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CORPORATE GROWTH AND M&A

CONTENTS President’s Letter

PE Fund Priorities

Pre-acquisition Success

Seven Deadly Sins of a Unicorn

M&A and IPO Trends

Bank Acquisitions Transaction Professional Fees

8 8

Seeking Certainty

Cybersecurity Threats

Sealing the Deal M&A Growth Plan

11 11

‘Materiality Scrape’

Acquisition Land Mines Middle Market Business Management

14 14

Succession Planning

Data Breaches

Asset-Based Lending Cross-Border Transaction Advisers

17 17

Financial Due Diligence

Managing Seller Risk

Tax Insurance

Valuations Traditional Sale Variations

21 21

Organic Growth Small World Brings Growth

22 22

Raising Early Stage Capital

‘Copyleft’ Software The Deal Maker Awards ACG Cleveland 2016-17 Officers & Board of Directors ACG Events Calendar

24 24 24 24

January 16, 2017 S3

PRESIDENT’S LETTER

ACG celebrates 35 years of Accelerating Cleveland’s Growth By JOHN M. SAADA JR.

hat a year to call Cleveland our home. The Republican National Convention, a redeveloped Public Square, a UFC heavyweight champion, the Calder Cup, an NBA championship and World Series baseball. At ACG Cleveland, we are proud of our city and our role in Accelerating Cleveland’s Growth. ACG Cleveland is among the largest and most respected ACG chapters in the country. Our 500-plus members are exposed to a diverse membership group and exceptional professional development and networking opportunities. Many of our members also actively participate on chapter committees or the board. I am honored to currently represent ACG Cleveland as its president, and look forward to another fantastic year for ACG Cleveland and Northeast Ohio. In 2016, ACG Cleveland hosted many unique and diverse events, including the Great Lakes Capital Connection, a two-day networking, deal sourcing and educational event sponsored by the seven ACG chapters from the Great Lakes region. Held at the new downtown Hilton, the event attracted more than 1,000 attendees from 29 states, the U.K. and Canada. We also hosted a panel discussion featuring the president, vice president and counsel to the RNC host committee. As a “members-only” event, we engaged in an energetic “off-the-record” discussion regarding Cleveland’s role in attracting, preparing for and hosting this historic event. ACG Cleveland also hosted more casual, intimate events, including our annual golf outing at Firestone Country Club; downtown, East Side and West Side happy hours at several new local

About ACG ACG is a global organization focused on driving middle-market growth. Its 14,500 members include professionals from private equity firms, corporations and lenders that invest in middle-market companies, as well as from law, accounting, investment banking and other firms that provide advisory services. Founded in 1954, ACG is a global organization with 57 chapters. Learn more at www.acg.org. ACG Cleveland serves professionals in Northeast Ohio and has more than 500 members. For more information, visit www.ACGcleveland.org

restaurants, theaters and breweries; clay shooting; and a family friendly event on the Polar Express. We take pride in offering something for everyone, and this year was no exception. We also take pride in our commitment to leading Northeast Ohio into the future. Over the past few years, ACG Cleveland Saada Jr. has been the first chapter to create nationally recognized, robust groups focused on attracting, retaining and providing professional development opportunities to the next generation of corporate leaders and professional women in Cleveland. They are being served by our Young ACG and Women in Transactions special interest groups. I would encourage Cleveland’s young professionals and women in business to look at ACG Cleveland. We have developed unique opportunities for members of these two groups through networking, educational and entertainment events that meet their specific interests. As a result of the resounding success of these two programs, those involved in Young ACG and Women in Transactions now represent nearly a third of our membership. Finally, one of our premier events, the annual Deal Maker Awards, will be held on Jan. 19 at the Cleveland Convention Center. This is an event not to be missed by anyone in Northeast

Ohio’s corporate community. We will honor Northeast Ohio’s top corporate dealmakers for demonstrated success in using acquisitions, divestitures and financing to fuel growth. This year’s honorees include Capital Works, Huntington Bancshares, Diebold-Nixdorf and Trademark Global. We will welcome nearly 1,000 people from Northeast Ohio and around the country to congratulate the winners and enjoy a night of networking. If you are considering membership, I encourage you to attend an event and see the benefits of membership first hand. Personally, I’ve met many wonderful people and have developed some longstanding and meaningful business relationships through my involvement with ACG. It’s truly an exceptional network of energetic, interesting and diverse corporate professionals at all levels in their careers. In closing, I would like to thank all of our current members for their continued support, and I would like to especially thank my fellow board members and those members who are active on an ACG committee. Your dedication and commitment is inspiring and makes ACG Cleveland such a great organization. John M. Saada Jr. is president of ACG Cleveland and a partner in the Private Equity Practice at Jones Day. For more information about ACG Cleveland, visit www.ACGcleveland.org.

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S4 January 16, 2017

CORPORATE GROWTH AND M&A

Deal sourcing, deploying capital among PE fund priorities in 2017 A

s we approach the end of 2016, private equity continues to be a significant driver in middle market M&A. While a number of factors will continue to impose increased operating costs and more competition for deal flow, the industry has largely had a great deal of success in fundraising. Accordingly, deal sourcing and deploying capital will be imperative tasks for private equity funds in 2017. The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Shelton Act in 2011 was a game changer for the industry. It required private equity fund advisers with $100 million or more of assets under management to register with the Securities and Exchange Commission. The SEC has made it clear that it will continue to push for increased transparency from private equity

funds with respect to fees, costs and fund allocation. Notably, Andrew Bowden, director of the SEC’s Office of Compliance, Infractions and Examinations, was highly critical of private equity practices in a speech titled “Spreading Sunshine in Private Equity.” The breadth and depth of SEC inspections will continue to expand, with emphasis on allocating expenses among funds, charging portfolio companies for operating partners to avoid payment as a management company fee, and portfolio company monitoring fees. Moreover, private equity fund investors such as pension funds are pushing for transparency as well. Regulatory compliance, often in the form of a chief compliance officer, will continue to be a “must have” for both registered and un-registered funds. The balance of power between private equity fund general partners and their investors changed significantly in favor of private equity fund investors — also known as

‘‘

While the independent sponsor model has its own inherent challenges (such as convincing a seller that the sponsor will be able to secure adequate capital to timely complete the transaction), most independents view their ability to avoid traditional fundraising as an important advantage of their business model.

limited partners — after the global economic downturn. However, there are some signs of the balance shifting back towards historic norms. Nonetheless, institutional investors who continue to allocate greater portions of their holdings to private equity and reinvest returned capital back into private equity are typically demanding more concessions from the funds in which they invest. As well as demanding greater transparency, limited partners are

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demanding greater concessions on management fees. The traditional 2% management fee structure is no longer a given. In many instances, limited partners are reserving capital for coinvestment opportunities, rather than committing their dollars and paying the associated management fee. As a result, fund managers now are likely to have much more complex fund structures, with multiple entities and varying fee structures for their funds’ limited partners. This complexity, coupled with reporting and disclosure requirements can, and typically does, significantly increase the amount of infrastructure required to operate a fund. In addition to the greater amount of complexity involved in operating a private equity fund since the enactment of Dodd-Frank, traditional private equity funds now find themselves competing for deal flow not only with strategic buyers (that have a presumptive advantage in their ability to pay more for a target company), but also a variety of alternative financial investors. For example, socalled “independent sponsors” (also commonly referred to as “fund-less sponsors”) are actively competing with traditional private equity funds for deal flow, without the need to expend time and effort on time-consuming fundraising activities. While the independent sponsor model has its own inherent challenges (such as convincing a seller that the sponsor will be able to secure adequate capital to timely complete the transaction), most independents view their ability to avoid traditional fundraising as an important advantage of their business model. Indeed, most independent sponsors have warm relationships with multiple investors that can provide necessary capital, thus mitigating any perceived risk as to certainty of closing. Another source of competition for deal flow is family offices. Traditionally, family offices were fund investors, and not direct deal

‘‘

By PETER K. SHELTON

investors. However, in the past several years, there has been a significant industry shift as family offices have been less inclined to pay the ongoing management fees required by limited partners. These days, family offices are very likely to deploy their capital on a deal-by-deal basis with independent sponsors or, often, they will make a direct investment without a sponsor. Certainly not all family offices are equipped to source, execute on, and then operate their own deals. However, more and more family offices are adding the internal resources needed to compete directly with traditional private equity funds. In addition to independent sponsors and family offices, private equity funds of all sizes are seeing greater downstream competition from funds that were traditionally investing in larger transactions. Despite the more complex regulatory environment, and despite increased complexity in general partner/limited partner dynamics and fee structures, private equity funds of all sizes and types have largely been successful in their recent fundraising efforts. Indeed, the expected broad shakeout of the private equity following the global downturn did not materialize for the most part. According to a Bain & Co. report, private equity funds managed $1.3 trillion in un-invested “dry powder” in 2016. Accordingly, deal sourcing to deploy capital (on terms that yield relatively attractive returns) will continue to be of paramount importance to private equity funds and their investors. Peter K. Shelton is a partner in the Corporate and Securities Group at Benesch LLP, and a member of the firm’s Private Equity Practice Group. He also serves on the Board of ACG Cleveland. Contact him at 216-363-4169 or pshelton@beneschlaw.com.

CORPORATE GROWTH AND M&A

January 16, 2017 S5

Transparency can pad a business’ price tag

Assess quality of earnings during pre-acquisition By MARK B. BOBER

ost studies suggest that 70% to 90% of acquisitions fail to generate the investment returns targeted by the acquirer. M&A has always been tricky business, but what can executives do to increase their odds of success? The success rate is highly dependent upon a number of key components, including thorough up-front due diligence, the quality of the man- Bober agement team, culture assessment, indepth understanding of the industry, and a comprehensive post-acquisition execution plan to generate whatever target returns are needed to pay for the acquisition. That’s a lot of ground to cover, so let’s focus just on understanding the quality of earnings. During the

pre-acquisition period, here are areas to assess: n Commercial due diligence, including

analysis of historical as well as projected revenue and margins by customer, channel and originator; n Analysis of fixed cost structure versus variable cost structure of business; n Net working capital requirements, historically as well as forecasted; n Pro forma financial projections and a reasonable assessment of the underlying assumptions behind such projections; n The appropriateness of revenue recognition and expense cut-off to assess its impact on income as reported; n Adequacy of reserves for items such as doubtful accounts receivable, excess/obsolete inventory, warranty obligations, litigation exposures, etc.; n The quality and adequacy of property, plant and equipment to

assess the extent to which equipment requires replacement, deferred maintenance or incremental capital expenditures to support growth; n The quality and adequacy of the accounting and finance systems as well as the financial management team; and n Tax compliance and exposures. Of course, workforce culture issues, legal and tax structure of the transaction, and other acquisition nuances are critical to understand before the deal is completed. Looking at any deal objectively, with these facts in hand, will go a long way to boost the odds that any deal is a win-win for both parties. Mark B. Bober is practice leader in Transaction Services at Bober Markey Fedorovich. Contact him at 330-255-2425 or mbober@bmfcpa.com.

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CORPORATE GROWTH AND M&A

S6 January 16, 2017

The seven deadly sins of a unicorn By JAYNE E. JUVAN and ASHLEY E. GAULT

kin to a white, wild and legendary beast with a mythical horn, a unicorn in the business world is a private company valued at $1 billion or more that lacks a lengthy track record. Modern examples include

Uber, an app-based transportation company; Theranos, a health care blood testing company; and Airbnb, an online marketplace for lodging. All Juvan of these companies quickly rose to prominence and have

received considerable media attention. While a unicorn is supposed to be a symbol of purity and grace, in the corporate arena, some comGault panies once deemed unicorns have lost their way. Too of-

ten, lawsuits and enforcement actions follow media hype praising a rapidly rising company. If you’re a founder chasing the brass ring or an investor targeting a company with unicorn potential, make sure to avoid each of the following seven deadly sins so that you’re positioned for long-term success.

SIN: PRIDE

SOLUTION: Vet for character. Unicorns receiving a lot of attention are at risk of engaging in negligent, reckless or illegal conduct to sustain results. Don’t overlook vetting executives for character. A company governed by leaders with a strong moral and ethical compass is more likely to stay grounded and take compliance with laws seriously.

SIN: GLUTTONY

SOLUTION: Develop a reasonable growth strategy. Instead of trying to build an empire to satisfy an extreme desire for more, develop a moderately ambitious strategy that is legal and ethical.

SIN: ENVY

SOLUTION: Don’t let competitors drive your every move. Companies that constantly covet what their competitors have run the risk of being unable to differentiate themselves in the marketplace.

SIN: SLOTH

SOLUTION: Implement a compliance program. Rapidly rising unicorns may neglect adopting a corporate compliance program, but this is a critical undertaking so that compliance with applicable laws becomes part of the fabric of the company’s culture.

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SIN: WRATH

SOLUTION: Value employees. An effective corporate compliance program encourages reporting misconduct, values employees who file reports and fairly investigates alleged wrongdoing without retaliation.

DEAL MAKERS

SIN: LUST

SOLUTION: Focus on long-term results. Jettison the desire for immediate gratification and put in the hard work of designing a quality product or service.

SIN: GREED

SOLUTION: Prove and sustain your valuation. Don’t chase a bloated valuation that is difficult to justify and driven by a longing for immediate wealth, power and status. Jayne E. Juvan is a corporate and securities partner at Roetzel & Andress LPA. She can be reached at 216-615-4837 or jjuvan@ralaw.com. Ashley E. Gault is a corporate and securities associate at Roetzel & Andress LPA. She can be reached at 216-615-4823 or agault@ralaw.com.

Association for Corporate Growth Driving Middle-Market Growth

www.ACGcleveland.com

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CORPORATE GROWTH AND M&A

January 16, 2017 S7

Dealmakers should prepare for M&A and IPO trends By BOB SAADA

016 will go down as one for the record books. The markets were able to shake off several major geopolitical events this year. From the Brexit vote to the lead up to the election of President-elect Trump, over the past year, businesses have been focused on adjusting their strategies to prepare for longterm outcomes. What resulted has been a sustained, robust Matteson level of deal activity following two years of record-breaking momentum. In the last 12 months, there have been 11,795 announced deals worth $1.75 billion. The resiliency and strength of the U.S. economy continues to make our country among the most attractive for deal making. With increasing appetite from companies to find avenues to grow quickly through inorganic means, dealmakers are preparing for several potential wildcards in 2017 and beyond, including:

Regulatory headwinds It’s still too early to tell how the regulatory landscape may shift or ease under President-elect Trump’s administration; however, companies are exploring various scenarios so that their long-term dealmaking strategy stays on the straight and narrow. Industries most likely to be impacted include: health care, pharma, technology, industrials, power/energy, banking and financial services. 2016 was the year for the most blocked megadeals in history. As such, dealmakers across sever-

al different industries are monitoring for developments surrounding the spate of recently announced megadeals, including AT&TTime Warner, Qualcomm-NXP, CenturyLink-Level 3 and GE-Baker Hughes. Everyone will be watching to see how closely these deals get scrutinized under the new administration and whether they actually make it to the finish line. Historical trends suggest we can expect to see a number Kelly of assets to come to market as a result of regulatory concerns or duplicity surrounding some of these mega transactions.

Cross-border opportunities Overall, cross-border activity in 2016 was slower than 2015, with deal value declining by 5% and volumes declining by 4%. While outbound deal volume decreased by 15%, inbound volume increased by 8% in 2016. Despite the decline in overall crossborder activity, the continued inbound interest signals that the U.S. is still an attractive place for investors. Foreign investors, particularly those in China, are gearing up to navigate more challenges for cross-border deals than previously anticipated. In some cases, the U.S. is the only place foreign buyers plan to invest. They view the U.S. market as a safer bet with the strength of the U.S. dollar and overall continued resiliency and economic stability when compared with Europe and other areas of the globe. Expect the recent wave of Chinese interest to continue despite recent reports about the Chinese government’s concerns

over capital flight. Chinese buyers are motivated by the desire to own and operate businesses in the U.S., particularly in health care, tech, media, telecom, hospitality, retail and consumer industries.

market debuts, prompting others to follow suit. The key for new issuers will be their ability to be prepared with their regulatory and marketing story early on to take advantage of the market when the window opens.

New year, new IPO market

Private equity gets creative

Early 2016 was one of the slowest periods for new public issuance activity since the financial crisis. The upside for 2017? Unicorns are finding it increasingly difficult to hold off on going public. Faced with mounting pressure from investors and employees to cash in, in addition to a decline in pace of private fundraising, investors will once again turn to the IPO market as a way to achieve returns. Expect a robust pipeline with several big names waiting to make their public

Increased competition from corporate sources has led the private equity industry to look for alternative ways to deploy capital. Private equity dealmakers are moving from large standalone deals toward bolt-on acquisitions within the existing portfolio companies. They are also looking at market-driven opportunities, including acquiring carve-out businesses from corporate sellers partially driven by the rise of shareholder activism. Private equity

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buyers are placing bets in disruptive but volatile sectors such as energy and health care. Despite many unknowns ahead, dealmakers will continue to aggressively pursue strategic plays that will allow them to influence and put pressure on the competition in their respective industries. Technologydriven disruption will remain a key driving force behind deal activity. In Cleveland, contact local Deals partners Brian Kelly at 216-8753121 or brian.kelly@pwc.com or Thorne Matteson at 216-875- 3441 or thorne.matteson@pwc.com. Cleveland M&A tax partner Bradley C. Thompson may be reached at 216-875- 3062 or bradley.c.thompson@pwc.com.

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CORPORATE GROWTH AND M&A

S8 January 16, 2017

Successful bank acquisitions start with customers, employees and communities By JAMES R. RESKE

aying the highest price isn’t the key to successful bank acquisitions. The banking landscape is littered with banks that overpaid for acquisitions and subsequently found themselves on the block. They confused being a successful bidder with being a successful acquirer. The key to long-term success in M&A is understanding the true

underlying concerns of potential sellers, and meeting those concerns better than the seller themselves would. Community bankers have typically spent their careers meeting the financial needs of their neighbors and their businesses. The seller wants to know that Reske their new partner will complete the mission they’ve started. Sellers are loy-

al to their customers, and want to know that their customers will have improved products and services, yet still delivered with a community bank style and touch. They are devoted to their employees, and want to know that their employees will have more opportunities with the acquiring institution. They love their communities, and want to know that their communities will be in even better hands with the new partner. Yes, these community bank sellers understand their obligation to

Consider value, service when evaluating professional fees in a transaction By ROSS VOZAR

hen completing a transaction, hiring experienced advisers is critical. However, qualified advisers come at a price, and professional fees can become a significant component of transaction costs.

Generally, investment banking, legal and accounting services come with the steepest price tag. Shopping for advisers by price isn’t recommended; rather, value for money is key. As a best practice, you should find the right advisers to fit your transactional needs first, and then negotiate fees.

Investment banking fees are typically success-based and are calculated as a percentage of the sale price. Law firms historically charge on an hourly basis, but recently, some have experimented with fixed fees. Consulting firms performing accounting functions can price contingently. Accounting

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maximize shareholder value. However, concerns over customers, employees and communities will naturally weigh heavily on the decision of whether to sell and to whom. Would-be acquirers must not just persuade a seller that they can deliver on these promises simply so that they can “win the deal.” Rather, truly successful acquirers will have woven the concerns of the customer, employee and community so deeply into the fabric of their own DNA

that when they do win a deal, the customers, employees and community respond to the acquiring bank in such a way that they all work together to make it a success. The result will be a win-win for the shareholders of both the acquirer and the seller.

firms, however, bill on an hourly basis, as independence is fundamental to the industry and contingent fees are not permitted. Fees for all of these service providers vary significantly based on experience, value and availability. BDO has long approached transaction services through a flexible and individualized scope. Accounting diligence Vozar should not be treated as “one size fits all.” Tailoring services and fees to meet each client’s needs is the best way to keep fees commensurate with transactional risk. A customized approach helps target diligence according to the primary drivers of the value and the goals of the client. Another way to reduce fee costs is to avoid duplicative efforts wherever possible. For example, if a company

already has an internal team focused on sales and profitability by customer or product line, these efforts could be eliminated from the scope of financial due diligence. Timely communication also is an essential tool for managing transaction costs. Red flags should be quickly communicated to all advisers and internal teams so priorities can be shifted if needed. Otherwise, wasted time and higher fees result if key findings are not delivered until after the report is generated. While each transaction is unique, abiding by these best practices keeps you ahead of the game in managing professional fees.

James R. Reske, CFA, is executive vice president, chief financial officer and treasurer at First Commonwealth Bank. Contact him at jreske@fcbanking.com.

Ross Vozar is managing director of BDO Transaction Advisory Services. Contact him at 216-325-1716 or rvozar@bdo.com.

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CORPORATE GROWTH AND M&A

January 16, 2017 S9

Seeking certainty in uncertain times

Amass expertise early on By JEFF SCHWAB

y definition, a trend is a general direction in which something is developing or changing. Prior to the end of 2016, the private equity environment trended cautiously optimistic. The seller’s market dominated, competition for deals (and talent) escalated, and purchases for add-on versus platform companies continued. At the same time, Schwab many private equity firms closed funds at or above targets, demonstrating that investors continue to look for multiples of return unmatched in traditional investment vehicles. To earn these returns, private equity is finding ways to increase efficiencies and manage risk in the buy/sell process and beyond. One such tactic that has directionally developed is having risk managers

involved earlier in the buy/sell process. Engaging an expert risk manager as a member of a due diligence team helps avoid roadblocks and can expedite the close of a deal, which benefits both the buyer and seller, and ultimately the investors. In addition, having the right transactional coverage in place can protect from unforeseen circumstances while the deal is in process. Once a deal is closed, smoothly navigating from the transaction phase to the growth phase requires the expertise of trusted advisory partners who address unforeseen transactional risks and needs, and can seamlessly convert coverage to longer term when the deal is complete. More firms are adding to existing platform companies to leverage synergies and reduce initial costs. These add-ons complement the platforms and in many cases help the firms develop niche verticals. As the year unfolds, we expect the unknowns of a new administration

to develop into more visible actions. While it is far too early to predict the dependent trends, each element will require nimble proactivity aligned with changing economics and an evergrowing arsenal of legal mandates. The most successful private equity firms have always been and must continue to be prepared for inherent risks,

develop viable business transactions and grow companies to satisfy investors. Simple steps can build certainty. As one of a firm’s trusted advisers, a good risk management and employee benefits consultant can add value well beyond the price of the due diligence fee. Looking at the full spectrum of insurance services can gain efficiencies

beyond a sale’s close date. Even in the most uncertain of times, reducing risk and maximizing returns is all about having the right team in your corner. Jeff Schwab is senior vice president and private equity practice leader at Oswald Cos. Contact him at 216-658-5208.

TMA Ohio Chapter announces 2016 award winners!

We congratulate Joseph F. Hutchinson, Jr., Baker & Hostetler LLP, winner of the 2016 Lifetime Achievement Award pictured with Sally Barton, TMA Chapter President.

We thank Joe for his leadership and the contributions that he has made both in the turnaround industry and in our community.

We congratulate the winners of the 2016 Turnaround of the Year Award (from left) Michael Kaczka, McDonald Hopkins, LLC; Christopher Peer and John Polinko, Wickens, Herzer, Paniza, Cook & Batista Co.; Scott Opincar, McDonald Hopkins LLC; John Lane, Inglewood Associates LLC; Mark Kozel, BDO USA, LLP; and Stewart Saddler, Inglewood Associates LLC.

We are proud of the achievements of these members and celebrate their specific accomplishments with this year’s award. To the winners, thank you for your contributions to the Turnaround Management Association.

CORPORATE GROWTH AND M&A

S10 January 16, 2017

CONGRATULATIONS! AND

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A successful transaction. Easy to say, hard to do. The complexity of mergers and acquisitions transactions demands skilled and dedicated advisors who can identify risks and opportunities and add value throughout the lifecycle of a deal. Be sure you have the right people at the right time, linking compensation to corporate objectives while protecting your business assets and optimizing financial position. To discover more, contact Jeff Nicholson (jeffrey.nicholson@aon.com) at 216.623.4152, or Jay Moroscak (jay.moroscak@aon.com) at 216.623.4143.

Risk. Reinsurance. Human Resources.

rivate equity firms are facing increased scrutiny from investors, regulators and legislators around cybersecurity. As private equity firms make investments, they are preparing for an eventual attack, both during their due diligence and as part of their ongoing monitoring. Rather than a historically reactive approach to security, many companies are forced to proactively prove they are secure. Five years ago, a company would answer some basic questions pertaining to security. Most often, Schulman no further questions were asked. Now, acquisition targets typically ask questions related to a firm’s IT infrastructure, thirdparty vendors, and whether they conduct regular penetration testing to proactively prevent attacks. We hear mostly about the major cyberattack events, but the small events can be the most significant. Email attacks — receiving requests for wire transfers or links to malware — start off small and often blossom into something bigger. To prevent email attacks, there are a few steps firms can take, such as reviewing internal policies and controls, including procedures related to wires and how they are processed. Cash transfer requests should be double-checked, and employees should be trained on the proper procedures and policies. The 2016 NetDiligence report

shows that 77% of employee incidents are accidental, which means training and employee controls are very important. While it may be frustrating to employees to have to change their passwords every 30 days, or be denied access to social media sites, most understand the value of the security when their employer explains the risks. If an incident does occur, the first call should be to external legal counsel. They will be able to determine whether there was data exfiltration in a ransomware case, which will later assist your insurance claim, and whether the firm should pay the ransom. Additionally, if the ransom is attributed to funding terrorism, the firm could be liable if it were to pay the ransom. The mounting cost of cyberattacks has heavily impacted insurance companies, which are now taking several measures to assure they manage claims and losses. It is very important to read the entire policy and understand your obligations, what is covered or what is excluded. At a time when private equity firms are already being hit by increasing compliance requirements and costs related to business continuity, fees and expenses reporting, and standardization, cybersecurity has emerged as yet another major burden for firms. But it has also become indispensable as the threat to the industry grows. Jay Schulman is principal of Security and Privacy at RSM. Contact him at jay.schulman@rsmus.com.

CORPORATE GROWTH AND M&A

January 16, 2017 S11

Assemble a qualified team to seal the deal By ALBERT D. MELCHIORRE

or most business owners, the sale of a business is a once-in-alifetime endeavor. Owners should evaluate a sale and how it aligns with their goals and objectives for themselves, their families, companies and legacies. The following advice can help facilitate a successful sale process. To begin, be prepared if you want to maximize the value Melchiorre of the business and create a smoother sale. The areas of business to focus on include improving operational efficiencies; removing obsolete items from your inventory; complying with all environmental laws and regulations; preparing accurate monthly and annual financials (review or audit); ensuring the right management personnel are in

the right positions; and identifying a successor if you are retiring. Before you begin the process, you will need to assemble a strong M&A deal team. This will include an experienced M&A attorney, accountant, investment banker and investment adviser. Based on the input of this team, it is important to determine if your valuation goals and objectives can be met given the current state of the M&A market. Discuss your role post-closing. Some questions to think through: Are you looking to retire immediately after closing? Do you have your successor in place? Would you like to rollover a portion of your proceeds to participate in the future growth of the business to get a second bite of the apple? The M&A process will be a distraction to your business. The process can take between six to 12 months from the time your investment

High-growth firms should formulate an M&A plan

that a buyer might identify in due diligence. Make sure the business is performing at a high level throughout the process. Finally, try and keep an open mind when it comes to buyers. You need to balance keeping your eye focused on the end game of achieving your goals and objectives, and treating each interested buyer as if they are “the one.” Make sure you perform your own due diligence with each buyer, and understand their past performance and plan for the business after the transaction to ensure they are a good fit. banker is hired until close. A solid deal team will help minimize disruption by managing the process. That being

said, it is important you manage your business in ordinary course throughout the process to avoid negative surprises

Al Melchiorre is president and founder of MelCap Partners LLC. Contact him at 330-239-1990 or al@melcap.co.

Calfee Congratulates CapitalWorks and Huntington as 2017 ACG Cleveland Deal Maker Award Recipients

Seasoned team can help propel growth By MICHAEL SHAW

“W

e want to do some deals to supplement organic growth, but don’t know where to start.” This is a common refrain we hear from new clients and prospects. An active, programmatic M&A campaign to supplement organic growth can be a powerful tool when executed efficiently. Also, it is critical for high-growth companies to structure deals to allow for future investment. We typically recommend Shaw starting by identifying the M&A team and documenting a process that will be followed on a continuous basis.

Focus on team, process The team should consist of internal and external parties. Internal parties are typically those responsible for target identification, operational due diligence, financing and implementation. Your external team may consist of legal, accounting and buy-side advisers. The buy-side advisers will be able to help quarterback the process,

drive deal flow, structure the deal and keep the internal team focused on its core objectives. The M&A team should then be tasked with documenting a systematic, disciplined approach to deal discovery and execution (the playbook). Look to your external advisers for input on the playbook, as they should each have a breadth of experience executing deals for clients.

The attorneys at Calfee are proud to represent companies that engage

Financing acquisitions

in middle-market mergers and acquisitions and corporate finance.

High-growth businesses need to invest cash into working capital or capital expenditures, which may not leave significant cash resources for acquisitions. Acquirers can utilize non-dilutive sources of financing like seller financing or non-bank debt. Seller financing is a very attractive option — this can come in the form of a seller note, earn-out or having the seller roll equity. Outside of seller financing, non-bank debt can be attractive due to its flexible principal amortization structure, allowing an acquirer to preserve cash. Michael Shaw is partner at Copper Run Capital LLC. Contact him at 614-888-1786 or mshaw@copperruncap.com.

We congratulate our clients and all other award winners.

Calfee. Clients First. Cleveland | Columbus | Cincinnati calfee.com

CORPORATE GROWTH AND M&A

S12 January 16, 2017

‘Materiality scrape’ can be more than a minor cut Provisions unexpectedly alter a transaction By CHRISTAL L. CONTINI

ny business owner who has sold a business through a merger, stock sale or asset sale has gone through what I like to call the “death march,” wading through the various proposed representations and warranties. The owner has to recall and describe anything that would qualify as an exception to the long list of disclosures required by the buyer in the purchase agreement. Inevitably, the sellside lawyer and business people heavily negotiate with the buyer team to increase the Contini number of representations and warranties that would be qualified by “materiality” in order to limit the disclosures to areas of significance to the business. However, after all of the compromises are made, one sentence — which is usually found at the end of the purchase agreement — can undo all of the protection that the seller thought he or she had negotiated by inserting qualifiers, such as “material” or “material adverse effect” into certain representations and warranties.

Deal term surveys have indicated an increase in the use of the legal provision called a “materiality scrape.” The typical materiality scrape is a double materiality scrape. It eliminates or reads out any materiality qualifiers in a representation and warranty for purposes of determining whether or not a breach has occurred and the amount of indemnifiable losses as a result of the breach. For example, in a purchase agreement that includes a materiality scrape, the typical representation and warranty “seller is in compliance, in all material respects, with all laws” would be read for indemnification purposes as “seller is in compliance, in all respects, with all laws.” The word “material” would be completely disregarded and the seller would be liable for any losses incurred by the buyer as a result of the seller’s failure to comply with all applicable laws. Buyer’s reasons for including the materiality scrape include the following:

The purchase agreement usually contains an indemnification threshold (a basket) that serves to protect the seller. This prohibits the buy-

er from recovering losses until the total losses for seller’s breaches of representations and warranties exceed a pre-agreed threshold amount. The materiality scrape protects the buyer from “double materiality” hurdles because the buyer will have to prove materiality and have losses that exceed the threshold amount.

When determining the amount of losses resulting from a breach, the purchase agreement should be clear that the resulting losses recoverable from the breach should not just be those above a material amount.

Excluding materiality qualifiers can serve to eliminate or reduce post-closing disputes

over what constitutes “material.” Seller’s reasons for excluding the materiality scrape include the following:

The materiality scrape could give the buyer an incentive to search for any claim, no matter how minor, to pursue the seller postclosing for immaterial breaches of representations and warranties.

The seller will have an increased burden to disclose every immaterial exception to a representation and warranty. This could create inefficiencies in finalizing the disclosure schedules and ultimately closing the transaction.

Often, the materiality scrape does not apply to determining whether closing conditions have been satisfied. In this instance, the representations and warranties will be read for purposes of closing to include the materiality qualifiers. Therefore, the same representation and warranty that was true at closing may not be true immediately after closing, and the seller could be held accountable for a breach immediately after the closing.

The use of materiality qualifiers in certain representations and warranties is central to the meaning of the clause, and removing “materiality” in some instances can cause unintended applications. For example, the financial statement representation is based on generally accepted accounting principles, which provide

that the financial statements “fairly present in all material respects” the financial condition of seller. While no one wants to terminate a transaction negotiation over one sentence in a purchase agreement, a materiality scrape has a significant impact on the overall risk allocation of the transaction between buyer and seller. Therefore, the following compromises are often used to bridge the gap in negotiation: Increase the amount of the indemnification basket. n Specifically exclude certain representations and warranties from the materiality scrape to avoid unintended applications. n Instead use a “single materiality scrape” — the materiality scrape only applies to the determination of losses, but not for purposes of determining whether a breach has occurred. n

Like most negotiated points in a purchase agreement, the inclusion or exclusion of a provision will likely depend upon which party has the stronger negotiating position. While it is not uncommon for both parties to feel like they have a few cuts and bruises at the end of a negotiation, sellers should understand the potential effect that the inclusion of one powerful provision can have on an overall transaction. Christal Contini is a member in the Mergers and Acquisitions Practice Group at McDonald Hopkins LLC. Contact her at 216-430-2020 or ccontini@mcdonaldhopkins.com.

RALAW.COM ROETZEL & ANDRESS A LEGAL PROFESSIONAL ASSOCIATION

Our attorneys provide experienced counsel to boards on corporate growth strategy, governance, and compliance.

www.ralaw.com/corporate

B USINESS C R EDI T

Because sometimes capital hides in plain sight. Leveraging your collateral can be a powerful way to secure financing. An asset-based loan can help you with acquisitions, unexpected growth, recapitalization, cyclical needs and more – all while managing risk. We’ve financed solutions for hundreds of companies in wholesale, distribution, manufacturing, retail and more. Here are just a few of them.

Biery Cheese Co. $ 37,600,000 Senior Secured Credit Facility Refinancing April 2016

Sellars Absorbent Materials, Inc. $ 45,300,000 Senior Secured Credit Facility Recapitalization April 2016

Orsini Pharmaceutical Services, Inc. $ 12,500,000 Senior Secured Credit Facility Refinancing May 2016

Specialty Foods Distribution, LLC $ 5,500,000 Senior Secured Credit Facility Refinancing May 2016

Sierra Lobo, Inc. $ 14,100,000 Senior Secured Credit Facility Growth Financing May 2016

Martex Fiber Southern Corp. $ 19,200,000 Senior Secured Credit Facility Refinancing June 2016

Formed Fiber Technologies, Inc. $ 61,000,000 Senior Secured Credit Facility Acquisition Financing November 2016

Beck Aluminum Corporation $ 45,000,000 Senior Secured Credit Facility Acquisition Financing November 2016

If you’d like to work with us too, we’re ready. Contact the Huntington Business Credit team:

Doug Winget

Executive Vice President 216-515-0789 doug.winget@huntington.com

Joe Kwasny

Senior Vice President 216-515-0754 joe.kwasny@huntington.com

CORPORATE GROWTH AND M&A

S14 January 16, 2017

5 common acquisition land mines to avoid Sidestep recurring mistakes with these tips By DAVID P. MARIANO

or an acquisition to be considered successful, one would assume the newly combined entity is better off than either of the parts were previously. Simply put, value is enhanced, not destroyed. No acquisition is perfect, but with failure rates often cited as 60%-80%, there is plenty of room for improvement. Below is a list of five common mistakes companies make when buying businesses as well as ways to avoid each.

NOT HAVING A PLAN. Not having a plan for finding, purchasing and integrating a business is like choosing a random city in the U.S. and then attempting to drive there without a map. You’ll waste a ton of time (if you make it there at all). When you arrive, you might wonder why you went in the first place. If you don’t know where to look for the right companies, you will waste time on the wrong ones. Even worse, you may actually close a deal that

doesn’t make sense. How to avoid: Ask yourself, “What type of acquisition would fulfill a relevant and current market need and benefit all my stakeholders?” Formulate a plan to guide you through the process, and solicit input early on from your stakeholders, financing sources and advisers to avoid making moves you might regret. OVERPAYING. This is the classic mistake. You get caught up in the emotions of a deal, possibly end up in a bidding war, and later realize the acquisition didn’t make financial sense. This isn’t just a rookie mistake. Even the most seasoned businesspeople can fall in love with a deal. As Shakespeare said, love is blind. How to avoid: Know the market, retain experienced advisers, include your team in the decision and stay disciplined. Stick with your original plan.

one can sneak up on you. You could consider it overpaying’s evil stepsister. Often under the guise of discipline, not wanting to overpromise, or assuming one can convince the seller to be more “reasonable,” far too many would-be buyers underbid and never reach the negotia- Mariano tion table. Be conscious that sellers are very aware of what their companies are worth these days. Don’t expect to see many bargains. How to avoid: Again, know the market, retain experienced advisers, and don’t quit too early on those opportunities that are truly strategic. You can craft an offer letter that provides a fair and attractive value to the seller while still giving you, the buyer, an opportunity to make sure the seller’s claims and information check out.

UNDERBIDDING. Most buyers do anything they can to avoid paying too much, but this

INSUFFICIENT DILIGENCE. Much of this error is a result of simply not investing enough

time and resources to get the necessary work done. Executing a thorough diligence plan can be intense at times, but the outcome can be very rewarding when done well. Just as important as doing enough diligence is spending time on the right things. If the acquisition opportunity is strategic and fits your criteria, you should know where to focus so you don’t waste valuable time on the wrong things. How to avoid: Create a list of the top three to five items that will make or break the deal and focus on them. Some items require checking the box, while others deserve more attention. Don’t forget the areas that are easy to overlook during negotiations, such as culture, leadership and employee dynamics. These are often the areas that can burn you after closing. Use your time wisely and involve your internal and external teams early.

issues post-transaction including, wasted time and money, customer defection, employee attrition and a damaged reputation. One common oversight is not involving the target in the integration plan and execution. You may be the new owner, but don’t take their experience and perspective for granted — it may contain valuable information required for a better outcome. How to avoid: Formulate a plan as early as possible with your internal and external teams and let the plan evolve as things unfold. Have open and direct conversations with the target about life after the deal. Seek third party help if you need it. There are certainly other ways to sabotage an acquisition, but if you fall into one of the five traps above, your odds of a successful transaction are certainly diminished.

David P. Mariano leads the Acquisition Advisory Practice at Western Reserve Partners and hosts Fully Invested, a podcast for business owners. Contact him at 216-574-2108 or dmariano@wesrespartners.com.

NOT EXECUTING AN INTEGRATION PLAN. Closing the transaction requires a lot of work, but that’s just the beginning. Not having an integration plan is far too common and can lead to many

Solid PE ownership key to middle market business management By DICK HOLLINGTON

T “I know exactly who you should call.” People who know Private Equity, know BDO.

The Private Equity Practice at BDO Strategically focused. Remarkably responsive. A century of experience. BDO’s Private Equity Practice provides integrated, value-added assurance, tax, advisory and consulting services across the fund cycle, and across the world – all through a single point of contact. BDO Hanna Building, 1422 Euclid Avenue, Suite 1500, Cleveland, OH 44115, 216-325-1700 Accountants and Consultants © 2016 BDO USA, LLP. All rights reserved.

www.bdo.com/privateequity

here are four key elements to effectively manage middle market businesses: strategy, talent, alignment and governance. Mastering these four elements will improve the likelihood that you will have a successful business and investment outcome. Private equity owners must work with the management teams to develop clear threeto-five year strategies that articulate an aspiration for the business and provide a roadmap for how to get there. Making choices and Hollington prioritizing among strategic options is critical to developing a sound plan. Just as important is focusing on execution; otherwise the best plans are never realized. There is no question that having the right talent in key leadership positions is critical to the business success. Today’s leaders need to be smart, committed and willing to engage their teams to pursue a compelling vision. The alignment of the management team and ownership through compensation and equity incentive programs

drives the right behavior and encourages them to make decisions like owners. To do this, management teams need to have competitive current compensation with annual bonus plans aligned to the critical strategic and financial goals for the year. Longterm equity incentives tied to the ultimate value creation for investors complement these benefits. Finally, creating a high value governing board keeps the team on track. Finding successful industrial entrepreneurs and executives who can add deep strategic value to a middle market business is very important. These individuals can bring market perspectives that lower middle market business may not always understand. The board members become an extension of the private equity owner, and can be critical when trying to recruit top management talent and add credibility to the strategic planning process. The cadence and discipline that the board process brings to a middle market business further facilitates a successful outcome. Dick Hollington III is managing director and CEO of CapitalWorks. Contact him at 216-781-3233 dhollington@capitalworks.net.

CORPORATE GROWTH AND M&A

January 16, 2017 S15

Company Succession Planning 101 Address basic questions before selling closely held business

By JACOB DERENTHAL

losely held business owners know they someday need a succession plan, but most are focused on day-to-day operations and delay addressing the transition process. Company and family dynamics are unique to each situation, so there is no onesize-fits-all solution. Often, the hardest Derenthal part is knowing where to start. The simplest way is to ask three critical, interrelated questions.

WHO IS INVOLVED? Identify all existing stakeholders. Address which trusted stakeholders can continue operations. Those given management responsibility do not need to be the same people who take ownership. Then identify (a) what additional

training is needed to allow designated successors to run the business; (b) how to compensate successors to keep them incentivized; (c) what is needed to keep management personnel from being removed if they donâ&#x20AC;&#x2122;t control equity; and (d) a backup plan should preferred management exit the business. If no one from the next generation can successfully take over, owners must search for outside talent or begin strategic planning required to prepare for a company sale to an unrelated buyer.

WHEN TO TRANSITION? Most family owned business owners have identified a date (or age) when they want to walk away from day-to-day operations. Ask if current owners desire to remain involved in critical decisions going forward or if they want to exit without looking back. Tax and estate planning may be required to ensure ownership transfer is completed in the most efficient manner.

Consider if it is advantageous to transfer equity over time or implement a recapitalization to separate voting and economic interests. Certain deferred compensation plans and insurance products are most useful when implemented in advance

of retirement. Your transition structure will drive these transfer dates.

HOW TO IMPLEMENT THE PLAN? Economics drives most succession plans. Do current owners plan to give

the company away, or do they desire a buyout? Do the proposed future owners agree to assume financial responsibility and ensure their elders get paid? Knowing exactly who expects to be paid and in what amounts allows planning to maximize payout and minimize taxes. The succession proposal should be communicated to all parties before drafting documents. Once there is sufficient consensus from all participants, the formal succession plan should be created through corporate agreements and estate documentation. Experienced financial, accounting and legal counsel can provide options and identify areas of concern. A good succession plan will eliminate lingering uncertainties and ensure your companyâ&#x20AC;&#x2122;s long-term future. Jacob Derenthal is a partner in the Corporate Transactions Group of Cleveland-based Walter | Haverfield LLP. Contact him at 216-928-2933 or jderenthal@walterhav.com.

CORPORATE GROWTH AND M&A

S16 January 16, 2017

Don’t let a data breach derail the deal Cybersecurity assessments critical in M&A By TOD A. NORTHMAN and THOMAS R. PEPPARD JR.

he global cost of cybersecurity breaches in the business world is forecasted to exceed $2 trillion by 2019. The average cost of each data breach is more than $4 million and growing annually, according to a 2016 IBM-sponsored study. Of those businesses that participated in the study, 26% were likely to experience a cyberbreach in the next 24 months. Earlier this fall, Northman Verizon signaled the need to reevaluate its $4.8 billion bid to buy Yahoo! upon discovering a previously undisclosed Yahoo! data breach. With all of those cringe-worthy statistics in mind, cybersecurity due diligence should no longer be an afterthought to most buyers and their legal counsel. For many buyers, the focus on business diligence ends once they get their arms around the usual suspects such as financials, process, personnel, customers and suppliers. That is unfortunate, because the

likelihood and significance of losses from cybersecurity breaches can be readily mitigated by well-designed due diligence. In addition, potential targets can enhance the value of their businesses by adopting robust cyber risk-management programs. Buyers tend to evaluate a target’s information technology system based on whether the technology is sufficient to conduct business. Those buyers also are most concerned about confirming that industry-specific Peppard data security certifications, such as payment card industry compliance, are in place. Certification is important but insufficient. Target, Home Depot, and Yahoo! all were payment card industry-certified when their credit card systems were breached. Failure to rigorously explore a target’s cybersecurity plan is an expensive lost opportunity. Valuable intelligence can be learned by modestly expanding the scope of review if knowledgeable advisers, both legal and technical,

guide the investigation. The goal is to evaluate the sophistication of the target’s understanding of its data security risks, but the problem is that many don’t even know where to begin. While certainly not comprehensive, these are some suggested lines of inquiry for buyers to get the ball rolling: n

Review the target’s cybersecurity organizational structure. C-suite leadership should spearhead the effort. Stakeholders across the business functions (operations, treasury, legal, human resources, IT, risk management and audit) must participate. Alarm bells should go off if cybersecurity is the province of the IT department alone. Analyze the role of target’s counsel in evaluating and complying with the regulatory and enforcement environment. Evaluate target’s cybersecurity budget and consider its annual growth. Review the target’s unaccomplished goals for cybersecurity. Study target’s recovery plan, including the adequacy and reasonableness of its recovery points and time objectives. Consider when it was last reviewed and by whom.

Assess how target exploits and protects its IT assets. Target should prioritize defending against the greatest threats to target’s information, networks and systems.

Investigate prior cyberbreaches. Consider what is known about the attackers, what information was taken and what use was made of it, and how long it took from the time of intrusion until detection.

Analyze cybersecurity training programs for personnel. Review how frequently audits are performed. Human error causes 25% of cyber breaches in the U.S., behind malicious and criminal attacks (48%) and system glitches (27%).

Determine if third-party business partners hold company-sensitive information or are given the ability to access the company’s systems. Examine whether protections are in place to safeguard such information.

Assess the adequacy of breach notification systems. The longer it takes to detect and address the breach, the greater the damage done.

Evaluate the process for protecting the business’ information from misappropriation by former employees. Buyers should also consider

including express representations and warranties in the definitive purchase agreement relating to privacy, data protection and security (including any security breach notification requirements). This ensures compliance with applicable law, industry standards and the target’s existing policies and procedures. Having policies in place is the first battle, but compliance wins the war. The need for express representations and warranties is two-fold: to ensure the necessary information sharing and to make certain that there is an appropriate level of risk allocation between the buyer and seller. Without understanding the target’s data security policies, any prior or existing breaches, and how the target’s plans and procedures can be retained (or replaced) going forward, there is no way for buyers to perform an educated assessment of the potential risk in a proposed transaction. Tod A. Northman is counsel at Tucker Ellis LLP. He can be reached at tod.northman@ tuckerellis.com. Thomas R. Peppard Jr. is counsel at Tucker Ellis LLP. He can be reached at thomas.peppard@tuckerellis.com.

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Vice President, Transactional Risk Practice Leader 216.777.6100 jphillips@oswaldcompanies.com Learn more:

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CORPORATE GROWTH AND M&A

January 16, 2017 S17

Making the move to asset-based lending By DOUG WINGET

ith the continued economic recovery, more businesses are seeking to expand and diversify. All the more, they’re making this happen by leveraging a major financing opportunity still at their disposal: the value they have in their assets. With that in mind, how do you decide if an asset-based loan is Winget right for you? Businesses looking for greater availability from their working capital can often be a good fit for an asset-based loan. Companies in wholesale, distribution, manufacturing, retail and even service companies may find an asset-based loan a powerful way to lever-

age their assets to secure financing for such things as acquisitions, unexpected growth, recapitalization, cyclical needs and more — all while managing risk. Of asset-intensive businesses, those with a lower ratio of earnings before interest, taxes, depreciation and amortization with higher working capital needs generally are more likely to benefit from asset-based lending structures. Higher EBITDA margin companies with lower working capital needs generally benefit more from a traditional cash flow multiple-debt structure. Attributes of an asset-based loan credit structure usually require fewer financial covenants, but necessitate more collateral reporting based on the company’s accounts receivable, inventory, working capital and related materials. Another difference over conventional lending structures is the requirement

‘‘

Sometimes capital hides in plain sight

Of asset-intensive businesses, those with a lower ratio of earnings before interest, taxes, depreciation and amortization with higher working capital needs generally are more likely to benefit from asset-based lending structures.

of cash dominion for an asset-based loan. This typically involves establishing an efficient approach to optimizing cash flow and reducing debt through a comprehensive treasury management solution that includes a controlled disbursement account. The account channels the company’s receivables to a lockbox designated for paying down the revolving line of credit. Additionally, business owners RS-Crains-ACG-Ad-2016_v1.pdf typically aren’t required to provide a

personal guarantee in an asset-based lending solution. Asset-based lending finances companies with satisfactory asset availability and will also finance into a substantial turnaround situation, if the company has sufficient availability. Asset-based lenders are able to provide more flexible loan structures that may not require personal guarantees. Additionally, asset-based lending generally requires fewer financial 1 11/30/16 3:37 PM covenants for private business owners.

There can be much to consider when evaluating available financing options. The next time you’re in need of loan, the value you have in your assets may reveal a smart alternative to conventional commercial and industrial lending structures. Doug Winget is president of Huntington Business Credit and executive vice president of Huntington Bank. Contact him at 330-384-7448 or doug.winget@huntington.com.

Cross-border transaction advisers facilitate deals By TOM KELSEY and JESSICA XIE

he U.S. M&A market has seen an influx of Chinese buyers in the last few years. The resourcerich Chinese state-owned enterprises led the wave. However, those companies’ M&A activities have slowed down in the past year or two as a result of the Chinese anti-corruption movement. Instead, nonstate owned companies — mostly publicly traded companies and private equity funds — have become the leading force in Chinese M&A investments in the U.S., focusing on real estate, advance manufactur- Kelsey ing, consumer products and health care. The investments are driven by lack of room for growth in China due to the economic slowdown along with an increase in advanced technology and market expertise to China. Needless to say, that investing in the U.S. has always been a desirable globalization or asset diversification strategy to Chinese businesses. Even though Chinese companies have strong interests in acquiring U.S. entities, their chances of winning deals are lower than other U.S. competitors. Most Chinese buyers have little crossborder M&A experience. The language barrier, significant difference in culture and regulations, and tough U.S. national security scrutiny have made Chinese M&A investments in the U.S. even more challenging and risky. A lot of U.S. sellers are hesitant to work with Chinese buyers despite their

heftier price offerings. The key to success is to engage advisers who have strong cross-border transaction experience and expertise in finding the optimal target companies. Capable advisers perform high-quality due diligence and know how to manage and identify risks. Proficiency in both the Chinese and English languages is also critical. An adviser’s experience in risk management is another important consideration, as U.S. insurance considerations are still new to many Chinese investors. Insurance due diligence and transactional insurance products, such as Representations & Xie Warranty and Environmental Liability, will help facilitate deal success and reduce post-acquisition disputes. These issues may include patent infringement, material adverse change, tax considerations, contingent liability, litigation disputes or indemnities related to past transactions. In order to optimize opportunities with Chinese investors and obtain a comprehensive report on risk-related matters and opportunities for insurance risk capital use, engagement with experienced cross-border advisers is recommended. C

This City Inspires Us

And that’s why we call Cleveland our home To learn more about Riverside’s strategies to grow

CMY

Tom Kelsey is client executive at Hylant Cleveland. Contact him at 216-674-2511 or Tom. kelsey@hylant.com. Jessica Xie is vice president of Cross-Border Transactions at Hylant Toledo. Contact her at 419-259-2729 or jessica.xie@hylant.com.

companies with up to $30 million in EBITDA, contact Cheryl Strom, Origination, at +1 216 535 2238 or cstrom@riversidecompany.com.

The Riverside Company | 50 Public Square, 29th floor Terminal Tower, Cleveland, OH 44113 www.riversidecompany.com

CORPORATE GROWTH AND M&A

S18 January 16, 2017

Is conducting financial due diligence enough? Private equity buyers should canvas commercial, supply chain process

By DARON GIFFORD

rivate equity buyers need to think twice before limiting their due diligence to financials. Numbers can be checked and doublechecked, but they can be unreliable and misleading if they aren’t evaluated in the right market context. Commercial due diligence, especially involving your target’s customer base and supply, is critical for obtaining an accurate view of operations and marketplace position.

Commercial due diligence An effective commercial due diligence process provides buyers insight into the future growth of their target acquisition. But achieving this clarity calls for a thorough review of financial forecasts, operational procedures and market strength. Consider the following:

CUSTOMER COUNTS. A company’s future earnings are directly tied to its customer base. Disproportionate revenues coming from a few select clients indicate the customer list may be less stable than if sales were spread

evenly over more clients. Durability of customer relationships is critical to meeting future expectations. It’s important to understand the level of intimacy with the top purchasers, as well as the employees responsible for maintaining touchpoints.

PRODUCT LINE STRENGTH. Without a quality product line, there’s a risk of compromising loyalties. Examine the seller’s portfolio carefully to gauge product stability. Pay close attention to new offerings. Weigh them against the seller’s skill set and alignment with future customer demands. Verify whether the seller’s selfprofessed skills are capable of delivering the results they promise. If not, decide if those skills are easily obtained elsewhere — and at what cost.

SALES PROJECTIONS. If sales are spiking, confirm if the increase is organic or attributable to risk-related events. If the latter, distinguish between fleeting and long-term risks that could disrupt sales trends down the road. Assess whether forecast projections are logical in the context of your

target’s customer relationships. For instance, if sales with a tech startup are projected to triple, due diligence will flag the projection and perform a more realistic assessment. Perform a comprehensive industry analysis to understand short- and long-term trends. Document any Gifford uncertainties. Some industries require closer scrutiny, including health care, energy, telecommunications and manufacturing.

SIZE UP THE COMPETITION. Assess the seller’s marketplace position and value propositions against those of its competitors. Look for factors that threaten long-term financial health while charting growth (or decline) of market share. Recent M&A activity among competitors can also impact future earnings.

SALES FORCE DYNAMICS. Explore the seller’s sales organization to understand how business is secured and retained. This can reveal hidden, though important, business relationships. For example,

“WE ARE CREATING THE MOST SIGNIFICANT LIQUIDITY EVENT IN THE HISTORY OF OUR CLIENTS’ LIVES… AND WE TAKE THAT RESPONSIBILITY VERY SERIOUSLY.”

ers, should an event compromise supplies from the primary source.

if the seller offers a customer ongoing price reductions, make sure this expectation has been accounted for in post-integration projections.

Supply chain due diligence Market fluctuations, volatile foreign exchange rates, political turmoil, labor unrest and natural disasters all present risks that can interrupt the supply chain, which may cause part shortages and production slowdowns (or even shutdowns). In some instances, they can impact cash flow and trigger financial instability. A critical element of your commercial due diligence should include a thorough review of the acquisition’s supply chain. Evaluate these areas to mitigate risks:

CONSIDER SPEND CONCENTRATION. Examine the spend concentration among suppliers, particularly for highly strategic/critical commodities and categories. An imbalance of qualified suppliers could lead to supply chain disruptions. Also note products procured from a single source. These arrangements may present profound risks, depending on the supplier’s stability, backup facilities options and sphere of operations.

DETERMINE THE SUPPLIER’S FOOTPRINT. Assess the footprint to understand any known or probable risks, such as those related to geopolitical, disaster, political, economic or environmental factors. If the target relies on a single supplier, be sure to understand the availability of other qualified suppli-

REVIEW CONTRACTS. If the company presents a very small percentage of the supplier’s business, delivery during a supply chain event may face a greater chance of disruption than if they represented a larger percent of the supplier’s business.

EXAMINE SUPPLIER PERFORMANCE. Review all supplier relationships, assessing their performance and strength. Performance should be tied to specific metrics — cost, quality and delivery — while strength addresses trust, collaboration and efficiency. Understand where there are opportunities for improvement.

ASSESS MANAGEMENT PROCESSES. While the target should maintain robust supply chain monitoring, does the supplier offer the same? Assess the supplier’s qualifications and supply chain management processes. While financials tend to be the most thoroughly examined aspect of the due diligence process, commercial and supply chain considerations should be equally examined to gain a more reliable view of the prospect’s business. The end result? Added clarity for what the future holds for the buyer. This helps mitigate risk to the buyer, strike the appropriate transaction price, and potentially can lead to a higher return on the investment. Daron Gifford is a partner and leads Plante Moran’s Commercial Due Diligence practice. Contact him at 877-622-2257, x33709 or daron.gifford@plantemoran.com.

WHERE WILL YOUR GROWTH COME FROM?

At MelCap Partners, our goal is to show you, our valued client, that you are not just a number to us. We strive to provide high quality and innovative investmentbanking services to middle market companies. We are here to help you reach your goals and objectives.

MelCap Partners, LLC Middle Market Investment Bankers

1684 Medina Road, Suite 102 Medina, OH 44256 Phone: (330) 239-1990 Fax: (330) 239-1991 www.melcap.com

Securities offered through M&A Securities Group, Inc. Member FINRA/SIPC. MelCap and MAS are not affiliated entities. The testimonial presented above does not guarantee future performance or success.

Copper Run’s merger and acquisition advisory professionals provide senior level attention on every transaction. We help our clients transition ownership, grow through acquisitions, or secure financial partners for future growth.

SELL-SIDE ADVISORY | BUY-SIDE ADVISORY | VALUATIONS Copper Run Capital LLC | 614-888-1786 | Copperruncap.com

CORPORATE GROWTH AND M&A

January 16, 2017 S19

Managing seller risk in M&A transactions By MARIE C. KUBAN and DOUGLAS K. SESNOWITZ

ou’ve decided to sell your company. You’ve found the right buyer, the parties are completing due diligence and are negotiating the purchase agreement. It might seem like the perfect time to focus on managing your post-closing risk. After all, that’s what you are paying legal counsel to do — draft an ironclad agreement that protects you. However, if you wait to manage your risk until the due diligence or purchase agreement phase, then it might already be too late. Many provisions get negotiated at the purchase agreement phase to protect sellers. Such provisions include negotiating a working capital methodology schedule with appropriate principles and benchmarks to determine target working capital, inserting “knowledge” and “materiality” qualifiers in the representations and warranties to limit risk shifting, including a deductible to Kuban reduce liability for incidental losses, negotiating a damages cap so the entire purchase price isn’t in jeopardy, and limiting earnouts and seller notes so that more of the pur- Sesnowitz chase price is paid in cash at closing. The preparation of thorough disclosure schedules to the purchase agreement is also an important protective measure for sellers to reduce the risk of post-closing indemnification claims. A strong purchase agreement is certainly a key component to managing risk. However, to get a deal done, a seller may not be able to get all of the protections it wants into the purchase agreement. Mitigating risk in an M&A transaction should begin long before a purchase agreement is negotiated, or even before a buyer shows interest in the company. Self-assessment is one of the most important steps a seller can take to mitigate its risk in an M&A transaction. While a company should always be assessing its business activities, it is even more critical to identify actual or perceived issues with the business when a sale transaction is under consideration — or even just a possibility. For example, is the company collecting taxes and filing returns in every jurisdiction where filings are required? Does it have adequate compliance policies in place? Are there any minority shareholder or key employee issues that need to be addressed? Are there any material issues with customer or vendor contracts or other performance issues? A seller that can identify potential issues and either remedy them, start the correction process, or have an explanation that limits the potential negative impact of such information

is better able to manage its own risk. This ground work can put the seller in position to push back if the buyer tries to introduce its own “protective” measures in the purchase agreement, and may even forestall a buyer from introducing such measures. Such buyer protective measures can include lowering the purchase price, re-

quiring a larger indemnification escrow that lasts for a longer period of time, introducing special escrows, having longer survival periods for representations and warranties, or requiring specific indemnities not subject to caps and deductibles. There will always be business issues that will need to be addressed when negotiating an M&A transaction. But

if a seller does its own proactive “due diligence” and can take corrective measures and control the narrative before issues are discovered by the buyer, it will strengthen its negotiating position, protect transaction value and reduce its post-closing risk. Marie C. Kuban, Esq., is vice chair

of the Business Law Group at Ulmer & Berne LLP. Contact her at 216-583-7434 or mkuban@ulmer.com. Douglas K. Sesnowitz, Esq., is vice chair of the Business Law Group at Ulmer & Berne LLP. Contact him at 216-583-7144 or dsesnowitz@ulmer.com.

Your deal gets done here. Coshocton County Memorial Hospital Association Acquisition of assets of LC Drug and Alcohol Testing Associates, Inc.

Sale to Prime Healthcare Foundation, Inc. in Chapter 11

Gulfstream Polo, LLC $30 million sale of polo club to Pulte Homes

Kirtland Capital Partners Sale of Precision Dialogue to RR Donnelley

Ohio Travel Bag Manufacturing Co.

Pocono Mountain Recovery Center Sale of stock to CRC Health, LLC (a public healthcare company)

Flint Group North America Corporation Acquisition of American Inks and Coatings

MCM Capital Partners Acquisition of Action Industries, Ltd., Torsion Source LLC, Torsion Plastics, LLC and Flex Brush LLC

PT Liquidation Corp.

f/k/a Premier Tool & Die Cast Corp. Sale to MV Metal Products & Solutions, LLC

Sale to Zorro Capital, LLC

Quaker Steak & Lube Sale to TravelCenters of America pursuant to Bankruptcy Code § 363

Zacara Farm $27 million sale of equestrian polo facility

Purchase of assets of De Garmo Marketing

Patrick J. Berry

Co-Chair, Mergers and Acquisitions

$24 million recapitalization of multi-tenant industrial flex warehouse portfolio

Michael J. Meaney

Co-Chair, Mergers and Acquisitions

McDonald Hopkins LLC 600 Superior Avenue East, Suite 2100 | Cleveland, OH 44114 | 216.348.5400

mcdonaldhopkins.com

CORPORATE GROWTH AND M&A

S20 January 16, 2017

Tax insurance bolsters deal security T

ax insurance is one of a suite of risk-transfer insurance products — along with Representations and Warranties insurance and others — that are aimed at addressing deal risks. Tax insurance offers protection to a taxpayer in the event that the IRS or a state, local or foreign taxing authority challenges its tax position. In concept, it’s quite simple. The policy works to provide comfort through insurance similar to what would be achieved by receiving a Private Letter Ruling from the IRS. The insured taxpayer sets the limit of liability it buys, and policies typically run concurrent with the Blitz statute of limitations up to seven years. Reasons vary why tax insurance is used, as do the type of product user. Private equity firms often use the product to avoid a large unanticipated

Acquisition of Multiple Tim Hortons Stores in Dayton and Zanesville

‘‘

By GARY BLITZ

Private equity firms often use the product to avoid a large unanticipated tax payment that could compromise the economic upside of a deal.

tax payment that could compromise the economic upside of a deal. A fast-growing part of the tax insurance market is use of the product with no transaction, simply to manage a large contingent exposure. Institutional tax equity investors also use tax insurance to achieve comfort that an anticipated tax credit, say the Solar ITC, will be available as projected and not recaptured. For example, in the M&A context, a buyer and a seller might disagree over the availability of a 338(h)(10) election to achieve a basis step-up because of issues surrounding the target’s status

as an S-corporation. The insurance addresses buyer’s concerns if the seller’s more positive view of its tax position does not pan out post-closing. Similarly, a Fortune 500 corporation might seek comfort that the tax treatment of a reorganization or restructuring will be respected by the tax authorities. Tax-free spin-offs, redemptions, REIT qualification, net operating loss carry forwards and transfer pricing also have been the subject of tax insurance. With an experienced tax insurance broker and seasoned insurers, tax insurance can be an effective tax

risk management tool. For corporate taxpayers as well as parties to M&A transactions, it is a means to add certainty where the size or complexity of a tax issue might raise concerns.

We Close Deals.

Gary Blitz is senior managing director and co-practice leader of Aon Transaction Solutions. Contact him at 212-441-1106, 301-7044640 or gary.blitz@aon.com.

Joint Venture in China

Representative Transactions January 2016

Sale to Pierry, Inc.

Underwriters to Medical Transcription Billing Corp.

Acquisition of Ohio Legacy Corp.

November 2016

July 2016

September 2016

Sale to Middlefield Banc Corp.

Refinancing Sale/Leaseback

December 2016

January 2016

Acquisition of Chem Link, Inc.

For more information please contact: July 2016

Sale to ICON PLC

April 2016

September 2016

Sale of a Controlling Interest to Stone-Goff Partners II, LP

Brian M. O’Neill Business Department Chair brian.oneill@tuckerellis.com 216.696.5590 Christopher J. Hewitt Mergers & Acquisitions Group Chair christopher.hewitt@tuckerellis.com 216.696.2691 M. Patricia Oliver Financial Services Group Chair patricia.oliver@tuckerellis.com 216.696.4149

November 2016

Acquisition of Retail Division of Pexco LLC

November 2016

Sale of Eureka® Brand Vacuum Cleaner Assets to Midea Group Co., Ltd.

December 2016

CORPORATE GROWTH AND M&A

January 16, 2017 S21

Valuations: Is the tide still rising? By ANDREW K. PETRYK

e have witnessed conditions of a seller’s market, certainly for high quality businesses, as the “status quo” for a sustained period. Combined corporate cash hordes and bulging private equity coffers have fed a persistent imbalance between capital and available deal flow. Aggressive capital providers have moved in lock step — extending full leverage — supported by the rise of alternative Petryk lenders and a recharged mezzanine market. Factoring in a higher degree of seller sophistication, you are left with a market fervor that has fueled bidding wars and a run-up in valuations, with purchase price multiples returning to levels observed during the previous 2007 peak. Today’s multiple inflation of 1x to 2x EBITDA (earnings before interest, taxes, depreciation and amortization) doesn’t discriminate by company size. The market premium widens

when there is strategic interest, with differentiated assets in growing sectors garnering multiples in the double-digits. EBITDA multiples for the middle market — whose enterprise values are between $25 million and $500 million — have remained within a tight band. They averaged 8x to 9x throughout 2016, according to Standard & Poors Leveraged Commentary & Data. In November, median EBITDA multiples for strategic and financial buyers were 7.4x and 9.5x, respectively, on transactions valued less than $250 million, and 10.3x and 8.5x on transactions valued between $250 million and $500 million. Middle market leverage multiples reached an annual high in October, with total leverage expanding to 4.8x. Are valuations at a peak? Timing is everything, which reminds us of the old adage, “all good things must come to an end,” particularly as we head into extra innings in the current business cycle. Uncertainty is the bane of the M&A market, which will be digesting the ramifications of a changing political climate on the economy, interest rates

and the capital markets. All will have the effect to sway investor confidence and influence corporate acquisition strategies. What is certain: The rationale for acquisitions remains unchanged. Limited organic growth opportunities are driving strategic acquisitions to meet shareholder expectations, with buyers looking to acquire technology, broaden product portfolios and diversify into growing markets. Capital availability and deal scarcity should sustain purchase price multiples at current elevated levels, at least in the near-term. Sellers can be sure there is no better time to evaluate strategic options. Andrew K. Petryk is a managing director and principal at Brown Gibbons Lang & Co. Contact him at 216-920-6613 or apetryk@bglco.com.

Experienced insights. Agenda-free advice. Our private equity and M&A specialists are ready to help you evaluate complex risks and give you the advice we would want if we were you. Hylant. Working hand in hand with clients since 1935 to position them for success.

ACQUISITIONS & DIVESTITURES

FINANCINGS

GROWTH CAPITAL

Variations to traditional sale offer additional benefits By MICHAEL D. MAKOFSKY and STEVEN P. LARSON

hen owners contemplate a business sale, many envision selling their entire interest to a third party. This traditional type of sale, however, may not always be possible or in the owner’s best interest. The following are two types of transactions that may provide additional benefits to the owner and allow them to meet their goals.

Recapitalization In an equity recapitalization, a private equity investor buys out most, but not all, of the owner’s interest in the business. This allows Makofsky the owner to unlock some of the value tied up in the company and creates a liquidity event for what is often the largest portion of the owner’s net worth. It also gives the owner the opportunity to remain involved in the operation and the decision-making process. Moreover, when the investor sells the business in the future, the owner may sell his or her remaining equity as well, thus gaining additional upside from a second liquidity event.

Management buy-out A management buy-out is a transaction where a company’s management team purchases the assets and oper-

ations of the business that they already manage. The existing managers acquiring the business have a better understanding of the company. There is little to no associated learning curve, as opposed to a new set of managers learning the business on the fly. This transaction can be structured to occur all at once, with the owner leaving or staying as a consultant, or it can be structured over a period of years to allow control to gradually transition from the owner to the managers. This option especially makes sense when the owner is not quite ready to walk away entirely but wants to take on a reduced role in the business. There is no “one size Larson fits all” approach when owners are selling their business. These alternatives are among many variations that can provide flexibility and better meet the needs of the owner. Michael D. Makofsky is a principal in McCarthy Lebit’s Mergers & Acquisitions and Banking & Finance practice areas. Contact him at 216-696-1422 or mdm@ mccarthylebit.com. Steven P. Larson is an associate in McCarthy Lebit’s Business & Corporate, Mergers & Acquisitions and Real Estate & Construction practice areas. Contact him at at 216-6961422 or spl@mccarthylebit.com.

A Focus on Success Through Partnership Cascade Partners LLC is an investment banking firm serving entrepreneurs, businesses and investors active in the middle market. We work with our client partners and provide: n

Outsourced Corporate Development Services

Sell Side Advisory Services

Acquisition Advisory Support

Growth Financing

Recapitalizations

FOR ADDITIONAL INFORMATION CONTACT: Ken Marblestone n 216.404.7221 kenm@cascade-partners.com Kevin Groff n 216.404.7560 keving@cascade-partners.com

Securities offered by Cascade Partners BD, LLC – FINRA/SIPC Member

CLEVELAND 216.404.7221

| WWW.CASCADE-PARTNERS.COM

Cascade Partners is a Midwest focused firm with offices in Cleveland, Detroit and Chicago

S22 January 16, 2017

CORPORATE GROWTH AND M&A

Shrewd corporate planning aids in organic growth By KEVIN GROFF

ontrary to perceptions created by the pace of M&A activity, not all business owners are clamoring for an exit. Across the landscape are high-functioning private companies planning for expansion. The persistent challenge, however, is that sustaining real growth in sales and earnings is difficult, even for the most skilled managers. Organic growth results from increasing Groff output, customers or new products. These initiatives are all challenging, and have front-loaded expenses with long gestation periods. Inorganic growth refers to enhancing performance by acquiring assets (such as product lines, customers, technologies and

companies) from others. In times of slow economic expansion and cheap capital, firms wisely employ their balance sheets to enhance profitability. Unfortunately, a conflux of forces is creating headwinds for companies lacking a committed corporate development function. Since the end of the Great Recession, capital availability has ballooned. There are approximately 2,000 private equity firms now active in North America. Coupled with historically high levels of cash on corporate balance sheets, the competition for “deal flow” is as high as we’ve seen in years. The notion of effective ad hoc expansion strategies is dead, as competing players are highly organized. In the absence of a proactive and consistent effort, the opportunities to drive growth will be unavailable or priced out of reach for producing

achievable returns. Companies that succeed in acquisitions exhibit consistent traits that can be emulated. They create value by committing resources — internal or outsourced — to a proactive, disciplined and repeatable approach that ties to their strategic plans. They map and track competitive landscapes and build relationships outside of the enterprise. A high-functioning corporate development team should identify valued assets before they trade, and establish multiple pathways to engage (commercial, joint venture or acquisition) and finance them before they come to market. Preparation is the key to success. Kevin Groff is a director in the Cleveland office of Cascade Partners. Contact him at 216-404-7560 or keving@cascade-partners.com.

Small world means big potential for private equity Firms finding growth around the globe By STEWART KOHL

n its early years, private equity was largely practiced only in the United States. As globalization has increasingly affected all economies, private equity firms have become more adept at capturing the opportunities presented by a much more international marketplace. Few firms were doing deals in Europe when The Riverside Co. launched its European fund in the 1990s. That changed rapidly as Kohl the Eurozone came into being and regulations changed to allow more private equity growth. Likewise, the Asia-Pacific region had very little private equity presence until the last decade or so. We expect private equity to be practiced avidly in most parts of the world soon. Beyond the regulatory changes, decline in trade barriers and investors’ appetite for international funds, we believe there’s a simple driver behind private equity’s global spread — good private equity stewardship benefits industries and economies everywhere it is practiced. It helps companies thrive, creates jobs and helps build strong communities. As the world gets smaller and private equity firms learn markets and industries even better, we expect more activity across the world, with options for those who prefer to invest

in developed economies, emerging economies and even distressed economies. This interconnected world means more than finding the best companies in which to invest, wherever they reside. It also means harnessing those connections. Riverside and other companies benefit from globalization not just by finding a German bike parts retailer or an Australian orthopedic supply company. They benefit by applying talent and resources to connect markets, suppliers and potential across their portfolios. This effort is perhaps most dramatically illustrated by crossborder add-on acquisitions. Some investors’ finest platforms have been bolstered by an international add-on (or three). Even something that seems mundane can prove vital. Growing sales internationally doesn’t sound exciting, but it can be a matter of success or failure if the company’s home economy is struggling. Savvy private equity investors with local knowledge can get the job done, whether helping a U.S.-based company understand complex regulations and markets to reach customers overseas or assisting a Spanish company tap the U.S. market. The shrinking world indeed is a growing world of opportunity. Stewart Kohl is co-CEO of The Riverside Co. He can be reached at 216-344-1040 or info@riversidecompany.com.

CORPORATE GROWTH AND M&A

January 16, 2017 S23

4 ways to prepare for raising early stage capital By TERRY DOYLE

aising capital for an early stage company can be a daunting task. There is a lot of useful advice and “better” practices but unfortunately no definitive road map for success. For most entrepreneurs, raising money will be a trying process that will require significant time and resources. However, entrepreneurs who prepare for success can lead a more focused process and typically have better outcomes. Below are four tips to prepare for fundraising that will allow you to hit the ground running when your business requires capital.

The first offer is not necessarily the best offer. At the outset, you should develop a detailed financial plan so that you know how much capital your business requires. This sounds intuitive, but many entrepreneurs raise too little or too much early stage capital because they have

not done the “bottoms-up” financial planning to determine how much their business needs. Knowing your financial needs will ensure you are talking to the right investors and can prevent unnecessary dilution. Raising too much money and failing to efficiently convert it to value, or acquiring too little money and having to Doyle raise money again at a flat or lower valuation, are both are less than ideal outcomes.

Pick the right investors. Just because an investor has the funds does not mean that individual is the best fit for your business. Pick an investor that understands your business and industry, is comfortable with your company’s stage of development and has a good reputation in the industry. Entrepreneurs should diligence how “hands on” an investor likes to be and should be on the same page regarding what the investor

will deem a successful return.

Prepare for due diligence. Regardless of the size of the investment, most sophisticated investors will conduct some level of due diligence. Be prepared for these diligence probes by requiring employees to enter into invention assignment agreements, cleaning up your cap table and developing a repository for your material contracts. Most entrepreneurs are surprised at how much work remains after the term sheet. Proper documentation will greatly reduce the time it takes to secure your investment capital.

Determine the structure of your offering. Preparation and knowing your structure options will allow you to jointly decide with your investor which structure is best for your company. Deal structure is always a negotiation. If one side is dictating all of the terms, chances are both sides will lose. Make sure you have discussed all of your options with your

accounting and legal advisers to ensure you are making the most informed decisions that give your business the best opportunity for success. Raising capital for an emerging company can be an arduous process, but spending some time and money on the

front end to be better prepared can go a long way toward reaching your goals. Terry Doyle is partner at Calfee, Halter & Griswold LLP. Contact him at 216-622-8499 or tdoyle@calfee.com.

Eliminate Surprises BMF Transaction Advisory Services provides thorough due diligence and quality of earnings assessments that help you better evaluate the value of a target company so there are no surprises down the road. Mark B. Bober, CPA/ABV, CFF, CVA Partner and Practice Leader Transaction Advisory Services bmfcpa.com • 330.255.2425

Own success at every turn Navigating deals requires confident decisiveness to stay a step ahead of frequent shifts in complex government regulations and global market demands. Our professionals can help you move ahead boldly with the right insights at the right time for the right deals. We bring extensive regional and sector experience as well as an understanding of your culture and situation, so we can assist on a variety of your deal needs including: domestic and cross-border acquisitions, divestitures and spin-offs, capital markets transactions like IPOs and debt offerings, and bankruptcies and other business reorganizations. For more information on how we can help you, please contact Brian Kelly at (216) 875 3121 or Thorne Matteson at (216) 875 3441.

© 2016 PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

266234-2017 Crain's Cleveland Deals ad op2.indd 1

11/23/2016 9:43:35 AM

CORPORATE GROWTH AND M&A

S24 January 16, 2017

Buyers should be wary of ‘copyleft’ software Certain licenses impact target company’s valuation By TERRENCE H. LINK and LINDSIE EVERETT

ompanies are increasingly using open source software in their businesses, and for some companies, this type of software is critical to their business models. Buyers should be mindful of the unique challenges this software poses in M&A transactions, particularly in terms of a target company’s valuation. A buyer acquiring a technology company with valuable, revenue-driving proprietary software may spend millions only to

purchase software tainted by open source software, rendering it worthless. Open source software is software with public source code developed through a collaborative process, which is licensed with different sets of requirements. Software developers rely on open source software because it is easy to use, Link yields better quality code, and is cost-efficient and rapid. Nevertheless, using open source software poses significant risks depending on the licensing scheme.

Open source software generally falls under two groups of licenses. Under a “permissive” license, companies with proprietary software incorporating open source software retain proprietary rights in the software by restricting access to the proprietary code. Everett This preserves the software’s economic value. Conversely, when companies develop proprietary software using open source software obtained under a strong “copy-

left” license, the open source software is deemed to have “tainted” the proprietary software. This requires disclosure of the software’s source code to the public. Consequently, the ability of the company’s competitors, potential clients, and other third parties to have unlimited, free access to the proprietary software destroys the software’s economic value. Buyers can avoid over-valuing a target company by conducting thorough due diligence of the target company’s software and use of open source software. Periodically, an audit scan of the software source code may be appropriate. Buyers should also negotiate protective representations, warranties, and indemnification

Northeast Ohio’s leading deal makers to be honored ACG Cleveland, Northeast Ohio’s leading organization for merger and acquisition and corporate growth professionals, will recognize the winners of its 21st Annual Deal Maker Awards at 5:30 p.m. Thursday, Jan. 19, at the Huntington Convention Center of Cleveland. The Deal Maker Awards are a tribute to Northeast Ohio’s preeminent corporate deal makers for their accomplishments in using acquisitions, divestitures, financings and other transactions to fuel sustainable growth. The 2017 winners are:

DIEBOLD-NIXDORF During the past year, Diebold divested a non-core business and made an acquisition that effectively doubled the size of the company. In February, it divested its electronic security business to Securitas AB for approximately $350 million. Then, in August, Diebold completed a $1.8 billion acquisition of Wincor-Nixdorf, a €$2.5 billion, publicly traded German business, to create the world’s largest financial self-services and ATM company. This transaction transformed the company into a global entity heavily focused on services and software, with annual sales in excess of $5 billion. In addition, Diebold formed two joint ventures in China.

HUNTINGTON BANCSHARES In August, Huntington Bancshares merged with FirstMerit in a transaction valued at $3.4 billion. The merger established the largest bank in Ohio by deposit market share, with combined assets of nearly $100 billion. It was overwhelmingly approved by shareholders of each bank. FirstMerit shareholders received 1.72 shares of Huntington common stock, plus a fixed $5 per share for each share of FirstMerit stock outstanding. This represented a 32% premium over FirstMerit’s share price at the time of the announcement. The combined company will operate approximately 1,000 branches in eight Midwest states, including Ohio, Michigan, Pennsylvania, Indiana, West Virginia, Kentucky, Wisconsin and Illinois.

TRADEMARK GLOBAL LLC

provisions in the purchase agreement to address open source software risks. While using open source software is beneficial, buyers should identify risks throughout the due diligence process and consider those risks when negotiating purchase agreements. These steps help buyers appropriately value target companies’ software and minimize risks of “copyleft” surprises following the closing. Terrence H. Link II is a partner at Roetzel & Andress. Contact him at 330-849-6755 or tink@ralaw.com. Lindsie Everett is an associate at Roetzel & Andress. Contact her at 330-849-6611 or leverett@ralaw.com.

ACG Cleveland 2016-17 Officers/ Board of Directors OFFICERS President – John Saada Jr., Jones Day President Elect – Brian Kelly, PwC

Based in Lorain, Trademark Global is a multimillion-dollar e-commerce and drop-shipping business. Among its clients are household names such as Amazon, Walmart and Overstock. In order to accelerate growth, Trademark Global partnered with Blue Point Capital Partners in 2013. It proceeded to establish a sourcing center in China that increased its speed to market and improved quality control. It also upgraded its IT platform and recreated its inventory management and product development processes, which provided Trademark with increased operational leverage. The company was sold to Bertram Capital in November. During its partnership with Blue Point, Trademark Global demonstrated exceptional top€line and margin growth, and nearly doubled its EBITDA.

CAPITALWORKS LLC CapitalWorks is a Midwestern, family focused private equity firm that acquires lower middle-market companies and gives them the capital, support and freedom to grow. Over the past two years, the firm has been extremely active despite middle-market M&A being very competitive. Since December 2013, CapitalWorks has completed five platform acquisitions, four portfolio add-ons, three portfolio dividend recapitalizations and exited two portfolios.

Executive Vice President, Brand – Brad Kostka, Roop & Co. Strategic Integrated Communication Executive Vice President, Programming & Innovation – Dale Vernon, Bernstein Executive Vice President, Resources – Joseph C. Adams, Plante Moran Treasurer – Brian Leonard, Edgewater Capital Partners Secretary – M. Joan McCarthy, MJM Services Immediate Past President – David Dunstan, Western Reserve Partners

BOARD OF DIRECTORS Kevin Bader, MCM Capital Partners Rudolf Bentlage, Chase Mark Brandt, RSM US LLP Denise Carkhuff, Jones Day Jeffery Fickes, Vorys

Sponsors supporting the 2017 Deal Maker Awards include Benesch, Huntington, Grant Thornton, KeyBanc Capital Markets and Oswald Cos.

John Grabner, Hylant Group Beth Haas, Cyprium Partners

2017 ACG Events Calendar DATE Jan. 19 Jan. 26 Feb. 2 Feb. 9 Feb. 16 Feb. 21 Mar. 9 Mar. 23 Apr. 27 May 10 May 11 May 24 Jun. 13 Sept. TBD

Chris Hogan, KeyBanc Capital Markets

For more information and to register, visit www.ACGclevland.org

EVENT 21st Annual Deal Maker Awards Young ACG Lunch & Learn Regional Networking — East — Minority Business Owners Regional Networking — Central — Dale Wollschleger, ExactCare Regional Networking — West — Mike Ripich, AT&F George Veras, CFO, Football Hall of Fame (joint event with FEI) Anil Makhija, Board Member, National Center for the Middle Market Young ACG Networking and BVU Presentation Dick Pace, President, Cumberland Development, Waterfront Project Women in Transactions, Strategic Charisma, Part 1 David Given, Frank Linsalata, Stewart Kohl — Wizards & Legends of Private Equity Women in Transactions, Strategic Charisma, Part 2 Spring Social 13th Annual Golf Outing

TIME 5:30 p.m. Noon 5:30 p.m. 5:30 p.m. 5:30 p.m. 5:30 p.m. 11:30 a.m. 4:00 p.m. 4:30 p.m. 7:30 a.m. 4:00 p.m. 7:30 a.m. 5:30 p.m. TBD

LOCATION Cleveland Convention Center Vorys Shaker Country Club Lockkeepers Lakewood Country Club Union Club Union Club Tucker Ellis Nuevo Modern Mexican Jones Day Ritz-Carlton Plante Moran Shoreby Club Firestone Country Club

Jonathan Ives, SCG Partners Sean McCauley, Key Community Bank Jay Moroscak, AON Risk Services Kevin Murphy, Deloitte Matt Roberts, MelCap Partners Peter Shelton, Benesch Jeff Schwab, Oswald Cos. Bertrand Smyers, New Heights Research Cheryl Strom, The Riverside Co. Karen Tuleta, MPE Partners Theodore Wagner, Bober Markey Fedorovich William Watkins, Harris Williams & Co. Thomas Welsh, Calfee Halter & Griswold Rebecca White, Western Reserve Partners