Leveraging Corporate Real Estate

By Mike Myatt, Chief Strategy Officer, N2growth

Most corporations of any size and scale have large investments in the land and facilities necessary for the successful operation of their business. While making corporate investments into real estate assets may seem to be a reasonable strategy at first glance, they are rarely investment or capital driven decisions, but rather operating decisions that in retrospect usually fail to maximize the leverage and value of their land and facilities beyond what is typically provided for within traditional ownership and financing structures. In today’s post I’ll address one of the popular options for leveraging your corporate real estate assets   

When an operating business finds itself in need of low cost capital their corporate real estate assets should be evaluated as a source of readily accessible quality capital. While a number of financially engineered solutions are available to maximize corporate real estate assets, the most commonly used structures center around sale leaseback transactions. These sale leaseback transactions are popular solutions for the following reasons:       

  1. Improved Financial Statements: By moving corporate real estate assets “Off-Balance Sheet” financing solutions are engineered that create no mortgage or other indebtedness to be carried as debt on your company’s balance sheet. The immediate boost in cash without offsetting debt can improve the overall financial health of a business. Book income typically increases in the transaction’s early years, with rent payments less than the interest and depreciation under conventional financing. With most sale leaseback solutions, the book value of company assets is effectively understated thereby enhancing your company’s Return on Assets (ROA).  
  2. Financial Flexibility: Corporate real estate transactions are not bound by formalized loan industry or REIT requirements, giving lenders flexibility to meet the operating needs of your business. Rents can be fixed for the full lease term without inflation adjustments or any percentage rent. Rents can also be stepped to be lower in the early years or reset periodically to take advantage of improved credit, interest rates and other conditions. The sale leaseback structure can also be engineered to address seasonal financial variations.  
  3. Operational Control: Even though you no longer own the facility, most lenders offer programs that will allow you to retain complete operational control of the property for as long as it is required in your business.
  4. Low After-Tax Cost: The lease payment under a sale leaseback structure is fully deductible over the lease term, making the after-tax cost to your company less than with alternative forms of asset-based financing and is also less than the market rent you would typically pay. For federal income tax purposes, a company can only depreciate buildings and other physical improvements, but not land. Most sale leaseback solutions factor the value of the land into the rent. The rent is fully deductible, effectively enabling you to depreciate the cost of the land.  
  5. Credit Tenant Property Can Provide Similar Financial Benefits to the Issuance of Corporate Bonds: If a business is deemed to be a credit tenant or its financial equivalent, its corporate real estate assets can be effectively used to secure management-free cash flow with exceptional liquidity and high leverage performing like corporate bonds while preserving the benefits that real property offers. Because of the secure character of credit tenant property investments, properties can be leveraged far more highly than traditional real estate. Based on the lease guarantee by the tenant, non-recourse financing may be arranged with a 1.0 debt coverage ratio, allowing for financing Up to 100% loan to value. Income from an investment grade tenant over the length of a multi-year lease offers reliable returns comparable to those of corporate bonds.  Credit tenant leases are usually written for terms ranging from 10 to 25 years.  Lengthy terms eliminate concern about tenant turnover normally associated with real estate ownership.  
  6. Near-Zero Volatility: Many of the corporate real estate programs today offer fixed rent structures providing full inflation protection. Because the key value determinant of credit tenant property is the long-term corporate guarantee, this asset does not experience the cycles affecting other real estate markets.  Long-term, highly leveraged financing removes interest rate risk and minimizes pricing volatility.  Circumstances affecting traditional real estate, such as changes to surrounding property, local politics and market swings have little impact on credit tenant property values. 
  7. Liquidity: The long-term corporate guarantee of rental income and expense coverage combined with the tenant-based financing enable corporate real estate assets to be traded with exceptional liquidity not typically associated with real property. Most lenders will allow businesses to convert existing fixed real estate assets into cash at fair market value at what may be a premium over book value. Funding can also be used for new construction including the cost of the land acquisition. Proper use of corporate real estate as a financing tool will eliminate the need for a business to tie up capital or credit in land or buildings.  
        

     

A wide variety of sale leaseback structures are available from lenders who have a practice area dedicated to corporate real estate finance. When developing your capital formation strategy make sure you evaluate corporate real estate assets as a viable vehicle for accomplishing your goals. 

 

Positioning Your Business for Sale

By Mike Myatt, Chief Strategy Officer, N2growth

While the M&A space is very frothy with transactional volumes at record levels and premium valuations abounding, the risk associated with getting deals done might just also be at an all time high. Ideally selling a business should really be about taking what the CEO believes is the best deal, however lately it has become more about doing the deal that the CEO perceives as the most defensible transaction when evaluating the impact of the sale on a variety of constituencies. In today’s post I’ll share my thoughts on getting the right deal done with the least amount of litigation risk

Okay, so you’ve received board approval to put your company it play, but now what? How do you cover all your bases in an attempt to mitigate the risk of regulatory scrutiny and shareholder litigation? Taking the following steps will not only help you maximize transaction value, but will likely insure that the transaction sticks with the least amount of post transaction risk:

  1. Pre-sell the deal internally: State your case early on by clearly articulating the business logic for the disposition. Make it known why selling benefits various constituencies and lay-out your game plan to the board, key executives, major shareholders, etc. If you are pursuing a strategic deal that you believe may be in the best long-term interests of shareholders, but may not maximize current valuation you should definitely trial balloon your thinking very early on and build key support for such a decision. By assuaging potential concerns prior to going to market you will minimize the potential for trouble down the road. 
  2. Hire the right sell-side advisors: Retain reputable legal, tax and transactional counsel to insure all the “T’s” are crossed and the “I’s” are dotted. Your investment banker should conduct a comprehensive search for potential suitors that reaches across all genres including strategic buyers, private equity firms, hedge funds etc. A comprehensive marketing approach shows a good faith effort in attempting to solicit the best offer. Good legal and tax counsel can make sure that the appropriate concerns and proper protections/disclosures (i.e. indemnifications, legal and tax opinions, full disclosure provisions, Revlon concerns, SOA provisions etc.) are addressed and included in the documentation.
  3. Shop the deal: Make sure that a “Go-Shop” provision is included in any agreement with a potential suitor. Stand-Still provisions are becoming a thing of the past as they set-up the seller for third party allegations that the seller failed to fulfill their fiduciary responsibilities by agreeing to sell the company at a “low-ball’ price, and/or by signing off on measures designed to dissuade competing bidders. The offset for buyers to induce them into agreeing to a go-shop provision is the provision to pay a break-up fee should the seller unwind the deal due to a better competing offer. Just last Thursday, Peter Huntsman, president and CEO of chemical company Huntsman, terminated a $5.6 billion deal with Basell AF, paying almost $200 million to break the deal with the Dutch manufacturer. Instead, Apollo Management LP will pay $6.51 billion to purchase the company. Apollo agreed to reimburse Huntsman for half the breakup fee resulting in a substantial net gain to Huntsman.
  4. Seek a third-party valuation: In addition to being a good management tool, by having your company valued on a regular basis you establish a third party baseline for what your company is worth and have something to benchmark any potential offers against. For many companies having your valuation updated annually is standard operating procedure. I suggest that when you order your valuation and subsequent updates that the transaction be ordered by your law firm such that it becomes privileged information and therefore mitigating the risk of a bad valuation surfacing to haunt you at an inopportune time.

Seller Considerations

By Mike Myatt, Chief Strategy Officer, N2growth

Let me begin with the disclaimer that there are many different types of exit strategies and many different reasons for exit. That being said, in the text that follows we will only focus on the entrepreneur who sells the business and stays on in an executive capacity for the new entity. Most entrepreneurs are taught to begin identifying their exit planning strategy as early into the lifecycle of a venture as possible. In fact many entrepreneurs are so predisposed to selling their company for the proverbial pot of gold at the end of the rainbow that they spend more time positioning for sale than operating their business. But my question to you is this: Is selling your business all that it’s really cracked-up to be? In today’s post I’ll discuss the flip-side of the coin by pointing-out what most entrepreneurs usually fail to consider; the downside of selling a business…

In my experience I’ve found that there tends to be four types of entrepreneurs: 1) The Cowboy: those that jump into a business venture as a type of “get rich quick” scheme looking to position their business for sale at the earliest possible opportunity. The Cowboy entrepreneur has no interest in being part of any long-term endeavor; 2) The Builder: entrepreneurs who while still predisposed to exit via sale take a bit more time and effort in their endeavors by using a more strategic and calculated approach in their exit planning. The Builder entrepreneur grows the enterprise according to a plan for the purposes of maximizing valuation within a given time frame and will only sell under very specific and favorable circumstances; 3) The Opportunist: Those entrepreneurs who never really intend to sell the business but get approached by a private equity firm, investment banker or principal buyer and decide to “get while the getting’s good” and; 4) The Operator: Those entrepreneurs who view themselves as one with the business and would never sell under any circumstances.

Let’s face it; selling a business feels good – the press, the public accolades, the sense of personal and professional achievement, and last but certainly not least, the rather large and sudden balance increase in your bank account are all good things. What’s not to like? The reality is that in the courtship leading up to the sale, and in the honeymoon immediately following the sale, there is much to like and not too many unplanned or unanticipated headaches to deal with. But as time marches on and the business of business starts to take over, the facades begin to fade and the ugliness of what really has happened begins to set in. The truth of the matter is that until you’ve gone through this process a few times you don’t really know what you don’t know. You certainly understand the price you’ve been paid to induce you to sell the business, but it is not until long after the deal is done that you begin to understand the very true and real cost of acquisition. You may be interested in reading a prior post entitled “Managing Disposition Risk.”

The best dispositions are the ones in which you cash out and walk away – a clean break is always best for a wide variety of reasons. However this is not the case with most business sales as the key principals will normally stay on in some capacity. The seller sees becoming a key-employee of the new entity as a benefit to the transaction that will add significant value moving forward. The buyer sees keeping the seller on board as a necessary evil of closing the deal and rolling up a new business. The buyer needs you to stay engaged to help sell your key employees and keep people together during the transition until the buy-side has time to make necessary assessments and changes without disrupting the continuity of operations. It really is just part of the way the game is played. Very rarely do you see sell-side principals make it for the long haul as part of the new entity.

The buy-side pitch of autonomous operations and independent decisioning quickly becomes a forgotten promise that is pushed aside for the benefit of the greater whole. If the seller doesn’t acquiesce to the whims of the new owners they become labeled as “not a team player.” It’s not that the buyer doesn’t value the seller’s intellect or ability, but the goal of the buyer is to transition every part of the new business into the overall culture of the acquiring entity as seamlessly and efficiently as possible to take advantage of the leverage and economies of scale priced into the acquisition. This all happens much easier by placing the seller into a position of while having a decent title and paycheck, really has little final say or authority….this is the first step in phasing the sell-side principals out altogether.

Ask anyone familiar with the M&A world and they’ll tell you that making the deal is the easy part, but it is the post acquisition integration of culture and personality that causes most deals to fall short of the pre-transaction projections. Most companies that are seasoned at the acquisitions game are skilled at business process engineering and systems integration, and manage the non-human aspects of transactions fairly efficiently. However few companies are as relationship centric as they would like to be, and it’s easier to systematically consolidate and eliminate positions than to absorb them.

I’m not saying all buyers and investors are evil, but you need to keep in mind that at the end of the day they typically have their best interests at heart and not yours. While there are clearly good reasons to sell, and also transactions that have motivational, value and pricing alignment between the buy-side and the sell-side, the really good deals where both sides win are few and far between. My advice is certainly not to avoid all sales, but rather go into things with your eyes wide open knowing the realities associated with your decisioning. It is always better to do a deal from a completely informed perspective rather than being blinded by the ignorance of unrealistic expectations and assumptions.

 

Interview with Marty Secada

By Mike Myatt, Chief Strategy Officer, N2growth

Marty SecadaWhen it comes to the business of business few decisions are as pivotal as those surrounding capital formation issues. Understanding when to seek capital, where to look for funding, how to structure the deal and other such decisions are at a minimum complex, and if made incorrectly problematic if not disasterous. For those executives and entrepreneurs who deal with such issues you’re in for a treat…Today’s post contains an exclusive interview with Marty Secada, one of the leading minds in alternative corporate finance.

For those of you not already familiar with Marty Secada let me give you a brief overview of his background…Marty received his Bachelor’s degree from the University of Pennsylvania, a Masters in Science from Drexel University and his MBA in Finance from the Wharton School of Business. As the Managing Director of Broad and Wall Advisors Marty is an advisor to Hedge Funds, Private Equity Funds and Merchant Banks where he evaluates hundreds of transactions every year. In addition to advising clients like Goldman Sachs, UBS, Deutsche Bank and Chase, Marty also founded the Wharton Angel Group, revived the Wharton Investment Resource Exchange (WIRE) and founded the IvyPlus alternative investment network. 

As a recent guest lecturer at Wharton, Marty was kind enough to refer to me as one of today’s top business advisors and while I appreciate the compliment I will gladly defer to Marty’s capital markets expertise. I hope that the following interview will shed light on the reason’s why I value Marty’s advice and counsel. On with the interview…

Mike Myatt
: As the Managing Director at Broad and Wall Advisors, can you give our readers a brief overivew of your company and the constituencies you serve?

Marty Secada
: Broad and Wall Advisors is an advisory company to alternative investment firms. We assist private equity firms with deal origination, mergers and acquisitions firms with deal fulfillment and hedge funds migrating to private equity with their strategy. We typically interact with fund managers who are looking for deals or strategy.I also run a network for alternative investors called IvyPlus, www.ivyplus.biz.  IvyPlus runs closed and sometimes open events for people in the alternative universe so they can socialize, share ideas and strategies.  We’ve developed great feelings of fraternity in the group and are dedicated towards positive networking and fantastic time management practices.  We had more than 350 good referrals last year and probably already have around 100 for the first two months of the year. We seldom have meetings run over schedule and are remarkably efficient networkers. That’s important when you work long hours and want to get home to a family life. 

Mike Myatt
: You have been involved in a number of high profile deals over the years. What was the toughest transaction you ever put together and why?

Marty Secada
: There isn’t any one toughest transaction, but the toughest transactions usually entail getting both sides to see each other’s intrinsic value.  Early on I spent time trying to get sides that didn’t necessarily match to see each others intrinsic value.  Because of trends in private equity finance and greater specialization, many aspects of early stage finance have become more about knowing who is the right investor for you rather than trying to coax an investor who doesn’t invest in your sector to move out of his sweetspot.  Though most investors are looking for good deals, deal flow is so strong at the early stages that if you have to educate the investor over too long a period of time, it is highly likely they will find a deal over that period that is more desirable and closer to their comfort zone.  One well known investor out of Silicon Valley who invested in Google early on told me that the best deals are always the easiest.  That may be true as investors continue to have narrower focuses, however, terms for deals and syndication of deals continue to become more sophisticated.  There are more players with more types of financing than ever before. 
 
Mike Myatt: CEOs and entrepreneurs seeking financing often have a difficult time sorting out the differences between various investors as well as the types of financing and capital structures that are proposed. Can you give our readers a brief overview of the differences between VCs, private equity firms, hedge funds, merchant banks and investment banks?

Marty Secada
: Great question. People seeking funds need to educate themselves on the variety of potential investors out there and the trends with those investors.  The groups you mention above can really be put in the alternative investment category which has had incredible growth over the last 10 years for many reasons.  Source information varies but for global assets under management, there is somewhere between $1.5-4 trillion in hedge funds, $400-750 billion in private equity of which about 15% can be classified as Venture Capital (VC).  There are also angel investors who as a group, invest about the same amount in total as VCs but spread over far more deals.  These groups can be differentiated between those who invest in high growth, asset poor companies and those who invest in asset rich, lower growth companies or public companies. 
 
VCs typically invest in high growth companies and expect high returns.  There is a known gap in early stage investing that is widening for average investments made.  Most of this can be found at the University of New Hampshire web site for angel investing or at the Angel Capital Association web site. The average VC investment these days is about $8 million. Less than 4,000 deals were done by VCs in 2006.  The average VC invests in 4-6 deals annually, they see more than 2,000 a year.  The average angel investor deal is about $450,000.  About 44,000 Angel deals were done in 2006.  Follow on rounds are included in these figures.  If you are looking for investments between $800,000 and $5 million, it may be problematic to find funding sources.  There is some conjecture on hedge fund migration or convergence to private equity but most hedge funds from my network don’t play in the VC space, though some hedge fund individuals may from time to time. 
 
There are also family offices, foundations and institutional investors.  Investment banks may help later stage and some times early stage companies find funding.  Merchant banks have some elements of an investment bank but may also invest their own capital in deals.  There are many creative ways to structure these deals and business owners need to educate themselves on the best fit for them and their business philosophy. 
 
Mike Myatt: From your perspective what’s more material to a potential investment; the idea, the management or the market?

Marty Secada
: It depends.  Most macro-economists would argue that market conditions influence the overall success more than anything else.  Market size matters but without a strategy to dominate, can be irrelevant.  Ideas are more common than most entrepreneurs believe.  I’ve had the same idea pitched to me by people from radically different backgrounds on the same day.  
 
Most investors come back to assessing the management team as the key deciding factor.  Management teams should have skin in the game, chemistry working together, and overwhelming trust with the investors and other key stakeholders.  Lots of VCs talk about picking managers who refuse to lose, but that really translates into management that reacts well to market changes and are robust enough in their thinking to stick with a winning strategy and find a new one when the old one no longer works.   I find some entrepreneurs exaggerate the role their advisors play with them and they should try not to overstate it.  Great management teams know how to generate interest in their product without exaggeration.  
 
Mike Myatt: Which sectors are receiving the most attention from investors right now and what sectors are falling out of favor?
 
Marty Secada: There is a strong political and economic push for alternative energies and a political push for ecology friendly energy strategies.  China buys extended forward contracts on energy promising competitive consumption with the U.S. for years to come and consumers are concerned about the environment.  Wellness is hot as our population ages and related biotech and medtech are meaningful.  Homeland security is an essential growth industry.  In larger private equity deals, infrastructure projects in emerging and newly industrializing countries are pervasive as well as rollup deals and mergers in those same arenas.  On a lesser note, I like on-line communities because of the immense value they add to members lives but think there may be a correction in valuations. 
 
Several alternative energy strategies such as solar energy or corn based ethanol may not be the most economically efficient and vulnerable to changes in political winds and valuations. 
 
Out of favor sectors are shrink wrapped software (vs. services) which is dead, wholly internet advertising driven businesses and old media.  I’m not too sure about the effectiveness of electronic grids delivering broadband as a meaningful strategy outside of the absolute value an electrical distribution network may have from locating sensors ubiquitously and the savings and efficiency delivered from that.  But that has little to do with broadband and may actually be more of a clean energy play than broadband.  It’s amazing that Microsoft still makes money from selling shrink-wrapped software like Office but they have a great brand and monopoly capability.

Mike Myatt
: What do you feel is the most important element of a company’s core strategy?
 
Marty Secada: The core component I like to review once I make sure the financials sound right is how the company will come to dominate it’s market sector or market segment and then leverage that dominance to take over related segments.  I like to hear numbers like months of competitive advantage and market share.  That entails solid knowledge of distribution, channels, revenue and branding.  If you don’t have dominating market share, branding and marketing power then you probably don’t have pricing power.  Without pricing power, profitability may be questionable. 
 
Finance is always important.  I like to look at the components of expenditures as a way to do a reality check on the overall strategy.  If it is a software or web platform, I start to question numbers if I see product expense spiraling past 20% or if the rollout period is too long.  I want to see a management team that keeps its product development expense in check so it has money to market it’s product and create brand value.  Likewise, I like to see the company have realistic quarterly milestones including product rollouts. 

Mike Myatt: What’s the most common mistake you see entrepreneurs make when attempting to raise capital?
 
Marty Secada: Many entrepreneurs underestimate the value of professional management practices in their plan and presentation.  Most of the questions in business at any stage are around who is going to do what next.  Some think that because they have an idea, investors are beholden to them, but it actually is the other way around.  A company puts together its list of milestones and timelines and the next question is who will accomplish these milestones?  Many entrepreneurs walk in with ill-conceived org charts, no management practices or an idea with a board of advisors and no management team.  Well, how is that management team and organization going to change from year to year? Is management going to be able to take advantage of human resource arbitrage opportunities to keep expenses down?  How does the management team make decisions and who do they look to for advice on making those decisions?  Who from the existing management team is going to hire the required new staff?  It all comes down to who is going to do what today and in the future.  Otherwise it’s just another piece of paper, not a business.
 
Early stage investors do due diligence but most of them are really looking at the maturity of the management and how one builds a management model that grows from year to year and sustains the business through to success.  There’s a project that Laura Romeo, a good friend of mine, runs called the Fortunate 400 project.  She has letters that are hundreds of years old from some of the most savvy business people in american history mulling new ventures.  One of the the first things they would conceive back then was an org chart to say how the business, once up and running, would be managed.  It was important then, it is important now.
 
Mike Myatt: Do you have a mentor and how valuable has that relationship been to you?
 
Marty Secada: I’ve had many mentoring style relationships that I’ve taken something away from though I wouldn’t say I had any one relationship that led me to where I am today.  Of course I had a strong relationship with my father who was an immigrant and worked 3 jobs to make ends meet yet found time to attend school activities.  Other than that, a professor named Myron Lieberman was a straight shooting philosopher on life, Mike Singer, another Wharton grad was one of the first master networkers I met preceding the internet era.  Vartan Gregorian and Sheldon Hackney were two great networkers I met at university who had huge, high quality, trusted networks.  All these influences made me realize early on that great information can come from several sources and that one must continually grow and re-evaluate these sources.  Nowadays I am as likely to seek advice from grizzled 30 year industry veterans as well as 22 year old Canadian newsletter writers.  I’ve found Darren Herman, an under 30 entrepreneur out of New York, to have great insight on what works and what doesn’t when it comes to internet marketing and generating traction in business.  It all depends on the circumstance and question. I also like to read Mike Myatt’s blog!
 
Mike Myatt: If you could give one piece of advice to our readers what would that be?
 
Marty Secada: Continually add to your network and continually re-evaluate your network for its best elements and its elements that can be trusted.  Staying in touch with and helping your network is essential to grow in business and in life. 

Mike Myatt
: What’s next for Marty Secada?

Marty Secada
: I’m heading to the nexus of private equity convergence. 

Mike Myatt
: Is there anything else you’d like to share with our readers?

Marty Secada
: Yes, keep a positive outlook.  Long term positive outlook reflects the market, shortsellers i.e. negative types, seldom have great long term success.  It is always important to remember that the overall value in markets is to move upwards even though commodities themselves may decline in value.  Keep a positive outlook.

Why Angel Investors Might Not Be For You

By Mike Myatt, Chief Strategy Officer, N2growth

There is hardly a week that passes where I don’t receive numerous inquiries about using “Angel” investors to finance early stage companies. I entered the phrase “Angel Investor” into Google and received almost 6 million returned searches comprised of everything ranging from individual investors to various groups, clubs and syndicates purportedly looking for deals, to investment portals where investors seeking capital can advertise to the “Angels”. In today’s blog post I’ll address the pros and cons of dealing with high net worth individuals as investors.  Let me begin by sharing my bias I come from the institutional world and prefer to deal with seasoned VC’s and private equity funds. In most cases I am not a big fan of Angel investors. Now that my disclaimer is out of the way let’s start by answering the question: “What is an “Angel” investor?” Answering that question is difficult as “Angel” investors are not a formal investment class and therefore the term means different things to different people. In my book an Angel investor is simply an individual investor nothing more. I know a hand full of Angel investors that are competent, well funded, thoughtful, experienced and savvy investors. An example of this type of Angel investor would be the Band of Angels in Palo Alto, California. This syndicate of Angel investors has more than 100 members, averages $600,000 per investment, and has invested close to $50 million dollars in total. The problem is that in my experience this is the exception not the rule. Regrettably there are many more low net worth posers who prey on businesses by calling themselves Angels who attempt to leverage themselves into opportunities at the expense of the entrepreneur.

Angel investors do have two distinct advantages in that they almost always have some presence in the market, and entrepreneurs can often times cut better deals with non-institutional investors. That being said, angel investors are rarely anything more than a band-aid solution to capital formation as they rarely have deep enough pockets to carry and enterprise through multiple rounds of financing through to sustainability. Furthermore early stage angel investors often muck-up a capital structure such that they actually create a barrier to entry for VC’s, private equity firms and other investors looking to make later stage investments.  If you do seek capital from Angel investors I would strongly suggest that at a minimum you follow the guidelines listed below: 

  1. Look past the immediate need: Request a copy of their financial statement and evaluate not only their net worth, but their liquidity. Ask them straight out if they have the ability to meet future capital calls or make later stage investments.  

  2. Experience and connections can mean more than the capital: As for references from previous companies that they’ve funded. Talk to those entrepreneurs and ask if they received any assistance from the Angel other than the investment and if they would use them again. 

  3. Make the Angel play by usual and customary industry practices: Demand a term sheet from them at the outset. If they can’t perform in the time between term sheet issuance and final documentation then they likely won’t perform later when you really need them. Make sure you always negotiate a buy-back provision so that you can unwind the deal for either non-performance or if it just turns out they are difficult to work with. 

If you are currently seeking capital I would suggest reading the following two earlier posts as they will provide additional valuable information: The first piece entitled Private Equity vs. Venture Capital and the second piece entitled My Philosophy on Valuations.

Venture Capital Prefers US Market

By Mike Myatt, Chief Strategy Officer, N2growth

Venture Capital firms talk a good game when it comes to internationally diversifying their portfolio, but how aggressively do they really seek offshore investment opportunities? According to a recent study published Deloitte & Touche and the National Venture Capital Association apparently not very often. It seems that VCs feel that domestic investments are more attractive when contrasted to expatriating their capital abroad. While I don’t doubt that the US is a more mature, stable and certainly familiar market, I do question the study’s findings that it’s a more attractive market. In this blog post I’ll give the other side of the story from the perspective of someone who has been doing business internationally since the mid 80’s. 

The 2006 Global Venture Capital Survey polled 505 venture capitalists with 53% of the respondents stating that they are looking to invest abroad in the next 5 years. I have two questions: Why wait 5 years, and what in the world are the other 47% of the VC’s that were polled thinking? It is not just a cliché that this is a global economy. From a business perspective the world is getting smaller and smaller. For early stage investors with a strong risk tolerance it seems to me that venture capital firms are missing the boat. With the benefits of tax advantages, currency leverage, smart aggressive entrepreneurs and burgeoning economies why is there not more interest in going abroad? The answer can be boiled down to four words: Fear of the unknown… 

There is no doubt that history has proven ill-conceived foreign investments to be fraught with peril. However the operative word in the aforementioned sentence is “ill-conceived”.  I’m not suggesting that VCs not familiar with the intricacies of foreign markets should run off half-cocked and make foolish investments, but I am suggesting that they should not wait 5 years, or even worse, not consider foreign investments at all. Venture Capital firms need to get of the dime and immediately hire tier one talent with international experience, begin establishing key professional relationship abroad and start doing their market research. 

The upside in emerging markets is tremendous and the opportunities five years from now will certainly not be what they are today. VCs looking to maximize returns should be looking to make allocations to markets like India, China, Brazil and former eastern block countries among others. I am as patriotic as the next person, but the US is not going to be able to maintain the dominant financial position it has held for decades as the economies of these giant emerging markets continue to develop. Moreover the increased flow of funds into capital markets is causing increased competitive pressure to place funds here domestically, and with to much capital chasing too few quality deals valuations are rapidly escalating. Tight investment supply and strong money supply is just one of many reasons venture capital firms should be looking abroad. 

The bottom line is this…Those venture capital firms that make a first movers play into foreign markets will capture the best relationships, establish a foothold in the market with their brand and will ride the wave of economic growth abroad. 

Private Equity vs. Venture Capital

By Mike Myatt, Chief Strategy Officer, N2growth

Based upon numerous requests from N2growth Blog readers and subscribers I will be publishing my advice and opinions in answer to your questions each Monday in a new series creatively named: “Myatt on Mondays“. Any questions related to the topic of business in general (Branding, Finance, Leadership, Talent Management, Marketing, Sales, PR, Strategy, etc.) are fair game. While I will do my best to accommodate as many requests as possible, the reality is that not all submissions will be accepted. Furthermore, because I am only going to publish an answer to one question each week it may be sometime before your answer is published (assuming your request is accepted). Therefore if you need immediate response, please mark your inquiry accordingly and I will attempt to contact you directly. Now that the ground rules are out of the way the first question I’ll answer is: “What is the difference between Venture Capital and Private Equity?”

The text book answer that would be given by most B-School professors is that venture capital is a subset of a larger private equity asset class which includes venture capital, LBO’s, MBO’s, MBI’s, bridge and mezzanine investments. Historically venture capital investors have provided high risk equity capital to start-up and early stage companies whereas private equity firms have provided secondary traunches of equity and mezzanine investments to companies that are more mature in their corporate lifecycle. Again, traditionally speaking, venture capital firms have higher hurdle rate expectations, will be more mercenary with their valuations (please see an earlier post on valuations) and will be more onerous in their constraints on management than will private equity firms.

While the above descriptions are technically correct and have largely held true to form from a historical perspective, the lines between venture capital and private equity investments have been blurred by increased competition in the capital markets over the last 18 €“ 24 months. With the robust, if not frothy state of the capital markets today there is far too much capital chasing too few quality deals. The increased pressure on the part of money managers, investment advisors, fund managers and capital providers to place funds is at an all time high. This excess money supply has created more competition between investors, driving valuations up for entrepreneurs and yields down for investors.

This increased competition among investors has forced both venture capital and private equity firms to expand their respective horizons in order to continue to capture new opportunities. Over the last 12 months I have seen an increase in private equity firms willing to consider earlier stage companies and venture capital firms lowering yield requirements to be more competitive in securing later stage opportunities.

The moral of this story is that if you are an entrepreneur seeking investment capital your timing is good. While the traditional rules of thumb first explained above can be used as a basic guideline for determining investor suitability, don’t let traditional guidelines keep you from exploring all types of capital providers. While some of the ground rules may be changing your capital formation goals should remain the same: entertain proposals from venture capital investors, private equity firms, hedge funds, and angel investors while attempting to work throughout the entire capital structure to seek the highest possible valuation at the lowest blended cost of capital while maintaining the most control possible.

The Impact of Globalization on Business

By Mike Myatt, Chief Strategy Officer, N2growth

Economic Isolationism is no longer prudent...I have traveled to more than 22 countries and have had the opportunity to transact business in various parts of Asia, the Middle East, Canada, Central and Latin America, Russia and former Eastern Block countries, India, and the European Community. Conducting business on a global basis has always been of great personal interest to me, and it has also been both a pleasurable and financially rewarding experience. However the days of doing business abroad are no longer a luxury. The ability to conduct business internationally is an absolute necessity if you hope to remain competitive in today’s marketplace. In today’s post I’ll look at the impact of globalization on business…

Expanding the geographic footprint of your business has always been an expensive and risky proposition – the risks have not gone away, they’ve just shifted. I believe we’re in an environment where we have a short window (3 – 5 years) before the landscape changes again. Currently, globalization is a developing and stabilizing force, but I’m fearful that the interdependencies now shoring up some of the risk, may at some point down the road turn against us in the form of financial ripple turns Tsunami.  Here’s the caution – times change and markets are fluid. Short term opportunity abroad abounds, but with that opportunity comes the potential for unforeseen future risk. That said, and with eyes wide open, if you are not taking aggressive steps to expatriate your business then you may be making a big mistake.

In today’s marketplace conducting business internationally is as much of a defensive play as an offensive play.  In examining the upside of going global, consider the sheer size of international markets as contrasted with the size of the domestic market and you will likely find that the majority of your potential customers live abroad. So if you could double, triple or quadruple your revenue why wouldn’t you aggressively pursue that goal? Now consider the downside of not going global –  if your company is not pursuing those customers your competition will be. They will not only take a first mover’s advantage of securing customer loyalty and brand recognition, but they will also tie-up key partners and distribution agreements. As consumers continue to become more demanding and the world economy continues to flatten there will soon be an expectation that you be able to serve multiple markets in a seamless fashion. Being a slow adopter in today’s world could eventually damage your business.

The phenomenon of “Globalization” is not new. In fact, it has been creeping up on us since the dawn of time; it just hasn’t been so visibly impactful until recent years. The broad macro-economic effects of globalization being experienced today arguably became most identifiable with the end of the cold war, and have only continued their rapid advancement with the development of third world countries and other emerging markets, establishment of free trade agreements, the creation of the Internet and other technology/communications improvements, the growing multi-national footprint of business, the emergence of the European Community, the stabilizing impact of the Euro on global currency markets, as well as the increased liquidity of more sophisticated and efficient capital markets.

The above referenced worldwide macroeconomic maturation, more commonly referred to today as “Globalization,” has served to stabilize business and financial markets in such a dramatic fashion that many industry pundits have yet to reach an understanding of the depth and breadth of the impact it has had on lowering political, financial, and economic volatility. Here’s the trick – markets don’t go up for ever, and when you tie your fortunes to a broader set of variables and unknowns you expose your business to the potential for a domino impact that will work against you. I mentioned a 3 -5 year window above, but like anyone who looks forward, this is just my best guess. At some point in the near to mid term, I believe we’ll see a shift in markets that unwind much of the current stability driving our current frothy capital markets and business expansion.

Let’s examine the stabilizing factor globalization has had on the world economy. Today’s trade deficit, petroleum pricing, down equity markets, housing crisis, constricted flow of funds, and overall cost of living should be challenging us more than it is. Conventional economic theory would suggest that with many of the negative economic metrics in play today, our interest rate environment should more closely resemble that of 1980 than the low interest rates we are experiencing today. The difference between today’s financial landscape as contrasted with that of 1980 is the emergence of a truly global economy which is acting as a stabilizing factor. In fact, when the US went through the Great Depression it was largely a result of having an isolated economy. If (more likely when) the US economy does falter again, the inter-dependant nature of the global economy will likely stave off a collapse. In the event of severe financial turmoil in the US, you would see foreign investment from the G7, and countries like China, Japan, and Dubai would see it as an opportunity to affordably acquire interests in US companies.

The theory espoused above, while working for us presently, can only hold true for so long…The stability we are experiencing now, could turn against us if the economic downturn continues for an extended period. You see, the interdependancy that is presently shielding the US could in fact turn into a global domino effect causing a worldwide recession if the right combination of things fall into place. I guess what I’m trying to point out here is that the current hedge could turn into an adverse accelarant in a worse case scenario…

Also keep in mind that emerging markets in Eastern Europe, India, Latin America, China and the rest of Asia present scenarios for higher growth, even on a risk adjusted basis. On an aggregate basis the statistics are impressive. For example, currently 80 percent of the world’s population accounts for 20 percent of world GDP. By 2015, 50 percent of world GDP will be accounted for by emerging markets. Consider the following:

1. Rising Economies: Over the past decade, China has routinely experienced 8 percent to 9 percent annualized growth and India has followed closely with 7 percent annualized growth.

2. Demographics: For the most part, these markets represent younger populations, growing numbers of well-educated professionals, an expanding middle class, growing consumer bases, urbanization, and rising incomes. In addition, the structure of family life for these modern middle class populations is assuming the “western” nuclear form and moving away from the more traditional extended cohabitating family unit.

3. Commercial Demand: The economic expansion, as well as the presence of global companies that bring employment oriented around intellectual capital, is creating demand for modern, western style commercial real estate infrastructure. Core assets such as office, industrial, retail, multi-family, and hospitality are all experiencing rising demand.

4. Infrastructure Improvement: While communications, utilities, and efficient transportation can still be spotty in areas, it is much improved over what one would have experienced even a decade ago. In most metropolitan areas you will have most of the creature comforts that you experience in the United States.

5. Closed market systems opening up: Most successful emerging markets have been engaged in systematic reform of basic societal values we take for granted in the developed world. These include property rights, legal process, and published regulations and statues. In addition, specific reforms such as privatization of state owned industry, relaxation of capital controls, and liberalization of rules regarding foreign direct investment are all encouraging growth and investment.

In order to meet increased consumer demand many businesses are attempting to expand their geographic footprint and extend their value chain to an international level. The impact of globalization on business is best evidenced by the huge proliferation in cross-border transactions. In order to protect yields and maintain competitiveness, businesses are continuing to diversify their footprint as it lowers the beta factor on their investments by spreading risk across a broader market.

There is nary a week that passes where I don’t speak with offshore entities looking for inbound opportunities or domestic businesses seeking outbound plays. The bottom line on globalization is that it creates an opportunity for businesses to expand revenue streams, diversify risk and increase brand equity.  My suggestion is to get a toe hold in the global market before the ship leaves the harbor and your window of opportunity has closed. I would also suggest you pick your markets well, and that you realize a few years down the road, the landscape will look differently than it does today – this could work for you or against you. Use caution.

The Typical Approach to Capital Formation is often the Wrong Approach

By Mike Myatt, Chief Strategy Officer, N2growth

The architecture of your corporate capital formation strategy should be engineered by design and should not be something that evolves by default over time. However all too common is the enterprise that organizes itself improperly out of the gate by making the wrong choice of entity, issuing the wrong type, class and amount of stock or member units, seeking equity investments either from the wrong sources or at the wrong time, utilizing the wrong form of debt financing and the list goes on In today’s post I’ll examine some common capital formation mistakes to avoid.

I conducted an informal pole not too long ago with the goal being to try and understand how entrepreneurs choose to organize their companies.  The following five questions were posed to a group of bright, successful and sophisticated entrepreneurs and the answers received ranged from the sublime to the ridiculous, to the very enlightened. The answers displayed below are representative of the most common responses:

1. How did you select the your entity structure? “I asked my accountant which form of entity to use and he said that a Sub S would be the best choice for minimizing my tax burden”

2. How did you organize your capital structure?  “My attorney just told me to issue 100 shares of common stock.”

3. What was your capital formation plan? “I had a little cash saved up and I figured once I had been in business for a while and established some revenue I’d get a bank loan.”

4. What was your valuation strategy? “I didn’t really have a valuation strategy I thought it would take care of itself at the right time.”

5. What was your exit strategy? “I didn’t really have an exit plan per se, I just thought I’d survey my options when the time was right and see what produced the best return.”

The truth is I’ve seen companies make all the wrong choices in their formative stages and yet still do well. However these companies that have succeeded in spite of themselves had the luxury of having the time and the money to reengineer their business at a later date. The sad reality is that most companies don’t have the time or the capital to unwind critical mistakes in their strategic financial plans. 

My advice is simple Do not fall into the trap of working with a small “mom and pops” accountant or attorney; rather seek out the highest caliber professional advisors when developing your corporate financial plan. Time spent in the development of a sound strategic financial strategy will help your company secure capital at the best terms, rates and conditions thereby allowing your company to scale by leveraging the lowest blended cost of capital into the best valuation resulting in the highest return on equity.

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