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Harvard Business School 9 297 110rev November 24 1998professor Paul Harvard Business School 9 297 110rev November 24 1998professor Paul Harvard Business School Rev. November 24, 1998 Professor Paul Gompers prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. reproduce materials, call or write Harvard Business School Publishing, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

1 Sky Air, Inc. Samuel Kaplan stared at the proposal sitting on his desk from Thyestean Ventures outlining their proposed investment in Sky Air, a small, regional airline. Kaplan was somewhat disappointed in Thyestean’s terms. The offering price, $6 million for a 30% equity stake in the company, seemed to be far too low. Kaplan knew that Sky Air had huge promise. After all, he had built the company up from scratch over the past ten years. The investment from Thyestean Ventures was expected to allow Kaplan to diversify his wealth at a time when his family was beginning to grow. (Sarah Kaplan, Samuel’s wife, was pregnant with triplets.) As Samuel sat in his office in downtown Idaho Falls, he wondered how to respond to Thyestean’s offer.

Should he reject the offer outright? If he decided to negotiate, how could he improve his bargaining position? Finally, how could he maximize the value that Thyestean Ventures was willing to pay for their 30% equity stake? Today was February 4, 1997 and he had less than two weeks to come up with a counter proposal. Sky Air Sky Air was founded by Samuel Kaplan in the summer of 1986 shortly after he was discharged from the Air Force. Samuel had trained as a mechanical engineer at the Air Force Academy and had served for ten years in the Tactical Air Command. In addition, Kaplan was a talented golfer, having won the U.S. Amateur Championship when he was only twenty years old. During the past ten years, Kaplan had had little opportunity to play golf, although the completion of a PGA quality course in Idaho Falls seemed to offer hope of increasing his playing time. Kaplan, who grew up in Idaho Falls, believed that a regional airline based there would be highly profitable.

Idaho Falls was a market that was then only served by Vixenne Air. Vixenne had a dismal track record for safety violations and on-time service. Kaplan felt his military experience would allow him to run an efficient, safe airline. Kaplan began service in August 1986. Sky Air's initial schedule provided convenient service to ten cities in the Northwest and upper Midwest. Sky Air was an immediate success. Its aircraft continued to run at capacity, and Kaplan worked hard to expand service. By leasing and buying used aircraft, Kaplan increased Sky Air’s seating capacity and expanded service to over 75 domestic and international destinations over the next ten years. Do not copy or post [email protected] or 617.783.

Sky Air, Inc. 2 February 1997 By February 1997, Sky Air was showing consistent profits, albeit not stellar results. The company was run exclusively by Samuel Kaplan who served as Chairman of the Board, CEO, CFO, and Controller. The board consisted of Kaplan, his wife, and his cousin Bob. In addition to his salary of $400,000 per year, Kaplan also had a company car and a company apartment. With the expected additions to the family, Kaplan was in the market to purchase a second company car and a larger company apartment, although these decisions would wait until after the investment by Thyestean Ventures was completed. He simply had no time right now to shop for them. Sky Airlines had been consistently in the black since its incorporation. Profitability growth had slowed recently, and even declined slightly in the last year, but Kaplan explained this as a temporary slowing of revenue growth, and was confident that cash flow would continue to grow at its historical rate in the future. Sales $2,250 $4,500 $9,000 $15,000 $22,500 $30,000 $36,000 $42,200 $48,600 $53,000 Operating Expense $1,750 $3,500 $7,000 $12,250 $17,500 $22,750 $28,875 $33,250 $38,500 $43,750 EBIT $500 $1,000 $2,000 $2,750 $5,000 $7,250 $7,125 $8,950 $10,100 $9,250 (in thousands) The Offer Because of the approaching birth of his triplets, Kaplan thought it was time to “pull some money off of the table.” He contacted Thyestean Ventures, a local venture capital firm that was known to invest in family-owned businesses. Thyestean Ventures had an excellent track record and managed almost $500 million in assets. Kaplan had wanted to retain control of the company and therefore offered to sell 30% of his company to Thyestean Ventures, but they would not get board representation. He was certain that given the illustrious ten year history the 30% stake was worth well over twenty million dollars. After their due diligence, however, Stacy Simms, Thyestean’s managing general partner, informed Kaplan that Thyestean would pay no more than $6 million for the 30% equity stake. Kaplan was distraught. He was certain that his company was worth more, but he did not know how to respond to Thyestean. As Kaplan got up from his desk and walked through the door on the way to his car, he pondered his options. He could walk away and continue to manage the firm as he had for the past ten years. His second option was to come up with a new proposal for Thyestean that might generate a higher offer. He did not have much time to decide.

Paper For Above instruction

In this paper, we analyze the valuation dilemma faced by Samuel Kaplan with his regional airline, Sky Air, in the context of investment negotiations with Thyestean Ventures. The core issue concerns the valuation of Sky Air and the strategic decisions Kaplan must make to maximize his company's worth amidst a potential sale. This analysis examines the valuation aspects, negotiation strategies, and ethical considerations associated with entrepreneurship and investor relations.

Introduction

Kaplan’s dilemma encapsulates a common challenge faced by entrepreneurs: how to effectively value their business during negotiations with investors. Since Sky Air had shown steady, albeit slowing, profits and growth over ten years, Kaplan perceived the valuation to be significantly higher than the $6 million offered by Thyestean for a 30% stake. His confidence in the company's potential and his personal attachment compounded his reluctance to accept the proposed valuation. This paper explores key valuation principles, negotiation tactics, and potential pathways to enhance the company’s perceived value, thereby improving Kaplan’s bargaining position.

Valuation of Sky Air: Assessing the Company’s Worth

The valuation of Sky Air hinges on multiple factors, including historical financial performance, growth prospects, market position, and risk profile. Financially, Sky Air's revenues grew from $2.25 million in 1988 to over $53 million in 1997, with an upward trend in profitability, though recent growth had decelerated. Using valuation methods such as discounted cash flow (DCF) and comparable company analysis, a more accurate estimation can be derived.

Given the company’s consistent profits and cash flows, a discounted cash flow analysis would likely provide a valuation substantially above the $6 million offer. Factors such as the company’s market expansion, owner’s experience, and regional dominance support a higher valuation. Kaplan believed the 30% equity stake was worth over $20 million, aligning with his view that the company’s perceived value should reflect upcoming growth prospects and asset base.

However, Thyestean’s low valuation indicates a conservative or risk-averse approach, possibly due to perceived volatility in the airline industry and the company’s recent slowdown in growth. This discrepancy highlights the importance of how valuation is communicated and perceived during negotiations.

Negotiation Strategies to Maximize Valuation

To negotiate effectively, Kaplan should gather comprehensive data supporting a higher valuation, including detailed financial forecasts, industry comparables, and strategic growth initiatives. Building a narrative around Sky Air’s unique regional market position, safety record, and planned expansion can help justify a higher offer. Additionally, Kaplan can consider alternative deal structures, such as earn-outs or performance-based incentives, to bridge valuation gaps.

Negotiation tactics such as anchoring—initially proposing a valuation closer to Kaplan’s estimate—and demonstrating willingness to walk away can influence the bargaining process favorably. Engaging professional advisors, such as valuation experts or investment bankers, could also lend credibility and strengthen Kaplan’s position.

Furthermore, exploring options like minority investments with future rights or structuring a phased investment plan could address Thyestean’s risk concerns, making the deal more attractive while preserving the company's value.

Ethical Considerations in Negotiation

Ethically, transparency and honesty in valuation discussions are critical. Kaplan’s perception of higher value must be balanced with fair communication, ensuring that investor expectations are aligned with realistic projections. Overvaluation or misrepresentation can lead to future conflicts and damage reputation. Conversely, ethical negotiation involves respecting the investor's perspective, maintaining integrity, and fostering mutually beneficial relationships.

Additionally, considering the interests of all stakeholders—including employees, customers, and the community—ensures that negotiations do not compromise ethical standards. For example, a fair valuation respects the company’s true worth and avoids overpromising future returns that may not materialize.

Conclusion

Kaplan’s challenge illustrates the importance of strategic valuation, effective negotiation, and ethical conduct in entrepreneurial ventures. By leveraging accurate financial analysis, developing strong persuasive narratives, and adhering to ethical principles, Kaplan can better position Sky Air for a deal that reflects its true value. Ultimately, balancing assertiveness with integrity will facilitate negotiations that serve both the company and its stakeholders well, supporting sustainable growth and personal success.

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