Ownership Transition: Know Your Options ACEC/NC Summer Conference | July 31, 2015

ACEC/NC Summer Conference 2015 | July 31, 2015 Presented by Neil Churman Principal Consultant Morrissey Goodale LLC 2

ACEC/NC Summer Conference 2015 | July 31, 2015 Agenda Two Paths and How to Choose Them Internal Transition Options External Transition Options Case Study of One Seller Summary 3

ACEC/NC Summer Conference 2015 | July 31, 2015 StrategyM&A Workplace 2020 Research & Publishing About Morrissey Goodale LLC: AEC Industry Consulting & Research 4 Buyer Advisory Seller Advisory Deal Pricing Deal Structuring Integration Market Research & Assessment Scenario Planning Strategy Development Market Research Executive Search Executive Coaching Leadership Development Ownership Transition

ACEC/NC Summer Conference 2015 | July 31, 2015 Events 5 Houston, TX | October 8, 2015

ACEC/NC Summer Conference 2015 | July 31, 2015 Morrissey Goodale Locations 6 Denver Boston Houston

ACEC/NC Summer Conference 2015 | July 31, 2015 The Key is Time 7 Everyone who operates a company will reach a point when it’s time to leave Start now – Every firm needs a transition plan Avoid the three D’s: Death, Disaster or Divorce

ACEC/NC Summer Conference 2015 | July 31, 2015 Two Paths 8 Transitions can be either internal or external

ACEC/NC Summer Conference 2015 | July 31, 2015 So What to Do? 9 Culture? Next Tier? 5+ Year Timeline? Yes No Risk Tolerance? External Sale Internal Sale

ACEC/NC Summer Conference 2015 | July 31, 2015 Culture 10 Is an internal transition in our DNA? Past history Past promises or discussions Current owner preferences

ACEC/NC Summer Conference 2015 | July 31, 2015 Next Tier 11 Is the next generation capable? Motivated Shared values and belief in the firm’s vision Ability to think strategically about the future Leadership and team building skills Tolerance for and willingness to assume risks Trust and integrity “People who are unable to motivate themselves must be content with mediocrity, no matter how impressive their other talents” – Andrew Carnegie

ACEC/NC Summer Conference 2015 | July 31, 2015 Risk Tolerance 12 Are you prepared to wait to get our money out? Every transition has risk More time = more risk Time Risk External Transaction Internal Transition External transition yields more money sooner Harder to simply walk away with an internal transaction than external

ACEC/NC Summer Conference 2015 | July 31, 2015 Available Timeline 13 Now 10 Years When do we want to be out? A shorter timeline limits viability of internal transfer External transitions still require significant time investment 4 Years 8 Years

ACEC/NC Summer Conference 2015 | July 31, Internal Transition (Selling In)

ACEC/NC Summer Conference 2015 | July 31, 2015 Internal Transition: Options 15 Direct Employee Ownership ESOP Management Buyout

ACEC/NC Summer Conference 2015 | July 31, 2015 Internal Transition: Direct Employee Ownership 16 Why direct employee ownership? Known players Retain and incentivize the next tier Arrange for orderly exit

ACEC/NC Summer Conference 2015 | July 31, 2015 Internal Transition: Mechanics 17 Defined ownership transition plans will include: Valuations: quarterly or annually Formulas: book value, tangible net worth, earnings and others Generally done by third party advisor Schedule: plan the timeframe for share transfer

ACEC/NC Summer Conference 2015 | July 31, 2015 Internal Transition: ESOP 18 Why an ESOP? Creates a market for closely held shares Provides liquidity for shareholders and fund a buy-out with pre-tax dollars Provides tax deferral for sale of C-corporation to ESOP Creates a tax-advantaged entity with an S-corporation Employee recruitment and retention Source: Wells Fargo Advisors

ACEC/NC Summer Conference 2015 | July 31, 2015 Internal Transition: ESOP 19 Source: Wells Fargo Advisors How it Works Company ESOP Trust Build Employee Equity Over Time Shareholders Purchase Shares At Current FMV

ACEC/NC Summer Conference 2015 | July 31, 2015 Internal Transition: ESOP 20 Advantages May obtain financing to purchase shares Principle and interest payments are tax-deductible Tax deferred rollover for seller Deferral of taxation for participants Employee motivation Takeover protection Source: Wells Fargo Advisors

ACEC/NC Summer Conference 2015 | July 31, 2015 Internal Transition: ESOP 21 Disadvantages Fiduciary responsibility Valuation requirement Dilution of ownership Operating costs Cash flow issues Employee impact if stock goes bad Repurchase requirement for departing employees Source: Wells Fargo Advisors

ACEC/NC Summer Conference 2015 | July 31, 2015 What is a management buyout? A company’s management team purchases the assets and operations of their own business MBOs are favored exit strategies for private businesses where the current owners wish to retire Heavy financing requirement Internal Transition: Management Buyout 22

ACEC/NC Summer Conference 2015 | July 31, 2015 Internal Transition: Keys to Success 23 Start early Motivate and mentor the future owners Establish transparent valuation Communication Don’t neglect team building Remain available as a resource

ACEC/NC Summer Conference 2015 | July 31, External Transfer (Selling Out)

ACEC/NC Summer Conference 2015 | July 31, 2015

U.S. M&A Trends 26

ACEC/NC Summer Conference 2015 | July 31, 2015 Global M&A Trends 27

ACEC/NC Summer Conference 2015 | July 31, 2015 Where the Buyers are 28

ACEC/NC Summer Conference 2015 | July 31, 2015 Where the Sellers are 29

ACEC/NC Summer Conference 2015 | July 31, 2015 States in Demand 30

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: The Mechanics 31 Culture What adds value What subtracts value Valuations can differ An accounting moment Show me the money

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: Culture 32 Why is culture so important in the A/E/C world? Your staff, your firm and its legacy

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: What Adds Value 33 Greater market penetration Expand services to current clients Augment staff and quality Add future leaders Increase revenue growth Expand backlog

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: What Subtracts Value 34 Limited focus or depth Owner(s) don’t remain Undercapitalization Inconsistent financials Low growth prospects Little backlog

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: Valuations Can Differ 35 Different Values from Different Buyers Strategic value to buyer Amount of perceived risk Motivations of seller Buyer revenue projections Future outlook

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: An Accounting Moment 36 Why do we focus on profitability and EBITDA? Profits are a proxy for free cash flow the buyer can expect EBITDA excludes expenses that can obscure how a company is actually performing EBITDA makes it easier to compare firms

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: Show Me The Money 37 Payment methods Cash Promissory note Deferred compensation Stock in Buyer’s company Earn ‐ outs

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: Options 38 Merger Sale to strategic buyer Sale to financial buyer (private equity)

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: Merger 39 Why do mergers happen? Expansion (new geographies, markets, or services) Capital – lower potential capital need Industry trend to consolidation Fear

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: Sale to Strategic Buyer 40 What are the issues? Cons Pros More scale and scope Offload back-office pain and suffering Business alignment Brand recognition and reputation Additional opportunities for staff Loss of control Integration issues Non-compete agreements for sellers Time and resource investment Trading one illiquid stock for another

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: Sale to Financial Buyer 41 What are the issues? Cons Pros Abundance of capital Management stays in place Maintain existing way of doing things Increased focus on financial performance Outsiders on Board Few precedents in A/E/C industry Less industry knowledge Eventual “exit”

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: Common Pitfall 42 This is flawed thinking: “I can work for three more years and make more money than they are offering me” Selling your business today transfers risk to the buyer and compensates you for your years of hard work now

ACEC/NC Summer Conference 2015 | July 31, 2015 External Transition: Keys To Success 43 Strong cultural compatibility Provide professional opportunities to key leaders and staff Start early and allow enough time Know your value proposition and walk away price Communication Seek outside advice

ACEC/NC Summer Conference 2015 | July 31, Case Study

ACEC/NC Summer Conference 2015 | July 31, 2015 Case Study 45 Situation $6 million in revenue at 12% EBITDA Three offices in the US Transportation and public works sectors Owner doing well after 20 years in business Key clients secure, but competitive pressure in specific markets

ACEC/NC Summer Conference 2015 | July 31, 2015 Case Study 46 The Decision 1.Culture? Yes, wanted to transfer internally 2.New Tiers? Competent, but none were willing to take second mortgages to make payroll 3.Risk Tolerance? Owner sensed market was peaking, didn’t want to “let it ride” 4.Timeline? Owner wanted out in 3-5 years Result: Pursue an external sale

ACEC/NC Summer Conference 2015 | July 31, 2015 Case Study: Potential Outcomes 47 Internal Timeframe: 6-8 years Growth: Steady Valuation Method: 5x EBITDA External Timeframe: 2-3 Years Growth:10% Valuation Method: 16% discounted cash flow Result: $3.6M valuationResult: $4.5M valuation

ACEC/NC Summer Conference 2015 | July 31, 2015 Case Study 48 Process Engaged three larger firms operating in similar markets One local One ENR 500 One ENR 200 Midsized firm offered $4.2M Initial: 20% upfront, 50% over 3 years, 30% earn-out Final: 60% upfront, 30% over 3 years, 10% earn-out Result: Closed transaction within 11 months

ACEC/NC Summer Conference 2015 | July 31, 2015 Summary 49 Whichever option is best for you, start early High-quality leaders are a key in the A/E/C industry Culture, culture, culture More time = more risk

ACEC/NC Summer Conference 2015 | July 31, Neil Churman Principal Consultant Morrissey Goodale ex