CHAPTER 12 The Harvest Plan Part 3 Developing the New Venture Business Plan CHAPTER 12 The Harvest Plan © 2008 Cengage Learning. All rights reserved.

Looking AHEAD After you have read 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. © 2008 Cengage Learning. All rights reserved.

The Importance of the Exit 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 © 2008 Cengage Learning. All rights reserved.

Methods for Harvesting a Business 12-1 Methods for Harvesting a Business © 2008 Cengage Learning. All rights reserved.

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. © 2008 Cengage Learning. All rights reserved.

Financial Acquisitions Bust-Up LBO Build-Up LBO Types of Leveraged Buyouts (LBOs) Management LBO © 2008 Cengage Learning. All rights reserved.

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 the exit method of last resort. Motivates the employee-owners to perform. © 2008 Cengage Learning. All rights reserved.

Leveraged ESOP Buyout Process 1. Employer firm guarantees payment of loan. Employer Firm 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. ESOP Trust 3. Cash from loan is used to buy owner’s stock. 4. Stock is sent to ESOP trust for benefit of employees. Selling Owner © 2008 Cengage Learning. All rights reserved.

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 © 2008 Cengage Learning. All rights reserved.

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. © 2008 Cengage Learning. All rights reserved.

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. 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 the public offering, an offering price is decided upon. Offering the stock to the public and seeing how it is received. © 2008 Cengage Learning. All rights reserved.

Harvesting: Using Private Equity 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 © 2008 Cengage Learning. All rights reserved.

Private Equity Financing 12-2 Private Equity Financing © 2008 Cengage Learning. All rights reserved.

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 Valuation 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. © 2008 Cengage Learning. All rights reserved.

Harvesting: The Method of Payment Payment Alternatives Cash Immediate and stable in value Tax liability consequences Stock Immediate but uncontrollable in value Potential problems with disposal of stock © 2008 Cengage Learning. All rights reserved.

Developing an Effective Harvest Plan Manage for 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 © 2008 Cengage Learning. All rights reserved.

Developing an Effective Harvest Plan Understand What Motivates You 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” © 2008 Cengage Learning. All rights reserved.

What’s Next Whatever you decide to do, do it with passion and let your life bless others in the process. © 2008 Cengage Learning. All rights reserved.

Key TERMS harvesting (exiting) leveraged buyout (LBO) bust-up LBO build-up LBO management buyout (MBO) employee stock ownership plan (ESOP) leveraged ESOP initial public offering (IPO) private equity opportunity cost of funds © 2008 Cengage Learning. All rights reserved.