BYU study reports the best way to “harvest” entrepreneurial ventures

Wall Street Journal
Deseret News

Zappos founder Tony Hsieh, who sold his fast-growing shoe and apparel company to Amazon for $1.2 billion, recently revealed that he would have preferred to take the company public instead. But board members had other ideas and thought selling the company was a better way to “harvest” their investments.

A Brigham Young University study published in the new issue of the Journal of Business Venturing shows that Hsieh – and any entrepreneur looking for the best return on investment – might be better served by a combination of the two strategies.

It’s well accepted that the fastest way to get the equity from your company is to get another firm to acquire it – a “sell out.” But because you are avoiding the risks that would accompany selling shares directly to the public, you generally accept a discounted return.

Lead author Jim Brau, associate professor of finance in BYU’s Marriott School of Management, and his co-authors wanted to identify strategies to minimize that discount. They examined 679 takeovers during a 10-year period, combing regulatory filings and press accounts to categorize the various approaches used.

The researchers thought the best results would come from a combination of two general strategies, known as a “dual-track sell-out.” One “track” is courting interest in the mergers and acquisitions market, at the same time you’re pursuing the other “track” by filing for an IPO. This increases the number of potential buyers and gives the entrepreneurs more options, driving up the sale price.

For example, the private equity firm that owned Bird’s Eye Foods filed for an IPO in October of 2009, then announced in November it was instead selling the company to Pinnacle Foods for $1.3 billion.

And sure enough, the study showed that dual-track sell-outs earned a 22-26 percent higher premium than those companies that were sold without also filing for a public offering. But the surprise, Brau says, was yet to come.

Conventional wisdom and business theory would predict that the best results would come from taking a company all the way through an IPO and then selling out shortly thereafter. This means that owners take all the risk of taking a company public and proving its value under intense scrutiny. They generally expect to receive a premium for their troubles. But the analysis of what happens in the real world found that these types of sell-outs – when a company is sold within 12 months of going public – earned only an 18-21 percent premium over single-track sell-outs.

“Entrepreneurs need not go through the hassle to take their company public,” Brau said. “They can employ this strategy of increasing potential buyers and options and then earn just as much, if not more, than if they sold after going public.”

Intrigued, the researchers looked at the types of companies most likely to use this dual-track approach. They were more likely to be larger, venture-backed and working with prestigious investment banks.

“The smart money already knows to do this,” Brau explained. “We’ve now been able to provide evidence with the numbers.”

Brau says he enjoys studying entrepreneurial finance because “it has very direct implications on practice. The coolest thing is when entrepreneurs and practitioners see my articles and call me to ask questions about putting it into practice.”

In that spirit, Brau boiled down the new study to this recommendation:

“If I were an entrepreneur looking to maximize the sell-out harvest of my company, I would try to engage an investment bank to become a target in both the mergers and acquisitions market AND the IPO market, which would hopefully earn a higher premium. And, if I got a competitive bid prior to the IPO, I would take it – that’s the surprise in our findings.”

The study was co-authored by Ninon K. Sutton of the University of South Florida and Nile Hatch, also at BYU.

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