7/18/2023

Entrepreneurship and New

Ventures
SESSION 8
HARVESTING

Why Entrepreneurs cash out?

 Need to diversify wealth
 The business has reached end of its life
 The owner’s urge to begin something new
 Age and health don’t allow commitment to the business

7/18/2023 2

1
 7/18/2023

Exit Strategies
 Acquisition by another company
 Management buy-out
 ESOPs
 Initial public offering (IPO).
 Succession by a family member or a nonfamily member

Exit Strategies
Acquisition by another company
 Most popular mode of exit
 Bigger, established companies look out for patents, manufacturing
capabilities, and product lines of entrepreneurial ventures
 Ambiguity regarding valuation of the business
• Different valuation methods produce different valuations

 Structuring of the payment

• Often, buyers will purchase a business using notes based on future profits.
If the new owners fail in the business, the seller may receive no cash
payment and possibly may have to take back the company

 Relationship of the entrepreneur with the merged or acquired entity

• Restricts the power and clout of the entrepreneur over the business

7/18/2023 4

2
 7/18/2023

Exit Strategies
Management buy-out
 Direct sale of the venture for some predetermined price
 Sale of a venture to key employees for cash
 The management can finance the purchase
• Financing the sale of the venture through a bank
• or the entrepreneur could also agree to carry the note
o Stream of income is spread over a longer period of time ensuring cash
flows and reducing tax impact
 Good for the business as the existing management is aware of the
business and its operations

7/18/2023 5

Exit Strategies
ESOPs
 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
 Motivates employees to put in extra time or effort
 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 or any dividends paid

7/18/2023 6

3
 7/18/2023

Exit Strategies
Succession by a family member
◦ 30 percent of family businesses survive into the second generation
◦ only 12 percent survive into the third generation
◦ Can be an emotional and contentious issue
◦ May cause rift within the family
◦ Owner may have to choose “sides”
◦ Succession is influenced by individual attributes (age, education,
gender), organizational characteristics (e.g. size, structure) and
environmental factors (e.g. availability of financial resources)

7/18/2023 7

Exit Strategies
Things to consider while transferring to business to family
members –
 Role of owner - full-time/part-time/retire.
 Family dynamics.
 Income for working family members and shareholders.
 Transition in business environment.
 Treatment of loyal employees.
 Tax consequences.

7/18/2023 8

4
 7/18/2023

Exit Strategies
IPO

 Higher price for the business

• Almost 5 times higher than the other best options
 Enhanced public scrutiny
 Excessive regulatory requirements (reporting
requirements)
 Requirements regarding sound financial health

7/18/2023 9

Financial requirements of a
company for an IPO
 The company must have a net worth (assets – liabilities) of at least 1crore for
each of the last 3 years.
 The company must have tangible assets of at least Rs. 3 crore in each of the 3
preceding years. Out of these assets, a maximum of 50% must be held in
monetary assets.
 The average operating profit for each of the last three years must be at least
Rs.15 crore.
 If the company has changed its name in the last one year it must have earned
at least 50% of the revenue for the preceding full year from the activity
indicated by the new name;
 The existing paid-up share capital of the company must be fully paid or
forfeited. This means that the company looking for an IPO should not have
partly paid-up shares as a part of its equity.

7/18/2023 10

10

5
 7/18/2023

IPO requirement in India

When a profitable company goes public, this is how
shares are allocated:
Qualified Institutional Buyers – 50%
High Net worth Individuals – 15%
Retail – 35%
When a loss-making company goes public, this is how
shares are allocated
Qualified Institutional Buyers – 75%
High Net worth Individuals – 15%
Retail – 10%

7/18/2023 11

11

Zomato shareholding pattern

7/18/2023 12

12

6
 7/18/2023

PayTm shareholding pattern

7/18/2023 13

13

Succession and Harvesting

Planning Tips
 Allow sufficient time for the process by starting early.
 Estimate the firm’s value or hire a consultant to do that for you
 Evaluate potential successors on their merit – not on whether they remind you
of yourself
 If family members are being considered, make sure they have the skills and
motivation necessary to carry on the business.
 Provide a transition period so that the successor can learn the business.
 Consider options such as employee stock option plans (ESOPs) for a
management succession
 Set a date for completion of the transition and stick to it.
 Most important
◦ Business should be thriving and in good health for better valuation
◦ Entrepreneur’s health should be sound

14

7
 7/18/2023

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

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.

16

8
 7/18/2023

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.
◦ Get nondisclosures from key employees.
◦ Try to maintain a good management team.
◦ Prepare and plan in advance.

17

Options for Selling the Business

◦ An important consideration is the type of payment the buyer will
use.
◦ Business brokers may be helpful.
◦ The best way to communicate the business to potential buyers is
through the business plan.
◦ The role of an entrepreneur may vary depending on the sale
agreement or contract with the new owner(s).

18

9
 7/18/2023

Options for Selling the Business

Employee Stock Option Plan
◦ 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.

19

Options for Selling the Business

• Advantages:
• Motivates employees to put in extra time or effort.
• 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 or any dividends paid.

20

10
 7/18/2023

Options for Selling the Business

Management Buyout
◦ Usually involves a 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.
◦ Sale of a venture can be:
◦ For cash.
◦ Financed through banks
◦ Through sale of voting or nonvoting stock.
◦ The entrepreneur may agree to carry a note.

21

Spyder Active Sports - 2004

Manufacturer of high-performance ski apparel.
Owned and managed by its founder David Jacobs.
His two sons, Jake and Bill, also work at the company.
In 1997, Jacobs sold a minority stake in the company to CHB Capital
Partners, a private equity firm.
By 2004, CHB is seeking a liquidity event,
Jacobs is considering alternate types of equity transactions that would
allow him to harvest his wealth.

22

11
 7/18/2023

Shareholding

Alternatives 25.4
11.3

37.9
CHB

David Jacobs

CHB has decided to liquidate its holdings 25.4 Shimokobu

◦ Option 1 – IPO ?
Jake and other
◦ Option 2 - Jacob sells his holdings employees
◦ Shimokobu too sells his holding
◦ Jake follows his father and sells his holdings too
◦ Leads to liquidation of 90% of shareholdings
◦ Option 3 - Jacob looks for a strategic investor.
◦ Option 4 - Jacob looks for a financial investor.
◦ Option 5 – Management buy-out
◦ Jake or John Walbrecht buys out the company
◦ Option 6 – Jacob and Shimokobu don’t sell
◦ Just look for a new financial investor

23

Is it the right time to sell?

For Jacob?
◦ Getting older?
◦ Wife, four daughters?
◦ Lose control of a firm, of which he has been so passionate.
◦ For Jake and Bill?
◦ Both lose their jobs
◦ Jake had been instrumental in product development. He loses something he
has been passionate about.
◦ Shimokobu
◦ Not much information is given in the case

24

12
 7/18/2023

Is it the right time to sell?

Current state and future prospects of the company?
◦ Is the company doing well?
◦ High-end brand image
◦ Shifted from a product orientation to marketing orientation
◦ Excellent product design and production processes (Exhibit 7)
◦ Sales increase from $17.2 million in 1999 to 61.4 million forecast in
2004. CAGR of 29% (Exhibit 5).
◦ Company’s valuation?
◦ To take the company to the next level now requires much larger
scale and diversification into multi-seasoned product line.

25

Is it the right time to sell?

Is the market condition right for selling the company?
◦ Exhibit 8 shows higher multiples (higher valuations) in the current year.

26

13
 7/18/2023

Sell to a strategic buyer or a

financial buyer?
Strategic Buyer
Pays higher premium taking into account synergy benefits
XControls operations
Financial Buyer
XPays lesser
Control remains with the existing owner

27

Decisions
Strategic 1. Sell Majority Stake to Strategic Buyer

Sell
Financial
1. Sell Majority Stake to Financial Buyer

Don’t
Sell 3. Sell Minority Stake (CHBs share) to Financial Buyer
Yet

28

14
 7/18/2023

What happened?
Spyder sold 80% of its equity to a financial buyer at $ 100 million
Rejected a higher bid from a strategic investor.
CHB was payed fully
David Jacobs, Jake and Shimokubu retained some ownership.
David retained the CEO position initially, but by 2007 became the
chairman with Jake becoming the CEO.
John Walbrecht left the company in 2004.

29

Thank You………..

7/18/2023 30

30

15