Acquisition Financing: A Banker s Perspective

1. Acquisition Financing: A Banker�s Perspective Presentation to AFOA National Conference Carla Woodward National Manager, Aboriginal Banking RBC Royal Bank February 8 � 10, 2005

2. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 2 OVERVIEW Background Challenges of Growing Companies Importance of the Business Plan Managing the Acquisition Financing Gap Assessing Acquisitions: the business case purchase terms purchase price financial metrics Ongoing Risk Mitigation and Monitoring Questions & Discussion Reference Material Slide 3 Slide 4 Slide 5 Slide 6 Slide 7 Slide 8 Slide 9 Slides 10, 11, 12 Slide 13 Slide 14 Slide 15

3. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 3 Background: Acquisitions are a means for companies to grow at a rate faster than may be possible through organic growth �. but, acquisitions can be fraught with risk for the company and its financiers: studies suggest up to half of all acquisitions actually reduce shareholder value even in successful acquisitions, it typically take up to 2 years to successfully integrate the operations of the acquired company with the acquiring company�s operations � thus, a banker will evaluate acquisition financing requests with particular scrutiny!

4. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 4 Challenges of Growing Companies: Challenges: Relatively few SMEs grow into large mature firms Growth: Organic Growth vs. Growth through Acquisition Successful Growth through Acquisition is not a given What differentiates the Winners? Strategic planning processes & formal business plans Strong management Strong equity backing

5. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 5 Importance of the Business Plan Only 40% of all SMEs have a formal business plan Of Canada�s 50 Best Managed Companies (Queen�s Centre for Enterprise Development Award) 77% have a formal business plan of the 77% with formal business plans, 97% are updated annually plan � These figures are for SMEs in general; given the additional challenges and opportunities posed by acquisitions, a sound business plan is even more important!

6. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 6 Managing the Acquisition Financing Gap Acquisitions may be financed via: Any combination of: Equity Angels Venture Capital Mezzanine Financing / Subordinated Debt Bank Financing* * while all financiers may expect to review some form of business plan, this presentation highlights the issues a Banker may typically expect a business plan for acquisition financing to address and is not intended to cover business plan requirements other financiers may have.

7. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 7 Assessing Acquisitions: the business case Does the acquisition make sense from a business perspective? Industry considerations: consolidation trends, cycles, structure Synergies via economies of scale in production, sales, R & D Diversification of product lines, customers, distribution networks, geographic presence Consistency with core business Management expertise Execution risk Friendly or Hostile

8. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 8 Assessing Acquisitions: purchase terms 2. What are the purchase terms? Purchase Agreement, due diligence reports, appraisals, etc. Terms and conditions of all financing for the deal Riskiest: Deals with purchase prices paid 100% cash and based on forecast vs. historical earnings Mitigating Risks: by negotiating earn-out provisions or vendor take back financing; using an accounting firm to assist with due diligence

9. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 9 Assessing Acquisitions: purchase price 3. Is the purchase price reasonable? Valuation methods vary based upon the industry and features of the deal: asset approaches, earnings/cash flow approaches, rules of thumb (eg. EBITDA multiples) Caution: EBITDA multiples vary over time and between industries Comparisons should be made to other recent transactions, if possible Professional (�CBV�: Certified Business Valuator) valuation of the target company and completion of due diligence

10. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 10 Assessing Acquisitions: financial metrics 4. What are the financial metrics? Minimum 3 years historical financial statements Consolidated projections prepared by borrower Consolidated projections sensitized by the banker: Base case model using average historical financial performance Worst case sensitivity analysis using cash flow only of acquiring company

11. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 11 Assessing Acquisitions: financial metrics 4. What are the financial metrics (continued)? Downside risk variables: how would borrower respond? Is the company's cash flow sufficient to service its proposed debt in both the base case and worst case analyses?

12. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 12 Assessing Acquisitions: financial metrics 4. What are the financial metrics (continued)? Reasonable EBITDA cushion between the borrower and the bank-sensitized projections: what is Break Even EBITDA where FCC* = 1:1? Other financial metrics include Funded Debt/EBITDA and TL/TNW, TL/Equity in some situations * FCC = Fixed Charge Coverage = EBITDA - cash income taxes - unfunded Capex +/- Corporate Distributions_ Interest Expense + scheduled principal payments in respect of Funded Debt Note: Where material, operating lease payments should be added to EBITDA in the numerator and included in Fixed Charges in the denominator.

13. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 13 Ongoing Risk Mitigation and Monitoring Annual, updated Business plan will likely be a reporting requirement Interim (monthly or quarterly) financial reports should include comparison of actuals to plan Bank financial covenants based on the plan will likely be monitored on a monthly or quarterly basis and should be reviewed annually Loan structures: term, amortization and committed/uncommitted should be appropriate to the risk Regular communication between bank and acquiring company�s management is critical

14. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 14 Questions & Discussion

15. Acquisition Financing: A Banker's Perspective February 8 -10, 2005 15 RBC Royal Bank Reference Materials Managing for Growth report: http://www.rbc.com/newsroom/20031022smallbusiness.html Expanding a Business: http://www.rbcroyalbank.com/busexpanding/ Definitive Guides: http://www.rbcroyalbank.com/business/definitiveguide/index.html Business Banking Centres in Canada: http://www.rbcroyalbank.com/business/locations/index.html