chapter
17
Exit Strategy
Lonni Steven Wilson, Medaille College
Key Chapter Objectives
• Describe the techniques that can help spot
financial trouble.
• Understand how to reorganize a troubled
business.
• Compare the types of bankruptcies available.
• Describe the process of selling a business.
Red Flags
Here are some key factors associated with business
failures:
• Economic weakness
• Industry downturns
• Poor location
• Too much debt
• Too little capital
These concerns can lead to temporary cash flow problems
that can often be worked out. However, sometimes the
concerns indicate a permanent problem.
Reasons for a Lender to Request
Early Repayment
• Loan covenants have been repeatedly violated.
• The bank is losing money on the relationship.
• New bank managers favor a different loan mix or institute
new policies.
• The bank does not understand or is uncomfortable with the
industry segment.
• The bank’s credit exposure in the industry segment is too
great.
• A loan guarantor’s financial condition has deteriorated.
• The bank has lost faith in the business’ management team
(Broni, 1999).
The Business’ Response to a Called
Loan
The business needs to establish a policy
to deal with the lost cash:
• Try to negotiate a short-term extension.
• Use assets to help secure needed funds
(asset-based loans).
• Use a commercial finance company that
specializes in “unbankable” loans.
Means to Satisfy Debt Holders
•
•
•
•
•
Informal reorganization
Informal liquidation
Bankruptcy
Removal of assets
Selling the business
Informal Reorganization
• “Workouts”
– extensions (of time allowed to pay back
the debt)
– composition (process of asking to repay a
lower amount)
• Most banks would rather get some money
than no money.
• Not all banks engage in workouts.
Informal Liquidation
• If the company has more assets than debt, it
is “worth more dead than alive.”
• Assignment (term for the informal liquidation
process)
– Lenders normally obtain a greater return
through assignment than through
bankruptcy.
– Lenders should focus on encouraging
informal reorganization or liquidation
rather than trying to force a company into
bankruptcy.
Bankruptcy
The primary technique used by business owners
when they are facing mounting obligations and do
not have the resources to finance continued
operations
• The first bankruptcy laws were passed in 1898.
• There are 291 bankruptcy courts.
• Personal filings (rather than business filings)
account for most bankruptcies.
Chapters of Bankruptcy Filings
Chapters 1, 3, 5 – general provisions
Chapter 9 – municipalities
Chapter 12 – family-owned farms
Chapter 15 – a system of trusts to administer bankruptcy
proceedings
Chapter 7 – liquidation of debtor’s assets
Chapter 11 – formal business reorganization supervised by
the court
Chapter 13 – designed for consumers
Involuntary Bankruptcy
• Three or more unsecured creditors holding
bona fide debts of at least a combined
$10,000 file a petition against the debtor. If
fewer than 12 creditors exist, only one
needs to file a bankruptcy petition.
• Company “forced into bankruptcy.”
• Debtor has 20 days to respond to the court.
• Relief granted to creditor only if obligations
not paid as they come due.
Athletes Filing Bankruptcy
• Numerous athletes have faced financial problems,
from agents squandering money to simply
spending too much.
• In 2003 Mike Tyson filed for bankruptcy protection.
• In 2005 Riddick Bowe filed for bankruptcy
protection.
• In 2006 former Detroit Red Wing Darren McCarty
filed for bankruptcy protection.
Removal of Assets
Selling assets (downsizing) can
• reduce costs and
• raise cash.
The Boston Celtics used to own their own television
and radio stations but sold them because these
assets did not fit into the team’s business plans.
Note: Most owners would prefer to sell the business
entirely rather than a piece at a time.
(continued)
Removal of Assets (continued)
To remove assets, owners can do the
following:
• Pay dividends
• Increase their own salaries, pay
themselves bonuses, and fund benefits
of various kinds
• Sell or lease part of a business
Reasons for Selling a Business
•
•
•
•
•
Wishing to retire
Wanting to make a profit
Wanting to change careers
Wanting to get out while they can
Finding the level of competition
unacceptable
Options for Selling a Business
•
•
•
•
A taxable sale of company stock
A tax-free sale of company stock
A taxable sale of company assets
A tax-free sale of company assets
Calculating a Business’ Value
• Asset-based valuation methods: The business’
value is determined based on the value of tangible
and intangible assets, net of liabilities.
• The market-based approach: Gives the value of
the business based on some multiple of operating
results, such as profits or revenues. The multiples
are based on market transactions involving similar
businesses.
• Income-based approaches: The value of the
business is estimated based on the present value
of all earnings and cash flow that the business
provides to the owners during the time that it is
owned.
Considerations When Selling a
Business
• Do not let employees know too early that you
might be selling; this can affect employee morale.
• Do not let competitors know too early about an
impending sale; they might try to steal customers
or hinder the sales process.
• Do not accept a purchase agreement calling for
the seller to receive cash and a note; the note
could be worthless if the new owner runs into
financial hardships.
(continued)
Considerations When Selling a
Business (continued)
• Do not accept a significant bonus based on future
financial success; you will remain tied to the
business and its potential success or failure.
• Do not get so involved in the sales process that
the business suffers and becomes even more
difficult to sell (Livingston, 1998).
• Do not specifically exclude certain assets from the
final sale such as cash, past-due accounts
receivable, deposits, refunds, and other valuable
assets such as business records (Parrish &
Maloney, 1999).
Questions for In-Class Discussion
1. What is the best technique for determining a
business’ value?
2. If you were facing hard financial times, would you
be willing to file for bankruptcy? What are the
advantages and disadvantages you should
consider?
3. Is it better to buy an entire business or just its
assets?
4. Do you think it would be a good idea for a team
owner to sell a team to the players?
5. If you were selling a sport business, what
strategies would you use to try to find some
potential buyers?