Chapter 12 The Harvest Plan1

12The Harvest Plan

— / CHAPTER 12 LECTURE NOTES
1 / Explain the importance of having a harvest plan.
PPT 12-1
Chapter 12
The Harvest Plan
PPT 12-2
Looking Ahead
PPT 12-3/TM 12-3
The Importance of the Exit
[Acetate 12-3] /
  1. The importance of the Harvest
  • Define harvesting as the methods entrepreneurs and investors use to exit a business and, hopefully, reap the value of their investment in the firm.
  • Mention the challenges of harvesting—e.g., capturing value, reducing risk, and creating future options.
  • What are the personal and non-financial considerations of selling out?
  • Describe investor (e.g., venture capitalist) expectations for exit strategies.

2 / Describe the options available for exiting.
PPT 12-4/TM 12-4
Methods of Exiting
a Business
[Acetate 12-4]
PPT 12-5
Exiting: Selling the Firm
PPT 12-6
Exiting: Selling the Firm
PPT 12-7
Exiting: Selling the Firm
PPT 12-8
Exiting: Selling the Firm
PPT 12-9/TM 12-9
Leveraged ESOP Buyout
PPT 12-10
Exiting: Releasing
the Firm's Cash Flows
PPT 12-11
Exiting: Going Public
PPT 12-12
Exiting: Going Public--
The IPO Process
PPT 12-13
Exiting: Using Private Equity
PPT 12-14
Private Equity Financing /
  1. Methods of harvesting a business
  2. Selling the firm
  • Entrepreneurs usually sell a company to enhance estate planning or to diversify their portfolio of investments.
  • Different types of buyers have different motivations.
  • Sales to strategic buyers
  • Value depends upon the synergies that can be created.
  • Strategic buyers will usually pay more than financial buyers.
  • Ask students to think about how a buyer might go about assessing the strategic fit between the harvested firm and the buying firm.
  • Financial acquisitions
  • Views the harvested firm as a stand-alone, cash-generating business.
  • What are the implications for the personnel of the harvested firm?
  • Leveraged buyouts—describe bust-up LBOs versus build-up LBOs.
  • Sales to employees
  • Employee Stock Ownership Plans (ESOPs) provide one way for the owner to cash out and employees to acquire the business.
  • ESOPs are considered the harvest method of last resort. Do the students agree with this assessment? Why or why not?
  1. Releasing the firm’s cash flows
  • Immediate sell off is not economically optimal for high performing firms.
  • The owners stop growing the firm, while reaping excess cash flows.
  • This form of harvesting will only work with a mature business.
  • Advantages: owners maintain control and need not search for a buyer.
  • Disadvantages: lost growth opportunities that eventually reduce firm value, tax disadvantages (compared to other exit methods), and the patience required in the harvesting process.
  1. Going public
  1. The IPO as a harvest strategy
  • Review Lisa Stein’s list of reasons for going public.
  • Outline the motivations for CEOs initiating IPOs.
  • The IPO process
  • Lead students through the seven basic steps of the IPO process.
  • Describe the exhilarating and frustrating features of IPOs.
  • Control shifts from managers (entrepreneurs) to investment banker.
  • Understand the investment banker’s motivations in the IPOprocess.
  1. Using private equity
  • Review the findings and implications of the Upton and Petty survey.
  • Compare creative financing approaches:
LBOs may better suit owners of firms with greater growth potential.
Alternative approaches may allow family owners to retain control.
Have students offer situations where each alternative would be preferred.
3 / Explain how to value a firm being sold and how to decide on the method of payment.
PPT 12-15
Firm Valuation and the Harvest
PPT 12-16/TM 12-16
Exiting: The Method
of Payment /
  1. Firm valuation and the harvest
Two critical matters regarding value -- actual value and method of payment.
  1. The harvest value
  • Explain the concept of opportunity cost of funds -- the rate of return that could be earned on an investment with similar risk.
  • The negotiating skills of the old and new owners largely determine the division of value between these parties. Ask the students what they think of this? They are likely to think that this is less than fair since the this split should be based on the value each party receives; so you can use this to illustrate the imperfections of the process. What alternatives can they come up with?
  • Buyers/sellers usually value a company based on market comparables.
  • Explain EBITDA and its computation using the Visador Corporation illustration.
  • Emphasize the "art and science" nature of the valuation process.
  • The method of payment
  • Discuss the cash versus stock alternatives.
  • Ask students why investors prefer cash (outside of tax consequences).

4 / Provide advice on developing an effective exit strategy.
PPT 12-17
Developing an Effective
Exit Strategy /
  1. Developing an effective harvest plan
The actual value of the firm is only one issue—another is method of payment.
  1. Manage for the harvest
  • Entrepreneurs often do not appreciate the difficulty of selling/exiting a company. Ask the students why this is the case.
  • The impact of uncertainties—e.g., effects on employee morale
  • Getting entrepreneurs to develop a mind-set that is similar to investors (e.g., planning for an exit strategy from the beginning)
  • Jim Knister (of Donnelly Corp): start thinking about exit about 2-3 years ahead of the event to allow time to position the firm for attractiveness. This is especially important when planning an IPO.
  • Having an exit plan can allow the entrepreneur to exploit a narrow window of opportunity.
  • Expect conflict—emotional and cultural
  • The qualities that make entrepreneurs successful often make it difficult to work under a new owner.
  • The chapter states the following: “Having bought other companies does not prepare entrepreneurs for the sale of their own.” Ask students to talk about entrepreneurs they know of who have sold their businesses. Has this been the case for these individuals?
  • Mention some of the problems that often go along with exiting a business. Can the students think of others?
  • A recent trend shows more individuals are planning their next company before exiting their current business (professional company starters).
  1. Get good advice
  • When harvesting only once in a lifetime, the entrepreneur should take suggestions from business professionals and those who have experience with harvesting.
  • An IPO may be just the beginning, not an end.
  • An entrepreneur will not be able to cash out for some time after an IPO.

PPT 12-18
Developing an Effective
Exit Strategy
PPT 12-19
What's Next? /
  1. Understand what you want
  • Exiting a business can be a very emotional experience for entrepreneurs.
  • Entrepreneurs should think very carefully about their motives before exiting and what they plan to do before exiting.
  • Exiting for the money is unlikely to provide much satisfaction.
  • Owning and a sense of identity—lost after the sale
How to avoid seller's remorse? Peter Hermann's advice: search your soul, make a list of what you want to achieve with this exit, determine whether exiting will support this list of achievements. The students may not readily related to these concerns (mostly because of age), so try to get them to relate it to something more relevant to them (e.g., changing majors?).
  1. What’s next?
•Since entrepreneurs are purpose-driven, it is important that they find meaning in life following exit.
•For many, giving back to the community and charitable causes may bring meaning and purpose to post-exit life.
— /

Answers to end-of-chapter discussion questions

  1. Explain what is meant by the term harvesting. What is involved in harvesting an investment in a privately held firm?

p. 265Harvesting is the method entrepreneurs and investors use to exit a business and, hopefully, reap the value of their investment in the firm. For the privately-owned company, there are four basic ways to harvest investment. First, the owners can simply sell the firm. This strategy is most likely to be used when the entrepreneur has estate planning needs or a desire to diversify his or her portfolio of investments. Second, the owner(s) can release the firm’s free cash flows, using one of the options available to achieve this. Third, stock in the company can be offered to the public in an initial public offering (IPO). Finally, the owners can extract some of the value of the firm via private equity placements.

  1. Why should an owner of a company plan for eventually harvesting his or her company?

p. 265 - 266There are several good reasons for planning in advance for the exit. For example, when a company changes hands, employees face considerable uncertainty and morale often suffers. This has a negative effect on the company's performance. A well-planned exit can minimize dysfunctional employee behavior and turnover, which helps maintain stable performance during the transition (which is also important to the exiting entrepreneur if he/she receives all or some payment in the form of stock in the exited company). Having an exit plan can also guide the entrepreneur in positioning the company for optimal value in the years prior to the sale and ensure a smooth transition to public ownership (in the case of an IPO). Finally, exit planning can prepare the company for rapid sale if a window for such an opportunity should open and close quickly.

  1. Contrast a sale to a strategic buyer with one to a financial buyer.

p. 267 - 268These two acquisitions differ primarily in terms of the goals of the buyer. In a strategic acquisition, the buyer is interested in gaining synergies from the fit of the target acquisition with current holdings. In contrast, the financial acquisition looks primarily to the stand-alone potential for cash generation as the source of its value.

  1. Explain the term leveraged buyout. How is a leveraged buyout different from a management buyout?

p. 267Leveraged buyouts are acquisitions that rely on heavy debt financing. If the LBO includes the firm’s top management as significant shareholders in the acquired firm, then it is referred to as a management buyout. Thus, a management buyout is a type of LBO.

  1. Distinguish between bust-up LBOs and build-up LBOs.

p. 267 - 268During the 1980s, the leveraged buyout (which is a financial acquisition involving a very high level of debt financing) became synonymous with the bust-up LBO. This strategy involves owners who pay the debt down rapidly by selling off the acquired firm's assets. The build-up LBO replaced bust-up LBOs in the 1990s. The build-up LBO involves the integration of smaller acquisitions into a larger enterprise that can then be taken public in the IPO.

  1. What is the primary purpose of an initial public offering (IPO)? How does an IPO relate to harvest?

p. 270The initial public offering refers to a strategy of making available the stock of a privately-owned company to any interested investor. The primary purpose of an IPO is to raise additional equity capital to finance company growth, but it can also serve as an additional strategy for harvesting the investment of owners. Once the company’s stock is publicly traded, the pre-offering owners can cash out eventually by selling their stock on the market.

  1. Why might an entrepreneur find going public a frustrating process?

p. 271Going public does offer liquidity and eventual harvest benefits to a company. However, this move also brings significant frustrations, such as facing the scrutiny of public-market investors and dealing with investment bankers (who have their own unique interests in such an offering). Perhaps as frustrating as any other feature of the process, the IPO process involves a shift in control from firm management (including the entrepreneur) to the investment banker.

  1. What determines whether a firm has value to a prospective purchaser?

p. 274A firm’s value is based on its return on invested capital relative to the investors’ opportunity cost of funds, which is the rate of return that could be earned on an investment of similar risk. If the return on the invested capital for the purchaser is greater than the opportunity cost of the money invested, value will be created. Otherwise, value will be destroyed; that is, for every dollar invested, it will be worth less than a dollar.

Growing a venture to the point of diminishing returns and then selling it to others who can carry it to the next level is a proven way to create value. In this case, the purchaser is able to do more with the business than the seller, and is thereby adding value.

As described in the appendix at the end of the book on Firm Valuation, buyers and sellers frequently base the harvest value of a firm on a multiple of earnings. For instance, a company might value at five times its earnings. (An example of an entrepreneur, Robert Hall, who sold his firm for a multiple of earnings is provided in the appendix.)

  1. What problems can occur when an entrepreneur sells a firm but continues in the management of the company?

p. 277Entrepreneurs with experience in acquisitions often find that they enjoy buying other companies more than being bought. Going from being the boss to taking orders from the new owners, entrepreneurs often do not make good employees. The very qualities that made them successful entrepreneurs can make it difficult for them to work under the new owner(s), which often leads to their disillusionment and premature resignation. A clash between the culture of the company before and the new corporate culture can also lead to intense feelings of disappointment.

  1. How may harvesting a firm affect an entrepreneur's personal identity?

p. 279 - 280Entrepreneurs who leave their business often become disillusioned when they come to understand how much their personal identity was intertwined with their business. Some have done less than rational things after cashing out (for example, buying exotic cars and expensive houses that they did not need), and this can compound any regrets that follow the exit. Finally, entrepreneurs tend to be very purpose-driven, so they may need to adjust their lives to derive meaning from the post-exit world. This might very well mean giving back to the community or joining in the work of charitable cause(s).

— / COMMENTS ON CHAPTER “YOU MAKE THE CALL” SITUATIONS

Situation 1

  1. How could the Waughs be disappointed with $32 million?

When this story is told to students, they find it difficult to believe that anyone could have remorse with $32 million in the bank. But to the Waughs, especially Bill, he felt that he lost the foundation for much that he was about and did. The Waughs simply had not thought carefully enough about what was most important to them. They probably had mistaken impressions about what it would be like to have the "good life." The journey is what is important, not the final outcome.

  1. What should the Waughs have done to avoid this situation?

As already suggested, they should have given more thought to what really mattered to them. They also could have talked to others who had been through the process, which they did after the fact.

  1. What advice would you offer Bill about continuing to work for the business under the new owners?

He should expect that things will change. Most likely, the new owners will have different values and will run the company differently than he did, which indeed happened. So he should not have held onto rigid expectations about what it would be like after the sale; otherwise, he would be disappointed, which he was.

Situation 2

  1. Do you agree with the Bonneaus’ decision to sell? Why or why not?

The Bonneaus were becoming less and less interested in the business. It was no longer fun for them, which suggested that they needed a change. Also, it was time to sell so that someone else with deeper pockets could consolidate several firms in the same business and gain power in dealing with the larger customers, such as Wal-Mart.

  1. Why did the buyers retain Ed as a consultant? (In answering this question, you might consider the quote by Bonneau in the chapter.)

It was intended as a de facto non-compete agreement.

  1. Do you see any problem with having the Bonneaus' son-in-law become the new chief operating officer?

It placed Bonneau and his son-in-law in an awkward position. The son-in-law was having to negotiate from the perspective of the new chief operating officer after the sale, so he had certain needs. Bonneau, on the other hand, was negotiating from the perspective of someone who would be exiting the firm. There were some conflicts of interest as a result.

Situation 3

  1. Compare the people in the above true stories in terms of their feelings about harvesting their firms.

Lipper understood that there would be some emotional stress after selling his firm, but he also understood that a time might come when someone else could do more with the business than he was able to do. Thus, his emotions were balanced with the reality of the situation. Siverman avoided any emotional problems by having other priorities that gave meaning to her life apart from the company. The golfer clearly was emotionally distressed by not having other interests that made a difference to someone. Golfing did not provide an adequate foundation for a positive self-image.