In October of 2010, Ryan Cochran, the 42 year old President
of Builderâ€™s Depot, was pondering the future of his company. Although the company had a long history of
profitability, he and the other three shareholders of the company (Andy
Peterson, Ron Thompson, and Mike Schaeffer), were interested in selling the
company and moving on to new adventures.
Earlier in the year, the company received a buyout offer of $8 million
in cash and stock from National Building Supply Co., a publicly traded company
in the same industry. However, a
stipulation of the deal was that Ryan must stay with the company and manage the
daily operations. Ryan was not thrilled
with this offer. If he was to be
responsible for the financial performance of the company, he wanted to be able
to reap the rewards that ownership often provides. After deliberations with the other
shareholders, the offer from National Building Supply Co. was rejected. No subsequent offers had been received in 2010.
It had become apparent to Ryan that he was the key to the
recent success enjoyed by the company, and any subsequent offers would most
likely contain the same stipulation as the offer from National Building Supply
Co. As a result, Ryan considered the
idea of personally buying out the ownership of the other three
shareholders. This option would provide
Ryan with the potential rewards from the effective management of the company
while allowing the other shareholders to pursue their other interests. Although Ryan found this option extremely
appealing, a number of issues would have to be resolved before any deal could
be finalized. The basic and important
issues included the following:
much was the company worth?
should the potential buyout be financed?
there important tax considerations that need to be considered in the
deal? If so, what is the best way
to structure the purchase to minimize the tax impact and maximize the
likelihood that all of the shareholders will agree to the deal?
Because of the complexity of the issues, it was clear to
Ryan that he would need assistance to properly plan a buyout that is beneficial
to all the shareholders. He came to
Ready and Able, LLP, inPortland,
Oregon. Like many CPA firms today, this firmâ€™s core
practice was in tax and audit, but it also offered assistance in helping
clients navigate the purchase and sale of businesses. Will B. Ready, the firmâ€™s managing partner,
met with Ryan to discuss the buyout options available and determine whether
this transaction was indeed feasible from Ryanâ€™s perspective.
Builderâ€™s Depot was created by Henry Bass in 1955 as a
wholesale supply company for the construction industry. In 1990, the company was purchased by Andy
Peterson (who remained the sold shareholder of the company from 1990 to 2001)
for $400,000. During this time period,
the company experienced consistent growth in revenue and profitability. In 2001 revenue passed the $5 million
plateau. By 2001, at the age of 52, Andy
decided to reduce his participation in the company, and in 2002 he sold some of
his share to Ryan and Mike. In 2004 he
further reduced his involvement in the company by selling shares to Mike. Since that time the company has been managed
by Ryan (President), Ron (Vice President for Operations), and Mike (Vice
President for Finance). During the first
decade of the 2000s Andy continued to divest his interest in the company by
gifting additional shares to Andy, Ron and Mike. By 2006 Andy owned just 381 shares of the
companyâ€™s 5,100 shares outstanding, while Ryan, Ron and Mike owned 1,573
shares. The three managers had
individual strengths that contributed to the success of the company. Ron was a very good marketer and
salesman. His â€œpeopleâ€ skills attracted
many new customers. Mike was in charge
of the companyâ€™s finances. Ryan was
responsible for managing the everyday activities, building strong relationships
with key customers, and creating a strong employee culture. Ryan in many ways was the key to the success
enjoyed recently by the company.
Since 1990 Builderâ€™s Depot had become the recognized
industry leaders in its geographic market.
The combination of engineering expertise and extensive product offering
made the company the distributor of choice for its market. Unique to its market, Builderâ€™s Depot entered
into long-term supply contracts with many of its larger accounts. These contracts name the company as the sole
source supplier for various building supply needs. These contracts show the
great trust and confidence that customers place in Builderâ€™s Depot. In addition, the company has a diversified
client base with over 600 active accounts in 2010. Its customers included many construction
firms and the top account was just 8% of sales.
Builderâ€™s depot has also been very dedicated to its
employees. In particular, Ryan has
stressed the importance of each employee, and he believes that a harmonious
workplace is the key to success. Not
only does the firm have little turnover, but it has received tremendous
productivity from its employees.
During the early 2000s, the company experience sustained
growth. In 2010 Builderâ€™s Depot had thirty
employees and sales of $13.2 million.
The growth of the company resulted in the companyâ€™s need for new office
and warehouse space. In 2006 the four
shareholders formed a partnership for the purpose of acquiring land and a
building. After an appropriate location
was acquired, Builderâ€™s Depot moved its operations to its current location and
entered into a long-term lease for the property with the partnership. As a result, Builderâ€™s Depot has a 15 year
lease on a building with a 50 year useful life, and the land and buildings are
not included on the books of Builderâ€™s Depot.
By 2010, the four stockholders mutually agreed that it was
time to sell the business and move into other ventures. At this time, Andy had become an outside
shareholder and did not actively participate in the management of the
company. Although each of the other
three shareholders were in their early 40s, they had desires to start new
challenges in their lives. In
particular, Ron and Mike had each reduced their role in the company management
for the past couple years. The company
hired a business broker to prepare the necessary information and begin a search
for a buyer. The broker was able to locate one potential buyer â€“ National
Building Supply Co. â€“that offered cash and stock valued at $8
million. For Ron and Mike, who each
owned 30.8% of the company, this created an implied value of $1.85 million for
their respective shares. As noted
earlier, this offer was rejected by the shareholders and no subsequent offer
Feasibility of Ryanâ€™s Buyout
In October 2010, Ryan came to Ready and Able, LLP to explore
the option of purchasing the company. Andy,
who was no longer active in the operation of the business, was willing to go
along with whatever the other three shareholders decided. Ron and Mike were willing to sell their
shares, but the offer received in early 2010 had established a company value of
$8 million in their minds.
Unfortunately, neither the company, nor Ryan personally, had the assets
available to support a purchase price of that magnitude. In order to consummate the purchase, funds
would have to be financed externally.
Ryanâ€™s initial instinct was to purchase the company through
an ESOP (Employee Stock Ownership Plan) structure. Ryan had a genuine concern for the employees
and believed this method would provide the employees with the necessary
motivation to work harder and become â€œcompany oriented.â€ The ESOP would need to
obtain a loan from a bank and then use the proceeds to purchase the shares of Andy,
Ron and Mike. After this initial
transaction, the ESOP is formally the owner of the shares (its assets) and has
a liability for the bank loan. Because
the ESOP is a separate legal entity, Builderâ€™s Depot would need to guarantee
the future payments of the loan. In
subsequent years, Builderâ€™s Depot would make annual profit sharing
contributions to the plan. The ESOP
would then use these proceeds to make interest and principal payments on the
bank loan. In addition, as the payments
are made, the shares of stock are awarded to the accounts of the individual
Unfortunately, Ryan would not significantly increase his
ownership share through this type of structure.
Will Ready offered a different idea â€“ use the companyâ€™s assets and
future cash flows to secure bank financing, plan a financial and tax structure
for the acquisition, and use the proceeds from the bank debt along with the
companyâ€™s strong cash flow to finance the acquisition. It was this latter method that became the
focal point in formulating a buyout proposal.
Because of the complexity of the deal, negotiating between the
shareholders continued well into 2011.
A separate spreadsheet,Builders Depot.xls, is
available with the balance sheets, income statements, and statements of cash
flow from 2006 â€“ 2010.
Related Party Transactions
As is common for many small privately held companies, Builderâ€™s
Depot, had numerous transaction with its four shareholders. Because Ryan would be the sold shareholder
after the buyout, these transactions must be considered when evaluating a â€œpost
buyoutâ€ value of the company. Following
is a summary of related party transactions for the five-year period covered by
the financial statements that were included in operating expenses.
Because Builderâ€™s Depot is a C-Corp, the company would
annually distribute earnings in the form of compensation to the owners in tax
deductible benefits, salary and dividends.
This accounts for the relatively large salary adjustments outlined
above. If Ryan acquired the company, he
believed that other employees could assume Ronâ€™s primary duties, and Mikeâ€™s current
assistant (with the help of Will Ready) could handle Mikeâ€™s financial
responsibilities. Therefore, Ryan did
not foresee the need of hiring additional employees after the buyout was
The interest expense above represents amounts paid to Andy
on loans made to the company. The
balance of this loan was included in long-term debt. Andy would continue to
carry the loan as long as payments were made as previously scheduled. Andy would also was willing to subordinate
his loan to the primary financing for the buyout.
Using the data on spreadsheet provided for
builderâ€™s depot, determine value for the following assumptions for the period
of 2011 â€“ 2016. Your team will be assigned a role of Neutral , Pessimistic or Optimistic). Using these assumptions develop prospective
financial statements for Builders Depot for the period of 2011 â€“ 2016.
Using the above assumptions
develop prospective financial statements for Builders Depot for the
period of 2011 â€“ 2016.
Part C_ i Calculate the Beta Factor for Builders Depot
using the data supplied
You may assume that
the following information represented comparable public company information at
the end of 2010.
C ii Calculate the discount rate
for free cash flow to debt and equity holders .
Your answer needs to explain your
assumptions about the risk model that applies to Builders Depot
the discount rate that you established in the above question, calculate an
estimated value of Builderâ€™s Depotâ€™s equity using the discounted cash flow
does the value that you computed in (1) compare to the $8 million offer
the company received from National Building Supply Co.? Discuss possible reasons for the
discrepancy. What changes in the
assumptions used in (1) would be required to obtain an $8 million value?
that the value you established in
Part D is used determine the cash payments made to the
respective shareholders solely in return for the net assets of the company
(e.g., Ryan would purchase all of the companyâ€™s assets and assume all of
the companyâ€™s liabilities). What
would be the tax ramifications for the company of structuring the sale of
the business in this way? What
would be the tax implications for the shareholders of structuring the sale
of the business in this way?
the perspective of a lending institution would you be willing to make a
loan to Builderâ€™s Depot for the amount need in this buyout? Over what period of time would you
structure the loan, and can Builderâ€™s Depot make the payments need to
retire the loan? If so, what
covenants would you include in the loan agreement to safeguard the bankâ€™s
- List 3 thing that you have learned from this