The economy matters for private equity

I have been following Arnold on Twitter. You know, Arnold, ex-Terminator and now governor of California. He has been sharing his budget pain and what he is trying to negotiate.
California accounts for 10% of the U.S. economy. It's state budget is about $125 billion and the deficit is about $25 billion. By law, California must balance its budget each year and the fiscal year ends June 30. Back in February, the Democrat-controlled legislature could not agree with Republican Governor Arnold Schwarzenegger on spending cuts, but it did agree to put a series of tax increases and borrowing schemes before the voters in a referendum. On May 19, all were defeated. California treasurer Bill Lockyer appealed to Washington for access to bank bailout funds, but he was turned down. He has since warned that the state only has enough cash to meet payrolls until mid-summer. We are all watching.
California matters because of its sheer size on the U.S. economy, and because 49 other governors are watching to see how Washington reacts to its budget crises. State governments are contemplating layoffs, program cuts, tax hikes, facility closures and other such measures all of which will cut in U.S. employment and consumer spending in the third quarter. Over the summer we will learn how these issues play out.

Tips for strategy

As investors evaluate business plans there are certain tests to pass.
No matter the size of company, the first test (besides the people) is around the strategy. One thing I have learnt is that the right strategy is unknowable in advance.
I would far rather see that the company has a strategy to learn, rather than a strategy to implement.
All industries are ripe for disruption and that counts whether it’s banking, computers, brokerage, private equity or even the venture capital industry itself. The odds do favour the incumbent but when a “sustaining” technology is introduced, this has the potential to disrupt the current scene. As private equity fund managers know; disrupter companies can be a great investment.
So what makes a good disrupter? Some are obvious but others, not so much. Here's a quick rule of thumb: If the company’s technology gives skills to a less wealthy and skilled large group of people; it is a good indication that it passes the investor test.
The technology has a higher potential to take hold and gain market share. Now you are talking.
If I were to give some advice to “disrupters” or those wanting to be disrupters, it would be that if a business model seems unattractive to the current dominant players, and clearly is not a sustaining technology to anyone else, then you are cleared for a green light.
Time to go for it!
If you want to ponder more on disruptive strategies, I recommend any of Clayton Christenen's articles.

Are you naive about the recession's end?

So it's official - The Conference Board reported that the recession is over, but don't be too quick to think everything will be hunky dory, cautions The Gartman Letter:

Firstly, however, we shall note that The Conference Board reported its Leaders, Coincidents and Lagging Indicators yesterday, with the former rising 0.7%, almost spot on as had been expected. We note that this was the third month in a row of increases, and historically three consecutive months in a row of advances is the sign that the recession is about to end.

By definition, the “Leaders” lead, and so those reliant solely upon the Board’s Leading Indicators are not prepared to join us in our statement that the recession has ended.

We’re “OK” with that.
More importantly to us, the Board’s Coincident Indicators in June fell modestly, losing 0.2%, while the Laggers fell even more, losing 0.7%. Thus the Ratio of the Coincident to Lagging Indicators rose yet again, not by a material sum, but it rose nonetheless. This is our favourite economic data point, and it has now risen for two months in a row. Historically, it turns “spot on” the turning point of the recession, although it has fired off one or two false signals in the past. However, when the Ratio turns higher coupled with a “spike” downward in weekly jobless claims, the Ratio does a truly spectacular job of telling us that the economy is at its worst levels and that a turn higher is hard upon us.
It has turned higher; that is all we need or wish to know. What we must also remember, however, is that the economic news shall remain horrid for several months yet for we must always remember that the end of the recession means that we are at the nadir of the economy. Things are at their worst at the lows.

Consumer psychology is months, if not a full year, away from turning for the better. Retail sales will look terrible for months; housing sales, although rising from their lows, will still be hundreds of thousands of units in annualised terms below the decent levels of two and three years ago; auto sales will seem horrid in comparison to those of ’05 and ’06 and ’07; unemployment is heading inexorably toward 10% or higher and will continue to rise long into ’10, but the worst is probably upon us now and better numbers lie ahead.

Thus, those who think that just because we have called the recession’s end to be upon us means that we shall see remarkably strong economic data points immediately are naïve and out-of touch historically.

Thanks to Scott Tomenson, Family Wealth Management. You can see more of Scott at http://www.jstomenson.ca/ and also
http://familywealthmanager.blogspot.com/

Stories of Private Equity

When the announcer yelled out, “The winner of the Media category, Ernst & Young Entrepreneur of the Year—Somerset Entertainment!” Andy Burgess grinned and bounded up to the stage to collect the award.
It all looked so easy to be standing there in a tuxedo waving the trophy, but this moment of appreciation came from painful years of slogging late into the night.
Andy Burgess is one of the owners of Somerset Entertainment, which produces and distributes specialty music to gift stores and other non-traditional retailers using interactive displays where you can push a button and listen to the CDs. They have 28,000 displays in over 18,500 locations that now include mass merchants and specialty stores.
With business and Juno awards filling their shelves, Somerset Entertainment did various acquisitions and moved from $5M in revenues to $11M, until eventually they were achieving $21M in revenues. They bought a distributor and, in 1998, levered up with four flavours of debt: term debt, debt at 17% interest rate, revolving credit, and a vendor take back loan. Then the cracks began to show.
The Buffalo distribution fulfillment center had been shipping comfortably to over 100 different retail points when Andy asked, “Can you do higher volume?” Naturally, they answered, “Yes!” when in fact that was far from the truth. Somerset had been a company with $8M revenues and $2M in EBITDA (earnings before interest, tax, depreciation, and amortization—see glossary) but had grown into the supply chain approach with a distributor turning out to be slow and with the uncanny ability to mess up orders. They would say they had shipped goods—the display case with CDs—and Somerset would then invoice the retailer who, it turnrf out, had not received anything except a bill. It was October—prime pre-holiday selling time with the Christmas season around the corner.
Not good!
American retailers are the toughest sons of guns and were furious at being bamboozled. They told Andy they did not get the goods, but then told him not to bother coming around any more—they were through. Yikes! In one fell swoop, Somerset had gone from being swift deliverers of orders to slow, unreliable duds.
“We hit $36M in sales with $8.5M EBITDA but our debt was at $15M and for the first time, we stressed about breaking covenants. We got a valuation of $15M and, with reluctance, we decided to go with a private equity investment of $21M.”
In hindsight, Andy says getting private equity was good for the owners’ motivation. It took the edge off the worry about money and retirement. “With private equity buying part ownership, we were allowed to take a large chunk out for ourselves straight away but still retain control. I had been working very hard and it was good to get $6M out for the founder and owners.”
The money meant Somerset could pay off their debt straight away and still have $4M to make acquisitions.
Andy says, “With that extra cash, we set up an office in Chicago that has turned out to be the vital springboard into the American market, taking Somerset to the next level. We’ve had a bad year in there, but we did not have to worry about the business blowing up. The peace of mind meant we could focus on battening down the hatches to the storm and finding a new way forward.”
The private equity partners proved to be great sounding boards when Somerset was making acquisitions. The investors were more aggressive in wanting growth but respected Somerset’s decision to step away from some identified targets.
“Also, when we nearly lost a key person,” Andy adds, “The investors did bring him around and get him to stay.”
Andy adds, “When you are an entrepreneur working your butt off, it is great to get that cash pay out as well as have cash to grow the business. With private equity you get the best of both worlds—the cash liquidity without the rigorous scrutiny of the public market.”
“Not every company can go public,” says Andy. “Private equity will transition you.” See if you can go public. Take Andy’s test and put the necessary tick marks next to your chart.
− You are making enough money to pay for public listing and accounting.
− You are profitable.
− You have a strong growth curve for your revenues.
− You have a decent management team.
− You are a good size.
Andy says, “At the time of the private equity deal, we were too small to go public. With private equity investors, we got to retain control and we got liquidity. Private equity took us back from the brink with risky debt and looming covenants. They were the stepping stone to getting big enough until in 2005, Somerset did our initial public offering (IPO). Selling those secondary shares was sweet, too.”
As Andy Burgess stood on the stage and let the applause of the audience sweep over him, it struck him how far Somerset Entertainment had come and what a ride it had been so far.

This is an excerpt from Money Magnet: Attracting Investors to your Business. Read more:

Women need to break through in banking

A new study finds no progress breaching top ranks despite industry's employment growth, says Dana Flavelle, Business Reporter for The Globe & Mail.
I must add here that I just finished a meeting with a South African finance expert who commented that although Canada is so open in business culture to people from anywhere, Bay Street is a tight knit group of Canadians. So, although this banking study focusses on women's difficulties in getting to the top, there are very similar issues for males not from the inner circle of Canadians. The South African went on to comment on how Wall Street is far more open to outsiders.
My question is does that make Canada's finance industry more secure and less likely to suffer Ponzi schemes and Enron debacles? Today, financial business is being done more and more with people you know. Perhaps the Bay Street inner circle does seem to work at keeping stability? I think we need to keep a great deal more in mind when reviewing these damning reports which make great press but are far more complicated with long term consequences we may not understand.
Here's Dana's article:
Stunned silence, groans of recognition and occasional laughter greeted the disappointing data and frank talk yesterday about women and the glass ceiling on Bay Street.
While Canada's banks have made progress promoting women in their other lines of business, in the rough-and-tumble world of stock and bond trading and private wealth management, they have made "virtually no gains," a study shows.
Part of the problem is the industry's lingering image as dominated by a "cigar-chomping group of men" where everyone works 15-hour days, Lynn Kennedy, managing director of foreign exchange for BMO Capital Markets, told a blue-chip luncheon at the King Edward Hotel, where the report was released yesterday.
The idea women need to network after office hours to get ahead is probably overrated, Kennedy added. "In those networks, I think we think a lot more goes on than actually does," she said to a burst of laughter. "I like to think I'm recognized for what I do during the day."
Still, stunned silence greeted the revelation that the latest study by Catalyst Canada found women have made no progress even as employment in capital markets at the management level grew 12 per cent to 16,300 during an eight-year period ending in April 2008.
Despite the stated support of senior bank executives, women remained stuck at 17 per cent of all senior managers, those with jobs that lead to a shot at the corner office, the study found. They made up 21 per cent of all middle managers. Even when support staff are taken into account, women make up just 40 per cent of employees.
"To say we are reporting progress would be overstating the data and before you blame the recession, the data was collected before it began," said Catalyst Canada vice-president Deborah Gillis.
"The truth is women have made virtually no gains," she added, sparking audible groans from an audience of 250 men and women who work in the capital markets industry. "There is still no one holding the title of chairman, president or chief executive officer."
Indeed, women may have lost ground since the credit crunch that began in the United States sparked a global financial meltdown and sweeping layoffs in the investment industry, the study's main client said in an earlier interview.
"We don't even know the impact of the enormous financial crisis. It's a huge concern for me," said Martha Fell, chief executive officer of Women in Capital Markets.
There is debate in some circles that more women at the top would have prevented the kind of testosterone-fuelled risk-taking that caused the financial crisis, Fell added. "I'm not saying I agree with that, but it makes you stop and think."
Catalyst Canada has long argued that presenting the data would lead to change and Fell said she is personally convinced that's the case.
However, she acknowledged in an interview the fact that four highly publicized studies of women in capital markets in eight years have produced little change raises disturbing questions.
"How the heck is this possible? Everything we're doing suggests we should have moved the dial by now," said Fell, whose non-profit advocacy group works with women to help them get ahead.
At least one bank, TD Financial Group, defended its record, saying women had made good progress in its other lines of business.

Finance Club For Women

For women meeting with private equity investors, you will be judged within the first five minutes. Will you convey confidence that you deserve to manage a whole lot of capital entrusted to you or will your body language say that you are not strong enough?

You may give off the wrong message without even opening your mouth.
Here's Forbes Woman's best advice for transforming your self-presentation into one that commands respect. Read more:
Raquel Laneri tells us, "Jeannine Fallon, executive director of corporate communications at Edmunds.com, learned this at a training course called "Women Unlimited," which she attended when she worked at Volvo 10 years ago."
"I distinctly remember one insight," she says of the session. "At a boardroom table, women tend to pile all their materials neatly and sit tucked into the table, while men tend to sprawl out, push away from the table, cross his ankle over a knee and lock arms behind his head. It was impressed upon us that the concept of taking up space correlates to the concept of dominance." The result? "I've never sat tucked into a table since."

Carey O'Donnell Public Relations Group, based in West Palm Beach, Fla., "many of us have no idea that our non-verbal cues are making an impact. There are thousands of micro-expressions, and people are reading these, even if they are only subconsciously translating these cues."
Some of the visual ticks common to women:
--Tilting your head--a sign of listening that can be misinterpreted as one of submission or even flirting.
--Folding your hands on your lap--hiding your hands under a conference table or desk, for example, signals untrustworthiness; a cue from ancient times, when men would reveal their palms to show they were unarmed.
--Crossing your legs--a sign of resistance.
--Excessive smiling--an indication that you lack gravitas and seriousness.
--Folding your arms in front of you--translates to insecurity or defensiveness.
--Playing with or tugging at your hair, jewelry or clothes--can signal distress or, again, be misinterpreted as flirting.

Well, now we know. I love to play with my jewelry so I had better cut that out! Check out the grumpy comments from men who came to the Forbes site to read the article. One fellow pouts,"If I had known this was body language for women, I would not have checked out this site." Poor man...

5 Items to have ready for an investor

You are going to have to do a lot more than pray for money when seeking investors. You are going to have to get "investor ready" as once they look at you, like what they see, then they will want a whole truck full of information...NOW.
I get asked all the time, "Where do I find investors?"
That part is easy, actually.
The question everyone should ask is, "what will get the investor to put cash into my business?"
This is the part which separates the men from the boys (and the women from the girls.)
Before you begin looking for people, get yourself ready. As sure as the sun rises in the East, there are items that us investors will require from you. First up, let's look at the 5 items about finances that we will need to tell us more about your business or idea:
1. The income statement is paramount.
If nothing else, if, at the very least, we can look at the income statement from one year of history we can judge how big the company is and how large of a financing it can generate. We would simply look at the earnings, calculate the EBITDA and get a rough idea of the general size of the company
Multiplying this by 6 times would give a very rough idea of the valuation of the company (enterprise value) and how much financing it can withstand. Some people are saying multiple it by 3 times but I think that is a little cruel.
2. The balance sheet is also very important.
From this we can determine the capital structure of the company.
3. Then there's the structure.
Looking at the capital structure allows us to determine what the structure of the financing might look like. It also allows us to determine a more accurate valuation (equity value) and determine the amount of dilution to management.
4. Cash is king, as the saying goes.
Cash flow statements can be derived from having both of these statements, but it is helpful in determining things like how much money management must invest each year to maintain the operations of the company.
5. We are history buffs for a reason.
History: we like to get three years. This is because at least three years allows an analyst to see any financial trends in the company. Having more than three years is even better, but three years is the minimum for noticing trends.


If you are wanting to learn more and get a simple explaination on this in far more details, check out Money Magnet: Attract Investors to Your Business.
It's written by J. Loewen and is simple and, surprisingly, readable because it is written for business owners.

What's a Great Job Now?

One of the hottest jobs for B-School graduates is Private Equity and this article in the WSJ is a good reflection of the trend. (If we count the resumes flooding our office, I would agree.)
I suspect many of these recently minted MBAs think that the private equity asset class is where the big salaries lurk and may be disappointed. Private equity is about far more than the money, the best PE people are fighters for the businesses they bring into their portfolios. They have to know the full range of business - in particular, cash flow. You can not get that from an MBA. Anyway, here's the WSJ article in brief:
"The percentage of graduates from the world's top business schools taking private-equity jobs has more than doubled in the past six years, according to the business schools' numbers.
"Financial News analyzed figures from five of the most popular M.B.A. schools:
- Harvard Business School,
- Stanford Graduate School of Business and
- the Wharton School at the University of Pennsylvania in the U.S.;
- the U.K.'s London Business School; and
- Insead, based in France and Singapore.
The percentage of Harvard M.B.A. graduates moving into private equity and venture capital has more than doubled, from 8% in 2003 to 21% among last year's graduates. In that time, the proportion moving into investment banking rose far less, from 7% in 2003 to 9% last year.
Data from Stanford showed a similar trend, with 9% of graduates choosing private equity in 2003 rising to 19% last year, compared with 4% and 5% for investment banking. Harvard supplied the highest number of M.B.A. graduates moving to private equity last year, with 191. Stanford was second with 72, ahead of Wharton's 45, Insead's 25 and London's 22.
Private equity's rise in popularity reflects the perception that graduates could make more money working in the asset class than in investment banking, but also follows substantial growth in the size of the private-equity market. However, an M.B.A. isn't a prerequisite for joining many private-equity firms. A sample of 10 large European and U.S. firms showed that 52% of the executives at partner level or above had obtained M.B.A.s.
Firms' Web sites showed French group PAI Partners had the lowest proportion, with 21%, or four of its 19 partner-level executives.The private-equity units of U.S. firms Kohlberg Kravis Roberts and Blackstone Group also had high proportions of MBAs among their senior staff, 61% and 63%, respectively.
Patrick Dunne, group communications director at 3i Group PLC, where 48% of partner-level staff had M.B.A.s, said: "For some people, [an M.B.A.] can be fantastically helpful -- for those without a finance background, for example, it can be a useful way of picking up necessary skills and knowledge."

How's your AQ?

I was reading the lists of the businesses that made it the Profit 100 fastest growing companies list, and I was reminded of one of Rick Spence's recent Twitter postings. He commented, "Being an entrepreneur is like being punched in the face, frequently, but to have the ability to keep on going."
Something like that.
Like Rocky, my favourite movie character, said, "It's not how hard you can hit, but how much you can take and still keep moving forward.
So, when I emailed the many entrepreneurs I knew from the Profit 100 list, I mentioned that their adversity quotient must be very high. Most of them understood what I was saying, but a few wrote back asking if this was their "pig-headedness" quotient too!
Here's a quick summary of AQ:
Adversity Quotient, called AQ, is like Intelligence Quotient or IQ.
AQ is the science of human resilience.
People who successfully apply AQ perform optimally in the face of adversity — the challenges, big and small, that confront us each day. In fact, they not only learn from these challenges, but they also respond to them better and faster. For businesses and other organizations, a high-AQ workforce translates to increased capacity, productivity, and innovation, as well as lower attrition and higher morale.

5 Ways GE is charging up their tired batteries

Jeff Immelt spoke before the Detroit Economic Club yesterday and I got summary notes from Judith Ellis via Tom Peters web site. Here is some of what he said:
"Many bought into the idea that America could go from a technology-based, export-oriented powerhouse to a services-led, consumption-based economy — and somehow still expect to prosper. That idea was flat wrong."
"Recently my colleague Peter Loescher, the CEO of Siemens, extolled the importance of Germany as an exporting country. In my career, I have never heard an American CEO say that the United States should be leading in exports. Well, I am saying it today: This country ought to be, and we can be, not just the world’s leading market but a leading exporter as well. GE plans to lead this effort. We have restructured during the downturn, adjusting to the market realities. At the same time, we are increasing our investments. We plan to launch more new products during this downturn than at any time in our history. We will sell these products in every corner of the world. We are creating a better company coming out of this reset. Similarly, America needs a dramatic industrial renewal. We have to move forward on five fronts."
First: Increase investment in research and development.

"GE has never forgotten the importance of R&D. Each year, we put six percent of our industrial revenue back into technology — so much that more than half of the products we sell today didn’t even exist a decade ago. As a consequence, we are a huge exporter… GE’s R&D budget has not been cut. And that’s a course of action I’d recommend to every company that wants to get through the economic crisis even stronger than before."
Second: America should get busy addressing the two biggest global challenges — clean energy and affordable health care.

"There is no question whether there will be break throughs in these areas — just by who and when. The leader in these fields will dominate the global economy in the decades that come."
Third: We must make a serious commitment to manufacturing and exports.

"This is a national imperative. "We all know that the American consumer cannot lead our recovery. This economy must be driven by business investment and exports… America has to get back in that game … and it starts with a strong core of innovation."
Fourth: We should welcome the government as a catalyst for leadership and change.

"There’s a long history in this country of government spending that prepares the way for new industries that thrive for generations. Think of the NIH or NASA, and all the new innovations that came out of these programs — from computing to communications to health care. America has that kind of chance with unprecedented levels of new government investment. ... The key is making sure those hundreds of billions of dollars fall on the fertile ground of innovation, and not bureaucracy."
Fifth: It is possible for a global business leader to also be a good citizen.

"We must partner in our communities. Big business should work with smaller companies in our supply chain to help them compete globally. And we should partner with local governments to fix our education system. In the end, business leaders are accountable for the competitiveness of their own country. We must say so publicly. This will not hurt our ability to globalize. Rather, I think it will make other countries admire our business leaders more. We must end the impression that American CEOs are short-term speculators."

Fighting words from Immelt and interesting themes.

Here in Canada, our Government is certainly listening and asking what they can do to help business. Government can play a big role in driving markets and being the first customer of size. At least Jeff Immelt is an American leader taking all the criticism about the US and, as a result, doing something differently today. Lead on, Jeff.