James Melton Reporting
David Brophy has an interesting take on Michigan. Brophy, director of the Center for Venture Capital and Private Equity Finance at the University of Michigan’s Ross School of Business, sees our state as in the heart of the “natural home” of private equity and buy-outs.
The Midwest, he says is a place where a lot of money will be made from buying, selling and re-engineering private companies. But that doesn’t mean profits will fall like rain. It can take years, he said, for business owners to get their operations ready for a sale. WWJ’s James Melton asked him to discuss why you need a harvest strategy – even if you don’t plan to sell.
WWJ: What is a harvest strategy?
Brophy: The strategic plan for positioning your company for an orderly “monetization” of the business through transfer of ownership, before or at the time of your phased or final retirement or death, either to family members, employees, or “outside” buyers through a merger or acquisition.
WWJ: As owner of a private busines, why do I need a harvest strategy?
Brophy: If you are the sole owner, and the company is a large portion of your estate, it should be “clean and ready” for transfer or sale in the event of your sudden demise. This same motive will prepare the company for orderly transfer upon your retirement. The better and earlier your strategy, the more this retirement can be “on your own terms.” As well, this will relieve your spouse, family and employees of uncertainty regarding their future connection to the firm.
WWJ: What bad things can happen if I don’t have a harvest strategy?
Brophy: Perhaps the worst outcome is forced liquidation to pay estate taxes at your death. This takes away the earning asset at a depressed price and possibly with a 50 percent tax bill. Alternatively, if you have transferred ownership but have not prepared the company for “life without you”, your spouse, relatives or employees will have to struggle with whatever business and tax problems you’ve left behind, probably defeating the purpose of your hard work to build the company for their economic benefit. Executing your harvest strategy also prepares you economically for ill health or a simple desire to do other things without struggling with a declining business as you age.
WWJ: What forms can this strategy take?
Brophy: A basic strategy assures that someone else can step in to run and grow the value of the company, having purchased or inherited it from you or your estate.This involves at a minimum being sure that the company has strong relationships with and good documentation on all employees, customers and suppliers and their contracts, agreements, transactions and accounting records, and is in full compliance with all regulatory requirements.
Regarding form, in a family transfer, this might involve a “value freeze”, by which the transferring generation takes dividend paying preferred stock and the transferee generation receives full voting common shares.In a transfer for value to employees or outsiders, a leveraged buyout is a common device, with the seller being compensated in cash while, in some cases, retaining securities as “seller financing.”
If you haven’t “monetized” the firm through IPO, sale or “value freeze”, management succession is a key part of this strategy, including a “carve in” investment by those chosen to succeed you. Having these decisions made and executed in advance of ill health or retirement can be helpful and comforting to all involved and can reflect your wishes, perhaps arrived at in consultation with all involved and not in your absence.
WWJ: How can I protect the interest of family members who own minority shares in the company?
Brophy: Orderly conduct and organization of the business provides a good base for this, along with transparency of information for those whose interest you wish to protect. The family transfer referred to above is a good framework in which to do this, and may involve buyout of minority interests for cash as well. A voting trust can be a value, as a device for keeping the block of family shares together and avoiding individuals selling minority shares to people wishing to gain a “toehold” or information rights in the business.
WWJ: How can I protect the interests of key employees?
Brophy: While you can’t give “employment tenure” that binds a future buyer, you can involve key employees as shareholders of the company and encourage them, through executive education training, to have job independence as well as firm-specific domain knowledge. These programs provide your key executives with increased incentives and make them value-adding assets of the company and key parts of your harvest strategy.
This article appeared in The Daily Dash, WWJ Newsradio 950’s Business e-publication.
© 2010 WWJ Radio, All Rights Reserved.