Planning for the Harvest

1. Planning for the Harvest PART 3 Developing the New Venture Business Plan

2. Looking AheadAfter studying this chapter, you should be able to: Explain the importance of having a harvest, or exit, plan. Describe the options available for harvesting. Explain the issues in valuing a firm that is being harvested and deciding on the method of payment. Provide advice on developing an effective harvest plan.

3. The Importance of the Harvest • Harvesting (or Exiting) • The process used by entrepreneurs and investors to reap the value of a business when they get out of it. • The process involves: • Capturing value (cash value) • Reducing risk • Creating future options

4. Exhibit 13.1Methods for Harvesting a Business

5. Selling the Firm: Buyers’ Reasons for Purchasing a Firm • Sales to Strategic Buyers • A purchase in which the value of the business is based on both the firm’s stand-alone characteristics and synergies that the buyer thinks can be created by the strategic fit of the firm and a potential buyer. • Sales to Financial Buyers • A purchase in which the value of the business is based on the stand-alone cash generating potential of the firm being acquired.

6. Financial Acquisitions Bust-Up LBO Build-Up LBO Types of Leveraged Buyouts (LBOs) Management Buyout (MBO)

7. Selling the Firm: Buyers’ Reasons for Purchasing a Firm (cont’d) • Sales to Employees • Employee Stock Ownership Plan (ESOP) • A method by which a firm is sold either in part or in total to its employees. • Employees retirement contributions are used to purchase shares in the firm. • Frequently is exit method of last resort. • Motivates employee-owners to perform.

8. Leveraged ESOP Buyout Process 1. Employer firm guarantees payment of loan. EmployerFirm Lender 5. Employer firm makes annual contribution for employee stock purchases. 2. ESOP trust borrows money from lender. 6. ESOP trust makes payment on loan. ESOPTrust 3. Cash from loan is used to buy owner’s stock. 4. Stock is sent to ESOP trust for benefit of employees. SellingOwner

9. Selling A Business in Difficult Times Clean up the books Keep revenue strong Selling A Business Consider your sector and market

10. Releasing the Firm’s Cash Flows • Harvesting by Withdrawing Firm’s Cash • Advantages: • Retain control of firm while harvesting investment. • No need to seek a buyer or incur expenses associated with sale of business • Disadvantages • Loss of development potential and opportunities • Tax disadvantages of cash withdrawal • Requires patience to siphon off cash slowly

11. Harvesting: Going Public • Initial Public Offering (IPO) • Benefits of the sale of shares of stock to the public: • Signals to investors that a firm is a quality business and will likely perform well in the future. • Provides access to more investors when the firm needs to raise capital to grow the business. • Helps create ongoing interest in the company and its continued development. • Makes firm’s stock more attractive as incentive pay to key personnel.

12. Going Public: The IPO Process • The firm’s owners decide to go public. • If not already completed, an audit of the last three years financial statements is conducted. • An investment banker is selected to guide the IPO process. • An S-1 registration is drafted and filed with SEC. • Management responds to suggested comments by the SEC, and issues a Red Herring/Prospectus. • Firm goes “on the road” explaining its attributes to investors. • On the day before public offering, an offering price is decided upon. • Offering the stock to the public and seeing how it is received.

13. Exhibit 13.2IPOs Raising Less Than $25 Million Source: Dealogic, Capital Markets Advisory Partners, reported in David Weild and Edward Kim, “Why Are IPOs in the ICU?” White Paper, Grant Thornton, LLP, 2008, p. 8.

14. Harvesting: Private Placement • Private Equity (Capital) • Money provided by venture capitalists or private investors. • Factors in the Transfer of Family-Owned Firms • Liquidity for exiting family members • Continued financing for company growth • Maintenance of family control of the firm

15. Exhibit 13.3Private Placement—An Illustration

16. Firm Valuation and the Harvest • The Harvest Value • Opportunity cost of funds • The rate of return that could be earned on another investment of similar risk • Harvest Value/Market Comparable Valuations • Establishing the value of a privately held company based on the value of a similar or comparable publicly traded company. • Multiple of earnings method is frequently used.

17. Harvesting: The Method of Payment • Payment Alternatives • Cash • Immediate and stable in value • Tax liability consequences • Stock • Purchaser: protection from liabilities • Seller: immediate but uncontrollable in value • Seller: potential problems with disposal of stock • Merger with Purchasing Firm • Purchased firm is absorbed into purchasing firm

18. Developing a Harvest Plan • Anticipate the Harvest • Manage for the long-term. • Avoid playing the harvest game. • Expect Conflict—Emotional and Cultural • Strains of selling own business • Personal ties to the business after sale • Get Good Advice • Advisors with harvest transaction experience • Other entrepreneurs who have sold their firms

19. Developing a Harvest Plan (cont’d) • Understand What Motivates Your Exit • Motives for exiting: • Money • Independence • Health of the company • Your management team • An heir apparent taking over • Personal identity and the business itself • Avoid “seller’s remorse”

20. What’s Next? • Whatever you decide to do, do it with passion and let your life benefit others in the process.

21. Key Terms harvesting (exiting) leveraged buyout (LBO) bust-up LBO build-up LBO management buyout (MBO) employee stock ownership plan (ESOP) leveraged ESOP seller financing double taxation initial public offering (IPO) opportunity cost of funds