1. Harvesting a Venture

2. Introduction What is harvesting? Key question:
The sale of all or part of an entrepreneurial venture
A liquidity event
Key question:
Why harvest an ongoing or promising venture?
Hence, questions for the entrepreneur include:
Do I wish to realize all or only part of my investment?
Do I wish to continue to be associated with the company after the sale?
What form of payment do I want from the sale – equity in another company, cash on deferred terms, a pension, a consultancy retainer?
Which exit route will give me the greatest return?
If I decide to go for an IPO, what will it cost and who will help me?
If I decide to seek a trade sale or sale to a third party, how do I find a buyer?
How patient am I prepared to be?
Jeffrey Timmons and Stephen Spinelli, New Venture Creation, (McGraw-Hill Irwin: 2007).

3. Harvesting Alternatives
Continue with the business
Maximize free cash flows
Pass the business on to heirs
Sell the business to
Management
Employees through an ESOP
Outsiders (incudes the possibility of a merger)
Other companies (e.g. competitors, suppliers, or customers)
Private investors
The public through an initial public offering (IPO)

4. Increasing Free Cash Flows
By eliminating long-term investment
Advantages
founders maintain control and freedom of action
finding a buyer is time consuming
Disadvantages
double taxation if free cash is distributed as dividends
shrinking competitive advantage
greater risk because return does not come out at one time
Not as exciting as growing the business

5. Passing on the Business
Only 30% of family businesses reach the 2nd generation
Less than two-thirds of those survive through the second generation
And only 13% of family businesses survive through the 3rd generation
An interesting article:
Passing Your Business to the Next Generation: Is It Best for Your Family?
The next generation may have a grand scheme to turn the traditional printing business into a media empire or a liquor business into an entertainment enterprise. A few years back the second generation of a well known Chicago area computer leasing and IT Services Firm tried to turn it into an Internet Venture Firm with disastrous results.
Before you just assume that your torch will be carried by the next generation, make sure that the next generation even wants to run the business. Imagine the loss in value that would have occurred if the real estate billionaire from the western suburbs had turned his empire over to his son who simply wanted to produce plays.
Are your heirs even capable of running your business? Have you held on to the reins so tightly that the kids involved in the business have not been able to develop their decision-making or leadership skills? Do they command company respect because of their personal strength and skills or are they grudgingly granted respect because they are the child of the owner? If that is the case, the odds are not good for them taking over when you retire.
Another big challenge is trying to balance fairness in employing many children or even grandchildren in a family business with various skill levels, compensation levels and ownership levels. The jealousy and in fighting can absolutely grind the company’s progress to a halt.
The business owner must make some difficult decisions when he or she decides it is time for them to retire. Why did I create this business? Was it to keep this business in the family for generations or was it to provide for my family for generations? If the desire and the capability of the children are not evident and the company is large enough, it may be the right decision to first get outside board members actively involved as step one. Step two would be to hire professional management to run the business. A second alternative is to sell the company while you are still running it and it can command its highest value. If you have children that want to remain in the business for the immediate future, incorporate that into the sale agreement with employment contracts.
Another way to think of it is, while I am running the business, the best ROI is to keep the bulk of my net worth invested in this company. If I am no longer running the company what is the best risk reward profile for my net worth? Would my heirs be better off if the business was sold and the value converted to financial assets?
Simon Bridge, Ken O’Neill and Stan Cromie, Understanding Enterprise, Entrepreneurship and Small Business, London: MacMillan Press, 1998.

6. Selling a Venture
Therefore the entrepreneur or venture capitalist must
find the right time to sell
decide on the exit route
agree a price with the purchaser
have the same harvest vision as all key stakeholders
However, in a private company,
there may be restrictions on the ability to sell, e.g. the owner-manager may be required to offer the company to the existing shareholders (who cannot/will not buy)
the founder may only be a minority shareholder without the power to sell the entire venture

7. Management Buyout Advantages Disadvantages continuity of venture
incentives on the part of managers to increase value
Disadvantages
interests of managers and founders are often mis-aligned
asymmetric information can lead to mistrust
usually requires significant debt financing
greater risk if deal is financed by founders

8. Employee Stock Ownership Plan (ESOP)
Steps
Bank agrees to lend money for purchase of stock
Employer company agrees to guarantee loan
ESOP borrows money from lender
Cash from loan used to buy owners’ stock
Stock assigned to ESOP for benefit of employees
Firm makes tax-deductible contributions to ESOP
ESOP makes payments on loan
Advantages
owners can cash out quickly
tax advantages to owners, lender, ESOP
both principal and interest are deductible
Disadvantages
employee retirement and employment in one place
financial information must be disclosed to employees
all employees must be included in plan
employees tend to think like employees and not owners

9. Merger Advantages Disadvantages
diversification of risk
expansion and stabilization of business
cashing out
Disadvantages
loss of control and freedom
negotiations over value and deal structure
difficult to find the right partner
can be expensive structure
Requires due diligence from all parties to the deal

10. Initial Public Offering (IPO)
Advantages
access to capital
can mean tremendous wealth for founders
Disadvantages
Few ventures qualify
Need the right size, industry, management
Markets are unpredictable
Valuations tend to be lower than acquisition
Narrow windows of opportunity
New issues tend to under-perform
Time-consuming, expensive, arduous process
Founders now have responsibility to public
Company comes under SEC rules
Probable loss of control and freedom

11. Initial Public Offering Process
Consider going public
Company has all the power
Choose an underwriter
Prepare the prospectus
The road show
Investment banker gains power
Market and investment banker are in control
The pricing meeting
The consequence
The market takes over

12. The Decision to Sell
The decision to sell is mostly related to the price you expect to receive for your equity – it’s a lifestyle decision:
Hence, the key questions
What is the company worth?
Will this give me sufficient capital to do what I want to do with the rest of my life?
And this is dependent on two factors:
The size and profitable track record of the company
The state of the market
And therefore, you will need a valuation

13. Valuation
Per Robert Hisrich, there are eight factors that, although they vary by situation, the entrepreneur should consider when valuing the venture:
The nature and history of the business
The outlook for the economy in general and the industry in particular
An assessment of tangible and intangible assets in the venture
The overall financial condition of the company
The future earning capacity of the company
The dividend paying capacity of the venture
An assessment of all prior investments and valuations
The market price of stocks of companies engaged in the same of similar lines of business
Robert D. Hisrich, et. al., Entrepreneurship (McGraw-Hill Irwin: 2005).

14. Reminder: Valuing a Firm
All valuation is a negotiation and a function of cash, timing and risk
Analysts usually use more than one approach/method
Valuation approaches
discounted cash flow
VC model (e.g., investment must return three times its value in three years (100% ROI) or ten times in five years (58% ROI)
First Chicago method
comparables and multiples of earnings
fair value of assets
capitalized earnings
cash flow method
cost to create method
industry rules of thumb
Economic Value Added (EVA)
real options and decision trees

15. Exit Strategies for MedTech

16. Introduction
Eventually, the investors in a company will want to exit the investment as a mechanism for recouping the capital they have invested in the business. Investors may also seek an exit in an bit to diversify their business risk. Two common ways to exit an investment are
to sell the company to someone else through an acquisition or
enter the public markets rough an IPO.
Acquisitions and IPOs are best undertaken when the entrepreneur, his/her management team, and the board of directors believes that the company’s value has been maximized (meaning that they lave done all they can with the resources at their disposal) such that the only way to continue to grow and mature is to be acquired or raise additional money through an IPO.
However, exit events are often influenced by the external market environment and may not be available to the company at a desired time. Investors should be willing to provide capital to sustain the company until the external environment improves. Another alternative available to companies is to enter into a licensing agreement as a means of generating revenue and providing a payback to investors.
Stanford casebook

17. Acquisition
According to Ellen Koskinas, a partner with the VC firm InterWest Partners who specializes in medical devices, mergers and acquisitions accounted for as many as percent of device company exit strategies. The sale of a company is usually driven by the strategic fit between the assets or technology of the acquiree and the strategy of the acquirer. Acquisition can be an attractive exit strategy to investors because they receive cash and tradable stock that can be acted on immediately, while also avoiding much of the volatility and risk that can be associated with an IPO (see below). It can also provide investors with a reasonable way to exit a troubled company. An acquisition occurs outright when the acquiring company takes full and complete ownership of the business. The primary advantage of this approach is that it can provide a clean, and potentially desired, break for the founders and current management team, who may be replaced ‘he major disadvantage is that an outright acquisition typically results in less value (lower price) and an immediate loss of control of business to the founders and current management team. Another approach to an acquisition is to do an earn-out—staged milestones culminating in a purchase. The founders and employees usually continue to be involved under the aegis of the acquiring company to help the acquiring company meet these milestones. The benefits of this approach are that it often results in greater value while the founders retain some control of the business through the transition. On the other hand, there may be less certainty regarding the level of value ultimately realized (as this may depend on how much the acquirer invests in developing and promoting the product), the payout milestones may not be under the founder’s direct control, and the founders may need to remain with the company, allowing themselves to be directed by the acquiring organization.
Stanford casebook

18. IPO
An IPO refers to the first sale of a company’s common shares to public (versus private) investors. The main purpose of an IPO is to raise capital for the company while providing private investors with a potential exit strategy. While IPOs are effective at raising capital, they also impose heavy regulatory compliance and reporting requirements on the business. Due to these increased requirements, specifically the Sarbanes-Oxley Act of 2002, the frequency of IPOs by start-ups has decreased significantly. The rash of IPOs in the late 1990s also died down after the decade’s economic “bubble burst,” with many of the medical device companies that went public during this period failing to deliver on their high valuations. In late 2006, however, IPOs in the medical device industry appeared again to be on the upswing. According to one article about the medical device industry, “Just three companies went public in 2002 and none in Since 2004, however, 23 have gone public: 12 in 2004, seven in 2005, and four this year[2006].” With acquisitions and IPOs, entrepreneurs need to be cautious not to sell too soon. Entrepreneurs often act too quickly and, as a result, limit the potential future value of the company. However, there may be good personal reasons for an entrepreneur to sell early, such as a desire to try other industries or medical fields or to move back to an early-stage company if the current company has grown too large for the entrepreneur’s interest. Also, there is always the pure financial motive of wanting to make at least some return for one’s time and effort rather than continue with some degree of uncertainty and risk. In reality, however, the right time to sell will be determined by the market.
Stanford casebook

19. Licensing
Another strategy for companies seeking to realize a payback on their investments is to consider entering into a partnership, such as a licensing agreement. IP, technology development rights, product distribution rights, and brand names can all be licensed as a mechanism for generating revenue. For example, Angiotech Pharmaceuticals Inc. licensed its paclitaxel-based restenosis solution to Boston Scientific for use in that company's blockbuster drug eluting stent. While Angiotech continues to develop its own technologies and products, it generates sizable revenue from sales of the Boston Scientific stent which it can then use to underwrite R&D and fund other areas of its business. Nektar Therapeutics is another company that has generated significant revenue from licensing its inhaled drug delivery technology while concurrently developing its own products. While these kinds of deals can consume a sizable number of a company’s resources, they can allow a business to constrain its fundraising needs (preventing additional dilution).
Licenses typically include:
A detailed description of what is being licensed
Field of use
Terms of license
Performance requirements
Degree of exclusivity
Financial structure (usually including an up-front payment of cash and/or equity, as well as royalties).
Traditionally, large companies have sought to license technology to supplement or replace in-house discovery and development. Such deals can also help improve performance, accelerate time-to-market, and control costs. Small companies and entrepreneurs have been drawn to licensing deals due to the increased level of certainty they provide in comparison to acquisitions IPOs. On the other hand, some innovators have begrudgingly licensed their products to avoid the time and expense required to litigate their patents.
When considering licensing agreements, be sure to analyze the value of what is being given up. Think carefully about whether the agreement has the potential to cap the future value of the company and be certain to consider how the licensing deal will affect the company’s independence, business strategy, IP generation, and competitive position in developing new products or forming new business relationships.
Licensing can also be used as an exit strategy of sorts for an entrepreneur or young company that decides not to develop its technology into a standalone business.
Stanford casebook