valuing business edp sdm

8/6/2019 Valuing Business EDP SDM

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BUSINESSBUSINESS

VALUATIONVALUATION


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ValuationValuation

There are a number of tools available toThere are a number of tools available topredict value including complex softwarepredict value including complex softwaretools that promise to reduce valuation to atools that promise to reduce valuation to a

simple formula.simple formula.However, all of valuation comes down toHowever, all of valuation comes down tothis simple truth:this simple truth:

A business is worth what a buyer isA business is worth what a buyer iswilling to paywilling to pay..


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33

Fair Market ValueFair Market Value

Fair Market Value is defined as the valueFair Market Value is defined as the value

that athat a willingwilling seller and aseller and a willingwilling buyer, bothbuyer, both

beingbeing informedinformed of theof the relevantrelevant facts aboutfacts aboutthe company, could reasonably conduct athe company, could reasonably conduct a

buybuy--sell transaction, neither party under anysell transaction, neither party under any

compulsioncompulsion to do so.to do so.


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NonNon--quantitative Factors inquantitative Factors in

Valuing a BusinessValuing a Business

CompetitionCompetition

MarketMarket

Future CommunityFuture Community

DevelopmentDevelopmentLegal CommitmentsLegal Commitments

Union ContractsUnion Contracts

BuildingsBuildings

Product PricesProduct Prices


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What can theWhat can the

term value mean?term value mean?Fair market valueFair market value..

This is the price at which a willing seller wouldThis is the price at which a willing seller wouldsell and a willing buyer would buysell and a willing buyer would buy

every sale would ultimately constitute a fairevery sale would ultimately constitute a fair

market value sale.market value sale.


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term value mean?term value mean?

Intrinsic valueIntrinsic value. This is perceived value arrived. This is perceived value arrivedat by interpreting balance sheet and incomeat by interpreting balance sheet and incomestatements through the use of ratios, discountingstatements through the use of ratios, discounting

cash flow projections, and calculating liquidatedcash flow projections, and calculating liquidatedasset valueasset value

Investment valueInvestment value. This is the worth of the. This is the worth of the

business to an investor and is based on thebusiness to an investor and is based on theindividual requirements of the investor as to risk,individual requirements of the investor as to risk,return, tax benefits, and so forthreturn, tax benefits, and so forth


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term value mean?term value mean?GoingGoing--concern valueconcern value..

This is the current status of the business asThis is the current status of the business asmeasured by financial statements, debt load,measured by financial statements, debt load,

and economic environmental factors, such asand economic environmental factors, such as

government regulation, that may affect the longgovernment regulation, that may affect the long--

term continuation of the business.term continuation of the business.


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term value mean?term value mean?Liquidation valueLiquidation value. This value assumes the. This value assumes the

selling off of all assets and calculating theselling off of all assets and calculating the

amount that could be recovered from doing so.amount that could be recovered from doing so.

Book valueBook value. This is an accounting measure of. This is an accounting measure of

value and refers to the difference between totalvalue and refers to the difference between total

assets and total liability. It is essentiallyassets and total liability. It is essentially

equivalent to shareholders or owners equity.equivalent to shareholders or owners equity.


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Why Businesses Are AppraisedWhy Businesses Are Appraised

Mergers and AcquisitionsMergers and Acquisitions

Allocation of PurchaseAllocation of PurchasePricePrice

Estate and Gift TaxesEstate and Gift Taxes

Marital DissolutionMarital Dissolution

Liquidation orLiquidation orReorganization of aReorganization of aBusinessBusiness

BuyBuy--Sell AgreementsSell Agreements

Stockholder DisputesStockholder Disputes

FinancingFinancing

Initial Public OfferingInitial Public Offering

Damages LitigationDamages Litigation

Charitable ContributionsCharitable ContributionsFinancial ReportingFinancial Reporting


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Appraisal PrinciplesAppraisal Principles

Principle of SubstitutionPrinciple of Substitution

Principle ofFuture BenefitsPrinciple ofFuture Benefits Principle of AnticipationPrinciple of Anticipation


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Standards of ValueStandards of Value



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...the price at which the property would

change hands between a willing buyer anda willing seller when the former is not

under any compulsion to buy and the latter

is not under any compulsion to sell, both

parties having reasonable knowledge of

relevant facts.


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Fair ValueFair Value


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Fair Market Value v Fair ValueFair Market Value v Fair Value

1.1. Willing Buyer.Willing Buyer.

2.2. Willing Seller.Willing Seller.

3.3. Neither is under compulsion.Neither is under compulsion.

4.4. Assumes a typicalAssumes a typical hypotheticalhypothetical

buyer and seller.buyer and seller.

5.5. AA priceprice that isthat is equitable to both.equitable to both.6.6. Assumes both buyer and sellerAssumes both buyer and seller

havehave equal knowledgeequal knowledge..

7.7. AssumesAssumes reasonable knowledgereasonable knowledge

of both parties.of both parties.

1.1. Not always a Willing Buyer.Not always a Willing Buyer.

2.2. NotNot always aWilling Seller.always aWilling Seller.

3.3. Buyer may be compelled, butBuyer may be compelled, but

seller isseller is..

4.4. A concept of "fairness" to theA concept of "fairness" to theseller, considering the inabilityseller, considering the inability

to keep the stock.to keep the stock.

6.6. No such assumption.No such assumption.

7.7. No such assumptionNo such assumption


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Investment ValueInvestment Value


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Investment ValueInvestment ValueIntrinsic ValueIntrinsic Value


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Factors To ConsiderFactors To ConsiderNature of the business and history of the enterprise since itsNature of the business and history of the enterprise since its

inception.inception.

The economic outlook in general and the condition and outlook ofThe economic outlook in general and the condition and outlook of

the specific industry in particular.the specific industry in particular.

The book value of the stock and the financial condition of theThe book value of the stock and the financial condition of thebusiness.business.

The earning capacity of the company.The earning capacity of the company.

The dividendThe dividend--paying capacity.paying capacity.

Whether or not the enterprise has goodwill or other intangibleWhether or not the enterprise has goodwill or other intangible

value.value.

The market price of stocks of corporations engaged in the sameThe market price of stocks of corporations engaged in the same

or similar line of business having their stocks actively traded in aor similar line of business having their stocks actively traded in a

free and open market, either on an exchange or overfree and open market, either on an exchange or over--thethe--counter.counter.


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Determining the Value of the BusinessDetermining the Value of the Business1.1. Discounted cash flowsDiscounted cash flows: cash flows reduced: cash flows reduced

in value because they are to be received inin value because they are to be received in

the futurethe future

3.3. Net realizable valueNet realizable value: amount for which an: amount for which an

asset will sell, less the cost of sellingasset will sell, less the cost of selling

4.4. Replacement valueReplacement value: cost to acquire an: cost to acquire an

essentially identical assetessentially identical asset5.5. Earnings multipleEarnings multiple: ratio of value of a firm to: ratio of value of a firm to

its annual earningsits annual earnings

6-18


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1919

Business Valuation StepsBusiness Valuation Steps -- 11

Define PurposeDefine Purpose

Understand size & characteristics of ClientUnderstand size & characteristics of Client

Assessment of People and MarketsAssessment of People and Markets--------------------------------------------------------------------------------------------

Gather Additional DataGather Additional Data

Recast Financial StatementsRecast Financial StatementsRatio Analysis / Industry ComparisonRatio Analysis / Industry Comparison


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2020

Business Valuation StepsBusiness Valuation Steps -- 11

Define PurposeDefine Purpose

Understand size & characteristics of ClientUnderstand size & characteristics of Client

Assessment of People and MarketsAssessment of People and Markets--------------------------------------------------------------------------------------------

Gather Additional DataGather Additional Data

Recast Financial StatementsRecast Financial StatementsRatio Analysis / Industry ComparisonRatio Analysis / Industry Comparison


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Determining the Value of a BusinessDetermining the Value of a Business

Balance Sheet TechniqueBalance Sheet Technique

Variation: Adjusted Balance SheetVariation: Adjusted Balance Sheet

TechniqueTechnique

Earnings ApproachEarnings Approach Variation 1: Excess Earnings ApproachVariation 1: Excess Earnings Approach

Variation 2: Capitalized Earnings ApproachVariation 2: Capitalized Earnings Approach

Variation 3: Discounted Future EarningsVariation 3: Discounted Future EarningsApproachApproach

Market ApproachMarket Approach


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Adjusted Book ValueAdjusted Book Value

The book value of a going concern is simply theThe book value of a going concern is simply the

owners equityowners equity, that is, the value of the assets, that is, the value of the assets

less the outstanding debts.less the outstanding debts.


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Balance Sheet TechniquesBalance Sheet Techniques

Book Value ofNetWorth = Total AssetsBook Value ofNetWorth = Total Assets -- Total LiabilitiesTotal Liabilities

Variation: Adjusted Balance Sheet Technique:Variation: Adjusted Balance Sheet Technique:

(Adjusted for negatives or positives from balance sheet in(Adjusted for negatives or positives from balance sheet ininventory, equipment, land/buildings/receivables, etc)inventory, equipment, land/buildings/receivables, etc)

The balance sheet method lets one take the perspective of "I walkedThe balance sheet method lets one take the perspective of "I walked

away from this business tomorrow, sold everything that it owns, howaway from this business tomorrow, sold everything that it owns, how

much do I get?"much do I get?"


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Income ApproachIncome Approach

Definitions of IncomeDefinitions of IncomeNet income after taxNet income after tax

Net income before taxNet income before tax

Cash flow (gross or net)Cash flow (gross or net)

Debt free net incomeDebt free net income

Debt free cash flow (gross or net)Debt free cash flow (gross or net)

EBIT, EBDIT or EBDITA (EBITDA)EBIT, EBDIT or EBDITA (EBITDA)Earnings before owners compensation,Earnings before owners compensation,

interest and taxes (owners discretionary cashinterest and taxes (owners discretionary cash

flow)flow)


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Single Period ModelSingle Period Model

Capitalization: The process of converting abenefits stream into value by dividing the

benefits stream by a rate of return that is

adjusted for growth.


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MultiMulti--Period ModelPeriod Model

Discounting: The process of converting a

future series of benefit streams into value by

bringing them to present value at a rate of

return that reflects the risk inherent in the

benefits stream.


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Capitalization of benefits methodCapitalization of benefits method

Discounted future benefits methodDiscounted future benefits method

Excess earnings methodExcess earnings method


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Excess Earnings MethodExcess Earnings Method

1.1. Compute the adjusted tangible net worth of the business.Compute the adjusted tangible net worth of the business.

Tangible assets are adjusted up or down for market value; thenTangible assets are adjusted up or down for market value; then

liabilities are subtracted.liabilities are subtracted.

2.2. Compute the opportunity cost of this investment. How much wouldCompute the opportunity cost of this investment. How much wouldthe investor/buyer earn by investing the same amount in another,the investor/buyer earn by investing the same amount in another,

comparable investment?comparable investment?

3.3. Forecast net earnings. Earnings from previous income statementsForecast net earnings. Earnings from previous income statements

can provide a basis for the forecastcan provide a basis for the forecast


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4. Calculate the extra earning power, which is the difference between4. Calculate the extra earning power, which is the difference between

forecasted earnings and opportunity costs.forecasted earnings and opportunity costs.

5. Estimate the value of intangible assets or goodwill. If the business5. Estimate the value of intangible assets or goodwill. If the business

has extra earning power, that figure can be multiplied by what ishas extra earning power, that figure can be multiplied by what isknown as a yearsknown as a years--ofof--profit (YOP) figure.profit (YOP) figure.


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Earnings ApproachesEarnings Approaches

Variation 1: Excess Earnings MethodVariation 1: Excess Earnings Method

Step 1Step 1: Compute adjusted tangible net worth:: Compute adjusted tangible net worth:

Adjusted NetWorth = 2746380Adjusted NetWorth = 2746380 -- 1143250=1143250= 16031301603130

Step 2Step 2: Calculate opportunity costs of investing:: Calculate opportunity costs of investing:(25% is normal rate of return)(25% is normal rate of return)

Investment 1603130 x 25% = 400780Investment 1603130 x 25% = 400780

SalarySalary + 250000+ 250000

Total 65078

0Total 65078

0

Step 3Step 3: Project earnings for next year:: Project earnings for next year: 740000740000


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Step 4Step 4: Compute extra earning power (EEP):: Compute extra earning power (EEP):

EEP = Projected Net EarningsEEP = Projected Net Earnings -- Total Opportunity CostsTotal Opportunity Costs

= 740000= 740000 -- 650780 = 89220650780 = 89220

Step 5Step 5: Estimate the value of the intangibles (goodwill):: Estimate the value of the intangibles (goodwill):

Intangibles = Extra Earning Power x Years of Profit Figure*Intangibles = Extra Earning Power x Years of Profit Figure*

= 89220 x 3 == 89220 x 3 = 267660267660

* Years of ProfitF

igure ranges from 1 to 7; for a normal risk* Years of ProfitF

igure ranges from 1 to 7; for a normal riskbusiness, it is 3 or 4.business, it is 3 or 4.


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Step 6Step 6: Determine the value of the business:: Determine the value of the business:

Value = Tangible Net Worth + Value of IntangiblesValue = Tangible Net Worth + Value of Intangibles

= 1603130 + 267660 == 1603130 + 267660 = 18707901870790

Estimated Value of the Business = 1870790Estimated Value of the Business = 1870790


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Variation 2: Capitalized Earnings Method:Variation 2: Capitalized Earnings Method:

Value =Value = Net Earnings (Net Earnings (AfterAfterDeducting Owner's Salary)Deducting Owner's Salary)

Rate of Return*Rate of Return*

* Rate of return reflects what could be earned on a similar* Rate of return reflects what could be earned on a similar--riskrisk

investment.investment.

Value =Value = 74,000074,0000 -- 25,000025,0000 == 196,0000196,0000

25%25%


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Capitalization of EarningsCapitalization of Earnings

Either EBIT or EBITDA is divided by a capitalization rate,Either EBIT or EBITDA is divided by a capitalization rate,

which is the return the buyer requires on the investmentwhich is the return the buyer requires on the investment

For example, if the companys EBITDA was 500,000 andFor example, if the companys EBITDA was 500,000 andthe buyer needed a 20 percent return on investment, thethe buyer needed a 20 percent return on investment, the

price the buyer would be willing to pay would beprice the buyer would be willing to pay would be

2,500,000.2,500,000.

EBITDA / REQUIRED ROI = MAXIMUM PURCHASE PRICEEBITDA / REQUIRED ROI = MAXIMUM PURCHASE PRICE


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Capitalization ModelCapitalization Model

V = E / k-g

E = Earnings expected in next period

k = Discount rate

g = Long term sustainable growth rate


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Single Period Model ExampleSingle Period Model Example

Adjusted Net Income 1,000,000

Forecasted Growth x 1.05

Estimated Future Income 1,050,000

Capitalization Rate 25.0 %

Indicated Value from Operations 4,200,000

Add: Net Nonoperating Assets 357,350Total Enterprise Value 4,557,350

Rounded 4,600,000


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MultiMulti--Period ModelPeriod Model

E1 E2 E3 Et

V= --------- + --------- + --------- +... --------

(1 + i)1 (1 + i)2 (1 + i)3 (1 + i)t

Where

E = Benefit streami = Discount rate


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Variation 3: Discounted Future Earnings Method:Variation 3: Discounted Future Earnings Method:

Compute aCompute a weightedaverageweightedaverage of the earnings:of the earnings:

Step 1Step 1: Project earnings five years into the future:: Project earnings five years into the future:

Pessimistic + (4 x Most Likely) + OptimisticPessimistic + (4 x Most Likely) + Optimistic

6

$$

3 Forecasts:

PessimisticMost Likely

Optimistic


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Discounted Future EarningsDiscounted Future Earnings

MethodMethod

Step 1Step 1: Project earnings five years into the future:: Project earnings five years into the future:

Year Pess ML Opt Weighted Average Year Pess ML Opt Weighted Average

65,00065,00074,00074,000

82,00082,000

88,00088,000

88,00088,000

74,00074,00090,00090,000

100,000100,000

109,000109,000

115,000115,000

92,00092,000101,000101,000

112,000112,000

120,000120,000

122,000122,000

75,50075,50089,16789,167

99,00099,000

107,333107,333

111,667111,667

1122

33

44

55


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Discounted Future Earnings MethodDiscounted Future Earnings Method

Step 2Step 2: Discount weighted average of future earnings at the: Discount weighted average of future earnings at the

appropriate present value rate:appropriate present value rate:

Present Value Factor =Present Value Factor =(1 +k)(1 +k) tt

where...where...

k = Rate of return on a similar riskk = Rate of return on a similar risk

investmentinvestment

t = Time period (Yeart = Time period (Year -- 1, 2, 3...n)1, 2, 3...n)

11


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Discounted Future Earnings MethodDiscounted Future Earnings Method

Year Weighted Average x PV Factor = Present ValueYear Weighted Average x PV Factor = Present Value

11

22

33

44

55

.8000.8000

.6400.6400

.5120.5120

.4096.4096

.3277.3277

75,50075,500

89,16789,167

99,00099,000

107,333107,333

111,667111,667

Step 2 (continued)Step 2 (continued): Discount weighted average of: Discount weighted average of

future earnings at the appropriate present value rate:future earnings at the appropriate present value rate:

60,40060,400

57,06757,067

50,68850,688

43,96443,964

36,59336,593

Total 248,712Total 248,712


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MethodMethodStep 3Step 3: Estimate the earnings stream beyond five years:: Estimate the earnings stream beyond five years:

Weighted Average Earnings in Year 5 xWeighted Average Earnings in Year 5 x 11

Rate of ReturnRate of Return

= 111,667 x= 111,667 x 11

25%25%

Step 4Step 4: Discount this estimate using the present value factor for: Discount this estimate using the present value factor for

year 6:year 6:446,668 x .2622 =446,668 x .2622 = 117,116117,116


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MethodMethodStep 5Step 5: Compute the value of the business:: Compute the value of the business:

= 248,712 + 117,116 == 248,712 + 117,116 = 365,828365,828

Estimated Value of Business = 365,828

Estimated Value of Business = 365,828

Value =Value = DiscountedDiscounted

earnings in yearsearnings in years

1 through 51 through 5

++DiscountedDiscounted

earnings in yearsearnings in years

6 through ?6 through ?


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Discounting Cash FlowsDiscounting Cash Flows

Calculating how much an investor would payCalculating how much an investor would pay

today to have atoday to have a cash flow streamcash flow stream of X rupees forof X rupees for

X number of years into the future.X number of years into the future.


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Multiple of EarningsMultiple of Earnings

Using a price/earnings (P/E) ratio to value aUsing a price/earnings (P/E) ratio to value abusiness is a common method among publiclybusiness is a common method among publiclyowned companies because its simple and directowned companies because its simple and direct

This ratio is determined by dividing the marketThis ratio is determined by dividing the marketprice of the common stock by the earnings perprice of the common stock by the earnings pershare.share.

P/E RATIO = STOCK PRICE / EARNINGS PERP/E RATIO = STOCK PRICE / EARNINGS PER

SHARESHARE


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Commonly Used MultiplesCommonly Used MultiplesPrice/net earningsPrice/net earningsPrice/prePrice/pre--tax earningstax earnings

Price/cash flowPrice/cash flow

Price/revenuesPrice/revenues

Price/dividend capacity orPrice/dividend capacity oryieldyield

Price/operating profitPrice/operating profit

Price/gross profitPrice/gross profit

Price/book valuePrice/book value

Price/EBITPrice/EBIT

Price/EBDITPrice/EBDIT


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Risk FactorsRisk Factors

Economic riskEconomic risk

Business riskBusiness risk

Operating risksOperating risks

Financial risksFinancial risksAsset risksAsset risks

Product risksProduct risks

Market risksMarket risks

Technological risksTechnological risksRegulatory risksRegulatory risks

Legal risksLegal risks


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Market ApproachMarket Approach

Step 1Step 1: Compute the average Price: Compute the average Price--Earnings (PEarnings (P--E) Ratio forE) Ratio foras many similar businesses as possible:as many similar businesses as possible:

Company PCompany P--E RatioE Ratio

11 3.33.3

22 3.83.8 Average PAverage P--E Ratio = 3.975E Ratio = 3.975

33 4.74.7

44 4.14.1

Step 2:Step 2: Multiply the average PMultiply the average P--E Ratio by next yearsE Ratio by next yearsforecasted earnings:forecasted earnings:

Estimated Value = 3.975 x 740000 =Estimated Value = 3.975 x 740000 = 29415002941500


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PRICE TO EARNINGS

After-tax earnings 959,446

Multiple x 6.20

Oper.Entity Value 5,948,565

Net Non-oper. Assets + 250,000

Total Entity Value 6,198,565

Rounded 6,200,000


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Market Approach ExampleMarket Approach Example

GUIDELINECO. DATE P/E P/S P/B

Apple Company, Inc. 12/31/95 8.70 55.30% 2.85

Bananas R Us, Inc. 10/31/95 9.30 47.43% 4.65

Fruits, Inc. 12/31/95 8.50 35.25% 3.65

Cherry Corp. 12/31/95 6.60 54.80% 3.90

Grapes Corp. 11/30/95 7.80 48.20% 4.25

Median Multiple 8.50 48.20% 3.90

Selected Multiple 6.20 44.00% 2.50


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Financial Statement AdjustmentsFinancial Statement AdjustmentsGAAP adjustmentsGAAP adjustments

NonNon--operating/nonoperating/non--recurringrecurring

adjustmentsadjustments

Discretionary adjustmentsDiscretionary adjustments


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Discretionary AdjustmentsDiscretionary Adjustments

Owner's compensationOwner's compensation

Owner's perquisitesOwner's perquisites

Entertainment expensesEntertainment expensesAutomobile expensesAutomobile expenses

Compensation to familyCompensation to familymembersmembers

Interest expenseInterest expense


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Discount and Capitalization RatesDiscount and Capitalization Rates


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Components of a Discount RateComponents of a Discount Rate

Risk free rate of returnRisk free rate of return

General or equity risk premiumGeneral or equity risk premium

Specific risk premiumSpecific risk premium


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Discount For Lack of MarketabilityDiscount For Lack of Marketability

Restricted StockRestricted Stock

IPO StudiesIPO Studies

Cost ofFloatationCost ofFloatation


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Valuing a going concernValuing a going concernThe capitalization of future maintainable earnings method is the mostThe capitalization of future maintainable earnings method is the most

common way of valuing an existing business in good ordercommon way of valuing an existing business in good order

Multiplying an estimate of future maintainableMultiplying an estimate of future maintainable

Valuing new businessesValuing new businesses

The discounted cash flowThe discounted cash flow method is usuallymethod is usually used to value new or immatureused to value new or immature

businesses or a businessbusinesses or a business


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5858

The Lack of Strategic Planning

Reasons for the Lack of Strategic Planning1. Time scarcity

2. Lack of knowledge

3. Lack of expertise/skills

4. Lack of trust and openness

5. Perception of high cost


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13135959

Figure13.3 The Entrepreneurial Strategy Matrix: Independent

Variables

Source: Matthew C. Sonfield and Robert N. Lussier, The Entrepreneurial Strategic Matrix: A Model forNew and Ongoing Ventures.

Reprinted with permission from Business Horizons, May/June 1997, by the trustees at Indiana University, Kelley School of Business.


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13136060

Figure13.4 The Entrepreneurial Strategy Matrix: Appropriate

Strategies

Source:Matthew C. Sonfield and Robert N. Lussier, The Entrepreneurial Strategic Matrix: A Model forNew and Ongoing Ventures.

Reprinted with permission from Business Horizons, May/June 1997, by the trustees at Indiana University, Kelley School of Business.


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13136161

Venture Development StagesVenture Development Stages

LifeLife--Cycle Stages of an EnterpriseCycle Stages of an Enterprise(Chandler)(Chandler)

1.1. Initial expansion and accumulation ofInitial expansion and accumulation of

resourcesresources2.2. Rationalization of the use of resourcesRationalization of the use of resources

3.3. Expansion into new markets to assure theExpansion into new markets to assure the

continued use of resourcescontinued use of resources4.4. Development of new structures to ensureDevelopment of new structures to ensure

continuing mobilization of resourcescontinuing mobilization of resources


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Figure13.5 A Ventures Typical Life Cycle


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6363

The Entrepreneurial CompanyThe Entrepreneurial Company

in the Twentyin the Twenty--F

irst CenturyF

irst Century Major Challenges:Major Challenges:

Building dynamic capabilities that areBuilding dynamic capabilities that are

differentiated from those of emergingdifferentiated from those of emergingcompetitorscompetitors

InternalInternalutilization of the creativity andutilization of the creativity and

knowledge from employeesknowledge from employees

ExternalExternalthe search for externalthe search for external

competencies to complement the firmscompetencies to complement the firms

existing capabilities.existing capabilities.


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13.6 The Entrepreneurial Mindset


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Table13.2 The Managerial versus the Entrepreneurial Mind-Set

Managerial Mind-SetE

ntrepreneurial Mind-Set

Decision-makingassumptions

The past is the best predictor of the future.Most business decisions can be quantified.

A new idea or an insight from a uniqueexperience is likely to provide the bestestimate of emerging trends.

Values

The best decisions are those based onquantitative analyses.Rigorous analyses are highly valued for

making critical decisions.

New insights and real-world experiencesare more highly valued than results basedon historical data.

BeliefsLaw of large numbers: Chaos anduncertainty can be resolved bysystematically analyzing the right data.

Law of small numbers: A single incident orseveral isolated incidents quickly becomepivotal for making decisions regardingfuture trends.

Approach to problems

Problems represent an unfortunate turn ofevents that threaten financial projections.

Problems must be resolved withsubstantiated analyses.

Problems represent an opportunity todetect emerging changes and possibly new

business opportunities.

Source: MikeWright, Robert E. Hoskisson, and LowellW. Busenitz, Firm Rebirth: Buyouts as

Facilitators of Strategic Growth and Entrepreneurship, Academy of Management Executive 15(1): 114.


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13136666

Building the Adaptive FirmBuilding the Adaptive Firm

An AdaptiveF

irmAn AdaptiveF

irm One that Increases opportunity for its employees, initiatesOne that Increases opportunity for its employees, initiates

change, and instills a desire to be innovative.change, and instills a desire to be innovative.

How to remain adaptive and innovative:How to remain adaptive and innovative:

Share the entrepreneurs visionShare the entrepreneurs vision

Increase the perception of opportunityIncrease the perception of opportunity Institutionalize change as the ventures goalInstitutionalize change as the ventures goal

Instill the desire to be innovative:Instill the desire to be innovative:

A reward systemA reward system

An environment that allows for failureAn environment that allows for failure

Flexible operationsFlexible operations

The development of ventureThe development of venture teamsteams

Flexibility, innovation, speed, strategic leadership are importantFlexibility, innovation, speed, strategic leadership are important

for growing businessfor growing business


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The Transition from an Entrepreneurial Style to aThe Transition from an Entrepreneurial Style to a

Managerial ApproachManagerial Approach

Impediments to Transition:Impediments to Transition:

A highly centralized decisionA highly centralized decision--making systemmaking system

An overdependence on one or two keyAn overdependence on one or two key

individuals,individuals,

An inadequate repertoire of managerial skillsAn inadequate repertoire of managerial skills

and trainingand training

A paternalistic atmosphereA paternalistic atmosphere


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13136868

Table13.3 The Entrepreneurial Culture versus the Administrative

Culture

Entrepreneurial Focus Administrative Focus

Characteristics Pressures Characteristics Pressures

StrategicOrientation

Driven byperception ofopportunity

Diminishing opportunitiesRapidly changing technology, consumereconomics, social values, and politicalrules

Planning systemsand cycles

Social contractsPerformance measurementcriteria

Commitmentto SeizeOpportunities

Revolutionary, withshort duration

Action orientationNarrow decision windows

Acceptance of reasonable risksFew decision constituencies

Evolutionary, withlong duration

Acknowledgement of multipleconstituenciesNegotiation about strategiccourseRisk reduction

Coordination with existingresource base

Commitmentof Resources

Many stages, withminimal exposureat each stage

Lack of predictable resource needsLack of control over the environmentSocial demands for appropriate use ofresourcesForeign competitionDemands for more efficient use

A single stage,with completecommitment out ofdecision

Need to reduce riskIncentive compensationTurnover in managersCapital budgeting systemsFormal planning systems

Control of

Resources

Episodic use orrent of requiredresources

Increased resource specializationLong resource life compared with needRisk of obsolescence

Risk inherent in the identified opportunityInflexibility of permanent commitment toresources

Ownership oremployment of

requiredresources

Power, status, and financialrewardsCoordination of activity

Efficiency measuresInertia and cost of changeIndustry structures

ManagementStructure

Flat, with multipleinformal networks

Coordination of key noncontrolledresourcesChallenge to hierarchyEmployees desire for independence

Hierarchy

Need for clearly definedauthority and responsibilityOrganizational cultureReward systemsManagement theory

Source:Reprinted by permission of the HarvardBusiness Review. An exhibit from The Heart of Entrepreneurship, by Howard H. Stevenson

and David E. Gumpert, March/April 1985,

89. Copyright 19

85 by the President and

Fellows of Harvard College; all rights reserved.


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Understanding the Growth StageUnderstanding the Growth Stage

KeyF

actors During the Growth StageKeyF

actors During the Growth Stage ControlControl

Does the control system imply trust?Does the control system imply trust?

Does the resource allocation system imply trust?Does the resource allocation system imply trust?

ResponsibilityResponsibility

Creating a sense of responsibility that establishes flexibility,Creating a sense of responsibility that establishes flexibility,innovation, and a supportive environment.innovation, and a supportive environment.

Tolerance of failureTolerance of failure

Moral failureMoral failure

Personal failurePersonal failure

Uncontrollable failureUncontrollable failure

ChangeChange


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Understanding the Growth StageUnderstanding the Growth Stage

Managing Paradox and ContradictionManaging Paradox and ContradictionBureaucratization versus decentralizationBureaucratization versus decentralization

Environment versus strategyEnvironment versus strategy

Strategic emphases: Quality versus costStrategic emphases: Quality versus costversus innovationversus innovation


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Confronting the GrowthWallConfronting the GrowthWall

Successful growthSuccessful growth--oriented firms have exhibitedoriented firms have exhibitedconsistent themes:consistent themes:

The entrepreneur is able to envision and anticipate the firm as aThe entrepreneur is able to envision and anticipate the firm as a

larger entity.larger entity.

The team needed for tomorrow is hired and developed today.The team needed for tomorrow is hired and developed today.

The original core vision of the firm is constantly and zealouslyThe original core vision of the firm is constantly and zealously

reinforced.reinforced.

BigBig--company processes are introduced gradually ascompany processes are introduced gradually as

supplements to, rather than replacements for, existingsupplements to, rather than replacements for, existing

approaches.approaches.

Hierarchy is minimized.Hierarchy is minimized.

Employees hold a financial stake in the firm.Employees hold a financial stake in the firm.


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Unique Managerial Concerns of Growing VenturesUnique Managerial Concerns of Growing Ventures

PressuresPressures-- p ip, donationp ip, donationCommunityCommunity

PressuresPressures-- participation, leadership, donationparticipation, leadership, donation

DistinctionDistinction

of Small Sizeof Small SizeOneOne--PersonPerson--BandBand

SyndromeSyndrome

asas tete

TimeTime

ManagementManagement--assess,assess, prioritise,procedures,delegateprioritise,procedures,delegate

GrowingGrowingVentureVentureGrowingGrowingVentureVenture

ContinuousContinuousLearningLearning

Th Hi h f B i O tTh Hi h f B i O t


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The Hierarchy of Business OutcomesThe Hierarchy of Business Outcomes

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Business life cycleBusiness life cycle

Several models, with sameSeveral models, with same general ideasgeneral ideas::

Multiple stagesMultiple stages

Key issues, lessons, and actions at each stageKey issues, lessons, and actions at each stage

Level of risk business faces changes from stage toLevel of risk business faces changes from stage to

stagestage

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1.1. EmergenceEmergence: person thinks and takes: person thinks and takes

action towards starting a firmaction towards starting a firm

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2.2. ExistenceExistence: having the business in: having the business in

operation, but not yet stableoperation, but not yet stable

Risk is highRisk is high

Owners lack key informationOwners lack key information

3.3. SuccessSuccess: develop information, skills,: develop information, skills,

and routines to grow the businessand routines to grow the business

profitsprofits This is a stage that lasts a long timeThis is a stage that lasts a long time

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4.4. Resource maturityResource maturity: stable level of: stable level of

sales and profitssales and profits

Functional areas, the market, andFunctional areas, the market, andthe products or services are beingthe products or services are being

dealt with consistently and efficientlydealt with consistently and efficiently

Challenge is to avoid complacencyChallenge is to avoid complacency

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3 key components3 key components to staving offto staving off

customer complacency:customer complacency: RecencyRecency: be among the people your: be among the people your

customers have seen in the last few dayscustomers have seen in the last few days

FrequencyFrequency: stay in touch with customers on: stay in touch with customers on

a frequent basis (visits, phone calls, emails,a frequent basis (visits, phone calls, emails,etc.)etc.)

PotencyPotency: be remembered for the right: be remembered for the right

reasonsreasons

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5.5. TakeoffTakeoff: a period of exceptional growth: a period of exceptional growth

Might come from landing an unexpectedlyMight come from landing an unexpectedly

gigantic contractgigantic contract,, expandingexpanding into multipleinto multiple

locations, or just being in thelocations, or just being in the right place atright place atthe right timethe right time

Most small businesses never go through theMost small businesses never go through the

taketake--off phaseoff phase

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Types ofFirmsTypes ofFirms

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Sales Growth:Sales Growth: comes from several wayscomes from several ways

Increasing sales to existing steady customersIncreasing sales to existing steady customers

Make occasional customers into steadyMake occasional customers into steady

customerscustomers

Expand areas where you have smallExpand areas where you have smallcustomer basecustomer base

Technological growth:Technological growth: can take two formscan take two forms

Use technology to Improve efficiencies andUse technology to Improve efficiencies and

profitsprofits

Use it to create new products or servicesUse it to create new products or services

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Closing the Small BusinessClosing the Small Business

Every year, nearly 4 million go through changesEvery year, nearly 4 million go through changes

in ownership and existencein ownership and existence

HarvestHarvest: get maximum value they can for the: get maximum value they can for thebusinessbusiness

Initial public offering (IPO)Initial public offering (IPO): selling stock to: selling stock to

public on major stock exchangepublic on major stock exchange

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484

Methods for Harvesting a BusinessMethods for Harvesting a Business

After value creationAfter value creation


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After value creationAfter value creation

Harvesting the BusinessHarvesting the Business

What is harvesting?What is harvesting?It is the sale of some or all of the equity of a company.It is the sale of some or all of the equity of a company.

A number of possible exit routes:A number of possible exit routes:1.1. A trade sale to another companyA trade sale to another company

2.2. The sale of the investment to another corporate investorThe sale of the investment to another corporate investor

such as a venture capitalistsuch as a venture capitalist

3.3. The sale of equity to another individualThe sale of equity to another individual such as asuch as a

business angel or a fellow shareholderbusiness angel or a fellow shareholder or throughor throughmanagement busymanagement busy--out or buyout or buy--inin

4.4. The sale of equity to the public through an IPO (initialThe sale of equity to the public through an IPO (initial

public offering) on a stock exchange.public offering) on a stock exchange.


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The Importance of the ExitThe Importance of the Exit

Harvesting (or Exiting)Harvesting (or Exiting)

The process used by entrepreneurs andThe process used by entrepreneurs and

investors to reap the value of a business wheninvestors to reap the value of a business when

they get out of it.they get out of it.

The process involves:The process involves:

Capturing value (cash value)Capturing value (cash value)

Reducing riskReducing risk

Creating future optionsCreating future options

Releasing the Firms CashReleasing the Firms Cash


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Releasing the Firm s CashReleasing the Firm s Cash

FlowsFlowsHarvesting by Withdrawing Firms CashHarvesting by Withdrawing Firms Cash

Advantages:Advantages:

Retain control of firm while harvesting investment.Retain control of firm while harvesting investment.

No need to seek a buyer or incur expensesNo need to seek a buyer or incur expenses

associated with sale of businessassociated with sale of business

DisadvantagesDisadvantages

Loss of development potential and opportunitiesLoss of development potential and opportunities

Tax disadvantages of cash withdrawalTax disadvantages of cash withdrawal

Requires patience to siphon off cash slowlyRequires patience to siphon off cash slowly


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Harvesting: Going PublicHarvesting: Going PublicInitial Public Offering (IPO)Initial Public Offering (IPO)

Benefits of the sale of shares of stock to theBenefits of the sale of shares of stock to the

public:public:

1.1. Signals to investors that a firm is a qualitySignals to investors that a firm is a quality

business and will likely perform well in the future.business and will likely perform well in the future.2.2. Provides access to more investors when the firmProvides access to more investors when the firm

needs to raise capital to grow the business.needs to raise capital to grow the business.

3.3. Helps create ongoing interest in the companyHelps create ongoing interest in the company

and its continued development.and its continued development.4.4. Makes firms stock more attractive as incentiveMakes firms stock more attractive as incentive

pay to key personnel.pay to key personnel.


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Harvesting: UHarvesting: Using Private Equitysing Private Equity

Private Equity (Capital)Private Equity (Capital)

Money provided by venture capitalists orMoney provided by venture capitalists or

private investors.private investors.

Factors in the Transfer ofFamilyFactors in the Transfer ofFamily--OwnedOwned

FirmsFirms

Liquidity for exiting family membersLiquidity for exiting family members

Continued financing for company growthContinued financing for company growthMaintenance of family control of the firmMaintenance of family control of the firm


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TransfersTransfers: ownership is moved from: ownership is moved from

one person or group to anotherone person or group to another

2003: around2003: around 860,000 firms860,000 firms werewere

transferred within the familytransferred within the family

NearlyNearly 1 million1 million business sales took placebusiness sales took place

Occur only among the largest smallOccur only among the largest small

businessesbusinesses

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TransfersTransfers::

One key goal is minimizing theOne key goal is minimizing the tax effectstax effects

of the transferof the transfer

Business can lose as much asBusiness can lose as much as halfhalfof itsof its

value to the governmentvalue to the government Pass offPass off: owner gives the firm to someone: owner gives the firm to someone

as a gift, without compensation; 38% useas a gift, without compensation; 38% use

thisthis

Sell offSell off: everything is sold to another: everything is sold to anotherbusiness, with proceeds paying offbusiness, with proceeds paying off

remaining debtsremaining debts

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TerminationsTerminations: more likely for young firms: more likely for young firms

1.8 million per year1.8 million per year

Three types of terminations:Three types of terminations:

WalkawaysWalkaways closing the firm and quickly paying offclosing the firm and quickly paying off

any debts.any debts.

WorkoutsWorkouts-- when the debt cant quickly be paid off,when the debt cant quickly be paid off,

but the owner can make arrangements to pay itbut the owner can make arrangements to pay it

off over timeoff over time

BankruptciesBankruptcies-- for the firm, the owner, or both.for the firm, the owner, or both.

This may happen if a lot of money was investedThis may happen if a lot of money was invested

and the company never hit the successful stageand the company never hit the successful stage

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Selling the Firm: BuyersSelling the Firm: Buyers

Reasons for Purchasing a FirmReasons for Purchasing a FirmSales to EmployeesSales to Employees

Employee Stock Ownership Plan (ESOP)Employee Stock Ownership Plan (ESOP)

A method by which a firm is sold either in part or inA method by which a firm is sold either in part or in

total to its employees.total to its employees. Employees retirement contributions are used to purchaseEmployees retirement contributions are used to purchase

shares in the firm.shares in the firm.

Frequently is the exit method of last resort.Frequently is the exit method of last resort.

Motivates the employeeMotivates the employee--ownersowners

to perform.to perform.


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For the entrepreneur or venture capitalist:For the entrepreneur or venture capitalist:

-- find the right time to sellfind the right time to sell

-- decide on the exit routedecide on the exit route

-- agree a price with the purchaseragree a price with the purchaser

However, in a private company, there may beHowever, in a private company, there may berestrictions on the ability to sell: e.g.restrictions on the ability to sell: e.g.

OwnerOwner--manager may be required to offer to the existingmanager may be required to offer to the existingshareholders (who cannot/will not buy)shareholders (who cannot/will not buy)

May only be a minority shareholder without power to sell the entireMay only be a minority shareholder without power to sell the entireventureventure

Minority shareholding may be worthless to potential buyer althoughMinority shareholding may be worthless to potential buyer althoughan agreed, and binding, exit mechanism with pricing formula mayan agreed, and binding, exit mechanism with pricing formula mayalready exist.already exist.


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For the entrepreneur or venture capitalist:For the entrepreneur or venture capitalist:

-- find the right time to sellfind the right time to sell

-- decide on the exit routedecide on the exit route

-- agree a price with the purchaseragree a price with the purchaser

However, in a private company, there may beHowever, in a private company, there may berestrictions on the ability to sell: e.g.restrictions on the ability to sell: e.g.

OwnerOwner--manager may be required to offer to the existingmanager may be required to offer to the existingshareholders (who cannot/will not buy)shareholders (who cannot/will not buy)

May only be a minority shareholder without power to sell the entireMay only be a minority shareholder without power to sell the entireventureventure

Minority shareholding may be worthless to potential buyer althoughMinority shareholding may be worthless to potential buyer althoughan agreed, and binding, exit mechanism with pricing formula mayan agreed, and binding, exit mechanism with pricing formula mayalready exist.already exist.


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Hence, questions for the entrepreneur:Hence, questions for the entrepreneur:

Do I wish to realize all or only part of my investment?Do I wish to realize all or only part of my investment?

Do I wish to continue to be associated with the company after theDo I wish to continue to be associated with the company after the

sale?sale?

What form of payment do I want from the saleWhat form of payment do I want from the sale equity in anotherequity in another

company, cash on deferred terms. A pension, a consultancy retainer?company, cash on deferred terms. A pension, a consultancy retainer?

Which exit route will give me the greatest returns?Which exit route will give me the greatest returns?

IfI decide to float, what will it cost and who will help me?IfI decide to float, what will it cost and who will help me?

IfI decide to seek a trade sale or sale to a third party, how do I find aIfI decide to seek a trade sale or sale to a third party, how do I find abuyer?buyer?


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The NotThe Not--SoSo--Secret Secrets of SuccessSecret Secrets of Success

Critical Success Factors (CSF):Critical Success Factors (CSF): processes,processes,

benchmarks, or components of the business that arebenchmarks, or components of the business that are

essential for the business to be profitable andessential for the business to be profitable andcompetitivecompetitive

Come from sources external to entrepreneursCome from sources external to entrepreneurs

Fall into two categoriesFall into two categories

Outside helpOutside helpEntrepreneurial experienceEntrepreneurial experience

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Entrepreneurial ExperienceEntrepreneurial Experience

Being incorporatedBeing incorporated: a lawyer is likely to give small: a lawyer is likely to give small

business owners advice and help them avoid some ofbusiness owners advice and help them avoid some of

the major pitfalls of a new firmthe major pitfalls of a new firm

EmployeesEmployees: get more done, appeal to a larger market,: get more done, appeal to a larger market,

source of expertisesource of expertise

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Extreme startExtreme start--up capitalup capital: business starting with no start: business starting with no start--

up capital, and those starting with more than 50,000,up capital, and those starting with more than 50,000,

are among those most likely to survive long termare among those most likely to survive long termProtectable intellectual propertyProtectable intellectual property: patents or trademarks: patents or trademarks

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Brand name affiliations or partnersBrand name affiliations or partners: have been: have been

checked out and found to be acceptablechecked out and found to be acceptable

Optimal strategiesOptimal strategies: picking and starting a business in: picking and starting a business in

a growing industrya growing industry

PresalesPresales: pilot test through contracts, orders, or: pilot test through contracts, orders, or

letters of interestletters of interest

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Measuring Success with Four BottomMeasuring Success with Four Bottom

LinesLines

The FirmThe Firm::

Define the level of profit that they seekDefine the level of profit that they seek

Leadership of the industryLeadership of the industry

Employee satisfaction and wellEmployee satisfaction and well--beingbeing

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CommunityCommunity: how the business relates: how the business relatesto the communityto the community

Community impactCommunity impact

Building trustBuilding trust Promoting a positive culturePromoting a positive culture

Enhancing flexibilityEnhancing flexibility

Fostering innovationFostering innovation

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FamilyFamily: spend the time with your family: spend the time with your family

Leave personal time to make the transitionLeave personal time to make the transition

from work to familyfrom work to family

Clear your work list and your mindClear your work list and your mindYourselfYourself: personal returns: personal returns

Variety of expectations, dreams, and goalsVariety of expectations, dreams, and goals

Keeping the dreams aliveKeeping the dreams alive

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valuing business edp sdm

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