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References

Hisrich, R.D., Peters, M.P., & Shepherd, D.A. (2013 ). Entrepre

Education). New York: McGraw-Hill Irwin.

Custom Create Edition LAUREATE EDUCATION INC

I

I 452 : Entrepn

-----~-, eurship

SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE

VENTURE

1 To understand the planning that is necessary to allow for the effective succession of

ownership or leadership in a business.

2 To examine the options in providing for an exit strategy, such as the sale of the business

to employees (ESOP) or to an external source.

3 To illustrate differences in alternative types of bankruptcy under the Bankruptcy Act of

1978 (amended in 1984 and again in 2005).

4 To illustrate the rights of creditors and entrepreneurs in different cases of bankruptcy.

5 To provide the entrepreneur with an understanding of the typical warning

signs of bankruptcy.

6 To illustrate how some entrepreneurs can turn bankruptcy into a successful business.

Entrepreneurship, Eighth Edition 1 453 -----------------------------------------·------------ ----------------------------------------- : __ - ---~-~--~

OPENING PROFILE

TERESA CASCIOLI

It is not often that a bankrupt small business is able to successfully recover from bank-

ruptcy. However, one such case invo lves Teresa Cascioli, the first woman in Canada to

become president of a major brewery. Teresa not only led Lakeport Brewing out

of bankruptcy but launched the venture into one of the more successfu l Canadian

microbreweries.

In 1999 Teresa was getting ready to enter law

school. She had spent 12 years with the city of

Hamilton in Ontario, Canada, as finance manager

and another two years with Phi lip Services Corporation. Born of immigrant Italian

parents, she had spent her entire life in the city. Before she reached law school, a group of

private investors approached her to see if she could help out at an ailing company for the

summer. The company, Lakeport Brewing, was in trouble. The beer market is extremely

competitive and had seen companies like Amstel come and go during this period.

Lakeport was now in bankruptcy with little chance of being revitalized unless it could find

a new marketing niche in a very competitive market. Teresa was a bit concerned that her

only knowledge of beer was being able to tell a good brew from a bad one. However, she

not only took on the challenge but six months later actually took control of Lakeport

after Alphacorp Holdings invested $3.1 million in equity and working capital.

Teresa describes the f irst years of managing the bankrupt brewery as "hell." She had

many ups and downs during those first few years that took a great deal of energy, tena-

city, and a vision of success that would not be deterred. She had to work without senior

managers and often was in the plant seven days a week trying to learn the business. At

one point she actually spent time at night inside the bottling plant learning the business

from employees who had been working there for 20 years or more. In the early years, she

dedicated Lakeport's excess capacity to contract manufacturing of beer, near beer, and

coolers for brand names and private labels. Th is was the beginn ing of the turnaround and

kept the company in a positive cash flow until a major relaunch strategy could be devised.

In the summer of 2002, Teresa Cascioli was beginning to develop this new strategy

for the relaunch of Lakeport's beer products. It was time to find a profitable niche for

the Ontario-based brewery. She became aware of how many of her competitors were

constantly saturating newspapers with ads of $5.00 off. Her response to these ads was

439

, 454 I '""''""'"""' ~ ----+-- --- 440 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

always, "$5.00 off what?" As far as she was concerned, none of the beer a

clear message. It seemed that they were all trying to do the same thing-o

another with heavy advertising. Her response to this was a simple genius

strategy in her ads: A case of 24 for $24.00. At the time, this strategy amount ec :: -

to $10 savings from what her competitors were charging. More importa nt

vided a clear message to the customer.

This low-price strategy was successful because the company had extended --

time and effort redesigning and restructuring its infrastructure to allow for morE=

tive cost controls. As a result, the low prices still allowed the company enoug h ~:.

to earn a profit. This strategy made Lakeport a significant player in the Ontario

Market share of the take-home beer market, one of the company's prima ry rc = grew from a 0.5 percent share to more than a 6 percent share by the end of 2

In 2004 Teresa took complete control of the company. With financing fro

Growth Capital Partners and National Bank, she was able to purchase 100 per .. ~

the 200-employee company. Her effort in these early years was rewarded not ~-

the success of the company but also by the recognition of her peers. In 2005 s i:E

ranked eighth in the annual list of the top 100 successful women business o

Canada, and she was a finalist for the Ernst & Young turnaround entreprene ur -

year; in 2007 she was named entrepreneur of the year by Canada's Ventu re Cc:: '""

and Private Equity Association. In addition to successful labels such as Brava, S:r:o

Lager, and Lakeport Honey Lager, the company also kept its production lines bts

aggressively seeking deals to pack products such as hard lemonade and ready-t""""

mixes for other makers. In 2007 Lakeport had nine proprietary brands and was ra-

the third largest producer of beer in the very competitive Ontario market.

In June of 2005 Lakeport went public on the Toronto Stock Exchange. The res

a successful IPO as investors responded favorably to the company and Teresa 's lea::

ship. The company's gross revenue after the IPO continued to grow and at the er:: -

the third quarter of 2005 reached $39.2 million, up 86 percent from the previous 1=: Market share in the take-home market from early 2005 to the end of 2006 i ncre~'?-

from 9 percent to more than 12 percent. This remarkable growth created such pr

in this market that Labatt Brewing Company Ltd. decided that the only way t o c:::-_

pete was to tender an offer to buy Lakeport. In March 2007 Lakeport Brewing was s- -

to Labatt for $201 million. At the time of the sale Teresa held 21.6 percent owne

of Lakeport Brewing.

After the sale Teresa continued as a consultant to La batt until early 2008 but has '"'-

moved on to a new endeavor. With her substantial financial reward from the sa;e -

the company, Teresa, in wanting to give back to the community, established the Te,

Cascioli Charitable Foundation. As manager of this foundation, Teresa has given ba ·

the community through a number of important endeavors such as an endowed cha'--- -

entrepreneurial leadership at McMaster University (she graduated from there in 1~

and with a $1 million donation to St. Joseph's Hospital where she was born in 196 1.

will continue to be active in these endeavors, and given her strong entrepreneuria l

it is very likely that we will find Teresa in some new venture in the near future . 1

'"""'""'""hIp, Eighth Ed ttl 00 I ~- ·-~~-- - ·· - -- . ---- ---· --- ~-- 455 1

AS SEEN IN BUS/NESSWEEK

PROVIDE ADVICE TO AN ENTREPRENEUR ON HOW TO BEAT FAILURE AND BE THE BOSS AGAIN

A Maryland-based company that provides installations for conventions and special events around the country is about to be forced into liquidation by its bank. Meanwhi le, the $30 million business, which we'll call . " Shows 'R Us Inc.," is facing a leadership vacuum. The owner is in a state of denial and won't confront just how desperate his financial situation is. He also failed t o provide accurate financial information to his lender, and now the bank is on the wa rpath. As a result, the owner is about to lose the home he mortgaged for his loan. Three decades' worth of sweat and tears are heading down the drain.

It didn't have to get to this point. For years the ownership has allowed the Shows 'R Us "team" of 30 managers around the country to run their own re- gional operations. These managers have not been an- swerab le to anyone in the chain of command, because t here is no chain of command. Each office acts as a separate unit, responsible for its own hiring and ex- penses, and with no requirement to get out there and f ind new cl ients to justify its existence. Instead they de- pend on a short burst of activity during the convention season and put their feet up for the rest of the year. The result has been an egregious waste of resources. There are too many people on the payroll. Roles are duplicated, and offices that handle events in one state could just as easily cover two or three states with the amount of business that's coming in.

This was fine before the recession hit, when busi - ness was steady and there was always income from regular cl ients to cover operational and budget leaks. Today, lousy sales are unmasking a host of problems, and it's entirely the owner's fault.

SOLUTION: END DENIAL AND TAKE BACK CONTROL Now is the time for the owner to step up and lead. The CEO needs to conduct a major overhaul of oper- at ions and install a chain of command where every regional department head must be answerable only t o him. He should take a look at where each office is located on the map, where business is coming in, and w here it isn't. Decide which offices can be closed and w hich can be merged. Slash the workforce in half.

Leadership must call an emergency meeting of all t he regional office managers, f ly them to headquarters

in Maryland, and communicate the pl an. The owner needs to meet face to face with the people he wants to keep and let them know that it's do or die this time. They can either comply with a new system of accountability and accept compensation t hat is tied to performance, sales, and operating within or under a tight budget, or be out of a job in a matter of weeks when the bank shuts down the whole business.

I predict that morale will improve despite the fact that some employees will face drastic pay cuts and layoffs. Until now, employees in the regiona l offices have been working w ithout direction, with no con- nection to headquarters, and little sense that they're part of a larger organization . With no performance targets in place, ambitious workers have been flail- ing. As it is, there is zero opportunity or motivation to work hard. If Shows 'R Us survives this crisis, the star performers who remain will have a chance to make more money by bringing in more sales because their pay will be tied strictly to productivity.

The good news is that we have already bought Shows 'R Us some extra time with the bank, which will continue to work with the company as long as it sees that the business is taking serious steps to imple- ment these changes. It won't be easy, but it sure beats losing everything. *

ADVICE TO AN ENTREPRENEUR An entrepreneur friend sees the above article and comes to you for advice:

1. I recently hired fou r reg ional managers to run my business and have given them a lot of f lexibility to make decisions without constantly asking me. Is this a mistake?

2. How should I communicate with these regional managers without letting them know that I am concerned about their decision making?

3. Isn't the fact that these regional managers have flexibility enough to motivate them to make good decisions?

*Source: Reprinted from the August 4, 2009, issue of Business Week by special permission, copyright© 2009 by The McGraw-Hill Companies, Inc., "To Beat Failure, Be the Boss Again," by George Cloutier with Samantha Marshall, www.businessweek.com/smallbiz.

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442 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

This book has taken an in-depth view of the entire entrepreneurial process, fro m ~­ to a business plan and then successful funding and growth strategies. However, the preneur should also be prepared for a number of important issues that he or she mz_ in later years of the operations of the venture. Just as Teresa felt it was time to when a great offer was made, the entrepreneur should always be considering the fum::=: possible exit strategies or scenerios that may involve ending the venture. Exit sm::=_ consist of three important issues: planning for succession, harvesting the business, o ruptcy which will be discussed in this chapter.

EXIT STRATEGY Every entrepreneur who starts a new venture should think about an exit strategy. A n of possible exit strategies will be discussed in the following paragraphs. Exit strategi.::_ elude an initial public offering (IPO), private sale of stock, succession by a family me:::..J or a nonfamily member, merger with another company, or liquidation of the companY. -=- sale of the company could be to employees (an ESOP) or to an external source (ape persons, or a company). The IPO , private sale of stock, and merger options are dis elsewhere in this book (see Chapters 12 and 14).

Each of these exit strategies has its advantages and disadvantages, which are disc in the following and in Chapters 12 and 14. The most important issue is that the en neurs have an exit strategy or plan in place at the start-up stage, instead of waiting un!L may be too late to effectively implement a desirable option.

SUCCESSION OF BUSINESS By 2015 millions of baby boomers will be retired, causing a significant gap in the w force. This will be a critical issue for small businesses that are looking to find successo:: One study suggests that only about 35 percent of small and mid-size businesses have a ~­ cession plan ready to be implemented. This problem can be serious when there is a sudu-_ need to replace a key executive or owner of a successful company. 2 In the next sections r - will focus on important issues that can help the entrepreneur plan for the succession of business to either a family member, an employee, or an external party. Table 15.1 provi a summary of important tips that should be considered in any succession plan.

If there is no one in the family interested in the business, it is important for the entrepre- neur to either sell the business or train someone within the organization to take over. Eact of these transfer possibilities is discussed in the following sections.

[ TABLE 15.1 Succession Planning Tips

• Allow sufficient time for the process by starting early.

• Estimate the firm's value or hire a consultant to do it for you.

• Evaluate potential successors on their merit-not on whether they remind you of yourself.

• If family members are being considered, make sure they have the skills and motivation necessary to carry on the business.

• Provide a transition period so that the successor can learn the business.

• Consider options such as employee stock option plans {ESOPs) for a management succession.

• Set a date for completion of the transition and stick to it.

CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 443

Transfer to Family Members Successfully passing a business down to a family member faces tough odds. Experts esti- mate that half such attempts fail in the transition from first- to second-generation owner- ship. Only about 14 percent make it to the third generation. In addition, a 2007 survey of 1,000 family-owned businesses by the Family Finn Institute found that the leading causes of failure were insufficient estate planning, failure to plan for the transition, and lack of funds to pay estate taxes. 3 An effective succession plan should also be communicated clearly to all employees. This is particularly relevant to key personnel who may be affected by the succession transition. The solution to minimize the emotional and financial turmoil that can often be created during a transfer to family members is a good succession plan.

An effective succession plan needs to consider the following critical factors:

• The role of the owner in the transition stage: Will he or she continue to work full time? Part time? Or will the owner retire?

• Family dynamics: Are some family members unable to work together?

• Income for working family members and shareholders.

• The current business environment during the transition.

• Treatment of loyal employees.

• Tax consequences.

The transfer of a business to a family member can also create internal problems with employees. This often results when a son or daughter is handed the responsibility of run- ning the business without sufficient training. A young family member's chances of success in taking over the business are improved if he or she assumes various operational responsi- bilities early on. It is beneficial for the family member to rotate to different areas of the business to get a good perspective on the total operation. Other employees in these depart- ments or areas will be able to assist in the training and get to know their future leader.

It is also helpful if the entrepreneur stays around for a while to act as an advisor to the suc- cessor. As stated in Table 15.1, however, there should be a set date for when this transition will end. Although having the entrepreneur act as an advisor during the transition stage can be helpful to the successor in making business decisions, it is also possible that this can result in major conflicts if the personalities involved are not compatible. In addition, employees who have been with the firm since start-up may resent the younger family member's assuming control of the venture. However, if the successor works in the organization during this transi- tion period, he or she can justify assumption of the future role by proving his or her abilities.

Transfer to Nonfamily Members Often, family members are not interested in assuming responsibility for the business. When this occurs, the entrepreneur has three choices: train a key employee and retain some eq- uity, retain control and hire a manager, or sell the business outright.

Passing the business on to an employee ensures that the successor (or principal) is famil- iar with the business and the market. The employee's experience minimizes transitional problems . In addition, the entrepreneur can take some time to make the transition smoother.

The key issue in passing the business on to an employee is ownership. If the entrepreneur plans to retain some ownership, the question of how much becomes an important area of negotiation. The new principal may prefer to have control, with the original entrepreneur remaining as a minority owner, stockholder, or consultant. The financial capacity and mana- gerial ability of the employee will be important factors in deciding how much ownership is transferred. In many cases the transfer or succession of a venture can take many years to meet

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444 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

all the requirements of the parties involved. Since evidence indicates that most entrepreo.,_.. wait until it is too late, it is important to begin the process long before there is a need or transfer the ownership of the business. The U.S. Department of Commerce indicates about 70 percent of successful ventures never make it to the second generation of own

Ron Norelli was one of the exceptions because he realized the importance of a sion plan and hired a search firm to help him find a successor. Unfortunately, even he was able to hire someone who was to be groomed as his successor, the indi · decided that he did not want to take the risk. Norelli had to start the process all over ag and this time conducted the search personally by using his network of trusted business .c-- sociates. After a number of candidates were evaluated and interviewed by the staff . .:... settled on a successor who would, over a number of years, buy Norelli out. Norelli . even further by promoting one of his staff to vice president with the intent that this in·· · ual would be a good candidate to succeed his successor. The entire process took about 5. - years , and since he began the process early enough, it gave him the opportunity to leave business gradually with the confidence that it would successfully continue in the fu ture..-

If the business has been in the family for some time and the succession to a family rn.e=-- ber may become more likely in the future, the entrepreneur may hire a manager to run -- business. However, finding someone to manage the business in the same manner and the same expertise as the entrepreneur may be difficult. If someone is found to manage --.• business, the likely problems are compatibility with the owners and willingness of this son to manage for any length of time without a promise of equity in the business . Ex. tive search firms can help in the search process. It will be necessary to have a well-de job description to assist in identifying the right person.

In nonfamily business situations, succession planning may take on a slightly diff1 approach. In these businesses a key senior manager or group of managers may be step down or leaving the company. Since there are no family members involved, there may be - need to consider replacements from either external or internal sources. For a partnership process may be clearly outlined in the partnership agreement and could simply invoh-e - predetermined choice. However, there could also be a need to go outside the partne · · and find a successor for the partnership. In this instance, as well as in an S corporation an LLC, where there may be only a small number of shareholders, the succession pla:::. should consider the following important issues: 5

• Senior management of the company must be committed to any succession plan. The strategy must be one that everyone shares .

• It is important to have well-defmed job descriptions and a clear designation of skills necessary to fulfill any and all positions.

• The process needs to be an open one. All employees should be invited to participate that they will feel comfortable with the transition and thus minimize the possibility of their leaving the company.

The last option is to sell the business outright to either an employee or an outsider. The major considerations in this option are financial, which will likely necessitate the help o-= an accountant and/or lawyer. This alternative also requires that the value of the business be determined (see Chapter 12).

OPTIONS FOR SELLING THE BUSINESS There are a number of alternatives available to the entrepreneur in selling the venture. Some of these are straightforward, and others involve more complex financial strategy. Each of these methods should be carefully considered and one selected, depending on the goals of the entrepreneur.

Entrepreneurship, Eighth Edition

CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 445

Direct Sale This is probably the most common method for selling the venture. The entrepreneur may decide to sell the business because he or she wants to move on to some new endeavor or simply decides that it is time to retire. A sale to a larger company that can infuse much- needed capital may also provide opportunities for the company to grow and reach larger markets . If the entrepreneur has decided to sell the business but does not need to sell imme- diately, there are a number of strategies that should be considered early in the process. 6

• A business can be more valuable if it is focused on a narrow, well-defined segment. In other words, a larger share in a small market niche can be more valuable than a smaller share in a large market.

• The entrepreneur should concentrate on keeping costs under control and focus on higher margins and profits.

• Get all financial statements in order, including budgets and cash flow projections.

• Prepare a management documentation of the business explaining how the business is organized and how it operates.

• Assess the condition of capital equipment. Up-to-date or state-of-the-art equipment can enhance the value of a company.

• Get tax advice, since the sale of a corporation will involve different tax considerations than those for a partnership, LLC, or S corporation.

• Get nondisclosures from key employees.

• Try to maintain a good management team, allowing them to have day-to-day contact with key customers to lessen the firm's dependence on owner-customer relations.

• There is no substitute for advance preparation and planning.

One of the important considerations of any business sale is the type of payment the buyer will use. Often, buyers will purchase a business using notes based on future profits. If the new owners fail in the business, the seller may receive no cash payment and possibly may have to take back the company, which is struggling to survive.

Business brokers in some instances may be helpful, since trying to actually sell a busi- ness will take time away from running it. Brokers can be discreet about a sale and may have an established network to get the word around. Brokers earn a commission from the sale of a business. Generally, these commissions are based on a sliding scale starting at about 10 percent for the first $200,000. The best way to communicate the business to potential buyers is through the business plan. A five-year comprehensive plan can provide buyers of the business with a future perspective and accountability of the value of the company (see Chapters 7 and 8).

As indicated earlier, an entrepreneur may find that selling out to a larger company can provide much-needed resources to achieve important market goals. It has also become a more common exit strategy given that IPOs, the more traditional growth funding option, have become more rare given the current economic environment.

Frederick Schilling, the founder of Dagoba Organic Chocolate, realized that selling his com- pany to The Hershey Company would allow him to continue operations independent of the parent company and, more importantly, would allow him to grow Dagoba to reach more peo- ple. More and more organic-food entrepreneurs like Schilling are selling out to larger compa- nies to take advantage of their strong distribution networks to reach broader audiences. 7

Unlike Schilling, who remains as CEO, the role of an entrepreneur who sells to an em- ployee or passes the business on to a family member may vary depending on the sale agree- ment or contract with the new owner(s). Many buyers will want the seller to stay on for a short time to provide a smooth transition. Under these circumstances, the seller (entrepreneur)

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446 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

employee stock optio11

plan (ESOP) A two- to

three-year plan to sell the

business to employees

should negotiate an employment contract that specifies time, salary, and responsibi _ entrepreneur is not needed in the business, it is likely that the new owner(s) will the entrepreneur sign an agreement not to engage in the same business for a specifierl of years. These agreements vary in scope and may require a lawyer to clarify details..

An entrepreneur may also plan to retain a business for only a specified period -~ with the intent to sell it to the employees . This may be achieved using an employee option plan (ESOP) or through a management buyout, which allows the sale to only certain managers of the venture.

Employee Stock Option Plan Under an employee stock option plan (ESOP), the business is sold to employees over • of time. The ESOP establishes a new legal entity, called an employee stock ownersbi;: - that borrows the money against future profits. The borrowed money then buys the shares and allocates them to individual employees' retirement accounts as the loan is The ESOP has the obligation to repay the loan plus interest out of the cash flow of the ness. Typically, these ESOPs are a way to reward employees and clarify the su process. In addition, ESOPs result in significant stock values for employees, provided company continues to succeed.

Presently there are about 11,500 ESOP companies in the United States, of approximately 2,500 are wholly owned by the ESOP. ESOPs account for about 50 per.: of the nation's 10 million employees (about 10 percent of the private sector workforce addition, about 330 (or 3 percent) are publicly traded companies. 8

The ESOP has a number of advantages. First, it offers a unique incentive to empl _ that can enhance their motivation to put in extra time or effort. Employees recognize - they are working for themselves and hence will focus their efforts on innovations that tribute to the long-term success of the venture. Second, it provides a mechanism to. back those employees who have been loyal to the venture, particularly during more cult times. Third, it allows the transfer of the business under a carefully planned wri_- agreement. Finally, the company can reap the advantage of deducting the contributio- - the ESOP or any dividends paid on the stock.

ESOPs, due to a new law passed in 1996, are now possible for S corporations. How there are some important differences in the tax treatment between the C corporation and S corporation because of the pass-through feature of the S corporation (see Chapter 9). cause of the new tax law, the S corporation pays no income tax on the portion of the s owned by the ESOP.

However, in spite of its favorable attributes, the ESOP has some disadvantages . T;:;. type of stock option plan is usually quite complex to establish. It requires a complete val:: ation of the venture to establish the amount of the ESOP package. In addition, it raises ;_,_ sues such as taxes, payout ratios, amount of equity to be transferred per year, and ~ amount actually invested by the employees. The agreement also must specify if the e,....· ployees can buy or sell additional shares of stock once the plan has been comple Clearly, because of the complexity of this type of plan, the entrepreneur will need the an vice of experts if this type of plan is selected. A simpler method may be a more direct buy- out by key employees of the venture.

Management Buyout It is conceivable that the entrepreneur only wants to sell or transfer the venture to loyal, ke~ employees. Since the ESOP described earlier can be rather complicated and expensive, the entrepreneur may find that a direct sale would be simpler to accomplish.

Entrepreneurship, Eighth Edition j -- ------------- ---~-- -------------- 461

0 ETHICS INVOLVING EMPLOYEES, BANKERS, AND BUSINESS ASSOCIATES IN THE PROBLEM

Who should be made aware when a venture is in trouble? How much responsibility does the entrepre- neur have to his or her employees? How much should you tell your banker? Should clients be made aware of your problems? These are all legitimate yet difficult questions that an entrepreneur may struggle with when the business is on the verge of bankruptcy.

Some may feel that their only responsibility is to t heir family and themselves. Trying to get out of the dilemma with the least effect on your personal repu- t ation and financial well-being could in fact make matters worse. Ethically and morally the entrepre- neur is the leader of the organization, and trying to avoid responsibility will not rectify the situation.

In fact, there is evidence to indicate that involving your employees, banker, or other business associates can actually improve matters. Employees may take pay cuts or stock options to stay on with the company

and try to turn the business around. Bankers can be your financial best friend and can recommend ways to save money and generate more cash flow. Your clients and suppliers can also support turnaround efforts by helping to provide needed cash during the crisis. One example was an entrepreneur who ran out of cash to produce a product being sold by a large supermarket chain. A meeting with the important client that re- vealed the situation (brought on by a competitor's lawsuit that was settled) led to a simple solution. The supermarket appreciated the honesty of the entrepre- neur and agreed to prepay for all orders so that there would be sufficient cash to produce the product.

The entrepreneur needs to consider the past ef- forts of employees who made him or her successful in the first place. Thus, the best solution is participation. Get help rather than taking the selfish and perhaps immoral alternative. Honesty is the best strategy.

Management buyouts usually involve a direct sale of the venture for some predetermined price. This would be similar to selling one's house. To establish a price, the entrepreneur would have an appraisal of all the assets and then determine the goodwill value established from past revenue.

Sale of a venture to key employees can be for cash, or it can be financed in any number of ways. A cash sale is unlikely if the value of the business is substantial. Financing the sale of the venture can be accomplished through a bank, or the entrepreneur could also agree to carry the note. This may be desirable to the entrepreneur in that the stream of income from the sale would be spread out over a determined period of time, enhancing cash flow and lessening the tax impact. Another method of selling the venture would be to use stock as the method of transfer. The managers buying the business may sell nonvoting or voting stock to other investors. These funds would then be used as a full or partial payment for the venture. The reason that other investors would be interested in buying stock or that a bank would lend the managers money is that the business is continuing with the same manage- ment team and with its established track record.

Other methods of transferring or selling a business are through a public offering or even a merger with another business. These topics are discussed in Chapter 14. Before determin- ing the appropriate selling strategy, the entrepreneur should seek the advice of outsiders. Every circumstance is different, and the actual decision will depend on the entrepreneur's goals. Case histories of each of the preceding methods can also be reviewed to be able to effectively determine which option is best for the given circumstances.

BANKRUPTCY-AN OVERVIEW Failure is not uncommon in many new ventures, especially in light of the poor global eco- nomic environment, the wars in Iraq and Afghanistan, and the continued battle against ter- rorism. According to the Small Business Administration, about half of all new start-ups fail

447

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448 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

in their first years. The failures are personally painful for the entrepreneur and too often could have been prevented if the entrepreneur had paid more attention to certain critical factors in the business operation. It is important to understand the issues involved in bank- ruptcy since it does occur and there may even be an opportunity to use the bankruptcy op- tions to get the company back on solid financial ground.

Prior to a recent tightening of the bankruptcy laws by Congress in 2005, bankruptcies were running at about 1.6 million per year. In 2006 total filings dropped to about 618,000. a definite reflection of the new laws. Business filings represented about 20,000 of this to- tal. However, it should be noted that many of the nonbusiness filings could be failed pro- prietorships, partnerships, or home businesses. Since the recent economic crisis in 200 and 2009, total filings have again jumped to more than 1.1 million, of which about 44,000 were business filings. It is also important to understand that both business and nonbusines bankruptcy filings are divided by chapter filings, which will be explained in more detail later.

The most common type of business bankruptcy is Chapter 7, or liquidation, which ac- counted for about 69 percent of the total in 2008. Chapter 11 bankruptcy provides an op- portunity for a business to reorganize, prepare a new business plan (acceptable to the courts), and then, with time and achievement of new goals , to return to normal business op- eration. These bankruptcies represented about 19 percent of all business filings in 2008. The remaining business bankruptcies (about 12 percent) are Chapter 13 filings, which allow creditors to be repaid in an agreed-upon installment plan. 9

Bankruptcy is a term that has been on the minds of many entrepreneurs in the past cou- ple of years , as businesses face a weak economy, increased competition, and rising costs of doing business . As stated before, bankruptcy may not always mean the end of a business since it can offer the entrepreneur an opportunity to reorganize under Chapter 11 or merge with another company. The results of each bankruptcy filing can be quite distinct because of the nature of the business or the uniqueness of an industry. Some of the following examples describe the possible mix of results or experiences that can occur from a bankruptcy filing .

Although a Chapter 11 filing is designed to allow a company to reorganize and then emerge with its operations again, there have been some serious concerns given the new restrictions signed into law in 2005 . The Sharper Image filed for Chapter 11 bankruptcy in February 2008. Its intent was to close 90 of its 184 stores to save significant operating costs. However, because the new law has lessened the time that Chapter 11 firms can remain under court control, the management of The Sharper Image felt that there was not enough time to finance the restocking of the remaining stores, so the company instead chose liquidation to retain some value in the assets . Other retailers such as Wickes Furni- ture, Whitehall Jewelers, Levitz, and Bombay Company have had similar experiences. It is apparent that the new time restrictions have been particularly harsh to retailers .

In 2005 Jeff Yarbrough filed for Chapter 13 bankruptcy after his restaurants in Dallas failed. In wanting to share his experiences and to explain that there was no shame in bank- ruptcy, Jeff described how he survived. Since filing for bankruptcy he worked three jobs to provide for his family as well as pay off the debt. He is now running his own public rela- tions firm and also brokering commercial leases, which has allowed him to pay off the debts from his failed restaurants . His biggest lesson and response to entrepreneurs is to avoid ex- tensive debt at any cost. 10

In February 2004 disaster struck for 72 franchise stores when Ground Round Grill & Bar announced that it was filing for bankruptcy. The franchise stores were owned by local propri- etors under a license from the chain. The company also owned 59 restaurants. Founded in 1969, the restaurant had been a pioneer in the casual dining industry but now was faced with debt to unsecured creditors of between $10 million and $50 million. Sell-offs of a number of the restaurants had provided some funds, but any ability to survive the bankruptcy hit a snag

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CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 449

Chapter 11 bankntptcy

Provides the opportunity

to reorganize and make

the venture more solvent

Chapter 13 bankruptcy

Voluntarily allows

individuals with regular

income the opportunity

to make extended time

payments

Chapter 7 bankruptcy

Requires the venture

to liquidate, either

voluntarily or

involuntarily

when financing was delayed and the company defaulted on its loan payments. The franchisees, however, made some quick and innovative decisions and decided to organize themselves into a cooperative. With this new organization they were able to raise some internal and external funds to buy the brand from the bankruptcy court. As of early 2009 the cooperative operates 46 of the remaining restaurants from the original 72 that existed at the time of the declared bank- ruptcy. The new business model of a cooperative seems to be working as a number of the orig- inal franchise owners have now opened new restaurants. 11

Bankrate is one of a few Internet stocks that were able to survive the dot-com bubble burst. After an IPO at $13 per share in May 1999, the stock reached a low of $1 per share in August 2002. Since that low point, the company has made a complete turnaround, pri- marily due to the leadership of Elizabeth DeMarse. The company Web site lists compara- tive rate tables and fee information on 100 financial products such as mortgages, credit cards, auto loans, and money markets. Most of its revenue, however, is accumulated from advertising on the site. Now under new leadership, the company has reached new profit milestones in 2008 (reported net income of over $20 million). It has also enhanced its prod- uct line with a network of companies such as Interest.com, Mortgage-calc.com, Nation- wide Card Services, and Savingforcollege.com. 12

Some lessons that can be learned from those who have experienced bankruptcy are as follows:

• Many entrepreneurs spend too much time and effort trying to diversify in markets where they lack knowledge. They should focus only on known markets.

• Bankruptcy protects entrepreneurs only from creditors, not from competitors.

• It's difficult to separate the entrepreneur from the business. Entrepreneurs put everything into the company, including worrying about the future of their employees.

• Many entrepreneurs do not think their businesses are going to fail until it's too late. They should file early.

• Bankruptcy is emotionally painful. Going into hiding after bankruptcy is a big mistake. Bankruptcy needs to be shared with employees and everybody else involved.

As the preceding examples indicate, bankruptcy is serious business and requires some im- portant understanding of its applications. The Bankruptcy Act of 1978 (with amendments added in 1984 and 2005) was designed to ensure a fair distribution of assets to creditors, to protect debtors from unfair depletion of assets, and to protect debtors from unfair demands by creditors. The Bankruptcy Act provides three alternative provisions for a firm near or at a position of insolvency. The three alternative positions are (1) reorganization, or Chapter 11 bankruptcy; (2) extended time payment, or Chapter 13 bankruptcy; and (3) liquidation, or Chapter 7 bankruptcy. All attempt to protect the troubled entrepreneur as well as provide a reasonable way to organize payments to debtors or to end the venture.

CHAPTER 11-REORGANIZATION This is the least severe alternative to bankruptcy. In this situation the courts try to give the ven- ture "breathing room" to pay its debts. Usually, this situation results when a venture has cash flow problems, and creditors begin to pressure the firm with lawsuits. The entrepreneur feels that, with some time, the business can become more solvent and liquid to meet its debt require- ments. However, as we have seen in the preceding example, the new time restrictions regard- ing how long a Chapter 11 firm may continue under court control have made it particularly difficult for firms in retailing to reorganize effectively. However, it is still in the best interests of a company that has a chance to become solvent to seek protection under this option.

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450 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

A major creditor, any party who has an interest, or a group of creditors will usually sent the case to the court. Then a plan for reorganization will be prepared to indicate how __,._ business will be turned around. The plan will divide the debt and ownership interests · two groups : those who will be affected by the plan and those who will not. It will then spec- ify whose interests will be affected and how payments will be made.

Once the plan is completed, it must be approved by the court. All bankruptcies now handled by the U.S. Bankruptcy Court, whose powers were restructured under Bankruptcy Amendments and Federal Judgeship Act of 1984. Approval of the plan alS requires that all creditors and owners agree to comply with the reorganization plan ~ presented to the courts. The decisions made in the reorganization plan generally refl. one or a combination of the following: 13

1. Extension. This occurs when two or more of the largest creditors agree to postpone a=_ claims. This acts as a stimulus for smaller creditors to also agree to the plan.

2. Substitution. If the future potential of the venture looks promising enough, it may be possible to exchange stock or something else for the existing debt.

3. Composition settlement. The debt is prorated to the creditors as a settlement for any

Even though only 20 to 25 percent of those firms that file for Chapter 11 bankruptcy v.-:.:... make it through the process, it does present an opportunity to find a cure for any busines. problems. Some of these problems are resolvable, and without the Chapter 11 protecti even these 20 to 25 percent that file would never have the opportunity to succeed. It sho-'- also be noted that some firms that make it through the process often find that they c succeed and thus either must liquidate or find a buyer.

It is generally believed by experts that one of the primary reasons companies do not cessfully come out of Chapter 11 bankruptcy is that they wait too long before filing for tection. In May 2005, Heather Antonelli filed for Chapter 7 bankruptcy. She and her mothe:- JoAnn had opened a furniture wholesaling business, Eminence Style, in 1996 and ha: achieved steady growth in sales, reaching $3 million in 2000. Then in 2001 a buyer fro::::. Sears ordered $2 million worth of tables. The production of this large order necessitated S.- nancing, which Heather secured from the SBA, the Bank of America, and friends and fam- ily. She found a manufacturer in Hungary and made the one-third deposit and budgeted rl:= rest of the money for the final payment. Unfortunately, the value of the dollar took a di' ·· and her cost increased by one-third. Only a minimal profit was made, and then the buyer Sears was replaced by someone who had no interest in reordering. Competitors founc. cheaper manufacturing in China, and Antonelli found she could no longer compete oc. price. Customers then switched to the lower-price competitors and, as sales declined, the Bank of America demanded payment of the full amount of the debt. All during this perioc Heather still felt compelled to avoid bankruptcy and get things back on track. However, a!- ter much deliberation and with advice from a business consultant, she finally decided to s down the company and file for Chapter 7 bankruptcy. She now agrees that she waited toe long but, on a positive note, feels she learned some important lessons that will help her make better decisions in the future. 14

As in Heather's case, entrepreneurs have a tendency to ignore the warning signs of bank- ruptcy and hold on until there is an emergency, such as running out of cash. Recognizin:: the signals may give an entrepreneur the opportunity to develop a strategy or plan.

Surviving Bankruptcy The most obvious way to survive bankruptcy is to avoid it altogether. However, since bank- ruptcy is becoming such a common occurrence, it may be helpful for the entrepreneur

'"'"'""'"""'· E;ghth Ed;uoo I 465 ------·--------------------· ---·---·---------- ---· ----------------- -+----

AS SEEN IN BUS/NESSWEEK

ELEVATOR PITCH FOR nPOWER PERSONAL ENERGY GENERATOR

Your former partner, who has been a very successful investor in start-ups, has called you to ask if you are aware of any good investments. He just cashed out of a very profitable sale of one of his companies and has funds to reinvest. You know he likes to hike and thought that after learning about the following start- up, this may be a good option to propose to his for- mer partner. What do you think?

Lugging a stash of fresh batteries isn't something Aaron LeMieux wanted to do while hiking the Ap- palachian Trail. He had no alternative back in 1996, but he hopes he's got one for hikers, runners, and even walkers. It's called the nPower Personal Energy Generator. The 9-oz., 9-in.-long cylinder harvests ki- netic energy from the human stride and turns it into 2.5 watts of electricity, enough for an iPod, cell phone, or other gadgets. LeMieux invented the generator af- ter convincing his wife that he should quit his job as a management consultant in Cleveland . He then "emp- tied out the savings account," netting $20,000. After

three days of tinkering in his basement, the mechanical engineering graduate finished a prototype. In 2007, he formed Tremont Electric, in Tremont, Ohio, with himself as CEO. He's now selling the product for $149 through Tremont's Web site, greennpower.com. LeMieux, 34, didn't get this far on his savings alone: He's raised $135,000 from friends and family and a $55,000 loan from Cuyahoga County. And he's trying to bring in $1.5 million from government agencies and venture capitalists. He and his one full-time and seven part-time employees aren't paid. The gen- erator, which is manufactured in Cleveland, may be pricey. But it means no more batteries to throw out or dead devices while you're away from a recharger too long.*

*Source: Reprinted from the July 21, 2009, issue of Business Week by special permission, copyright© 2009 by The McGraw-Hill Companies, Inc., "America's Most Promising Startups: Tremont Electric," by Rachel Z. Arndt, www.businessweek.com/smallbiz.

have a plan should he or she find it necessary to declare bankruptcy. Some suggestions for survival are listed here:

• Bankruptcy can be used as a bargaining chip to allow the entrepreneur to voluntarily restructure and reorganize the venture.

• File before the venture runs out of cash or has no incoming revenue so that expenses not protected by bankruptcy can be paid.

• Don't file for Chapter 11 protection unless the venture has a legitimate chance of recovery.

• Be prepared to have creditors examine all financial transactions for the last 12 months, seeking possible debtor fraud.

• Maintain good records.

• Understand completely how the protection against creditors works and what is necessary to keep it in place.

• If there is any litigation in existence, transfer it to the bankruptcy court, which may be a more favorable forum for the entrepreneur.

• Focus efforts on preparing a realistic financial reorganization plan.

Following some of these suggestions and being prepared should bankruptcy be neces- sary is the best advice that anyone could give to an entrepreneur. Preparation will prevent unfavorable conditions and could increase the likelihood of successfully coming out of bankruptcy.

451

' i I _ 466~- Entrepreneurship

452 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

voluntary bankruptcy

Entrepreneur's decision to

file for bankruptcy

involuntary bankruptcy

Petition of bankruptcy

filed by creditors without

consent of entrepreneur

CHAPTER 13-EXTENDED TIME PAYMENT PLANS As of October 17, 2005, the ability of an entrepreneur to file for a Chapter 7 bankru~. now more difficult. The reforms in the Bankruptcy Code that were signed into law in~ ~ 2005 are based on the argument that a person should be obligated to repay some of her debt (Chapter 13 bankruptcy); therefore, these reforms make it more difficult to away from all debt by filing for Chapter 7 bankruptcy. Under this new law, individuals -- required to obtain credit counseling within six months of filing and to take a means tes.: ascertain if they are eligible for either Chapter 7 or Chapter 13 bankruptcy. The means - states that individuals may not file for Chapter 7 bankruptcy if their income is at or the state income median.

Under Chapter 13 bankruptcy, the individual creates a five-year repayment plan court supervision. In each case, a court-appointed trustee receives money from the d and then is responsible for making scheduled payments to all creditors. This reform is mv.. . favorable to creditors than the old law. The only problem is that, according to the B ruptcy Institute, about two of every three Chapter 13 filers ultimately fail to meet th"" planned obligations, thus resulting in a Chapter 7 filing .

The future effects of these reforms are still unknown . There are some who argue that new law will stifle entrepreneurial activity. On the other hand, creditors have long been •h losers under the old law since it was so easy for individuals to file a Chapter 7 bankrup and eliminate all their debt. 15

CHAPTER 7-LIQUIDATION The most extreme case of bankruptcy requires the entrepreneur to liquidate, either volun- tarily or involuntarily, all nonexempt assets of the business.

If the entrepreneur files a voluntary bankruptcy petition under Chapter 7, it constitutes a determination that his or her venture is bankrupt. Usually, the courts will also require current income and expense statement.

Table 15.2 summarizes some of the key issues and requirements under the involuntary bankruptcy petition. As the table indicates, an involuntary bankruptcy can be very complicated and can take a long time to resolve. However, liquidation is in the best interests of the entrepre- neur if there is no hope of recovering from the situation.

TABLE 15.2 Liquidation under Chapter 7 Involuntary Bankruptcy

Number and Claims Rights and Duties Requirements of Creditors of Entrepreneur Trustee

Debts are not being paid If 12 or more creditors, at Damages may be Elected by creditors. as they become due. least 3 with unsecured recovered if creditor files Interim trustee appointed

claims totaling $5,000 must in bad faith . by court. sign petition.

Custodian appointed If fewer than 12 creditors, If involuntary petition is Becomes by law owner of within 120 days of filing 1 creditor whose unsecured dismissed by court, costs, all property considered petition. claim is at least $5,000 must fees, or damages may be nonexempt for

sign the petition . awarded. liquidation.

Considered insolvent A proof of claim must be Must file a list of creditors Can set aside petitions; when fair value of all filed with in 90 days of first with courts . Must file a transfer of property to a assets is less than debts. meeting of creditors. current income and creditor under certain Called a balance sheet expense statement. conditions. test.

CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 453

STRATEGY DURING REORGANIZATION Normally, reorganization under Chapter 11 or an extended payment plan under Chapter 13 takes a significant amount of time. During this period, the entrepreneur can speed up the process by taking the initiative in preparing a plan, selling the plan to secured cred- itors, communicating with groups of creditors, and not writing checks that cannot be covered.

The key to enhancing the bankruptcy process is keeping creditors abreast of how the business is doing and stressing the significance of their support during the process. Improving the entrepreneur's credibility with creditors will help the venture emerge from financial difficulties without the stigma of failure. But trying to meet face to face with groups of creditors usually results in turmoil and ill will, so these meetings should be avoided.

Bankruptcy should be a last resort for the entrepreneur. Every effort should be made to avoid it and keep the business operating.

KEEPING THE VENTURE GOING We've already noted in this chapter's opening profile that not all bankruptcies have unfa- vorable endings. Teresa Cascioli, CEO of Lakeport Brewing, has led the emergence of her company from Chapter 11 bankruptcy to its current position as a formidable player in the Canadian beer market.

Any entrepreneur who starts a business should pay attention to, as well as learn from, the mistakes of others. There are certain requirements that can help keep a new venture go- ing and reduce the risk of failure . We can never guarantee success, but we can learn how to avoid failure.

Table 15.3 summarizes some of the key factors that can reduce the risk of business fail- ure. The entrepreneur should be sensitive to each of these issues regardless of the size or type of business.

Many entrepreneurs have confidence in their abilities, which is necessary for them to be successful in their field. This confidence allows them to meet changing market condi- tions by implementing new strategies and directions for their firms to achieve future suc- cess where others may have failed. Two examples of this approach are Eli and Sheri Gurock and Nathaniel Bernier. Eli and Sheri Gurock saw two big-name toy stores close their doors in their Massachusetts community. They believed that they could be success- ful with a community toy store by including a baby section that offered a wide variety of baby clothes and necessities. Their strategy was that expectant parents who shopped the store (named Magic Beans) would leave with the idea that this was also a great place to buy toys. In addition, even though toy sales tended to be very seasonal, sales of the baby necessities would create a good business environment all year long. Emphasizing them- selves as a community business that had excellent follow-through service during and

TABLE 15.3 Requirements for Keeping a New Venture Afloat

• Avoid excess optimism when the business appears to be successfu l.

• Always prepare good marketing plans with clear objectives.

• Make good cash projections and avo id capitalization .

• Keep abreast of the marketplace.

• Identify stress points that can put t he business in jeopardy.

468 Entrepreneursh ip . l

~~.~--~- --···--·---- !

454 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENlURE

after the sale has led to an expansion to three stores, an effective Web site, and the seven figures. 16

Nathaniel Bernier was the owner of Wild Rufus Records in the seaside town of • ,(j ·', s:- Maine. He found that CD sales were declining rapidly not only in his store but nati A local Wal-Mart added to the problem by increasing its music section. Bernier dJ rather than try to compete in CD sales, he needed to change his strategy before he - himself bankrupt. His solution was to focus on selling old technology-vinyl recro: bundled with pass codes allowing customers to download MP3 versions of the same He believed that this offered customers the best of both worlds, a rich analog sound of for home use and a digital version they could take anywhere. His unique strategy hE! suited in an increase of sales of 100 percent over the last yearP

Both entrepreneurs in these examples recognized the need to develop different st:rare'~ or face failure. In the first case we see the need to develop a unique mix of products - would help build a strong store image. In the second case the entrepreneur was faced ultimate failure unless he could find a unique marketing strategy to increase sales and .. its. We saw in Chapter 8 of this textbook the importance of market planning to help p for situations such as those described.

Good cash projections are also a serious consideration for the entrepreneur. Cash f1 one of the major causes for an entrepreneur to have to declare bankruptcy. Thus, in pre' cash projections, entrepreneurs should seek assistance from accountants, lawyers, or a f1 agency such as the Small Business Administration. This may prevent the situation reaching the point where it is too late for any hope of recovery.

Many entrepreneurs avoid gathering sufficient information about the market (see CU::...- ter 7 of this textbook). Information is an important asset to any entrepreneur, especi2. ~ regarding future market potential and forecasting the size of the immediate attainable m2::"- ket. Entrepreneurs will often try to guess what is happening in the market and ignore -"'-- changing marketplace. This could spell disaster, especially if competitors are reacting mo:-=c positively to the market changes.

In the early stages of a new venture, it is helpful for the entrepreneur to be aware 0: stress points, that is, those points when the venture is changing in size, requiring new vival strategies. Early rapid rises in sales can be interpreted incorrectly so that the vente= finds itself adding plant capacity, signing new contracts with suppliers, or increasing inven- tories, resulting in shrinking margins and being overleveraged. To offset this situatim:. prices are increased or quality weakened, leading to lower sales. This becomes a viciocs circle that can lead to bankruptcy.

Stress points can be identified based on the amount of sales. For example, it may be pos- sible to recognize that sales of $1 million, $5 million, and $25 million may represent kJ _ decision marks in terms of major capital investment and operational expenses such as hir- ing new key personnel. Entrepreneurs should be aware of the burden of sales levels o;: capital investment and operational expenses.

WARNING SIGNS OF BANKRUPTCY Entrepreneurs should be sensitive to signals in the business and the environment that rna, be early warning signs of trouble. Often, the entrepreneur is not aware of what is going on or is not willing to accept the inevitable. Table 15.4 lists some of the key early warning signs of bankruptcy. Generally, they are interrelated, and one can often lead to another.

For example, when management of the financial affairs becomes lax, there is a tendency to do anything to generate cash, such as reducing prices, cutting back on supplies to meet orders, or releasing important personnel such as sales representatives. A new office

'"'"P""'""hip, Eighth Ed;tloo I 469 - --- ----~---·--··---·- ------ --+----- ----

CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 455

TABLE 15.4 Warning Signs of Bankruptcy

• Management of finances becomes lax, so no one can explain how money is being spent.

• Directors cannot document or explain major transactions.

• Customers are given large discounts to enhance payments because of poor cash flow.

• Contracts are accepted below standard amounts to generate cash.

• Bank requests subordination of its loans.

• Key personnel leave the company.

• Materials to meet orders are lacking.

• Payroll taxes are not paid.

• Suppliers demand payment in cash .

• Customers' complaints regarding service and product quality increase.

furniture business catering to small or medium-sized businesses illustrates how this can happen. Top management of the firm decided that moving merchandise was its top priority. Sales representatives earned standard commission on each sale and were free to reduce prices where necessary to make the sale. Hence, without any cost or break-even awareness, sales representatives often reduced prices below direct costs. They still received their com- missions when the price charged was below cost. Thus, the venture eventually lost substan- tial amounts of money and had to declare bankruptcy.

When an entrepreneur sees any of the warning signs in Table 15.4, he or she should im- mediately seek the advice of a CPA or an attorney. It may be possible to prevent bankruptcy by making immediate changes in the operation to improve the cash flow and profitability of the business. Turnaround strategies are discussed later in this chapter.

STARTING OVER Bankruptcy and liquidation do not have to be the end for the entrepreneur. History is full of examples of entrepreneurs who have failed many times before fmally succeeding.

Gail Borden's tombstone reads, "I tried and failed, and I tried again and succeeded." One of his first inventions was the Terraqueous Wagon, which was designed to travel on land or water. The invention sank on its first try. Borden also had three other inventions that failed to get patents. A fourth invention was patented but eventually wiped him out because of lack of capital and poor sales. However, Borden was persistent and convinced that his vacuum condensation process, giving milk a long shelf life, would be successful. At 56, Borden had his first success with condensed milk.

Over the years, other famous entrepreneurs have also endured many failures before finally achieving success. Rowland Hussey Macy (ofMacy's retail stores), Ron Berger (of National Video), and Thomas Edison are other examples of struggling entrepreneurs who lived through many failures.

The characteristics of entrepreneurs were discussed in Chapter 3. From that chapter we know that entrepreneurs are likely to continue starting new ventures even after failing . There is evidence that they learn from their mistakes, and investors often look favorably on someone who has failed previously, assuming that he or she will not make the same mis- take again. 18

Generally, entrepreneurs who have failed in their endeavors tend to have a better under- standing and appreciation for the need for market research, more initial capitalization, and

470 1 Entrepreneurship _.;..c-~•~·--· .. --.0...:. ----------

456 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

stronger business skills. Unfortunately, not all entrepreneurs learn these skills from their experiences; many tend to fail over and over again.

However, business failure does not have to be a stigma when it comes time to seek ven- ture capital. Past records will be revealed during subsequent start-ups , but the careful entre- preneur can explain why the failure occurred and how he or she will prevent it in the future, restoring investors' confidence. As discussed in Chapter 7, the business plan will help sell the business concept to investors. It is in the business plan that the entrepreneur, even after many failures, can illustrate how this venture will be successful.

THE REALITY OF FAILURE Unfortunately, failure does happen, but it isn't necessarily the end. Many entrepreneurs are able to successfully tum failure into success. It is one of the important historical character- istics of entrepreneurs that we have continually identified throughout this text. Since fail - ure can happen, there are also some important considerations that should be mentioned if it should occur.

First and foremost, the entrepreneur should consult with his or her family. As difficult as it is for the entrepreneur to deal with bankruptcy, it is even more so for spouses. Problems occur because the spouse usually has no control over the venture's operations unless it is a family-operated business . As a result, he or she may not even be aware of any bankruptcy threats. Thus, the first thing the entrepreneur should do is sit down with his or her spouse and explain what is happening. This discussion will also help alleviate some of the stress of dealing with bankruptcy.

Second, the entrepreneur should seek outside assistance from professionals, friends, and business associates. Although not all of these people may be sympathetic, it is usually not difficult to find individuals among these groups who will be supportive. Pro- fessional support is also available from the Small Business Administration (SBA), universities, the Senior Corps of Retired Executives (SCORE), and small-business de- velopment centers.

Third, it is important to not try to hang on to a venture that will continually drain re- sources if the end is inevitable. It is better to consider the time spent trying to save a dying business as an opportunity cost. The time spent could be more effectively and profitably used to either start over or do something else. If a turnaround is considered possible (see the following discussion) , it is wise to set a time frame and, if it is not accomplished in that time frame, to simply end the venture.

BUSINESS TURNAROUNDS We have discussed a number of turnaround examples throughout this chapter, such as the opening profile on Lakeport Brewing, Bankrate, and Wild Rufus Records . All were faced with declining sales and earnings that either resulted in bankruptcy or threatened bank- ruptcy. What we have learned from successful examples of turnarounds is summarized and discussed in the next few paragraphs. 19

During a business's life cycle it is likely that an entrepreneur will face adversity, perhaps because of external factors (the economy; competition; changes in consumer needs; tech- nology; or unpredictable acts such as war, terrorism, or weather); or the adversity may be self-inflicted (that is, due to poor management). The severity of the adversity can result in bankruptcy or in a need to refocus the business and strive for a turnaround. The process of turnaround can take many directions, but there are some basic principles and support that can be considered to help the entrepreneur.

Entrepreneurship, Eighth Ed ition

CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 457

IN REVIEW

SUMMARY

First and foremost it is important for the entrepreneur to recognize the warning signs of bankruptcy discussed earlier and listed in Table 15.4. However, recognition of the warning signs does not solve the problem; instead, it is the point at which the principles discussed next should be considered. If the entrepreneur feels inadequate in dealing with any of these warning signs, then it is recommended that he or she consult with a CPA or an attorney. There are also a number of turnaround management consulting firms that support businesses of all sizes. They can be identified with a simple search on the Internet. The Business Finance and Turnaround Association can also provide support in this situation.

The first principle in any successful turnaround (reflected in all our earlier examples) is aggressive hands -on management. Leadership in all these cases focused initial efforts on getting out among, meeting, and communicating with all employees. This high-visibility strategy is significant to identify the roots of any issues that are contributing to the threat of bankruptcy or to the need to successfully resurface from bankruptcy. The entrepreneur needs to keep all the employees energized and focused on bringing the company back to a position of market and financial stability and then, it is hoped, moving it toward managed growth. The entrepreneur needs to be honest and up-front with all the employees regarding the situation to get them involved in identifying the issues that need to be addressed. Historically, at this stage neither an absentee management nor a bunker mentality in which management works long hours is sufficient.

The second principle is that management must have a plan. We've discussed many times in this text that there are three questions that need to be addressed in any planning process (see Chapter 8). The same questions are applicable here as part of a turnaround plan. Step 1 in this plan is getting out into the business and trying to understand the problem, as described in the preceding paragraph. This addresses the situation analysis, or the question, "Where are we now?" The second question in any plan is, "Where are we going?" This is when the plan becomes important, since goals and objectives will need to be developed to get the company turned around. Again it is important to get everyone in the organization in- volved in looking for opportunities to improve the company's existing market and financial position by cutting costs, increasing efficiencies, and improving customer service and loyalty, as well as by pursuing strategies to increase sales.

The third and last step, or principle, in the turnaround process is action. This relates to the third question in the planning process, which is, "How do we get there?" The plan should involve aggressive corrective action. Time is of the essence here, either to avoid bankruptcy or to prove to the creditors or the bankruptcy court that you can get the com- pany back on track. At this point, a turnaround consultant may be called in to support these actions if the entrepreneur feels inadequate.

This chapter of the textbook deals with exit strategies that the entrepreneur will need to consider. These decisions can involve finding a successor to the venture, selling the busi- ness either totally or partially, or ending the venture because of bankruptcy. All of these likely scenarios are real and common among small businesses. Thus, to be prepared the entrepreneur should understand each of these issues and be prepared with an exit plan before it is too late. One of the venture-ending decisions that an entrepreneur may face

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458 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

is success ion of the business. If the business is family owned, the entrepreneur woulc likely seek a family member to succeed. Other options, if no family member is available or interested, include transferring some o r all of the business to an employee or outsider or hiring an external person to manage the business. Direct sale of the business, em- ployee stock option plans, and management buyouts are alternatives for the entrepre- neu r in selling the venture. These are all exit strategy options for the entrepreneur an need to be planned for early so that crises are minimized.

Even though the intent of all entrepreneurs is to establish a business for a lo ng time, many problems can cause these plans to fail. Since about one-half of all new ve tures fail in their first four years of business, it is important for the entrepreneur to u derstand the options for either ending or salvaging a venture.

Bankruptcy offers three options for the entrepreneur. Under Chapter 11 of the Ba n!\.- ruptcy Act of 1978 (amended in 1984 and again in 2005), the venture will be reorganizec under a plan approved by the courts. With this plan the entrepreneur strives to revita ize the financial condition of the venture and return to the market with new strateg ies.

Chapter 13 of the Bankruptcy Act provides for an extended time payment plan t cover outstanding debts. The 2005 amendment to the Bankruptcy Act has made th' particular choice a more likely first option-and an option that must be exhausted be- fore the entrepreneur is allowed to file for Chapter 7 liquidation. The courts feel tha-: individuals should be required to pay back some of their debt, and therefore t h' amendment makes it more difficult to file for Chapter 7 liquidation. If the ind ividua l · unable to make extended payments, then liquidation, either voluntarily or involunta •- ily, is the final option.

Keeping the business going is the primary intent of all entrepreneurs. Avoiding ex- cessive optimism, preparing good marketing plans, making good cash projections. keeping familiar with the market, and being sensitive to stress points in the business can help keep the business operating .

Entrepreneurs can also be sensitive to key warning signs of potential problems. Lax management of finances, discounting to generate cash, loss of key personnel, lack of raw materials, nonpayment of payroll taxes, demands of suppliers to be paid in cas. and increased customer complaints about service and product quality are some of t he key warning signs that a firm is headed for bankruptcy. If the business does fail, hovt- ever, the entrepreneur should always consider starting over. Failure can be a learnin, process, as evidenced by the many famous inventors who succeeded after many failu res.

RESEARCH TASKS

c 1. Find three accounts by entrepreneurs in which they describe their experience with poorly performing firms and the process of going through bankruptcy. In what ways were their experiences similar? In what ways were they different? Did emotions pia a role? Did the entrepreneurs learn from the experience?

2. Interview a member of a family business and gain a deeper understanding of the issues surrounding the management of such a business, especially those related to succession.

3. Write an account of the emotions that you felt when someone or something close to you was lost forever (you will not be required to present this to the class). How did these emotions impact your ability to perform other tasks? How did you overcome these negative emotions? To what extent do you believe that entrepreneurs go through a similar process when their businesses fail?

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CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 459

CLASS DISCUSSION

1. If your family had a highly successful business, would succession to the next generation (you and/or your siblings) likely be smooth, or would there be the potential for conflict and hurt feelings? What would be a "fair" way to set up succession?

2. Do you believe the laws should be changed to make it easier for entrepreneurs to go into, and recover from, bankruptcy? What are the implications of your answer for the entrepreneur, creditors, and the national economy?

3. What are the issues facing an entrepreneur in deciding whether or not the business needs to be put into bankruptcy today?

4. The following role-plays require you to think and act as if you were the person being described in each situation.

a. Role-play 1. One student prepares and presents a speech as if she or he is an entrepreneur informing employees that her or his business has failed and will not be operating from tomorrow on. The rest of the class can respond and ask questions as if they are devoted employees upset about losing their jobs.

b. Role-play 2. In small groups, role-play the interchange between an entrepreneur of a failed business expressing his or her negative emotions and a friend providing advice on how to best cope with the situation.

SELECTED READINGS

Avila, Stephen M.; Ramon A. Avila; and Douglas W. Naffziger. (May 2003). A Compari- son of Family-Owned Businesses: Succession Planners and Nonplanners. Journal of Financial Service Professionals, vol. 57, no. 3, pp. 85-92.

This study compares family-owned businesses that had a business succession plan with those that did not have a plan. Survey results indicate that a succession plan can affect business transition, tax planning, and the ownership structure.

Baird, Douglas G.; and Edward R. Morrison. (December 2005). Serial Entrepreneurs and Small Business Bankruptcies. Columbia Law Review, vol. 105, no. 8, pp. 2310-68.

Chapter 11 is thought to preserve the going-concern surplus of a financially dis- tressed business. However, the typical Chapter 11 debtor is a small business whose assets are rarely enough to pay tax claims. This article discusses the implications of Chapter 11 bankruptcy to those entrepreneurs who do not wish to stay with their business but instead are more interested in other opportunities.

Brodzinski, Carrie. (June 13, 2005). ESOP's Fables Can Make Coverage Risky. National Underwriter/Property Casualty Risks & Benefits Management, vol. 109, no. 23, pp. 16, 44.

This article focuses on employee stock ownership plans (ESOPs) that invest solely in employer stock. These plans can be risky for employers and employees and are often misunderstood. Important issues related to these plans are discussed.

Davis, James. (May 2003). Staking Your Life on a Betting Future. Accountancy, vol. 131, no. 1317, pp. 54-56.

The author in this article provides a discussion of the factors that need to be con- sidered before implementing a management buyout. The article includes a discus- sion of the role of the board of directors, management presentations, and due diligence.

Hoffman, John. (Summer 2008). Planning Early Will Maximize Return from a Liquidity Event. Family Business, pp. 32-37.

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460 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

Timely planning is important during a buyout by private-equity firms, strategic;;_ ers, financial buyers, or publicly traded firms. To be prepared for such an event. :::-= author recommends including financial advisors, business associates, and a tf11S"2: network of friends to coordinate the process so that specific goals can be met in~= sale negotiations.

Jackson, Kirk. (July 2005). Case Study of a Succession Plan. Journal of Financia l Plii. - ning, vol. 18, no. 7, pp. 39-42.

This article relates the experiences of the author in succession planning. It is a cas.= study of the author's family business and how various conflict situations led to de sions for succession of the business.

latham, Scott. (Apri l 2009). Contrasting Strategic Response to Economic Recess io Start-Up versus Established Software Firms. Journal of Small Business Manageme~­ vof. 47, no. 2, pp. 180-201.

Economic recession, especially among small firms, can be a significant factor in viva/. This study surveyed 137 software executives regarding their strategic respo to the recent economic downturn. The results suggest that small firms tend t o revenue-producing strategies to combat economic recession whereas larger fi, tend to pursue cost-cutting strategies.

Maddy, Monique. (2000). Dream Deferred: The Story of a High-Tech Entrepreneu r i. _ Low-Tech World. Harvard Business Review, vol. 78, no. 3, pp. 56-69.

Monique Maddy discusses the important lessons that the failure of her sta rt-u::: Adesemi, taught her about starting a business in an emerging-market country.

Phillips, Edward A. (Winter 2006). Bankruptcy Law: Changes in Protection Make Pia ning Critical. CPA Journal, vol. 76, no. 4, pp. 1-4.

This paper provides in-depth discussion and analysis of the impact of the ne ... bankruptcy laws on accounting issues. The author discusses the importance o; planning in the process. Each area that needs to be considered in this pla n · discussed.

Shepherd, Dean A.; Evan J. Douglas; and Mark Shanley. (2000). New Venture Surviva Ignorance, External Shocks, and Risk Reduction Strategies. Journal of Business Ven tw- ing, vol. 15, no. 5-6, pp. 393-410.

The authors develop a model to explain new venture failure. The theoretical mode argues that risk of failure is largely dependent on the degree of novelty (ignorance~ associated with a new venture-novelty to the market, novelty to the technology o: production, and novelty (experience) to management.

Shepherd, Dean A.; and Andrew Zackarakis. (2000). Structuring Family Business Succ es- sion: An Analysis of the Future Leader's Decision Making. Entrepreneurship: Theo ry & Practice, vol. 24, no. 4, pp. 25-39.

This article examines the perception of potential family business leaders from a be- havioral economics theory perspective. The authors argue that founders sho uf, structure succession so that the future leader incurs both financial and behavio ra sunk costs as well as hold the future leader to stringent performance requirements prior to the succession.

Warren, Elizabeth; and Jay lawrence Westbrook. (February 2009). The Success of Chapter 11: A Challenge to the Critics. Michigan Law Review, vol. 107, no. 4, pp. 603-41.

Nearly all troubled companies choose Chapter 11 over Chapter 7 liquidation. Ma ny of these firms are eliminated in the early screening and are forced into liquidatio n. The new regulation that shortens the time under court control has prevented many small businesses from being able to reorganize. Data indicate that small businesses were more successful in reorganizing under the old regulations than under the new stricter regulations.

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CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 461

END NOTES

1. See Chris Daniels, "Small-Town Beer, Big Impact, " Marketing Magazine (De- cember 19, 2005), pp. 22-24; Jennifer Morrison, "Lakeport's Lady Boss Has That Steel City Drive," Hamilton Spectator (October 4, 2004}, p. A01; "Lakeport Brewing Financial Results," LexisNexis Canadian News Wire (November 10, 2005); Paul Wildie, "A Soft Spot for Would Be Entrepreneurs," LexisNexis Canadian Report on Business (December 29, 2007), p. B2; and Peter Koven, "Labatt Snaps up Lakeport: $201 M Offer Defensive Move against Discoun- ters," Financial Post (February 2, 2007), p. FP3.

2. Mclean Robbins, "Small Companies Have Big Shoes to Fill: Proper Succession Planning Safeguards 5MB's Future Success," LexisNexis, Employee Benefit News (April 15, 2008), pp. 15-16.

3. Family Firm Institute, www.ffi.org. 4. C. Dannhauser, "Will My Beloved Survive Me?" BusinessWeek Frontier (January

21, 1999), www.businessweek.com. 5. M. Kindley, "Grooming Your Successor," Network World (July 22, 2002), p. 7. 6. Clyde E. Witt, "Plan Ahead, Stay Ahead," Material Handling Management

(January 2006), pp. 33-35. 7. Shelby Scarbrough, "Sell without Selling Out," Entrepreneur (June 2008),

pp. 19-21. 8. The ESOP Association, www.esopassociation.org. 9. See American Bankruptcy Institute's Web site, www.abiworld.org; and

www. uscou rts. gov/ba n kru ptcystats. 10. Jeffrey Yarbrough, "Back from the Brink," FSB: Fortune Small Business

(October 2008), p. 94. 11. Carlye Adler, "The Grand Rebound," FSB: Fortune Small Business (February

2005), pp. 56-60; and www.groundround.com. 12. www.bankrate.com. 13. David Twomey and Marianne Jennings, Anderson's Business Law and Legal

Environment, Standard, 20th ed. (Mason, OH: West Legal Studies, 2008), pp. 752-73.

14. Nadine Heintz, "Anatomy of a Business Decision: A Case Study," Inc. (December 2005), pp. 59-60.

15. Lawrence S. Clark, Randall Hanson, and James K. Smith, "Bankruptcy Reform Is Here," Journal of Accountancy 200, no. 5, (November 2005), pp. 51-59.

16. Nichole L. Torres, "Underdog Days," Entrepreneur (April 2008}, p. 94. 17. Jonathan Blum, "New Spin on Vinyl," FSB: Fortune Small Business (March

2009), p. 28. 18. L. M. Lament, "What Entrepreneurs Learn from Experience," Journal of Small

Business Management (1972), p. 36. 19. See W. P. Schuppe, "Leading a Turnaround," The Secured Lender (January

2003), pp. 8-14; and W. H. Fetterman, "The Team Approach to Turnarounds," Journal of Private Equity (Summer 2003), pp. 9-10.