Succession planning and strategies for harvesting and ending the venture

References

Hisrich, R.D., Peters, M.P., & Shepherd, D.A. (2013 ). Entrepre

Education). New York: McGraw-Hill Irwin.

Custom Create Edition LAUREATE EDUCATION INC

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I 452 : Entrepn

-----~-, eurship

SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE

VENTURE

1 To understand the planning that is necessary to allow for the effective succession of

ownership or leadership in a business.

2 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.

3 To illustrate differences in alternative types of bankruptcy under the Bankruptcy Act of

1978 (amended in 1984 and again in 2005).

4 To illustrate the rights of creditors and entrepreneurs in different cases of bankruptcy.

5 To provide the entrepreneur with an understanding of the typical warning

signs of bankruptcy.

6 To illustrate how some entrepreneurs can turn bankruptcy into a successful business.

Entrepreneurship, Eighth Edition 1 453 -----------------------------------------·------------ ----------------------------------------- : __ - ---~-~--~

OPENING PROFILE

TERESA CASCIOLI

It is not often that a bankrupt small business is able to successfully recover from bank-

ruptcy. However, one such case invo lves Teresa Cascioli, the first woman in Canada to

become president of a major brewery. Teresa not only led Lakeport Brewing out

of bankruptcy but launched the venture into one of the more successfu l Canadian

microbreweries.

In 1999 Teresa was getting ready to enter law

school. She had spent 12 years with the city of

Hamilton in Ontario, Canada, as finance manager

and another two years with Phi lip Services Corporation. Born of immigrant Italian

parents, she had spent her entire life in the city. Before she reached law school, a group of

private investors approached her to see if she could help out at an ailing company for the

summer. The company, Lakeport Brewing, was in trouble. The beer market is extremely

competitive and had seen companies like Amstel come and go during this period.

Lakeport was now in bankruptcy with little chance of being revitalized unless it could find

a new marketing niche in a very competitive market. Teresa was a bit concerned that her

only knowledge of beer was being able to tell a good brew from a bad one. However, she

not only took on the challenge but six months later actually took control of Lakeport

after Alphacorp Holdings invested $3.1 million in equity and working capital.

Teresa describes the f irst years of managing the bankrupt brewery as "hell." She had

many ups and downs during those first few years that took a great deal of energy, tena-

city, and a vision of success that would not be deterred. She had to work without senior

managers and often was in the plant seven days a week trying to learn the business. At

one point she actually spent time at night inside the bottling plant learning the business

from employees who had been working there for 20 years or more. In the early years, she

dedicated Lakeport's excess capacity to contract manufacturing of beer, near beer, and

coolers for brand names and private labels. Th is was the beginn ing of the turnaround and

kept the company in a positive cash flow until a major relaunch strategy could be devised.

In the summer of 2002, Teresa Cascioli was beginning to develop this new strategy

for the relaunch of Lakeport's beer products. It was time to find a profitable niche for

the Ontario-based brewery. She became aware of how many of her competitors were

constantly saturating newspapers with ads of $5.00 off. Her response to these ads was

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, 454 I '""''""'"""' ~ ----+-- --- 440 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

always, "$5.00 off what?" As far as she was concerned, none of the beer a

clear message. It seemed that they were all trying to do the same thing-o

another with heavy advertising. Her response to this was a simple genius

strategy in her ads: A case of 24 for $24.00. At the time, this strategy amount ec :: -

to $10 savings from what her competitors were charging. More importa nt

vided a clear message to the customer.

This low-price strategy was successful because the company had extended --

time and effort redesigning and restructuring its infrastructure to allow for morE=

tive cost controls. As a result, the low prices still allowed the company enoug h ~:.

to earn a profit. This strategy made Lakeport a significant player in the Ontario

Market share of the take-home beer market, one of the company's prima ry rc = grew from a 0.5 percent share to more than a 6 percent share by the end of 2

In 2004 Teresa took complete control of the company. With financing fro

Growth Capital Partners and National Bank, she was able to purchase 100 per .. ~

the 200-employee company. Her effort in these early years was rewarded not ~-

the success of the company but also by the recognition of her peers. In 2005 s i:E

ranked eighth in the annual list of the top 100 successful women business o

Canada, and she was a finalist for the Ernst & Young turnaround entreprene ur -

year; in 2007 she was named entrepreneur of the year by Canada's Ventu re Cc:: '""

and Private Equity Association. In addition to successful labels such as Brava, S:r:o

Lager, and Lakeport Honey Lager, the company also kept its production lines bts

aggressively seeking deals to pack products such as hard lemonade and ready-t""""

mixes for other makers. In 2007 Lakeport had nine proprietary brands and was ra-

the third largest producer of beer in the very competitive Ontario market.

In June of 2005 Lakeport went public on the Toronto Stock Exchange. The res

a successful IPO as investors responded favorably to the company and Teresa 's lea::

ship. The company's gross revenue after the IPO continued to grow and at the er:: -

the third quarter of 2005 reached $39.2 million, up 86 percent from the previous 1=: Market share in the take-home market from early 2005 to the end of 2006 i ncre~'?-

from 9 percent to more than 12 percent. This remarkable growth created such pr

in this market that Labatt Brewing Company Ltd. decided that the only way t o c:::-_

pete was to tender an offer to buy Lakeport. In March 2007 Lakeport Brewing was s- -

to Labatt for $201 million. At the time of the sale Teresa held 21.6 percent owne

of Lakeport Brewing.

After the sale Teresa continued as a consultant to La batt until early 2008 but has '"'-

moved on to a new endeavor. With her substantial financial reward from the sa;e -

the company, Teresa, in wanting to give back to the community, established the Te,

Cascioli Charitable Foundation. As manager of this foundation, Teresa has given ba ·

the community through a number of important endeavors such as an endowed cha'--- -

entrepreneurial leadership at McMaster University (she graduated from there in 1~

and with a $1 million donation to St. Joseph's Hospital where she was born in 196 1.

will continue to be active in these endeavors, and given her strong entrepreneuria l

it is very likely that we will find Teresa in some new venture in the near future . 1

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AS SEEN IN BUS/NESSWEEK

PROVIDE ADVICE TO AN ENTREPRENEUR ON HOW TO BEAT FAILURE AND BE THE BOSS AGAIN

A Maryland-based company that provides installations for conventions and special events around the country is about to be forced into liquidation by its bank. Meanwhi le, the $30 million business, which we'll call . " Shows 'R Us Inc.," is facing a leadership vacuum. The owner is in a state of denial and won't confront just how desperate his financial situation is. He also failed t o provide accurate financial information to his lender, and now the bank is on the wa rpath. As a result, the owner is about to lose the home he mortgaged for his loan. Three decades' worth of sweat and tears are heading down the drain.

It didn't have to get to this point. For years the ownership has allowed the Shows 'R Us "team" of 30 managers around the country to run their own re- gional operations. These managers have not been an- swerab le to anyone in the chain of command, because t here is no chain of command. Each office acts as a separate unit, responsible for its own hiring and ex- penses, and with no requirement to get out there and f ind new cl ients to justify its existence. Instead they de- pend on a short burst of activity during the convention season and put their feet up for the rest of the year. The result has been an egregious waste of resources. There are too many people on the payroll. Roles are duplicated, and offices that handle events in one state could just as easily cover two or three states with the amount of business that's coming in.

This was fine before the recession hit, when busi - ness was steady and there was always income from regular cl ients to cover operational and budget leaks. Today, lousy sales are unmasking a host of problems, and it's entirely the owner's fault.

SOLUTION: END DENIAL AND TAKE BACK CONTROL Now is the time for the owner to step up and lead. The CEO needs to conduct a major overhaul of oper- at ions and install a chain of command where every regional department head must be answerable only t o him. He should take a look at where each office is located on the map, where business is coming in, and w here it isn't. Decide which offices can be closed and w hich can be merged. Slash the workforce in half.

Leadership must call an emergency meeting of all t he regional office managers, f ly them to headquarters

in Maryland, and communicate the pl an. The owner needs to meet face to face with the people he wants to keep and let them know that it's do or die this time. They can either comply with a new system of accountability and accept compensation t hat is tied to performance, sales, and operating within or under a tight budget, or be out of a job in a matter of weeks when the bank shuts down the whole business.

I predict that morale will improve despite the fact that some employees will face drastic pay cuts and layoffs. Until now, employees in the regiona l offices have been working w ithout direction, with no con- nection to headquarters, and little sense that they're part of a larger organization . With no performance targets in place, ambitious workers have been flail- ing. As it is, there is zero opportunity or motivation to work hard. If Shows 'R Us survives this crisis, the star performers who remain will have a chance to make more money by bringing in more sales because their pay will be tied strictly to productivity.

The good news is that we have already bought Shows 'R Us some extra time with the bank, which will continue to work with the company as long as it sees that the business is taking serious steps to imple- ment these changes. It won't be easy, but it sure beats losing everything. *

ADVICE TO AN ENTREPRENEUR An entrepreneur friend sees the above article and comes to you for advice:

1. I recently hired fou r reg ional managers to run my business and have given them a lot of f lexibility to make decisions without constantly asking me. Is this a mistake?

2. How should I communicate with these regional managers without letting them know that I am concerned about their decision making?

3. Isn't the fact that these regional managers have flexibility enough to motivate them to make good decisions?

*Source: Reprinted from the August 4, 2009, issue of Business Week by special permission, copyright© 2009 by The McGraw-Hill Companies, Inc., "To Beat Failure, Be the Boss Again," by George Cloutier with Samantha Marshall, www.businessweek.com/smallbiz.

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442 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

This book has taken an in-depth view of the entire entrepreneurial process, fro m ~­ to a business plan and then successful funding and growth strategies. However, the preneur should also be prepared for a number of important issues that he or she mz_ in later years of the operations of the venture. Just as Teresa felt it was time to when a great offer was made, the entrepreneur should always be considering the fum::=: possible exit strategies or scenerios that may involve ending the venture. Exit sm::=_ consist of three important issues: planning for succession, harvesting the business, o ruptcy which will be discussed in this chapter.

EXIT STRATEGY Every entrepreneur who starts a new venture should think about an exit strategy. A n of possible exit strategies will be discussed in the following paragraphs. Exit strategi.::_ elude an initial public offering (IPO), private sale of stock, succession by a family me:::..J or a nonfamily member, merger with another company, or liquidation of the companY. -=- sale of the company could be to employees (an ESOP) or to an external source (ape persons, or a company). The IPO , private sale of stock, and merger options are dis elsewhere in this book (see Chapters 12 and 14).

Each of these exit strategies has its advantages and disadvantages, which are disc in the following and in Chapters 12 and 14. The most important issue is that the en neurs have an exit strategy or plan in place at the start-up stage, instead of waiting un!L may be too late to effectively implement a desirable option.

SUCCESSION OF BUSINESS By 2015 millions of baby boomers will be retired, causing a significant gap in the w force. This will be a critical issue for small businesses that are looking to find successo:: One study suggests that only about 35 percent of small and mid-size businesses have a ~­ cession plan ready to be implemented. This problem can be serious when there is a sudu-_ need to replace a key executive or owner of a successful company. 2 In the next sections r - will focus on important issues that can help the entrepreneur plan for the succession of business to either a family member, an employee, or an external party. Table 15.1 provi a summary of important tips that should be considered in any succession plan.

If there is no one in the family interested in the business, it is important for the entrepre- neur to either sell the business or train someone within the organization to take over. Eact of these transfer possibilities is discussed in the following sections.

[ TABLE 15.1 Succession Planning Tips

• Allow sufficient time for the process by starting early.

• Estimate the firm's value or hire a consultant to do it 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.

CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 443

Transfer to Family Members Successfully passing a business down to a family member faces tough odds. Experts esti- mate that half such attempts fail in the transition from first- to second-generation owner- ship. Only about 14 percent make it to the third generation. In addition, a 2007 survey of 1,000 family-owned businesses by the Family Finn Institute found that the leading causes of failure were insufficient estate planning, failure to plan for the transition, and lack of funds to pay estate taxes. 3 An effective succession plan should also be communicated clearly to all employees. This is particularly relevant to key personnel who may be affected by the succession transition. The solution to minimize the emotional and financial turmoil that can often be created during a transfer to family members is a good succession plan.

An effective succession plan needs to consider the following critical factors:

• The role of the owner in the transition stage: Will he or she continue to work full time? Part time? Or will the owner retire?

• Family dynamics: Are some family members unable to work together?

• Income for working family members and shareholders.

• The current business environment during the transition.

• Treatment of loyal employees.

• Tax consequences.

The transfer of a business to a family member can also create internal problems with employees. This often results when a son or daughter is handed the responsibility of run- ning the business without sufficient training. A young family member's chances of success in taking over the business are improved if he or she assumes various operational responsi- bilities early on. It is beneficial for the family member to rotate to different areas of the business to get a good perspective on the total operation. Other employees in these depart- ments or areas will be able to assist in the training and get to know their future leader.

It is also helpful if the entrepreneur stays around for a while to act as an advisor to the suc- cessor. As stated in Table 15.1, however, there should be a set date for when this transition will end. Although having the entrepreneur act as an advisor during the transition stage can be helpful to the successor in making business decisions, it is also possible that this can result in major conflicts if the personalities involved are not compatible. In addition, employees who have been with the firm since start-up may resent the younger family member's assuming control of the venture. However, if the successor works in the organization during this transi- tion period, he or she can justify assumption of the future role by proving his or her abilities.

Transfer to Nonfamily Members Often, family members are not interested in assuming responsibility for the business. When this occurs, the entrepreneur has three choices: train a key employee and retain some eq- uity, retain control and hire a manager, or sell the business outright.

Passing the business on to an employee ensures that the successor (or principal) is famil- iar with the business and the market. The employee's experience minimizes transitional problems . In addition, the entrepreneur can take some time to make the transition smoother.

The key issue in passing the business on to an employee is ownership. If the entrepreneur plans to retain some ownership, the question of how much becomes an important area of negotiation. The new principal may prefer to have control, with the original entrepreneur remaining as a minority owner, stockholder, or consultant. The financial capacity and mana- gerial ability of the employee will be important factors in deciding how much ownership is transferred. In many cases the transfer or succession of a venture can take many years to meet

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444 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

all the requirements of the parties involved. Since evidence indicates that most entrepreo.,_.. wait until it is too late, it is important to begin the process long before there is a need or transfer the ownership of the business. The U.S. Department of Commerce indicates about 70 percent of successful ventures never make it to the second generation of own

Ron Norelli was one of the exceptions because he realized the importance of a sion plan and hired a search firm to help him find a successor. Unfortunately, even he was able to hire someone who was to be groomed as his successor, the indi · decided that he did not want to take the risk. Norelli had to start the process all over ag and this time conducted the search personally by using his network of trusted business .c-- sociates. After a number of candidates were evaluated and interviewed by the staff . .:... settled on a successor who would, over a number of years, buy Norelli out. Norelli . even further by promoting one of his staff to vice president with the intent that this in·· · ual would be a good candidate to succeed his successor. The entire process took about 5. - years , and since he began the process early enough, it gave him the opportunity to leave business gradually with the confidence that it would successfully continue in the fu ture..-

If the business has been in the family for some time and the succession to a family rn.e=-- ber may become more likely in the future, the entrepreneur may hire a manager to run -- business. However, finding someone to manage the business in the same manner and the same expertise as the entrepreneur may be difficult. If someone is found to manage --.• business, the likely problems are compatibility with the owners and willingness of this son to manage for any length of time without a promise of equity in the business . Ex. tive search firms can help in the search process. It will be necessary to have a well-de job description to assist in identifying the right person.

In nonfamily business situations, succession planning may take on a slightly diff1 approach. In these businesses a key senior manager or group of managers may be step down or leaving the company. Since there are no family members involved, there may be - need to consider replacements from either external or internal sources. For a partnership process may be clearly outlined in the partnership agreement and could simply invoh-e - predetermined choice. However, there could also be a need to go outside the partne · · and find a successor for the partnership. In this instance, as well as in an S corporation an LLC, where there may be only a small number of shareholders, the succession pla:::. should consider the following important issues: 5

• Senior management of the company must be committed to any succession plan. The strategy must be one that everyone shares .

• It is important to have well-defmed job descriptions and a clear designation of skills necessary to fulfill any and all positions.

• The process needs to be an open one. All employees should be invited to participate that they will feel comfortable with the transition and thus minimize the possibility of their leaving the company.

The last option is to sell the business outright to either an employee or an outsider. The major considerations in this option are financial, which will likely necessitate the help o-= an accountant and/or lawyer. This alternative also requires that the value of the business be determined (see Chapter 12).

OPTIONS FOR SELLING THE BUSINESS There are a number of alternatives available to the entrepreneur in selling the venture. Some of these are straightforward, and others involve more complex financial strategy. Each of these methods should be carefully considered and one selected, depending on the goals of the entrepreneur.

Entrepreneurship, Eighth Edition

CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 445

Direct Sale This is probably the most common method for selling the venture. The entrepreneur may decide to sell the business because he or she wants to move on to some new endeavor or simply decides that it is time to retire. A sale to a larger company that can infuse much- needed capital may also provide opportunities for the company to grow and reach larger markets . If the entrepreneur has decided to sell the business but does not need to sell imme- diately, there are a number of strategies that should be considered early in the process. 6

• A business can be more valuable if it is focused on a narrow, well-defined segment. In other words, a larger share in a small market niche can be more valuable than a smaller share in a large market.

• The entrepreneur should concentrate on keeping costs under control and focus on higher margins and profits.

• Get all financial statements in order, including budgets and cash flow projections.

• Prepare a management documentation of the business explaining how the business is organized and how it operates.

• Assess the condition of capital equipment. Up-to-date or state-of-the-art equipment can enhance the value of a company.

• Get tax advice, since the sale of a corporation will involve different tax considerations than those for a partnership, LLC, or S corporation.

• Get nondisclosures from key employees.

• Try to maintain a good management team, allowing them to have day-to-day contact with key customers to lessen the firm's dependence on owner-customer relations.

• There is no substitute for advance preparation and planning.

One of the important considerations of any business sale is the type of payment the buyer will use. 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, which is struggling to survive.

Business brokers in some instances may be helpful, since trying to actually sell a busi- ness will take time away from running it. Brokers can be discreet about a sale and may have an established network to get the word around. Brokers earn a commission from the sale of a business. Generally, these commissions are based on a sliding scale starting at about 10 percent for the first $200,000. The best way to communicate the business to potential buyers is through the business plan. A five-year comprehensive plan can provide buyers of the business with a future perspective and accountability of the value of the company (see Chapters 7 and 8).

As indicated earlier, an entrepreneur may find that selling out to a larger company can provide much-needed resources to achieve important market goals. It has also become a more common exit strategy given that IPOs, the more traditional growth funding option, have become more rare given the current economic environment.

Frederick Schilling, the founder of Dagoba Organic Chocolate, realized that selling his com- pany to The Hershey Company would allow him to continue operations independent of the parent company and, more importantly, would allow him to grow Dagoba to reach more peo- ple. More and more organic-food entrepreneurs like Schilling are selling out to larger compa- nies to take advantage of their strong distribution networks to reach broader audiences. 7

Unlike Schilling, who remains as CEO, the role of an entrepreneur who sells to an em- ployee or passes the business on to a family member may vary depending on the sale agree- ment or contract with the new owner(s). Many buyers will want the seller to stay on for a short time to provide a smooth transition. Under these circumstances, the seller (entrepreneur)

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446 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

employee stock optio11

plan (ESOP) A two- to

three-year plan to sell the

business to employees

should negotiate an employment contract that specifies time, salary, and responsibi _ entrepreneur is not needed in the business, it is likely that the new owner(s) will the entrepreneur sign an agreement not to engage in the same business for a specifierl of years. These agreements vary in scope and may require a lawyer to clarify details..

An entrepreneur may also plan to retain a business for only a specified period -~ with the intent to sell it to the employees . This may be achieved using an employee option plan (ESOP) or through a management buyout, which allows the sale to only certain managers of the venture.

Employee Stock Option Plan Under an employee stock option plan (ESOP), the business is sold to employees over • of time. The ESOP establishes a new legal entity, called an employee stock ownersbi;: - that borrows the money against future profits. The borrowed money then buys the shares and allocates them to individual employees' retirement accounts as the loan is The ESOP has the obligation to repay the loan plus interest out of the cash flow of the ness. Typically, these ESOPs are a way to reward employees and clarify the su process. In addition, ESOPs result in significant stock values for employees, provided company continues to succeed.

Presently there are about 11,500 ESOP companies in the United States, of approximately 2,500 are wholly owned by the ESOP. ESOPs account for about 50 per.: of the nation's 10 million employees (about 10 percent of the private sector workforce addition, about 330 (or 3 percent) are publicly traded companies. 8

The ESOP has a number of advantages. First, it offers a unique incentive to empl _ that can enhance their motivation to put in extra time or effort. Employees recognize - they are working for themselves and hence will focus their efforts on innovations that tribute to the long-term success of the venture. Second, it provides a mechanism to. back those employees who have been loyal to the venture, particularly during more cult times. Third, it allows the transfer of the business under a carefully planned wri_- agreement. Finally, the company can reap the advantage of deducting the contributio- - the ESOP or any dividends paid on the stock.

ESOPs, due to a new law passed in 1996, are now possible for S corporations. How there are some important differences in the tax treatment between the C corporation and S corporation because of the pass-through feature of the S corporation (see Chapter 9). cause of the new tax law, the S corporation pays no income tax on the portion of the s owned by the ESOP.

However, in spite of its favorable attributes, the ESOP has some disadvantages . T;:;. type of stock option plan is usually quite complex to establish. It requires a complete val:: ation of the venture to establish the amount of the ESOP package. In addition, it raises ;_,_ sues such as taxes, payout ratios, amount of equity to be transferred per year, and ~ amount actually invested by the employees. The agreement also must specify if the e,....· ployees can buy or sell additional shares of stock once the plan has been comple Clearly, because of the complexity of this type of plan, the entrepreneur will need the an vice of experts if this type of plan is selected. A simpler method may be a more direct buy- out by key employees of the venture.

Management Buyout It is conceivable that the entrepreneur only wants to sell or transfer the venture to loyal, ke~ employees. Since the ESOP described earlier can be rather complicated and expensive, the entrepreneur may find that a direct sale would be simpler to accomplish.

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0 ETHICS INVOLVING EMPLOYEES, BANKERS, AND BUSINESS ASSOCIATES IN THE PROBLEM

Who should be made aware when a venture is in trouble? How much responsibility does the entrepre- neur have to his or her employees? How much should you tell your banker? Should clients be made aware of your problems? These are all legitimate yet difficult questions that an entrepreneur may struggle with when the business is on the verge of bankruptcy.

Some may feel that their only responsibility is to t heir family and themselves. Trying to get out of the dilemma with the least effect on your personal repu- t ation and financial well-being could in fact make matters worse. Ethically and morally the entrepre- neur is the leader of the organization, and trying to avoid responsibility will not rectify the situation.

In fact, there is evidence to indicate that involving your employees, banker, or other business associates can actually improve matters. Employees may take pay cuts or stock options to stay on with the company

and try to turn the business around. Bankers can be your financial best friend and can recommend ways to save money and generate more cash flow. Your clients and suppliers can also support turnaround efforts by helping to provide needed cash during the crisis. One example was an entrepreneur who ran out of cash to produce a product being sold by a large supermarket chain. A meeting with the important client that re- vealed the situation (brought on by a competitor's lawsuit that was settled) led to a simple solution. The supermarket appreciated the honesty of the entrepre- neur and agreed to prepay for all orders so that there would be sufficient cash to produce the product.

The entrepreneur needs to consider the past ef- forts of employees who made him or her successful in the first place. Thus, the best solution is participation. Get help rather than taking the selfish and perhaps immoral alternative. Honesty is the best strategy.

Management buyouts usually involve a direct sale of the venture for some predetermined price. This would be similar to selling one's house. To establish a price, the entrepreneur would have an appraisal of all the assets and then determine the goodwill value established from past revenue.

Sale of a venture to key employees can be for cash, or it can be financed in any number of ways. A cash sale is unlikely if the value of the business is substantial. Financing the sale of the venture can be accomplished through a bank, or the entrepreneur could also agree to carry the note. This may be desirable to the entrepreneur in that the stream of income from the sale would be spread out over a determined period of time, enhancing cash flow and lessening the tax impact. Another method of selling the venture would be to use stock as the method of transfer. The managers buying the business may sell nonvoting or voting stock to other investors. These funds would then be used as a full or partial payment for the venture. The reason that other investors would be interested in buying stock or that a bank would lend the managers money is that the business is continuing with the same manage- ment team and with its established track record.

Other methods of transferring or selling a business are through a public offering or even a merger with another business. These topics are discussed in Chapter 14. Before determin- ing the appropriate selling strategy, the entrepreneur should seek the advice of outsiders. Every circumstance is different, and the actual decision will depend on the entrepreneur's goals. Case histories of each of the preceding methods can also be reviewed to be able to effectively determine which option is best for the given circumstances.

BANKRUPTCY-AN OVERVIEW Failure is not uncommon in many new ventures, especially in light of the poor global eco- nomic environment, the wars in Iraq and Afghanistan, and the continued battle against ter- rorism. According to the Small Business Administration, about half of all new start-ups fail

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448 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

in their first years. The failures are personally painful for the entrepreneur and too often could have been prevented if the entrepreneur had paid more attention to certain critical factors in the business operation. It is important to understand the issues involved in bank- ruptcy since it does occur and there may even be an opportunity to use the bankruptcy op- tions to get the company back on solid financial ground.

Prior to a recent tightening of the bankruptcy laws by Congress in 2005, bankruptcies were running at about 1.6 million per year. In 2006 total filings dropped to about 618,000. a definite reflection of the new laws. Business filings represented about 20,000 of this to- tal. However, it should be noted that many of the nonbusiness filings could be failed pro- prietorships, partnerships, or home businesses. Since the recent economic crisis in 200 and 2009, total filings have again jumped to more than 1.1 million, of which about 44,000 were business filings. It is also important to understand that both business and nonbusines bankruptcy filings are divided by chapter filings, which will be explained in more detail later.

The most common type of business bankruptcy is Chapter 7, or liquidation, which ac- counted for about 69 percent of the total in 2008. Chapter 11 bankruptcy provides an op- portunity for a business to reorganize, prepare a new business plan (acceptable to the courts), and then, with time and achievement of new goals , to return to normal business op- eration. These bankruptcies represented about 19 percent of all business filings in 2008. The remaining business bankruptcies (about 12 percent) are Chapter 13 filings, which allow creditors to be repaid in an agreed-upon installment plan. 9

Bankruptcy is a term that has been on the minds of many entrepreneurs in the past cou- ple of years , as businesses face a weak economy, increased competition, and rising costs of doing business . As stated before, bankruptcy may not always mean the end of a business since it can offer the entrepreneur an opportunity to reorganize under Chapter 11 or merge with another company. The results of each bankruptcy filing can be quite distinct because of the nature of the business or the uniqueness of an industry. Some of the following examples describe the possible mix of results or experiences that can occur from a bankruptcy filing .

Although a Chapter 11 filing is designed to allow a company to reorganize and then emerge with its operations again, there have been some serious concerns given the new restrictions signed into law in 2005 . The Sharper Image filed for Chapter 11 bankruptcy in February 2008. Its intent was to close 90 of its 184 stores to save significant operating costs. However, because the new law has lessened the time that Chapter 11 firms can remain under court control, the management of The Sharper Image felt that there was not enough time to finance the restocking of the remaining stores, so the company instead chose liquidation to retain some value in the assets . Other retailers such as Wickes Furni- ture, Whitehall Jewelers, Levitz, and Bombay Company have had similar experiences. It is apparent that the new time restrictions have been particularly harsh to retailers .

In 2005 Jeff Yarbrough filed for Chapter 13 bankruptcy after his restaurants in Dallas failed. In wanting to share his experiences and to explain that there was no shame in bank- ruptcy, Jeff described how he survived. Since filing for bankruptcy he worked three jobs to provide for his family as well as pay off the debt. He is now running his own public rela- tions firm and also brokering commercial leases, which has allowed him to pay off the debts from his failed restaurants . His biggest lesson and response to entrepreneurs is to avoid ex- tensive debt at any cost. 10

In February 2004 disaster struck for 72 franchise stores when Ground Round Grill & Bar announced that it was filing for bankruptcy. The franchise stores were owned by local propri- etors under a license from the chain. The company also owned 59 restaurants. Founded in 1969, the restaurant had been a pioneer in the casual dining industry but now was faced with debt to unsecured creditors of between $10 million and $50 million. Sell-offs of a number of the restaurants had provided some funds, but any ability to survive the bankruptcy hit a snag

'"'"'""'""h;p, E;gh

CHAPTER 15 SUCCESSION PLANNING AND STRATEGIES FOR HARVESTING AND ENDING THE VENTURE 449

Chapter 11 bankntptcy

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

when financing was delayed and the company defaulted on its loan payments. The franchisees, however, made some quick and innovative decisions and decided to organize themselves into a cooperative. With this new organization they were able to raise some internal and external funds to buy the brand from the bankruptcy court. As of early 2009 the cooperative operates 46 of the remaining restaurants from the original 72 that existed at the time of the declared bank- ruptcy. The new business model of a cooperative seems to be working as a number of the orig- inal franchise owners have now opened new restaurants. 11

Bankrate is one of a few Internet stocks that were able to survive the dot-com bubble burst. After an IPO at $13 per share in May 1999, the stock reached a low of $1 per share in August 2002. Since that low point, the company has made a complete turnaround, pri- marily due to the leadership of Elizabeth DeMarse. The company Web site lists compara- tive rate tables and fee information on 100 financial products such as mortgages, credit cards, auto loans, and money markets. Most of its revenue, however, is accumulated from advertising on the site. Now under new leadership, the company has reached new profit milestones in 2008 (reported net income of over $20 million). It has also enhanced its prod- uct line with a network of companies such as Interest.com, Mortgage-calc.com, Nation- wide Card Services, and Savingforcollege.com. 12

Some lessons that can be learned from those who have experienced bankruptcy are as follows:

• Many entrepreneurs spend too much time and effort trying to diversify in markets where they lack knowledge. They should focus only on known markets.

• Bankruptcy protects entrepreneurs only from creditors, not from competitors.

• It's difficult to separate the entrepreneur from the business. Entrepreneurs put everything into the company, including worrying about the future of their employees.

• Many entrepreneurs do not think their businesses are going to fail until it's too late. They should file early.

• Bankruptcy is emotionally painful. Going into hiding after bankruptcy is a big mistake. Bankruptcy needs to be shared with employees and everybody else involved.

As the preceding examples indicate, bankruptcy is serious business and requires some im- portant understanding of its applications. The Bankruptcy Act of 1978 (with amendments added in 1984 and 2005) was designed to ensure a fair distribution of assets to creditors, to protect debtors from unfair depletion of assets, and to protect debtors from unfair demands by creditors. The Bankruptcy Act provides three alternative provisions for a firm near or at a position of insolvency. The three alternative positions are (1) reorganization, or Chapter 11 bankruptcy; (2) extended time payment, or Chapter 13 bankruptcy; and (3) liquidation, or Chapter 7 bankruptcy. All attempt to protect the troubled entrepreneur as well as provide a reasonable way to organize payments to debtors or to end the venture.

CHAPTER 11-REORGANIZATION This is the least severe alternative to bankruptcy. In this situation the courts try to give the ven- ture "breathing room" to pay its debts. Usually, this situation results when a venture has cash flow problems, and creditors begin to pressure the firm with lawsuits. The entrepreneur feels that, with some time, the business can become more solvent and liquid to meet its debt require- ments. However, as we have seen in the preceding example, the new time restrictions regard- ing how long a Chapter 11 firm may continue under court control have made it particularly difficult for firms in retailing to reorganize effectively. However, it is still in the best interests of a company that has a chance to become solvent to seek protection under this option.

464 I "'"'preooo"hip ·-----~------ ----- --~-----

450 PART 5 FROM FUNDING THE VENTURE TO LAUNCHING, GROWING, AND ENDING THE NEW VENTURE

A major creditor, any party who has an interest, or a group of creditors will usually sent the case to the court. Then a plan for reorganization will be prepared to indicate how __,._ business will be turned around. The plan will divide the debt and ownership interests · two groups : those who will be affected by the plan and those who will not. It will then spec- ify whose interests will be affected and how payments will be made.

Once the plan is completed, it must be approved by the court. All bankruptcies now handled by the U.S. Bankruptcy Court, whose powers were restructured under Bankruptcy Amendments and Federal Judgeship Act of 1984. Approval of the plan alS requires that all creditors and owners agree to comply with the reorganization plan ~ presented to the courts. The decisions made in the reorganization plan generally refl. one or a combination of the following: 13

1. Extension. This occurs when two or more of the largest creditors agree to postpone a=_ claims. This acts as a stimulus for smaller creditors to also agree to the plan.

2. Substitution. If the future potential of the venture looks promising enough, it may be possible to exchange stock or something else for the existing debt.

3. Composition settlement. The debt is prorated to the creditors as a settlement for any

Even though only 20 to 25 percent of those firms that file for Chapter 11 bankruptcy v.-:.:... make it through the process, it does present an opportunity to find a cure for any busines. problems. Some of these problems are resolvable, and without the Chapter 11 protecti even these 20 to 25 percent that file would never have the opportunity to succeed. It sho-'- also be noted that some firms that make it through the process often find that they c succeed and thus either must liquidate or find a buyer.