Case # 5-0022
Note on Exits
PY
Updated December 15, 2004
C
O
In the investment world, an “exit” is the process by which founders, management
and investors in a startup or growth company successfully find public or corporate
buyers for some or all of the company’s shares. Through an exit, investors can
realize returns while the company receives an infusion of capital and/or a new
strategic direction from a corporate partner.
O
T
The most popular exit strategies are:
• A merger with another company, either public or private
• An acquisition by another company, either public or private
• An Initial Public Offering (“IPO”) whereby a private company offers its
shares to the general public through a registration process with the
Securities and Exchange Commission (“SEC”)
• A private placement, whereby the company sells its securities to
accredited or institutional investors.
N
As shown in Exhibits 1 and 2, mergers and acquisitions are much more common in
recent years than IPOs. Entrepreneurs that dream of an IPO and insist upon it when
seeking an exit are vastly reducing their opportunities for successfully monetizing
their shares.
D
O
The number and dollar value of exits declined significantly during the economic
downturn of 2000. In 1999, equity underwritings in the technology, health care,
and consumer segments totaled 665 but by 2002, the total was just 151 transactions.
Mergers and acquisitions for the same sectors totaled 988 in 1999 and just 388 in
This document was written by Adjunct Assistant Professor Fred Wainwright and Research Assistant
Angela Groeninger, under the supervision of Professor Colin Blaydon as a basis for class discussion
rather than to illustrate either effective or ineffective management.
Copyright © 2003 Trustees of Dartmouth College. All rights reserved. To order additional copies,
please call (603) 646-0522. No part of this document may be reproduced, stored in any retrieval
system, or transmitted in any form or by any means without the express written consent of the Tuck
School of Business at Dartmouth College.
Note on Exits
Case # 5-0022
2002.1 Furthermore, many companies that did conduct IPOs during the bubble did
not achieve success – almost 70% of companies that went public between 1997 and
2000 could not maintain a market capitalization above $200 million.2
PY
More recently, statistics and market conditions indicate potential for a greater
number and value of exits. Specifically within the private equity industry, given the
increase in number of companies wanting to exit and the rising number of
disenchanted limited partners wanting to see returns on their investments, there is
an increased sense of urgency for portfolio companies to seek exits.
O
The exit market is beginning to show signs of life as 2003 annualized (Q3) activity
in IPOs and M&A transactions well exceeds 2002 levels. See Table 1 below:
Peak Years
531
69
65
665
75
77
45
197
Recession Periods
1991
2002
2003
Annualized
2003 v 2002
% change
55
133
76
264
60
68
23
151
176
140
40
356
193%
106%
74%
136%
42
49
27
118
218
135
35
388
312
136
64
512
43%
1%
83%
32%
T
228
146
138
512
N
M&A
Technology
Health Care
Consumer
Total
1999
O
Equity
Underwritings
Technology
Health Care
Consumer
Total
1993
C
Table 1 – Equity Underwritings and M&A Activity in Select Years
684
239
65
988
D
O
Source: SDC /Thomson Financial and America’s Growth Capital, “Emerging Growth Capital Markets Update,
Third Quarter 2003”
1
SDC/Thomson Financial and America’s Growth Capital, “Emerging Growth Capital Markets
Update, Third Quarter 2003”
2
Liang, Jim and Florence, Tony, Private Equity Exit Alternatives, Morgan Stanley, November 2003
Center for Private Equity and Entrepreneurship
2
Note on Exits
Case # 5-0022
Early Exit Thinking and Strategic Considerations
PY
As part of the Center’s study of exit strategies, we interviewed approximately 25
general partners with venture and buyout firms, entrepreneurs, investment bankers,
lawyers, and accountants. A recurring theme among nearly all of the GPs was that
they only invest in a portfolio company if they have a clear sense at the beginning
of what the exit will be. Several GPs indicated that they need to see at least three
clear buyers at the outset to believe that an M&A exit approach is viable. It is
important early on to explore the type of buyers that would be interested in the
business. If a GP believes that an IPO is the exit vehicle of choice, he needs to
evaluate the likelihood (early on) of the company being able to survive as a
standalone entity.
O
When deciding whether to exit or remain independent, a company’s management
and board of directors should consider several strategic factors3:
C
• How does an exit strategy fit with the company’s original business plan
objectives? A company’s ability to stand as an individual entity should not
be compromised by its pursuit of an exit.
O
T
• Is the company approaching an exit in a position of strength or one of
weakness? Has the marketplace dictated the need for a significantly larger
scale that can be gained through an IPO or M&A or has the market
deteriorated such that being acquired is a means of survival?
N
• What are the financial motives behind the pursuit of an exit strategy? A
successful exit strategy balances the need for additional growth capital with
the need to provide returns on capital to early investors who, after several
years, often seek liquidity.
D
O
• What is the risk/reward trade-off of conducting an exit strategy vs.
remaining a stand-alone entity? It is important to examine the pros and
cons of exiting. Does the potential for expansion and access to additional
capital outweigh potential dilution of ownership and the loss of job security?
3
• Is the company able to manage itself throughout the process? Execution of
an exit strategy involves a significant amount of time and money, especially
the IPO process. Does the company have sufficient funds to complete an
exit strategy? Do the management team and board of directors have the
ability and qualifications to lead the company through this process?
Liang, Jim and Florence, Tony, Private Equity Exit Alternatives, Morgan Stanley, November 2003
Center for Private Equity and Entrepreneurship
3
Note on Exits
Case # 5-0022
• What is the state of public markets? Public markets are volatile, and a
successful exit strategy largely depends on market timing. Many IPOs have
been pulled at the last minute at a high cost due to unfavorable market
conditions.
PY
• What is the state of the company’s systems and controls? Before conducting
an exit strategy, a company will be subjected to a stringent due diligence
process to ensure that all of the proper systems and controls are in place. Is
the company ready for the intense scrutiny of its management and
operations that accompanies the exit process?
C
O
• What decision is in the best interest of shareholders? Evaluate the timing of
the exit – would it benefit shareholders to continue to strengthen the
company as a standalone entity and fetch a higher valuation at a later time,
or is now the optimal time to exit?
N
•
•
•
Does the business solve a particular problem, and if so, is there a large
market demanding that the problem be solved?
How accessible is the target market?
What kind of capital do you have/need to open access to these markets?
What is the company’s track record in meeting or achieving goals and
performance measures?
O
•
T
In addition to these strategic considerations, general partners that we interviewed
also noted the following factors that impact their investment decisions and
eventually the success of their exit strategies:
Comparing IPOs and M&A
O
The following table details the pros and cons of conducting an IPO:
D
[see next page]
Center for Private Equity and Entrepreneurship
4
Note on Exits
Case # 5-0022
Table 2 – Pros and Cons of an IPO
Cons of Conducting and IPO
Significant Time and Money:
Preparation of documents, the due
diligence process, and lengthy meetings
take up a significant amount of
management’s time. Furthermore,
lawyers, accountants, underwriters and
other counsel charge high fees to assist
with the IPO process.
Increased Visibility: Due to the
Increased Scrutiny: When a company
increased media and analyst coverage of goes public, it must file numerous
public companies, an IPO results in
documents with the SEC and disclose
increased visibility for both the company information on its management and
itself and startups in general.
board of directors. With this increased
visibility comes intense scrutiny of
financial information and management
behavior.
Profitability: If an IPO is successful in
Ongoing Disclosure: Public companies
the long-run, founders and early
are required to disclose all events
investors can generate even greater
material to their business through press
returns.
releases and 8K filings with the SEC.
Annual reports, 10K’s, 10Q’s, and other
financial documents must also be
prepared and/or filed for public access.
Opportunity for Liquidity: An IPO
Control Reduced: Founders and/or early
creates an active market where investors investors lose exclusive control of the
can liquidate their shares for cash
company after conducting an IPO.
(following certain regulations). While
Shareholder approval is required for
early investors are usually subject to a
certain activities such as issuing new
lock-up period, they can often make a
stock, M&A activity, or instituting an
significant profit.
employee stock purchase plan.
Attract Solid Personnel: IPO’s offer the Reliance on Market Conditions: Market
ability to entice quality personnel with
conditions have a significant impact on
various stock incentive plans.
the success or failure of an IPO.
D
O
N
O
T
C
O
PY
Pros of Conducting an IPO
Opportunity for Growth: An IPO
exposes a company to a significant
number of investors, giving it access to a
larger pool of capital to use for growth
purposes.
Center for Private Equity and Entrepreneurship
5
Note on Exits
Case # 5-0022
The following table details the pros and cons of conducting a merger or acquisition:
Table 3 – Pros and Cons of an M&A Decision
O
PY
Cons of M&A
Loss of Control: Getting acquired or
merging with another company often
results in a loss of control. In a merger,
the combined company might blend
management teams together or dismiss
current management, depending on the
terms of the deal.
Closures or Job Losses: After a merger
or acquisition, the surviving entity
attempts to achieve synergies resulting
from the combination. These synergies
are often attained by cutting back or
downsizing in areas now deemed to be
unnecessary, duplicated, or extravagant,
which often results in facility closures
and job losses.
O
T
C
Pros of M&A
Accessibility: A merger or acquisition
usually gives the target company access
to additional resources that it did not
have as a standalone entity, thus giving
it more opportunity for growth. For
example, the acquiring/merging
company might have more access to
capital, larger distribution channels, or a
wider customer base.
Liquidity: If a company is acquired or
merges with another company, initial
investors can usually liquidate their
investment in a quick and timely fashion
as compared to an IPO (but may fetch a
lower valuation.)
The IPO Process
D
O
N
An Initial Public Offering (“IPO”) occurs when a private company offers its shares
to the general public after registering its issue with the Securities and Exchange
Commission (“SEC”). The main purpose of an IPO is to raise additional capital
from outside investors to fund the growth of the company. The offer and sale of
securities are governed by the Securities Acts of 1933 and 1934 and enforced by the
SEC on a federal level. On a state level, Blue Sky laws govern the IPO process.
The purpose of these laws is to ensure adequate disclosure to investors and to
prevent fraud. Under the Securities Act of 1933, companies intending to conduct an
IPO must file a detailed registration statement with the SEC which includes in depth
financial, management, and operational information.
Center for Private Equity and Entrepreneurship
6
Note on Exits
Case # 5-0022
Preparation for an IPO
PY
There are a number of requirements a company must fulfill as well as steps it can
take to better position itself for a potential IPO. Depending on the exchange where
the securities will trade, the company will have to meet a minimum market
valuation. The ability to raise a sufficient amount of capital in its offering and the
achievement of a minimum growth rate are also keys to a successful IPO. 4
The cost of taking a company public has increased substantially, largely as a result
of the Sarbanes Oxley Act of 2002. Therefore, M&A has become the more popular
exit strategy in recent years. However, if an IPO is conducted, popular opinion is
that the minimum size for a company to go public has risen from $20-$30 M to
$75-$100 M.
O
T
C
O
If a company is to conduct an IPO as its exit strategy, it needs to begin operating
like a public company well beforehand. Some GPs note that it should be fully
functional as a public company at least 2 quarters before the IPO. Even in an M&A
deal, an acquirer will not want a company with sloppy controls, inaccurate financial
statements, or other questionable practices. It is important to introduce accounting,
financial, and legal internal controls early on in the lifecycle to create the perception
that the company is ready for public scrutiny. Some actions a company can take
prior to conducting an IPO include 1) cleaning up its financial records and ensuring
they are free of material misstatements; 2) creating an investor relations department
to prepare to deal with investors and analysts; and 3) establishing controls to ensure
the timely and accurate preparation of the upcoming disclosures required of a public
company.
D
O
N
A sound and qualified board of directors is also a necessity in completing a
successful IPO, and its selection should be made well before the IPO process
begins. Depending on the exchange, a public company must adhere to strict
corporate governance standards. There are mandatory rules as to the number of
directors that must be independent, and this requirement can prove difficult for
many companies. Venture capitalists who serve on the boards of their portfolio
companies will often be forced to resign as they do not meet the current
independence standards. Furthermore, Sarbanes-Oxley has created even more rules
for public companies, making it expensive and difficult to find qualified directors.
For example, under this new act, five of a company’s directors must be financially
literate and at least two must have had a CPA license at one point.5 These
additional rules and standards emphasize the need for companies with prospects of
4
Gabor Garai and Susan Pravda, How to Take Your Company Public the Right Way at the Right
Time, Epstein Becker & Green RC, May 1996
5
American Institute of Certified Public Accountants (AICPA) Website
Center for Private Equity and Entrepreneurship
7
Note on Exits
Case # 5-0022
going public to find qualified board members early on, as it can be difficult to fulfill
these requirements at the last minute.
O
PY
Finally, many general partners have also noted that it is sometimes necessary to
replace the management team of a portfolio company before it exits. Actually, it is
common to replace management throughout the life of the business. In the venture
capital sector, general partners may replace the entire management team two or
three times as the business enters different phases. Different skill sets and teams are
often needed to manage an early stage company versus a rapidly growing operation
versus a public company. It is important to anticipate when these management
changes are necessary rather than waiting until it is too late and a crisis develops.
Although buyouts are almost certain to make some personnel changes, these will
likely be confined to a handful of key people.
More on Sarbanes-Oxley
T
C
Sarbanes-Oxley has introduced meaningful costs to public companies, taking the
form of internal compliance measures, external audits, and consulting expenses.
The managing director of one accounting firm indicated that internal compliance
costs are the largest costs related to being a public company, but also the hardest to
quantify, and attributes them directly to Sarbanes-Oxley legislation.
N
O
The cost of the legislation is meaningful and often means that a company might
conduct a trade sale in today’s environment (versus an IPO pre Sarbanes Oxley). At
a recent Tuck conference, one VC claimed that compliance costs shaved 4-5
cents/share from portfolio companies. A buyout firm viewed the costs for
compliance to be on the order of $1-2MM a year in ongoing efforts, depending on
the size of the company, and noted that the cost of D&O insurance has also risen
dramatically.
D
O
The average shift in the minimum effective size for companies to go
public is at least largely attributable to increased regulatory costs. Furthermore,
since acquirers who are SEC registrants need to swiftly integrate acquisitions into
their control systems, even portfolio companies exiting via trade sale will have to
undertake compliance activities. The result is that VCs cannot avoid SO expenses
by shunning the IPO route to liquidity.
Center for Private Equity and Entrepreneurship
8
Note on Exits
Case # 5-0022
Selection of an Underwriter
•
Is the underwriting firm too large or too small to handle the size of the
issuance?
Does the underwriting firm have experience in the relevant industry sector?
Does the underwriter have a wide client base and the ability to distribute
shares to a range of institutional and individual customers?
T
•
•
C
O
PY
One of the first steps in conducting an IPO is the selection of an underwriting firm.
An underwriting firm assists throughout the whole IPO process, from the
preparation of the registration statement to setting a price for the company’s
securities. With its access to capital markets, the underwriting firm helps distribute
the company’s shares to institutional and retail clients. Where a private equity firm
is involved, the general partners and Finance Committee often select the
underwriter, as many firms try to limit the involvement of the management team in
the whole process. Both the IPO and M&A processes can be very distracting to
management and take up too much of their time if they are too involved. When
evaluating an underwriter, it is important to consider the size and types of IPOs the
firm has handled in the past as well as its client base. During our interviews with
private equity firms, general partners noted that pricing, sell-side coverage, and
company positioning are important factors to consider when choosing an
investment bank. Other key questions include:
N
O
When a company is planning to conduct an IPO, it will typically hire more than one
underwriter to gain access to a larger pool of public investors. The group of
underwriters working on the deal is called a syndicate. One firm is usually
designated as the lead underwriter with heightened responsibilities, including
setting the final price for a firm’s securities before the IPO, entering into the
underwriting agreement, and controlling advertising. In recent years, the formation
of an underwriting syndicate has been common given the large size of many IPOs.
D
O
As a syndicate, more than one firm will put up the capital to purchase the securities,
and the risk of not selling the securities to the public is spread among the
investment banks. Once a company has selected an underwriter or underwriting
syndicate, a non-binding letter of intent is drafted. The letter of intent includes a
description of the security, the tentative number of shares to be issued, a tentative
price range, underwriters’ compensation, the type of underwriting (firm
commitment or best efforts), and which expenses the company will be responsible
for if the offering doesn’t succeed.6 The agreement does not become final until the
6
Equity Analytics, Ltd. Website, IPO Resource Center
Center for Private Equity and Entrepreneurship
9
Note on Exits
Case # 5-0022
SEC approves the issue and all parties sign a contract, binding them to the letter of
intent.
PY
The underwriting syndicate is paid out of the spread, the difference between the
price the issuing company receives from the lead underwriter and the offering price
to the public. The spread is expressed as a percentage of the gross proceeds of the
offering and is typically about 7%. The fee paid to the syndicate to compensate
them for their expenses and risk is called the syndicate allowance. The lead
underwriter also receives a percentage of every security sold, known as the
manager’s fee.
Types of Underwritings
O
T
C
O
The two main types of underwritings are “firm commitment” and “best efforts.”
“Firm commitment” underwritings are the most popular in the United States, where
the underwriting firm purchases the new securities from the issuer at a stated price
and assumes the risk of not being able to sell them to the public at a higher price.
As mentioned above, the formation of a syndicate mitigates the risk of one firm
being left with all the unsold shares. Furthermore, underwriters often wait until the
last minute, hours before the registration statement is declared effective, to price the
shares, limiting the amount of time between their purchase of the shares and the sale
to investors. There are certain situations where an underwriter can get out of his
“firm commitment” agreement, stated in a “market out” clause of the underwriting
agreement. These situations are usually extreme, as a lenient “market out” clause
would defeat the purpose of a firm commitment underwriting.
O
N
In a “best efforts” underwriting, the issuing company retains the risk of holding any
remaining unsold shares. The underwriter uses its best efforts to sell the shares, but
the underwriting firm never actually owns the securities, and it only makes a
commission on the shares it sells. Any unsold shares belong to the issuing
company. While best efforts underwritings are less common, they are options for
companies conducting riskier IPOs.
The Pre-Filing Period
D
The preparation of the registration statement, usually the Form S-1, begins after the
letter of intent has been signed. The time period before the filing of the registration
statement is called the pre-filing period. The registration statement serves to fulfill
the requirements of the Securities Act of 1933, providing full disclosure on the
company intending to go public. The registration statement includes the prospectus,
which is given to potential investors, along with additional information on the
company. It provides investors with detailed information on the company, its
Center for Private Equity and Entrepreneurship
10
Note on Exits
Case # 5-0022
PY
management, its business, and its relevant risk factors to allow investors to make an
informed decision. It also includes the company’s financial statements. The
registration statement is prepared by a group of attorneys, accountants, and
underwriters, in collaboration with the issuer. For a more detailed description of the
items included in the registration statement, see Exhibits 3 and 4. There is
significant legal liability for any material misrepresentations in the document;
therefore a lengthy due diligence investigation of the issuer is conducted. Duediligence procedures entail reviews of the company and its management, including,
but not limited to, visiting facility sites, reviewing significant agreements and
contracts, financial statements, tax returns, board of directors and shareholders'
meeting minutes, and performing various analyses of the company and the industry
in which it operates by the attorneys and underwriters.7
C
O
During the pre-filing period, it is imperative that the issuing company makes no
offers to sell its securities. Formal or veiled attempts at publicizing an offer to sell
securities before the registration statement is filed, also known as “gun-jumping”, is
strictly prohibited as it could generate demand for the issuance with potentially
misleading information. If the SEC finds a company guilty of inappropriate
disclosure, it can impose fines or postpone the IPO.
T
The Waiting Period (or Cooling Off Period)
N
O
The waiting period is the time between the filing of the registration statement with
the SEC and its effective date. During this period, oral offers to sell the issuer’s
securities can be made, but no actual sales can take place. There are specific
regulations as to the type of written material that can be distributed during the
waiting period (no brochures, television advertisements, articles, etc. about the
issuer).
D
O
Company management and underwriters will also visit institutional investors who
have interest in the IPO in a road show. The road show gives an indication of the
demand for the new issue, but any indications of interest are non-binding. A red
herring, or preliminary prospectus, can be given to potential investors. A red
herring does not include any price-related information on the securities since the
offering price is not set until the effective date, but it does include most of the other
pertinent information that investors would use to make a decision. It must be stated
in the document that it is not intended to be an offer to buy or sell securities.
A tombstone ad is also permitted during the waiting period to provide limited
information on the IPO (although it is typically published after the effective date of
7
PricewaterhouseCoopers Website, The Going Public Process
Center for Private Equity and Entrepreneurship
11
Note on Exits
Case # 5-0022
the registration statement). The ad can announce the offering and its dollar amount,
identify certain members of the underwriting syndicate, and note where and from
whom a copy of the company’s prospectus can be obtained.8
C
The Post-Effective Period
O
PY
After the registration statement is sent to the SEC, there is a review process
whereby the SEC and the company intending to go public exchange edits.
Typically, the SEC takes an average of 30 days to release its initial revisions in a
comment letter. Each comment must be addressed; furthermore, amendments must
be made to the registration statement for any interim developments between its
filing date and the effective date. The offering is usually priced immediately before
the underwriting agreement is signed and the day before the registration statement
is effective. The underwriter prices the shares, with the approval of company
management, based on the company’s financial performance and growth prospects,
the stock price of other companies in the sector, market conditions, and the amount
of interest already generated in the issuance from the road show.
N
O
T
After the revisions have been made to the registration statement and approved by
both the SEC and the company, the statement becomes effective with the SEC.
During the post-effective period, offers to buy and sell may be made freely.
Investors, management, and insiders owning pre-IPO shares in the issuing company
are subject to a lock-up period, typically 180 days after the IPO is declared
effective, where they are not allowed to sell their shares. If insiders were allowed to
sell their shares immediately, it could cause a downward spike in the company’s
stock price, undermining the initial public offering price. Furthermore, pre-IPO
shareholders are often limited in the amount of shares they can sell, as large sales
might convey the perception to investors that early stakeholders lack confidence in
the company’s future.
After the IPO
D
O
After conducting an IPO, a company must abide by a new set of rules set forth by
the SEC to regulate public companies. These new requirements often entail a
significant amount of extra time and money as compared to the company’s pre-IPO
life. The most time-consuming changes to a newly public company are the
increased reporting and disclosure requirements. At a minimum, public companies
must file quarterly (10Q’s) and annual (10K’s) earnings reports with the SEC, as
well as annual reports to shareholders and proxy solicitation materials.
Furthermore, public companies have an obligation to report matters through press
8
Ibid.
Center for Private Equity and Entrepreneurship
12
Note on Exits
Case # 5-0022
releases that could have a material impact on their business, such as earnings
revisions, merger/acquisition activity, or management changes.
Mergers and Acquisitions
C
O
PY
Along with the increased disclosure requirements comes increased scrutiny of
company management and directors. Individuals involved with a public company
are prohibited from taking certain actions. For example, insider trading, or trading
securities based on non-public information, is strictly prohibited. Along those lines,
Regulation Fair Disclosure (“Reg FD”) went into effect in October 2000. This rule
bars companies from practicing “selective disclosure” of pertinent nonpublic
information. It is especially applicable to the disclosure of information to analysts
and institutional investors. If information is disclosed unintentionally, a subsequent
press release must be issued 1) within 24 hours of the disclosure or 2) before the
next market opening, whichever is later. There are also numerous other disclosure
and corporate governance rules depending on the exchange on which the company
trades.
O
T
The cost of conducting an IPO has significantly risen in recent years due to the
passage of the Sarbanes-Oxley Act and an increase in regulations required by the
SEC and the various exchanges. Combining this cost increase with the need for
consolidation and improved performance by many companies, M&A is now the
dominant exit strategy. Good companies will exit roughly 80% M&A and 20% IPO
– many other companies will not find an exit.9
D
O
N
Some experts argue that a company should not exist with the sole intention to
merge or be acquired but should first experience success as a stand-alone entity.
The need to merge or be acquired should then come when the company is on a fast
track and needs an infusion of capital to grow, access to facilities or distribution
channels, or additional expertise that only another company could provide.
Furthermore, M&A deals often yield the best terms for companies with strong
growth prospects rather than a solid past performance. In other words, terms of a
combination or acquisition are likely to be much more favorable for companies with
a solid market share and the potential to improve margins.
9
America’s Growth Capital, “Emerging Growth Capital Markets Update, Third Quarter 2003”
Center for Private Equity and Entrepreneurship
13
Note on Exits
Case # 5-0022
M&A Structures
The following table shows a sample of the most common M&A structures.
Type of Structure
Forward Merger
Description
Target merges into acquirer’s company and target
shareholders get acquirer’s stock
Acquirer merges into target’s company and acquiring
shareholders get target company’s stock (In some cases a
private company uses a reverse merger with a public one as
a way to go public at a lesser cost and with less stock
dilution than through an IPO.)
An acquirer incorporates an acquisition subsidiary and
merges it with the target company.
Target company’s assets are conveyed to the acquirer’s
company in exchange for the acquirer’s stock.
The acquirer purchases all or substantially all of the
common stock of the target company for a specified price.
The buyer replaces the selling stockholders as the owner of
the target company.
The buyer buys specific assets and perhaps some liabilities
that are explicitly detailed. The tax and accounting basis of
the assets, including any goodwill being purchased, is the
purchase price.
Triangular Merger
O
Stock Acquisition
T
Subsidiary Merger
C
O
Reverse Merger
PY
Table 4 – Common M&A Mechanisms
N
Asset Purchase
O
Source: Nicholas J Jr Mastracchio and Victoria M Zunitch “Differences Between Mergers and
Acquisitions,” Journal of Accountancy, November 2002
M&A Preparation
D
There are a number of issues to take into account when considering merging with
another company or getting acquired.
•
Who is the potential acquirer? A company in the M&A market should take
the time to identify its own strengths and weaknesses and then compare
them to those of the potential combining/acquiring company. It is important
Center for Private Equity and Entrepreneurship
14
Note on Exits
Case # 5-0022
to understand what the acquirer has to offer, how these attributes would
benefit the target company, and the motive behind the desire to merge or
acquire. Common motives behind the pursuit of a merger or acquisition
include the following:
Strategic: the target company has a technology or service that the
acquirer cannot or will not build or develop on its own.
Defensive: the target company offers too much competition or is
stealing too much market share from the acquirer.
Financial: the purchasing entity needs the target company to
strengthen its financial statements.
Growth: a financial conglomerate has the capital, a well-developed
distribution network, and certain expertise to further develop an
existing company.
PY
O
What will be the impact on the target company’s business? When
considering M&A activity, it is necessary to assess whether or not the
combination will enhance the target company’s core competencies. Will the
acquirer provide the target with the best opportunity to expand and gain
additional market share? Are the founders and initial shareholders ready to
relinquish their leadership and control of the company if necessary?
•
What will be the impact on the management and employees? Retention of
key management and personnel can be critical. Furthermore, employees
often become nervous upon hearing rumors of M&A activity within their
own companies, especially since it can lead to downsizing and layoffs. In
fact, studies found ‘employee problems’ as being responsible for between
one-third to a half of all merger failures.10 If downsizing must occur, it is
important to conduct it in a sensitive manner as it will affect the morale and
loyalty of existing employees.
N
O
T
C
•
How will a merger/acquisition impact investor returns? M&A activity is
the exit strategy of choice in today’s economic environment, partially
because it usually allows investors to exit faster than an IPO. However,
competition among acquirers has declined in recent years, allowing buyers
to shop around and negotiate cheaper deals, resulting in lower returns for
early investors.
D
O
•
10
Jennifer Jin, The Ups and Downsizing of Mergers, Business Weekly, 2002
Center for Private Equity and Entrepreneurship
15
Note on Exits
Case # 5-0022
Current Trends
PY
Given today’s volatile economy and the difficult IPO market, companies are finding
it necessary to explore their exit options. Some companies elect to employ a “dual
track” strategy whereby one team looks for potential acquirers while the other team
prepares for an IPO. Under this strategy, the company tries to better position itself
to take advantage of either exit vehicle should the opportunity arise.
Despite the weakness in exits over the past few years, there are signs of an up-tick
in transactions. The following table details the current conditions that indicate a
potential increase in IPO and M&A activity:
M&A
Overcrowding in many sectors and
maturing product lines are encouraging
consolidation.
Strong stock prices and improved
operating performance have made both
buyers and sellers more enthusiastic
about M&A.
Companies are poised to acquire after
focusing on structure and cost
containment, but active buyers are more
sensitive to value, accretion, and
potential shareholder reaction.
Targets now have real traction and
revenue growth.
T
C
IPO
Increase in investor confidence and
appetite for risk due to recent improved
returns in financial markets.
Private companies have gone a long
time without new capital and liquidity.
O
Table 5 – Recent IPO and M&A Trends
D
O
N
O
Private companies have had 3 years to
mature and grow stronger. Companies
that have emerged from the downturn at
or near profitability are very strong IPO
candidates.
Emerging growth businesses are much
healthier today and showing some
growth with the economy.
Hedge funds have hundreds of billions
of dollars to invest and are leading the
way. They have also encouraged major
investors to act more aggressively in this
environment.
Wall Street is ready to get back to
business.
Large buyers have taken advantage of
lower asset values.
Going private transactions are beginning
to gain momentum.
Source: America’s Growth Capital, “Emerging Growth Capital Markets Update, Third Quarter
2003”
Center for Private Equity and Entrepreneurship
16
Note on Exits
Case # 5-0022
Dutch Auctions
PY
Dutch auctions have recently been brought to the forefront given the highly
publicized Google IPO. W.R. Hambrecht introduced the OpenIPO, a Dutch
auction, in 1999. Since then a handful of companies have used the process to go
public including Peets Coffee & Tea and Overstock.com.
O
In a Dutch auction, a company reveals the maximum amount of shares being sold
and sometimes a potential price for those shares. Investors then state the number of
shares they want and at what price. Once a minimum clearing price is determined,
investors who bid at least that price are awarded shares. If there are more bids than
shares available, allotment is on a pro-rata basis--awarding a percent of actual
shares available based on the percent bid for--or a maximum basis, which fills the
maximum amount of smaller bids by setting an allocation for the largest bids.11
D
O
N
O
T
C
It remains to be determined whether the Dutch auction method will become a
popular alternative to the traditional IPO.
11
IPO Dutch Auctions vs. Traditional Allocation, Ari Weinberg, Forbes.com
Center for Private Equity and Entrepreneurship
17
Note on Exits
Case # 5-0022
Exhibit 1 - Total Value in Millions of Dollars
Q2 03
Q3 03
$13,458
$187
$15,109
$1016
$9,210
$0
$15,650
$238
$1,515
$0
$2,011
$0
C
O
PY
Transaction Values
Q1 02
Q2 02
Q3 02
Q4 02
Q1 03
Technology
M&A Transactions
$8693
$11,914 $9150
$8538
$6920
IPOs (a)
$125
$324
$0
$0
$0
Health Care
M&A Transactions (b) $4,218
$11,028 $4,860
$7,463
$6,710
IPOs
$2,522
$1,126
$30
$522
$0
Consumer
M&A Transactions
$3,507
$2,765
$1,500
$2,381
$1,088
IPOs
$691
$413
$155
$146
$0
Note: Includes US Transaction valued at or above $20 million.
(a) Excludes $870M IPO for Seagate Technology, Q4 02
(b) Excludes Pfizer Inc acquiring Pharmacia Corp on 7/15/02 for $59.5 B.
T
Source: America’s Growth Capital, Emerging Growth Capital Markets Update, “Third Quarter
2003”
O
Exhibit 2 - Total M&A and IPO Volume
Q2 03
Q3 03
51
2
78
6
24
0
34
3
13
0
16
0
D
O
N
Transactions
Q1 02
Q2 02
Q3 02
Q4 02
Q1 03
Technology
M&A Transactions
69
57
41
51
37
IPOs (a)
2
6
0
0
0
Health Care
M&A Transactions (b)
42
38
20
35
26
IPOs
3
9
1
3
0
Consumer
M&A Transactions
13
7
9
6
12
IPOs
2
3
2
2
0
Note: Includes US Transaction valued at or above $20 million.
(a) Excludes $870M IPO for Seagate Technology, Q4 02
(b) Excludes Pfizer Inc acquiring Pharmacia Corp on 7/15/02 for $59.5 B.
Source: America’s Growth Capital, “Emerging Growth Capital Markets Update, Third Quarter
2003”
Center for Private Equity and Entrepreneurship
18
Note on Exits
Case # 5-0022
Exhibit 3 - Items Included in the Prospectus (Part I)
•
•
•
•
PY
O
•
•
•
C
•
•
•
•
•
•
•
•
•
A summary of the information presented in the prospectus.
A discussion of risk factors
A description of the company, including what business it is in, its corporate name and
operating history.
Information regarding management.
Information regarding any promoters.
Summary information on corporate earnings.
A description of the company’s capital structure.
A description of the stock being registered and other securities being registered.
The plan of distribution.
An explanation of how the proceeds are to be used.
A list of sales being made for other than cash.
A list of the principal holders of securities along with the number of shares owned by each
principal holder.
Disclosures of any interests management has in certain transactions.
A statement setting for the compensation of officers and directors.
Disclosure of any options to purchase securities, including the number of options
outstanding and their exercise price.
Disclosure of any pending legal proceedings.
Any legal opinions of counsel.
Management’s discussion and analysis of the company’s financial condition and results of
operations.
Financial Statements
T
•
•
•
D
O
N
O
Source: Heim, Robert G, Going Public in Good Times and Bad, 2002
Center for Private Equity and Entrepreneurship
19
Note on Exits
Case # 5-0022
Exhibit 4 - Items Included in Part II of the Registration Statement
•
•
PY
•
•
A list of expenses associated with the issuance and distribution of the securities.
Disclosure of any relationship with experts named in the registration statement.
Listing of sales to special parties.
Disclosures of any recent sales of unregistered securities.
Information about the registrant’s subsidiaries.
A discussion of the effect of any charter provision or bylaw under which an officer or
director is indemnified against liability which he may incur in his capacity as such.
Any exhibits, including any material contract not made in the ordinary course of business.
Disclosures of certain undertakings that the issuer must perform after the conclusion of the
offering.
Signatures of the company’s officers and directors to confirm that they have read and
approved the registration statement.
Consent of the certified public accountant to the use of its auditing reports in the
registration statement.
O
•
•
•
•
•
•
D
O
N
O
T
C
Source: Heim, Robert G, Going Public in Good Times and Bad, 2002
Center for Private Equity and Entrepreneurship
20
Note on Exits
Case # 5-0022
Exhibit 5 - Estimated Cost of Going Public (NASDAQ Exchange)
$2,363,174
$50 million
5,880,000 shares
Estimated Fee
19,828 (2)
6,250 (3)
100,000 (1)
160,000 (1)
200,000 (1)
25,000 (1)
34,200 (1)
63,725 (4)
11,960 (5)
5,000 (1)
PY
$25 million
5,880,000 shares
Estimated Fee
9,914 (2)
3,375 (3)
100,000 (1)
160,000 (1)
200,000 (1)
25,000 (1)
34,200 (1)
63,725 (4)
11,960 (5)
5,000 (1)
O
Offering Value
Total shares outstanding
Item
SEC Fees
NASD Fees
Printing and Engraving
Accounting Fees & Expenses
Legal Fees & Expenses
Blue-Sky Fees (6)
Miscellaneous
Nasdaq Entry Fees
Nasdaq Annual Fees
Transfer Agent and Registrar
Fees
Total
$4,125,963
D
O
N
O
T
Source: NASDAQ Website, Going Public Manual
C
(1) Mean value; issuers should be aware that all aspects of the relationship, including underwriting, can be negotiated.
(2) 1/29 of 1 percent of the offering value, inclusive of over-allotment shares.
(3) $500 + .01 percent of the offering value, inclusive of over-allotment shares, not to exceed $30,500.
(4) Includes a $5,000 one-time company initial fee and a fee based on 5,880,000 total shares outstanding.
(5) Fee shown is a full year’s fee. On Nasdaq, first year of annual fee will be prorated based on month listed.
Center for Private Equity and Entrepreneurship
21
Note on Exits
Case # 5-0022
Exhibit 6 - Initial Public Offering Schedule
Company
1-2 years before
1-6 months before
Act like a public
company
Select the team;
execute letter of
intent
Perform
housekeeping of
company records;
Draft S-1; file with
the SEC; file
Nasdaq listing
application.
Clean up and restate
balance sheet;
prepare and review
audited financial
statements
Assess market;
make presentation to
board.
PY
This schedule applies to a fully syndicated, fixed price offering for both U.S. and non-U.S.
companies. The time frames are merely illustrative.
Begin due diligence
Prepare NASDR
filing; undertake
blue-sky filings
Produce SEC &
NASDR filing
packages.
Review
preliminary
registration
statement; issue
comfort letter
Review
preliminary
registration
statement; issue
comment letter
N
O
T
Investment
Banker(s)
O
SEC
Request pre-filing
advice, if necessary
D
NASDR
Print preliminary
registration
statement/prospectus
Confer regarding
problems, if
necessary
Center for Private Equity and Entrepreneurship
1-4 weeks
before
Executives
present the road
show
Clear SEC
comments
Prepare draft
comfort letter
Prepare updated
financial
statements, if
necessary.
Continue due
diligence.
Orchestrate road
show; solicit
expressions of
interest
Clear NASDR
comments.
C
Company
Accounting
Firm
Investment
Banker’s
Counsel
Financial
Printer
Prepare & file
preliminary
registration
statement
O
Company Law
Firm
1-3 months
before
Select printer &
transfer agent
Resolve
comments.
22
Note on Exits
Company
Law Firm
Company
Accounting
Firm
Investment
Banker(s)
Deliver draft
comfort letters
Investment
Banker’s
Counsel
Financial
Printer
Continue due
diligence
Price the
offering;
execute
underwriting
agreement.
Day of IPO
Trading of
company’s
securities
begins.
Request
acceleration;
file final
registration
statement.
Deliver final
comfort letter
Execute
underwriting
agreement
3 days after
Provide
certificates;
collect
proceeds
Deliver
documents/
opinions
Deliver bringdown comfort
letter
Provide net
proceeds
0-30 days
after
Provide
additional
certificates;
collect
additional
proceeds.
Update
closing
documents.
Assist in
closing
Second bringdown comfort
letter
Exercise
overallotment
option; make
determination
about issuing
research
report.
Assist in
second
closing
Print final
registration
statement/
Prospectus
Declare
offering
effective
Declare no
objections.
O
N
SEC
T
C
Form
syndicate;
place
tombstone ad.
1 day before
PY
1-10 days
before
Issue press
release.
O
Company
Case # 5-0022
NASDR
D
O
Source: NASDAQ Website, Going Public Manual
Center for Private Equity and Entrepreneurship
23
Note on Exits
Case # 5-0022
Sources
America’s Growth Capital, Emerging Growth Capital Markets Update – Third
Quarter 2003 “Revival of the IPO”
PY
Bierce & Kenerson, P.C. Website, Angel Investors and Venture Capital Investing:
Financial Investor’s Rights in a Startup Venture
Fellers, Charles, Making an Exit: VCs Examine their Options, Venture Capital
Journal, May 2001
O
Garai, Gabor and Pravda, Susan, How to Take Your Company Public the Right Way
at the Right Time, May 1996
Heim, Robert G, Going Public in Good Times and Bad, 2002
C
Kerig, Bill, The Initial Public Offering, The Successful Exit, December 2002
Lajoux, Alexandra and Elson, Charles, The Art of M&A Due Diligence, 2000
T
Levin, Jack, Structuring Venture Capital, Private Equity, and Entrepreneurial
Transactions, March 2001
O
Liang, Jim and Florence, Tony, Private Equity Exit Alternatives, Morgan Stanley,
November 2003
N
Machiz, Robert, M&A Viewpoint, Pricing Acquisitions, Moneysoft Website
Mastracchio, Nicholas and Zunitch, Victoria, Differences Between Mergers and
Acquisitions, Journal of Accountancy, November 2002
O
NASDAQ Website, Going Public Manual
Nasr, Heidi, IPO Candidates Opting Out for Merger, The Daily Deal, April 2001
D
Neal, John and Pinson, Linda, Developing an Exit Strategy, Start the Race with the
Finish Line in Sight, Anatomy of a Business Plan, 1999 & 2002
Newbold, Gail, Getting Acquired, The Successful Exit, December 2002
Orol, Ron, The New Costs of Going Public, The Daily Deal, 2003
Center for Private Equity and Entrepreneurship
24
Note on Exits
Case # 5-0022
PricewaterhouseCoopers Website, The Going Public Process
Primack, Dan, IPOs: An Exit Strategy of the Past for VCs, Private Equity Week,
September 2002
PY
Rind, Kenneth and Mushkin, Martin, “Exiting” by Disposition – Negotiating an
Acquisition, October 1996
Snow, David, Private Equity Exit Alternatives, Private Equity Central, May 2003
Sormani, Angela, Exits: The IPO Alternative, European Venture Capital Journal,
November 2002
O
Stein, Tom and Debellis, Matthew, VC-Backed Companies: Desperately Seeking
Partners, Private Equity Week, August 2002
C
Volpe, Lou, On Their Own, The Daily Deal, May 2003
D
O
N
O
T
Weinberg, Ari, IPO Dutch Auctions vs. Traditional Allocation, Forbes.com
Center for Private Equity and Entrepreneurship
25
When It Comes To Developing An Exit Strategy, It Pays To Be Creative
By Chris Myers
I write about my journey as a first-time CEO and startup founder.
Forbes.com – April 18, 2018
When it comes to exits, it pays to be creative.
If you sit back and think about it, the concept of modern tech
investing seems ludicrous. Investors pour vast sums of money
into ideas they believe will become the “next big thing” and only
stand to gain in the event of an exit.
When most of us think about business exits, our minds instantly
go to one of two scenarios: acquisition or IPO.
Of course, only a fraction of entrepreneurial ventures ever get
acquired, and even fewer ever decide to go public. How then, are
investors ever supposed to see a return on their capital?
PHOTO BY BERNARD HERMANT ON UNSPLASH
The truth is that most don’t. Most entrepreneurial ventures, especially those in the tech world, sit by
hoping to be acquired until they eventually (and inevitably) run out of cash
Sure, there are a few that focus on generating cash flow (such as Basecamp and Infusionsoft), but
they’re in the minority. Most have the philosophy of “go big or die trying.”
I think this belief is ridiculous and limits both investors and the entrepreneurs they back.
In reality, there’s more than one way to exit a business, and entrepreneurs would be wise keep this fact
in mind.
The tragedy of the “all or nothing approach”
Over the past eight years at BodeTree, my co-founder and I have fielded more discovery calls with
potential acquirers than I can remember. Nearly all of our prospective suitors were interested in one
aspect or another of the business, but rarely the entire entity.
At the time, however, we found ourselves in a position where we could only accept an “all or nothing”
offer. We felt that an all-out acquisition was the only way to provide an attractive return for investors,
and we weren’t exactly wrong.
I remember the first serious offer we ever had. We were four or five years into BodeTree at the time
and were approached by a publicly-traded bank technology company from the East Coast.
They loved what we had built, but were only really interested in the technology and offered a price that
was far below the valuation established in our most recent investment round.
We stuck to our guns and pushed for a valuation that would provide a positive return for our investors,
and ultimately looked a little foolish for doing so. Suffice to say; the deal died rather quickly after that.
When faced with adversity, get creative
My partner and I realized that we had boxed ourselves in by our business model and valuation. While
our technology was valuable, we did not yet have the cash flow necessary to justify our desired sales
price.
Now, in frothy markets, this isn’t an issue. Companies will pay a tremendous premium for strategic
purposes when pursuing a hot market. The banking sector, however, proved to be far different.
Not only was it more conservative, but it also had little interest in the broad application of our
technology. Instead, most acquirers wanted to incorporate it in-house to bolster their tech credentials.
This led to a significant revelation. We needed to change our approach so we could open up new ways
to maximize the value of our assets.
How we did it
First, we had to take our product and carve out distinct offerings based on sales channel. The
technology needed to be unique enough to serve a particular segment of the market, while still retaining
the necessary flexibility to suit our diverse needs.
We did this by focusing on two verticals: franchising and banking. This move enabled us to begin to
isolate the value of each respective channel and package it for a potential sale.
Next, we expanded our business so that we had the cash flow necessary to support the company
independently, thus lessening our dependence on any one given product. We did this by acquiring
VelocityFD, a services-based franchise development company that complemented our strategy and
provided an independent revenue stream.
At this point, we were in a position to do two things: First, we could sell our banking channel as-is at
a valuation that made sense for more buyers. Second, we managed to retain the franchising segment of
the business, which was profitable.
This allowed us to offer our investors an outsized and, far more confident, return. There was the onetime bump that resulted from the sale, but also the cash flows from the remaining business.
Don't be afraid to break the rules
As entrepreneurs, we find ourselves often adhering to an unspoken set of rules about how things are
done. The truth is that there are no rules for exiting a business. We are limited only by our creativity.
The partial sale that BodeTree pursued made excellent sense for our team and our investors. It enabled
us to sell off an asset and line of business for a price that made sense in the market while refocusing
the existing company toward a new and more profitable segment.
More entrepreneurs should abandon the pursuit of the all or nothing sale and instead find creative ways
to realize value for shareholders.
Chris Myers is the Cofounder and CEO of BodeTree, a Partner at BT Ventures, a frequent MSNBC
contributor and the author of “Enlightened Entrepreneurship.”
Purchase answer to see full
attachment