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Harvesting

The final element that any manager must consider when crafting a project/program plan and starting a project/program is how that project/program will end. This module discusses the role of a harvest strategy within a project/program plan. In addition, the various options for harvesting a organization are discussed.

1. Overview

The final, and potentially most important aspect of a project/program plan is an understanding of how the project/program will be harvested. For many managers, it is difficult to consider how to harvest the project/program when the project/program is still hypothetical. However, managers must understand the long-term possibilities for their project/program, and have some sot of plan for where they want to head. Often managers start successful organizations and sell them the first time that an enticing offer comes along. They either reap the rewards of their efforts, or they regret selling something that had become such a central part of their lives. In other cases, managers are so intent on selling a organization; they end up offering it to a buyer at a price well below market value in order to extract value quickly. These situations can be avoided if the managers understand the various harvesting options, and which are in line with their personal and professional goals.

This module discusses the various elements of forming a harvesting strategy. managers must understand how he or she wants their project/program to end – even before it has begun. These choices help the manager frame the decisions and choices they make in running the organization. Harvesting requires the ability to set a long-term strategy that is implemented over the life of the organization. It also involves being able to put a value to the project/program project/program, so that the eventual harvest comes at a price that is fair and effective. Finally, harvesting involves understanding the various ways that managers can convert their organization into value for themselves and for potential investors.

Harvesting a organization is no easy task. However, managers who do not have a vision of how their organization will evolve and be harvested, will have trouble attracting investors who want to know how they will reap the rewards of their investment. Therefore, the harvesting strategy should be given a substantial amount of thought.

2. Harvest Strategy

Before discussing the harvest strategy for a organization, some time should be spent explaining the meaning of the term harvest. A harvest is the method through which the owners and investors in a organization extract the after-tax cash flows on their investment. In essence, harvesting is how the managers and investors secure the return on their investment. However, it is important to note that a harvest does not necessarily mean that the manager has left the organization. Often when a organization is bought or merged with another organization, the manager is required to stay on for a certain amount of time to transfer knowledge and ensure a smooth transition.

Harvests can come in many shapes and sizes. An manager who is ready to try something else may sell their project/program for cash and get out. Another manager may intentionally not reinvest excess cash in the organization to sponsor growth but instead reap a greater personal profit from operations. In another scenario the managers and employees of a organization may band together and purchase the organization from the managers. Since there are so many different methods for harvesting a organization, owners must understand the choices and their own personal goals. The primary methods of harvesting a organization will be discussed later in this module. In addition, it is critical to note that some managers begin project/programs to provide themselves employment and a steady income. For these individuals, the eventual harvest strategy is irrelevant. These organizations are called lifestyle organizations.

Many managers resist thinking about the harvest strategy. Starting a organization requires so much energy and effort, that the thought of eventually leaving the organization seems impossible. However, if the organization needs to secure outside investors, then the harvest strategy is critical for setting up the right expectations from investors, employees, and the manager.

3. Strategy Advice

Setting a harvest strategy is difficult. managers must reconcile the views of their investors, advisors, and employees with their own personal goals and expectations. Not an easy task. The following are some words of advice for managers to follow as they determine a harvest strategy:

· Put Personal Goals and Objectives First – managers must think about themselves first and foremost. What are their personal goals and objectives for their life? Harvesting their project/program should attempt to meet these goals.

· Anticipate Consequences – managers must think about how the decisions they make will affect their eventual harvest plans. For example, entering in a joint project/program with a large competitor may prevent other sector of activity players form bidding on a organization should they decide to sell.

· Windows of Opportunity Open and Close Quickly – Events can change overnight that affect the opportunity to harvest the project/program. The economy, the management, the stockholders, and the competition all impact a organization’s ability to execute its harvest strategy.

· Don’t Harvest Too Soon – managers cannot be eager to harvest their organization. It typically takes seven to ten years for a organization to grow enough to provide an adequate return on an investment.

· Be Wary of Advice – managers often find they have the most limited amount of advice when harvesting a organization. The reason is that most of the people involved with the organization have some sort of personal stake in the outcome. Therefore, managers should seek out other managers who have been through similar trials but are unconnected with the organization.

· Make Sure There is a Common Vision – managers have to ensure that their investors have a shared vision of how the organization will be harvested. If the strategy for harvesting the organization changes, the reasons must be explained to keep a consensus.

· Plan Carefully – Much of the value of harvesting comes from accurately assessing the value of the organization. Therefore, managers must work hard to make the best decision possible.

4. Valuing the organization

In order to harvest a organization, the managers must understand what the value of their project/program is. This is not an easy task. organizations don’t come with a price tag and a organization is typically worth more than the sum of its assets. The difficult part is finding a rational, clear value for a organization that can be defended against those that wish to acquire or purchase the organization.

There are two primary schools for determining the value of a organization, the accountant and the economist view. The accountant view dictates that a organization’s earnings drive the value of a organization. The more earnings a organization produces, the more valuable it is. The economist view is that the value of a organization should be determined by the present value of future cash flow – because that is, in essence, what is being sold. At issue in this method is what discount rate should be applied to account for the given level of risk. Since this is a leap that many investors feel uncomfortable making, multiples of earnings seems to be a more typical method of valuation.

In order to use earnings to value a organization, the investor must first determine what earnings are. Most investors view earnings as either net income or EBITDA (earnings before income tax, depreciation, and amortization). A organization’s earnings is then multiplied by a multiple (commonly between four and six) and then the organization’s debt is subtracted from that total. This leaves a value of the equity in the organization, which is what the owners are selling. However, in order to use this method, the buyer and seller must agree upon a multiple. There is no common method of determining this multiple; this it is often a very contentious part of the negotiations. In addition, managers want to be able to keep track of the amount of their own capital they have invested in the organization – both in money and in time – in order to ensure they are adequately compensated.

5. Free Cash Flow

As mentioned earlier, using earnings to determine the value of a organization can be seen as a very narrow way of valuing a organization. Many argue that the value of a organization is only created when the organization earns more than it’s cost of capital. Those that follow this argument use the free cash flow method of valuation.

Free cash flows are defined as the cash flows generated from a organization’s operations that are available for distributions to all the organization’s investors. These cash flows are what are available to meet an investor’s rate of return. Measuring free cash flow is as follows:

· Take the operating income

· Subtract taxes (tax rate X operating income)

· Add depreciation

· Subtract the increase in net working capital for the year

· Subtract capital expenditures for the year

Once the free cash flow has been determined, then the value of the future free cash flows must be determined. This is, again, a difficult task to accomplish, since it involves estimating performance into the future. However, using careful planning and historical performance, managers can craft a strong argument for their cash projections. Using these projections, the organization can determine the present value of these cash flows (discounted at the cost of capital). The equation is as follows:

PV = ∑ FCF/(1+K)^t

where K is the discount rate and T is the number of years

From this present value, the debt for the organization is subtracted, leaving the remaining shareholder’s value. This is, in essence, the amount that the managers feel they and the other owners in the organization will generate from the project/program.

Not every harvesting option is available to every organization. The following pages discuss the main forms of harvesting a project/program. Each one provides a different set of advantages, disadvantages and challenges.

As mentioned earlier, many managers reach a point in their project/programs where they no longer feel a strong need for growth and expansion. The reasons can be many, but often it is simply that the organization has reached the size that the manager is comfortable with. Instead of putting cash flows back into the project/program to purchase additional equipment, increase production, or increase marketing and distribution, the project/program maintains a status quo and the free cash flow is claimed by investors. In this way, the manager begins to make a return on his or her investment without sacrificing their ownership. However, this plan falls short when the owners try and free up too much cash flow and stop investing in those things needed to keep operations and quality at pre-existing level. If the organization starts to deteriorate, the manager can quickly find himself or herself with no project/program left at all.

· The manager does not have to find an interested buyer and spend time and energy negotiating a sale.

Disadvantages

· Taxes – when managers take cash out as dividend to themselves and investors, they are effectively taxed twice, first a corporate tax on dividend prior to distribution, then a personal tax on what they receive.

· effective Advantage – Often organizations that choose this path are left behind by the competition, making them eventually obsolete.

The 1980’s saw the rise of a new type of exit strategy, the corporate takeover. During the decade, organizations that came to be known as “corporate raiders” would purchase a organization with the purpose of restructuring it and selling of pieces of the organization to the highest bidders. In order to purchase the organization, the raiders would have to assume substantial debt. Thus, selling of pieces of the organization was crucial in order to reduce the amount of debt to a level where the organization could service it with its free cash flow. Often these takeovers were hostile, with the corporate raiders purchasing the stock from other owners until they had control over the organization. This was called a leveraged buyout. Clearly, managers would not want to plan for a leveraged buyout since it requires them to lose control of the organization.

Occasionally, leveraged buyouts occur within the organization, with the organization’s management raising debt and purchasing the organization’s stock. This is called a management buyout, and it is often conducted with the blessing of the founders and investors. In fact, managers may feel this is an excellent way to exit the organization, and leave it in the hands of individuals who understand the organization’s culture and mission and have a strong understanding of the issues facing the organization.

· Management buyouts leave the organization in the hands of managers who understand the project/program.

· Management buyouts typically rely heavily on debt financing. The debt financing often comes from either a lending institution or the seller himself or herself. Therefore, if the new owners cannot meet the debt service requirements, the manager is still at risk.

Most organizations have some sort of retirement plan for their employees. Many of these plans involve employees being able to purchase stock in the organization. However, an employee stock ownership plan (ESOP) can be an effective way to harvest a project/program and leave the ownership in the hands of the employees. Here’s how it works.

Typically, a organization contributes a certain amount of money to the employee stock plan. This fund occasionally makes purchases of the organization stock on behalf of the employees. However, in what is called a leveraged ESOP, the employee stock plan can purchase the entire share of a organization, essentially transferring ownership of the organization from the managers and investors to the employees. However, most ESOPs do not have enough funds to purchase a organization. Therefore, they secure a loan from the bank to purchase all the outstanding shares from their existing owners (including the manager). Then, as they make payments on the loan to the bank, the appropriate amount of shares are released to the ESOP on behalf of the employees of the organization. Eventually, once the loan is paid off, the employees are the owners of the organization and can appoint members to the board of directors, giving them control over the organization’s operations and management.

· Tax benefits – Current tax structures allow selling the organization to an ESOP many tax advantages over selling it to an outside party.

· Motivation – Every employee becomes an owner in the organization. Thus, employees feel more motivated and invested in the organization’s success.

· Disclosure – managers must disclose many things in the process of selling the organization to an ESOP including executive salaries.

· Employees may then depend on the organization not only for their job and income, but also for their entire retirement savings, increasing their risk.

One of the most common forms of harvesting for organizations that have reached a certain size and level of success is merging with another organization or being acquired by them. In today’s global marketplace, large organizations often purchase smaller organizations in order to enter certain markets, broaden their product line, or expand their services. This is much simpler and faster method than developing the capabilities internally. In today’s world, large multi-national organizations strive to be the biggest and the best in their particular sector of activity. This creates a strong market for selling a organization to a larger player.

Mergers or acquisitions often are considered from the view of the shareholders. A organization’s management has a fiduciary responsibility to act on behalf of their shareholders. Therefore, in their decision to purchase another organization, they must be able to provide evidence that their decision will increase value for their shareholders. In addition, this value must be greater than the value that the shareholders could have created on their own by purchasing stock in the other organization themselves. All too often, organizations purchase other organizations in order to become bigger but they do not necessarily become better. They might assume debt or problems associated with the new organization that they had not anticipated. Or they may find that the new project/program does not operate well within the existing organization’s structure.

· Selling a organization to another organization allows the manager to extract the value of their project/program and pursue new opportunities.

· Often the new owner has much more capacity to secure capital and allow the organization to grow and expand.

· Determining the value of the organization is a long and difficult negotiation.

· Buyers often walk out of a negotiation at the last minute if the terms are not amenable to them. This leaves the manager demotivated to return to the organization and has distracted their attention for the duration of the negotiations.

· Often the owner is required to continue working with the organization under the new management. This can be an incredibly difficult scenario.

When thinking about harvesting a new project/program, many think of an initial public offering (IPO). During an IPO, a organization offers ownership in the organization to the general public in the form of stock. Stocks for public organizations are traded on markets such as the New York Stock Exchange or the NASDAQ market. Stock prices fluctuate at market rates determined by the balance between buyers and sellers. Successful IPOs can provide a organization with an incredible amount of new capital from the equity market. However, going public also introduces a wide range of regulations and scrutiny into the organization’s operations. For this reason an IPO is only appropriate for a small number of project/programs.

In order for a organization to go public, a organization must meet several basic requirements. First, it must have sound operations and a market base that can support returns on the stock issued to the public. Investors want their stock to appreciate, and this happens when a organization shows strong sales and quarterly earnings growth. Second, it must be a organization in an sector of activity that the public markets understand and support. Most industries have players that have gone public, however, in some most of the players are privately held. For this reason, investors are wary of investing in the sector of activity since it is relatively unknown and information about competitors is unavailable. Finally, a organization must have the appropriate management on board. Investors want to see a management team, and specifically a CEO, that has the background and determination to make the right decisions for the organization and it’s stockholders.

At first glance, an IPO seems like the perfect harvest strategy. In doing so, a organization secures substantial capital, and can easily raise more in the future by offering more stock. Ownership in the organization becomes liquid, and managers can trade their ownership in the organization and extract value if they so choose. However, along with the status of a public organization, organizations also must manage a heavy new burden. First, going public requires the addition of many new regulatory processes and disclosures. The US Securities and Exchange Commission governs public organizations and requires that they produce quarterly reports. Within these reports, public organizations must make public their financial statements, their project/program strategy, their strengths and weaknesses. In addition, the markets become focused on quarterly performance, and organization’s that have a slow quarter may find their stock price dropping rapidly. Increasingly, managers are finding increasing pressure to keep short-term profits up with less focus on long-term growth. Finally, the offering of stock can leave organizations vulnerable to outsiders who want to purchase the organization. The organization is essentially always for sale to the highest bidder who wants to make a leveraged buyout.

#1 Matching the Columns

A. When they write the project/program plan

2. When an manager harvests their project/program, they ____________ continue to work with the organization.

B. Sometimes

3. In forming a harvest strategy, managers must put ________________ goals and objectives first.

D. Their own

D. Accountant’s

5. Those who argue that the value of a organization is only created when the organization earns more than it’s cost of capital use the __________________ method of valuation.

A. Free cash flow

6. managers who want to make a return on their investment without sacrificaing any ownership might choose the ____________________ harvest method.

D. Increase Free Cash Flow

C. Leveraged Buyout

8. managers who want the organization to stay in the hands of employees may use a ____________________ to harvest their organization.

B. ESOP

Harvesting a organization is a critical step for successful managers. While many managerial project/programs fail, those that do succeed must be prepared for their success. That means that the managers must understand where the organization is headed, and how they and other investors will extract value from the investment on their time, energy, and funds. However, harvesting is not a simple prospect. It involves selecting the appropriate method of exiting the organization in order to meet the goals and objectives of the owners and investors, while protecting the livelihood of employees. Since harvesting is such an important event in the life of a organization, managers must craft a harvesting strategy early when crafting the project/program plan.
Module Test

True/False Questions

1. managers are typically excited at the thought of harvesting their project/program.

5. Using the free cash flow method to value a organization is an accountants view of value.

6. Corporate raiders purchase organizations using substantial debt and then sell of pieces to reduce it.

7. ESOPs can be risky for employees since their employment and retirement are tied to one organization.

8. managers don’t like ESOPs as a harvest strategy since the tax liability is greater.

9. organizations should acquire other organizations only when the value created is greater than investors could have created on their own.

Bygrave, William D. The Portable MBA in managership, Second Edition (John Wiley & Sons), 1997.

Harvest - the method through which the owners and investors in a organization extract the after-tax cash flows on their investment.

Free Cash Flow - The cash flows generated from a organization’s operations that are available for distributions to all the organization’s investors.

Employee Stock Ownership Plan (ESOP) – Retirement plans that enable employees to purchase stock in the organization. These can be used to purchase the organization on behalf of the employees.

Initial Public Offering (IPO) - A organization offers ownership in the organization to the general public in the form of stock.

· To understand the role harvesting plays in the life of an enterprise, and the importance of a harvesting strategy within a project/program plan.

· To understand the various options for harvesting a organization, and the advantages and disadvantages of each.

1. What is harvesting? Why is a harvest strategy important within a project/program plan?

Harvesting a organization is the method through which managers extract value from their project/program on behalf on themselves and other investors. Essentially, harvesting is how these parties earn a return on their investment. For that reason, harvesting is a critical element of an manager’s strategy, since investors want to know how they will earn a return on their contributed capital. Thus, managers must have a strategy in place when they write the project/program plan. In addition, the harvest strategy will have implications on how the managers will manage and grow their project/program. Therefore, they need to have a clear vision of the end goal for the organization.

managers often have a difficult time thinking about harvesting a project/program before it has even begun. However, it is crucial that they spend the time finding the best strategy for them and their project/program. Clearly, the harvest strategy may change as the project/program moves forward. But starting with a clear and appropriate strategy is necessary for making key decisions in the future. The first thing managers must keep in mind is their own goals and objectives. Do they want the organization to provide them employment for life, or are they looking to start something else in the future? Next, managers must anticipate the consequences of their harvest strategy on the growth of their organization. Lifestyle project/programs make very different decisions than organizations that eventually want to be sold. Third, managers must understand that opportunities for harvesting come and go quickly. In order to be prepared to capitalize on opportunities, the strategy must be clear. Fourth, managers must be careful not to harvest too soon. In addition, they should be wary of harvesting advice from those that have a financial interest in the organization. Finally, managers must make sure that they and their investors and partners all share a common vision of how the project/program will be harvested.

There are several options in harvesting organizations. The five most prevalent are:

Increasing Free Cash Flow – In this scenario, managers run the organization to maximize the free cash flow, instead of reinvesting the profits into the organization for growth.

Management Buyout – The management team purchases the organization using debt from a lending institution.

Employee Stock Ownership Plan – The employee pension plan is used to purchase the organization and the employees become the owners.

Merger/Acquisition – Another organization purchases the project/program and brings it into their organization.

Initial Public Offering – Stocks of the organization are sold to the public over a trading market and the stockholders become owners of the organization.

a. Harvest	1. A leveraged buyout carried out within a organization.
b. Free Cash Flow	2. Cash available for distribution to all of a organization’s investors.
c. Management Buyout	3. A organization is purchased by another organization.
d. Employee Stock Ownership Plan	4. A organization offers stock to investors on a public market.
e. Merger/Acquisition	5. Selling a organization to the employees.
f. Initial Public Offering	6. Owners and investors extract value from their investment in the organization.