4 Worries for Owner Operators According to Private Equity

Private equity fund managers are in touch with the business operator/owners and report that the top issues keeping these business leaders up at night are:
1) Key employee retention
2)  Management Succession in the C and V suites
3) Customer retention
4) Operational efficiency

What do you think?

Entrepreneurial Businesses Drive Job Growth, says Harvard

Politicians are too likely to guess wrong about which industries are worth attracting. With job growth worrying politicians, Toronto City Hall may be tempted to chase big companies to take a tax break and set up shop.
"That's a misguided approach," says Ed Glaeser and Bill Kerr, Harvard.
Job growth and the big economic development coming from these new work roles is now proven to come from the successful incubation of "small, entrepreneurial employees--not a few big companies." Even adjusting for variables such as tax or industry, Glaeser and Kerr say, "the relationship between small firms and job growth rate stands."
Industries with smaller firms and more start-ups had faster job growth than an industry an industry in the city without a cluster of start-ups. So a gnat like cloud of small companies buzzing around larger companies will be far better suited to job growth.
According to Glaeser and Kerr, apparently large companies generate less job growth than these "gnat" sized businesses. Also, once a city establishes itself as entrepreneurial, it tends to be self perpetuating.
So Toronto needs to market itself as a City for Entrepreneurs.
A big thank you to The Globe & Mail for organizing a 6 Mayor Candidate Town hall on what to do for business.
Give your views on Facebook to:
Sarah Thomson
Rocco Rossi

4 Reasons Governments want to help Business

Business owners will be able to attend a town hall on how Toronto can help business. Thanks to the Globe & Mail for sponsoring the Sept 9th discussion with the 6 mayor candidates.

The economy has changed business as usual approach by government from city to country levels and encouraging a return to government involvement from puppet master to financial supporters of business. 

Four main forces are driving this revival of industrial policy. 

First is the weak state of the world economy. Governments are under pressure to reduce unemployment and stimulate growth: support for chosen industries is a way of saving jobs and helping local firms fight foreign competitors. 

Second, some countries, such as America and Britain, want to rebalance their economies away from finance and property. Along with older manufacturing, clean technology is emerging as a favourite direction. Nearly every large economy has plans to win global market share and create green jobs.

Third, emergency use of industrial-policy tools leads to demands for more. Mr Obama has responded to complaints that only big companies such as General Motors and AIG, an insurer, have enjoyed the state’s largesse by setting up a $30 billion small-business lending fund. 

Fourth, rich countries are responding to the apparently successful policies of fast-growing economies, notably China and South Korea.

Industrial policy remains controversial. Defined as the attempt by government to promote the growth of particular industrial sectors and companies, there have been successes, but also many expensive failures. Policy may be designed to support or restructure old, struggling sectors, such as steel or textiles, or to try to construct new industries, such as robotics or nanotechnology. 

Does Government Involvement in Business Help or Hinder?

Toronto's Mayor candidates will talk to entrepreneurs about how the City can help. I have been asking business owners about their thoughts. These owners tend to run companies that are making a decent cash and the majority say,  "Simplify paperwork, taxes, hiring and firing rules and stay out of the way." They do not reach out for government programs like SREDS and find these annoying. Lawyers, who make a good living from explaining the difficult rules, may not like these ideas. I have also noticed that the companies that look for help from the government are often the ones who should not be getting a subsidy, while the stronger ones do not reach out for programs.

So, does Government involvement help or hinder business development? Many governments are now looking at industrial policy. Justin Lin’s book is well worth reading on the topic. He tries to sort out good industrial policy from bad. 

When does state intervention lead to structural upgrading, a la East Asia, and when does it merely generate a bunch of uncompetitive companies being kept on artificial life support by state subsidies, as sometimes happened elsewhere? His conclusion is that the state should not depart too far from a country’s comparative advantage, but consciously push it towards upgrading by imitating neighbours that are similar, but have travelled further along the upgrading path – basically the East Asian ‘flying geese’ model. 
Think of it as the state pulling a country along by a piece of elastic – pull too little and nothing happens, pull too hard and the elastic snaps. 
For a review of his paper, and Justin’s response in a guest blogpost, visit Oxfam’s From Poverty to Power blog onhttp://www.oxfamblogs.org/fp2p/?p=2982.

A useful industry that will probably become more useful as it becomes less grandiose

Less Pomp and Circumstance and more humbleness is wanted from private equity, according to The Economist.  The recent article goes on to go over the same, tired hypothesis that private equity developed a weak model of using bank debt madly (which the banks were throwing at Private Equity) and buying up companies like drunken sailors.
Yes, and the government policies and mortgage craziness had nothing to do with the last three years?
The Economist does grudgingly admit that zero of the top 20 companies owned by private equity have gone under or needed a bail out, while banks have been wiped from the top 100 Bank list. Canadian banks find themselves in the top 20 banks in the WORLD!
Here is a look at the article:

IF PRIVATE-EQUITY outfits were once the kings of capitalism then during the credit crunch they behaved a bit like George III. Gripped by a bout of madness, they overpaid for firms at the top of the economic cycle and loaded them with too much debt. Today private-equity types are quick to admit things got out of control, just as in the buy-out booms of the late 1980s and 1990s. Most big shops, including Blackstone (see article), are keen to clean up the mess and move on. Yet it will take the industry a long time to rebuild its credibility.

Capitalism still needs private equity in its pure form. The stockmarket is not good at dealing with some firms—those that need surgery, are in the grip of bad bosses, or in industries that fund managers sniff at. Then it can make sense to have a lone, obsessive owner—particularly if it uses a dollop of debt to concentrate managers’ minds and locks in its own investors so long-term decisions can be made. The mere threat of a buy-out also helps keep managers at all listed firms on their toes.

The 2005-07 boom was damaging because it was so wild. Some $1.6 trillion of buy-outs took place—not far off the total for the preceding three decades, after adjusting for inflation. There was also a shameless degree of mission creep, with buy-out firms investing in volatile industries that are allergic to debt, such as semiconductors, and taking stakes in listed firms much as any investor might. A few private-equity outfits even listed their own shares and managed to keep a straight face.

READ MORE

Pay to Get Investor Ready

"Founders, do not fall in love with your product or your people.  Before you talk to anyone about funding get experienced people to rip your strategy and pitch apart.   You only get a few chances to get it done so make sure they count. Network like there’s no tomorrow.  Gather people around you who have proven “big league” execution skills.  Talk to everybody who can spread the message and bring value.  Get yourself down to the Valley. Cold-call and get connected to anyone who can make your business move faster and smarter.  If you don’t your competitor will."
Howard Gwin tells Canadian owners, "Bring it or stay home.  If you are in the Canadian technology ecosystem, run faster, harder and set higher goals or we are going to fall behind – and we will not catch up."
READ MORE of Howard Gwin
I read  Howard's article just after I saw yet another owner-operator who had a healthy company at $20M, but waited until it dropped to $9M to speak with Loewen & Partners. The damage was too bad by then. The worst part was that he had bought out his partner and debt and it was ALL his own capital in the business. Rule # 1: Use other people's money. Rule #2: As Howard Gwin says - Bring it or stay home. Realize that this is the time of private equity and the money is here now. If you don't, your competitors will be accessing private equity and think how much market share they could gain.

What do mayor candidates say about business owners?

Business owners, here is worthwhile an event by the Globe & Mail, September 9th, 2010 to the first major debate to start off the fall mayoral campaign.  This is for business owners in the city and how the mayoral candidates plan to address them. The town hall will be streamed live and be interactive on the web.  We know that small & medium businesses create the most jobs. Governments the world over recognize this and are putting forward efforts to stimulate their growth. What do the candidates have to say about what they would do to make Toronto a place for entrepreneurship, small & medium businesses?
Quick Facts:

• Toronto has the highest small business growth rate 7.5% between 2008-09: national average is only 2.7%
• 240,000+ self-employed people in Toronto & at 17%, Toronto has the highest rate of self-employment in Canada. 
• There are about 84,000 employer businesses in Toronto. 
• Toronto serves a constituency of about 300,000 micro-enterprises in Toronto (self-employed + businesses with fewer than 10 employees). 
• 1-10 women are self-employed 

Mayor Miller won with 332,969 votes in 2006.  It is a constituency that can certainly make a difference to a candidate.
Candidates:
• Rob Ford
• Joe Pantalone
• Rocco Rossi
• George Smitherman
• Sarah Thomson
Media Questioners:
• Marcus Gee, Columnist, The Globe & Mail
• Julie King, Publisher & Managing Editor, CanadaOne.com
• Rick Spence, Columnist, Financial Post

A big thank you to the Globe & Mail for making this topic a worthwhile issue. The Ontario Government leadership vote sure did not even mention business until they announced the Family Day Holiday which cost me a day's wages for my staff at a time when the economy was imploding. 

So big shout out to Globe & Mail. Also, quite a few of the candidates are business owners so that will be useful.

Finally, stop calling it SMALL business. There was a magazine called that and they had to rebrand. We hate to be called small - early stage, business operator, owner managed, but not SMALL.

If You Gave Toronto Mayor Advice on Business Development

If you could give the top six mayor candidates advice on what to do to help entrepreneurship and early stage companies, what would it be? I have been asking various people and came across a blog by Jevron MacDonald who is the entrepreneur-in-house for Innovacorp and he has a sensational set of ideas that I have posted below. I am attending the town hall held by the Globe & Mail, September 16th which will be live streamed on the Globe's website. I will send Jevron's point of action ahead of time to Sarah Thomson and Rocco Rossi, maybe even the others too - Facebook makes it so much easier. Here is Jevron:

Disconnected government policy-making is problematic. Outside of the impressive moves by the government of Quebec, there have been no signals from governments (provincial or federal) that they understand the changes taking place in the landscape or that they intend to proactively support them. So what are we supposed to do?

Early stage opportunities are here, and we need to develop a virtuous cycle of angels, superseed funds, and follow-on capability that is able to benefit from the aggregate of activity taking place in cities across the country. We do not have a single place to look for opportunities, but a set of active mini-hubs that each need attention.

We need to start small and encourage the development of superseed funds that are able to source deals within their specific geographies and spheres of influence. Fundamentally, we have to believe this is all worth doing and that Canada is capable of developing a scalable and high-return environment for venture investment. Until we stop imitating the outside world, however, we will never figure out just what it takes to make things work right here at home.

Then, when we have something unique, we can tell the story of our successes as they happen. It is time to put our pride on the line and measure ourselves against the best in the world.

If it’s a choice between go big or go home, I know which I want to do. We need to take advantage of growth-stage opportunities as they come out of our unique network of cities and seed funds in order to develop the mega-exits we all see in our future. This will require coordination and focus from government, LPs, and a new breed of venture investors who are willing to connect more closely with the entrepreneurs who are creating the financing opportunities they need.

There are a lot of returns to be earned here and those who roll up their sleeves and get a little messy will be the ones to profit.

Read Jevron more at his blog HERE

African Private Equity Investments Up One Third

After the embarrassing comments on China made in a private meeting with the head of GE, is the bloom off the Asian rose? The GE leader mentioned that GE would be exploring Africa. It appears that Private Equity is catching that African fever too. Financial Times reports:

Private equity investors have started to put more money to work in emerging markets following a sharp fall in allocations during the financial crisis. Funds targeting the region raised $11bn (£6.8bn, €8.3bn) of fresh investment in the first half of 2010, up from $9bn in the same period last year, according to the Emerging Markets Private Equity Association“African funds raised through June already exceeded the full year 2009 total, and some sizeable funds being raised point to a return to pre-crisis levels,” said Sarah Alexander, president of Empea.

More than a third of institutional private equity investors are currently making allocations to Africa, compared to just 4 per cent four years ago, according to Empea.

Emerging Capital Partners, a US house, said last month it had raised $613m for a fund dedicated to the continent, while Aureos Capital said earlier in the year it had amassed $381m for a vehicle targeting smaller and medium-sized African companies.

The volume of transactions by emerging markets private equity funds has also picked up “significantly” since the crisis, according to Empea, a Washington, DC-based trade body. Some $13bn of deals were struck in the first half of the year, up from $8bn in the same period of 2009, while the number of transactions rose 44 per cent to 402, led by a “surge” into Latin America, China and India.

“There are more and better quality deals in the pipelines; the continued easing of price expectations among sellers means managers have been more successful in closing transactions. Emerging market fund managers are increasingly bullish in light of stabilising markets and lower valuations,” said Ms Alexander..

Pension Funds Still See Private Equity Managers as Worthwhile

Mega funds like Ontario Teachers have been in the press about side stepping private equity funds and investing directly into companies, taking on the responsibility of board governance to ensure performance. This is a nice thought, but really, the private equity funds, in general, do a very difficult job very well, and I find it hard to see their skills being done by the larger funds. The big fund's time is better suited doing the bigger picture and leaving the PE funds to do the dirty work. 

David Currie at SL Capital has just put out an article explaining the reasoning of this. David says:

"The majority of global pension funds remain open to the idea that the additional layer of fees charged by private equity fund of funds represents a price worth paying to get the requisite access and the assurance over administration and compliance that an experienced manager can bring. Our pension fund clients engage us to provide a complete private equity solution for what is typically only ever up to 5 per cent of their total investment portfolio."

The majority of pension funds do not have the €100m (£83m, $132m) allocation to private equity that has been noted as the level that would allow them to invest directly in a structured long-term way into private equity. For these schemes, the hurdles of minimum allocation, administration of the investments and the risk diversification mean that a fund of funds is the only viable route.

In SL Capital’s fund of funds, the average commitment by a client is €12m, which would normally represent the pension fund’s entire private equity commitment, or at least its entire US or European private equity commitment. It is impossible to get true diversification, across at least 10 private equity funds, with a €12m allocation, as most funds require a minimum commitment of €5m.

It is also worth noting that the larger funds of funds sit on the private equity funds’ advisory boards as a matter of course. These positions are open only to the largest or most sophisticated investors and offer a deeper access and relationship to the manager, enabling added insight, a view on strategic direction and a first look at valuations and performance. This really matters when times are difficult, as the experienced fund of funds investors can deploy their team’s deep knowledge and expertise to help restore confidence in leadership or offer solutions to ensure all investors are protected.

While the world’s largest pension funds operate significant teams globally, we as a fund of funds also work closely with them to deploy capital. In this case we are providing support in a specific area of the European or US markets that they find hard to access, due to their proximity to the market or knowledge of the best managers in that segment. In these terms we are the “eyes and ears” for these larger groups in specific areas, such as smaller, regional or local funds, secondaries and direct co-investments. They recognise the advantages of working with fund of funds that can add value to their overall programme.

Private Equity Funds may phone you, but are you really prepared?

You may get a phone call from private equity, but be aware that only 5% of companies contacted actually get an offer. Shocking as that might be, owner-operators go to private equity thinking they are prepared and then are bitter that their time was wasted.

As a financial advisor to owner-operators, our team is constantly discussing how to show our value-add to potential clients. We help owners access fantastic private equity partners, get their valuation higher than they could on their own and then help them through the five years of partnership. 

Owner operators are getting phone calls from private equity funds and not preparing themselves properly. They think they can just show up with out knowing how a Private Equity partner works, what they want and their hot buttons. 

Here's a good article in the Globe and Mail about selling a company that I thought you may find interesting and thanks to Winnie Chou. She picked up this article and has some excellent points. Winnie says,

The interesting part is from the initial prospecting, the Riverside fund sent an introductory letter to 30% of the total list of companies and from that pool, the fund sent an LOI to less than 5% of the companies.

So even though a company may feel like they are being targeted by a big fund, the chances of an actual deal occurring are slim and often, the business owner will not receive an offer without knowing what they did wrong in the meeting.

The management of new costs

There are two concepts not in business owners' heads:
1. Hiring someone new - unless you are OpenText who needs 2,000 new people right now. The American government has introduced changes to business rules, taxes and employee costs. These will need to be digested for a while before owners get optimistic and expand again.
2. Growth. Expanding is not in the plans of many Canadian business owners. In fact, many are reducing their footprint, closing their American manufacturing plants and sticking to Canada. The costs of doing business in America are going up.
I listen to experts and advisors who rattle off these phrases of job creation and growth. Yet, these experts have not been owners themselves. they have not had the stress of meeting payroll and surviving through this past few years.
Having government change your profit and loss ratio by bringing a sudden new law with arbitrary regulations, making your business costs that much more unpredictable, shuts down business joy. For example, Dalton McGuinty's family day holiday was given by the Ontario government the day after he won his elvetion. For business owners, that gift to millions of happy employees meant a loss for 600,000 Ontario business owners. Many of them did not take home a paycheck that month.

The Difference with Entrepreneurs

A Rotman professor of Finance called me last week to speak about running a financial clinic for their business owner program. I hung up the phone understanding why Rotman is such a strong education institution.
The professor told me that they knew that the content of the MBA finance courses would not match with the needs for earlier stage companies - the clinic "students" would all have revenues under $10 million. That delighted me to hear her views as it is easy to clump small business into the same box as even mid-sized companies.
As with every other element of business, finance is a mathematical fit to size of revenues. Skill set requirements change for owners as the business grows. MBA finance is more of a fit for the larger corporates and this Rotman professor wanted her class to get their skill requirements matched, not have MBA cut down. What a concept, a university actually listening to their clients and working hard to deliver the best program.
The different attitude towards business by business owners versus professional CEOs,  reminded me of a favourite quote from a terrific book called The Philosophy of Money by George Simmel.
You do not make great wealth by following the safe paths and the rest of the herd. Simmel says,

"We burn our bridges and step into the mist."

That does sum up the adventure of private equity for business owners and te best private equity experts (not the banker types). You can imagine being back in Roman times, heading off for new fortunes, and it has a good ring of Beowolf to it.

What happens when the Term Sheet has a Put that was not in the LOI?

A great deal can change between the letter of intent (LOI) and the term sheet. Business owners who try to be the expert and manage the relationship with private equity by themselves will discover two things.
1. The private equity team may change terms more if they think you do not have an expert by your side to point out changes.
2. The due diligence charges will become a huge issue if you do not close the deal after the LOI. Clarify who is responsible for picking up the tab. If you have an excellent financial advisor, they should have made sure 75% of due diligence was already done.
Here is a story where the business owner thought they should do the private equity themselves.
A business owner asked me to drop by and as I walked along the street to his offices, enjoying the summer heat, I assumed it was more for social reasons. He did speak about his children's issues but quickly moved the conversation to his business and money. He had been successful at getting the banks to give loans and he told me he now had $10M of his own tied up in the company. He was approaching fifty and did not see the need to sell. He was offered $30M by a private equity group, but turned it away. He also had several Angels wanting to invest, he says.
Last year, a well known private equity group approached him and wanted to invest $5M. He retained a lawyer from a top Bay Street firm to assist. He also hired a finance person to do the analytical work. He tells me that he was fine with the LOI and then the due diligence began. He says it took him a great deal of time and effort but seemed to be worth it.
When the final term sheet arrived, he read that it had a Put, which had not shown up on the LOI. He was shocked that this was now being put on the table and did not want to sign a deal.
He said that his financial person wanted her to sign, but the owner believed it was due to the nature of the finance person's fees. The finance expert was paid the lion’s share of fees only if the deal closed. The owner thought that affected his judgement, and did not trust him to act in his interests. In addition, the owner believed the financial advisor would put his financial needs before hers. So he did not believe he had unbiased expert help.
After all that work, he turned down the PE fund. This respectable private equity group have turned around and decided to sue for $120,000 to cover their costs of due diligence. The Bay Street lawyer says he never saw that coming. He did not have it covered either in the paper work.
It was a surprise to me too. First of all, deciding who pays for the due diligence seems to me to be what gets covered in Law 101, and this lawyer was a top guy charging big fees. If this owner had read the last chapter of Money Magnet, that Bear Trap was laid out clearly, along with his other issues. The lawyer was obviously not experienced in private equity deals. Remember to ASK for past experience. I wish I had a dollar for every deal I have seen papered up by lawyers at great expense, only to have it collapse leaving nothing for the owner. The lawyer then is paid again to clean up the wreckage. Great business, law.
This owner had used the finance expert as a book keeper. If you have an agent of status, the private equity group is not going to play these games as they know they will never see another deal again. Sure, the valuation can drop by 15% from start to end but again, that PE group will become a pariah and EMDs learn pretty quickly who plays these games.
As for transaction fees versus pay for hours worked, raising capital is really tough. I would rather have someone who had the same risk to push the deal along.

2 Reasons to Use a Financial Advisor

There are two reasons you use a great financial intermediary to find you capital and private equity partners.
1. The private equity guys you want to meet are not the ones who have hired a lackey to cold call your office.
2. The best private equity guys only meet with company owners with a personal connection to them. Get the advisor with weighty personal connections.

Here is a great article by Scott Kirsner explaining these two points in detail:

 Bob Davoli likes to position himself as an entrepreneur who just happens to be making investments on behalf of a venture capital firm.

“Having been a CEO, I don’t want some VC calling me up every week and saying, ‘Let’s have a cup of coffee.’ So I don’t micromanage,’’ he says. His approach is to either “let the guy run the company’’ (all but one of his chief executives are guys); identify a problem and work together to fix it; “or you fire him.’’

Peter Bell, who was the founder and chief executive at StorageNetworks, sought Davoli’s advice when he became a venture capitalist.

“If the guy isn’t delivering, or you no longer support the strategy that he has laid out, you’ve probably got to replace the guy,’’ Bell recalls Davoli telling him.

Davoli says he doesn’t read trade publications or analyst reports. He doesn’t share advice or investment interests on a blog or via Twitter.

He doesn’t speak on panels or look at business plans e-mailed to Sigma. “We’re very relationship-driven,’’ he says, meaning that most of the entrepreneurs he meets are introduced to him by people he already knows.

When asked whether that strategy might mean that he’d miss the next Facebook, a company started by a young entrepreneur not already connected to the start-up scene, Davoli acknowledges that it would. “But hopefully, when the VPs from successful companies go to start their own companies, we hope they come to us,’’ he says.

At GlassHouse, chief executive Shirman says he didn’t feel pressured by Davoli to take the company public in 2007 or this year. “His position is, if the markets are hostile and the timing isn’t right, you just wait,’’ Shirman says.

Davoli is “the anti-VC VC,’’ Shirman continues. “He doesn’t have a lot of respect for VCs who aren’t independent thinkers, or who are numbers jockeys. He enjoys building and growing companies.’’

Davoli is happy to ride on his reputation; some might characterize him as tough, but he says he’s fair and that the only time he gets “really vicious’’ is when someone has lied to him.

“If you have too many bad scorecards, guess what?’’ he says. “The new entrepreneurs aren’t going to come to you for money.’’

Scott Kirsner can be reached at kirsner@pobox.com.

Does Private Equity Have to Do Deals?

Private Equity funds are in the business of doing deals and buying into companies. What they want to see is usually the opportunity to do something with a flagging business, and to have their strategy for growth ready before signing the Term Sheet. In Carlyle's case, the market is thinking its vitamins deal is not that great, as the opportunities to grow it seem to have been taken.
The suspicion is that Carlyle needed to show its Limited Partners that their money was better off with them, rather than in gold.

Not so fast. In my opinion, the products are beautifully designed (check out the bottles), and with an aging population, there is always growth opportunity. I think it is a smart addition to their portfolio
Here's an interesting take by Christopher Swann, Breakingviews, National Post

Carlyle Group is hoping a big dose of vitamins will boost its portfolio. The private-equity firm's US$3.8-billion purchase of supplements-maker NBTY is its biggest deal in years. But it's not immediately clear what extra juice Carlyle can add to the business to generate outsized returns. Without that, NBTY could just be a deal for a deal's sake.

Carlyle has had to sate its appetite with small snacks in recent years. Its last deal on this scale was back in December 2007 with the US$6.3-billion purchase of HCR Manor-Care. Yet for all its waiting to jump back into big deals, Carlyle's latest target would appear to lack some of the wrinkles private equity firms usually find so attractive.

True, NBTY has recently fallen out of favor with investors -- losing a quarter of its value since mid-April. But Carlyle is offering a 57% premium, more than making up for the shortfall -- and even surpassing the company's all-time high set back in 2007. The enterprise value -- at just over eight times this year's EBITDA -- falls smack in line with the buyout median since the start of 2009.

 http://www.financialpost.com/Carlyle+takes+dose+vitamins/3284358/story.html#ixzz0u2Z9al8l

Do you know where you are in your industry cycle?

Visiting a large manufacturer located in Waterloo, the town looks shabby. My client has a large facility though, kept spotless and with a full car park early in the day. Looked good. I was impressed by his plans to sell his business in a few years.

"This is will be the culmination of my life's work," he told me.

Two years ago, he had gone out for private equity with a top bank taking them to 12 private equity firms in Canada and 12 in the USA. Since he was in cyclical business of machine parts, I said it probably was not a success as the valuations given by PE would not fit his estimates.
"You are correct," he said and went on to ask me about this business cycle issue.
It is very important to know your industry and the cycles it follows. Mining and oil has big cycles while the food industry may have lower ups and downs. (A flatter cycle means fewer overnight millionaires in that industry.)
During this owner's capital raise process, no one had mentioned to this owner that his business happened to follow very steep dips and slopes. Th is team of bankers took him to private equity when he was at the absolute peak of the cycle.
No wonder he coud not get the valuation he deserves.
Even more shocking, if he follows his current plan which is to sell in three years, he will be back smack dab at the peak again.
For this owner, it is time to strike now while the industry is in the trough. We are seeing him again this week. I hope we can help him retire really rich, rather than with regrets.

Bull is not Bullish - Gloom to Continue

July is shaping up to be a tough month for public markets. If you had sold in May and come back in September, 2010, you would be fine but my account statements are not looking happy. Meanwhile, I got to spend some time with David Rubenstein of Carlyle and private equity is able to be the nose of the dog when it comes to investing. His company has been busy this July as it bought NBTY for $3.8bn, property in London in the billions and also in China too. The Financial Times reports:

Taking NBTY private is reminiscent of the buy-out bubble that burst in 2007, when big listed companies were regularly taken over by private equity.However, buy-out activity remains at a fraction of pre-credit crisis levels, even after a rally in recent months. The NBTY deal is different from most recent buy-outs, many of which have involved private equity selling companies to each other.

Carlyle is now doing mega deals in China and it is those size of deals that were done originally by the early private equity firms in America with which gave them their lead. It put cash in the bank for later and gave enormous market profile. All of a sudden, the deals will now flood to Carlyle before any other PE player as they have put serious cash into China.
For those of you still all in the public market, here is a quick recap that arrived in my email today from KJ Harrison and a great market analyst with the right name - Ms. Sarah Bull:

The catalyst for the current correction continues to be the fear of a relapse of the 2008 global economic recession. This is really being fuelled by the:

• US debt and deflationary issues, 
• European problems and 
• Prospect of much slower growth in China. 

Here's the detailed analysis:

• China’s growth rate has slowed – not good given its “engine” status for global growth.

• European sovereign and bank capital issues continue to remain unresolved issues.Uncertainty as to the Euro sustainability is a large issue for global markets.

• U.S. employment growth appears to have peaked – in fact last month the U.S. lost 125,000 jobs, and the average work week fell. Average hourly earnings fell, and widely defined measures of unemployment actually rose. In short, the anemic recovery in employment seems stalled, suggesting the private sector is incapable of taking the “hand off” from government stimulus.

• The G‐20 in Toronto came out strongly in favour of fiscal restraint – unfortunately major economies are not strong enough to withstand near term restraints, and as such investors are now very worried about policy error. If we are at the end of Keynesian policy initiatives, what happens if we double dip?

We believe that this pessimism will continue and that we will have higher than normal volatility in the markets over the next few months. Given this view, our disciplined approach is more important than ever and we are allocating our client’s capital to securities with good balance sheets and a significant margin of safety.

 by

Sarah Bull

Partner

KJ Harrison Partners Inc.

Why is Productivity Private Equity's Obsession?

What if you heard there was a way for an investor to achieve improved results; secured jobs; created more jobs; made the Canadian office the Head Office which means more high level careers for our CFOs and CEOs. Sounds pretty good, doesn’t it? Yet, when I was visiting private equity in Boston, they were skeptical about Canadian companies ability to improve their productivity.

The Globe & Mail is running a fantastic series on productivity and Canadian attitudes. I appreciated that openness to the growing resource of private equity, not only the Bank money. Partnering with investment experts helps owners grow their businesses -- although this mantra of growth, I have discovered, is not what many owners want. Anyway, here is the article.

What could do all this you might ask? Well, the answer lies with something that most Canadians know little about—improving “productivity.” And while improving productivity can help us achieve such benefits, there are no guarantees that all these benefits will be realized. It will depend on the decisions that are made if we are successful in improving productivity. So, at the outset, let’s be clear that improved productivity brings opportunity for economic benefits—not a guarantee. 

But What is Productivity?

Productivity is essentially concerned with how we combine our various resources—labour, tools, equipment, etc.—to produce goods and services. That is, it relates to the decisions we make, and the actions we take, to try to make the best use we can of all the various resources we have available.

I heard Frank McKenna speak about making Canada a high tech expert in oil and mining products and services. This makes great sense if industries cluster and the state encourages this market - Paul Bremmer touches on this in his book, The End of the Free Market. Here is one of the comments to this article that adds to that theme.

Rather than playing to our strengths - i.e. the basic geographic and institutional make up of the country (firms, governments, land, capital, labour), most economic policy wonks and practically every government talks about the "knowledge economy", "innovation", and "productivity" in complete isolation from what it is that Canadians *actually do*. If we want those things (and in some ways we have innovative financial services for the mining industry, a technically advance energy sector, etc) then policy and thinking needs to explicitly connect them to the reality of the country. For example we are the world's *experts* in energy use and production. Per capita we use (and waste), distribute and produce the most, it's a cold country. Let's get "productive" in energy, it's a big input cost across the board. Focusing on the "strength of our banking system" and the sexy high-techiness of Blackberries and bio-tech without linking that to productivity improvements in forestry, water and energy use, mining, oil, etc. etc. proves that there is no real national effort to improve economic productivity. If it happens it's an accident of statistics and of policy.

6 Bear Traps sabotaging funding efforts for mature companies

Having seen many family companies who think they can get money because the investors will fall in love as hard as they have, I thought I would write a quick list of 6 Bear Traps of raising private equity. I asked a few fund managers for their opinions which are quoted in the book, Money Magnet. I also checked out some blogs where these sorts of lists are popular. Here are the top Bear traps sabotaging most funding efforts, in decreasing priority sequence:

1. Lack of a growth story. That story has to begin with the painful problem shared by a large collection of viable customers, with your competitive solution and why your company needs to grow. It has to be a big enough difference to get people to switch. Clay Christenson, Harvard Business School, wrote an entire book about how to get people to move from using the stairs to a new technology called the escalator. Many mature companies have not thought about how to grow their business, preferring to stay in the same, safe markets. Additionally, you need to be able to communicate the essence of that story and value to investors in a couple of sentences – your elevator pitch.
2. Lack of simple goals. Often, the number one question that owners fail to address is: “How much money do you need, and what valuation do you place on your company?” Then you have to have evidence to support your request. I’ve asked this question many times of presenters in angel meetings, and often get a blank look. What are the three things you would do with the money and in what time frame? Keep it to three. How much is your company worth and over five years forward, how much will it grow? Remember, the investor's other options are the stock market and putting the same amount of capital on gold - can you beat that growth?
3. Failure to prepare for due diligence. Any serious investor will perform a thorough archeological dig on your business and your background. Make sure there are no surprises, so you should explain any possible issues first, in the best possible light, before being asked. Get a professional financial advisor to ge you and your company ready and that should include 100% of due diligence already done and ready for the investors to merely review.
4. Lack of understanding of the fund. The book Money Magnet helps you get inside the head of the person with the capital. The key here is to create a win-win situation for your investors. Discussion of risks and rewards in an open fashion, without sleight-of-hand or shortcuts, will convince investors that they can count on you, and will avoid shareholder lawsuits later. 
5. Reliance on inappropriate business professionals. Using well-respected professionals to find you capital and introduce you to the right people as well as stick handle your way through to the check signing is smart. If you can attract well-known advisors, attorneys, and accountants, it will give potential investors comfort that you have been able to get an implied endorsement of your concept, as well as your integrity.
6. Being unprepared for the next steps. After a good elevator pitch or initial presentation, investors will ask for your formal business plan and financial projections. Don’t derail their enthusiasm or risk your professional image by not having these materials immediately available. The same thing goes for incorporating your company, having key hires lined up, and facilities arranged as required.

American businesses are uncertain about Obama's Plans for Business

I commented that I was shocked by my trip to Boston and the lawyers' and private equity's anger with government, particularly as this city would be voters for the current government. (I get tired of the obsession with Obama - it's his team too.) Even the Harvard Business Review online is bringing up "leadership lessons" directed right at Obama--which surprises me. Niall Ferguson, my favourite money expert, was on CNN talking about how American businesses are hoarding cash, not spending. And why would you hire people if you do not know the consequences of cost or maybe new rules around reducing work force and so forth. As I said before, it's a business owners's summit needed, not a job summit.
Anyway, it is clear that there is terrible uncertainty being created by Washington--where they are more lawyers and, apparently, zero business leaders or MBAs. Lack of business appreciation does create a narrower world view and when the goose is unsettled, the goose is not going to lay the golden eggs to pay for all those big union jobs. Washington needs to get to terms with this and fast.
Perhaps CNN was on in Joanna Slater's home too and she writes in The Globe & Mail:
For a clue to Corporate America’s state of mind, look no further than the piles of money stashed under its mattress. Facing an uncertain economic environment, U.S. firms have socked away cash at a rapid clip, amassing a rainy-day fund the likes of which hasn’t been seen in over 40 years. At the end of March, non-financial firms had accumulated a record $1.84-trillion (U.S.) in cash and other liquid assets on their balance sheets, according to the latest figures from the U.S. Federal Reserve Board. As a percentage of total company assets, which include factories and other investments, cash is at its highest level since the early 1960s.

When and where companies decide to use their stockpile will be a key factor in the strength of the recovery. If companies feel confident enough to invest in new equipment or make acquisitions, it will spur economic activity and hiring. If they remain anxious, such decisions will be delayed, dampening overall growth.

Such hoarding can’t go on forever. Companies that keep piles of cash sitting in the bank earning razor-thin interest rates will eventually face the ire of investors, who will demand that the money be put to better use or returned to shareholders. Two options: paying higher dividends or buying back shares.

Here are some of the more interesting comments:

 Companies use to use lines of credit or short term loans for regular operating expenses, so they didn’t need to keep such high levels of cash, but now a great majority of US banks are effectively bankrupt and lines of credit and short-term loans are all but impossible to obtain, even for the largest and most successful companies. This is why companies now must keep a high level of cash just to be able to meet financing needs for daily operations. There is no “EXCESS” hoarding of cash as this article suggests, that is just silly. 

Canadian banks see a huge market for lines of credits to American businesses and this is why our 4 big banks have huge expansion plans for the US. The American banks are dead, they are broke, so Canadian banks will move in to fill a need there. This article is off base. Yes, corporate cash is up. Corporate long term debt is slightly below record highs. This another smoke and mirror article by someone that doesn't do their homework. Corporate America is swimming debt. They have a little more cash in one pocket and a huge liability in the other. Go ahead and cheer for a day or two. It's a mess of debt out there. The party is going to end in tears.

Can we leave it to start ups to rebuild the economy?

Even Linkedin has White House staff posting questions on the public forums asking for advice on how to create jobs. If you could give the government one recommendation to create jobs, what would it be?
If that interests you, I recommend reading this month's Inc magazine; their superb cover story is

 a plan to revitalize the American economy by creating lots of new start-ups. Some of the proposals, such as a offering visas to foreign-born founders, are already generating controversy. There is a the question whether more start-ups would be good for America. In a Bloomberg Businessweek cover story, former Intel CEO Andy Grove attempts to challenge this widely accepted idea. "The underlying problem," Grove writes. "[Is] our own misplaced faith in the power of startups to create U.S. jobs."

Exactly, Andy, start ups can not work in isolated patches. You need the big companies to be the cruise ship and the start ups can be all the harbour services to that cruise ship. By letting these big cruise ships leave the harbour for China, we explicitly miss-out on the next new industry ("but what of the industries we haven't created yet?") when the knowledge and expertise that accumulates in the ecosystem of manufacturers and suppliers is largely offshore. 
Think batteries, solar power, etc. What seems like a sound farming-out-of-commodity-work this year turns into a wholesale ceding of the next step in an industry's development five years down the road. 
I believe Groves is absolutely right that we need to re-think our assumptions about what the link is between what is in the interest of an individual company and what is in the interest of our nation medium-term. 
It is not always natural for many in the business world to have an honest discussion of what kind of society we should aim for - and accept that societies do not build themselves but are build by leaders who have a vision greater than their own economic freedom. It is a discussion we should have. 
Nortel was one of those major cruise ships and should have been given the GM package of bail out money too. Problem was that no one at Nortel believed that they were in such bad shape and no one did what GM did, get together a large group of businesses and go to Ottawa to lobby their case. 
I feel heartened that finally these stories are on front page covers of magazines and that great business leaders are bringing their points to the debate.

Private Equity sees the value in Health Care

The tale of rival Indian and Malaysian bidders for a Singapore-based health-care chain might be described as "same hospital bed, different dreams."

A full-on bidding war for Parkway Holdings Ltd., a successful Singaporean provider of swanky, high-end hospital care, broke out last week when India's Fortis Healthcare Ltd. announced an offer for the shares it doesn't already own in Parkway that values the company at 4.32 billion Singaporean dollars (US$3.10 billion). Fortis's bid of S$3.80 a share tops a partial takeover offer of S$3.78 a share from a unit of Malaysia's sovereign-wealth fund aimed at securing majority control without having to buy the whole asset.

The two offers share one thing in common: a belief that rapidly growing demand for quality health services around Asia represents a unique business opportunity. But the offers from each of Parkway's two biggest shareholders envision different players—one government-owned, another a private-sector industry leader—grabbing the consolidator's position.

Malaysia's interest in Parkway is clear. It holds 24.1% of Parkway outright through Khazanah Nasional Bhd., the state-owned investment fund, and owns 60% of a Malaysian Parkway affiliate. Parkway also generates 26% of its revenue in Malaysia, which is expected to be a key driver of its future growth, according to a Citi Investment Research report.

Moreover, Parkway offers tiny Singapore's bigger, less developed neighbor a chance to leapfrog into a leading position in high-end health care, an industry the government has singled out for strategic growth. Malaysia already has used government funds in that effort: state-owned oil company Petroliam National Bhd., or Petronas, owns a luxury, "futuristically designed" (as the website puts it) 300-bed hospital in the country's capital, Kuala Lumpur, built two years ago in part to promote medical tourism.

For Fortis, Parkway offers a chance to expand from its base in India across the region. One of India's largest hospital groups, Fortis is run by billionaire brothers of the Singh family that founded drug maker Ranbaxy Laboratories Ltd. In an email, Fortis Chairman Malvinder Mohan Singh said a combination between Fortis and Parkway would create a "pan-Asian health-care platform" that stretches from the Gulf to Southeast Asia, with both China and India representing big opportunities.

Read more...

Bono Values Private Equity

Elevation Partners, the private-equity firm whose founders include Bono and Roger McNamee, added to its stake in Facebook with a $120 million investment, according to a person familiar with the matter. Elevation bought the shares from equity owners in private transactions and has invested a total of $210 million in the company. The social-networking site, with about 500 million users, is valued at $19.9 billion, according to SharesPost Inc.

Read more: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/07/03/BU9B1E8EGF.DTL#ixzz0slHUtFg9

"An Unfair Advantage"? Combining Banking with Private Equity Investing

"Does the combination of banking and private equity investing endow banks with superior information that allows them to identify good prospects and garner superior returns?" asks Lily Fang, Victoria Ivashina, and Josh Lerner from HBR. "Or does the combination bestow banks with an unfair ability to expand their balance sheets, capturing benefits within the bank at the expense of the overall market and ultimately the taxpayers?"
When I first went to meet with all of Canada's Private Equity players, I quickly learned that Canada's banks had tried doing private equity, but have exited this industry. The main reason is that the Bank culture is very different from Private Equity. Banking is about managing risk, while private equity culture requires embracing higher risk than most could stomach.
It reminds me of General Stanley McChrystal's situation who was reported in Rolling Stone to have made insubordinate comments about the USA government. Many of these comments, such as "Bite Me", I have heard a million times from very senior men during my career in finance. 
Many have condemned the General for being light with his criticisms of the top leadership of the USA in front of a reporter. Yet, they would probably mostly agree that McChrystal is very smart and good at his work -cutting edge, in fact. Those criticizing McChrystal would probably even agree that his innovations have reinvented the US military. That is quite an accomplishment for a man who has now been fired for criticizing his boss in the media.
If you did a quick survey, I predict that those who think McChrystal should be fired for his insubordinate (and foolish) remarks are usually working for big companies. They can not fathom making such comments to any media, even a music magazine. I suspect that McChrystal probably thought Rolling Stone would be empathetic to his coolness and repaint the military as a hip place to be, after the Bush years of ridicule. 
Business owners and private equity would be more likely to say McChrystal should have been reined in, but certainly not have lost his job. Private equity and entrepreneurs look past these terse, sarcastic jokes and appreciate if the job is being done very well. Private equity would first ask and look for the answer "yes" to every question:

• Is this warrior of top value to building the military of the future?
• Is this person an innovator? 
• Is he bringing more to the bottom line even as he grates? 
• Does this person challenge authority, but is there value in what he is saying? 
• Could we bring him in and coach him more on how to keep the team working together, and encourage a little less of the Clint Eastwood shots from the corner of the room? 

OK then. You have a good person here, but with a badly misguided PR problem. 
General McChrystal is operating in a very different world than most corporate people. His world requires entrepreneurial thinking and attitude to challenge sacred cows. I can guarantee that corporate behaviour is not going to save lives and it is why the US military has been spinning its wheels because they stifle their true warriors. 
McChrystal's brashness  is his value. His riskier behaviour is change agent behaviour. When the leadership takes out their innovators, a bad message goes out to the rest of the military strategists. Think, but do not speak your mind. It is why innovation does not happen in big corporates. the rest of the people will not stand for it. They stamp it out viciously. 
General McChrystal demonstrates private equity behaviour. His boss, General David Petraeus, is steady at the wheel type of fellow, who tows the line, illustrates more bank relevant culture. And that - in a military story - is why banks should not do private equity.

Read more: 

  Read more at Harvard's excellent article on this: 

INSEAD's Lily Fang and Harvard Business School professors Victoria Ivashina and Josh Lerner examined nearly 8,000 unique private equity transactions between 1978 and 2009, looking in depth at the nature of the private equity investors, the structure of the investments, and the performance of the firms. Collectively, findings suggest that there are risks in combining banking and private equity investing. The results are consistent with many of the worries about these transactions articulated by policymakers. Key concepts include:

• The cyclicality of bank-affiliated transactions, the time-varying pattern of the financing benefit enjoyed by affiliated deals, and the generally worse outcomes of these deals done at market peaks raise questions about the desirability of combining banking with private equity investing.
• These investments seem to exacerbate the amplitude of waves in the private equity market, leading to more transactions at precisely the times when the private and social returns are likely to be the lowest.
• Investments involving both affiliated and nonaffiliated firms appear particularly vulnerable to downturns.
• Some information-related synergies, however, are captured internally by the banks. But banks' involvement poses significant issues as well.
• The share of banks in the private equity market is substantial. Between 1983 and 2009, over one-quarter of all private equity investments involved bank-affiliated private equity groups.

Read more at the National Post