Harvesting
Frank Moyes
Leeds College of Business
University of Colorado
Boulder, Colorado
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This Week’s Agenda
 Harvest strategy
 Visitor – Bob Gill
 Hand in Feasibility Plan
 FCQ’s
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Harvesting
 Definition: “Method for achieving terminal after-tax cash
flows on investment.” Bygrave
 You harvest because?
Investors require rate of return. For high growth ventures,
won’t come from dividends.
Entrepreneur wants a new challenge
Become part of the problem
“I can’t stand it any more.”
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Lifestyle Business
 Perfect life style business
Independence, autonomy & control
Make sufficient income for your requirements
Good at it & enjoy
 Quiet desperation
Don’t see an alternative
Marginal income
Not good at it, family destroyed, alcoholic
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When Should Entrepreneur Step Aside?
 Do you have the skills to continue?
 When does it stop being exciting and fun?
 Examples
John Walker of AutoDesk founder return to full time
programming
Steve Jobs of Apple, replaced by John Scully of PepsiCo
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You Are Ready When
 Company generating steady earnings
 Company is at a stage where it must make a transition
 Your company has value, but is not liquid
 Becoming cautious - represents your entire net worth
 No longer working 80 hours per week (or the thought of
continuing is daunting)
 Founding team interests are changing
 You are becoming bored
 Your family is becoming restless
Stolze: Start-up
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Harvesting Alternatives
 Increase the free cash flows
 Management buy-out
 Leveraged buy-out
 Employees – ESOP’s
 Sell entire business
 Initial public offering
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Increase Free Cash Flows
 Cash cow
 Pros
Not necessary to exit the business
Retain ownership
Don’t need to find buyer
 Cons
Tax implications
Sustainable competitive advantage
Takes time
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Management Buy-out (MBO)?
 Pros
Management understands business & are motivated
Founder knows & trusts
Management likely to maintain culture & retain employees
Bankers understand & willing to fund equity and/or debt
 Cons
Management must put up large amounts and/or
Founder willing to accept installment payments
High amount of debt affects cash flows
Risk of default
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Leveraged Buy-out (LBO)?
 Pros
Managers from large companies looking to become
entrepreneurs
Bring experience and new perspective
Credibility with lenders
 Cons
Founder doesn’t know new owners
May not maintain culture and retain employees
Final payment depends on earn-out (may be required in
order to agree on valuation)
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Employee Stock Ownership Plan (ESOP) I
 Leveraged ESOP
 ESOP borrows money from a lender to buy owner’s
stock. Held in trust.
 Company make tax-deductible contribution to trust to
repay loan.
 Company guarantees debt of ESOP
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ESOP II
 Pros
Tax advantages
 If ESOP owns > 30%, then owner can avoid capital gain tax by
purchasing stocks or bonds of another US company
 If ESOP owns> 50%, then lender is taxed on only 50% of income;
therefore can offer lower interest rate.
 Dividends are tax deductible, i.e. like interest
Employees own share of company
Suitable for companies in industries where acquisition is not
likely, e.g. construction
 Cons
Owner may not want employees to control company
Must disclose information such as exec salaries
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Sale of Entire Business
 Company needs to finance growth
 Company at a transitions stage
 Founder wants
Diversify investment
Change for personal reasons
Another challenge
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Sale Issues I
 Owners naiveté
Expectations towards value
Selling your soul
Founder negotiating deal
 Deal structure
Valuation
Cash or shares - risk of holding shares
Lock-up period
Tax implications
Earn out
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Earn-Outs I
 Final purchase price depends on how the company
performs in the years subsequent to the purchase
 Buyer:
Wants company to perform well
Doesn’t want to buy a cat in a bag
Management to be motivated to make a success
 Seller:
Believes the business is worth more
Willing to take a risk to increase amount receives
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Earn-outs II
 Inherent conflicts
Buyer wants to pay lowest price
Seller wants to receive highest price
 Works when Buyer and Seller interests are aligned
 Buyer can manipulate earnings to reduce final purchase
price
Accounting policies
Inter-company transactions
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Sale Issues II
 Can take a long time (up to 18 months)
 Deal may fall through
Devastation
Impact on employees
Loss of momentum
 What do I do now?
Continue in management? – become a manager, decision
making, culture
Sail your boat
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Valuing the Company for Harvest
 Multiple of
Earnings
 Net Income
 EBITDA
Cash flow
Revenues
 Net Assets
 Present Value of Free Cash Flows
 Importance of intangibles
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Intangibles
 Inventory undervalued
 Replacement value of assets is high
 Company has been run to minimize income taxes
FastTrac
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Carmel Art Gallery
 20 years in business, profitable
 Established wealthy client and art buyer from all over world
 10 year lease in prime location with heavy traffic
 Well trained sales people who understand the customers’
needs
 Excusive rights to 6 famous local artists
 Operating permit – moratorium on art gallery licenses
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How Find a Buyer?
 Investors, Board of Directors
 Accountants, bankers, attorneys
 Investment banker – Lehman formula
 Brokers - fee is based on sale price
 Founder’s industry contacts
 Be proactive – identify potential buyers early
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Preparing Your Company for Sale I
Window of opportunity
Record of growth and profitability
Luck
Strong management team & Board of Directors
& Advisors
Clean ownership structure
Minority shareholders
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Preparing Your Company for Sale II
Avoid legal hassles
Ready for due diligence process
Audited financials by a top firm
Management controls & information systems
Representations and warranties
What tell employees?
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IPO Process
Consider
Going Public
Company Has
All the Power
Choose
Underwriter
Prepare
Prospectus
Road Show
Pricing
Meeting
Consequence
Teaching Notes, CML (B) & (C)
Harvard College 1985
Investment Banker
Gains Power
Market & Investment
Banker In Control
Market Takes Over
Initial Public Offering Cons?
 Not suitable for most companies: size, history,
management
 Timing is everything – hot issues
 Difficult for founders to sell shares – lock up period
 Cost is high: legal fees, underwriters
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IPO Cons II
 Time required from management before, during, and
after – 6 to 18 months
Roadshows
Underwriters, lawyers, accountants
Disillusionment
 Price of shares may fall below offer price. Market “under
values”
 Shareholder suits
 Disclosure requirements – Sorbaine
 Pressure for short term profits
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Initial Public Offering Pros?
 Pressure for short term profits
 Liquidity
 Alternative to venture capital
 Higher valuation
Flavor of the month
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IPO Pros II
 Company more visible
Easier to hire employees
Credibility with bankers, suppliers, customers
 Impact on competition, funding
 More fun for top management, if going well
 If decide to merge with a larger company, will get higher
valuation
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Harvesting Conclusions
 Should plan for harvesting? It may not happen.
 Don’t take actions that preclude selling to the highest
bidder, e.g. strategic alliances
 A company with an exit strategy is easier to manage
Motivating force
Set high standards
Required actions help run the business
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