978-1259912191 Chapter 13 Lecture Notes Part 1

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Chapter Thirteen: Exit/Harvest/Turnaround

Table of Contents

Brief Chapter Outline…………………………………………………………………………………….. 2

Chapter Outline and Lecture notes…………………………………………………………………..3

Key Terms………………………………………………………………………………………………….. 16

Suggested Text

Responses………………………………………………………………………………17

Class Activities and Sample Assignments………………………………………………………..20

Discussion Questions for Online/Hybrid classes……………………………………………….21

Lecture Links……………………………………………………………………………………………… 24

Lecture Link 13.1: Valuing the Business…………………………………………………….24

Lecture Link 13.2: Evaluate the Loan Request……………………………………………25

Lecture Link 13.3: Angels on the Directory for Entrepreneurs………………………26

Bonus Internet Exercises………………………………………………………………………………27

Bonus Internet Exercise 13.1: Give Me 5…………………………………………………..27

Bonus Internet Exercise 13.2: Initial Public offering (IPO)…………………………….28

Bonus Internet Exercise 13.3: Business Valuation Tools……………………………….29

Critical Thinking Exercises…………………………………………………………………………….30

Critical Thinking Exercise 13.1: De.ning Valuation Techniques…………………….30

Critical Thinking Exercise 13.2: Selling the Business…………………………………..32

Critical Thinking Exercise 13.3: Closing the Business…………………………………..34

Bonus Cases………………………………………………………………………………………………. 37

Bonus Case 13.1: Reputation and the Small Business Owner……………………….37

Bonus Case 13.2: Designs Exchanged for Sales and Pro.ts………………………….38

Bonus Case 13.3: Industry Indicators and Business Opportunities…………………39

Endnotes…………………………………………………………………………………………………… 41

Brief Chapter Outline

I. Learning Objectives (text page 244)

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Chapter Thirteen: Exit/Harvest/Turnaround

Explain the need for developing an exit or harvest plan and ideal timing for

that plan.

Outline the steps for selling a business.

Discuss the concept of turnaround and business in decline

Recognize the implications and issue involved in closing a business.

II. Exit/Harvest (text page 246 through 248)

Learning Objective 13-1: Explain the need for developing an exit or harvest plan

and ideal timing for the plan.

III. Steps for Selling a Business (text page 248 through 259)



Learning Objective 13-2: Outline the steps for selling a business.

IV. Turnaround and Business in Decline (text page 259 through 261)



Learning Objective 13-3: Discuss the concept of turnaround and business in

decline

V. Closing the Business (text page 261 and 262)



Learning Objective 13-4: Recognize the implications and issues involved in

closing a business.

VI. For Review (text page 262)

Chapter Outline and Lecture notes

1. Learning Objectives (text page 234)

Explain the need for developing an exit or harvest plan and ideal timing for that

plan.

Outline the steps for selling a business.

Discuss the concept of turnaround and business in decline

Recognize the implications and issues involved in closing a business.

2. Need for Developing an Exit or Harvest Plan and Ideal Timing for That Plan (text

pages 246 through 248)

Learning Objective 13-1: Explain the need for developing an exit or harvest plan

and ideal timing for that plan

A. Why consider exit/harvest now?

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Chapter Thirteen: Exit/Harvest/Turnaround

i. Developing a practical exit plan within the business plan may help

validate the business idea

1. Provides peace of mind to the family and investors

ii. Develop an accurate valuation of the business as the firm begins to

have cash flow.

1. Provides insight for the founders as to the amount of future

capital and labor that they should invest in the effort

2. The business obtains loans (either direct or working capital)

by demonstrating the value of the firm to potential creditors

3. Convinces outside equity investors of the potential long-term

returns associated with the harvesting of the business

4. The owners can field potential offers to buy out the business

a. This is common in the life of a small business

5. Benchmarks the growth of the firm by establishing a true

starting point

B. Why consider exit or harvest later?

i. Laying some of the initial groundwork will help the small business

person if he later decides to exit the business

ii. Recap of Chapter Two

1. The small business entrepreneur must determine what the

business is to accomplish

2. The new small business owner might decide to exit a

successful business if the business owner does not enjoy

the work

3. The business might take too much time and personal

commitment to be enjoyable

4. The business owner might want to pursue other

opportunities that arise

5. Though the business is strong now, it might not have the

same potential in the future

3. Steps for Selling a Business (text pages 248 through 259)

Learning Objective 13-2: Outline the steps for selling a business

A. Valuation

i. There are a series of steps that occur when a business owner

decides to sell or harvest the business

ii. There are several standard valuation models and rules of thumb for

established, publically traded businesses to consider when they

determine the value of the business

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Chapter Thirteen: Exit/Harvest/Turnaround

1. The value of the business today is valued at established

market capitalization

2. Wall Street standards reveal that market value capitalized

today already accounts for future earnings and all future

prospects of the business

3. Market capitalization is the floor from which all negotiations

start

4. Calculating the premium that is offered above the market

capitalization is considered more of an art than a science

5. The amount of cash that is to be paid versus the amount of

stock transferred is negotiable

6. Any future investment in the newly combined organization is

negotiated

7. Another important factor to consider is what will happen to

the executives of the acquired

8. The valuation techniques for an established publically traded

business is different than the considerations for the valuation

and acquisition of a privately held venture

iii. All new businesses are private firms that do not report their

earnings to the public

iv. Small businesses often adjust their earnings with the payment of

large year-end bonuses in order to limit the profit and taxes

associated with the business

v. Small businesses may have creative company perquisites, often

called perks

1. Perquisites are benefits that are paid for by the company

a. Examples include vacations, vehicles, loans, gifts,

financial contributions to retirement plans, etc.

2. Perks reduce the tax owed by the business

3. The business pays less taxes

4. The firm appears to be worth less than it actually is

vi. The value of a business is the amount of money that a willing seller

and a willing buyer agree upon for the sale of the business

vii. There are unique systems used for the valuation of a private

business

1. Discounted future net cash flow (text page 249)

a. This is the most widely accepted method of valuation

b. Discounts the estimated future net cash flows of the

business

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Chapter Thirteen: Exit/Harvest/Turnaround

c. The cash flow method of valuation of a business

requires that the net cash flow of the business be

projected for some period of time into the future

d. Estimating the cash flow five years into the future and

then adding a salvage value for the firm is a good

ballpark floor valuation for a small business

e. Investors, lenders, equity investors, and founders

recognize that cash flow is an estimate based on a

set of assumptions

f. An addition to the business plan there is a complete

set of assumptions used by the founders

i. Discounting the cash flow (page 249)

1. Values are discounted by a rate that not

only represents the return expected by

an investor, but also accounts for the

riskiness of the venture

2. Discount rates range from rates as low

as ten percent to very high rates of 90

percent

3. The rule of thumb is to use 30 percent

as the discount factor

a. The calculation considers an

annualized rate of return and a

reasonable factor of risk

b. The discount rate remains the

same and the factor increases as

you move into the future

c. To calculate a discounted future

net cash flow take the net cash

flow figure generated for each

year and discount that cash flow

back in today’s dollars. The

discount rate remains the same,

while the factor increases as you

move farther away from today.

Thus, in year 2 the discount rate

is squared (1.e* 1.3), in year 3 it

is cubed (1.3*1.3*1.3). etc.

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Chapter Thirteen: Exit/Harvest/Turnaround

d. Illustration of the Present Value of

the Net Cash Flow. See Figure

13.1 on page 250

2. Price/earnings valuation (page 251)

a. Price/earnings (P/E) ratio

i. This is a value derived from public companies

that divide the current earnings per share into

the price per share

ii. This ratio is used to estimate the value of a

business

iii. This system uses the industry in which the

start-up operates

iv. It is done by locating the P/E ratio for public

companies in the same industry

v. To calculate the price/earnings ratio, take the

average and multiply it by the net cash flow for

year 5 and discount it back as a potential sales

price in year 6 of the venture

1. Use 1+ the discount rate raised to the 6th

power

2. Illustration on page 251

3. Asset-based valuation (page 252)

a. This is a method of business valuation that simply

totals all of the hard assets of the organization and

adds in a goodwill value

b. Asset valuation involves accounting for all of the hard

assets of the organization

i. Buildings owned by the business

ii. Equipment owned by the business

iii. Furniture

iv. Cash

v. Marketable securities held in the name of the

company

vi. In most cases the value of signed and

executable contracts

vii. The value of all the assets of the organization

is totaled

1. Calculate the value of the business

a. Take the total assets and add the

acquisition (goodwill) value

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Chapter Thirteen: Exit/Harvest/Turnaround

b. The acquisition or goodwill value

is determined by examining

similar companies that have been

acquired or by looking at the

percentage premium being

offered in general on all new

public acquisitions

c. A businesses that has poor

performance does not have any

goodwill value

d. Asset valuation is the lowest

business valuation number that

you calculate, unless you are an

asset-intensive business

e. Review page 253 for an

illustration of asset valuation

4. Capitalization of earnings valuation (page 253)

a. This is a method of valuation achieved by taking the

earnings (net profit), of the organization; subtracting

or adding any unusual items that the lender or

investor feels are not customary, normal, or usual

items; and dividing that figure by a capitalization rate

i. To calculate, take the net profit, or earnings,

and subtract or add any unusual items that the

lender/investor feels are not customary,

normal, or unusual items; and divide that

figure by the capitalization rate

ii. The capitalization rate is determined by the

nature of the business, including longevity,

business risk, consistency of earning, quality

of management, and general economic

conditions

iii. Review page 253 for an illustration of the

capitalization of earnings valuation

iv. Lenders and investors adjust the (net profit)

earnings figure to account for the individual

actions of the founders

v. Potential buyers readjust the net profit to

account for these nuances of a new business

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Chapter Thirteen: Exit/Harvest/Turnaround

and then apply a capitalization rate to this

figure

1. The capitalization rate is a combination

of the buyers’ risk propensity and the

current situation in the business

acquisition marketplace

2. Illustration is on page 254.

5. Market estimation valuation (page 255)

a. This is a method of business valuation that involves

taking the earnings of the business and multiplying

that figure by the market premium of companies in its

industry

b. This is the simplest valuation method

c. The market estimation valuation is calculated by

taking the earnings (projected earnings) of the

business and multiplying that figure by the market

premium of companies in its industry

d. Popular method of calculation is to take the EBITDA

(earnings before interest, taxes, depreciation, and

amortization) and rework that figure based on an

analysis of the cash flow statement and multiplying

the remaining figure by a market multiple.

e. An examination of the NASDAQ OR NYSE lists a

group of companies in virtually every industry

classification

f. Analyzing business in your industry yields an

estimated market premium that can be used to

calculate the value of the business

g. Lenders and investors adjust the earnings of the

organization to reflect a balanced view of these

figures

h. Review page 254 for an illustration of the market

estimation valuation technique

6. Valuation Overview (page 254)

a. These are the variations in the potential valuation of

the business analysis

b. Companies have unique features that provide it with a

competitive advantage in their business or industry

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