Exit Strategies: When It ’ s Time to Say “ Good-Bye ”

1. Exit Strategies: When It’s Time to Say “Good-Bye”

2. All good things must come to an end… • Entrepreneurs often have deep commitments to their companies • Remember “entrepreneurial passion?” • But still, there often comes a time to depart • Why? • Stage of Life (e.g., Bill Gates) • Time to “smell the roses…” • Desire to do something else… • Start other companies! • What else??? What would you do if you made a huge amount of money from your company?

3. So, how to exit gracefully, well, and…profitably! • Major strategies: • Sale or transfer to insiders • Family-owned business succession (ca be a big problem!) • Leveraged buyouts—managers become owners • Why? They believe they can do it better! (Going “private” • Employee Stock Ownership Plans—gradual transfer • Sale to Outsider—very common

4. When to sell? (The perennial question for stocks, companies, and almost anything else…) • Sell when company is in right stage of development—not too soon, not too late! • Sell when business cycle is strong • Sell when patents, trade secrets, trademarks are secure • Sell when profits are good, balance sheet strong

5. Valuing a Business: Art and Science! • To sell a business, you must value it • How do you do this? • For public company, straightforward: market capitalization is central • For private companies: much more complex • Balance sheet Methods (Net worth = Assets – Liabilities) • Earnings Methods: is the business earning more or less than the average in its industry • This considers tangibles and intangibles

6. Capitalized Earnings Method • Expected net earnings are capitalized to determine value • Capitalized net earnings: Net earnings – Owner’s salary/Rate of return • Discounted Future Earnings Method • Market Method: market value for price-earnings approach • Compares the price-earnings ratios for publicly traded companies in same industry

7. IPOs Revisited: Do IPO Stocks always go up? • NO—in fact, a majority go down • Depends on the timing of the IPO • Depends on the industry • Depends on the “buzz” concerning the company • Depends on the “buzz” concerning the entrepreneurs • Depends on what other companies are going public at the same time • Depends on support from the underwriters

8. Taking a Company Public—Key Steps and Stages • Is it all positive? Many believe this, but it is not • The “Pluses” • New equity capital • Liquidity • Prestige, recognition • The “Minuses” • Reduced control; Sarbanes-Oxley Act (2002)—SEC regulations, etc. • Large costs—legal, brokerage, etc. • Lock-up!

9. Sarbanes-Oxley Act (SOX) • Public Company Accounting Oversight Board (PCAOB) Title I consists of nine sections and establishes the Public Company Accounting Oversight Board, to provide independent oversight of public accounting firms providing audit services ("auditors"). It also creates a central oversight board tasked with registering auditors, defining the specific processes and procedures for compliance audits, inspecting and policing conduct and quality control, and enforcing compliance with the specific mandates of SOX. • Auditor Independence Title II consists of nine sections and establishes standards for external auditor independence, to limit conflicts of interest. It also addresses new auditor approval requirements, audit partner rotation, and auditor reporting requirements. It restricts auditing companies from providing non-audit services (e.g., consulting) for the same clients. • Corporate Responsibility Title III consists of eight sections and mandates that senior executives take individual responsibility for the accuracy and completeness of corporate financial reports. It defines the interaction of external auditors and corporate audit committees, and specifies the responsibility of corporate officers for the accuracy and validity of corporate financial reports. It enumerates specific limits on the behaviors of corporate officers and describes specific forfeitures of benefits and civil penalties for non-compliance. For example, Section 302 requires that the company's "principal officers" (typically the Chief Executive Officer and Chief Financial Officer) certify and approve the integrity of their company financial reports quarterly.[4]

10. Sarbanes-Oxley (Continued) • Enhanced Financial Disclosures Title IV consists of nine sections. It describes enhanced reporting requirements for financial transactions, including off-balance-sheet transactions, pro-forma figures and stock transactions of corporate officers. It requires internal controls for assuring the accuracy of financial reports and disclosures, and mandates both audits and reports on those controls. It also requires timely reporting of material changes in financial condition and specific enhanced reviews by the SEC or its agents of corporate reports. • Analyst Conflicts of Interest Title V consists of only one section, which includes measures designed to help restore investor confidence in the reporting of securities analysts. It defines the codes of conduct for securities analysts and requires disclosure of knowable conflicts of interest. • Commission Resources and Authority Title VI consists of four sections and defines practices to restore investor confidence in securities analysts. It also defines the SEC’s authority to censure or bar securities professionals from practice and defines conditions under which a person can be barred from practicing as a broker, advisor, or dealer. • Studies and Reports Title VII consists of five sections and requires the Comptroller General and the SEC to perform various studies and report their findings. Studies and reports include the effects of consolidation of public accounting firms, the role of credit rating agencies in the operation of securities markets, securities violations and enforcement actions, and whether investment banks assisted Enron, Global Crossing and others to manipulate earnings and obfuscate true financial conditions.

11. Sarbanes-Oxley (Cont’d.) • White Collar Crime Penalty Enhancement Title IX consists of six sections. This section is also called the “White Collar Crime Penalty Enhancement Act of 2002.” This section increases the criminal penalties associated with white-collar crimes and conspiracies. It recommends stronger sentencing guidelines and specifically adds failure to certify corporate financial reports as a criminal offense. • Corporate Tax Returns Title X consists of one section. Section 1001 states that the Chief Executive Officer should sign the company tax return. • Corporate and Criminal Fraud Accountability Title VIII consists of seven sections and is also referred to as the “Corporate and Criminal Fraud Accountability Act of 2002”. It describes specific criminal penalties for manipulation, destruction or alteration of financial records or other interference with investigations, while providing certain protections for whistle-blowers.

12. More Legislation… • Corporate and Criminal Fraud Accountability Title VIII consists of seven sections and is also referred to as the “Corporate and Criminal Fraud Accountability Act of 2002”. It describes specific criminal penalties for manipulation, destruction or alteration of financial records or other interference with investigations, while providing certain protections for whistle-blowers.

13. Major Steps to Going Public… • L-day (listing on exchange day) • Phase 1: prepare for this—make company look its best • Phase 2: IPO work group (underwriters, investment bankers, attorneys) to prepare all documentation (registration statement, prospectus, road show material) • Phase 3: actual distribution • Phase 4: constant flow of information to stock analysts and investors

14. Prospectus… • A prospectus is a legal document that institutions and businesses use to describe the securities they are offering for participants and buyers. • A prospectus commonly provides investors with material information about mutual funds, stocks, bonds and other investments, such as a description of the company's business, financial statements, biographies of officers and directors, detailed information about their compensation, any litigation that is taking place, a list of material properties and any other material information. • In the context of an individual securities offering, such as an initial public offering, a prospectus is distributed by underwriters or brokerages to potential investors.

15. What they look like…

17. Underwriting—what it is.. • Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage, or credit). • The name derives from the Lloyd's of London insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea voyage with associated risks of shipwreck) in exchange for a premium, would literally write their names under the risk information that was written on a Lloyd's slip created for this purpose.

18. Other considerations… • Choosing an underwriter—the one that actually sells shares • Timing: when to go public • Meeting government requirements for registration of shares • Prospectus—loaded with details • S-1: actual financial statements such as balance sheet for last two fiscal years

19. Bankruptcy—a less desirable kind of exit!!! • Chapter 7: most common type—company ceases to exist, 70% of all companies that enter bankruptcy • Chapter 11: much more hope—reorganization rather than liquidation • 1% of companies are permitted to do this

20. Famous Companies that went…. “Bye, bye” • Kodak. • Enron. ... • Blockbuster. ... • Schwinn Bicycle Company. .. • Borders’. • Readers’ Digest • Northwest Airlines

21. Did you ever fly on NWA? You never will again!

23. Another… • Polaroid makes itself disappear… • How can a company ensure its demise? By not adapting to evolving technology. No matter how successful it once was, and no matter how well known the brand, the failure to adapt is fatal\ • Just ask the Polaroid Corporation. They were the household name in instant photos for decades -- over half a century, actually. • Things were going smashingly for the company for much of its existence. Amid increasing competition in the 1980s, it won a patent battle with Kodak, forcing them out of the instant camera business. With the competition gone, Polaroid could focus on business at hand.

24. Polaroid (continued) • Unfortunately, management did not view the emergence of digital cameras as something they needed to be concerned with. Of course, digital photography erupted, leaving Polaroid in the dust. • They filed for Chapter 11 in October of 2001. The company would not reemerge, selling most of its assets to a subsidiary of Bank One (which has since been purchased by Chase). Polaroid Corporation changed its name to Primary PDS, but it is nothing more than an administrative shell, and in 2008 it emerged from CHAPTER 11, but not as an independent company—it is part of a much larger bank • The Polaroid name is still in use under certain licenses. While instant cameras are still part of the picture, they are seemingly being phased out. The Polaroid name has also been pasted on LCD and plasma televisions, as well as portable DVD players.

25. Polaroid—a brand that vanished…

26. Warning signs that a company is in trouble (What they don’t tell you in the annual report…) • Large discounts to customers for orders • Management of financial matters is not “transparent” • Banks and other financial institutions say “No!” • Payroll taxes are not paid on time • Suppliers demand payment in cash • Sudden exit of key people • Growing volume of customer complaints about product quality, service

27. Exit Strategies and Human Life… • People change throughout life—physically, energy, vision, hearing, etc. • Cognitively: there is some decline, although the rate is very slow for many people • Emotionally (feelings get “toned down”) • Goals, interests, attitudes, • For instance, more conservative and less willing to take risks • What else could influence the decision to continue…or stop? • Now, here are some famous entrepreneurs at different ages….

28. So, is any one exit strategy best? • Of course not: it depends on what you want • If you want to get rich, “go public” • If you want to retire—sell or go public • If you want to start another company: sell or go public • If you want to be sure the company is in good hands and remain committed to it—sell to insiders • If you want to slow down, exit gradually and stay connected • If you want to retire, exit quickly and completely • To date, virtually no research on this issue