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.

 

QE Fuels Inflows

Markets Surge

by Terry Stidham

The U.S. will not end its quantitative easing program (an asset purchasing program in which the Fed has been buying $85 billion in Treasuries and mortgages a month in order to provide monetary stimulus) before 2014, according to Christian Menegatti, managing director of research at Roubini Global Economics. The U.S. central bank has kept benchmark interest rates close to zero since 2009 and has tried to stimulate the economy through three rounds of quantitative easing, or bond purchases.

This has meant good news for equity markets, which have gotten used to the flow of easy money. Wall Street's Dow Jones Industrial Average has rallied over 17 percent so far this year.

Private Equity - 130 private equity funds raised $69.3 billion globally in the first quarter of 2013. This is similar to 2012 when on average $73.7 billion was raised in each quarter. However, the total represents a significant upside vs. fund targets of $59.9 billion. Although the LP's have improved confidence they continue to seek firms that can deliver.

VC - VC Funds invested $6.9bn in US start-ups across 841 deals during the first 3 months of this year, up from $6.8bn in the fourth quarter of 2012, which saw 834 transactions, a study by industry database CB Insights has estimated.

According to the analysis, funding for internet companies soared by 12% on a sequential basis during the first quarter of 2013, to over $2.7bn.

Hedge Funds – The Hedge Fund Review reports that the hedge fund industry assets surged by $122 billion to a record $2.375 trillion, with the top ten funds receiving the majority of the new capital in Q1. John Van, VP of Van Hedge Fund Advisors reported that, “The average U.S. hedge fund was up 4 percent through March, while the average equity mutual fund was up only 1.7 percent”. 

IPOs - U.S. companies are on track to raise the most money through initial public offerings since before the financial crisis, driven by the same thirst for risk among investors that has pushed the stock market to new highs.

Through Q1, 64 U.S.-listed public offerings had raised $16.8 billion, according to Dealogic. In the same period in 2012, the biggest year in dollars since the financial crisis, 73 companies raised a total of $13.1 billion.

If an investor had bought shares in every IPO raising more than $25 million in 2013, they would be up 15% so far this year, according to Dealogic, matching a 15% gain if they had owned the Russell 3000, which includes large- and small-cap companies, since the beginning of the year.

Mutual Funds - U.S. investors poured $184 billion into long-term mutual funds in the first quarter. With the stock market climbing, investors “are buying at a higher price. But are they overpaying? They’re sick of being cautious and making nothing. They've got kids to send to college. They need cash. They’re telling their advisers to address the issue that they’re not getting enough of a return on their investments.

As they have for nearly two years, taxable bond funds made the strongest showing during the quarter. But funds focused on U.S. stocks showed signs of life, posting their first positive quarter since early 2011, according to a Morningstar Inc. report. Investors plowed nearly $80 billion in new money into all stock funds in the first quarter, compared to net inflows of $5.3 billion a year ago.

Boston mutual fund giant Fidelity Investments saw net inflows of $8.9 billion in the first quarter, and just shy of $3 billion in March, according to Morningstar. A year ago, Fidelity’s net inflows were $4 billion in the first quarter and $425 million in March.

Eaton Vance also saw a dramatic turnaround, with inflows of $5 billion for the quarter and $1.5 billion for March. That’s compared to net outflows of nearly $900 million for the first quarter a year ago and $365 million in March 2012.

Net inflows were $362 million in the first quarter at Putnam Investments, which was hit hard during the Great Recession. It saw net outflows of $60 million in March. A year prior, Putnam’s first quarter outflows were nearly $1.1 billion, and outflows for March totaled $350 million.

In addition to U.S. stocks, international stock funds and alternative investment funds posted strong first quarter flows compared to a year ago. Inflows to international stock funds were about $47 billion for the quarter compared to $5 billion a year ago, while net flows into alternative funds totaled $9 billion for the quarter compared to $3 billion the previous year.

Leon Black with Apollo Global Management recently said that he has never seen such a good debt market. “The financing market is as good as we have ever seen it. It’s back to 2007 levels. There is no institutional memory,” Black said. He believes that rising equity markets and cash-rich corporations are making it difficult to buy and much easier to sell. With interest rates at historic lows, how can someone afford not to be an active investor?

Musical Chairs – We all know the game and what happens when the music stops. Somebody is eliminated, the music restarts and the game proceeds until there is only one person left who is deemed the winner.  Can anybody answer what happens when the music or in this case the presses stop and we still have all of this capital floating around in the economy?  How will the markets react? What happens to interest rates when the Feds stops the repos? Is it time to care? Should we care? or as they say in South Louisiana, "Laissez les Bon Temps Roulez".

If you are executing or contemplating an acquisition or investment strategy and need help in sourcing targeted opportunities then contact the business development and deal flow specialists at Target Search Group today.  

Investors Move into the Hedges

Follow the Money

by Terry Stidham, President of Target Search Group

Q1, 2013 funding for VCs and for Private Equity are up and according to Hedge Fund Review, hedge fund industry assets surged by $122 billion to a record $2.375 trillion, with the top ten funds receiving the majority of the new capital. John Van, VP of Van Hedge Fund Advisors reports that, “The average U.S. hedge fund is up 4 percent through March, while the average equity mutual fund is up only 1.7 percent”. 

Investors like the performance of late along with the flexibility hedge funds have to make among a broad set of short-term investments.  Many strategies are being used (long/short equity, credit, macro, statistical arbitration, etc) with trades lasting from milliseconds to years.  Most hedge funds are staying in relatively liquid securities so that they can trade out at any point in time to lock in their profits.

Sondra Harris gives us the following 8 Reasons Why the Hedge Fund Industry Deserves a Second Look in 2013 that she picked up from Michael Collins at the Investment Management Institute earlier this month:

1. Managers are better than ever - With the froth of the ’90s over, we are seeing less of the accompanying frenzy that had people putting money into hedge funds without really knowing what they were getting.

Today there is an expanding group of good managers, a better crop than we've ever seen, so the quality tends to be good, and because of the various market forces at work, their fees are going down. 

2. Correlations in markets are down, and that’s a strong tailwind for hedge fund strategies - The high market correlations in recent years contributed greatly to dampened hedge fund returns. That’s changing. Spikes in correlation over the last 18 months are far shorter. That gives managers some breathing room and prevents whiplash. They can put on the trades, make a profit and move on. This type of environment should help raise the tide for all hedge funds.

3. Hedge funds are good bond alternatives - This is even more important for institutional investors like pension plans. They know that holding a portfolio with a 30/40 percent traditional bond allocation may be a potential time bomb. The free ride on their bond portfolio for the last 30 years is over. They’re all focused on it. Good hedge fund managers will either avoid unattractive bonds completely or profit from the inevitable sell-off.

Hedge funds can do very well in those sell-offs. Managers can short or actively trade a hedged portfolio of bonds, whereas, traditional bond funds cannot. Increasingly, investment advisors are substituting a diversified portfolio of hedge funds for part of their traditional bond allocation.

4. Holding periods are shorter; manager expertise is deeper - Geopolitical shocks and general market sentiment are driving hedge funds away from longer duration holding periods. Managers are using a variety of trading strategies, not just putting the position on, taking it off and going on to something else, but being able to trade it both ways and do that very profitably.

They can do this nowadays by relying on markets with deeper liquidity. This is good for individual investors, as well, whose own time horizon has come in dramatically in the last couple years.

5. It’s a buyer’s market for hedge funds - In general, redemption terms for all of the very best performing hedge funds will become more favorable as all funds are going to have to compete for assets. Frankly, it’s become a buyer’s market. Again, a good thing for investors. It also means more liquidity. In fact, liquidity has become as important an indicator as performance when evaluating hedge funds.

6. The general landscape for hedge funds will become even more populated - This will happen as the number of options for new and creative ways to trade and manage risk becomes more sophisticated. Investors who want to add hedge funds to their portfolios will need help from their advisor in selecting managers who can build a dynamic and diversified portfolio.

7. Fundamental long-short managers are paying a lot more attention to technical indicators - Traders have acquired new tools and quicker access to more data over the past couple of decades. These modernizations of hedge fund trading can improve managers’ abilities to protect their capital should the unexpected shock occur. Frankly, as we’re all beginning to learn, tail events seem to be the new normal. The good news is that the managers are even more aware and prepared to adapt quickly to different environments.

8. We’re seeing more and more hedge fund mutual funds - This used to be considered an oxymoron. It’s now becoming a necessity, driven by demand from investors who want even more transparency. They also want more liquidity, daily liquidity. They want daily NAV. 

The funds that demonstrate performance and innovative strategies will continue to attract the bulk of the investors. Other major investor considerations are:

• Investment Objective: Is it lower volatility, enhanced return, less correlation to other investments, etc?
• Structure: Is the fund have a single manager / strategy fund to build out an allocation or is it a fund of funds?
• Team: What is the makeup of the investment team in terms of diversity, experience and history, and the culture of the overall organization?
• Sophisticated Risk Management: Is risk management an independent function that provides checks and balances to the investment process?
• Operations: Does the fund have a sound operational infrastructure backed by dedicated support groups (e.g. legal, technology, due diligence) to allow the investment team to focus solely on investing?
• Improved Transparency 

Terry Stidham is the President and founder of Target Search Group. He is a 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 been instrumental in aiding thousands of business owners prepare their businesses for eventual sale by teaching them how to maximize efficiencies in operations leading to significant increased cash flow.