2013 vol 1 - The Journal - ACG Chicago by ACG Chicago

The

Journal 2013: Vol 1

Opening Notes ........................................................................................... 2 Maximizing Deal Value through technology and operational improvements .... 5 Due Diligence Issues in Startup Investments .............................................. 9 What Business Leaders are Saying About the Complexities of Enterprise Risk Management (ERM) ..................................................................... 13 Considerations for Middle-Market Lenders Seeking to Use a CLO Financing Structure.............................................................................. 19 General Partners Anticipate a Slow & Steady Recovery for Private Equity in 2013 ................................................................................................ 22 Sunny Days for Valuations Ahead?............................................................ 26 For Private Equity Investors, Section 1202 May Be Worth Another Look ... 30

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Association for Corporate Growth

Greater awareness

ACG Chicago is the premier network of leading authorities on corporate growth. ACG Chicago engages its members through unparalleled opportunities for networking, deal making, personal growth, and professional development. ACG Chicago continues to expand its prominence by developing a relevant brand in the business community, by growing and promoting its diverse membership, by presenting strong educational programs in person and electronically, and through unique access to industry leaders, financing and expertise.

Craig Miller, CEO

Mission

The ACG Chicago Board takes very seriously the quality of membership, benefits of belonging and building your value. In our most recent strategic planning sessions, the mission was reviewed and revised slightly to reflect a few key points: • We no longer describe Chicago or Midwest as our focus because so many of you are leading authorities across the US, the Americas, and the world; • We look to engage all of you as much as possible through our current and constantly developing networks, programs and initiatives; • We will continue to tell everyone about your talents, expertise and relevance in a world that is in constant need of leadership. The mission to the left reflects these changes, both identifying who we are and how we hope to grow with you.

Sharing our successes As an organization we continue to have a strong and dedicated membership that has helped us develop extremely successful conferences and programs. Many of these professionals are also being recognized widely outside of ACG. Three of our newest board members have been recognized recently by other organizations for their excellence. Warren Lawson’s packaging firm ARI was recently honored as one of Crain’s Fast Fifty. Ada Nielsen was recently recognized as one of the country’s top intellectual property executives by LES. And, Sherman Wright’s agency,common ground marketing, was honored last fall as ad agency of the year by Ad Age Magazine and recently was chosen as a finalist on The Pitch (to be aired in August). We know that many other members have been recognized for their professional and civic achievements. We will be developing more ways to capture this and to share your expertise and successes online and in our other communications.

and driving a broad choice value for you and the community. ®

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Over 100 volunteers work on the Board and the Networks outlined to the right. They bring us together 30-40 times a year to share leadership insights and for

networking. In addition to the regular programming, we build or institute numerous initiatives throughout the year. These include dedicated teams of experts in healthcare, food, energy and more industries are diving into the critical growth issues with open and intense discussions. Targeted conferences are drawing nearly 300 focused specifically on these growth sectors for the key insights and, of course, the networking. The Entrepreneurship Bash will return for its 4th year again this year allowing us to provide you access to the dozens of organizations driving energetic new corporate growth in Chicago. We are not competing at the start-up level but look to be the bridge to the middle market for those graduating and rapidly outgrowing these early stage groups. And, we continue to work on building our corporate membership base, extending awareness of your expertise to the broader Chicago community through initiatives with other organizations, and developing governance and research programs in the coming year to extend your leadership.

Why are we doing this and more? We do all this because the world is changing faster than ever and because the ACG Chicago network as well as the ACG Global reach is critical to staying ahead of the curve. ChicagoTech (September 10) highlights our global leadership across industries in new, innovative growth. Our look at SBICs (September 24) will drive new investment options. And this yearâ&#x20AC;&#x2122;s Global Market Trends (October 4) will focus on quick changes and new approaches to growth. All the trends we knew were driving international growth such as Chinaâ&#x20AC;&#x2122;s hypergrowth, the BRICs and outsourcing have been flipped into a Global Rebalancing that middle market companies must understand to thrive in the next decade. The G20 just launched a corporate tax restructuring initiative that will clearly change many plans whether it is finalized or not. The G8 agreed last month to launch Social Impact Investment initiatives as a global call to drive investment for the good of the world. Since our members generate 6-7x more jobs than the normal economy, we need to share the positive impact of your work and investment as these messages drive new policies. And on the US front, the dramatically visible shift in demographics that we have all spoken about for years clearly played out in the 2012 election. We'll leave Washington and the electorate to figure out their political issues but corporate America cannot ignore the mosaic of constituencies that are driving growth in our new America. In this respect, we offer the chance to be the conduit of communication between cultures by offering the common ground of professional expertise, capital for growth and the opportunity to prosper. We look for your thoughts, experiences and feedback on building an organization that can help you lead in the coming years and provide a network of peers that are the leading authorities on corporate growth.

The Networks Private Equity Network is the premiere network of middle market merger and acquisition leaders from the corporate and private equity communities. Corporate Network comprises senior executives from public and private companies throughout the Chicago area that foster strategic and organic growth. International Network identifies the needs of both M&A professionals dealing with crossborder transactions and executives competing globally with organic growth projects. Entrepreneurship Network is collaborating with many to build awareness and investment within this critical area of economic development and corporate growth.

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Thank you for being a member of ACG Chicago, Craig www.ACGChicago.com

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Maximizing deal value through technology and operational improvements

Uncovering efficiencies in your IT and operational initiatives can generate a significant return on your investment By Carl Monje

It’s a new era for private equity firms. Long gone are the days when private equity firms create value primarily through leverage and financial engineering. Today’s successful firms focus on driving value through both bottom-line efficiencies (e.g., sourcing, operational efficiencies, working capital optimization) and revenuegrowing initiatives (e.g., sales force effectiveness, cross selling, pricing strategies), all of which are highly dependent on having the right technology and operational processes in place.

Start early To have the greatest impact, it is best to combine technology and operations assessments early in the process, typically at the due diligence phase. A successful due diligence goes well beyond risk identification – it also highlights opportunities and the ROI impact of operational and technology enhancements. IT and operations are intertwined, and it is critical to understand their interdependencies in order to build viable, sustainable improvements long after the transaction is completed. When areas of opportunity are found, you likely will need to implement operational and IT projects to address them; however, these should never be developed in a vacuum. Information technology and operations are inseparable—operational improvement initiatives typically involve an IT component, and IT initiatives most often have a significant impact on operations.

Plan ahead During your operational and IT due diligence assessments, incorporate findings and improvement opportunities into your consolidated post-transaction execution plans (100 day, Year 1, Year 2). Objectives should also be prioritized to increase the potential for success of the recommended initiatives and to help the acquired company better manage and adapt to change. A combined view requires fewer assumptions, creating a more refined cost and risk estimate and a more defined view of collective milestones, timelines, and key performance indicators.

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Capture synergies Improving operational and IT efficiencies can create positive synergies. Consider these examples.

Example 1: Supply chain operational and technology improvements are key to a retailer’s expansion and profitability

About the Author

Carl Monje

Senior Manager West Monroe Partners Carl Monje is a Senior Manager in West Monroe Partners’ Private Equity practice. Carl works with private equity and strategic buyers to perform pre-deal IT and operational due diligence of target acquisitions in order to identify potential issues and sources of opportunity. He also leads post-transaction integration, merger, and carveout execution activities. Carl has served as an advisor on over 75 merger, acquisition, or carve-out transactions.

A private equity buyer was looking to aggressively expand the number of retail hardware stores operated by the target company as part of its investment thesis. However, the company struggled with new regional competitors and inefficient warehouse operations. This, combined with a lack of space in its distribution center, forced the company to rent additional warehouse space to meet its shortterm needs but it was clear a longer-term strategy was required. The combined operational and IT due diligence team conducted a supply chain assessment to understand the company’s current environment. The team was able to analyze the company’s methods for calculating safety stocks, the demand planning processes, and replenishment methods. The team then performed a deep dive on the functionality of the company’s operations management system. A make (develop) or buy analysis for a new supply and demand planning system was also performed. Additionally, the team was able to identify a series of monitoring systems that would produce key performance indicators such as inventory levels, procurement costs, inventory turn rates, and service levels.

Once the transaction was completed, the team moved immediately into the selection and implementation of a best-of-breed demand planning solution. Through a comprehensive design approach and execution plan, the company was able to realize significant economic, efficiency, and customer benefits including reducing its inventory levels by 18%, increasing forecasting accuracy by 10%, minimizing working capital and procurement costs, automating supplier constraints and financial agreements, and reducing required safety stock by 35%. Example 2: Better sourcing and procurement operations and an integrated data management system allow a global manufacturer to realize substantial savings

Consider another example, a global manufacturer whose initial IT and operations assessment identified sourcing and procurement as its main source of future improvement and value creation. The business faced many challenges including decentralized purchasing, disparate ERP systems, minimal spend data visibility, and poor supplier management. As part of the post-transaction execution plan, a software sourcing initiative was recommended to select best-fit procurement tools. Additionally, an infrastructure needed to be built to enable standard data capture across the disparate source systems for purchasing data.

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During the diligence phase, annual spend data was collected, classified, and analyzed from each of the business units and unique systems to prioritize initiatives and develop an implementation roadmap. From this analysis, it was found that synergies could be achieved across the enterprise by leveraging spend analysis, eSourcing, and vendor contracts management capabilities. Post-transaction, over 60 data warehousing, business intelligence and strategic sourcing solutions were evaluated through a rigorous software selection process. Once selected, a tailored software implementation framework was leveraged to effectively deliver on multiple work streams. Lastly, a customized, three day interactive and hands-on training class was developed to achieve end-user buy-in on the newly established business processes and technology. 6

With a multi-faceted approach, combining operational improvements with a new technology toolset, the business was able to achieve impactful results. A spend management solution enabled visibility and analysis of annual spend. A process to streamline ongoing standard data capture across the business’ more than 100 source systems was also developed. Prior to the assessment, the business had little to no visibility of procurement operations across its global locations. In the end, the business was able to consistently provide consolidated data to its executives and procurement teams, realizing over 10% in annual savings via procurement category initiatives for direct/indirect materials and transportation. Maximize upside potential Incorporating operational and IT improvements into your target company is a critical component of any acquisition strategy. Too often, due diligence is viewed as a means to discover “red flags” rather than as a way to identify and create value in the target company. Planning is often performed through independent work streams, which in turn makes aggregating the information and creating a single executable plan more difficult. To achieve the maximum upside potential, conduct a thorough diligence that examines both operations and IT (and the impact they have on your bottom line) to not only identify meaningful business improvements but also to implement them holistically. By looking at your diligence and posttransaction execution plans with a wide lens across operations and technology, you can consolidate initiatives that will deliver effective and sustainable improvements. For more information on how West Monroe can help you drive value during due diligence and post-transaction planning, please contact Carl Monje at cmonje@westmonroepartners.com. n

Chicago’s Tech Center of Excellence Role & Opportunities

This article is one in a series of contributions by ACG Chicago’s Sponsors. We appreciate their support. West Monroe Partners is a North American, business and technology consulting firm focused on guiding organizations through projects that fundamentally transform their business. With the experience to create the most ambitious visions as well as the skills to implement the smallest details of our client’s most critical projects, West Monroe Partners is a proven provider of growth and efficiency to large enterprises, as well as more nimble middle-market organizations. Our more than 350 consulting professionals drive better business results by harnessing our collective experience across a range of industries, serving clients out of offices across the US and Canada. For more information, visit our website at www.westmonroepartners.com.

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Due Diligence Issues in Startup Investments By: Kelley L. Smith In order to avoid funding companies with unnecessary risk many venture capital firms have become more discerning about their early-stage investments. At the same time, hedge funds, private-equity firms and other asset-management firms have stepped into the early-stage funding arena, lured by the promising returns that still exist.

The heightened interest in early-stage funding by non-VC firms coupled with Chicago’s expanded footprint in the startup community has generated increased deal-flow of early-stage investments. Investing in early-stage companies is subject to numerous pitfalls which must be carefully managed when representing an investor in an angel funding or venture capital financing. By examining common areas of concerns during the diligence process, potential liabilities can be addressed before they seriously impact the operations and valuation of a promising young company. Jurisdiction of Formation The answer to the simple question “where was the company formed?” may yield a surprising array of headaches. While it is rare to see a startup structured as anything other than a corporation, it is all too common to discover that a company was formed outside of a jurisdiction with attractive corporate laws like Delaware.

In a recent transaction, a company had incorporated in a shareholder-friendly state, and the voting thresholds required to complete the migration to Delaware prior to closing necessitated a full shareholder meeting and the assistance of local counsel. The entire process delayed the funding, and caused the company to incur legal fees that could have been easily avoided. For a smaller-sized round, these types of costs can eat up a significant percentage of the funding–money far better spent on a company’s operations. Even with the hurdles involved, it is strongly recommended to require a company located elsewhere to incorporate in Delaware in order to avoid higher costs in the future. Ownership Rights and Capitalization Next, examine how the company has funded itself prior to the current funding. Consider whether prior investors have rights of first refusal to participate in the investment round alongside your client. The answer will likely be yes, and if so, has the company confirmed whether such investors will participate, and have proper waivers been obtained for those opting out? 9

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If the company has issued options to its employees, determine whether those options were properly documented and properly priced. Did the board of directors approve each grant? How were the options priced? What is the vesting schedule for such grants? Also confirm that the founders’ ownership of their shares is subject to a right of repurchase by the company with a standard vesting schedule.

About the Authors

Kelley L. Smith

Partner Ungaretti & Harris LLP Kelley L. Smith is an associate in the Corporate Department at Ungaretti & Harris LLP. Her practice focuses on mergers and acquisitions, venture capital financings, corporate lending and advising investment advisers and broker-dealers.

Convertible Debt A startup may have issued convertible notes to finance its operations, which is useful if the company wants to save itself from the costs of a preferred stock financing or avoid pricing an equity round. Most, if not all, convertible promissory notes contain an automatic conversion clause that requires the automatic conversion of the convertible debt upon a “Qualified Financing” along with a discount feature allowing the note holder to convert into the round at a discounted price per share. Key issues related to convertible notes include the amount of debt outstanding and the applicable discount rate(s). If a startup has relied extensively on convertible debt, your client’s proportionate share of the round will be negatively impacted by the large amount of stock issued to the converting lenders. Also, note holders must be paid interest, which continues to accrue each day that the closing of a financing is delayed, resulting in more equity being issued to the converting note holders. Alternatively, it may be possible to repay the accrued interest in cash. This may be attractive depending on the terms of the debt. Additionally, a startup with outstanding convertible debt could be technically insolvent, and officers and directors may have enhanced duties to creditors.

Intellectual Property Because the value of a startup lies in its intellectual property assets, this area is ripe for potential liability. Many smart but inexperienced founders fail to place enough importance on properly securing their intellectual property assets.

As an initial matter, it is necessary to determine the source of the company’s key IP, and confirm that the responsible individuals have executed written IP assignment agreements, or will execute such agreements as a closing condition to the financing. A cash-strapped company may use foreign contractors for software coding rather than paying higher costs for U.S. employees/contractors under standard IP agreements. In such a situation it can be very difficult and costly to fully secure the rights to all of a company’s code since the exact creator may be unknown.

When a company’s founders are the primary creators of the key IP assets, questions to ask regarding this issue are: Are all founders still with the company? If not, what were the circumstances of the departure? Are there any threatened claims by a former founder or employee for rights to key IP? Do the former employers of the founders have any potential claims for trade secret misappropriation or IP ownership rights?

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In some instances, a business’s own name may be infringing on another’s trademark rights. An infringing or potentially-infringing brand is not entirely unexpected in that founders often alight on an evocative word or turn of phrase, and overlook ownership issues. The availability of a domain or entity name may be the only hurdles in the branding process. And even if IP issues are considered, a full mark search is cost-prohibitive for most early-stage companies.

In one recent financing, a business had just launched its branded product, only to learn during diligence that its name was registered in two similar product categories. In another, a company was unable to use its legal name in certain states due to the existence of other similarly-titled entities. Although frustrating to encounter, neither of these defects proved fatal to the investment round, and cleaning up the IP helped both companies avoid costly litigation. Finally, check whether the startup has the right to use all non-original IP necessary for its business. Is the business missing an important license from a contractor, consultant or university? Does its product incorporate any open source code under restrictive licenses? Restrictive licenses require that all works created using the open source code must be openly available for free or at nominal fee, and if applicable, these licenses can decimate the value of a company’s final software product.

Conclusion While the diligence process is important in any transaction, specific areas are of particular concern with respect to startup companies. Paying close attention to the issues outlined above will protect the interests of the investor and help to ensure its role in the future success of a promising company. n

This article is one in a series of contributions by ACG Chicago’s Sponsors. We appreciate their support. Ungaretti & Harris LLP was founded in 1974 and has grown to more than 100 attorneys who practice in three basic areas. These groups are business (M&A for private equity funds, privatelyheld and public companies and family office consultation, corporate finance, corporate governance, real estate, finance and restructuring, financial services, tax and benefits), healthcare/regulatory (service providers and medical product manufacturers and distributors), and litigation (commercial litigation, labor, insolvency and anti-trust). U&H has offices in Chicago and Springfield, Illinois and in Washington, D.C.

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T The he difference difference is is clear clear Seyfarth’s Seyfarth’s LLeading eading M Middle-Market iddle-Market M M&A & A Pr Practice actice The key to o ur success is a constant, unrelenting focus on innovative ways to meet the needs of our clients and remain committed to excellence in all aspects of our work. Our commitment to delivering outstanding legal ser vices has been praised by both BTI and Financiall TTim imes. For the second consecutive year Sey farth has been named to the BTI Client Ser vice A-TTeeam, ranked 5th out of 650 law firms. Also for the second consecutive year Sey farth ranked as a top 10 innovative law firm in the Financial T Tim imes U.S. Innovative Law yers Repor t.

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Our M&A practice is supported by a national group of specialists in areas IP, such as finance, ance, employee benefits, IP P,, labor and employment, tax, real estate, environmental and antitrust Our M&A practice includes more than 60 attorneys who have a focus on middle-market transactions © 2013 2013 Seyfarth Sey far th Shaw Shaw LLP LLP

What Business Leaders are Saying About the Complexities of Enterprise Risk Management (ERM) By Kristin Trahan Winford and Hannah Zeffiro TAs we begin the second quarter of 2013, economic uncertainties abound as investors continue to seek stable markets. Daily there are new instances of fraud and white collar crime permeating the news, leaving those in leadership positions with the task of answering tough questions and striving to build businesses able to withstand the economic storm currently playing out on both a micro and macro level. Uncertainties about changes to the regulatory environment and overall economic condition of the United States remain a central focus of politicians and business people equally, particularly during a presidential election year. As a thriving market covers all sins, the inverse has also proven to be true in the current economic environment – as fraud is still pervasive and presents itself on a regular basis. This realization has left business leaders and law makers asking the question–What measures should be undertaken to prevent this cycle from perpetuating itself?

Since the onset of the financial crisis in 2008 and the resulting market corrections, politicians, scholars and the like have studied the causes, effects and outcomes in search of ways to prevent similar events from happening again. A quest for the contributing factors has led to new regulations as well as the implementation or redesign of corporate risk management programs. The industry response to these undertakings appears to be mixed. According to a survey1 of over 400 C-level executives across the United States conducted by Mesirow Financial Consulting (“MFC”), nearly 40 percent of respondents felt that regulation has a “very negative impact” on their industry because it “impedes the ability of business to grow”. An overwhelming majority (78.5 percent) felt that their company had appropriate protocols in place to identify potential business risk, while 60.9 percent of the same respondents indicated they do not have an Enterprise Risk Management (“ERM”) program in place. Startlingly, 82.9 percent of those respondents without an ERM program in place also indicated that they are not looking to implement an enterprise-wide risk mitigation program. If that is the case, how do corporate executives evaluate risk mitigation programs while ensuring they are properly considering all potential risk factors facing their organizations? ®

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About the Authors

Kristin Trahan Winford Chief Operating Officer MFC

Kristin Trahan Winford is chief operating officer of MFC and has extensive experience with strategic operations and performance improvement services, corporate governance, enterprise risk management and the development and refinement of internal controls. With a strong background in global technology and professional services firms, Winford has a proven track record of partnering with executives to realize strategic business objectives, design highly effective organizational structures and ensure profitable growth. Currently, Winford leads all aspects of MFC’s business operations and is chief operating officer of its global joint venture, BTG Mesirow Financial Consulting.

Hannah Zeffiro

Vice President MFC

Hannah Zeffiro is a vice president and a member of MFC’s Litigation, Investigative and Intelligence Services team. She has experience advising clients in fraud-related investigations, forensic accounting and other complex critical issues facing companies.

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The History of Enterprise Risk Management (ERM) The advent of ERM can be traced back to compliance measures enacted in response to the Foreign Corrupt Practices Act in the late 1970s as well as the billion dollar failures in the financial sector in the mid-1990s. With the subsequent highprofile collapses of Tyco, Enron, WorldCom and others, greater and more stringent focus was placed on evaluating internal controls, risk management and corporate governance. In 2004, the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)2 published a document to provide guidelines and best practices in the design and development of an enterprise-wide risk monitoring and management system. This initiative was led by a group of accounting and finance organizations and, as a result, was primarily formed on the basis of an accounting and audit methodology. According to a 2009 article by Michael Power, the Director of the Centre for the Analysis of Risk and Regulation at the London School of Economics, there is a necessary balance between a risk management program consisting of audit-type operational controls and the development of a holistic, dynamic and multi-faceted ERM program. He states “the risk management of nothing” and the impact of a model created on “…preserving…the logic of the audit trail, rather than a boundary-challenging practice which confronts and addresses the complex realities of interconnectedness”3 results in the creation of a risk mitigation process focused only on quantifiable risks. The exclusion of the non-quantifiable risks is problematic as it oversimplifies the operating environment of many businesses and the creation of a check-the-box compliance exercise described as “ERM by the numbers”.4

In a survey conducted in 2010, COSO found that in the six years since the implementation of the 2004 guidelines, 60 percent of the respondents indicated that their risk management tracking was informal and not enterprise wide.5 These findings corroborate the results reported in the MFC survey conducted almost two years later and suggest that even with the passage of The Dodd-Frank Act (“DoddFrank”) in 2010, corporations are still struggling with the concept of an enterprisewide risk management system and continue to focus on defined, quantifiable elements of risk. The MFC survey also highlighted the fact that nearly 75 percent6 of respondents feel they have done enough to prevent fraud and 68.3 percent feel they have done enough to protect whistleblowers. Moreover, nearly 80 percent reported that they had strong internal controls and an appropriate system in place to identify potential business risks. With the juxtaposition of the number of survey respondents who indicate they have appropriate controls in place relative to those respondents that state they do not currently have, nor do they plan to implement an ERM program, we are left to ponder what it all means in a period of increased public scrutiny, governance and regulation?

Finding the Right Mix While the amount, type and administration methods of financial regulation can be controversial, it is a tool used by governments and businesses to increase transparency, maintain confidence and prevent wrongdoing internally and externally. Despite the survey strongly indicating that business leaders feel regulation has a very negative impact on their industries, the results also indicated that the largest percentage of those surveyed feel there are too few regulations in the areas of anti-fraud, anti-corruption and insider trading. Financial regulation empowers and requires organizations to monitor activities and to manage risk to the

business as well as the marketplace. From a macro perspective, this is carried out through various government agencies and federal and state lawmakers. Financial regulation aims to identify risks that arise out of the interconnectedness of U.S. business and financial institutions and provide a tool and window into businesses to be sure that laws are being obeyed and ultimately investors and interested parties are being protected. Conversely, from a micro angle, financial regulation manifests itself through internal corporate governance and ERM programs. Regulatory requirements are a part of the overall framework companies can use to develop a robust risk management program. If done correctly, a robust risk management program complements a firm’s unique relationship with government and regulators in the context of their business and industry. When developing an ERM system, it is essential to identify and assess quantifiable and qualifiable risks to ensure their proper handling comprehensively across an organization. This assessment includes the necessary step of considering how these risks are measured, evaluated and tied to individual performance and rewards. A 2010 study found that there are three unique types of ERM programs that companies attempt to integrate into their organization: compliance, corporate governance and pervasive performance.7 The compliance model of ERM is predominately focused on the internal management of risk and tends to be based on the audit methodology of internal controls. This focus does not provide employees a mechanism to identify unknown risks as they are only attentive to the sources of risks they already know. The corporate governance model of ERM is focused on identifying mostly known internal risks, but simultaneously providing the external market (and customers and shareholders) a feeling of assurance regarding the ERM program in place. This type of ERM program is still not holistically embedded in the organization and does not provide the basis for employee autonomy in the identification of new risks or threats. Pervasive performance, however, attempts to marry the organization’s and the employee’s responsibility to identify, manage and communicate risk issues. By creating a sense of shared ownership in risk management, the pervasive performance model of ERM creates a culture of action whereby managers and line employees assess each of their actions – and the potential impact – in the framework of a holistic risk management program.

This article is one in a series of contributions by ACG Chicago’s Sponsors. We appreciate their support.

Mesirow Financial is a diversified financial services firm headquartered in Chicago. Founded in 1937, it is an independent, employeeowned firm with approximately 1,200 employees globally. With expertise in Investment Management, Global Markets, Insurance Services and Consulting, Mesirow Financial strives to meet the financial needs of institutions, public sector entities, corporations and individuals. For more information about Mesirow Financial, visit its website at mesirowfinancial.com.

Recommendations When considering improvement to businesses, the implementation of a strong ERM / Internal Controls program is essential. Key steps to consider include: n

Provide employees examples of risks that they play a hand in controlling and ask for them to critically assess and communicate other risks that they may not be currently focused on.

Include elements of risk management in employee presentations and communications, in addition to providing tangible reminders of the ERM program in the form of placards or desk tombstones. This is important as creating an enterprise-wide culture of risk management requires constant communication and branding of the effort.

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Use historical examples to highlight pertinent instances where unexpected failures occurred. Move the conversation away from ERM as a concept of “things” to be measured or reports to be generated and move towards a more strategic discussion of the various risks and issues that impact the business, identifying specifically what employees can help assess and control.

Ensure that performance management and reward plans give appropriate consideration for an employee’s success or failure in helping to manage and mitigate the various risk components they can control. n

Mesirow Financial Consulting contracted IBOPE Zogby International to conduct an online survey of more than 400 C-level executives across the United States. The margin of error is +/- 5.0 percentage points 2 The Committee of Sponsoring Organizations of the Treadway Commission (COSO) is a joint initiative of the American Accounting Association, American Institute of CPA’s, Financial Executives International, The Association of Accountants and Finance Professionals in Business and The Institute of Internal Auditors. It is dedicated to providing thought leadership through the development of frameworks and guidance on enterprise risk management, internal control and fraud deterrence. 3 Power, M. (2009). The risk management of nothing. Accounting, Organizations and Society, 849 - 855. 4 Arena, M., Arnaboldi, M., & Azzone, G. (2010). The organizational dynamics of Enterprise Risk Management. Accounting, Organizations and Society, 659-675. 5 COSO’s 2010 Report on ERM 6 Approximately 73.3 percent 7 Arena, M., Arnaboldi, M., & Azzone, G. (2010). The organizational dynamics of Enterprise Risk Management. Accounting, Organizations and Society, 659-675. 1

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{Teamwork.} Your goals are our central concern. Working with CPAs and consultants who put their clientsâ&#x20AC;&#x2122; interests first gives you confidence and puts your challenges into perspective. Helping you to achieve lofty goals when facing uncertainty is

a higher return on experience.

Contact: Dennis Graham Private Equity Practice Group Leader dennis.graham@plantemoran.com plantemoran.com

The Entrepreneurship Bash Bridging Entrepreneurs with the Middle Market & Capital

The 4th Annual Gathering of Chicago Organizations Representing Entrepreneurs, Innovators, Executives, Investors & Advisors

@ Galleria Marchetti

November 6th 17

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A S C, D P M , ESRD ESRD D & HCI T. IISS HERE ERE A LEN DER TH T H AT SSPE PE A K S M Y LA N G GE? GU UA GE

The Authority on Middle Market Loans

GOLUB CAP I T A L’ S AR HE A LT HC CA RE E O ES. T EA M DOE

Golub Capital. Of course.

Contact: C ontact: Andy Steuerman Head of Middle Market Lending 212.660.7280 212.660.728 0 asteuerman@golubcapital.com

Global Rebalancing Our annual look at global market trends effecting middle market growth

@ The Standard Club • Register @ www.ACGChicago.com

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October 4 th 18

Considerations for MiddleMarket Lenders Seeking to Use a CLO Financing Structure By Michael T. Mullins and Tracie Harris Traditionally, the middle market has been viewed as more stable than the large cap market because middle-market lenders exhibit a greater tendency to hold the loans and commitments that they have made to a borrower on their balance sheet until the maturity date of the credit facility. As middle-market lenders seek to grow their balance sheets or otherwise obtain financing from their loan portfolios, some have used the collateralized loan obligation (“CLO”) market. This White Paper addresses various considerations for middle market lenders seeking to place middle-market loans into a CLO. CLO Background CLOs can take various forms for middle-market lenders. One structure is commonly referred to as a “private CLO” whereby a middle-market lender transfers portions of loans from its balance sheet to a special purpose entity that obtains advances from one or more banks and other financial institutions, which advances are secured by those middle-market loans. This special purpose entity is frequently, but not always, owned directly or indirectly by the middle-market lender or one of its affiliates. Another common structure is the more traditional managed CLO whereby a special-purpose entity that acquires middle-market loans issues debt and equity securities to investors in a capital markets transaction. In both private CLO and managed CLO structures, the middle-market lender or one of its affiliates services or manages the loan portfolio for the benefit of the interestholders (i.e., lenders/noteholders and equityholders), and there is typically a revolving or reinvestment period which allows the manager to reinvest proceeds of sales, prepayments, and repayments of loans. In both structures, the specialpurpose entity is a separate “lender” for all purposes of the underlying loan documents and the originating lender typically retains a significant stake in the same tranches of loans transferred to the CLO.

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About the Author

Michael T. Mullins

Partner Winston & Strawn LLP

Michael Mullins is a partner in Winston & Strawn’s corporate department and has a broadranging corporate finance practice, focusing primarily on commercial financings, debt capital markets, and structured products. Mr. Mullins represents finance companies, banks, and investment funds in connection with a wide range of financing transactions, including secured and unsecured syndicated credit facilities, leveraged buyouts, and recapitalization transactions. mmullins@winston.com

Tracie Harris

Associate Winston & Strawn LLP

Tracie Harris, an associate in the firm's Chicago office, concentrates her practice in corporate finance transactions. Ms. Harris has represented numerous financial institutions in syndicated secured and unsecured loan transactions, involving both domestic and international credit facilities, for sponsored acquisitions and mezzanine financing transactions. She also represents major corporations and equity sponsors in connection with syndicated debt facilities. tbharris@winston.com

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Eligibility Criteria In order for a loan to be acquired by a CLO, it is necessary that the underlying loan documents related to such loan comply with the CLO eligibility criteria and for any deviations from such criteria to be specifically identified to determine whether such loan is permitted to be purchased by the CLO. Eligibility criteria generally include a lengthy list of loan attributes tailored to provide a specific risk and diversification profile for interestholders. Generally, managed CLO eligibility criteria are less onerous than private CLO eligibility criteria. Since middle-market loans (especially sponsored loans) are highly negotiated, middle-market lenders should pay particular attention to avoid “negotiating away” provisions that are necessary in order to satisfy CLO eligibility criteria. Obligations Under CLOs When negotiating the terms of a CLO transaction, it is critical that the middlemarket lender/manager carefully examine the obligations under the proposed facility to ensure that there are no restrictions, limitations, or liabilities that would conflict with the rights and duties of the lenders under the underlying loan documents or cause a breach or default of such underlying loan documents. Of course, since a CLO entity has only those rights afforded to a lender and CLOs typically hold only a minority position in each loan, middle-market lenders must ensure that the requirements imposed by the CLO documents do not suggest that the CLO itself can control the rights and remedies of the lender group vis-a-vis the underlying loan documents. These issues are more acute in a private CLO where the financial institutions providing the financing to the CLO want to maintain greater control over the transaction and the activities involving the manager and the underlying loan documents. Transferability and Pledgeability of Underlying Loans A middle-market lender also should focus particular attention on the definitions of “Affiliate” and/or “Approved Fund” as well as on the assignment provisions set forth in the underlying loan documents to ensure that a loan is freely assignable and that it may be pledged as collateral security for the obligations of the CLO. Specifically, the definition of “Affiliate” and/or “Approved Fund” in the underlying credit agreement should be broad enough to include a CLO (e.g., due to the lender/manager exercising management and control over the CLO). Additionally, middle-market lenders should confirm that the underlying credit agreement permits it to freely assign a portion of or all of its loans to an affiliate without having to obtain the prior written consent of the administrative agent, any other lender, or the borrower in order to avoid unnecessary costs and delays. Confidentiality Middle-market lenders typically share more information regarding underlying loan portfolios with CLO financing providers and investors than would be the case for broadly syndicated loans. Standards for the treatment of confidential information often vary between credit agreements and confidentiality agreements to which CLO investors are party. First, not all credit agreements contain an exception to the general prohibition on the disclosure of confidential information for disclosure of such confidential information to a person that is an investor or financing provider in a CLO transaction. Second, credit agreements typically do not provide for time limitations in respect of non-disclosure of confidential information, whereas confidentiality agreements with CLO investors are more likely to contain limitations of one or two years. 20

Ongoing Relationship with Sponsor/Borrower and Voting In the middle market, lenders typically have strong relationships with borrowers and sponsors. To that end, when a lender elects to transfer a portion of the loan held by that lender to a CLO, the borrower and the sponsor could view such assignment as a threat to the stability of that relationship. The fact that the middlemarket lender or one of its affiliates typically manages the loans owned by a CLO should alleviate these fears. However, especially in a managed CLO where the equity of the CLO may be held by third-party investors, the lender/manager has fiduciary duties to the CLO and its investors, and care must be taken to properly balance the interests of the CLO versus the interests of the lender that has retained an interest in the underlying loan when making decisions with respect to that loan.

In summary, CLOs can be advantageous opportunities for middle-market lenders to finance or otherwise grow their balance sheets, but it is critical for such lenders to recognize and understand the risks and occasionally conflicting interests that may arise in connection with undertaking such transactions. n

June 3, 2013

The 18th Annual ACG Chicago Golf Outing

This article is one in a series of contributions by ACG Chicagoâ&#x20AC;&#x2122;s Sponsors. We appreciate their support. Winston & Strawn is a global law firm and advises clients in commercial and investment matters. We represent clients in commercial lending matters, private equity matters, leveraged buyouts, recapitalizations, as well as in debt capital markets, public and private securitization, lease finance, debt fund management and trading, and derivatives transactions. Winston & Strawn attorneys are well prepared to handle our clientsâ&#x20AC;&#x2122; ever-changing global needs.

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General Partners Anticipate a Slow & Steady Recover y for Private Equity in 2013 By Lee Duran and Jerry Dentinger Private equity professionals expressed cautious optimism at the start of 2012. Both 2010 and 2011 saw year-over-year increases in the overall level of deal flow volume and capital invested, the U.S. economy seemed to be improving, and private equity firms were sitting on more than $450 billion of “dry powder” just waiting to be invested. It seemed almost certain that 2012 was poised to be the best year for the private equity industry since the financial downturn in 2008.

However, early optimism was quickly muted as political and regulatory uncertainty in the U.S., combined with a dearth of desirable deal opportunities, contributed to an unexpected decline in total deal flow volume and capital invested through September 2012. Even so, the year was not without its bright spots. In fact, a turnaround began to take shape during the fourth quarter, when, according to PitchBook, the amount of capital invested neared levels not seen since the fourth quarter of 2011, and, before then, the fourth quarter of 2010.

To take the pulse of the industry and identify the key challenges and opportunities that will impact private equity in 2013, the Private Equity practice at BDO USA, LLP, conducted its fourth annual PErspective Private Equity Study from November through December 2012. This year’s study, which examined the opinions of more than 100 senior professionals at private equity firms throughout the U.S., found that despite a disappointing year in 2012, private equity professionals remain confident in the industry’s sustained recovery, as firms continue to adjust and adapt to today’s evolving investment environment.

In fact, the majority of private equity fund managers (75 percent) responding to BDO’s study reported that they believe the current environment is either “somewhat” or “very” favorable for private equity funds looking to invest. That’s compared to a mere 3 percent of respondents who identified the current environment as “very unfavorable” and another 22 percent who said it was “somewhat unfavorable” for private equity funds trying to close new deals.

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At the same time, however, fund managers are not anticipating a sudden boom in the level of deal volume in 2013. Fifty-seven percent of fund managers – regardless

of fund size – expected to close between two and four new deals during the next 12 months, which is only a small increase from the 47 percent of fund managers who indicated they closed between two and four new deals during 2012. Fund managers did, however, report a more optimistic outlook than last year, when only 7 percent of respondents expected to close more than four new deals in the year ahead. Looking into 2013, 36 percent of fund managers expect to close more than four new deals during the next 12 months. That’s a 29 percent increase in the number of funds that expect to close five or more deals last year, and, if expectations hold true, it could point to a marked uptick in deal flow volume in 2013.

Correspondingly, fund managers remain confident in their primary investment strategies. Only 11 percent of respondents said they have asked their Limited Partners (LPs) to allow them to change investment strategies to broaden opportunities and only 9 percent said they will do so during the next 12 months. Fund managers at large funds – those with more than $1 billion in assets under management – were the most likely to reevaluate their investment strategies, with 22 percent having done so in the past year and 16 percent indicating they will do so in the coming year. Secondary Buyouts Expected to Drive Deal Flow When it comes to opportunities for deal flow, secondary buyouts are expected to be a major driver of activity in 2013. According to PitchBook, 47 percent of the more than 6,500 private equity backed companies at the end of 2012 were acquired from 2005 to 2008, during the height of the investment boom. With the median age of a PE-backed company at approximately 4.9 years, many private equity funds will be looking hard for opportunities to exit their mature investments in 2013. Conversely, with billions of dollars of “dry powder” still in many funds’ coffers, others will be eager to put that capital to work. As such, BDO’s study found that 64 percent of fund managers believe that private equity funds exiting their current investments will be the key driver of private equity deal flow in the next 12 months. Manufacturing & Technology Industries Attract Investors, Experience Fluctuating Valuations When it comes to investment opportunities by industry, the largest percentage of private equity fund managers identified manufacturing and technology (equally, 25 percent) as the sectors that will provide the greatest opportunities for new investments during the next 12 months. Expectations for manufacturing were consistent with last year’s study when 28 percent of respondents identified it as the sector that will provide the greatest opportunities. Expectations for technology, however, represent a marked improvement from last year, when only 10 percent of fund managers identified it as the most attractive sector for new investments in 2012.

About the Authors

Lee Duran National Private Equity Practice Leader, Assurance Partner BDO USA, LLP Lee Duran is a partner and national Private Equity practice leader with BDO. He has more than 20 years of experience working with funds and portfolio companies, providing transaction advisory, accounting and auditing services, in addition to leading the acquisition due diligence process across industries and geographies for financial and strategic buyers. lduran@bdo.com Jerry Dentinger Transaction Advisory Services Central Region Practice Leader, Assurance Partner BDO USA, LLP Jerry Dentinger is a partner and Transaction Advisory Services practice leader in the Central Region with BDO. He has more than 20 years of experience providing corporate finance advice to senior executive teams of middle market and Fortune 1000 companies. jdentinger@bdo.com

The healthcare and biotech industry was also identified as an attractive sector for new investments in 2013, with 19 percent of respondents indicating that it will provide the greatest opportunities, followed by natural resources and energy (17 percent), financial services (5 percent) and media/information (4 percent). Only 3 percent of respondents indicated that retail and distribution will provide the greatest opportunities during the coming year. ®

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The BDO PErspective Private Equity Study is a national survey conducted by PitchBook, an independent and impartial research firm dedicated to providing premium data, news and analysis to the private equity industry. More than 100 senior executives at private equity firms throughout the U.S. with $15 million to $157 billion in assets under management responded to BDO’s latest study, which was conducted from November through December 2012. This article is one in a series of contributions by ACG Chicago’s Sponsors. We appreciate their support. SBDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies. For more than 100 years, BDO has provided quality service through the active involvement of experienced and committed professionals. The firm serves clients through 45 offices and more than 400 independent alliance firm locations nationwide. As an independent Member Firm of BDO International Limited, BDO serves multi-national clients through a global network of 1,204 offices in 138 countries. BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. For more information please visit: www.bdo.com Material discussed is meant to provide general information and should not be acted on without professional advice tailored to your firm’s individual needs.

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Mastering the Art of the Deal d e l e l l a y r t a i p Un ortun Opp

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Sunny Days for Valuations Ahead? By Michelle Moreno, CFA, Sean Mirzabegian and Dale Q. Williams Right, depends who you talk to. Still, pent-up demand by all parties runs high. Whether your perspective is as a privately held business that has been considering a sale or growth capital, chances are you have been waiting for improved financial performance before going to market to put a number on your company. Or, perhaps your perspective is of a private equity fund that is looking to invest in another platform or add-on and putting capital to work is a time-sensitive activity. Well, just like investing in public securities, market timing is important but getting in on a well considered and consistent basis is even more important. Or, maybe your perspective is an operating company that is seeking to grow through acquisition or divest non-core businesses. Investment bankers may be a different breed, always looking for the next transaction, but we too want our deals to be winwin so we can go back with the next one. Being in the market delivers more knowledge on valuations and insights on the views of buyers and sellers, balanced by the cost of gaining that knowledge.

Is the Fed helping or hurting? Again, depends who you talk to. Being agnostic on monetary policy and politics may actually be the best approach. There will always be some economic variable to “fix”. Shifting sands in the macroeconomic arena may drive us to shift our focus – restrained capital expenditure budgets would suggest that valuations in the capital-intensive industries are indeed low. As the below chart demonstrates, most capital intensive companies have yet to return to their peak valuations of the mid-2000s, but have still recovered from the valleys experienced in 2009. As uncertainty continues to linger in regards to the overall economy and consumer sentiment, valuations can be assumed to continue their convergence between their decade peak and low, as shown in the graph above. The important factor will be how these firms deliver growth in such a sluggish economic environment. In the interim, buyout opportunities may be particularly attractive in the capital-intensive sector. Note that these industries were selected in aggregate only for illustrative purposes.

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About the Authors

Michelle Moreno, CFA

Or, perhaps the asset-light services sector is the way to go, particularly in a technology-enabled manner. While Software and Services and Business Process Outsourcing have nearly returned to their pre-2007 peaks while Wireless Services has surpassed its pre-2007 valuation. A disparate group, asset-light services is benefitting from several demographic and global trends that favor the sector. Namely, mobility and hosted solutions enable higher returns per dollar of investment at a volume of activity. With lower investment required to drive to higher profitability, at least in theory, the returns to this sector are reflected in generally rising valuation levels.

Managing Director Dresner Partners mmoreno@dresnerco.com Michelle leads M&A, strategic advisory, valuation and capital raising for owners and investors in the Services and Applied Technologies industries

Dale Q. Williams

Associate Dresner Partners dwilliams@dresnerco.com

Sean Mirzabegian

Analyst Dresner Partners smirzabegian@dresnerco.com

Or, maybe hedging against financial asset inflation bodes best for the commodity sector. Long considered a hedge to an inflated financial sector, the commodities themselves are likely to remain a leading indicator of global economic activity rather than a guidepost for M&A and capital valuations.

The highly fragmented nature of the M&A and capital markets is an inspiring factor, enabling market participants to position and capture â&#x20AC;&#x153;alphaâ&#x20AC;?. Knowing where your sector or industry has been and is headed in light of macroeconomic

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This article is one in a series of contributions by ACG Chicagoâ&#x20AC;&#x2122;s Sponsors. We appreciate their support. Dresner Partners is a middle market investment bank specializing in merger & acquisition advisory, institutional private placements of debt and equity, restructuring and valuation. We are deeply committed to exceeding client expectations and maintaining the highest levels of integrity.

and microeconomic vectors directs the speed and proactive leadership with which investments or divestitures are made.

So, sunny, cloudy, snowy, rainy are all qualifiers for the U.S. postal service. M&A and public and private capital markets are for those that know how to position themselves and optimize returns. n

Tatum optimizes portfolio investments We specialize in: t C-Suite & Executive Leadership t Mergers & Acquisitions t Carve-outs t Preparing Companies for Sale t Technology Consulting Jim Dimitriou National Practice Director T 312.233.2402 E Jim.Dimitriou@TatumLLC.com

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For Private Equity Investors, Section 1202 May Be Worth Another Look

Included in the American Taxpayer Relief Act of 2012 were provisions that extended some of the more significant benefits of Internal Revenue Code Section 1202. For those who aren’t aware, that is the Code provision that permits eligible noncorporate taxpayers to exclude from taxable income (within limits) a specified percentage of any gain from the sale or exchange of “qualified small business stock” (“QSBS”) held for more than five years. That percentage, which when Section 1202 was first enacted in 1993 was 50 percent of the recognized gain from the sale of the QSBS, was expanded to 100 percent of such gain for QSBS acquired after September 27, 2010 and before December 31, 2010. The 100 percent exclusion was extended through December 31, 2011 pursuant to the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010; the American Taxpayer Relief Act of 2012 (“ATRA”) retroactively extended the 100 percent exclusion for QSBS acquired in 2012 and 2013. More importantly (to some), the ATRA also extended the rule that excluded that gain not only for regular income tax purposes but for alternative minimum tax purposes as well.1 Historically, private equity investors weren’t all that interested in trying to take advantage of Section 1202. This was the case for a number of reasons, including: n

The fact that Section 1202 is, by its terms, limited to newly-issued stock of a C corporation. Section 1202 has a number of requirements that must be satisfied in order for its stock to qualify as QSBS – relating to the method by which the noncorporate taxpayer acquires the stock, the type of business in which the corporation can be engaged2 and, as discussed below, the size of the corporation (measured by gross assets). Indeed, with regard to the first requirement, it is arguably the case that the benefits of Section 1202 (which were aimed at encouraging investments in new enterprises) were not really supposed to apply to a typical private equity investment (which often results in no new capital being invested in the business but rather a cashing out of the current owners’ invested capital). That said, where, as is the situation with many private equity investments, the structure of the transaction calls for a new corporation to be created, it may be that this particular requirement can be satisfied.

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The corporation issuing the QSBS could not, at the time the QSBS was issued (and at all times since August 10, 1993 through that date) have more than $50 million of gross assets. Many corporations in which private equity is invested have gross assets that exceed this threshold. The five-year holding period for the stock was not realistic. Many private equity firms plan to, or in fact, exit their investment in less than five years. Whatever tax benefits might be derived from Section 1202 are frequently (and appropriately) trumped by business and investment considerations.

The treatment of a portion of the excluded gain as a “tax preference” item for alternative minimum tax purposes would often negate the regular income tax benefit from Section 1202. The allocation of gain on a disposition of a private equity investment and the eligibility of such gain for exclusion under Section 1202 is all determined at the investor level. For an investor who is otherwise an AMT taxpayer or whose allocable share of Section 1202 gain made the investor an AMT taxpayer, the treatment of a portion of that excluded gain as a tax preference3 would often make the effective federal income tax rate on the gain only 2 to 12 basis points below what was the effective rate had the gain not been eligible for Section 1202. Indeed, in this situation, an investor probably would only claim the benefits of Section 1202 if, as was sometimes the case, it resulted in an effective reduction in the state income tax rate payable with respect to the gain.

So why should private equity investors now take another look at Section 1202?

About the Author

Daniel N. Zucker Managing Director Partner McDermottt Will & Emery LLP Daniel N. Zucker is a partner at McDermott Will & Emery LLP in Chicago. Co-chair of the Acquisitions Restructurings practice and chair of the Private Equity Tax practice, he focuses his practice on federal and state tax matters, with particular emphasis on structuring mergers and acquisitions, tax-free reorganizations, tax free spin-offs and split-offs, and restructurings of financially troubled companies.

First, in this uncertain business climate, holding periods for investments may be longer than originally anticipated, i.e., more than five years, making gains – for the first time – eligible for the benefits of Section 1202.

Second, federal long-term capital gains tax rates have gone up, from 15 percent to what is for most individual private equity investors, 23.8 percent. In the meantime, the tax rate applied to the non-excluded Section 1202 gain has not changed. As such, a 2013 sale at a gain of otherwise eligible QSBS stock (i.e., stock that, among other things, has been held since 2008) would be subject to an effective federal income tax rate of 15.9 percent or, to the extent the investor is an AMT taxpayer, an effective federal income tax rate of 16.88 percent, in either case, a savings over the regular capital gains tax rate of almost nine percentage points.4 This, of course, is on top of any effective reduction in the investor’s state income tax rate on the gain.5

Third, depending on when the QSBS was acquired, the reduction in the effective federal income tax rate on the gain from a sale in future years could be even more significant. For QSBS acquired between February 18, 2009 and September 27, 2010 – not eligible for the benefits of Section 1202 until, at the earliest, February 19, 2014 – the portion of the gain eligible for the exclusion under Section 1202 is 75 percent, making the effective federal income tax rate on the gain 7.95 percent (for investors who are not subject to AMT) and 13.83 percent (for investors who are). For QSBS acquired between September 28, 2010 and December 31, 2013, the effective federal income tax on such gains is zero percent for both regular income tax and AMT purposes. Of course, the first sales of QSBS eligible for the zero percent rate cannot occur until September 29, 2015 and, for any QSBS investments made this year, not until sometime in 2018 (when the federal capital gains tax rates generally may have changed one or more times!). 31

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Although the recent changes in capital gains tax rates have made the benefits of Section 1202 more compelling, these benefits are still, for many reasons, speculative. As such, an otherwise unsuitable investment should not be made, nor fundamental business terms compromised, solely to fit within the parameters of Section 1202. That said, if the size of the investment, the structure of the transaction, and the anticipated holding period for the stock all indicate that private equity investors could take advantage of reduced federal (and state) capital gains tax rates, making sure that the investment otherwise constitutes valid QSBS should not be overlooked. This article is one in a series of contributions by ACG Chicago’s Sponsors. We appreciate their support. McDermott Will & Emery is a premier international law firm with a diversified business practice. Numbering more than 1,100 lawyers, we have offices throughout the United States, Europe and Asia. Established in 1934 as a tax practice in Chicago, Illinois, McDermott has grown its core practices and offices around the globe. The expansion of our international platform has supported numerous crossborder transactions and litigation matters, while providing the experience necessary to offer corporate and commercial, international and domestic tax, labor and benefits, competition, intellectual property and regulatory counsel to clients across all industries.

For QSBS acquired before September 28, 2010, a certain percentage of the gain excluded under Section 1202 – here, too, the percentage has varied over the years – was treated as a “tax preference” and added back to taxable income for purposes of computing a taxpayer’s alternative minimum tax, or AMT. As discussed below, in many cases, this negated nearly all of the tax benefit derived from Section 1202 in the first place. 2 In order for stock to meet the requirements of QSBS, the corporation issuing the stock must be engaged in a “qualified trade or business” which does not include most professional services businesses (e.g., health services, legal, accounting, engineering, consulting, performing arts and “any trade or business where the principal asset is the reputation or skill of one or more employees”); any banking, insurance, financing, leasing, investing or similar business; any farming business; any business involving the extraction of products eligible for a depletion deduction; and any business of operating a hotel, motel, restaurant or similar business. 3 The portion of the excluded gain that is treated as a tax preference for AMT purposes has substantially changed over the years. Originally, 50 percent of the excluded gain was to be treated as a tax preference. It has been reduced several times since then and, effective for QSBS investments made on or after September 28, 2010 through, as a result of the latest tax legislation, December 31, 2013, none of the excluded gain is to be treated as a tax preference for purposes of the AMT. 4 These effective rates assume that the investor’s income will be at a level at which the new 3.8 percent “net investment income tax” (enacted as part of the Obama healthcare legislation) will be applicable and that the 50 percent of the gain not excluded under Section 1202 will be subject to this tax. 5 The amount of QSBS gain that can be excluded under Section 1202 in any one year from any one investment is limited to the greater of (i) $10 million (reduced by Section 1202 gains excluded in earlier years), or (ii) 10 times the basis of the QSBS being disposed of in that year. 1

SBICs: Driving Middle Market Growth

Everyone in Middle Market M&A needs to know why SBICs are critical for growth capital, new opportunities and your capacity to use this tool. Join

Robert Castillo

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Kristi Craig

Robert J. Castillo, Principal, Invision Capital Jeffry S. Pfeffer, Managing Partner, CapX Partners Edward H. Ross, Chairman & CEO, Fidus Investment Corporation Kristi W. Craig, Senior Vice President, Small Business Investor Alliance (Moderator)

Don’t Miss This on Tuesday,

Edward Ross

Jeffrey Pfeffer

September 24 - 11:30 AM – 1:30 PM

ACG Chicago Annual Program Sponsorships

As noted in our opening pages, ACG Chicago is the premier network of leading authorities on corporate growth. Our 1,000 members, all vetted through our approval process, represent the base of clients and relationships that are driving growth, investment and deal flow in the middle market. Your firm can stand out in this crowd through various packages that include: • ACG Chicago homepage web recognition • Signage recognition at our regular events • Recognition in our event emails • News postings in our weekly news • Recognition at our annual golf outing • Complimentary registrations • Ads in our ACG Chicago Journal • Whitepaper Journal publication of your work • Discounts on sponsorships of our targeted conferences • and, new this year, the opportunity to share your expertise further by presenting a Sunrise Session roundtable discussion for members only at the ACG Chicago offices. We continue to look for the most effective ways to share your expertise and experience with this network of great leaders. This includes bi-annual sponsor breakfasts to discuss new ideas like the Sunrise Sessions that come from our last meeting. Join this elite collection of leading middle market firms.

The 14th Annual Midwest ACG Capital Connection Sponsorships

The Midwest ACG Capital Connection is the premier networking conference for middle market merger and acquisition professionals. This year marks the 14th year Chicago has hosted this wildly popular event. the last five years of this conference have boasted 150 exhibitors and 1200 attendees. We expect you and the Midwest to lead the way again this year.

The Titanium level is sold out but there is still time to reach this great base of M&A professionals with Diamond, Platinun, Gold, Silver & Bronze level packages. This year the Sponsor/Lounge/Refreshment area is in the center of the action. Join us there. To download the sponsor program packages, click on www.ACGChicago.com/sponsorships.aspx

For further details, contact us at 877-ACG-NETWORK [877-224-6389] Craig Miller • CMiller@ACGChicago.com or Terry Cobb • TCobb@ACGChicago.com

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EXECUTIVE BOARD President Thomas M. Turmell TMT Capital Partners, LLC tturmell@tmtcapital.com Executive Vice President Suzanne L. Saxman Seyfarth Shaw LLP ssaxman@seyfarth.com

Secretary Venita E. Fields Smith Whiley & Company venita.fields@smithwhiley.com Treasurer Murray R. Lessinger White Oak Group mlessinger@whiteoakgroup.net

Past President Dustin R. Weinberger GE Capital dustin.weinberger@ge.com Chief Executive Officer Craig A. Miller ACG Chicago CMiller@ACGChicago.com

OFFICERS / COMMITTEE CHAIRS Corporate Network David G. Heinke Grant Thornton LLP david.heinke@us.gt.com International Network Mark E. Lanyon Morningstar, Inc. mark.lanyon@morningstar.com

Jeffrey Mengel Plante Moran, PLLC jeff.mengel@plantemoran.com John McGuire Citibank N.A. john.mcguire@citi.com

Private Equity Network Ryan Rassin LBC Credit Partners rrassin@lbccredit.com

Terry M. Keating Amherst Partners, LLC tkeating@amherstpartners.com Steven M. Bernard (Research) sbernard543@comcast.net

Entrepreneurship Network Daniel P. Howell Mesirow Financial dhowell@mesirowfinancial.com

John C. Bintz Valuation Research Corporation jbintz@valuationresearch.com

ADVISORY COUNCIL Advisory Council Chair Dustin R. Weinberger GE Capital dustin.weinberger@ge.com

Steven M. Dresner Dresner Partners sdresner@dresnerco.com

Paul E. Krantz PNC Business Credit paul.krantz@pnc.com

Gary I. Levenstein Gerald T. Eisenstein Ungaretti & Harris, LLP McGladrey LLP gerry.eisenstein@mcgladrey.com gilevenstein@uhlaw.com Michel J. Feldman Seyfarth Shaw LLP mfeldman@seyfarth.com

James A. McNair Corinthian Capital Group, LLC jmcnair@corinthiancap.com

Carol A. Morse Daniel P. Howell Mesirow Financial Private Equity Fifth Third Bank dhowell@mesirowfinancial.com carol.morse@53.com Andrew W. Rice The Jordan Company arice@thejordancompany.com

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A T- L A R G E D I R E C T O R S Joseph A. Contaldo Corporate Finance Associates jac@cfachicago.com

Craig McCrohon Burke Warren cmccrohon@burkelaw.com

Brian Crannell Knowles Electronics brian.crannell@knowles.com

Ada C. Nielsen The PeregrineMaven Group ada@peregrinemaven.com Stefan Timms Blake, Cassels & Graydon LLP stefan.timms@blakes.com

David Gaito PNC Business Credit david.gaito@pnc.com

James A. Valderrama James_valderrama@yahoo.com

Charles A. Gonzalez Albion Investors LLC cgonzalez@albioninvestors.com Michael Gruber Independence Equity mgruber@independence-equity.com Ankur Gupta McDermott Will & Emery LLP ankurgupta@mwe.com Warren E. Lawson ARI Packaging, INC wlawson@ari-packaging.com

James K. Vargo Wells Fargo Bank jim.vargo@wellsfargo.com John B. Weber HSBC Bank USA john.b.weber@us.hsbc.com Andrew L. Weil DLA Piper LLP (US) andrew.weil@dlapiper.com Sherman Wright Common Ground Marketing sherman@discovercg.com

S TA F F Chief Executive Officer Craig A. Miller CMiller@ACGChicago.com

Intern Events Assistant Anne McNair Lou Ann Grebenor LGrebenor@ACGChicago.com AMcNair@ACGChicago.com

Vice President of Operations Terry D. Cobb TCobb@ACGChicago.com

Events Assistant Ryan Baker RBaker@ACGChicago.com

ACG Chicago, Inc. 181 W. Madison St. Ste. 3350 Chicago, IL 60602

www.ACGChicago.com

877-ACG-NETWORK

877-224-6389

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