Copyright 2013 Jack M. Kaplan & Anthony C. Warren Exiting the Venture Patterns of Entrepreneurship...

Copyright 2013 Jack M. Kaplan & Anthony C. Warren

Exiting the Venture

Patterns of Entrepreneurship Management4th Edition,Chapter 13

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

Building and Exiting

ESOP’s andMBO’s

Financial Issues


Presentation Outline

• Personal Reasons for Selling• Business Reasons for Selling• Valuing the Company• Determining Best Candidates • Tax Considerations• Selling to Employees or Managers• Transferring to Family Members• IPOs• Running the Business while Selling

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Personal Reasons for Selling

• Investors are demanding a LIQUIDITY event• Entrepreneur wishes to cash-in part or all of their

ownership • Disagreements between shareholders• Acceptable Unsolicited Offer• Business - Burn Out• Personal Event• Poor Health• Retirement Planning

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Be Clear Why You are Selling

• Strategic Reasons• Growth Exceeded Management Capabilities• Diversify Personal Net Worth• Other Interests• Getting Older - Illness - Divorce• Owner Disagreements• Investors Desire to Liquidate

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Business Reasons for Selling

• Business Requires Significant Capital for Growth

• New Competition Appearing

• Limited Opportunity for Growth

• Close to Bankruptcy

• Market Condition Forecasts are Unattractive

• Consolidation is Occurring in the Sector

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Determine the Company’s Valuation

Before considering a sale of the company, it is important to estimate the potential value:

−Valuation based on purely financial evaluation

−Valuation on strategic fit that might be perceived by an existing corporate purchaser. This often attracts a premium in a competitive market sector.

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


As a company grows and has a few years’ history of asset purchases, sales, and profits, conventional methods for valuation are used:

Asset Valuations include:

–Book Value = Current assets + property + equipment

–Adjusted Book Value =Current assets + market value of property + equipment + intangible

assets

–Liquidation Value does not include intangible factors such as reputation, talent, or goodwill

–Replacement Value is cost of replacing assets after a total loss

Valuation Techniques for Later Stages –Asset

Based

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


• Can be based on either historical or projected earnings, or a blend

• Estimate Price/Earnings (P/E) ratio by

• comparing to similar public companies if available

• or use S&P quarterly industry analysis handbook

• Modify based on an assessment of these factors on a 1-6 scale • Risk (high/low)

• Competitive position (strong/weak)

• Industry (attractive/non-attractive)

• Growth opportunity (high/low)

• Desirability

• Sum the factors and take the average as a multiplier for the P/E

Valuation Techniques for Later Stages – Earnings

BasedChapter

13Reasons for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Once there is a history and solid projections on future financial performance the DCF method can be used effectively for later stage companies

The discount rate and risk adjustment factors are much lower than for a pre-revenue company

Valuation Techniques for Later Stages – DCF Based

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Determine Best Candidates

• Strategic Buyers– Competitors– Related or Complementary Businesses– Manufacturers of Related Products– Companies with Announced Acquisition Plans

• Financial Buyers– Management – ESOP– Management Buy-out Firms– Related Businesses– High Net Worth Individuals

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Types of Transactions

• Several different methods of payment are used for a corporate transaction

− In a “Stock for Stock” purchase the seller takes certain risks – if the buyer is a public company and the stock is restricted then the final price might decline, for a private company there may be no liquidity option

− Cash for Stock is the preferred method but the final price is usually lower

− Installment transactions are common, in which the final payment depends on the performance after purchase which has inherent risks associated with control issues.

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Beware - Double Taxation

• It is important to take tax advice long before selling is contemplated

• Taxation rules are complicated and depend on the form of transaction that is used

• For example Asset Sales can lead to two levels of taxation, both Corporation. Tax + Stockholder Tax

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Up-to-Date Financials

• Maintain the finances on a consistent monthly P & L and cash flow basis long before a sale is contemplated

• Fully audited accounts for the last three years are mandatory prior to a sale unless it is a strategic sale of assets

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


3-Year Projections

As well as historical financial records at least 3- year detailed forecasts are required:• by Month Actual Account Plus Future Accounts• by Actual Product Plus New Products• by Region and/or by Location• by Division or Subsidiaries

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues

Selling to Employees - ESOPs

Definition of 'Employee Stock Ownership Plan - ESOP‘

• A qualified, defined contribution, employee benefit plan designed to invest primarily in the stock of the employer. ESOPs are "qualified" in the sense that the ESOP's sponsoring company, the selling shareholder and participants receive various tax benefits. ESOPs are often to align the interests of a company's employees with those of the company's shareholders

• An ESOP can be structured so that over time employees can end up with owning the company and thereby “cashing out” the founders

• It is also a way in which the culture and uniqueness of the company can be retained

• Although the gross value to the founders may be somewhat lower than an outright sale to a third party, the net proceeds may be attractive because of the special tax treatments.


Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues

Selling to Managers – MBO’s

Definition of “Management Buyout – MBO” – When the managersand/or executives of a company purchase a controlling interestin a company from existing shareholders

• These shareholders can be founders who feel they wish to “cash-out” and allow key managers to continue to run the company

• In most cases, the management will buy out all the outstanding shareholders because it feels it has the expertise to grow the business better if it controls the ownership completely

• If the company is public, the new team will take the company private

• Often, management will team up with a venture capitalistspecializing in MBO’s to acquire the business because it's a complicated process that requires significant capital.

• Often much of the purchase price is funded through debt in which case the transaction is referred to as a “leveraged buy-out, (LBO)”


Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues

Transferring Ownership to Family Members

Family owned businesses constitute the largest percentage group of private companies:


Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Despite the need to transfer ownership to later generations, the process is fraught with difficulties. This chart shows the survival rate just through two generational shifts:


Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


Transferring to the next family generation is much more difficult that to an established and trusted management team. Some of the reasons are:

• Unwillingness to confront mortality by the founders

• Emotional family relationships hinder rational decision making

• Failure to prepare the new management team – holding onto control

• Family members not engaged so passionately to the business as the founders

• Company is in poor financial health

• Systematic planning is required to hand-over control and preparation for a smooth transition take several years.

• Often the transition is forced for health reasons unexpectedly


Things to Do While Still Running the

Business• Keep Term Liability Agreements Short

– Leases - 2 to 3 Years with Options to Renew– Distributor Agreements - Short Term Cancellation– Supplier Agreements - Cancel at Your Option or in

30 - 60 Days

• Keep Term Asset Type Agreements Longer– Employee Non-Compete Agreements– License and Royalty Agreements– Sales Agreements with Price Escalation

• All Agreements Must Be Assignable if possible

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


A Model for Running the Business for Greater

Perceived Value• Develop a Prestigious and Stable Customer List• Keep a Well-Maintained Facility• Show a Continuous Growth in Sales and Profits• Develop Propriety Assets

– Patents, Copyrights, Trademarks– Process Know How: Formulations and Clear Documentation

• Develop a Well-Respected Sales Distribution Channel• Document and Organize All Contractual and Legal

Obligations• In General, Do Things That Others Will Value Much

Higher Than Your Cost to Create Them

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


The Actual Process of Selling

(Average Time from Beginning to Closing is Up to One Year)

• Develop a List of Candidates– Choose a group of strategic buyers

• Try to Play the Role of a “Reluctant Suitor”

– Have Others Make Initial Contacts– Investment Bankers - Consultants - Brokers, etc.

• Get More Than One Serious Candidate– Use Competitive Negotiation Strategies– Let All Candidates Know Others Are Interested– Negotiate An Equitable Sales Price And Related Issues

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues


The Actual Process of Selling

(Average Time from Beginning to Closing is Up to One Year)

• Select One Candidate– Develop A Letter of Intent

A) All Equity Issues Described “How Much”

B) A Period of Due Diligence - up to 60 Days

• Negotiate a Definitive Agreement of Sale

• Closing

Chapter 13Reasons

for Selling

Valuation and

Candidates

Running and

Selling a Business

Intra-family sale

ESOP’s andMBO’s

Financial Issues

Copyright 2013 Jack M. Kaplan & Anthony C. Warren Exiting the Venture Patterns of Entrepreneurship...

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Transcript of Copyright 2013 Jack M. Kaplan & Anthony C. Warren Exiting the Venture Patterns of Entrepreneurship...