Week 8 – Harvesting

What are the different types of exit strategies for a business? I often think about this as I have exit goals to sell the company I founded once it reaches a certain level, or the market indicates that it is time. Winning Angels: the 7 Fundamentals of Early Stage Investing list seven harvesting methods that we will discuss in this blog entry.

Walking Harvest – this is when a business gives money directly to the investors as it is earned (289). There are two reasons why an investor, or group of investors, would choose this harvesting strategy. One reason is that the multiple of cash flow is too low and they’d rather take the cash as it is earned. The other reason is when controlling investors decide they’d rather have the positive cash flow.

Partial Sale – this is when the investors stake in the company is sold off to management or someone else (293). This harvesting strategy usually occurs when an investor has a stake in a company that does not have a great exit strategy, and the company is only moderately successful. Without a good exit strategy, it is difficult to keep the interest of an investor.

Initial Public Offering (IPO) – is often referred to as “going public”. This is when a company sells a percentage of its shares, creating a market for investors to buy and sell stock in a company (294). These shares are sold on one of the stock market exchanges. This is good for investors because their shares can be sold for a higher price than when the company went public, but the flip-side is that the stocks are restricted for 6 months and the value of the stock may also decrease dramatically by then.

Financial Sale – this is when financial buyers purchase a company for the cash flow (296). The benefit to a financial sale is that financial buyers are usually buying the entire company for cash. The drawbacks are that financial buyers don’t know the industry, so there may be some added value (i.e. management team, location, etc) that financial buyers don’t place an added value on.

Strategic Sale – this is when someone in the industry buys the company for strategic purposes (297). The benefit to this kind of sale is that the buyer will pay a value beyond cash flow. There is an added benefit to owning the company to a strategic buyer. The only drawback is that you are having to share information with a competitor.

Chapter 11 – This form of bankruptcy is called reorganization bankruptcy. Virtually all equity holders are washed out and the chance of earning a return is significantly reduced (299). This process is very costly with lawyers’ fees, but there is still an opportunity to save the company.

Chapter 7 – This is when the company is completely liquidated and investors may get little to nothing at all. There is pretty much no upside to this harvesting strategy (can you even call this a strategy?) except that there are no more outstanding liabilities (300).

Ideally, as an investor or as an entrepreneur, a strategic sale is the “prize”. This, in my opinion, it the best way to sell a company because a buyer will see the same value that you see in the company you are invested in. It’s also the best way to earn higher multiples on your investment. Clearly, the worst-case scenario is Chapter 7 bankruptcy. Pretty much, no stakeholders receive anything except a get out of debt free card…but it’s not necessarily free. It haunts you for many years to come.

 

Source

Amis, David and Howard Stevenson. Winning Angels: the 7 Fundamentals of Early Stage Investing. Pearson Education Limited, 2001.

3 Comments

  1. Alex,
    I agree Chapter 7 is possibly the worst case scenario. I am pretty sure that’s why the authors consider this strategy a negative harvest. If losing or liquidating a company isn’t bad enough the authors also mention that the business owner(s) can be held liable to lawsuits filed by investors. The business almost becomes reminiscent of a bad relationship that won’t go away and that you are constantly reminded of.

    Like

  2. Alex,

    You don’t really think that you need to plan your exit strategy from the beginning, but this shows that is clearly the right thing to do. And the strategic plan can be planned from the beginning which makes it easy to start out with the end in mind, and not have to worry about your exit plan down the road.

    Thanks,
    Mackensie

    Like

  3. I agree a strategic sale is the best option for an investor. I believe the entrepreneur needs to work toward multiple exits before soliciting investment. This way, he or she can identify the most probable scenario–hopefully the strategic sale–to entice the investment. Investors always want to know how they’re going to be able to harvest their investment. The more talk about this at the beginning, the more comfortable the investor will be in the opportunity.

    Like

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