INITIATING THE M&A DEAL

1. INITIATING THE M&A DEAL PREPARING FOR THE DEAL, FINDING A BUYER, CONDUCTING DUE DILIGENCE & FINANCING THE DEAL By James L. Rench, Esq. DealSupportServices.com

2. CURRENT MARKET CONDITIONS • Challenges of last recession have caused many to take very strategic look at their industry o What are growth prospects of industry? o What will it take to become or remain competitive in industry? o How will profits be affected by changing landscape? • Many are making decision of whether they should be, or could be, a consolidator • Others are assessing strategic alternatives • Deal activity will continue to be fueled by o Ongoing access to capital & financing o Strengthened balance sheets of strategic buyers o Increasing private equity activity • S&P 500 companies have $2 trillion in cash on balance sheets & are increasing acquisition activity • Private equity firms have $348 billion in capital to invest • Relatively healthy debt markets with lenders active & competitive in M&A lending

3. CURRENT MARKET CONDITIONS (Cont’d) • Current M&A market presents both opportunities & challenges o Companies that maintained or improved earnings over last 24 to 36 months can be highly valued in today’s M&A environment o Strong competition for quality assets as both businesses & private equity continue to seek deals to fuel growth & deploy capital o General worldwide macro events & general trends in U.S. economy, reflected in volatility of U.S. debt & equity markets, have a direct impact on M&A market activity o Assuming a relatively stable economy, 2013 & 2014 anticipated to be an active M&A market with attractive valuation multiples

4. Will 2013 See Record Valuations for Middle Market Business Sales? On March 5, 2013, John Slater of FOCUS, a nation-wide investment bank, blogged the following (in part): “Business owners time their exits for many reasons: health, retirement planning, availability or lack of family successors, competition, technology change and many more. Yet overwhelmingly the question we are most often asked as a financial advisor to entrepreneurial companies is “What’s my business worth?” All things being equal, a rational business owner will presumably choose to sell at a point of optimal value for his or her interest in the firm. For the reasons outlined below, we believe that the next eighteen months may see the highest pricing for good middle market companies in the thirty years I have been in the M&A advisory business. While the M&A market could be derailed by a major decline in the equity markets or further chaos in Washington, we believe that the odds favor a strong market for sales of middle market companies through sometime in 2014. By then a correction will be overdue and the likelihood of a cyclical bear market in equities may become increasingly high. Generally a serious decline in the stock markets leads to a precipitous fall in M&A activity. The next 12-18 months will almost certainly be a highly favorable period for business exits. If this proves to be a cyclical market top, the next favorable period for businesses owners wishing to sell may not come around before the 2020s. In 2020 today’s sixty-six year old Baby Boomer will be seventy-three and today’s fifty-eight year old will be sixty-five and studying Medicare options.”

5. INITIATING THE TRANSACTION • Privately held companies, by their nature, have less perpetuity than their public counterparts • Founder/CEO energies & shifts in personal desires • Wealth concentration; desire to diversify • Competitive landscape & cost of growth • Ultimately, business owner is confronted with many important decisions, including • How do I monetize value I’ve built in my company for the past 10, 20, 30+ years? • What is my company worth? • Who are potential buyers (best partner) & what’s the best way to contact them? • What are my goals for a transaction & my role post-transaction? • Who will help through this process?

6. INITIATING THE TRANSACTION (Cont’d) • Often once-in-a-lifetime decision • Issues are complex & impact many who have contributed to success of enterprise • Emotional aspects are real • Getting it right is perfect stepping stone to next chapter of life • There are no go-to plans or established formulas/rules • Assessing client’s situation, objectives, dynamics of company & its industry are critical steps • Approach should be tailored to client’s desires

7. Seller’s Mindset • Owner’s Feelings • Fear of unknown future • Fear of losing meaning & purpose • Fear of being taken advantage of • Ignorance about “the process” • Concern for employees • Will I receive enough proceeds to accomplish my goals? My family’s goals?

8. Seller’s Mindset • Dogmatic • Can’t get elsewhere the same returns I’m currently receiving from business (may be a reality in 2013)

9. STRATEGIC OPTIONS CONSULTING • Assist clients with understanding liquidity options available to them based on their goals & unique characteristics of company or industry • Determine valuation range for their company & potential interest level from buyer/investor/lenders • Prepare after-tax proceeds analysis & tax strategies for various options • Identify value drivers of the company that could be leveraged in negotiations with buyer/investor/lenders • Identify potential red flags that might have an impact on success of a transaction or impact valuation • Discuss liquidity event process, timing & probability of a successful transaction

10. Business Transition – It’s a Process • Transition process should provide opportunity to recognize strengths, deal with weaknesses & improve operations & bottom line

11. Enhancing Business – Execution StrategyElements How to Professionalize a Business • Build upon your core strengths (“secret sauce”) • Define market strategy • Size box (physical element) • Tame complexity (process element) o Ability to manage complexity & scale o Managing by group theory (product lines, property, values) • Manage processes, not people (people element) o Create culture of change o Process defines organization, not function o Create standard work • Successfully apply information technology (IT element)

12. Enterprise Value Project(24–36 Months from Planned Transaction) Objectives • Cause owner to “think like a buyer” o Exhibit track record o Professionalize o Attract “quality buyers” • Use runway to improve EBITDA margins • Enhance operations – infrastructure • Demonstrate sustainability • Highlight transferability • Situational – each company

13. Mold a Strong Management Team • Success of company should depend on entire organization, not a few people • Loss of one or two key personnel should not negatively affect company • Need strong second-in-command & junior-level management

14. Business Plan • Develop business plan–reasonable & attainable assumptions • Clearly define internal & external growth opportunities • Identify & explain operation or margin improvements (investment in technology, improved supplier terms) • Identify capital expenditures • Identify capital requirements (internal CF, outside capital) • Hit your numbers

15. Financial Statements • Effective financial controls o Audited or reviewed financial statements o GAAP internal financial statements o Dependable accounting department • Gives sense of security, credibility • Lowers due diligence costs • Lowers holdbacks

16. Invest in the Future • Putting off needed expenses may not add value • Review & address operational processes • Ensure systems & controls are in place • Invest in technology or equipment • Give best appearance possible • Also applies to investment in human capital o Management o Other personnel

17. Improve Margins & Profitability • Eliminate unprofitable products &/or customers • Examine expenses (excessive, personal/family-related, nonrecurring expenses) • Review & improve supplier contracts • Sell divisions or locations if they significantly lower earnings & are not strategic • Manage working capital

18. Customer Concentration • Too much revenue with too few customers can give appearance that business may be risky • Improve quality (profitability) & diversification of customers • Attempt to get sales contracts or agreements • Be prepared for holdbacks in transaction

19. Balance Sheet • Clean up o Working capital o Obsolete inventory o Loans to shareholders • Will clarify assets & liabilities in transaction

20. Controlled Ownership • Different owners = different objectives • Beneficial to buy out minority shareholders • Can ensure smoother transaction & may increase value

21. Pre-Due Diligence • Litigation • Corporate records • Contracts • Financial records • Allow time to fix what might impact value

22. Timing • If selling your company is your exit plan, timing can be single most important factor to consider • “Buy low, sell high” applies to business sales as well • Sell on your own terms • In difficult market, deal structure & partner going • forward are critical • Don’t be a lone ranger

23. LIQUIDITY EVENT PROCESS • Research, interview and engage accountants and advisors • Assemble and review financials • Prepare financial analysis (including trends) • Recast financial statements • Prepare projections • Market analysis • Identify and research potential buyers  (PE groups, competitors, strategic buyers, others) • Identify and research recent transactions in the industry • Finalize offering materials • Mailing and fulfillment of approved buyers • Detailed tracking process • Strict confidentiality screening

24. LIQUIDITY EVENT PROCESS (CONT’D) • Coordinate buyer questions and responses • Arrange interviews • Schedule site visits • Manage information exchange • Negotiating letters of intent • Coordinate competitive bidding process • Buyer selection • Prepare transaction schedule and deal team contacts • Manage due diligence (virtual data room) • Prepare transaction documents (Including ownership, acquisition and finance agreements) • Handling third-party matters • Hart-Scott-Rodino procedure (see Annex A attached to these materials) • Closing

25. LIQUIDITY EVENT PROCESS (CONT’D) TYPICAL MARKET TO CLOSING TIMELINE: Prepare for Market 1-3 Mos. Identify Buyers 1 Mo. Project Launch 1 Mo. Manage Inquiries 1 Mo. Select Buyer 1 Mo. Due Diligence 1-3 Mos. Negotiation & Closing 1-2 Mos. TOTAL INCLUDING PRE-MARKET PLANNING: 9 MONTHS TO ONE YEAR

26. WHO IS ON THE TEAM Key members of the deal team: Owners Management Accountants Legal Counsel Investment Banker/Financial Advisor Valuation expert Tax Advisors

27. Going to Market…Questions What business is the seller in? Why is the seller in that business? Who are the seller’s customers? What are the seller’s immediate and long-term objectives? How will the seller achieve those objectives? Who is responsible and accountable for what? Are those roles and responsibilities understood? How does the seller compare to its competitors? Through answers to these questions (and many, many more) • More likely the seller will attract more buyers • More likely the seller will get a higher valuation

28. FINANCIAL ADVISOR/VALUATION EXPERT Benefits of using Financial Advisor: • Manage the sale process (Save time) • Create competitive bidding (Save money) Selection criteria: • Knowledge of the Market (potential buyers and sources of financing) • Knowledge of the Industry • Success Rate (percentage of engagements closed) • Shared goals & vision Benefits of Valuation Expert: • Objective confirmation of rule of thumb • Expertise to defend valuation against objectors • Provide fairness opinion (if applicable) Selection criteria: • Financial credentials • Industry experience

29. ENGAGEMENT OF FINANCIAL ADVISOR Exclusivity Contacts with potential Buyers • Pre-screened and pre-approved • Before first contact Retainer fees • Non-refundable • Credited against success fee Success Fee • Lehman formula (1%-5% based on deal value) no longer market standard • Typically 1%-4% with over/under thresholds Scope of services • Sale, investor, joint venture or capital raise • Preparation and dissemination of the offering memorandum (the “deal book”) • Exclude existing investors and parties with options or known interest

30. ENGAGEMENT OF FINANCIAL ADVISOR (CONT’D) Term and Termination • Fixed term, renewable • Terminable at-will upon notice Tail coverage • Typically 6 Mos. to 2 years • Only pre-screened and pre-approved buyers • Consider excluding any buyer not introduced by advisor Expenses • Ordinary out-of-pockets, billed monthly • Expenses in excess of $x require pre-approval • No general overhead or legal fees Disclaimer of ownership of work product Indemnification Confidentiality, non-disclosure

31. ENGAGEMENT OF FINANCIAL ADVISOR (CONT’D) Confidentiality/Non-Disclosure Agreement (NDA) to be provided to Recipients of Confidential Information (CI) • To be executed by Recipients upon first contact and before receiving any CI • Seller’s counsel to approve any Recipient requested revisions to NDA • Advisors prefer their “standard form” of NDA – Seller’s counsel should review and propose revisions • NDA should expressly cover postings to VDR as CI • Disclosure does not waive attorney-client privilege; back-up with joint defense language • Recipient should agree to indemnify Seller for breaches of NDA by 3rd parties to whom Recipient discloses CI • Recipient should be prohibited from “teaming” with others to make a joint bid • Recipient should be prohibited from contacting Seller’s employees without Seller’s consent • Provide for return or destruction of CI upon deal termination, including revocation of access to VDR (possible exception for one copy retained by Recipient’s counsel in event of future litigation) • Seller does not represent or warrant disclosure materials Sample NDA with VDR provisions attached as Annex B to these materials

32. ENGAGEMENT OF FINANCIAL ADVISOR (CONT’D) Advisor’s Engagement Agreement • Advisors prefer their “standard form” of engagement letter – Seller will focus on fee structure in letter - Seller’s counsel should review and propose revisions to benefit Seller • Some provisions of engagement deserving careful scrutiny: • No contacts without signed NDA and Seller’s consent • Seller to have final review & approval of Offering Memorandum and other disclosure materials • All postings to VDR to be pre-approved by Seller’s counsel • Advisor must be licensed broker-dealer or affiliated with one • Exclusivity of engagement to be mutual • Carve-out leads provided by Seller or reduce fees for them • Define carefully “Transaction” which triggers success fees • Define carefully “Consideration” which provides basis for calculating success fees • Provide for fees on deferred or contingent payments to be payable if and when paid to Seller • Provide a fixed term subject to termination without cause by either party upon notice to the other

33. ENGAGEMENT OF FINANCIAL ADVISOR (CONT’D) Advisor’s Engagement Agreement (cont’d.) • Define carefully the “tail period” during which Advisor is entitled to fees and the qualifying characteristics of the tail period buyer (e.g., a party referred by Advisor & who signed NDA during the term) • Provide for confidentiality and non-warranty of information provided to Advisor • Provide for mutual indemnifications (usual standard is gross negligence, bad faith or willful misconduct) • Provide for controlling law and venue in Seller’s home jurisdiction Sample Engagement Letter with Drafting Tips attached as Annex C to these materials

34. Common M&A Fee Structures

35. LIQUIDITY EVENT OPTIONS • Sale of 100% (or less) to strategic buyer • Sale of 100% (or less) to financial buyer (Private Equity Group or Family Office) • Majority recap • Minority recap • Leveraged recap • Sale to management team (MBO) • ESOPs

36. STRATEGIC BUYERS • Operating companies that provide comparable products & services Often competitors, suppliers or customers • Could also be unrelated to target or its industry Companies looking to diversify revenue streams Companies seeking to build upon their business model &/or competencies to enhance earnings or reduce risks • Buyer motivations are multifaceted & varied, including • Strategic positioning • Market share; new channels • New products & processes • New customers or deeper penetrations • Technologies • Scale; synergies; earnings enhancements • Management skills; corporate know-how • Diversification • Accelerated growth; seeking higher margins & earnings

37. STRATEGIC BUYERS (CONT’D) • Primary advantages • Potentially, deep universe of buyers • Perspectives of risks & returns among candidate buyers can vary significantly • Long-term investment horizons • Often lower return hurdles (typically meaning higher valuations) • May be motivated to grow in industry with average or below-average prospects • Often, can bring deeper management talent • Typically, cash/stock buyers with lower transitional demands • Issues • Confidentiality • Tire kickers; data seekers • Industry knowledge – double-edged sword • Protecting sensitive performance data, IP, know-how • Consolidation more prevalent • What is current management’s role going forward? • Is there a good culture fit? • Potential loss of jobs

38. FINANCIAL/PRIVATE EQUITY/FAMILY OFFICE BUYERS • Firms with capital & resources that look to buy companies & utilize value-creation strategies • Financial buyers can vary significantly • Traditional buyout funds • Firms with “buy & hold” strategies • Firms with existing holdings • Generalists vs. industry-specific funds • Firms with CEO partners • Special situation funds • Hold periods often relatively short (generally, three to seven years, although there are many buy & hold firms) • Family office (typically longer holding period than traditional private equity fund) • Leverage is often deployed to enhance returns • Financial buyers may become strategic buyers as they execute their growth strategies (add on acquisition vs. platform acquisition) • PEGs have closed roughly 10%-20% of middle market deals in past 10 years

39. FINANCIAL/PRIVATE EQUITY/FAMILY OFFICE (Cont’d) • In general, PEGs have been successful investors in middle market • Disciplined buyers (pay for quality; shy from average) • Deploy resources to assist growth • This success has led to expanding universe of PEGs & large pool of capital to deploy • Current overhang is roughly $348 billion • Primary advantages of PEG’s • Large universe of efficient buyers • Hot deals can garner aggressive bidding • Equity stakes for incumbent management; noteworthy wealth creation • Solid capital resources • Pay for excellence • Very focused growth agendas • Need management teams & infrastructure

40. FINANCIAL/PRIVATE EQUITY/FAMILY OFFICE (Cont’d) • Issues • More need to sell industry attributes; due diligence scrutiny • Use of leverage • Aggressive growth & earnings enhancements is hard work • Must have capable management team • Center of influence? • Possibility of near-term & medium-term sale

41. RECAPITALIZATIONS • Portion of equity is purchased & selling shareholder(s) often retain meaningful stake & continue to operate company • Popular for owners who desire to diversify their personal wealth, yet remain active in growing business & recognizing future wealth • Majority vs. Minority vs. Leveraged Recaps

42. MAJORITY RECAPITALIZATIONS Selling majority stake ‒ Advantages • Provide liquidity to ownership • Retain minority equity position that could potentially double or triple in value in five to 10 years • New investors provide capital/resources & will work with management to formulate growth plan & assist in execution • Key management remains with company (two- to three- year transition period) with board representation • If platform transaction, company typically continues to operate independently Issues • New investor now controls company • New investor will most likely leverage balance sheet • Could experience major restructuring if acquired by portfolio company

43. MINORITY RECAPITALIZATIONS • Sell minority equity stake • Advantages • Ownership retains control • New investor can provide resources (financial & operating) • Issues • Will most likely see lower enterprise valuation due to minority investment • Operate with some leverage • Investor will have some minority protections (first right of refusal, preemptive rights, anti-dilution provisions, redemption rights, board representation, etc.)

44. LEVERAGED RECAPITALIZATIONS • Leverage recap (leverage company & pay dividend/buy out shareholders) • Advantages • Do not give up any equity (potentially minority stake – 25%) • Allows for liquidity event to owners without a sale • Issues • Have to service debt prior to distributions • Financial covenants can impact operating flexibility • Company more susceptible to macro events—industry or economic events • Risk of bankruptcy (possible fraudulent conveyance)

45. MANAGEMENT BUY-OUTS (MBO’s) • Owners often recognize team’s leadership contributed greatly to his or her wealth creation • High-performing teams in solid companies can execute rewarding deals • Personal capital investments do not need to be large, but they do need to be meaningful • Capital resources (Sr. & Jr. debt & private equity) to facilitate deals for solid, well-managed companies • Main element in MBO is control & continuity of management & business operations • Equity rewards can be far more rewarding if team controls deal & pursues capital partners in competitive process

46. MANAGEMENT BUY-OUTS (MBO’s) • Advantages • Reward most meaningful long-term contributors • Operating team remains in control of process • Company maintains culture & community presence • Due diligence issues are rare, as are purchase price modifications • Can retain small equity stake in new company • Balance sheet integrity can be maintained • Issues • Lack of strategic value • Requires capable team with demonstrated results • Team needs to have clear vision & articulate a compelling plan • Operate with some leverage

47. ESOP’s • Advantages • Retain control & continue to run company (regardless of level of ESOP ownership) • Favorable tax treatment • Reduce or even eliminate corporate income tax • Company repays acquisition debt with pre-tax dollars • Interest & principal on acquisition debt is tax deductible • Preserve culture, jobs & community • Provide stockholder liquidity (over time) tax efficiently • Reward key management & long-term employees • Uniquely position company for growth via acquisitions • Issues • Sell company at fair market value; could potentially “leave money on the table” • Stockholder liquidity may be realized over time, not immediately

48. Whatis Private Equity? Generallyspeaking, privateequity is the useof capitalto invest in privateor non-public companies. PEG’s are intermediaries between investorsand private businesses. Whoinvests in private equity? • PublicPension Funds • CorporatePensionFunds HedgeFunds • Insurance Companies ,Endowments and Foundations • Funds-of-Funds • FamilyOffices • High-Net-WorthIndividuals • SovereignWealth Funds

49. BasicFund Structure Sponsors/Principals Investors Manager/ GeneralPartner Limited Partnership Interests (No active Management) General Partnership/CarriedInterest (ActiveManagement) Fund PortfolioCompanies

50. Key Features of PE Funds General Partner/Manager Compensation • Management Fee (2% of commitments) • “Carried Interest” (20% of profits) • Subject to “hurdle rate” (8% of profits) Limited Partners subject to capital commitments Investment Period for new investments (5-6 years) Term of Existence (10 years; Additional 1-year extensions; Subject to early termination in event of “key person(s)” ceasing to manage the fund)