Operational, Transitional and Exit Strategies for Closely-Held and Entrepreneurial Business Owners

1. Operational, Transitional and Exit Strategies for Closely-Held and Entrepreneurial Business Owners 1/17/2007 Robert Gabrielski, Esq., Moderator

2. Joe Faire

3. Not Faire

4. Uma Faire

5. Well Faire

6. Boris & Natasha

7. Business Ownership and Transitions Stefanie McNamara

8. Laize Faire Software • Organized as a C-Corporation • Choose right entity for transition planning • Tax planning • Management structure • Ownership structure • Possibility of providing incentive arrangements • Laize Faire may not have been organized as a C-corp today

9. Choosing an Entity • Corporation • Centralized management • Taxation on entity and shareholder level • S-Corporation • Tax election as shareholder pass-through • Subject to certain limitations • No more than 100 individual shareholders • May only have common stock

10. Choosing an Entity – con’t • Limited Liability Company • Pass-through taxation • No personal liability for members • Flexibility in structuring management; ownership rights and distribution rights • Partnership • Pass through taxation • Personal liability for partners

11. Negotiating Exit Strategies (Cashing out) • Plan for exits in buy-sell agreement • Provide liquidity of ownership interest • Exits may be restricted but cannot completely prohibit transfer • Issues to consider in planning transition • Voluntary transfer restrictions • Address and plan for involuntary transfers • Structure different classes of ownership rights (depends on type of entity)

12. Restrictions on Voluntary Exits • Right of First Refusal • Must offer to other owners and/or company first on same terms and conditions • Put/Call Rights • Shareholder’s right to require other shareholders and/or company to buy interest (Put) • Company’s right to purchase interest (Call) • Tag/Drag Along Rights • Right (Tag-Along) or requirement (Drag-Along) to participation in sale of assets or ownership interest

13. Address Involuntary Exits • Death • Disability • Retirement • Termination for Cause • Lien placed on interest (i.e., bankruptcy) • Valuation; terms of payment - may depend on circumstance

14. Structuring Ownership Rights • Vehicle to facilitate transition • Can have varied rights (i.e., voting or non) • Can be equity, debt and/or combination • Can be structured to: • maintain control • obtain preferred return • offer incentive compensation • provide liquidation or any other preference

15. Executive Compensation Charles A. Bruder, Esq.

16. Executive Compensation Planning Considerations • Attract new employees • Retain existing “key employees” • Provide employees with a greater sense of involvement in the financial performance of the company

17. Executive Compensation Additional Considerations • Succession planning issues • Increased productivity/profitability • Financial targets • Cash flow planning issues • Employment contracts – “golden handcuffs”

18. Executive Compensation - Equity • Outright grants of stock shares/LLC units • Provides the employee with an ownership interest in the company • Permits the employee to share in the financial success of the company • Can utilize different classes of stock • Shareholder dilution/transferability issues • Current income taxation

19. Executive Compensation – Equity • Restricted Shares/LLC Units • Addresses transferability issues • May result in deferred income tax recognition by the recipient • Requires a written agreement between the company and the employee • Shareholders Agreement • Liquidity issues • Buy-back, claw back, employment termination

20. Executive Compensation – “Phantom Equity” • A bookkeeping entry that provides an “equity like” interest • Value may be determined based upon an underlying equity interest in the company • Stock Appreciation Rights (“SARs”) • Can provide for dividends/distributions • Does not provide the plan participant with an ownership interest in the company • Liquidity issues

21. Executive Compensation – Deferred Compensation • Current promise to pay compensation in the future • Flexible structure – nonqualified arrangement • Company stock/equity can be an “investment” option • Easily tied to company financial performance • Administrative burdens/liquidity issues • Code Section 409A • Funding options

22. Executive Compensation – Other Equity Arrangements • Stock Options • Non-qualified and incentive stock options • Qualified Defined Contribution Retirement Plans • Investment options • Matching contributions • Employee Stock Ownership Plans (“ESOPs”) • Employee Stock Purchase Plans (“ESPPs”)

23. Executive Compensation - Planning Considerations • Who should benefit? • What type of benefit should a participant receive? • What costs are involved to the sponsoring company? • Incentive compensation goals vs. succession planning goals • Income tax issues • Cash flow maintenance

24. Tax Minimization William J. McDevitt, CPA, CVA

25. What taxes are we trying to minimize? • Income tax • Ongoing operations • Sale of business • Estate / Gift tax • Sales and Use • Import / Export duties • ALL OF THEM

26. Three Rules for Making Effective Business Decisions • Decisions should make sense short-term • Decisions should position the business for the best chance of long-term success • Decisions should be tax-efficient (See the three rules of tax planning)

27. Sale of a Business

28. What do sellers want? • Maximum selling price • Minimize tax / taxable income

29. What do buyers want? • Lowest possible selling price • Maximize current tax deductions* * Public companies are generally more interested in maximizing EPS than minimizing taxes

30. Tax Rates • Federal Top Rate • Ordinary 35% • Capital gains (long-term) 15%

31. Tax Rates Top Rate • AMT 28% • AMT – Capital gains (long-term) 15%

32. Tax Rates • State Top Rate • New Jersey 8.97% Note: State taxes are not deductible when subject to AMT

33. What are you selling? • Stock / Partnership / Interest • Asset Sale

34. Purchase Price Allocation • What is good for sellers may not be good for the buyer

36. Worst Case C-Corp Asset Sale Assume selling price $92,000,000 C-Corp tax (40%) – 36,800,000 Proceeds to seller $ 55,200,000 Individual tax (24%) – 13,248,000 Net after tax to seller $ 41,952,000 Tax cost ≈ 55%

37. New Businesses Generally should be • Partnerships for tax reasons • Corporate protection for legal reasons “LLC”

38. Traps • Allocation of purchase price to: • Ongoing consultation Good for buyer Bad for seller

39. Business Valuation Issues

40. Why do you value a business? • Buy/sell agreements • Possible sale • Estate/Gift • Litigation

41. How do you value a business? • Depends on the purpose • However basic, the concepts are the same

42. How do you value a house? • Comparables • Correlate to subject house

43. With a business valuation, there is less reliable information available on the sales of other businesses

44. Case Study One • Cardboard box • Every Monday the box generates $100 (except for two weeks of summer) • The box has followed this pattern for the last 50 years • The box is expected to continue this path for the next 50 years

45. What would you pay for the box?

46. Case Study Two • Cardboard box • Every Monday the box requires a deposit of $100 (no summer vacation) • The box has followed this pattern for the last three years • The expectation is that the box now contains the next big thing in the industry

47. What would you pay for the box?

48. Discounts for Lack of Control and Lack of Marketability • If Boris is to get a 10% interest • Subject to numerous restrictions • Transferability • Voting Rights • Etc.

49. Discounts for Lack of Control and Lack of Marketability • Then the value of the 10% is not $9.2 million (10% of $92 million) • It is worth less than $9.2 million

50. Financial Strategies for Business Owners Patrick Sheridan