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

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

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

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

Table 15.1 - Succession Planning Tips

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

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

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

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

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

Options for Selling the Business Employee stock option plan: A two-to three-year 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

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

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

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

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

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)

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

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

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

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

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

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

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

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

Table 15.2 - Liquidation under Chapter 7 Involuntary Bankruptcy

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

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

Table 15.3 - Requirements for Keeping a Venture Afloat

Table 15.4 - Warning Signs of Bankruptcy

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

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

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