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