MGMT 14 & 15

• Harvest Plan

Defines how and when the owners and investors will realize an actual cash return on their investment. • Reasons for Harvesting To maintain managerial control and succession for successful continued operations. To initiate a "liquidity event" that will generate a significant amount of cash for the investors. An IPO (initial public offering) has become a reality. Most realistic opportunity is sale of the business.

Evaluation of an Acquisition

• A firm's potential to pay for itself during a reasonable period of time • The difficulties that the new owners will face during the transition period • The amount of security or risk involved in the transaction; changes in interest rates • The effect on the firm's value if a turnaround is required • The number of potential buyers • Current managers' intentions to remain with the firm • The taxes associated with the purchase or sale of the enterprise

Creating a Written Succession Strategy

1. The owner controls the management continuity strategy entirely. 2. The owner consults with selected family members. 3. The owner works with professional advisors. 4. The owner works with family involvement. 5. The owner formulates buy/sell agreements at the very outset of the company, or soon thereafter, and whenever a major change occurs. 6. The owner considers employee stock ownership plans (ESOPs). 7. The owner sells or liquidates the business when losing enthusiasm for it but is still physically able to go on. 8. The owner sells or liquidates after discovering a terminal illness but still has time for the orderly transfer of management or ownership.

Barriers to Succession Planning in Privately Held Businesses (Founder/Owner)

Death anxiety • Company as a symbol • Loss of identity Concern about legacy • Dilemma of choice • Fiction of equality Generational envy • Loss of power

Barriers to Succession Planning in Privately Held Businesses (Family)

Death as taboo • Discussion is a hostile act • Fear of loss/abandonment Fear of sibling rivalry Change of spouse's position

Other Factors to Consider

• Additional factors that may influence the final valuation of the venture: Avoiding start-up costs • Buyers are willing to pay more than the evaluated price for an existing firm to avoid start-up costs. Accuracy of projections • The sales and earnings of a venture are always projected on the basis of historical financial and economic data. Control factor • The degree of control an owner legally has over the firm can affect its valuation; more control, more value.

Advantages and Disadvantages of Family Controlled Firms

• Advantages Long-term orientation Greater independence of action Family culture as a source of pride Greater resilience in hard times Less bureaucratic and impersonal Financial benefits Knowing the business • Disadvantages Less access to capital markets may curtail growth Confusing organization Nepotism Spoiled-kid syndrome Paternalistic/autocratic rule Financial strain Succession dramas

The Exit Strategy: Liquidity Events

• Entrepreneurs consider selling their venture for numerous reasons: Boredom and burnout Lack of operating and growth capital No heirs to leave the business to Desire for liquidity Aging and health problems Desire to pursue other interests

Key Factors in Succession

• Forcing Events Happenings that cause the replacement of the ownermanager: • Death • Illness • Mental or psychological breakdown • Abrupt departure • Legal problems • Severe business decline • Financial difficulties • Pressures and Interests inside the Firm Family members Nonfamily employees • Pressures and Interests outside the Firm Family members Nonfamily elements

Sources of Succession

• Major Questions: Inside or outside successor? Which entry strategy will be implemented? How will power be transferred? Can the successor to gain credibility with the firm's employees? • Types of Successors Entrepreneurial successor Managerial successor Interim specialist • Carrying Out the Succession Plan Identify a successor Groom an heir Agree on a plan Consider outside help

The Management Succession Strategy

• Management Succession Is the transition of managerial decision making Is one of the greatest challenges confronting owners and entrepreneurs in privately held businesses. • Research on private firms shows: Many go out of existence after 10 years; only 3 out of 10 survive into a second generation. Only 16% make it to a third generation. Their average life expectancy is 24 years, which is also the average tenure for founders of a business.

Terms in Letters of Intent (LOI)

• Price/Valuation • Fully Diluted Ownership • Type of Security Convertible preferred stock • Liquidation Preference • Dividend Preference Cumulative Noncumulative and discretionary • Redemption Preferred Optional Mandatory • Conversion Rights • Antidilution Protection Price protection • Ratchet protection • Weighted average protection • Voting Rights • Right of First Refusal • Co-Sale Right • Registration Rights Piggyback rights Demand rights • Vesting on Founders' Stock

Identifying Successor Qualities

• Sufficient knowledge of the business • Fundamental honesty and capability • Good health; energy, alertness, and perception • Enthusiasm about the enterprise • Personality compatible with the business • High degree of perseverance • Stability and maturity • Reasonable amount of aggressiveness • Thoroughness and a proper respect for detail • Problem-solving ability • Resourcefulness • Ability to plan and organize • Talent to develop people • Personality of a starter and a finisher; and appropriate agreement with the owner's philosophy about the business.

Term Sheets in Venture Valuation

• Term Sheet Outlines the material terms and conditions of a venture agreement and guides legal counsel in the preparation of a proposed final agreement. Are very similar to letters of intent (LOI) in that they are both preliminary, mostly nonbinding documents meant to record two or more parties' intentions to enter into a future agreement based on specified (but incomplete or preliminary) terms.

Reasons for an Acquisition

• To gain access to new products or expand the existing product line • To increase the number of customers and market share • To integrate vertically, backward or forward to improve supply and distribution channels and to reduce inventory levels • To develop or improve customer service functions • To reduce indirect and direct operating costs and fixed costs by using excess production and service capacities and by eliminating duplicated operations

Due Diligence Questions

• Why is this business being sold? • What is the physical condition of the business? • How many key personnel will remain? • What is the degree of competition? • What are the conditions of the lease? • Do any liens against the business exist? • Will the owner sign a covenant not to compete? • Are any special licenses required? • What are the future trends of the business? • How much capital is needed to buy?

Analyzing the Business

•Many closely held ventures have the following shortcomings: Lack of management depth Undercapitalization Insufficient controls Divergent goals