Business

lindasa

ch112.pdf

Home >Business & Finance homework help >Management homework help >Business

Patterns of Entrepreneurship Management 5th Edition,Chapter 11

Chapter 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

Exiting the Venture

ESOP’s and MBO’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

• IPO’s

• Running the Business while Selling

Chapter 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 Based

Chapter 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’s

Financial Issues

Chapter 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’s

Financial Issues

Selling to Managers – MBO’s

Definition of 'Management Buyout – MBO’ -When the managers

and/or executives of a company purchase a controlling interest

in 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 capitalist

specializing 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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’s

Financial Issues

Transferring Ownership to Family Members

Family owned businesses constitute the largest percentage group

of private companies ( More on family businesses under chapter

14):

Chapter 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’s

Financial Issues

Transferring Ownership to Family Members

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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’s

Financial Issues

Transferring Ownership to Family Members

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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’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 11

Reasons for Selling

Valuation and

Candidates

Running and Selling a Business

Intra-family sale

ESOP’s and MBO’s

Financial Issues