Private Equity in Sell Mode

Well, business owners cannot moan that they were not warned that their opportunity to sell their business at a good price is rapidly declining. If you own a business in Canada, and particularly if your revenues are below $20M, you are going to have a far harder time selling your company. There is still time to get in Private Equity Partners who will buy 30% and let you stay on to grow the business with them and sell your remainder share five years down the road.

"For the first time in 16 years, private equity funds are selling more companies than they are buying," reports Andrew Willis, Globe and Mail. Here's what else Willis had to say: 

News on Monday that Cerberus Capital is selling a health care company in its portfolio, Talecris Biotherapeutics, to Spain’s Grifols marked something of a turning point for the private equity sector. According to data from Thomson Reuters, the $4-billion (U.S.) sale meant that for the first time since 1994, global mergers & acquisitions involving a private equity seller outweigh takeovers involving private equity buyers.Funds have sold $67.1-billion of companies, year-to-date, and done $64.2-billion worth of takeovers. Overall, the volume of deals involving private equity funds is soaring, largely due to a recovering in credit markets over the past year - loans fuel leveraged buyouts. Year-to-date 2010, Thomson Reuters found activity involving financial sponsors as sellers was up 132 per cent, while sell-side activity is up 174 per cent. M&A activity involving a private equity fund accounted for 13 per cent of the total value of worldwide M&A so far this year, up from 6 per cent of deals during the same period in 2009, according to Thomson Reuters. 

What does this mean for business owners? It is similar to the housing market, investors are selling off properties and this pulls down the price of housing in the neighborhood. Same for businesses. The last eight glory years of getting great multiples are over.

However, I was in Boston this past week and American Private Equity firms are very keen to buy into Canadian firms and willing to invest in equity partnerships of 35% upwards. They would be exciting partners for Canadian owners and are very similar in culture - polite. 

If you are a Canadian business owner with a company with revenues over $20,000 revenues, now is your chance.

Jacoline Loewen, expert in private equity, author of Money Magnet: Attract Investors to Your Business.

The Role of Institutional Development in the Prevalence and Value of Family Firms

It was a surprise to me the number of family firms in Canada, but this not unusual.

Family firms dominate economic activity in most countries, and are significantly different from other companies in their behavior, structural characteristics, and performance. But what explains the significant variation in the prevalence and value of family firms around the world? 

The two leading explanations are 

1. legal investor protection and 
2. institutional development.

Cross-country studies are unable to rule out the alternative explanation that cultural norms are what account for these differences. In contrast, China provides an excellent laboratory for addressing this question because it offers great variation in institutional efficiency across regions, yet the country as a whole shares cultural and social norms together with a common legal and regulatory framework. In this paper, HBS professor Belén Villalonga and coauthors study ownership data from a sample of nearly 1,500 publicly listed firms on the Chinese stock market. They conclude that institutional development plays a critical role in the prevalence and value of family firms, and that the differences observed across regions are not attributable to cultural factors. Key concepts include:

• Family firms do not inhibit growth and development, as is sometimes argued. This seems clear due to the relatively higher prevalence of family firms even in regions with high institutional efficiency.
• The effects of family, ownership, control, and management in China are remarkable similar to those found by professor Villalonga in her earlier research based on U.S. data. Namely, family ownership is positively related to value, family control in excess of ownership is negatively related to value, and family management, when exercised by the firm's founders as is primarily the case in China, is positively related to value. However, in China these effects are largely driven by the low institutional efficiency regions. In the high efficiency regions, none of these effects are significant.
• These findings are particularly relevant for China as it continues its transition from a central planning system to a market economy.
• On average, family firms are significantly smaller, younger, and less capital-intensive than non-family firms. Yet they exhibit significantly lower systematic risk, and they are not significantly different from non-family firms in their growth and leverage.

Read in Full at Harvard Business Review;

Published:June 23, 2010
Paper Released:May 2010
Authors:Raphael Amit, Yuan Ding, Belén Villalonga, and Hua Zhang

Every Family's Business: 12 Common Sense Questions to Protect Your Wealth

Surprise - Government stimulus can reduce private sector spending

If you are wondering if your tax dollars can re-build the economy, I recommend reading more about this fascinating study by HBS which confirms that government spending skews opportunities for private businesses.  I like it when we can separate out the social rhetoric and see the economic factors clearly, particularly with well-meaning government interventions. Central planning has been shown to be far less effective in the many political forms it has tried over the past century.  If you are running your own business and having to meet payroll, you will already be aware of these findings even thought the researcher, Joshua Coval, was surprised.

Executive Summary:

New research from Harvard Business School suggests that federal spending in states appears to cause local businesses to cut back rather than grow. Read the full article here - A conversation with Joshua Coval.
Key concepts include:

• The average state experiences a 40 to 50 percent increase in earmark spending if its senator becomes chair of one of the top-three congressional committees. In the House, the average is around 20 percent.
• For broader measures of spending, such as discretionary state-level federal transfers, the increase from being represented by a powerful senator is around 10 percent.
• In the year that follows a congressman's ascendancy, the average firm in his state cuts back capital expenditures by roughly 15 percent.
• There is some evidence that firms scale back their employment and experience a decline in sales growth.

Robin Hood Should Have Been in Private Equity

I saw Robin Hood this long weekend. It is a truly, extraordinarily bad film: long, boring and yet, at times, preposterously silly. The low point came towards the end, when a bloodied, chainmailed Robin lept out of the English Channel, and gave a dramatic, slow motion roar. The whole audience burst out laughing. But it’s a real shame the film is so terrible, because it actually has quite a positive message about hard working people keeping the results of their work. This is the not the Robin Hood conjured up by those Dalton McGuinty tax advocates, who think confiscating bank and business profits will solve all the world’s problems. This Robin makes speeches about liberty, battles King John’s tax collectors, and even tries to force the King to sign an early version of Magna Carta. If the film hadn’t been so utterly charmless, I’d have been cheering him on. Robin could have been a private equity partner to Maid Marion, helping her seed her farm while thinking bigger about the long term view.

This version of the Robin Hood story made me think of Jean Baptiste Colbert’s famous quote: “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing”. King John, plainly, failed to master that art. Yet modern governments have become very good at it, taking up to half of what people earn without triggering a revolt, or even any serious resistance. The reason is that people today often pay their taxes without realizing it. Most is simply withheld by their employers (hopefully they get a slip seeing what was taken), while much of the rest is passed on to the taxman by retailers with GST and HST. I suspect a lot more people would be advocating low taxes if they had to actually reach into their pockets and pay them directly with cash. In this spirit, perhaps it is time for tax withholding to go. Private equity is increasingly coming under pressure in the USA to have their income from investments into companies taxed as a business owner, not as a capital investment. That is a whole other blog.

"Should Lady Gaga have most of her wealth taken from her and redistributed to artists who did not sell five top chart hitters last year?" Eeer...that seems awfully unfair and why prop up those who have not created their own market? Conrad Black used this example to talk about taxes in his column in The National Post. Worth reading. Go to NP.

Uncertainty created by government involvement.

I watched the movie 1984 which was filmed in 1984 by, interestingly enough, Richard Bransom. Virgin's movie company, Virgin Films, does a good job interpreting the dense book 1984, and had the soundtrack by stars on the Virgin Records list. Very interesting as the movie tries to capture the human psychological results when the big government gets so involved in the market and day-to-day life of its citizens. You can see a few of Richard Bransom's personal bug bears, but it is well worth watching to remind ourselves of how 1948 looked to those who had suffered through the rise of a government like Hitler's, and why other countries and people accepted Nazis for so long.
We are experiencing a rise in how much the government gets involved in the economy again, and I listen to many earnest 27 years olds who fervently believe their government work is critical. A recent study by the rational and dispassionate Harvard Business School shows that this belief, just like 1984's O'Brian's belief, is dangerously misguided. In fact, this Harvard study shows that government spending shuts down private sector activity.
I have certainly seen that government funding of NGOs and not-for-profits sucks up talented engineers and marketing people while the public sector struggles to find such skills.
Find the full article here.
Here is the researcher's comments on their insights which they did not even mean to study:

Q: Although you didn't intend to answer this question with the research, what does your team suspect are some of the causes that could explain why companies retrench when federal dollars come into their neighborhoods?

A: Some of the dollars directly supplant private-sector activity—they literally undertake projects the private sector was planning to do on its own. The Tennessee Valley Authority of 1933 is perhaps the most famous example of this.

Other dollars appear to indirectly crowd out private firms by hiring away employees and the like. For instance, our effects are strongest when unemployment is low and capacity utilization is high. But we suspect that a third and potentially quite strong effect is the uncertainty that is created by government involvement.

Q: These findings present something of a dilemma for public policymakers who believe that federal spending can stimulate private economic development. How would you suggest they approach the problem that federal dollars may actually cause private-sector retrenchment?

A: Our findings suggest that they should revisit their belief that federal spending can stimulate private economic development. It is important to note that our research ignores all costs associated with paying for the spending such as higher taxes or increased borrowing. From the perspective of the target state, the funds are essentially free, but clearly at the national level someone has to pay for stimulus spending. And in the absence of a positive private-sector response, it seems even more difficult to justify federal spending than otherwise.

Christopher J. Malloy is an assistant professor in the Finance unit at Harvard Business School.

• More Working Knowledge from Christopher J. Malloy
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  About the author of the HBR article

  Sean Silverthorne is the editor-in-chief of HBS Working Knowledge.