Harvest strategy must be part of business plan

Entrepreneurs typically launch ventures for one of two reasons. Either they want to be their own boss for the long haul and develop a "lifestyle" business, or they want to grow a business and then subsequently harvest it.

An example of a lifestyle business is a mechanic who runs his own repair shop and who plans to run it for 30 years, passing the business down to his children. Another example is an attorney who hangs his own shingle and plans to practice law for his career and then pass the firm down to his children.

The second type of business is the type you hear people talk about when they "give birth" to a venture with the hope of harvesting the value and becoming independently wealthy. Most of us know someone or know of someone who is now a millionaire because he or she successfully built a business and then harvested it.

In a 2003 Journal of Business study titled, "The Choice of IPO versus Takeover: Empirical Evidence," two co-authors and I studied what types of firms harvest through an initial public offering and what types of firms harvest through being acquired by another firm.

In an IPO, exiting founders and investors sell shares of the firm to the public. The proceeds that are raised from the IPO either go into the company's coffers (primary shares) or to the selling founders and investors (secondary shares). Thus, if an entrepreneur sells personal (secondary) shares in the IPO, he or she can harvest the proceeds from those shares as personal gain. Typically, founders issue mostly primary shares in the IPO and then must wait through a lockup period, typically 180 days, before being able to sell their personally owned shares. After the lockup, founders can harvest by selling their personal shares on the open market , subject to certain selling restrictions.

The alternate path we studied in our Journal of Business article is the choice to sell the company to another firm. The robust mergers and acquisition market is evidence that many entrepreneurs choose to sell out rather than attempt the IPO path.

In our study, we found six factors that are positively related to the probability that a firm conducts an IPO rather than being taken over: 1) degree of industry concentration, 2) current cost of debt, 3) hotness of the IPO market, 4) size of the firm, 5) insider ownership percentage, and 6) if the firm is in a high-technology industry.

Our tests indicated four factors associated with the likelihood of selling out rather than pursuing an IPO: 1) firms in high growth industries, 2) firms in financial service sectors, 3) firms in high-debt industries, and 4) deals that involve greater liquidity for selling insiders.