C H A P T E R
16
Exit Strategy
Chapter 16
Chapter Objectives
• Describe the techniques that can help spot
financial trouble.
• Understand how to reorganize a troubled
business.
• Appreciate how a company can avoid bankruptcy
by selling assets.
• Describe the process of selling a business.
• Calculate the value of a sport business.
Red Flags
• Key factors associated with business failures
include economic weakness, industry downturns,
poor location, too much debt, too little capital, and
countless other reasons.
• A lender’s request for early repayment of a loan
could be a sign that the company is in trouble.
(continued)
Red Flags (continued)
• Following are reasons a bank might call a loan or
not renew a line of credit:
• 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.
(continued)
Red Flags (continued)
• If a bank calls a loan, the company can do the
following:
– Negotiate a short-term extension to try to resolve any
problems or secure new funding.
– Approach another bank (if business is strong
financially).
– Ask the bank what the problem was and investigate if it
can be fixed.
– Use assets to help secure needed funds.
– Approach a commercial finance company that
specializes in “unbankable” loans.
Informal Reorganization
• This allows a business to recover and reestablish
itself after facing a temporary financial crisis
• Voluntary plans in which all parties try to come to
an agreement are often called workouts.
• Reorganization process comprises extensions and
composition:
– Extensions are extensions of the time allowed for
repaying a debt.
– Composition is the process of asking to repay a lower
amount.
Informal Liquidation
• Assignment: The term used for the informal
liquidation process.
• Liquidating assets such as stocks or other liquid
assets is a way a company can pay back debt.
Removal of Business Assets
• Selling assets can reduce business cost or size or
raise cash.
• Primary reasons a company downsizes include
reducing income and changing focus.
• Here are some ways to remove assets:
– Take out profits as dividends.
– Business owner increases own salary.
– Owners can compensate themselves for independent
projects in the same way an independent contractor is paid.
– Pay bonuses.
– Owner can loan himself money from the business.
– Owner can sell or lease property to the business.
Selling a Business
• Reasons for selling a business include the
following:
–
–
–
–
–
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
• First step in selling any business is to gather
together all relevant financial information.
• If purchasing a business, the key component is
knowing exactly what will be purchased.
(continued)
Selling a Business (continued)
• There are four options for selling a business:
1.
2.
3.
4.
Taxable sale of company stock
Tax-free sale of company stock
Taxable sale of company assets
Tax-free sale of company assets
(continued)
Selling a Business (continued)
• Asset vs. Equity Purchase
– The person or other company interested in buying the
business would prefer to buy assets rather than stock for
various reasons.
• To reduce the purchasing company’s liability
– There are significant tax considerations for the seller and
the purchaser of assets as opposed to stock.
– Benefit of selling assets involves the “step-down” basis
for depreciable assets.
• Step-down provision is particularly important in the professional
sport industry in that players’ contracts are considered
depreciable assets.
(continued)
Selling a Business (continued)
• Calculating Business Value
– Valuation is the process of determining a business’
value.
– Sport valuations must incorporate numerous additional
factors when determining value:
• Total risks, the competitive environment, the business’ assets,
when the valuation was conducted, and the business’
ownership structure
(continued)
Selling a Business (continued)
• Typical valuation may include the following steps:
– An estimate of future benefits of the business based on
some combination of earnings, cash flow, revenues,
assets, and potential future value of the business
– An estimate of the capital required between the
purchase price and expected future investments
– A risk-adjusted estimated cost of capital or discount rate
to be used in the valuation
– An analysis of the timing, taxes, personalities, and other
nonfinancial factors that may influence a valuation
(continued)
Selling a Business (continued)
• These documents are needed for valuation:
– Complete financial statements (balance sheet, income
statement, statement of cash flow) for at least three years
• Supplemental financial statement schedules such as
compensation schedules for employees and officers, ownership
distributions, dividend payment schedules, and key-person life
insurance policies may also be important when assembling an
economic picture of the business
– Federal and state income tax returns for the same period
– Operating information
• Company history, marketing materials, copyrights, trademarks,
patents, organizational charts, customer and supplier
databases, contractual obligations, and so on
(continued)
Selling a Business (continued)
• These documents are needed for valuation:
– Planning information regarding current budgets and forecasts
• Particularly of capital requirements such as future capital
expenditures, deferred maintenance, and future working capital
requirements
– Business formation documents
• Corporate or partnership agreements, employee contracts such
as noncompete agreements, and employee stock option
purchase (ESOP) agreements
(continued)
Selling a Business (continued)
• Techniques to Calculate a Business’ Value
– Asset-Based Valuation Methods
• The business’ value is determined based on the value of
tangible and intangible assets, net of liabilities.
• Net worth is computed based on factoring in assets that appear
on the balance sheet along with assets that might not be
recorded.
• Technique is most relevant for valuing an established sport
business or in cases in which the valuation is being done in
response to the sale of an ownership stake that exceeds 50%.
• Asset Accumulation Approach
– This approach requires identification and summation of the current
economic values of all assets, tangible and intangible, that are
controlled by the sport business as of the date of the valuation.
(continued)
Selling a Business (continued)
• Techniques to Calculate a Business’ Value
– Asset-Based Valuation Methods
• Excess Earnings Method
– Value of net tangible assets is estimated on the basis of the return
that these assets can generate.
– Market-Based Approach
• This approach gives the value of the sport business based on a
multiple of operating results, such as profits or revenues.
• Value of the business based on market-derived multiples reflects
informed decisions negotiated between parties in transactions.
• Market multiples are derived based on multiples of earnings and
revenues.
– Obtained either from analysis of publicly traded companies similar
to the business or from data on actual transactions involving
acquired or merging public and private companies
(continued)
Selling a Business (continued)
• Techniques to Calculate a Business’ Value
– Income-Based Approaches
• Value is estimated based on the present value of all earnings
and cash flow that the company provides to the owners during
the time it is owned.
• Discounted Net Cash Flow Approach
– Estimates the present value of future economic income that is
expected to result from the operations of the business
– Is used because conceptually it represents all income that an
investor can hypothetically take out of the business
– Value is then computed as the sum of the present value of the
annual net cash flows over the forecast period plus the present
value of the terminal value.
– The concept of discounting recognizes that money received in the
future is worth less than it would be today.
Additional Considerations When Selling
• 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)
Additional Considerations When Selling
(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.
• 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.
Questions for Class Discussion
1. What is the best technique for determining the value of a
business?
2. If you were facing financial hardship what signs do you
think you would be able to see?
3. Is it better to buy an entire business or just its assets?
(continued)
Questions for Class Discussion
(continued)
4. Is there a difference in determining the value of a large
business such as a professional sports team versus a
smaller business such as a health club?
5. Do you think it would be a good idea for a team owner to
sell a team to the players?
6. If you were selling a sport business, what strategies would
you use to try to find potential buyers?