high. This means that private equity funds continue to aggressively seek out companies to buy. As their model generally involves a “buy and build” strategy, many funds are looking for add-on acquisitions to augment existing companies in their portfolios that they have purchased in the last 5 years. At the same time, most funds continue to seek out “platform” acquisitions, or foundational target companies around which they try to build through follow on acquisitions.
Total Enterprise Value (TEV)
TEV / Revenue
TEV / EBITDA
Source – GF Data ®
Fueling the activity level, as well as valuation multiples, is the continued low interest rate lending environment, coupled with aggressive underwriting. Basically, this means that banks are loaning more money at lower rates than at any time in history, which enables PE groups to pay higher prices for the companies they acquire. When rates are low, and liquidity is present in the market, asset values generally rise, as evidenced by multiples paid by private equity (i.e. higher valuations), rising real estate prices, and record highs being achieved in the public markets.
PUBLIC COMPANIES – FAVORABLE TO MARKET CONDITIONS FOR BUYERS RIGHT NOW
When a sale to a private equity fund is not the right fit, public companies often provide a great alternative. Here too, the market conditions are incredibly favorable to sellers at the moment. Whether public or private, companies continue to struggle to find new markets, new products, and other forms of organic growth. However, the pressure to growth is even more acute for public companies than those acquired by PE firms. At the same time, the stock prices of many public companies are either at all time highs, or at least at historically high levels. This continued need for growth, coupled with stock prices that facilitate relatively less expensive capital, enables public companies to buy private companies at historically high valuations.
ESOPS MINIMIZE TAXES, PRESERVE CORPORATE CULTURE
Finally, for those owners who are concerned about preserving corporate culture, minimizing tax, and/or enabling their employees to create wealth of their own, and Employee Stock Ownership Plan, or ESOP, remains a great alternative in some cases. We are seeing ESOP transactions that rival third party sales in terms of valuation multiples and net proceeds to sellers, with less risk of transactions stalling or failing, less intrusive due diligence, and less exposure of proprietary information to a potential competitor.
While the market conditions are favorable, due diligence in the era of Covid can be especially rigorous. The ability to isolate and explain the impact of the pandemic is critical to maintaining an agreed upon valuation through closing. At the same time, the ability to show recovery, or sustainability going forward, is often the crucial factor in getting a transaction closed. Buyers will generally pay you based on the past, but only to the extent that the future outlook is positive. If you have experienced a downturn and expect to return to or exceed your pre-Covid performance, it is vital that you are able to articulate your vision for how you will do this, and provide support for your assumptions where possible.
GETTING THE ONE RIGHT RESULT
Selling your company can be a daunting undertaking, and requires preparation, strategy, and execution. With over 30 years of experience in helping business owners with ownership transition, Acuity Advisors is uniquely qualified to help guide you through this process. While there are many possible outcomes to a transaction, there is generally one right result. Acuity Advisors helps you achieve it.
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The presidential election is upon us, and estate and gift tax exemptions are unprecedentedly high. But how will tax exemptions change after November? Understanding your worth is important to preserving your assets for your heirs.
It’s no secret that the outcome of the presidential election will have a direct impact on the future tax burden of individuals and families. Taxpayers should consider using their 2020 $11.58 million gift and estate tax exemption.
The gift and estate tax exemption is the amount that each individual may use to transfer property either during their lifetime or at their death without incurring a 40% tax under current federal law. This amount is scheduled to sunset at the end of 2025 with a reversion to $5 million indexed for inflation. Genuine concern exists that the current window of opportunity to effectuate a wealth transfer may eliminate sooner depending on the outcome of the presidential election.
The Tax Cuts and Jobs Act was effective prospectively to the beginning of 2018. It is, however, not outside the realm of possibility, that any future federal tax legislation passed in 2021 could be retroactive to January 1, 2021. Vice President Biden has called for “returning the estate tax to 2009 levels,” which implies the top rate would increase to 45%, and the gift and estate tax exemption would be $3.5 million per taxpayer. Biden also indicated that he would repeal the step-up in basis, which occurs when an appreciated asset is passed to heirs. Election-related concerns coupled with the economic downturn and increasing deficits caused by the COVID-19 pandemic could make increases in the estate tax an attractive option for enhancing revenue regardless of who wins the election.
The outcome of the election and extent of the downturn is unknowable, and the risk of a second wave of infection casts doubt on the recovery. The net effect of this uncertainty has resulted in higher risk premiums for impacted businesses leading to lower asset values.
In such an environment, now may be an optimal time to consider estate planning strategies. Transfers of interests held in entities require concise execution, and valuation support from a credible and independent valuation firm is critical. To minimize IRS scrutiny for valuations care needs to be taken to ensure that the valuation analysis is supportable, based on well-reasoned assumptions, and consistent with all of the existing revenue rulings and tax court cases available to the valuation profession.
SEG professionals are practiced in determining discounts for lack of marketability, control, and built-in-gains in complex ownership and legal structures. Our valuation experts are knowledgeable about the most recent applicable tax court cases, legislation, and related revenue rulings. We consider all relevant rulings specifically applying to estate planning and the application of minority interest discounts to assets owned by family members.
At SEG, we work with estate planning attorneys, business owners, taxpayers, and their advisors to value and document the transition of ownership. If you are interested in learning more about how an experienced valuation advisor can help you navigate these important and complex issues, we would love to hear from you. Contact Chris Kramer at email@example.com | (714) 380-3300 or Michael Perez at firstname.lastname@example.org | (714) 380-3304
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In the world of business and accounting, ASC 805 valuation does not need an introduction. This code is talked about by just about every appraiser—and rightly so. If you are confused about what this means for you and your purchases, it is time to stop worrying.
Here are the most straightforward answers to the most common queries about ASC 805 valuations. These explanations will help you out throughout your accounting procedure:
What Are ASC 805 Valuations?
To understand ASC 805 valuation and other codifications, you need first to understand what PPA is. Purchase Price Allocation (PPA) is a process wherein an entity purchases a new company. The purchaser is referred to as the acquirer. Likewise, the company that is purchased is known as the target. Now, per PPA, the purchasing price for this new company is set based on the accumulated worth of all the target’s assets and liabilities.
Additionally, these transactions are not independent deals. Rather, the Financial Accounting Standards Board (FASB) overlooks these purchases. There are numerous rules set by the FASB that are implemented in such transactions. The FASB currently sets all accounting standards under one code, ASC 805. This rule applies to all transactions in which one company acquires one or more new companies.
ASC 805 valuation ensures that tangible, as well as intangible, assets, factor into the total purchase price, based on the fair value (or FV) of each of these assets. To clarify further, tangible assets typically consist of land, buildings, and other similar possessions. On the other hand, intangible assets are comprised of copyrights, website domains, customer lists, intellectual property, and similar resources.
It is rather complex and tricky to follow these rules yourself. If you need help understanding all of the technicalities, you can contact us.
Business Combination Under GAAP
The business combination is, as its name suggests, a term for the combination of businesses. When an acquirer merges with or purchases another company, it is known as a business combination. However, since definitions under generally accepted accounting principles (GAAP) are different, whether or not a purchase is considered a business combination can vary.
GAAP defines a business as a group of assets which conducts activities that, in turn, generate an outcome that makes the group self-sustaining, while offering a return to investors, as well. A business must include three basic elements: inputs, processes, and outputs. Unless the company being purchased meets these requirements, the purchase of its assets and liabilities by an acquirer is merely a transaction, not a business combination.
Contingent consideration is a type of payment that an acquirer has to pay to the former owner of the target company. This payment is dependent on the occurrence of certain future events. It is calculated based on various factors, including taxation, revenue, earnings, and more.
Contingent consideration is documented at the time the target company is purchased. It is listed as an equity or liability as per its fair value. The acquirer pays the contingent consideration either in one lump sum or through a series of payments. This payment may be completed in cash or equity shares, depending on the preferences of the acquirer and the acquiree.
What Is FAS 141?
FAS 141 is now known as ASC 805 valuation. The major difference between ASC 805 and FAS 141 has to do with contingencies. Under FAS 141, contingencies were dealt with later in agreements. Under ASC 805, calculation and a listing of the contingencies is completed on the date of acquisition.
What Does ASC Stand For?
ASC stands for Accounting Standards Codification. It restructured existing FASB and GAAP accounting standards. As a result, ASC is a much more user-friendly approach that has made information more accessible and understandable for the public.
Calculating Fair Value of Consideration Transferred
To calculate the transferred consideration amount, fair values must be measured and compared. This calculation starts by summing up the fair values of the transferred liabilities and assets to the acquirer. Next, the fair value of the equity shares transferred from the acquirer to the acquiree is measured. The difference between these values is the fair value of transferred consideration.
What Constitutes a Business Combination?
In a business combination, an acquirer gains control over another company, this is called a target. This is a purchase or merger done for the increase in size and growth. A business combination is only done if the target is a company that has inputs, processes, and outputs. Unless a business is producing outputs for the investors in terms of reduced costs or increased economic benefits, the purchase is not a business combination.
Accounting for Acquisition
Say an acquirer decided to purchase a target company’s assets. A business combination is clear, but how do you account for it? Well, it is actually pretty simple. The first step is to identify the business combination. The next step is determining the acquirer.
If only some assets and liabilities were purchased, it can be confusing to tell whether the purchaser is technically the acquirer or the former owner. If there is a significant disparity between the fair values of the parties, the acquirer is the one with a higher fair value. In other cases, the group that makes payment or has a dominant role in the deal is considered the acquirer. Once these roles have been established, the transaction cost is measured. On the date of the acquisition, the cost of the business combination should also be measured. Lastly, it is important to account for goodwill. This process can be quite thorough and requires precise calculations, which is why it is best to hire the Strategies Equity Group and let the professionals handle it.
The buyer pays a deferred consideration paid to the former owner of the assets over a set time period. This amount and time frame are decided during the acquisition. The payment can be done in the form of cash or as a transfer of shares.
Contingent payments are very similar to deferred consideration. A contingent payment is a payment that the buyer makes to the seller after the acquisition. However, instead of setting a time period, this payment depends on whether certain events transpire. Basically the deal has been finalized, but payment will only be issued after a specific occurrence takes place. This contingency can also simply refer to a certain level of performance for the business.
SFAS stands for Statement of Financial Accounting Standards. SFAS 412 is one of 168 standards put forth by this category.
Above Market Lease
Generally, there is a set market rate for leases. If a lease is finalized in accordance with ongoing market rates, it is said to be “on market.” On the other hand, if the lease rate is less than the market standard, it is referred to as “below market.” A lease that is greater than the established market rate is “above market.”
GAAP and Its 4 Principles
Under GAAP, there are defined rules that every corporate financial and accounting transaction must follow. There are four basic principles of GAAP: objectivity, materiality, consistency, and prudence. Per these principles, all purchases should be objective, the true financial state of the business should be stated, a consistent standard should be followed, and reported facts should be authentic and genuine.
ASC 842 is also labeled ASU 2016-02. This is the latest lease accounting standard, as defined by the FASB. The previous standard that covered this area was ASC 840, which had issues regarding the rule for off-balance sheet operating leases. Under the ASC 842, all leases (with the exception of short-term leases) are capitalized on the balance sheets. Previously, there was no such obligation and operating leases only had to be reported in the footnotes of corporate financial statements.
Goals of FASB ASC
The main intention for the introduction of ASC was to serve as a restructuring of existing rules and regulations. ASC is no different from FASB or GAAP, except that the way its system is codified has made it an easy system to research. Users of ASC can attain official information on over 90 topics, all of which are documented and categorized within it for easy access. With ASC, accounting standards are easier to implement since knowledge is more widespread.
Fair Value Consideration
The entire accounting system of FASB relies on the measurement of fair values. Fair value is defined as the price of any asset or liability that the seller will receive if the relative asset or liability were transferred to a market participant on that same day.
How Do You Find the Fair Value of Noncontrolling Interest?
SFAS 412 (R) and SFAS 160 have defined how to account for noncontrolling interest or NCI. According to these codifications, the fair value of NCI is the same as the noncontrolling equity. Therefore, the fair value will be equal to the amount you would get if you were to sell this equity in the marketplace the same day. To properly calculate NCI, you must add fair adjustments to the calculated fair value. Then, the prorate income is added, and prorate shares are subtracted. This final total represents the fair value of the noncontrolling interest.
Fair Value Accounting
By now, you already know what fair value is. Fair value accounting uses the fair values of each specified assets or liabilities in its final measurements. In this accounting process, prevailing market values are used to estimate the number of assets and liabilities in a business combination. This is a step taken by FASB to yield standardized calculations.
Why Do You Need to Identify the Acquirer in a Business Combination?
Every business combination must identify which agent is acting as the acquirer. This is mandatory for accounting, per the standards set by FASB. Because the acquirer gains control over the assets and liabilities, identifying which party is acting in that role is important. In addition, fair value has to be calculated in accordance with what the acquirer accounts for.
Business Combination vs. Consolidation
In a business combination, two companies come together at the same level. One does not excel over the other, and there is no controlling or parent entity. Instead, both companies are under common control. The acquirer and the acquiree both have equity shares.
On the contrary, business consolidation has one controlling entity. The other group loses power. The parent company is the major beneficiary. The company or companies that are acquired are recognized by the parent organization’s name.
Advantages of Business Combination
Business combinations are highly beneficial. First, they cause an instant boost in the size of the company without any internal activities. Moreover, business combinations squash competitor threats and competition as far as the two companies in question are considered. Purchasing the goods in bulk reduces the overall cost, as well. This further leads to upscale production, reaping higher economic benefits. The capital of the business grows, while management costs are minimized. Business combinations are a step towards stability and success. In addition to all these advantages, business combinations also help maintain a stable price of producing goods. Since research opportunities dramatically increase with minimal cost, the chances of growth are multiplied even further.
Under FASB, there are many authorities to turn to for information on business and accounting, such as GAAP and SFAS. These codifications aim to standardize business mergers and acquisitions. Although ample material is out there, it can be hard to absorb it all before making deals. This is where our appraisers come in. We guarantee foolproof services that align with the standards set by the authorities.
Why wait when you can rely on professionals to take care of your workload? Contact us today for your accounting solutions!
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Profile factors like the size, industry, and lifespan of a company determine the type of retirement plans appropriate for a company’s ownership and employee base. Some plans prove beneficial to employees and owners alike—especially owners who foresee a partial or complete exit from the company.
An employee stock ownership plan or ESOP Services is an employee benefit plan that is especially beneficial to owners of mid-sized, private companies who are seeking to exit the company. That being said, an ESOP adds value and incentives to the employee base, because they are able to own shares in the company itself upon retirement.
Though ESOPs have surface similarities to typical retirement benefit plans such as 401(k), they differ in many key ways. In this article we will discuss the basics of a typical Employee Stock Ownership Plan, why it may be utilized, and how to best implement an ESOP in your company.
What Is An Employee Stock Ownership Plan?
Why Implement An ESOP?
What Makes An ESOP Different From Other Retirement Plans/Benefits?
Why Should I Utilize An External ESOP Service?
How Should I Choose An ESOP Service?
What Is An Employee Stock Ownership Plan?
An employee stock ownership plan (ESOP) is a method of employee participation in a privately owned company. In layman’s terms, an ESOP is a standalone trust fund made up of stock asset contributions from the employer. These stocks are distributed evenly amongst the employee base of a company upon their departure or retirement and taxed upon withdrawal.
Specifics of an ESOP structure can vary from company to company depending on size, industry, and type of ownership. For example, one company’s circumstances may lead it to contribute 75% of its stock assets to an ESOP fund while another might only contribute 15%.
It is important to note that the vast majority of ESOPs privately-owned companies – only about 10% of all ESOPs in the United States are in public companies. In the United States, ESOPs are regulated by the Employee Retirement Income Security Act (ERISA), which sets a minimum federal standard for investment plans in private industry.
Develop a trust fund into which it injects new shares of its own stock
Contribute its own money to purchase existing shares
Establish the ESOP as a borrowing plan in which the company makes cash contributions to enable loan repayment
Each of these options can prove advantageous depending on the specific nature and size of the company. For example, the contributions of a company employing the third option are tax-deductible.
It is essential that ESOPs maintain an egalitarian structure. Shares must be distributed equally among all employees, regardless of any given employee’s income or importance to the company.
Employees are rewarded their share of stock once they retire or leave the company, at which point they may sell their stock back to the company or on the stock market. Other avenues may be pursued, as well.
ESOPs are generally beneficial to both employees and employers. Though the quality of an ESOP depends on the strength and consistency of each company’s stock offerings, the plan itself can offer far stronger retirement/severance benefits to lower-income workers than a standard 401(k) plan.
In some cases, a company’s 401(k) plan works in tandem with its ESOP; employers match employee 401(k) contributions with equal contributions of their own stock. Because private companies are not mandated to provide retirement benefits, such plans aren’t necessarily common.
Why Implement ESOP Services?
ESOPs may not be the best call for every company. Companies that implement ESOP services commonly do so to either facilitate the creation of a vehicle for an owner’s retirement plan, monetize illiquid assets without selling the company, reduce corporate tax weight via deductible contributions, or further motivate an employee base by linking employee benefit to company performance.
Developing an ESOP can be beneficial for both owners and employees, but it must be thoughtfully executed to reap the most benefits. Let’s dive deeper into these main indicators for ESOP implementation:
Exit Strategy: According to ESOP.org, “about two-thirds of ESOPs are utilized to provide a market for the shares of a departing owner(s)” of a generally successful, closely-held private company. Because the ESOP is separate from the company, the departing owner can arrange a buyout of their stocks on terms that favor all parties involved—owner, employees, and the business.
Performance-Based Employee Benefits: For an employee, an ESOP can be a motivator to maintain high performance. Because the value of distributed company stock is naturally tied to the company’s performance, an ESOP can incentivize employees to maintain the drive that will lead to continuing success.
Monetize Illiquid Stock Assets: By creating an ESOP, an owner can monetize a number of their illiquid stock assets without selling the whole company. Stocks that would otherwise incur a loss can be restructured into an ESOP framework.
Reduced Tax Burden: With a tax-qualified ESOP services, contributions from the company to the trust are tax-deductible. However, ERISA standards dictate the limit for annual employer contributions to an ESOP.
What Makes an ESOP Different From Other Employee Plans?
The decision to implement an ESOP depends on the profile of the company, as with any other employee retirement/benefit plan. Size, sector, and other variables may dictate the retirement plans that make the most sense for an employer. All the same, ESOPs stand out from other retirement packages in a few key ways. Let’s first compare an ESOP plan with a more typical 401(k) plan.
ESOP plans are similar to 401(k) in that employer contributions are tax-deferred until employees receive their shares, meaning owners are taxed on withdrawal.
While 401(k) takes money out of every employee paycheck prior to taxation, an ESOP plan rewards an employee share upon completion of employment. An employer may consider these factor before adopting either policy:
Risk: 401(k) plans to benefit from the consistency of the collection. A 401(k) can be roughly calculated by an employee’s pay rate and time of employment. On the other hand, an ESOP’s value relies on the strength of the company’s stock prices at the time of the employee’s departure.
An ESOP can be subject to market volatility, which can jeopardize or enrich an employee’s retirement assets. Regardless, the structure inherently becomes riskier over time.
Maneuverability: Both ESOP services and 401(k) can be rolled over into an individual retirement account (IRA) without taxation or penalties.
However, both types of accounts incur a 10% early withdrawal penalty. While 401(k) can be activated at a standard federal minimum age, an ESOP is distributed on an individual basis upon employee retirement/departure. Other retirement plans such as the Roth 401(k) allow the employee to contribute already-taxed money to their account, which will never be taxed again. The same applies to a Roth IRA.
Depending on the size and ownership of a company, an ESOP may prove the most appropriate vehicle for employee retirement funds. If a company is confident about its longevity, structure, and market standing, an ESOP trust could be a strong option.
Why Should I Use an External ESOP Service?
Entrusting the ESOP creation process to an external agent can sound tedious, but advantages from hiring an outside entity can far outweigh disadvantages—especially for smaller private companies that lack the necessary expertise and capital.
When a company uses an external ESOP service, it transfers responsibility to a source with proven expertise. ESOP services analyze key factors of a company’s structure and overall health to best establish an ESOP trust that benefits all involved. Let’s break down the main reasons for using a third-party service:
Proficiency: External ESOP trustees are experts in the field. Development of an ESOP trust is a complicated process that can have its own set of challenges. External trustees have the experience to recognize and address issues that may arise in an ESOP.
Assumption of Liability: An external ESOP service assumes all legal responsibility for an ESOP, as dictated by ERISA. Because of that assumed legal burden, outside trustees are required to provide service that ensures total compliance with the Department of Labor guidelines.
Objectivity: Perhaps the most important component. Because third-party ESOP services operate under ERISA standards, objectivity in practice is a strict requirement. External trustees can provide a balanced ESOP with a neutral approach, avoiding the conflicts of interest that might arise if an internal source is tasked with ESOP creation.
Moreover, external ESOP services can provide fiduciary insurance to protect against claims made against it. Internal services may not have such insurance, which can open a company to potential financial and legal ramifications if ERISA standards are breached.
How Should I Choose an ESOP Service?
In any business decision regarding third-party services, reputation is the strongest indicator of quality. An ESOP trustee’s success hinges on the reputation that it has built through previous client relationships.
Implementing an ESOP service is no small decision. ESOP creation is a daunting task: shared stock ownership must exist in a structure that can stand the test of time and clear any legal hurdles.
Creating a new ESOP framework can be the first step in developing a retirement plan that works for all involved, from employees to owners. The most ironclad and comprehensive ESOPs result when companies employ a trustee who is not only results-oriented but relationship-driven, as well.
Strategic Equity Group has the experience and customer-oriented approach necessary to develop an ESOP for your company. Let us help you determine if an ESOP is right for your company—contact us today for a complimentary in-person meeting to discuss your company’s ESOP objectives.
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