Chapter 15 Succession Planning and Strategies for Harvesting and Ending the Venture McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives • To understand the planning that is necessary to allow for the effective succession of ownership or leadership in a business • 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 15-2 Learning Objectives • To illustrate differences in alternative types of bankruptcy under the Bankruptcy Act of 1978 (amended in 1984 and again in 2005) • To illustrate the rights of creditors and entrepreneurs in different cases of bankruptcy 15-3 Learning Objectives • To provide the entrepreneur with an understanding of the typical warning signs of bankruptcy • To illustrate how some entrepreneurs can turn bankruptcy into a successful business 15-4 Exit Strategy • Exit strategies include: • Initial public offering (IPO) • Private sale of stock • Succession by a family member or a nonfamily member • Merger with another company • Liquidation 15-5 Table 15.1 - Succession Planning Tips 15-6 Succession of Business • Transfer to family members • Role of owner - Full-time/part-time/retire • Family dynamics • Income for working family members and shareholders • Transition business environment • Treatment of loyal employees • Tax consequences 15-7 Succession of Business • Transfer to nonfamily members • Train a key employee and retain some equity • Retain control and hire a manager • Sell the business outright 15-8 Succession of Business • In an S corporation or an LLC: • Senior management of the company must be committed to any succession plan • Well-defined job descriptions and a clear designation of skills • Process needs to be an open one 15-9 Options for Selling the Business • Direct sale • Strategies to be considered: • • • • • • Focus on a narrow, well-defined segment Control costs and focus on higher margins and profits Get all financial statements in order Prepare a management documentation Assess the condition of capital equipment Get tax advice 15-10 Options for Selling the Business • Get nondisclosures from key employees • Try to maintain a good management team • Prepare and plan in advance • • • • Type of payment the buyer will use Business brokers Business plan Sale agreement or contract with the new owners 15-11 Options for Selling the Business • Employee stock option plan: A two-to threeyear plan to sell the business to employees • Establishes a new legal entity - An employee stock ownership trust • Obligates the firm to repay the loan plus interest out of business cash flows • Results in significant stock values for employees 15-12 Options for Selling the Business • Advantages • Motivates employees to put in extra time • Provides a mechanism to pay back loyal employees • Allows transfer of business under a planned written agreement • Permits the company to reap the advantage of deducting contributions on ESOP 15-13 Options for Selling the Business • Disadvantages • Quite complex to establish • Raises issues such as: • Taxes, payout ratios, amount of equity to be transferred per year, and the amount actually invested by the employees 15-14 Options for Selling the Business • Management buyout • Direct sale of the venture for some predetermined price • To establish a price, the entrepreneur should: • Have an appraisal of all the assets • Determine the goodwill value established from past revenue 15-15 Options for Selling the Business • Sale of a venture • For cash • Financed through banks • Entrepreneur could also agree to carry the note • Sale of voting or nonvoting stock 15-16 Bankruptcy—An Overview • Common types of bankruptcies: • Chapter 7 or liquidation (70% in 2011) • Chapter 11 or reorganization (21% in 2011) • Chapter 13 or installment payments (9% in 2011) 15-17 Bankruptcy—An Overview • Bankruptcy lessons • Too much time and effort is spent on diversifying in markets where entrepreneurs lack knowledge • Bankruptcy protects entrepreneurs from creditors, not from competitors • Difficult to separate entrepreneurs from the business • Entrepreneurs should file for bankruptcy early • Bankruptcy should be shared with employees 15-18 Bankruptcy—An Overview • Bankruptcy Act of 1978 (with amendments added in 1984 and 2005) ensures: • Fair distribution of assets to creditors • Protection of debtors from unfair depletion of assets • Protection of debtors from unfair demands by creditors 15-19 Bankruptcy—An Overview • Bankruptcy Act of 1978 provides three alternative positions • Chapter 11 bankruptcy: 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 15-20 Chapter 11—Reorganization • Courts try to give the venture “breathing room” to pay its debts • Plan for reorganization is prepared and approved by the US Bankruptcy Court • Decisions made reflect one or a combination of the following: • Extension - Postpone claims • Substitution - Exchange stock for debt 15-21 Chapter 11—Reorganization • Composition settlement - Debt is prorated to creditors as settlement • Surviving bankruptcy • Bankruptcy can be used as a bargaining chip to voluntarily restructure and reorganize the venture • File before failure of cash or revenue • Chapter 11 should be filed only if a chance of recovery exists • Be prepared for examination of transactions for fraud 15-22 Chapter 11—Reorganization • Surviving bankruptcy • Maintain good records • Understand how protection against creditors works • Transfer litigation to bankruptcy court • Prepare a realistic financial reorganization plan 15-23 Chapter 13—Extended Time Payment Plans • Individual creates a five-year repayment plan under court supervision • A court appointed trustee: • Receives money from debtor • Bears responsibility for making scheduled payments to all creditors • About two of every three Chapter 13 filers fail to meet their planned obligations • Result in a Chapter 7 filing 15-24 Chapter 7—Liquidation • Extreme case of bankruptcy • Voluntary bankruptcy: Entrepreneur’s decision to file for bankruptcy • Courts will require a current income and expense statement • Involuntary bankruptcy: Petition of bankruptcy filed by creditors without consent of entrepreneur 15-25 Table 15.2 - Liquidation under Chapter 7 Involuntary Bankruptcy 15-26 Strategy During Reorganization • The entrepreneur can speed up the process by: • • • • Taking the initiative in preparing a plan Selling the plan to secured creditors Communicating with groups of creditors Not writing checks that cannot be covered 15-27 Strategy During Reorganization • Enhancing the bankruptcy process by: • Keeping creditors abreast of how the business is doing • Stressing the significance of creditors’ support during the process 15-28 Table 15.3 - Requirements for Keeping a Venture Afloat 15-29 Table 15.4 - Warning Signs of Bankruptcy 15-30 Starting Over • Entrepreneurs start new ventures even after failing • Entrepreneurs have the need for: • Market research • More initial capitalization • Stronger business skills • Business failure does not have to be a stigma when seeking venture capital 15-31 The Reality of Failure • Important considerations for the entrepreneur in case of failure: • Consult with family • Seek outside assistance from professionals, friends, and business associates • Do not hang on to a venture that will continually drain resources 15-32 Business Turnarounds • Learn to recognize the warning signs of bankruptcy • Principles of a successful turnaround: • Aggressive hands-on management • Management must have a plan • Action 15-33