chapter 17

1. chapter17 Exit Strategy Lonni Steven Wilson, Medaille College

2. 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.

3. 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.

4. 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).

5. 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.

6. Means to Satisfy Debt Holders • Informal reorganization • Informal liquidation • Bankruptcy • Removal of assets • Selling the business

7. 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.

8. 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.

9. 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.

10. 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

11. 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.

12. 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.

13. 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)

14. 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

15. 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

16. 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

17. 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.

18. 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)

19. 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).

20. Questions for In-Class Discussion • What is the best technique for determining a business’ value? • If you were facing hard financial times, would you be willing to file for bankruptcy? What are the advantages and disadvantages you should consider? • Is it better to buy an entire business or just its assets? • Do you think it would be a good idea for a team owner to sell a team to the players? • If you were selling a sport business, what strategies would you use to try to find some potential buyers?