Planning For The Harvest

Transcription

1 CHAPTER OUTLINE Spotlight: Li l Guy Foods ( 1 The Importance of the Harvest Explain the importance of having a harvest, or exit, plan. Harvesting Also called exiting Used to get out of a business and obtain the value of the business Success a different term for different people Investors generally expect a well-thought-out harvest strategy 2 Methods of Harvesting a Business Describe the options available for harvesting. Selling the Firm first harvest strategy Sales to Strategic Buyers Strategic buyers look for a business that can be combined with another related business Critical issue in the sale is the fit with the other firm and the buyer s other business interests Sales to Financial Buyers These buyers look for stand-alone, cash-generating potential 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. Bust-up LBO a leveraged buyout involving the purchase of a company with the intent of selling off its assets 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. Management buyout (MBO) a leveraged buyout in which the firm s top managers become significant shareholders in the acquired firm. Sales To Employees Employee Stock Ownership Plans (ESOP) a method by which a firm is sold either in part or in total to its employees Seller financing Financing in which the seller accepts a note from a buyer in lieu of cash in partial payment for a business. Employee ownership used to create an incentive for employees to work harder Distributing the Firm s Cash Flows second harvest strategy Withdrawal of owners investment in the form of the firm s cash flows Generally accomplished slowly Advantages 140

2 Owners retain control of business while harvesting Owners do not need to find a buyer or incur the expenses associated with completing a sale of the business Disadvantages Reducing reinvestment negates possible growth and results in lost value creation Tax disadvantages to an orderly liquidation This method may require too much patience and therefore be destined to fail Double taxation taxation o f income that occurs twice- first as corporate earnings and then as stockholder dividends. Initial Public Offering (IPO) third harvest strategy Basically selling stock in the business Reasons for Going Public Company offers its stock to the general public Benefits Signals to investors that firm is a quality business and will likely perform well in future Stock traded publicly has access to more investors when capital needed to grow the business Helps create ongoing interest in company and continued development Publicly traded stock more attractive to key personnel whose incentive pay includes the firm s stock The IPO Process Steps in the IPO process Consider the shift in power that occurs during the process of an IPO Understand the investment banker s motivations in IPO process Consider costs of running a publicly traded company along with the initial costs of the IPO Private Placement fourth harvest strategy Described briefly in Chapter 12 Effective for family-owned businesses that need to transfer ownership to next generation Three goals Liquidity (cash) for the selling family members Continued financing for company s future growth Desire of buying generation to maintain control of the firm 3 Firm Valuation and the Harvest Explain the issues in valuing a firm that is being harvested and deciding on the method of payment The Harvest Value Opportunity cost of funds the rate of return that could be earned on a investment of similar risk Check Appendix B at end of book for specific approaches to and methods for valuing a company Method of Payment 141

3 When selling there are three basic choices Sell the firm s assets Sell its stock Merge with the buyer who owns another company Exiting entrepreneur Stock allow gain on the sale to be a capital gain, resulting in lower taxes Buyer may prefer to purchase assets rather than company stock 4 Developing an Effective Harvest Plan Provide advice on developing an effective harvest plan. Anticipate the Harvest Must be planned or may distract form day-to-day affairs causing loss of managerial focus and momentum Uncertainties may lower employee morale Investors always concerned about how to exit IPO had requirements not required of a privately held firm Expect Conflict Emotional and Cultural Buying a company and selling a company are very different Buyer can be unemotional and detached Seller likely to be more concerned about nonfinancial considerations Qualities that make successful entrepreneurs may make them difficult as employees Get Good Advice Harvesting not like day-to-day activities since is happens many fewer times Professional advice vital Also talk to other entrepreneurs Understand What Motivates You Harvesting an emotional experience Difficult to walk away from business, employees, and clients Personal identify tied to business 5 What s Next? Since entrepreneurs are purpose-driven, it is important that they find meaning in life following exit. For many, giving back to the community and charitable causes may bring meaning and purpose to post-exit life. ANSWERS TO END-OF-CHAPTER 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 and, hopefully, reap the value of their investment in the firm. For the privatelyowned company, there are four basic ways to harvest investment. First, the owners can simply sell the firm. This strategy is most likely to be used when 142

4 the entrepreneur has estate planning needs or a desire to diversify his or her portfolio of investments. Second, the owner(s) can release the firm s free cash flows, using one of the options available to achieve this. Third, stock in the company can be offered to the public in an initial public offering (IPO). Finally, the owners can extract some of the value of the firm via private equity placements. 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 uncertainty and morale often suffers. This has a negative effect on the company's performance. A well-planned exit can minimize dysfunctional employee behavior and turnover, which helps maintain stable performance during the transition (which is also important to the exiting entrepreneur if he/she receives all or some payment in the form of stock in the exited company). Having an exit plan can also guide the entrepreneur in positioning the company for optimal value in the years prior to the sale and ensure a smooth transition to public ownership (in the case of an IPO). Finally, exit planning can prepare the company for rapid sale if a window for such an opportunity should open and close quickly. 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 strategic acquisition, the buyer is interested in gaining synergies from the fit of the target acquisition with current holdings. In contrast, the financial acquisition looks primarily to the stand-alone potential for cash generation as the source of its value. 4. Explain the term leveraged buyout. How is a leveraged buyout different from a management buyout? Leveraged buyouts are acquisitions that rely on heavy debt financing. If the LBO includes the firm s top management as significant shareholders in the acquired firm, then it is referred to as a management buyout. Thus, a management buyout is a type of LBO. 5. Distinguish between bust-up LBOs and build-up LBOs. During the 1980s, the leveraged buyout (which is a financial acquisition involving a very high level of debt financing) became synonymous with the bust-up LBO. This strategy involves owners who pay the debt down rapidly by selling off the acquired firm's assets. The build-up LBO replaced bust-up LBOs 143

5 in the 1990s. The build-up LBO involves the integration of smaller acquisitions into a larger enterprise that can then be taken public in the IPO. 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 a privately-owned company to any interested investor. The primary purpose of an IPO is to raise additional equity capital to finance company growth, but it can also serve as an additional strategy for harvesting the investment of owners. Once the company s stock is publicly traded, the pre-offering owners can cash out eventually by selling their stock on the market. 7. Why might an entrepreneur find going public a frustrating process? Going public does offer liquidity and eventual harvest benefits to a company. However, this move also brings significant frustrations, such as facing the scrutiny of public-market investors and dealing with investment bankers (who have their own unique interests in such an offering). Perhaps as frustrating as any other feature of the process, the IPO process involves a shift in control from firm management (including the entrepreneur) to the investment banker. 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 earned on an investment of similar risk. If the return on the invested capital for the purchaser is greater than the opportunity cost of the money invested, value will be created. Otherwise, value will be destroyed; that is, for every dollar invested, it will be worth less than a dollar. Growing a venture to the point of diminishing returns and then selling it to others who can carry it to the next level is a proven way to create value. In this case, the purchaser is able to do more with the business than the seller, and is thereby adding value. As described in the appendix at the end of the book on Firm Valuation, buyers and sellers frequently base the harvest value of a firm on a multiple of earnings. For instance, a company might value at five times its earnings. (An example of an entrepreneur, Robert Hall, who sold his firm for a multiple of earnings, is provided in the appendix.) 9. What problems can occur when an entrepreneur sells a firm but continues in the management of the company? Entrepreneurs with experience in acquisitions often find that they enjoy buying other companies more than being bought. Going from being the boss to taking orders from the new owners, entrepreneurs often do not make good employees. 144

6 The very qualities that made them successful entrepreneurs can make it difficult for them to work under the new owner(s), which often leads to their disillusionment and premature resignation. A clash between the culture of the company before and the new corporate culture can also lead to intense feelings of disappointment. 10. How may harvesting a firm affect an entrepreneur's personal identity? Entrepreneurs who leave their business often become disillusioned when they come to understand how much their personal identity was intertwined with their business. Some have done less than rational things after cashing out (for example, buying exotic cars and expensive houses that they did not need), and this can compound any regrets that follow the exit. Finally, entrepreneurs tend to be very purpose-driven, so they may need to adjust their lives to derive meaning from the post-exit world. This might very well mean giving back to the community or joining in the work of charitable cause(s). COMMENTS ON CHAPTER YOU MAKE THE CALL SITUATIONS Situation 1 1. Describe the scenario as presented In the Spotlight at the beginning of the chapter. The owner s of Li l Guy Foods, a three-generation family-ownned Mexicanfood manufacturing business were faced with reduced margins to an increase in food and plastic packaging costs. Understandably, outside investors were nervous. During this time Li L Guy Foods was approached with an offer of acquisition by one of their larger competitor s, Tortilla King. Tortilla King saw this acquisition as a way to reduce competition and increase market share. The two companies agreed on an acquisition agreement and approached Tortilla Kings bank for financing. Just as the deal was about to close, the bank pulled back and the two companies were left to find a way to finance the deal on their own. Li l Guy Foods agreed to finance the purchase with a five-year repayment term with an interest arte of 8%. This was not ideal for either company but a result of the increased lending restrictions. 2. What would be the reasons for and against Christina and David Sloan working for Tortilla King? Some reasons for: Smoother transfer of ownership between the two companies Increased likelihood of success for all parties involved. With the Sloan s having a five year purchase agreement at stake, they want to ensure the success of this acquisition. 145

7 Some reasons against: Conflict could arise between the Sloan s and the management of Tortilla King due to differences in managerial styles. Either party may not want to be so closely invested with the either. 3. What advice would you offer the Sloans? The Sloan s need to guard their investment so they need to be agreeable to this transition process. The should establish boundaries up front. State a time frame for this transitionary period. Identify their role in the company; clearly state their responsibilities. Establish and end date. If their services are needed beyond that, negotiate, up-front, a compensation package. Situation 2 1. Do you agree with the Bonneaus decision to sell? Why or why not? The Bonneaus were becoming less and less interested in the business. It was no longer fun for them, which suggested that they needed a change. Also, it was time to sell so that someone else with deeper pockets could consolidate several firms in the same business and gain power in dealing with the larger customers, such as Wal-Mart. 2. Why did the buyers retain Ed as a consultant? (In answering this question, you might consider the quote by Bonneau in the chapter.) It was intended as a de facto non-compete agreement. 3. Do you see any problem with having the Bonneaus' son-in-law become the new chief operating officer? It placed Bonneau and his son-in-law in an awkward position. The son-in-law was having to negotiate from the perspective of the new chief operating officer after the sale, so he had certain needs. Bonneau, on the other hand, was negotiating from the perspective of someone who would be exiting the firm. There were some conflicts of interest as a result. Situation 3 1. Do you agree that the entrepreneur s company is not sellable? 146

8 Lipper understood that there would be some emotional stress after selling his firm, but he also understood that a time might come when someone else could do more with the business than he was able to do. Thus, his emotions were balanced with the reality of the situation. Siverman avoided any emotional problems by having other priorities that gave meaning to her life apart from the company. The golfer clearly was emotionally distressed by not having other interests that made a difference to someone. Golfing did not provide an adequate foundation for a positive self-image. 2. Are there any other options for the entrepreneur besides selling his business? A person who knows who he/she is and what is important to him/her will be more likely to have positive feelings about cashing out after the transaction is complete. SUGGESTED SOLUTION TO CASE 13: GREENWOOD DAIRIES 1. What type of buyer do you believe purchased Greenwood Dairies? What might have been its reasons for buying the firm? These were financial buyers who were conducting a sort of Build-Up-LBO. The company had positive cash flows and they were able to take advantage of this by consolidating the business and merging the operations with an existing cheese factory. Indeed, the investment bankers were capitalizing on scales of efficiency. 2. What advice would you have given the Greenwoods when they were in the process of deciding to sell the business? The Greenwoods appear to have structured a wise business deal. David, though was too attached to the company. He needed to sell the business and be done with it or not sell it at all. His attachment to the company caused him great remorse. Staying on as a consultant is beneficial to both parties but David had to let go of the company and detach himself from the emotional draw. 3. Given their age, was it a mistake for the Greenwoods to rebuy the dairy? Maybe or maybe not. Age isn't a factor. David certainly has the drive and determination to make the company a success. He has a proven track-record and is well established in the community. Peter Drucker was a strong proponent of working until one couldn't physically work any longer. Drucker firmly believed this and he himself worked up until he was 94 years old. For David, this makes sense although he has to be sensitive to Rose's needs. Together they should structure a work schedule so that David's time is not completely absorbed by the company. 147

9 4. What do you think should have been the Greenwoods goal when buying back the business? The goal should be to rebuild the company and make it financially healthy. Establish some sales and growth goals. Some profit goals and some long-term management goals. David seems to enjoy the challenge of turning the business around. Once that happens, he should have some idea of what his role will be in the company. He may perhaps want to sell his ownership share to his partner and stay on as a consultant, thereby alleviating him from the demands of the daily operations of the factory. 148