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differs from the unregistered shares, in that they are not subject to Rule 144. Based on the trading volume of Taylor
common stock over the preceding 12 months, the appraiser believed that it would likely take less than one year to
convert the block of registered stock into cash and estimated the discount at 13%, consistent with the Aschwald
(2000) studies.
Discussion Questions
1. Explain how the appraiser estimated the liquidity discount for Taylor’s unregistered shares.
Answer: The appraiser believed that the risk of Taylor’s unregistered shares is greater than for letter stocks,
which have a stipulated period during which the shares cannot be sold, because the Taylor shares lacked a
2. What other factors could the appraiser have used to estimate the liquidity discount on the unregistered
stock?
Answer: The appraiser could have considered a variety of adjustments to the 20 percent discount rate.
3. In view of your answer to question 2, how might these factors have changed the appraiser’s conclusions?
Be specific.
Answer: Without more information about the firm and the industry, it is difficult to estimate the amount of
4. Based on the estimated liquidity discount of 13 percent estimated by the business appraiser, what was the
actual purchase price premium paid to Tayco shareholders?
Answer: Assuming the shares exchanged were to be valued as of January 8, 2008, Tayco shareholders were
Taking Advantage of a “Cupcake Bubble”
__________________________________________________________________________________________
Key Points
Financing growth represents a common challenge for most small businesses.
Selling a portion of the business either to private investors or in a public offering represents a common way for
small businesses to finance major expansion plans.
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____________________________________________________________________________
When Crumbs first opened in 2003 on the upper west side of Manhattan, the bakery offered three varieties of
cupcakes among 150 other items. When the cupcakes became increasingly popular, the bakery began introducing
cupcakes with different toppings and decorations. The firm’s founders, Jason and Mia Bauer, followed a
straightforward business model: Hold costs down, and minimize investment in equipment. Although all of Crumbs’
The Bauers were no strangers to raising capital to finance the ongoing growth of their business, having sold one-
half of the firm to Edwin Lewis, former CEO of Tommy Hilfiger, for $10 million in 2008. This enabled them to
reinvest a portion in the business to sustain growth as well as to draw cash out of the business for their personal use.
The 57th Street General Acquisition Corporation (57th Street), a special-purpose acquisition company, or SPAC,
appeared to meet their needs. In May 2010, 57th Street raised $54.5 million through an IPO, with the proceeds
Panda Ethanol Goes Public in a Shell Corporation
In early 2007, Panda Ethanol, owner of ethanol plants in west Texas, decided to explore the possibility of taking its
ethanol production business public to take advantage of the high valuations placed on ethanol-related companies in
the public market at that time. The firm was confronted with the choice of taking the company public through an
initial public offering or by combining with a publicly traded shell corporation through a reverse merger.
After enlisting the services of a local investment banker, Grove Street Investors, Panda chose to "go public"
through a reverse merger. This process entailed finding a shell corporation with relatively few shareholders who
were interested in selling their stock. The investment banker identified Cirracor Inc. as a potential merger partner.
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The merger proposal provided for one share of Cirracor common stock to be exchanged for each share of Panda
Ethanol common outstanding stock and for Cirracor shareholders to own 4 percent of the newly issued and
outstanding common stock of the surviving company. Panda Ethanol shareholders would own the remaining 96
percent. At the end of 2005, Panda had 13.8 million shares outstanding. On June 7, 2007, the merger agreement was
Effects of Reverse Stock Split
Shares
Outstanding*
Ownership
Distribution (%)
Shares
Outstanding*)
Ownership
Distribution (%)
Before Reverse Split
After Reverse Split
A special Cirracor shareholders' meeting was required by Nevada law (i.e., the state in which Cirracor was
incorporated) in view of the substantial number of new shares that were to be issued as a result of the merger. The
proxy statement filed with the Securities and Exchange Commission and distributed to Cirracor shareholders
indicated that Grove Panda, a 78 percent owner of Cirracor common stock, had already indicated that it would vote
its shares for the merger and the reverse stock split. Since Cirracor's articles of incorporation required only a simple
majority to approve such matters, it was evident to all that approval was imminent.
surviving corporation are those of Panda Ethanol.
Discussion Questions:
1. Who were Panda Ethanol, Grove Street Investors, Grove Panda, and Cirracor? What were their roles in the
case study? Be specific.
Answer: Panda Ethanol owned ethanol manufacturing plants in West Texas and was interested in going
public either through a reverse merger or IPO. Grove Street Investors was the investment bank hired by
Panda Ethanol to evaluate their options and to locate a suitable public shell corporation if the decision was
2. Discuss the pros and cons of a reverse merger versus an initial public offering for taking a
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company public.
Answer: Many small businesses fail each year. In a number of cases, all that remains is a business with no
significant assets or operations. Such companies are referred to as shell corporations. Shell corporations
can be used as part of a deliberate business strategy in which a corporate legal structure is formed in
anticipation of future financing, a merger, joint venture, spin-off, or some other infusion of operating
3. Why did Panda Ethanol undertake a private equity placement totaling $90 million shortly before
implementing the reverse merger?
Answer: Private investment in public entities (PIPES) is a commonly used method of financing reverse
mergers. In such transactions, a public company sells equity at a discount to private investors, often hedge
funds. As the issuer, it is up to the company to register its shares with the SEC within 120 days. Once
approved by the SEC, the stock may be traded on public exchanges. PIPES often are used in conjunction
4. Why do you believe Panda did not directly approach Cirraco ? How were the Panda Grove investment
holdings used to influence the outcome of the proposed merger?
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Answer: Note that Panda could have approached Ciracco directly. However, this may have alerted the
Ciracco shareholders to the Panda’s intentions and could have encouraged them to hold out for a higher
purchase price for their stock. As an agent for Panda, Grove was able to buy the stock less expensively
Note: Total Panda shares outstanding (including 15 million newly issued shares in the private placement) equaled
28.8 million shares. As a result of negotiations, Panda shareholders would own 96% of the merged firms and
Cirracor shareholders 4%. This implied that total shares outstanding of the merged firms could not exceed 30
million shares (i.e., 28.8/.96). Consequently, Cirracor shareholders would own 1.2 million shares (i.e., 30 – 28.8).
Cantel Medical Acquires Crosstex International
On August 3, 2005, Cantel Medical Corporation (Cantel), as part of its strategic plan to expand its infection
prevention and control business, announced that it had completed the acquisition of Crosstex International
Incorporated (Crosstex). Cantel is a leading provider of infection prevention and control products. Crosstex is a
privately owned manufacturer and reseller of single-use infection control products used primarily in the dental
market.
As a consequence of the transaction, Crosstex became a wholly owned subsidiary of Cantel, a publicly traded
firm. For the fiscal year ended April 30, 2005, Crosstex reported revenues of approximately $47.4 million and pretax
income of $6.3 million. The purchase price, which is subject to adjustment for the net asset value at July 31, 2005,
was $74.2 million, comprising $67.4 million in cash and 384,821 shares of Cantel stock (valued at $6.8 million).
Discussion Questions and Answers:
1. What were the primary reasons Cantel wants to acquire Crosstex? Be specific.
Answer: Crosstex fits Cantel’s strategy as a leading provider of healthcare products in niche markets
2. What do you believe could have been the primary factors causing Crosstex to accept Cantel’s offer?
Answer: Crosstex’s president noted the firm was confronted with a host of opportunities. The firm
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3. What factors might cause Crosstex’s net asset value to change between signing and closing of the
agreement of purchase and sale?
Answer: During the period between signing and closing various components of net asset value could
4. Speculate why Cantel may have chosen to operate Crosstex as a wholly-owned subsidiary following
closing. Be specific
5. The purchase price consisted of cash, stock, and an earnout. What are some of the factors that might
have determined the purchase price from the seller’s perspective? From the buyer’s perspective?
Answer: The buyer may have been unwilling to meet the seller’s price expectation and thought it could
do so by adding an earn-out option and by offering stock to allow the sellers to participate in any future
Deb Ltd. Seeks an Exit Strategy
In late 2004, Barclay's Private Equity acquired slightly more than one half the equity in Deb Ltd. (Deb), valued at
about $250 million. The private equity arm of Britain's Barclay's bank outbid other suitors in an auction to acquire a
controlling interest in the firm. PriceWaterhouseCooper had been hired by the Williamson family, the primary
stockholder in the firm, to find a buyer.
The sale solved a dilemma for Nick Williamson, the firm's CEO and son of the founder, who had invented the
firm's flagship product, Swarfega. The company had been founded some 60 years earlier based on a single product,
Discussion Questions
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1. Succession planning issues are often a reason for family-owned businesses to sell. Why do you believe it may
have been easier for Nick than his father to sell the business to a non-family member?
Answer: Nick did not have the same emotional attachment that his father, as the firm’s founder, did. Such
2. What other alternatives could Nick have pursued? Discuss the advantages and disadvantages of each.
Answer: Nick could have tried to partner with another firm with the intent of passing on control of the firm
3. What do you believe might be some of the unique challenges in valuing a family-owned business? Be specific.
Answer: The challenges of valuing a family owned business include the absence of audited financial
GHS Helps Itself by Avoiding an IPO
In 1999, GHS, Inc., a little known supplier of medical devices, engineered a reverse merger to avoid the time-
consuming, disclosure-intensive, and costly process of an initial public offering to launch its new internet-based self-
help website. GHS spun off its medical operations as a separate company to its shareholders. The remaining shell is
being used to launch a ‘‘self-help’’ Website, with self-help guru Anthony Robbins as its CEO. The shell corporation
will be financed by $3 million it had on hand as GHS and will receive another $15 million from a private placement.
With the inclusion of Anthony Robbins as the first among many brand names in the self-help industry that it hopes
to feature on its site, its stock soared from $.75 per share to more than $12 between May and August 1999. Robbins,
who did not invest anything in the venture, has stock in the new company valued at $276 million. His contribution to
the company is the exclusive online rights to his name, which it will use to develop Internet self-help seminars, chat
rooms, and e-commerce sites.
Discussion Questions:
1. What are the advantages of employing a reverse merger strategy in this instance?
2. Why was the shell corporation financed through a private placement?
Answer: The private placement is often faster and cheaper than raising funds in the public debt markets
Valuing a Privately Held Company
Background
BigCo is interested in acquiring PrivCo, whose owner desires to retire. The firm is 100% owned by the current
owner. PrivCo has revenues of $10 million and an EBIT of $2 million in the preceding year. The market value of the
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firm’s debt is $5 million; the book value of equity is $4 million. For publicly traded firms in the same industry, the
average debt-to-equity ratio is .4 (based on the market value of debt and equity), and the marginal tax rate is 40%.
Typically, the ratio of the market value of equity to book value for these firms is 2. The average of publicly traded
firms that are in the same business is 2.00. Capital expenditures and depreciation amounted to $0.3 million and $0.2
million in the prior year. Both items are expected to grow at the same rate as revenues for the next 5 years. Capital
Calculating COE and WACC:
1. Unlevered Beta for publicly traded firms in the same industry = 2.00 / (1 + .6 x .4) = 1.61, where 2.00 is the
levered beta, .6 is (1-tax rate), and .4 is the average debt ratio for firms in this industry.
4. Cost of equity for the private firm = 6 + 2.21 x 5.5 = 18.16
Valuing the business using the FCFF model:
Year 1 2 3 4 5 6
EBIT (EBIT grows at 15% for the first $2.30 $2.65 $3.04 $3.50 $4.02 $4.22
five years and 5% thereafter.)
EBIT (1-Tax Rate) $1.38 $1.59 $1.82 $2.10 $2.41 $2.53
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Pacific Wardrobe Acquires Surferdude Apparel
by a Skillful Structuring of the Acquisition Plan
Pacific Wardrobe (Pacific) is a privately owned California corporation that has annual sales of $20 million and
pretax profits of $2 million. Its target market is the surfwear/sportswear segment of the apparel industry. The
surfwear/sportswear market consists of two segments: cutting-edge and casual brands. The first segment includes
high-margin apparel sold at higher-end retail establishments. The second segment consists of brands that sell for
Pacific’s Operations and Competitive Environment
Pacific imports all of its apparel from factories in Hong Kong, Taiwan, Nepal, and Indonesia. Its customers consist
of major chains and specialty stores. Most customers are lower-end retail stores. Customers include J.C. Penney,
Sears, Stein Mart, Kids “R” Us, and Target. No one customer accounts for more than 20% of Pacific’s total revenue.
The customers in the lower-end market are extremely cost sensitive. Customers consist of those in the 10–21 years
Pacific’s Strengths and Weaknesses
Pacific’s core strengths lie in their strong vendor support in terms of quantity, quality, service, delivery, and
price/cost. Pacific’s production is also scaleable and has the potential to produce at high volumes to meet peak
demand periods. Additionally, Pacific also has strong financial support from local banks and a strong management
Acquisition Plan
Pacific’s management objectives are to grow sales, improve profit margins, and increase its brand life cycle by
acquiring a cutting-edge surfwear retailer with a trendy brand image. Pacific intends to improve its operating
margins by increasing its sales of trendy clothes under the newly acquired brand name, while obtaining these clothes
from its own low-cost production sources.
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geographic markets, existing inventory, market brand recognition, price range, and overall ‘‘fit’’ with Pacific.
Pacific will locate this surfwear company by analyzing the surfwear industry; reviewing industry literature; and
Pacific’s screening criteria for identifying potential acquisition candidates include the following:
1. Industry: Garment industry targeting young men, teens, and boys
3. Size: Revenue ranging from $5 million to $10 million
5. Management: Company with management expertise in brand and image building
6. Leverage: Maximum debt-to-equity ratio of 3 to 1
After a review of 14 companies, Pacific’s management determined that SurferDude best satisfied their criteria.
SurferDude is a widely recognized brand in the surfer sports apparel line; it is marginally profitable, with sales of $7
million and a debt-to-equity ratio of 3 to 1. SurferDude’s current lackluster profitability reflects a significant
Valuation
On a standalone basis, sales for both Pacific and SurferDude are projected to increase at a compound annual average
rate of 20% during the next 5 years. SurferDude’s sales growth assumes that its advertising expenditures in 1998 and
1999 have created a significant brand image, thus increasing future sales and gross profit margins. Pacific’s sales
growth rate reflects the recent licensing of several new apparel product lines. Consolidated sales of the combined
companies are expected to grow at an annual growth rate of 25% as a result of the sales and distribution synergies
created between the two companies.
The discount factor was derived using different methods, such as the buildup method or the CAPM. Because this
was a private company, the buildup method was utilized and then supported by the CAPM. At 12%, the specific
The buildup calculation included the following factors:
Risk-Free Rate: 6.00%
Market Risk Premium to Invest in Stocks: 5.50%
Specific Business Risk Premium: 12.00%
The CAPM method supported the buildup method. One comparable company, Apparel Tech, had a ß estimated
by Yahoo.Marketguide.com to be 4.74, which results in a ke of 32.07 for this comparable company. The weighted
average cost of capital using a target debt-to-equity ratio of 3 to 1 for the combined companies is estimated to be
26%.
The standalone values of SurferDude and Pacific assume that fixed expenses will decrease as a percentage of
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Developing an Initial Offer Price
Using price-to-cash flow multiples to develop an initial offer price, the target was valued on a standalone
basis and a multiple of 4.51 for a comparable publicly held company called Stage II Apparel Corp. The standalone
valuation, excluding synergies, of SurferDude ranges from $621,000 to $2,263,000.
Negotiating Strategy
Pacific expects to initially offer $2.25 million and close at $3.0 million. Pacific’s management believes that
SurferDude can be purchased at a modest price when compared with anticipated synergy, because an all-stock
transaction would give SurferDude’s management ownership of between 25% and 30% of the combined companies.
Integration
A transition team consisting of two Pacific and two SurferDude managers will be given full responsibility for
consolidating the businesses following closing. A senior Pacific manager will direct the integration team. Once an
Discussion Questions:
1. What were the key assumptions implicit in Pacific Wardrobe’s acquisitions plan, with respect to the
market, valuation, and integration? Comment on the realism of these assumptions.
Answer: Market-related assumptions include consolidated sales growth of 25% per year during the five
years beginning n 1999 due to sales and distribution synergies created by combining the two firms. The
growth in sales is expected to be supported without additional advertising expenses because of the extent of
2. Discuss some of the challenges that Pacific Wardrobe is likely to experience during due diligence.
Answer: SurferDude’s lackluster profit performance is largely attributable to its heavy advertising
campaign in the years just prior to the proposed acquisition. Pacific needs to verify this key assumption.
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3. Identify alternative deal structures Pacific Wardrobe might have employed in order to complete the
transaction. Discuss why these alternatives might have been superior or inferior to the one actually chosen.
Answer: Pacific was primarily interested in obtaining the rights to produce and sell another brand of
clothing focused on what they believed would be a high growth market. They may have accomplished the
Cashing Out of a Privately Held Enterprise
When he had reached his early sixties, Anthony Carnevale starting reducing the amount of time he spent managing
Sentinel Benefits Group Inc., a firm he had founded. He planned to retire from the benefits and money management
consulting firm in which he was a 26 percent owner. Mr. Carnevale, his two sons, and two nonfamily partners had
built the firm to a company of more than 160 employees with $2.5 billion under management.
