Middle Market Equity Capital Report: Turbulent Market Conditions

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Middle Market Equity Capital Report Turbulent Market Conditions Suppress IPOs in 2015 and What to Expect Looking Forward January 2016 A CohnReznick LLP Report

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Middle Market Equity Capital Report ― January 2016


TABLE OF CONTENTS

Preface ..................................................................................................................................... 1 Highlights .................................................................................................................................. 2 2015 Middle Market IPO Activity ........................................................................................... 3 Middle Market Insights ....................................................................................................... 4 IPO Forecast for 2016 ......................................................................................................... 5 Middle Market Industry Insights ......................................................................................... 6 2015 IPO Dynamics ............................................................................................................. 8 Middle Market Follow-on Activity.................................................................................... 10 2015 Regulatory Milestones ............................................................................................. 11 Summary............................................................................................................................ 12 Top Middle Market Investment Bankers ......................................................................... 12 About CohnReznick’s Public Companies Group .......................................................... 13


PREFACE Equity markets perform best when market conditions are stable; when the answers to some of the most complicated economic questions are answered; when there is a sense of clarity and confidence. As we start 2016, the markets lack stability, clarity, and confidence. Equity markets seem less than stable, and less able to support a platform for vibrant equity transaction activity. Domestically, the impact of the gradual increase in interest rates on the U.S. economy is unknown, a presidential election looms, and organic growth in the middle market is somewhat stagnant. Globally, recent news from China has sent tremors through world markets. Volatility abounds.

Dom Esposito

Alex Castelli

In 2015, several companies postponed IPO offerings. Some of those may price in 2016 while others may wait

Unfortunately, market volatility will persist in the near

until 2017 or even 2018. Some may exit the process

term and will impact both public and private equity

entirely in favor of remaining private, or pursue an M&A

transaction activity. The rather substantial decrease in

transaction. In 2016, new IPO candidates will certainly

IPO transaction activity in 2015 is a reflection of a volatile

emerge. They will be met with growing investor scrutiny

yet dynamic market. Volatile in the sense of its jittery

as valuations and pricing are more thoroughly vetted.

reaction to news and issues of the day, and dynamic

Successfully pricing an IPO will depend on timing

in its longer term resilience.

and the performance of like issues. The role of the

WE ARE HOPEFUL THAT IPO ACTIVITY GAINS MOMENTUM IN 2016, BUT HURDLES ARE LIKELY TO PREVENT ANY MEANINGFUL PROGRESS.”

Some of that resilience has been buoyed by the availability of capital in the private market. Even though public issuers and investors are proceeding with increased caution, private financial and strategic investors have money and are willing to spend it on the right acquisition.

underwriters will become more critical in calculating when and if to go public. We are hopeful that IPO activity gains momentum in 2016, but hurdles are likely to prevent any meaningful progress. Many in the capital markets community question whether the IPO window will be open or closed in 2016. That remains to be seen.

Dom Esposito

Alex Castelli

CPA, Partner, CohnReznick’s National Liquidity and Capital Formation Advisory Group

CPA, Partner, CohnReznick’s National Liquidity and Capital Formation Advisory Group

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HIGHLIGHTS Middle market IPO* activity decreased by 43% in 2015 when compared to 2014. Market volatility may have kept some public investors on the sidelines. Further contributing to the drop-off in IPOs was the continued availability of private capital. Private equity and strategic investors offer an attractive combination of financial and intellectual capital without the costs or regulatory and reporting requirements that accompany an IPO.

The private sector can be characterized as a sellers’ market.

IPOs remained popular among healthcare and life sciences companies.

Fueled by access to capital, the competition

Healthcare and life sciences IPO activity continued to lead

for quality middle market acquisitions

all other industry sectors in 2015. With 45% of all middle market

continued in 2015. Private financial investors

IPOs issued by healthcare and life sciences companies, the

were challenged to compete with strategic

IPO remains an important and often used form of capital.

investors driving valuations skyward.

Market factors and economic conditions impacting transaction activity in 2015 will carry over to 2016.

Pricing an IPO has become increasingly challenging. As the year progressed, there was plenty of downward pricing pressure exerted on new issues. In Q4, not one middle market IPO priced above the target range set by the underwriters and 46% of new issues priced below the target range.

We believe this will result in 2016 public equity capital transaction activity at about the same level as 2015. The IPO on-ramp should remain open, but to a more select group of companies that can demonstrate growth in revenue and profit, and convince investors of their ability to thrive as a public entity.

Average proceeds raised from middle market IPOs increased in 2015. Even though total proceeds raised from middle market IPOs decreased by 32% in 2015, reflecting the decrease in IPO transaction activity, average proceeds per middle market IPO increased 18% reflecting the escalation in valuations.

*An IPO completed by a company with a market cap of $10 million to $1 billion post-IPO.

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Middle Market Equity Capital Report ― January 2016


2015 MIDDLE MARKET IPO ACTIVITY

Market volatility was triggered by economic concerns regarding Greece, China, and other nations

Middle Market IPOs by Quarter for 2014 and 2015

as well as uncertainty on domestic interest rate policies. This created enough instability in the market to keep many investors away from

62

60

IPOs. As the year progressed, many

53

60

57

companies on the path to an IPO postponed or abandoned the process entirely as a result of continued market volatility, downward pricing pressures,

33

27

and added investor scrutiny. Even the strong fundamentals of a continuing

24

U.S. economic recovery were not enough to lift the confidence of public investors.

Q1

Q2 2014

Q3

Q4

2015 Source: Thomson Reuters

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MIDDLE MARKET INSIGHTS An attractive private market contributed to the fall-off in middle market IPO

Middle Market Proceeds

transaction activity. Companies that

32 B

had been IPO candidates in the past

28 B

became investment targets for private financial investors such as private equity groups, and acquisition targets for strategic investors. With valuations

19 B

in the private market at heightened levels and capital available, companies seemed less motivated to pursue an IPO. Some companies that did complete an IPO experienced lower public market valuations and less favorable post transaction pricing performance.

Down 13%

Down 32%

2014

2015

Even though the average size of each transaction increased in 2015, total

2013

proceeds raised by middle market IPOs decreased. In 2015, some investors were not bashful about paying a premium for

Source: Thomson Reuters

quality investments as evidenced by the increase in average proceeds raised. When the right opportunity presented itself, investors appeared willing to participate—just not

Middle Market Average Proceeds

as often.

165 M 138 M 117 M

Up 18%

Down 29%

2013

2014

2015 Source: Thomson Reuters

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Middle Market Equity Capital Report ― January 2016


IPO FORECAST FOR 2016

While there has been a decrease in 2015 IPO activity, the Life Sciences industry still remains one of the top participants in new public equity raises. This is driven by many factors including a strong risk-reward proposition relating to novel science. In 2016, Life Sciences companies will need to be more strategic with their market timing and place additional diligence on achieving key milestones to drive investor interest.” CRAIG GOLDING

COHNREZNICK PARTNER, TECHNOLOGY AND LIFE SCIENCES INDUSTRY PRACTICE

During a presentation, Patrick J. O’Keefe, CohnReznick’s

items and global issues that impact market volatility

Director of Economic Research, once compared a series

and contribute to decreased investor confidence. The

of economic indicators from a past year to the year

availability of capital in the private market, along the

ahead. He closed that presentation by saying, “…if you

advantages associated with accessing private capital,

liked this past year, you’ll love next year.” This sums up

will be too great for many middle market companies

our outlook for middle market IPO activity in 2016.

to ignore.

CohnReznick believes that many of the market factors

Middle market IPO activity in 2016 may moderate slightly

and economic conditions that were at work in 2015

higher or slightly lower compared to 2015. However,

will continue in 2016. Public investors will continue to

absent any major disruptions to current market factors

evaluate each transaction with increased scrutiny

or economic conditions, we don’t expect a large swing

which will place downward pressure on public market

in either direction.

valuations. Equity markets will remain sensitive to news

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MIDDLE MARKET INDUSTRY INSIGHTS In 2015, the Healthcare and Life Sciences and Technology sectors were especially interesting to watch, but for different reasons. Healthcare and Life Sciences IPO activity continued to garner the lion’s share of middle market IPOs (45%). Technology IPOs, although second to Healthcare and Life Sciences, represented just 15% of middle market IPO activity. As a percentage of middle market IPOs, these two key industry sectors performed similarly to 2014.

Middle Market IPO Comparison by Industry, 2014 and 2015 2015 Technology

Other

Other

Retail 2% Retail

12%

Hospitality Energy and Utilities Real Estate

15%

6%

Hospitality 3% Energy and Utilities 6%

3% 4%

Real Estate

5%

Financial Services

14%

34%

11%

Life Sciences

10%

Healthcare

2014

y

Other

Technology

Retail 2% Hospitality 3% Energy and Utilities 6% Real Estate

13%

18% 7%

2%

Life Sciences

Life Sciences

37% Healthcare Source: Thomson Reuters

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Financial Services

Technology

IPO activity in the commercial real 18% sector may be estate Life in 2016 relatively quiet Sciences 7% as interest rates rise. Those searching for capital may find greater interest from private 37% equity sources or lending Healthcare institutions. We have noticed some disparity between pricing of REIT shares and net asset value so issuers may encounter challenges if they hope to exit through equity transactions.” ADAM KLEEMAN

COHNREZNICK PARTNER, COMMERCIAL REAL ESTATE INDUSTRY PRACTICE

14% Financial Services

2%

13%

2014

Middle Market Equity Capital Report ― January 2016


Healthcare and Life Sciences Healthcare and Life Sciences companies, with long development and regulatory approval processes, have found that IPO and subsequent follow-ons are the forms of capital that best meet their strategic needs. In 2016, we should see increasing public investor scrutiny before IPOs in these sectors come to market. This will result in moderating valuations and careful pricing. Companies in these sectors that are further along in the development and approval processes should receive a warmer reception from the public investment community. A valuation premium will be placed on companies with management teams that have successfully commercialized their products and services and have shown profitable growth. Additionally, companies that are in the early development and approval processes may find greater success partnering with a strategic or financial investor in 2016.

Technology Today, fewer technology companies price an IPO. This is partially due to the fact that the technology sector is most impacted by the availability of private capital and the corresponding hunger for acquisitions on the part of strategic and financial investors. Strategic investors in particular have rewarded technology acquisitions that they can integrate into their current platform or product service offerings. And with so much pressure placed on strategics to achieve growth goals in a low organic growth market, there is even more emphasis placed on growth through mergers and acquisitions pushing valuations even higher. For technology company management teams, 2016 should play out as a good time to seek interest from investors. It will also be a challenging time to acquire a technology company, or to raise capital by pricing an IPO. 2015 market factors should continue in 2016. Technology companies, long the beneficiaries of increased valuations in the private market may face valuation and pricing challenges if they attempt to access public equity capital.

Retailers like Neiman Marcus and Albertson’s both planned to go public in 2015 and both postponed citing “market volatility” as the main reason to hit the pause button. In 2016, organic growth will continue to be somewhat anemic in the retail and consumer products sector placing additional pressure on management teams to grow through mergers and acquisitions.” STEPHEN WYSS

COHNREZNICK PARTNER, RETAIL AND CONSUMER PRODUCTS INDUSTRY PRACTICE

Real Estate In 2015, real estate sector IPO activity started the year by showing signs of strength. There were four real estate IPOs in Q1, equaling the number of real estate IPOs that transpired in all of 2014. However, as 2015 progressed, market volatility increased and real estate sector IPOs dwindled. Nevertheless, the real estate sector ended the year with seven middle market IPOs—three more than recorded in 2014.

Retail and Consumer Products Although the numbers were on the low side, 2015 middle market IPO activity in the retail and consumer products sector was respectable with eight priced offerings in 2015 versus only four in 2014. Looking to 2016, retail and consumer products companies with a well-structured omni-channel strategy may be in the best position to attract public investor interest.

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2015 IPO DYNAMICS Smaller IPOs Gain Traction In both the public and private equity capital markets, this was the year of big dollar transactions. And the financial news media didn’t let us forget it. Barely a day passed without reference to “unicorns” and features focused on multibillion dollar deals. As such, we were pleasantly surprised to see that the proportion of smaller IPOs, those raising less than $50 million in proceeds, in 2015 actually increased to 25% from only 20% in 2014. In 2016, we hope to see a greater proportion of smaller IPOs come to market. CohnReznick believes that the success of the smaller IPO plays a critical role in contributing to the strength of the U.S. economy.

Smaller IPOs Comparing 2015 to 2014

25% 34 / 137

Smaller Middle IPOs Market IPOs

2015

20% 48 / 239

Smaller Middle IPOs Market IPOs

2014 Source: Thomson Reuters

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Middle Market Equity Capital Report ― January 2016

We are seeing some public valuations softening, playing a major role influencing transaction activity. The markets continue to be sensitive to news and events in the short-term, but are more resilient when taking a longer-term view. Timing plays a critical role in the success or failure of issuing an IPO and it highlights the important role of the lead underwriters. Higher valuations in the public market were once a motivating factor for companies to consider an IPO. But public investors are increasingly questioning valuations and we expect that scrutiny to increase in 2016.” ALEX CASTELLI

COHNREZNICK PARTNER, NATIONAL LIQUIDITY AND CAPITAL FORMATION ADVISORY GROUP


Pricing Middle market IPO pricing data clearly reflects

Pricing by Quarter for 2015

the downward pressure being applied from the investment community. In each of the first three quarters of 2015, 17% to 26% of middle market

17%

24%

26%

IPOs priced above their range. In Q4, no IPOs

54%

priced above their range. For the first three quarters of 2015, 15% to 27% of middle market IPOs priced below their range. But in Q4, a whopping 46% priced below their range.

49%

62%

As 2015 progressed, investor confidence

59%

decreased and market volatility continued to increase. This directly affected IPO pricing.

46%

In 2016, we expect similar pricing pressure to persist as investors carefully weigh and prove-out the value of each offer.

Private Equity Exits In 2015, the percentage of private equity

27%

21%

Q1 2015

15%

Q2 2015

Below Filing Range

Q3 2015

Within Filing Range

Q4 2015 Above Filing Range

backed middle market IPOs remained consistent with 2014 and 2013 suggesting that private equity investors will continue to evaluate public offerings as exit strategies.

Private Equity-Backed IPOs Private Equity-Backed IPOs

63 64 62 %

%

2013

2014

120/192

152/239

%

2015

85/137 Source: Thomson Reuters

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MIDDLE MARKET FOLLOW-ON ACTIVITY follow-on transaction activity decreased significantly in 2015—down 26% when compared to 2014. Proceeds raised from middle market follow-on transactions also decreased by 15%. Despite these declines, middle market public companies accessed in excess of $40 billion as the result of 2015 follow-on transaction activity.

Middle Market Follow-On Activity by Industry 2015 Other Retail Real Estate Energy and Ulitities

Technology 12%

3%

13,252

203

195

10,046

162

150

157 8,328

7,810

121

120

3,867

67

Q2 2014

7%

Q3

Q4 2015

Source: Thomson Reuters

38%

Many healthcare and life sciences companies utilize follow-on transactions to fuel growth and development

7%

and to sustain operations in advance of commercializing

Life Sciences

Healthcare

Technology 17%

company. This represents a sizable increase from the

for 15% of middle market follow-ons in 2015 while financial services companies tallied 11%. Even though investors may examine follow-ons with greater

3%

scrutiny in 2016, when compared to an IPO, they may feel a greater level of comfort investing in a company that

9%

23%

11%

Energy and Ulitities

follow-ons were issued by a healthcare or life sciences

these sectors in 2014. Technology companies accounted

Other

18%

products and services. In 2015, 45% of middle market

29% of middle market follow-ons issued by companies in

2014

13% Financial Services

Life Sciences

6% Healthcare Source: Thomson Reuters

10

15,450

14,447

Q1

11%

Real Estate

15,224

15%

7%

Financial Services

Retail

(Millions)

form of follow-on transactions. However, middle market

Middle Market Follow-On Activity by Quarter

Proceeds

the ability to access additional capital after the IPO in the

Number of Deals

One of the advantages of being a public company is

Middle Market Equity Capital Report ― January 2016

has a proven track record and that has demonstrated management skills associated with being a public company. Given the nature of their businesses, we expect that healthcare, life sciences, and technology companies will lead the pack in their utilization of the follow-on offering to support growth efforts in 2016.


2015 REGULATORY MILESTONES New Crowdfunding Rules May Be a Game Changer

CohnReznick continues to support middle market capital formation—whether it comes through the public markets, through private equity or venture capital, or from individual investors. We believe a solid balance must be maintained between fueling the needs of growth-oriented businesses and protecting investors eager to support the next generation of innovation. In 2015, the SEC took action on both Regulation A and crowdfunding, two key components of the JOBS Act

On October 30, 2015, the SEC approved final rules in permitting companies to offer and sell securities through crowdfunding. The new rules offer another capital raising option for growth oriented companies as well as additional investment options—and protection— for investors wishing to get in on the ground floor of what could be a very successful business.

of 2012.

As with any form of capital, CohnReznick

Regulation A+ Gives Small Companies Additional Access to Capital In a move designed to facilitate the capital

recommends that issuers consider the opportunities, challenges, and risks associated with offering and selling securities through crowdfunding. Therefore, we advise investors to perform an appropriate

raising needs of smaller companies, on March 25, 2015,

level of diligence before making any investment

the SEC updated and expanded Regulation A under

decision.

Title IV of the JOBS Act of 2012. The new rules, known as Regulation A+, enable growth companies to raise up to $50 million from unaccredited investors in a mini-IPO type offering. By doing so, investors will have more choices and smaller companies can, if desired, bypass big institutions for their capital needs by offering stock directly to their key constituents and to the general public. Regulation A+ may be best for the company that doesn’t want to involve institutional investors. It’s essentially a less expensive way to raise capital while still maintaining control of your company. Regulation A+ could be utilized by companies in advance of an IPO and could provide a nice transition to becoming public.

Even though we are bullish about increasing access to capital for middle market companies, entering into 2016 it is too early to measure the practical success of either Regulation A+ or crowdfunding. Since its inception in 2012, the JOBS Act has, at a minimum, stimulated conversation about the importance of accessing capital in the middle market. Some of the components of the JOBS Act are measurable in that every qualifying company pursuing an IPO today submits their registration to the SEC as an Emerging Growth Company as defined by the JOBS Act. This type of registration avails the issuer to the various provisions of the JOBS Act including “confidential filings” and “testing the waters.” Both of these have been credited with stimulating public equity capital transaction activity. Unfortunately, we don’t hear of any serious discussions concerning a JOBS Act 2 moving forward into 2016. Election year politics may provide an obstacle in introducing additional legislation that would encourage access to capital for middle market businesses.

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SUMMARY In 2015, IPO transaction activity was strongly influenced

quality investment opportunities. The sellers’ market is likely

by increased uncertainty, market volatility, and a lack of

to continue for companies accessing private capital.

investor confidence. These factors negatively impacted

Conversely, the dynamics more representative of a buyers’

IPO and follow-on activity. Despite the fact that the U.S.

market will persist for companies going public. And even

economy continues to show signs of strength, global

though the markets may have moved beyond many of

economic and political concerns, as well as uncertainty

the disruptors from 2015, they remain sensitive and on alert.

surrounding the Fed’s policy on interest rates, were obstacles

If the past is any indication of the future, more disruptors

to increased IPO activity. From a qualitative perspective,

are on the way, and timing will play a critical role in the

2016 may bring a more seasoned group of companies to

success or failure of issuing an IPO and highlights the

the IPO on-ramp. With a higher level of investor scrutiny,

important role of the lead underwriters.

only those companies truly ready for life as a public entity will be encouraged to go public. In 2016, private markets

Looking forward, we are hopeful that stability and investor

will continue to woo some companies once destined to

confidence return to the markets giving rise to additional

become public. Capital from private equity and strategic

capital transactions and increased access to capital to

investors is likely to remain plentiful as is their appetite for

those middle market companies that depend on it to grow.

Top Middle Market Investment Bankers Fifty-five different investment banks acted as a bookrunner on at least one middle market IPO in 2015 (137 IPOs). The total number of middle market IPOs reflected in the table greatly exceeds the 137 IPOs as most transactions involve more than one bookrunner.

INVESTMENT BANKER

NUMBER OF BOOKRUN IPOS

INVESTMENT BANKER

NUMBER OF BOOKRUN IPOS

Merrill Lynch Pierce Fenner & Smith

30

Wells Fargo Securities

9

Goldman Sachs & Company

29

Deutsche Bank Securities

9

Credit Suisse Securities (USA) LLC

25

Leerink Partners

9

Jefferies & Company Inc.

25

UBS Securities

9

JP Morgan & Company Inc.

20

BMO Capital Markets

8

Morgan Stanley & Company

18

Robert W Baird & Company

7

Barclays

18

Stifel Nicolaus & Company

6

Citigroup Global Markets

17

Evercore Group

5

Piper Jaffray Companies

14

Keefe Bruyette & Woods

5

Cowen & Company

14

Raymond James & Associates Inc.

5

RBC Capital Markets

12

Thirty-four additional investment banks participated in at least one middle market IPO in 2015. Source: Thomson Reuters

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Middle Market Equity Capital Report ― January 2016


About CohnReznick’s Public Companies Group Utilizing comprehensive resources and deep industry expertise, the professionals of CohnReznick’s Public Companies Group understand the goals of both middle market companies and investors to deliver timely and appropriate solutions and services. We understand the challenges and opportunities of the capital markets and possess the forward thinking technical skills and experience necessary to address the needs of clients, investment bankers, investment advisors, attorneys, lenders, investors, managements, audit committees, and the U.S. Securities and Exchange Commission and other regulatory authorities. • • • • • • • • • • • • • • •

Alex Castelli, CPA, Partner, National Liquidity and Capital Formation Advisory Group Anton Cohen, CPA, Partner, Renewable Energy Industry Practice Co-National Director Dom Esposito, CPA, Partner, National Liquidity and Capital Formation Advisory Group George Gallinger, Principal, CohnReznick Advisory − Governance, Risk, and Compliance National Director Craig Golding, CPA, Partner, Technology and Life Sciences Industry Practice Tim Kemper, CPA, Partner, Renewable Energy Industry Practice Co-National Director David Kessler, CPA, Partner, Commercial Real Estate Industry Practice National Director Adam Kleeman, CPA, Partner, Commercial Real Estate Industry Practice Gary Levy, CPA, Partner, Hospitality Industry Practice Leader Cindy McLoughlin, CPA, Partner, Hospitality Industry Practice Steven Schenkel, CPA, Partner, Chief Risk Officer Richard Schurig, CPA, Partner, Retail and Consumer Products Industry Practice Leader Mark Spelker, CPA, Partner, National Director of SEC Services Jeremy Swan, Principal, National Director, Private Equity and Venture Capital Industry Practice Stephen Wyss, CPA, Partner, Retail and Consumer Products Industry Practice

CohnReznick Advantage for Capital Markets Industry Insights, Optimized Solutions • Partners immersed in supporting public companies and capital markets transactions who understand your business drivers. • Support from industry specialists to offer comprehensive industry-specific solutions and insights. • Engagement teams utilize the Firm’s broad resources to provide innovative solutions and breakthrough ideas. Transformative Advice • Timely, relevant views about critical economic, business, legislative, tax, and global news and emerging trends in the capital markets. • Thought leadership reports, alerts, conferences, and events delivered in the context of what these issues mean to public companies, companies considering a public filing, the capital markets, and your business. Responsive Culture • Our partners are empowered and entrepreneurial decision makers. • They draw on our depth of knowledge and expertise to provide faster, smarter, more efficient service. Capital Markets Dexterity • Preparation, valuation, structuring, and facilitation of capital markets transactions, and introductions to capital sources. • Assistance with acquisitions, dispositions, liquidity events, and other capital-raising needs. Proactive, Resourceful Service • A true partner-led service model ensures direct access and active partner management. • Accountability and expectations are developed to meet your needs and documented in the CohnReznick Client Service Plan. National and Global Reach • With offices in 30 cities, we seamlessly and cost-efficiently serve clients on a regional, national, and international basis. • Companies with international interests in 100+ countries are served through our membership in Nexia International, a global network of independent accountancy, tax, and business advisors.

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CohnReznick LLP Š 2016 Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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