strategic-advisory

Strategic Advisory

Operational procedures for strategic finance advisory services to closely-held C-corporations. Covers the full advisory spectrum from transaction diligence through succession planning, with pricing guidance for scoping engagements.

M&A Due Diligence

Diligence Phases

Three sequential phases govern every transaction:

1. Preliminary — NDA, CIM review, initial financial screening (revenue trend, EBITDA margin, customer concentration, capital intensity), IOI with valuation range. Engage outside counsel and tax counsel early — structure drives economics.
2. Detailed — VDR access organized by functional area (financial, tax, legal, operational, HR, IT, environmental). Management presentations, site visits, detailed financial model, quality of earnings (QoE) report.
3. Confirmatory — Third-party confirmations (bank balances, AR, insurance coverage letters), working capital peg finalization, bring-down diligence, final report to buyer's board or investment committee.

Quality of Earnings Adjustments

QoE bridges reported earnings to sustainable recurring EBITDA. Three adjustment categories:

• Non-recurring — One-time gains/losses, restructuring charges, transaction costs, pandemic-related items (PPP forgiveness, ERTC, business interruption)
• Owner-related — Above-market officer compensation (benchmark using the compensation methodology below), personal expenses through the business, related-party rent vs. FMV, related-party transactions at non-arm's-length
• Accounting/pro forma — Revenue recognition differences, inventory method conversions, depreciation assumptions, accrual vs. cash conversion, full-year run rate of mid-year changes, annualized cost savings

Working Capital Normalization

Define working capital as current assets (excluding cash) minus current liabilities (excluding current portion LTD and income tax payable). Compute the peg using trailing 12-month average of monthly normalized working capital (24-month for seasonal businesses). Purchase agreement sets the target at signing; true-up occurs 60-90 days post-close.

Transaction Structure Decision

• Asset purchase — Buyer selects assets/liabilities, gets stepped-up basis (higher depreciation), seller recognizes gain per asset (ordinary recapture + capital gain on goodwill)
• Stock purchase — All assets and liabilities transfer, existing basis carries over, contracts/licenses stay in place, buyer inherits tax attributes (NOLs subject to Section 382)
• Section 338(h)(10) — Joint election on Form 8023 treating stock purchase as asset sale for tax only. Buyer gets step-up; seller reports deemed asset sale on final return. Advantageous when target has NOLs to offset deemed sale gain

Purchase Price Allocation (ASC 805)

Allocate total consideration to identifiable assets/liabilities at fair value. Tangible assets at FMV, intangible assets (customer relationships, trade names, technology, non-competes) each require separate valuation. Residual to goodwill — not amortizable for book (ASC 350 impairment), amortizable over 15 years for tax (Section 197). Engage a qualified valuation firm for transactions exceeding $5M enterprise value.

Diligence Red Flags

Declining gross margins without explanation, customer concentration >25% from one customer, heavy related-party transactions, off-balance-sheet obligations, deferred revenue inconsistencies, sudden revenue acceleration near transaction date.

Deep dive: Read references/ma-due-diligence.md for the complete financial diligence checklist (3-5 years of records), tax-specific items (ASC 740, NOL schedules, R&D credits), Section 368 reorganization types, earnout structures and tax treatment, integration planning (Day-One readiness, COA harmonization, cutoff procedures), and recording of acquisition entries in the accounting system.

Succession and Ownership Transition

Valuation Approaches

IRS Revenue Ruling 59-60 requires consideration of all relevant factors. Three primary approaches:

• Asset-based — Adjusted net asset value (restate each asset/liability to FMV). Best for asset-intensive businesses or holding companies.
• Income-based — Capitalization of earnings (normalized earnings / cap rate; typical small-company cap rates: 15-30%) or discounted cash flow (5-10 year projections discounted at WACC plus terminal value). Best for operating companies with earnings history.
• Market-based — Comparable transactions (BizBuySell, Pratt's Stats) or guideline public company multiples with size/liquidity adjustments.

Most engagements use two or more approaches and reconcile.

Valuation Discounts

• DLOM (lack of marketability): 15-35%, supported by restricted stock and pre-IPO studies
• Minority/lack of control: 15-25%, derived from control premium studies
• Key person: 5-25%, based on revenue/profit at risk from departure
• Combined discount cap: Stacked discounts exceeding 40-45% attract IRS challenge; each must be independently supportable

Buy-Sell Agreement Structures

• Cross-purchase — Remaining shareholders buy departing shareholder's stock; buyers get stepped-up basis. Unwieldy with >3-4 shareholders.
• Entity redemption — Corporation redeems stock. Simpler for multiple shareholders. Risk: Section 318 attribution may recharacterize as dividend.
• Hybrid — Entity has first right of refusal, then remaining shareholders.

Funding mechanisms: life insurance (most common for death trigger), installment notes (5-10 years, must meet AFR minimum under Section 7872), sinking fund (no underwriting required but exposed to creditors).

Ownership Transition Paths

• Internal sale — Installment sale, gift/sale combination using lifetime exemption, GRAT for appreciation exceeding Section 7520 rate
• MBO — Management equity + seller financing + third-party debt; consider Section 338(h)(10) election
• ESOP — C-corp seller can defer gain under IRC Section 1042 if ESOP holds 30%+ post-sale and proceeds reinvested in qualified replacement property within 12 months
• Third-party sale — Competitive bidding, 3-5 years clean financials, representations and warranties insurance
• Liquidation — Last resort; double taxation (corporate gain + Section 331 shareholder gain)

Estate Tax Considerations

Lifetime exemption: $13.99M per individual (2025). TCJA sunset risk: reverts to ~$7M if provisions expire. Anti-clawback rule (Treas. Reg. 20.2010-1(c)) protects gifts made under higher exemption. Section 2701 special valuation rules apply to junior equity transfers when senior interests retained.

Planning horizon: 3-7 years for optimal tax and operational outcomes.

Deep dive: Read references/succession-planning.md for full treatment of Section 1202 QSBS exclusion, accumulated earnings tax implications for transition cash reserves (Section 531), Section 302 redemption qualification tests, equity tracking for shareholder positions in the accounting system, and key person risk quantification methodology.

Compensation Benchmarking

IRS Reasonable Compensation Framework

The IRS 9-factor test (from the Reasonable Compensation Job Aid): training/education, duties/responsibilities, time/effort, comparable compensation, revenue/complexity, nature/scope of work, compensation history, ratio to non-shareholder employees, and compensation agreements.

Independent investor test (Exacto Spring Corp, 7th Cir. 1999): Would a hypothetical outside shareholder be satisfied with the return on equity after officer compensation? Calculate implied ROE: (net income after compensation) / shareholder equity and compare to risk-adjusted market returns.

Benchmarking Methodology

1. Define positions — Map officer duties to SOC codes. For multi-hat officers, identify each role separately with time allocation (e.g., 40% CEO, 30% CFO, 30% VP Sales)
2. Select comparables — Match by NAICS code (4-6 digit), revenue band, geographic market, company maturity
3. Apply adjustments — Geographic (BLS area differentials), revenue/size, industry, experience, multi-role premium (aggregate weighted market values)
4. Establish range — Present 25th-75th percentile; position within range based on qualitative factors
5. Document — Written study that a third party can follow; retain source data

Data Sources

• Tier 1 (free, authoritative): BLS OES (bls.gov/oes) — median/percentile by SOC code and MSA
• Tier 2 (commercial): ERI Economic Research Institute, Salary.com CompAnalyst, RCReports (IRS-ready reports)
• Tier 3 (supplemental): Robert Half Salary Guide, SEC DEF 14A proxy statements, trade association surveys

Documentation Package

Board resolution referencing benchmarking analysis, written employment agreement (signed before tax year begins), compensation study, job description, time records, and dividend history (for C-corps, demonstrates compensation is not disguised dividends).

C-corp optimization crossover: Higher compensation reduces corporate income (21% flat rate) but increases payroll tax (15.3% to SS wage base, 2.9% above). Model both sides.

Deep dive: Read references/compensation-benchmarking.md for Form 1120 Schedule E reporting requirements and IRS automated screening triggers, Section 162(m) $1M deduction cap applicability to private C-corps, zero-compensation year handling, and officer compensation account setup in the accounting system.

Insurance Adequacy Review

Core Coverage for C-Corps

• GL: $1M occurrence / $2M aggregate (foundation of any program)
• Commercial Property: Confirm replacement cost vs. ACV valuation; watch for flood/earthquake/equipment breakdown sublimits
• BOP: Bundles GL + property; cost-effective for smaller C-corps but compare against standalone quotes when revenue >$5M or property >$1M
• Workers' Comp: State-mandated; premiums based on payroll, job classification, EMR
• Commercial Auto: Required if business owns/leases vehicles; add hired/non-owned auto endorsement for employee personal vehicles
• Umbrella: $1M-$10M increments above GL, auto, employers' liability

Specialized Coverage

D&O (critical with outside directors/investors), E&O/professional liability (service businesses; some contracts mandate minimums), cyber liability (confirm ransomware, social engineering, regulatory fines, BI coverage), EPLI (risk scales with headcount), key person life insurance, business interruption.

Coverage Gap Analysis

1. Inventory assets and risks (physical, intangible, human capital, contractual)
2. Map each risk to existing policy coverage (limits, deductibles, exclusions)
3. Identify gaps — no coverage, inadequate limits, exclusions negating protection
4. Quantify exposure (replacement cost, lost revenue, legal defense, regulatory)
5. Recommend adjustments prioritized by severity and likelihood

Business Interruption Calculation

Monthly revenue baseline (trailing 12-month average) plus continuing fixed expenses plus extra expense coverage. Watch for coinsurance penalty (coverage below 80% of actual business income reduces payout proportionally). Match indemnity period to realistic recovery time — 12 months standard but may be insufficient for manufacturing or specialized operations.

Key Person Insurance Valuation

• Compensation multiple: 5-10x annual salary + benefits
• Revenue contribution: % of revenue attributable, projected over 1-3 year replacement timeline
• Replacement cost: Recruiting, training, ramp-up, interim revenue loss
• Lender-driven: Loan agreements may specify minimum amounts (overrides)

Tax Treatment

All standard commercial premiums deductible under IRC 162. Key person life insurance premiums NOT deductible (IRC 264) when company is owner/beneficiary, but death proceeds generally tax-free (IRC 101). Prepaid premiums: accrual- basis C-corps must allocate over the policy period.

Deep dive: Read references/insurance-adequacy.md for debt covenant insurance requirements (cross-reference with debt covenant monitoring), annual review trigger events, common underinsurance patterns, insurance expense sub-account structure, and prepaid insurance amortization entries.

Debt Covenant Compliance

Common Financial Covenants

• DSCR = NOI / Total Debt Service (min 1.20x-1.50x; below 1.0x means income cannot cover payments)
• Leverage = Total Funded Debt / TTM EBITDA (max 3.0x-5.0x; net variation subtracts unrestricted cash)
• Current Ratio = Current Assets / Current Liabilities (min 1.0x-1.5x)
• Tangible Net Worth = Total Equity - Intangibles (fixed floor or ratchet that never decreases)
• FCCR = (EBITDA - Unfinanced CapEx - Cash Taxes - Distributions) / (Interest + Principal + Leases) (min 1.10x-1.25x)
• Interest Coverage = EBIT / Interest Expense (min 2.0x-3.0x)

Always use the credit agreement's definitions — not textbook formulas. EBITDA add-backs, debt inclusions, and measurement periods are agreement-specific.

Compliance Monitoring

Quarterly cycle: extract financials as of measurement date, map accounts to agreement definitions, calculate ratios, compare to thresholds with cushion analysis, prepare compliance certificate, officer sign-off, submit within reporting window (typically 30-45 days after quarter-end).

Early warning thresholds:

• Green: >20% above covenant threshold
• Yellow: 10-20% above — proactive client discussion
• Red: <10% above or breached — immediate notification, explore remediation

Breach Consequences and Remedies

Technical default may trigger loan acceleration, cross-default on other facilities, default interest (+2-5%), restricted line access, enhanced reporting. Cure options: equity cure (typically limited to 2-3 times over loan term), 15-30 day cure period for financial covenants, waiver (one-time forgiveness), amendment (permanent change, 0.10-0.50% fee), forbearance (temporary standstill).

Deep dive: Invoke financial-planning:financial-modeling for the full debt covenant analysis reference, including financial report extraction workflow, EBITDA build-up from the P&L, ASC 842 lease impact on ratios, frozen GAAP provisions, and multi-facility tracking procedures.

Advisory Engagement Pricing

Pricing Models

• Hourly — Best for first-year or unpredictable-scope work. Rates by level: staff $100-175, senior $150-250, manager $200-350, partner $250-500. Rates vary by market and firm size.
• Fixed-fee — Defined deliverable at agreed price. Include scope-change clause reverting to hourly for out-of-scope work. Best for recurring engagements with historical data.
• Value-based — Priced on outcome value to client (e.g., tax planning saving $50K priced at $10-15K = 20-30% of savings). Highest margin; requires strong discovery conversation.
• Subscription/retainer — Fixed monthly fee for ongoing advisory access. Smooths seasonality, deepens relationships. Best for outsourced CFO, FP&A retainers.

FP&A Service Benchmarks

• Outsourced CFO: $2,000-$10,000/month
• FP&A/budgeting projects: $5,000-$25,000 per engagement
• Tax planning: $1,500-$5,000+ or value-priced
• Cash flow forecasting: $3,000-$8,000 model build; $500-$1,500/month ongoing
• Board/investor reporting: $2,000-$5,000 initial; $1,000-$2,500/month ongoing
• Entity restructuring advisory: $5,000-$15,000+

Profitability Metrics

• Realization rate = billings collected / (standard rate x hours). Target: 85%+ compliance, 100%+ advisory. Below 75% = systemic underpricing.
• Effective hourly rate = fee collected / actual hours. A $5K engagement in 12 hours = $417/hr; same engagement in 40 hours = $125/hr.
• Write-down rate = (standard - actual billing) / standard. Target <10%.

Track time even on fixed-fee work — not for billing, but for profitability measurement. Rank clients quarterly; bottom 10-20% typically destroy firm profitability.

Pricing Communication

Present in order: what the client gets, what it costs, how payment works. Never lead with price. Never discount without removing scope.

Deep dive: Read references/advisory-pricing.md for engagement letter pricing terms (payment schedule, expenses, annual adjustment, termination), client profitability analysis framework (profitable/high-utilization vs. unprofitable/unfixable matrix), bundling discount strategy, fee raise timing, disengagement criteria, and time tracking / invoicing setup.

Capital Allocation Framework

Capital allocation decisions draw from multiple advisory domains. Use this decision sequence:

1. Assess debt capacity — Calculate covenant headroom across all facilities. Available capacity = distance from covenant floors to current ratios, converted to dollar terms.
2. Evaluate reinvestment returns — Model projected ROI on internal projects (expansion, equipment, R&D) against WACC. Invoke financial-planning:financial-modeling for scenario analysis.
3. Consider acquisition opportunities — Run QoE-level diligence on targets. Compare acquisition ROI to organic reinvestment alternatives.
4. Review distribution capacity — For C-corps, model double taxation cost of dividends vs. retention. Check accumulated earnings tax exposure if retained E&P approaches $250K threshold.
5. Optimize compensation — Model the corporate tax deduction (21%) vs. payroll tax cost (15.3%/2.9%) crossover point.
6. Fund succession — If succession is on the 3-7 year horizon, earmark reserves for buyout funding (sinking fund, insurance premiums, installment capacity). Document as reasonable business need for AET defense.

Supporting References

Read these for detailed procedures, formulas, and compliance checklists:

• references/ma-due-diligence.md — Complete financial diligence checklist (core financial records, working capital, tax-specific items, legal/operational). Section 368 reorganization types (A/B/C/D) with continuity requirements. Earnout structures (tax treatment under Section 453, open vs. closed transaction doctrine, ASC 805 accounting). Integration planning (Day-One bank/payroll/insurance readiness, COA harmonization, cutoff procedures, opening balance sheet). Acquisition entry recording.
• references/succession-planning.md — IRS Revenue Ruling 59-60 valuation framework. Asset/income/market valuation approaches with selection criteria. Discount analysis (DLOM, minority, key person) with empirical support sources. Buy-sell agreement types, funding mechanisms, trigger events. Ownership transition paths (internal sale, MBO, ESOP with Section 1042, third-party, liquidation). Estate/gift tax implications (Sections 2701-2704, annual exclusion amounts, TCJA sunset). Section 1202 QSBS, Section 531 AET, Section 302 redemption. Shareholder equity tracking.
• references/compensation-benchmarking.md — IRS 9-factor reasonable compensation test with case law citations. Independent investor test (Exacto Spring). BLS/ERI/RCReports data source hierarchy. Five-step benchmarking methodology with multi-role premium calculation. Documentation package requirements (board resolution, employment agreement, time records). Form 1120 Schedule E reporting and IRS screening triggers. Section 162(m) applicability. C-corp payroll tax optimization crossover.
• references/insurance-adequacy.md — Core and specialized coverage types with typical limits. Coverage gap analysis methodology (5-step). Business interruption calculation (revenue projection, continuing expenses, coinsurance penalty, indemnity period). Key person insurance valuation methods (compensation multiple, revenue contribution, replacement cost, lender-driven). Debt covenant insurance requirements. Annual review triggers and common underinsurance patterns. Tax treatment of premiums (IRC 162 vs. 264). Insurance expense sub-accounts and prepaid amortization.
• references/advisory-pricing.md — Four pricing models (hourly, fixed-fee, value-based, subscription) with advantages/disadvantages and best-suited scenarios. Service-specific benchmarks (tax compliance, bookkeeping, FP&A, project-based). Engagement letter pricing terms. Client profitability analysis (realization rate, effective hourly rate, write-down rate). Profitability action matrix. Value-first pricing communication. Fee adjustment and disengagement decision points.

Cross-Plugin References

Invoke these skills for capabilities outside this skill's scope:

• Invoke financial-planning:financial-modeling for three-statement models, scenario/sensitivity analysis, and the full debt covenant analysis reference (ratio calculations, report extraction workflow, compliance monitoring, breach remediation)
• Invoke financial-planning:variance-analysis for budget-vs-actual context, KPI tracking, and historical trend data that informs strategic recommendations
• Invoke tax-prep:tax-planning for tax implications of strategic decisions — entity selection, officer compensation optimization, accumulated earnings tax planning, Section 338(h)(10) election analysis
• Invoke qbo-integration:qbo-reporting for QBO financial report extraction supporting covenant calculations, valuation data, and management reporting
• Invoke accounting-foundation:entity-profile for entity type, ownership structure, officer details, controlled group status, and foreign ownership that affect M&A, succession, and compensation planning