978-1305405745 Chapter 13

Chapter 13: Planning For The Harvest

CHAPTER 13: PLANNING FOR THE HARVEST

CHAPTER OUTLINE

Spotlight: Tapestry Medical

(https://www.facebook.com/pages/Tapestry-Medical-Inc/134797156571373)

1) The Importance of the Harvest

LO1: Explain the importance of having a harvest, or exit, plan.

i) Harvesting, also called exiting is used to get out of business and obtain the

value of the business.

ii) Investors generally expect a well thought-out harvest strategy.

2) Methods of Harvesting a Business

LO2: Describe the options available for harvesting.

i) There are four basic ways to harvest an investment in a privately owned

business:

(1) Selling the firm

(2) Distributing the cash flows generated by the business to its owners instead

of reinvesting the cash

(3) Offering stock to the public through an initial public offering (IPO)

(4) Issuing a private placement of stock.

a) Selling the Firm

i) Sales to Strategic Buyers

(1) Strategic buyers look for a business that can be combined with another

related business

(2) Critical issue in the sale is the fit with the other firm and the buyer’s other

business interests

ii) Sales to Financial Buyers

(1) These buyers look for stand-alone, cash-generating potential

(2) Leveraged buyout (LBO) – a purchased heavily financed with debt, where

the future cash flows of the target company are expected to be sufficient to

meet debt repayments.

(3) Bust-up LBO – a leveraged buyout involving the purchase of a company

with the intent of selling off its assets

(4) Build-up LBO- a leveraged buyout involving the purchase of a group of

similar companies with the intent of making the firms into one larger

company for eventual sale.

(5) Management buyout (MBO) – a leveraged buyout in which the firm’s top

managers become significant shareholders in the acquired firm.

iii) Sales to Employees

(1) Employee Stock Ownership Plans (ESOP) – a method by which a firm is

sold either in part or in total to its employees

(2) Tips for selling a business in a difficult economy:

(a) Clean up the books, i.e. pay off small debts if you can

(b) Keep revenue strong

(c) Consider your sector and market

(3) Seller financing – Financing in which the seller accepts a note from a

buyer in lieu of cash in partial payment for a business.

(4) Employee ownership used to create an incentive for employees to work

harder

b) Distributing the Firm’s Cash Flows

i) Withdrawal of owners’ investment in the form of the firm’s cash flows

ii) Generally accomplished slowly

iii) Advantages

(1) Owners retain control of business while harvesting

(2) Owners do not need to find a buyer or incur the expenses associated with

completing a sale of the business

iv) Disadvantages

(1) Reducing reinvestment negates possible growth and results in lost value

creation

(2) Tax disadvantages to an orderly liquidation

v) This method may require too much patience and therefore be destined to fail

vi) Double taxation – taxation o f income that occurs twice- first as corporate

earnings and then as stockholder dividends.

c) Initial Public Offering (IPO)

i) This occurs when a private firm sells its shares for the first time to the general

public.

ii) Requires registering the stock issue with the SEC and adhering to Blue Sky

Laws that govern the public offering at a state level.

iii) The initial cost of an IPO can cost as much as 20 percent of the issue.

iv) Reasons for Going Public

(1) Company offers its stock to the general public

(2) Benefits

(a) Signals to investors that firm is a quality business and will likely

perform well in future

(b) Stock traded publicly has access to more investors when capital

needed to grow the business

(c) Helps create ongoing interest in company and continued development

(d) Publicly traded stock more attractive to key personnel whose incentive

pay includes the firm’s stock

v) The IPO Process

(1) Steps in the IPO process

(2) Consider the shift in power that occurs during the process of an IPO

(3) Understand the investment banker’s motivations in IPO process

(4) Consider costs of running a publicly traded company along with the initial

costs of the IPO

d) Private Equity Recapitalization

i) Described briefly in Chapter 12

ii) Effective for family-owned businesses that need to transfer ownership to next

generation

iii) Three goals

(1) Liquidity (cash) for the selling family members

(2) Continued financing for company’s future growth

(3) Desire of buying generation to maintain control of the firm

3) Firm Valuation and Payment Methods

LO3: Explain the issues in valuing a firm that is being harvested and deciding

on the method of payment

a) The Harvest Value

i) Opportunity cost of funds – the rate of return that could be earned on a

investment of similar risk

ii) Check Appendix B at end of book for specific approaches to and methods for

valuing a company

b) The Method of Payment

i) When selling there are three basic choices

(1) Sell the firm’s assets

(2) Sell its stock

(3) Merge with the buyer who owns another company

ii) Exiting entrepreneur

(1) Stock allow gain on the sale to be a capital gain, resulting in lower taxes

(2) Buyer may prefer to purchase assets rather than company stock

4) Developing an Effective Harvest Plan

LO4: Provide advice on developing an effective harvest plan.

a) Anticipate the Harvest

i) Must be planned or may distract form day-to-day affairs causing loss of

managerial focus and momentum

ii) Uncertainties may lower employee morale

iii) Investors always concerned about how to exit

iv) IPO had requirements not required of a privately held firm

b) Expect Conflict—Emotional and Cultural

i) Buying a company and selling a company are very different

(1) Buyer can be unemotional and detached

(2) Seller likely to be more concerned about nonfinancial considerations

ii) Qualities that make successful entrepreneurs may make them difficult as

employees

c) Get Good Advice

i) Harvesting not like day-to-day activities since is happens many fewer times

ii) Professional advice vital

iii) Also talk to other entrepreneurs

d) Understand What Motivates You

i) Harvesting an emotional experience

ii) Difficult to walk away from business, employees, and clients

iii) Personal identify tied to business

e) What’s Next?

i) Since entrepreneurs are purpose-driven, it is important that they find meaning

in life following exit.

ii) For many, giving back to the community and charitable causes may bring

meaning and purpose to post-exit life.

Chapter 13: Planning For The Harvest

ADDITIONAL DISCUSSION QUESTIONS

1. Explain what is meant by the term harvesting. What is involved in

harvesting an investment in a privately held firm?

Harvesting is the method entrepreneurs and investors use to exit a business

2. Why should an owner of a company plan for eventually harvesting his or

her company?

There are several good reasons for planning in advance for the exit. For

example, when a company changes hands, employees face considerable

3. Contrast a sale to a strategic buyer with one to a financial buyer.

These two acquisitions differ primarily in terms of the goals of the buyer. In a

4. Explain the term leveraged buyout. How is a leveraged buyout different

from a management buyout?

5. Distinguish between bust-up LBOs and build-up LBOs.

During the 1980s, the leveraged buyout (which is a financial acquisition

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13-5

6. What is the primary purpose of an initial public offering (IPO)? How does

an IPO relate to harvest?

The initial public offering refers to a strategy of making available the stock of

can cash out eventually by selling their stock on the market.

7. Why might an entrepreneur find going public a frustrating process?

8. What determines whether a firm has value to a prospective purchaser?

A firm’s value is based on its return on invested capital relative to the

investors’ opportunity cost of funds, which is the rate of return that could be

9. What problems can occur when an entrepreneur sells a firm but continues

in the management of the company?

10. How may harvesting a firm affect an entrepreneur’s personal identity?

Entrepreneurs who leave their business often become disillusioned when they

SUGGESTED ANSWERS TO YOU MAKE THE CALL EXERCISES

Situation 1

1. What would be the reasons for and against Sloan working for Tortilla

King?

2. What advice would you offer Sloan?

Situation 2

1. Do you agree with the Bonneaus’ decision to sell? Why or why not?

2. Why did the buyers retain Ed as a consultant?

3. Do you see any problem with having the Bonneaus’ son-in-law become the

new chief operating officer?

Situation 3

1. Do you agree that the entrepreneur’s company is not sellable?

2. Are there any other options for the entrepreneur besides selling his

business?

3. What would you recommend the entrepreneur do? Why?

Student answer will vary but should include some of the following:

SUGGESTED SOLUTION TO CASE 13: NETWORK COLLIE

Note to Instructor: There are no one right or wrong answers to the questions for the

Network Collie case, but below are some thoughts to consider for discussion.

Case Overview: The case examines the struggles faced by any new start-up company

especially a software start-up. In addition to deciding whether to exit a business, it

highlights the many different challenges new venture enterprises experience, including

team development, ownership structure, new industry timing, customer development,

individual commitment needs, product pricing and company valuation.

1. Given the early stage of the business, should the Network Collie

management team even be considering an exit at this time? Why or why

not?

Chapter 13: Planning For The Harvest

• When planning for an exit, the goal should be to build a business that

2. If a company acquires Network Collie, what are they buying? What are

they not buying?

3. What criteria should the Network Collie management team use in making a

decision on what they should do?

The four founders viewed themselves as having four options:

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13-9

4. In your opinion, is Network Collie really worth $1 million?

Determining the “true value” of a start-up is for all practical purposes

impossible. It begins with a very subjective assessment of the potential

market, the economics of the opportunity, the management team, the fit of the

5. What do you see as the advantages and disadvantages of the two offers the

Network Collie founders have received?

The choice between the two offers largely involve a risk-return offer The

6. What would you advise the Network Collie team to do?

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13–10

Epilogue

The Network Collie team decided it was time to move on by trying to sell the company.

They did not believe in the company’s potential enough to leave their jobs and fully

commit to the business. As part of their efforts to sell the company, the team contacted a

new competitor that entered the market in late 2009. Without any attractive sales leads,

the team negotiated a price for the intellectual property and agreed to sell for a much

lower price than the Groovy ID offer that was rejected earlier. Shortly after the team

agreed to this transaction, Facebook and other leading social networks increased

restrictions and changed the protocol to access their networks. As a result, the Network

Collie application (and the acquirer’s similar software application) was not able to gather

the relevant usage data anymore.