Financing for Your Growing Business

GROWTH CAPITAL

by Terry Stidham

You just left another meeting with another bank for financing and they told you once again that if you did not need the money they would be glad to make you a loan. Somewhat of a catch 22 for the business owner and the banker whose hands are tied by strict debt-to-equity ratios. The frustration is obvious, yet the solution may be just around the corner with Private Equity (“PE”) funding.

Private Equity Financing can be somewhat of a mystery for many successful companies facing financing challenges, but can be a highly effective source of funds. Many business owners assume that it is only available for the largest companies that are looking to be acquired. This misconception arises from the industry’s history: private equity grew out of the leverage buyout firms that purchased and broke up major conglomerates in high profile deals during the 1980s. The assumption was that the individual businesses were worth more than the sum. Other people only know the venture capital part of the industry, which funds startup companies and received a lot of attention during the high tech boom. Neither picture is complete.

Today, Gordon Gecko’s mantra of “greed is good” is long gone and the .com boom has busted, yet the PE industry is alive and well. The complex industry gathers private and institutional money in funds with a range of objectives. They include:

• Buyout Funds
• Hedge Funds
• Venture Funds
• Growth Capital Funds
• Dedicated Capital from High Net Worth Individuals

Private equity firms place its money in one or more funds to make investments in what are referred to as “portfolio companies.” They typically have a charter which sets out well-defined parameters for investments to be made by the fund, including:

• Nature of Investments - Some funds like high-growth companies, others prefer investments with stable cash flow or dividends. Still others prefer turn-around situations.
• Geographic Scope - Some funds will primarily invest in a certain region or part of the country.
• Preferred Sectors - Some funds are generalist funds that will look at just about any sector, others focus on one particular sector, such as transportation, infrastructure, telecommunications, etc.
• Investment Size - Most funds will specify a minimum or maximum investment size.
• Ownership Interest - Some funds insist on control, others will take minority interests.
• Fresh Equity - Many financial investors are not willing to buy out shareholders, they only want to inject fresh equity into a company (e.g. to fund growth). Others will consider a combination of fresh equity and buying out existing shareholders. Buyout funds will want to buy 100% of a company.

PE firms provide capital in return for an ownership stake. They usually invest cash in exchange for convertible preferred shares in the portfolio company. While many firms focus on larger businesses seeking $50 million or more in funding, there are a number of PE firms that work with growing businesses valued at $5 to $50 million and are seeking as little as $2 million in funding. The funding can take many forms ranging from common stock to convertible debt, but unlike traditional funding sources, the PE firm becomes actively involved in the companies it funds through board representation and active mentoring.

 

It is therefore important to find a good match between a PE fund and a company. It is likely a waste of time to enter into discussions with a fund if the applicant company does not fit the fund’s criteria. So what does a private equity firm look for in its investment choices?

• A Solid Business Opportunity - that reflects its acquisition criteria (e.g. growth, size, geographic parameters, etc.)
• Exit strategy – who are the likely buyers for the company? What are the chances for a successful exit?
• A Strong Management Team - who is prepared to stay until the exit of the fund. (An owner-manager who is cashing out is often too high a risk for the private equity investor.
• Strong Corporate Governance – good decision structures, reporting systems, and strong documentation. Private equity investors seek management teams that are highly motivated, prepared to agree to ambitious goals and prepared to work extraordinarily hard to achieve significant financial gains. Conversely, if results are not forthcoming, managers that own shares may find their ownership diluted.
• Manageable Risks - No actual, pending or potential litigation. Minimal potential for surprises on the downside.

 

After the due diligence, the investment committee (or at least certain members) will usually review the due diligence report of lawyers and other advisors, and the proposed Sale and Purchase agreement. 

 

PE investors are an important potential source of financing for mid-sized firms that needs to be explored.

 

If you have a business that is seeking financing then contact us today to discuss what is needed to get in front of the right PE group for your business.

 

About the author: Terry Stidham is a Sales and Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment. He has served as the head of entrepreneurial organizations as well as Fortune 500 companies. He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions. Mr. Stidham has instructed thousands of business owners on how to prepare for a successful exit. He improves operational efficiencies leading to significant increased value.

 

Should Foreign Buyers Acquire or Go Greenfield in the US?

ACQUIRE or GREENFIELD?

by Terry Stidham



The answer to this question can depend upon a combination of many factors. They won’t all necessarily point in the same direction, but it’s important to weigh each in your decision process.

Greenfield Investments are foreign direct investments where a parent company starts a new venture in a foreign country by constructing new operational facilities from the ground up.

Acquire or go Greenfield?

Acquire - In the case of an acquisition, 

• How similar is your product line to that of the target? 
• Are there issues with proprietary or sensitive technology?
• What place will the U.S. venture occupy in your global structure?
• What is the scope and difficulty of the integration task that you’d be taking on? 
• How relevant is the cultural gulf between the two groups you intend to knit into a team? 
• And at what pace should you move?

Generally, acquisitions can get you into the market much faster and help you pre-empt competitors. But the price tag can be hard to quantify because considerations such as stay agreements, management, recruiting and integration carry their own costs. An acquisition also depends on synergy capture.
 

Greenfield - With a Greenfield investment, it’s important to evaluate your own organization’s degree of experience doing business in the United States and the scale of the entry you’re attempting.

• Do you have the strengths in management and technical competence, or are you looking to bolster one of these areas? 
• And what type of Greenfield move are you considering: licensing, a joint venture, or starting a new entity from the ground up?

In contrast, Greenfield investments make it easier to stage or phase commitments which give investors more direct control over risk management. However, it takes longer to build something new than to add it to your organization with the stroke of a pen.

 

Questions behind the questions

• Are the customers, suppliers, and service providers you’ll work with in the United States ready for a “new face” in the market, or is their comfort with an existing entity an asset?
• Is it more important for your U.S. operation to prosper on its own terms as a market presence or for it to serve the larger needs of the global organization?

Get Started

If you’re considering this choice, you probably aren’t operating in a vacuum. Compare the top handful of acquisition targets on your list with the top handful of Greenfield opportunities. Which ones offer:

• The more timely assimilation into your target market?
• The easier route to capital repatriation?
• The preferred security for your processes and knowledge?
• The more favorable tax advantages?

 

About the author: Terry Stidham, Managing Partner of Target Search Group (TSG). TSG is a business development firm providing mid-market deal flow and investment opportunities for a select number of private equity and corporate clients. TSG sources and originates investment opportunities that fit their client's strategy, size and focus on an opportunistic and a specific search basis. 

Mr. Stidham is a Sales and Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment. He has served as the head of entrepreneurial organizations as well as Fortune 500 companies. He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms. 

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions. Mr. Stidham has instructed thousands of business owners on how to prepare for a successful exit. He improves operational efficiencies leading to significant increased value.

Slowdown in China Chill Equity Investment Firms

The Chinese PE and VC Markets Falter Amid Awakening

Economy and a Freeze on IPO's.

by Terry Stidham

 

 

Zero2IPO Research Center reports that in the first half of 2013 $7.83 billion was raised by equity investment funds related to China marking the first decline in investable funds into the mainland market from this sector.

 

The report said 516 deals were made in the first half of the year, down 45.2 percent year-on-year value of the deals fell 20.9 percent to $9.9 billion.

 

Although activity by PE and VC investment firms has shown signs of a revival since the second quarter, the slowing economy and difficulties in exiting investments are keeping the overall condition from improving.

 

"Another important reason for the decline was the fierce competition among PE and VC firms, which made deals much more expensive," said Luo Yu, an analyst at Zero2IPO Research Center.

 

Luo said firms are proceeding more slowly and paying closer attention to their distinct advantages.

 

Only 73 exits were made in the first half, including 27 through mergers and acquisitions, 15 by equity transfers and 13 via initial public offerings. It was the first time that M&A deals were more popular exit strategies than IPOs.

 

Wang Chaoyong, chairman and chief executive officer of China Equity Group, said exit strategies are still the key issue for PE investors and the resumption of IPOs will be important in the second half.

 

Shan Xiangshuang, chairman of CSM Group, a major Chinese PE company, welcomed the coming IPO restart and said that the Chinese PE and VC market is undergoing a transformation.

 

"When the macro economy and market are changing, many PE and VC firms are trying M&As to exit and participating in the securities and insurance markets," said Shan.

 

IPOs are "still the main way to exit. Without exits, we could not have investment returns, and then not be able to raise new funds", said an investment manager at a large Beijing-based PE firm, who declined to be identified.

 

According to the China Securities Regulatory Commission, 83 companies have passed the examination of the agency's IPO committee and are waiting for the market to give an indication of their valuations.

 

Of this group, 50 are backed by 101 PE and VC firms, according to China Securities Journal.

 

 

1st Decision in an Acquisition/ Investment Can Be the Most Important

Right Target - Right Price

The First Decision Can Be the Most Important: Whom to Acquire/ Invest Into? Treat Price and Strategy as Related Elements.      

 by Terry Stidham, Target Search Group  

 

RIGHT TARGET: The first decision in an acquisition/ investment can be the most important: Whom to acquire or invest into? Going down a road after the wrong target can be a significant drain on organizational resources even if a deal never takes place. If you do commit, a false step can stick with you for a long time. 

Even worse, you may miss a universe of opportunities that were closer fits in the first place.

Get your senior team aligned on the strategic criteria that matter most to you. Then develop a long list of relevant prospects and filter that list to create a short list of priority targets. That sounds easy, but those filters are choices that represent your strategy. At the outset, there’s little risk in considering too many targets.

 

RIGHT PRICE: Of course, the often most important near-term criterion is the price you’ll pay. Whether financed by cash or leverage, it should compare favorably to your anticipated return. If operating across borders, currency questions apply at the time of sale and later on when you’ll be trying to realize the value you sought in the first place.

It’s important to treat price and strategy as related elements. 

Due diligence is critical, and your CFO will be at center stage – not only to help analyze the assumptions behind the initial transaction but also to help preserve and create value as the new entity moves forward. A “good” price for an investment that doesn’t advance your enterprise goals may turn out to be wasted money and a distraction from your strategy.

QUESTIONS TO ADDRESS:

• What are your chief acquisition/ investment criteria: 
• Sustained earnings
• Presence in a certain market or geography
• Ownership of intellectual property
• New products or something else?
• What are the specific deal issues that can have the biggest impact on valuation and return?
• Will the target require a cash infusion to operate even after you’ve paid to own it? Will that add to your debt load?
• Who else is competing to acquire your target? Do you have alternatives?
• What cultural issues will influence your post-merger operations?
• Are your accountants and theirs able to work together?
• What do you know about the people behind the brand you’re thinking of acquiring?

ABSOLUTES AND DEAL BREAKERS: Your senior team should be aligned on strategic priorities for M&A. Write down five criteria your acquisition should satisfy to be worthwhile in your eyes. Then write down five deal breakers that may likely disqualify a target, no matter how attractive in other ways.

CONTACT US: For more information on sourcing acquisition or investment opportunities, please connect with us at info@targetsearchgroup.com

H1, 2013 Corporate Venture Capital

H1, 2013 Corporate Venture Capital

by: Terry Stidham

According to a PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report the most recent data shows that corporate venture capital (CVC) activity is on the upswing. In the first half of 2013, corporate VCs invested an estimated $1.38B in 303 deals. This activity is attributed to 107 corporate VC groups and represents a participation level of 16.7% of the deals done by the industry and 10.9% of the dollars. This percent of dollars is a post-bubble record.

More than a quarter of the corporate dollars (27.7%) went to the software sector; 17.7% to biotech sector, and 11.6% to the industry/energy sector. Sectors where CVC was a significant player based on percentage of deals engaged in are telecom, networking and biotech.

For energy and clean tech, 15.8% of all CVC dollars went to this sector and corporate groups were involved in 19.7% of all the energy and clean tech deals.

When to Consider Mezzanine Capital

Pros and Cons of Mezzanine Capital

by Terry Stidham, President of Target Search Group

There are a number of situations in a business for which mezzanine capital may be appropriate. The following three examples would be good candidates to consider mezzanine financing:

1. Two equal partners have run a profitable business for many years and now one wants to retire and the other wants to continue working for at least another 5 years, but he does not have the money to buyout his partners interest.
2. There is a profitable, growing business that could grow much faster if it had the capital necessary to increase the amount of inventory maintained; but, the bank is only willing to advance 50% of the cost of such inventory. 
3. The president and senior management of an established, profitable company has an opportunity to buy it, but the sum of the cash that they are able to invest plus the amount that their bank is willing to lend is not enough.

Mezzanine capital is the middle (or “mezzanine”) layer of capital between the senior debt provided by banks and equity provided by stockholders. Accordingly, mezzanine capital is generally subordinate to bank financing, meaning that the bank loan has a first claim on any of the assets of the business and generally has a right to be repaid before the mezzanine capital. On the other hand, mezzanine capital is senior to the company’s equity.  Most mezzanine capital comes in the form of a loan that is secured by all of the assets of the business (in subordinate position behind the banks). However, in some instances, mezzanine capital can also be in the form of preferred equity without any collateral or requirement to receive current dividend payments. Such equity usually has a requirement that it be redeemed prior to any payments to the company’s common equity.

 

Banks will typically require that their loans be secured with assets of the company, mezzanine capital providers generally focus on the cash flow generated from the operations of the business. Accordingly, the most important aspect of a company looking to obtain mezzanine capital is that they have a proven track record of generating cash flow from their business. This generally disqualifies start-ups and turnarounds from being good candidates for mezzanine capital. In addition, how the company plans on using the capital is important.

 

As the three examples above indicate, using mezzanine capital to fund:

• Recapitalize the company
• Inventory build-up
• Facilitate a management-led, leveraged buy-out

are all good examples of when mezzanine capital is most helpful.

 

A company seeking to establish a sales and marketing organization, to cover operating deficits or to provide partial liquidity to an owner that remains active in the business are more appropriately funded with equity.

 

Return expectations are correlated with risk:

For this reason, it is best for a company to maximize each type of capital in the order of their cost. Accordingly, only after a company has obtained as much bank debt as the bank will provide (including a revolving line-of-credit and term loan) should it consider mezzanine debt. Then, only after a company has obtained as much mezzanine debt as the mezzanine capital provider will provide should it consider mezzanine equity, and so forth. Utilizing this financing strategy will minimize the company’s cost of capital and allow the company’s owners to retain ownership of as much of the company as possible.

 

The actual cost of each type of capital will depend on many factors as well as the amount of capital required.  Economies of scale apply to capital, as they do to almost all supplies. The more capital the company needs, the cheaper the cost of the capital.  Those businesses requiring in excess of $10 million will most likely pay less for their capital than a company seeking less than $10 million. This is because there are so many capital providers competing for the over $10 million deal size. One reason for so many providers to that segment of the market is because they all have a lot of money to invest; and, since the amount of effort to find, underwrite and close a large deal is not much different than it is for a smaller deal, they prefer to spend their time on the larger deals. There are still many choices of mezzanine capital providers for loans under $10 million, but the cost is slightly higher.

 

For mezzanine debt of $10 million or less, expect to pay origination fees of 1% to 3%, a current interest rate of between 12% and 16% and options to purchase equity in the company (referred to as detachable penny warrants) so that the capital provider’s total annual rate of return on their investment will be between 20% and 25%. There are many less providers of mezzanine equity of $10 million or less; but, if you can locate one, expect to pay between 30% and 35% annually for their equity investment. These yields are still less than institutional common equity investors that require more than 35% a year.

 

Advantages of Mezzanine Financing

• Mezzanine capital gives the business the ability to execute a change of control, expand or acquire a competitor
• Interest-only payment allows the company to conserve cash
• Generally there is no loss of majority control of the company
• Flexible financing can be structured to best meet the needs of the business
• Mezzanine lenders can provide strategic and financial guidance  
• Most mezzanine providers only require the right to regularly receive financial information about the company
• Mezzanine providers will accept a business with limited or no growth potential so long as the business has consistent earnings sufficient to service their debt

Disadvantages of Mezzanine Financing

• The owner may be required to give up some equity upside so the lender can achieve its required rate of return
• More costly that other forms of debt and may come with restrictive covenants
• Can be highly negotiated therefore making the process lengthy
• The lender may require a board seat (typically it would be nonvoting)

Business owners should carefully weigh all of the factors discussed above the next time they are in the market for capital. And, if they qualify, consider mezzanine capital after they have met with their banker and before they consider equity.

As always, I welcome your questions or comments. Feel free to contact me directly if you choose.

About: Terry Stidham, President and Founder of Target Search Group (TSG). Terry is a Sales and Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment. He has served as the head of entrepreneurial organizations as well as Fortune 500 companies. He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions. Mr. Stidham has instructed thousands of business owners on how to prepare for a successful exit. He improves operational efficiencies leading to significant increased value.

Best Targets Are The Ones Not Seen

Shortage of Quality Deals Above the Waterline

by Terry Stidham, President of Target Search Group

 

It has been said many times that “It’s Faster, Smarter, and Cheaper to buy than to build”. Mergers and acquisitions is one of the most effective aspects of a corporate business development strategy to help an enterprise grow. The challenge today is how or where to find the businesses to buy or invest into. 

How many times have you said or heard it said, “If we had known that company was for sale we would have bought it or at least tried to buy it" or "Why aren't we getting more targets to look at"? 

The fact is that the vast majority of business owners who would like to sell don’t want it known on the street that they are for sale. The business owners would prefer for a premium or strategic buyer to identify who they are, prove that they have the intent and means to buy and then to enter into serious discussions as to what they would like to accomplish.

 

Simple enough, Right?

 

I often get requests for my advice on something along these lines; “Our Company is looking to grow through acquisitions. I have used business intermediaries and we have an in-house person or team that is tasked with finding companies. What other options are available to us? We are not getting enough of the “right deals” to look at without too many strings attached. We have very specific requirements as to the size and geographic service area of the company we would be interested in purchasing. Efforts so far have not had very many positive results. Any suggestions or help would be appreciated.”

Strategic Buyers, Private Equity and VC firms are all faced with the challenge getting enough of the “right deals” to look at and to ultimately buy or invest into. The “right deals” are the ones that are aligned with the investment objectives that fit the strategy, size and focus of the investor.

 

Having spent the last 15 years sourcing deals, I can tell you that without a doubt that there is no shortage of quality companies to buy or to invest into. Below the waterline is where one has to go to find them. The outlook for targets to acquire looks extremely good as the baby boomers, who currently own over 60% of the businesses, continue to seek an exit in increasing numbers. 

 

"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." Warren Buffet to his share holders in 1989

 

The Majority of Deal Flow is being sourced from:

• Brokers or Intermediaries
• Web Sources
• In-house Business Development Teams
• Networking
• Referrals

This may be adequate for the very large players that have dedicated resources to source, review and scrub enough opportunities to meet their investment objectives. The numbers and the amount of dry powder tell us that for many this is simply not the case. Most strategic buyers and investors that are looking to grow through acquisitions may at best have a person or two that is assigned with the task of sourcing deal flow.

 

Abundance of capital (dry powder) to invest as of Q1:

• Approximately $900 Billion with private equity firms 
• Strategic Buyers (non-financial companies) with over $1 Trillion 

“Insanity is To Do the Same Thing Over and Over Again and Expecting Different Results” often attributed to Albert Einstein

 

Investors that are not meeting their acquisition/ investment objectives need to initiate or increase their Business Development efforts - either through in-house efforts or outsourcing it to a business development and deal sourcing specialist firm.

 

Advantages are exponential for the following reasons:

• The Deal is Typically Un-shopped
• Majority of the Quality Deals are Below the Waterline
• Avoidance of the Auction Process
• Committed Sellers
• Quicker Closings
• Confidentiality is Easier to Maintain
• Less Time Wasted on Deals that are Unaligned
• More Cost Effective

Successful business development to source proprietary acquisition/ investment opportunities involves being able to:

• Speak the Language of Both the Buyer and the Seller
• Segment Markets
• Identify Targets
• Establish Lines of Communication
• Gather Base Level of Information to Determine Suitability
• Get Level of Understanding as to Owners Initial Expectations

Call or contact me with your questions of comments.


About the Author:  Terry Stidham is a Sales and Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment. He has served as the head of entrepreneurial organizations as well as Fortune 500 companies. He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions. Mr. Stidham has instructed thousands of business owners on how to prepare for a successful exit. He improves operational efficiencies leading to significant increased value.