A Dual Track Sales Strategy

One of the toughest questions a business owner will ultimately face is when to sell the company. But once that decision is made, a host of other questions arise: How do I ensure I get the best value for my company? Do I want to walk away completely or retain some ownership and How long do I need to stay on after the sale to ensure the transition goes smoothly? And what about my employees, how do I make sure their loyalty and support is rewarded and their future secure? And that dreaded of all questions, how do I minimize the tax bite?

George Singleton and Jim Giuliano, owners of Orlando-based Unique Electronics, Inc., faced these questions when they came to PCE and asked us to help them sell their company. They were looking ahead to retirement, and they believed when they sold that the buyers would want them to stay on for a few years during the transition period. They didn’t want to have to wait until they were retiring to deal with the problem of how to sell.

Unique Electronics designs and manufactures specialty interconnect systems for the military and aerospace markets. About 60 percent of their sales are molded flat ribbon cable. You can find their products at NASA, in the V-22 Osprey Helicopter, the B-2 bomber, the F-22 and F-35 fighter planes and many types of unmanned missiles.

Singleton and Giuliano had a long history as senior executives for large defense contractors prior to their acquisition of Unique in 1994. Since then, they had turned it into a highly profitable company, producing a 12 percent annual growth rate and nearly doubling sales from 1998 to 2003. In the current market, with rising defense budgets fueled by continuing global conflicts and the war on terror, Unique was sure to command high multiples in a sale.

Potential buyers fell into two groups: internal and external. External buyers consist of strategic buyers (Those already in a similar business, a larger company looking to expand or a competitor who wanted to have less competition) and financial buyers (sometimes referred to as private equity groups or PEGs). Internal buyers consist of management and/or the employees, who could purchase their company under a program created by Congress called the Employee Stock Ownership Plan, or ESOP, designed to create incentives for employees to participate in the ownership of the company for which they work.

PCE suggested Unique market the company to both kinds of buyers through the dual track system, in which the company is marketed simultaneously to both the Strategic/Financial Buyers and Internal Buyers, (through the ESOP) which allowed them to maximize their valuation and give the owners a way to evaluate both kinds of sales in a realistic environment.  At first, Unique’s owners didn’t believe the employees could get adequate financing. Singleton and Giuliano wanted to simply create an an easy transition and be able to walk away. But PCE convinced them that an ESOP sale was feasible by showing the owners a comparison between one of their offers from a Strategic Buyer and an ESOP sale which demonstrated how the ESOP would put more net dollars in the owners’ hands and also give them significant tax advantages.

The biggest advantage of an ESOP is that under the federal tax law the owners can either defer or completely avoid paying capital gains tax on the sale of their stock, when the selling company is a C-Corporation. The ESOP is a trust which borrows money from a bank to purchase the sellers’ stock for the employees. The loan is paid back through the company’s profits. In this case, by using 100 percent of the company’s profits to pay back the ESOP, the company can also avoid having to pay corporate tax on its earnings. Meanwhile, the sellers can retain control of the company until the loan is paid off. In a sale to a Strategic Buyer, the sellers are often required to stay on for a transition period receiving sale proceeds tied to future performance but they don’t often retain control. Also under an ESOP, if the sellers take their profits from the sale and reinvest them in qualifying securities the sellers can defer paying capital gains taxes. And if they leave that stock in their investments and allow it to remain in their estate until it is transferred to their heirs, they can completely avoid paying any taxes on the gain from the sale of the company. (Please keep in mind that this benefit is only for sellers of C-Corporation stock.)

Here’s how using a dual track marketing strategy may work:

Suppose a Strategic Buyer offers $100 a share for the company. At a tax rate of 28 percent, a blend of ordinary income tax and capital gain tax, the after-tax proceeds per share is $72. Since the ESOP allows the sellers to defer or completely avoid the taxes, a $100-a-share sales price means $100 a share to the seller.(These figures are for illustration purposes only and do not represent the actual sales price of Unique, which is private and confidential information.)

Now ESOPs can’t just go out and put an unrealistic value on the company to drive up the price. In fact, under the law, the ESOP is required to hire an independent party to do the valuation. But a firm offer from a Strategic Buyer also constitutes a legitimate fair market value indication that can be considered in the ESOP valuation process.

PCE then goes back to the Strategic Buyer and tells them that they have a counter offer from another buyer. That other buyer, of course is the ESOP. Basically this then becomes an auction type process creating a more competitive environment and increaing the value of the company. If the Strategic Buyer does in fact offer a higher price then they have set a new fair market value for the company. The ESOP may then be able to consider the higher offer in the valuation process, thereby raising the price it can pay.

The dual track strategy is a winning combination that can lead a Strategic Buyer to more favorable terms and a higher selling price or increase values and after tax proceeds for ESOP scenarios.

For the sellers it’s a win-win situation.

If you have comments or questions about this article, or would like more information on this subject matter, please contact us.
David Jasmund

Investment Banking
Orlando Office

407-621-2100 (main)
407-621-2111 (direct)
407-621-2199 (fax)