1. What did Allen do right
Throughout the case, Allen Lane took a number of the right steps as part of his business evaluation strategy:
??? Allen had substantial consulting experiences since graduation from business school that he leveraged in choosing the right ???business fit??? for his skill-set. With an MBA in manufacturing and work experience in distribution, inventory control systems and consulting, Allen made the right decision to stay as close as possible to his knowledge-base and skill-set. He focused on distribution businesses since they were usually undermanaged and had potential for high returns through better management.
??? Allen decided from the start that he wanted to purchase a going concern rather than a new start-up. He rationalized that given his current position, start-ups would be too risky and he was more of a ???fixer??? than a ???creator???.
??? Unlike many entrepreneurs, Allen was very patient in his investment hunt.
? He stated that he had the time and resources to wait for a good deal.
? He performed thorough due diligence of all potential ventures.
? He developed a very thorough and consistent specs list that diversified financing and formulized the acquisition process.
??? Allen set a focus prior to beginning his process, because he felt that unless you know where you going, you were bound to pick the wrong path. Goal orientation is very helpful, especially when choosing to purchase a business where anyone can be easily influenced by the surface fit of a potential venture.
??? To save resources and time, Allan only approached ventures that he received some form of recommendation on. He never went on a cold call and made sure before even approaching a seller that the business was advised by his network of contacts.
??? Allen was very thorough in his search because of the great number of network relationships he had developed. He spoke to everyone and anyone, from lawyers, accountants, customers, suppliers, banks and close friends. Through one of these contacts, he was encouraged to look into electronics distribution and got a start on his hunt.
??? Despite the fact that financing is available when purchasing a business, Allen was able to save up $100,000 to contribute to the venture. This allowed him to keep as much equity as possible within the company and fund the remaining amount through a partner and debt financing.
??? Being a very honest man, Allen built up and protected a very good reputation within the industry. This will help him in his future dealings with sellers, banks and suppliers; and may just provide him the extra credibility to close a deal.
??? After his previous experiences, Allen was very smart in reevaluating any financial data he was provided with from existing business owners. He never took any numbers for granted and made sure to point out any ???window dressing??? or tax irregularities he saw.
??? Allen also structured the ownership of a company giving a partner an exact 50% share of the company would reduce any lack of performance or resentment between the two individuals.
??? Allen developed a very clear specifications sheet for selecting a lawyer that would serve him during a potential business purchase.
2. What did Allen do wrong
Despite all the correct steps, Allan could have done certain things better:
??? In his initial search, Allen went after public companies without an underwriting backer but he soon realized that this wasn??™t the best approach. Public companies are more costly to acquire (large accounting and lawyer fees) than private firms. Also a backer who is willing to underwrite the process is very necessary and crucial to the deal.
??? Allen??™s policy on being very open and straight forward with all parties involved is very ideal, but not as realistic as he hopes. Allan states, if a seller feels that you haven??™t been totally honest about any one part of the deal then they discount everything that you say. This may be true in other industries but in the distribution business ???window dressing??? (exaggerating net worth, financial numbers, or experience) to make a business more profitable is a common practice. We feel that his strict guidelines on this matter may have caused him to overlook some potentially great investments.
??? With regards to Allen??™s ethical concerns, the distribution business might not be the best fit for him as a lot of these businesses engage in border-line ethical practices. With his principle of keeping his own business completely ethical, Allen might not be able to compete effectively in the distribution business.
??? Towards the end of the case, Allan is debating on how to bid on Plas-Tek, which is a manufacturing company of specialty plastic components. Given his previous criteria, Allan focused only on distribution companies, and found no success. Had he broadened his requirements or focus early on, he may have pondered upon Plas-Tek or another similar company earlier and saved time and resources. However, we also understand that his previous failures gave him the experience he now has in correctly approaching Plas-Tek.
4. How is Allen more/less suited at the age of 45
There are many pros and cons of acquiring Plas-Tek or any other company for Allen at the age of 45:
|More-Suited |Less-Suited |
|Allen has acquired enough savings at this time in his life to invest |Allen has an opportunity cost to consider. If he was younger, |
|a substantial amount of money into the business ($100,000). |he would have fewer responsibilities and may be able to take |
| |such a risk. However, the opportunity costs of leaving the |
| |corporate world and starting fresh is a substantial risk to |
| |consider at the age of 45. |
|Through his experience, Allen has built a large network of past |Given his age, Allen needs to find a business where he has |
|co-workers, suppliers and other contacts. This allows him to leverage|enough profit to make money and pay off his financers quickly. |
|their advice and also obtain financing. |If he pays off his debt on a 15 to 20 year plan, then he will |
| |be able see full profit potential only when he reaches |
| |retirement age. |
|Being 45 is also an advantage to Allen because we feel that he is at |Allen also mentions that he wants a partner in the business |
|a ripe age (not to young and inexperienced, but not too old to be |because he does not want the business to be his life. This may |
|able to handle a new venture). Sellers will also take this into |be a concern if he is not willing to spend extra time or effort|
|account when debating between other potential buyers. |in the venture. Since he is used to working in a job setting as|
| |opposed to owning a business, Allen might be accustomed to |
| |working corporate hours and may not have the stamina and |
| |motivation that a business requires. |
|The biggest advantage the Allen has is his work and life experience. |Whether he invests in a start-up or a going concern, the |
|Many small businesses fail due to the lack of experience of the |business will always have an associated risk. Since Allen is |
|entrepreneur, but Allen will be able to utilize what he knows to run |middle aged, if the business fails, he may be too old to |
|the business effectively and efficiently. |recover from such a failure. |
5. Can a nice guy who doesn??™t cheat succeed in this business
While he may be able to succeed behaving honestly in a less-than-honest business, Allen Lane will have a very hard time doing so and is thus quite likely to fail. The rules of the game in this business are not stacked in favor of total honesty.
The distribution and manufacturing businesses encourage border-line ethical business practices in several ways. First, there are several small to mid-size players in each market with little differentiation beyond price, speed, reliability of deliveries and occasionally, quality of product, though the quality difference is often marginal in this business. The wholesalers and retailers who will contract with Allen will demand both a low price and some special treatment from him, usually in the form of kickbacks or discounts. Most of these businesses compete with close and distant substitutes for share of wallet. In such a competitive environment, success depends a lot on defending your margins vis-a-vis competition. An honest and ethical business owner, such as Allen, will likely make his costs greater and profit lower than the competition Secondly, the distribution business is often a cash one and involves very loose bookkeeping. This encourages expectations for kickbacks and border-line ethical practices such as the 80 cents on the dollar type of deals. Lastly, because the players in this industry are small businesses, every penny counts whereas a large company would have a much higher incentive to remain honest as they are more able to swallow the cost. Given the lack of oversight and regulatory scrutiny for small businesses, there are many a times in this industry where the owners are bending corners, making promises that they don??™t intent on keeping, and ???misplacing??? or ???accidentally misstating??? certain information to the IRS.
In such a business, Allen will find it difficult to find an enterprise to purchase where he will not have the potential risk of substantial revenues being generated unethically or IRS reporting being performed with irregularities. Even if Allen were to purchase such a business, he might not be able to compete effectively with other businesses engaging in such border-line business practices.
6. How would you value Plas-Tek
We would adjust the company evaluation performed by the bank as follows:
??? The influence of original owner Elson on the earnings ability of the company seems to be understated. With very little marketing, a majority of the business seems to be driven by Elson??™s personal relationships with the customers. While the customers had continued their business with the company even after Elson??™s death, the business could easily loose these customers if the new owner fails to establish a similar relationship with the customers. Also, there was some decline in sales starting late 1980 and continued leading up to and after Elson??™s death. Given a lack of clarity around this decline, we would take a more conservative net earning number at about $140,000 (using approaximately10% less pre-tax earnings before compensation of about $400,000 and using the same taxes).
??? Given the fact, most of the comparable companies were large public companies with proprietary product offerings and greater management depth, we would argue that a lower P/E multiple must be used to evaluate the company. Given the risk associated with the death of owner of the company and the potential impact on the earning capacity of the company in the near future, a P/E multiple of 4 would be more appropriate.
??? The value of the company using the above adjustments would be $560,000.
We would evaluate the company at about $560,000 based on the above considerations and given that fact that we would on the buyer side. This is with the assumption that we would be able to buy as a purchase of assets and would not be liable for any contingent liabilities.
7. How would you arrive at value to Allen Lane
In addition to the evaluation noted above in (6), the company evaluation would need to be adjusted for the following considerations specific to Allen Lane:
??? The business fit to Lane??™s skills ??“ while not a perfect fit, the business did warrant the management skills that Lane had developed as part of his corporate experience
??? Given Lane??™s management experience, he along with his partner could fill the management vacuum left by the original owner and take the company to previous level of sales or potentially higher sales
??? Given Lane??™s limited experience in manufacturing, he was dependent upon the shop foreman to provide him guidance with the manufacturing unit. Given the foreman??™s failing health, there was an additional risk that needed to be considered
??? If the bank did structure the deal to be a purchase of stock, then the risk associated with the contingent liabilities would need to be accounted for in the value of the company to Lane
We would add a 15% premium based on Lane??™s management fit and potential for increased revenues as result of his management and distribution experience after accounting for risk of losing the shop foreman in the near future due to health reasons. Starting with the company evaluation in (6) of $560,000, the value of the company to Lane would be about $650,000. This value is assuming a purchase of assets deal structure and would need to be adjusted downwards if the deal structure is based on a purchase of stock.
If the deal structure is based on a purchase of stocks, the contingent liabilities resulting from unreasonable compensation and/or accumulated earnings tax could be substantial ??“ as high as $370,000. Given Lane??™s principle of ethical business practices, there is greater chance of the potential liability materializing and hence, should be accounted for in the value to Lane. The value of the company needs to be adjusted downwards by about $200,000 based on a weight average of the three alternatives and their probabilities of being used by the IRS.
The value of the company to Lane in case of purchase of assets deal structure is $650,000 while the value of the company to Lane in case of purchase of sales deal structure is $450,000.
8. What should Allen Lane??™s bid be
Allen Lane??™s bid needs to take into account the following:
??? Lane was in no hurry to buy a business as he had sufficient savings to search for a business that best suited his specifications ??“ the value would be adjusted downwards to account for the same
??? The bank had contacted potential buyers in form of customers, suppliers and competitors but none had shown any interest in buying Plas-Tak at the asking price ??“ basically the bank had approached the Class A and Class B in hierarchy of buyers and found none at their asking price and hence, were now looking at Class C of buyers
??? The bank was obligated to find the best price for Plas-Tek
??? The bank wanted to close the deal and would not want to go beyond the current bidding process to find a suitable buyer ??“ in essence, the bank was keen close a deal on the sale of Plas-Tek
??? The bank was keen on a purchase of stock deal structure while Lane would want to stay away such a deal structure given the high risk of contingent liabilities due to tax practices at Plas-Tek
??? Given that the bank would not allow Lane to borrow on Plas-Tek??™s assets, Lane would need to depend upon his contacts and network to get the financing on top of $200,000 that he and his partner would contribute
As stated in (7), the value of the company to Lane is about $650,000 if the deal structure is purchase of assets. Given that the sale needs to be a cash transaction, the value of company Lane would be adjusted to $530,000. However, given that the bank will not consider any bids under $600,000 Lane??™s bid should be $605,000. This will enable Lane to get on a bargaining table with the bank and if the bid is accepted, Lane can bargain with the bank for either more relaxed terms of purchase to include financing (not cash-only) or further decrease the asking price based on the value of the company to him.
9. How can Allen finance the purchase
Going on the assumptions of the case we know he can use $100,000 from each himself and his business partner. Borrowing from the bank against the company??™s assets, Allen can get:
Inventory at 50% ~ $30,000
Accounts Receivables at 80% ~ $100,000
Machinery and Land (Real Estate) at 80% ~ $80,000
This gives Allen about $410,000 in cash from equity and asset-backed debt. To get the rest of the money, he could take out a personal loan (at a much higher interest) or go to friends and family. We know that he does not want to give up equity or get another partner, so loans from banks or friends and family seem like the best option. Also, Plas-Tek was a going concern with high profit margins and with Allen at the helm, the company will potentially continue to generate profits at the same levels before Elson??™s death. With the ability to pay off debt pretty quickly, Allen should be looking at debt-financing to fund the purchasing price for Plas-Tek. Moreover, given that Allen had submitted a bid of $3.4 million on a potential business purchase deal before, Allen was capable of raising substantial amount of debt from his network of backers and lenders. His reputation within the industry should help him securing these loans.