During the last period of economic boom many companies expanded through debt financing. The logic was if one machine is making money then adding three machines will make three times the money. As long as the economy was strong and margins remained high this was viewed as good thinking. After all, even if the economy dropped, the value of the equipment, even leveraged, would be equity that could be used to raise capital in a downturn.

Then just like the housing market, the phrase “mark to market” enters the valuation. Suddenly you find you’re upside down in the market. Whether you borrowed money to expand your organization, equipment, or inventory; all have suddenly become less valuable in a down economy. The true value of the equipment is the value of the goods produced by the equipment, not the intrinsic value of the equipment itself. The inventory values have declined. There is too much equipment on the market at the same time and suddenly the value of your asset has been cut in half. Your people are being paid a premium especially when compared to foreign markets but they are refusing to go along with your cost cutting measures.

The dictionary defines under-capitalization as follows:”A business has insufficient capital to carry out Read the rest of this entry »

For Corporate Buyers that Pursue a Disciplined Approach: 2009 is the Time to Buy a Company

Corporate executives at middle market companies understand that meeting investor demands for growth is difficult to achieve organically. Therefore, making strategic acquisitions are critical to building scale and growing revenues.

The impetus for pursing an acquisition have become even more compelling in light of the current challenging economic times, which has put downward pressure on valuation multiples. Indeed, a recent Boston Consulting Group report entitled “The Return of the Strategist: Creating Value with M&A in Downturns” underscores why a weak economy is often an ideal time to acquire a company.  Key findings of this report include:

• Corporate buyers are uniquely positioned to take advantage of the tough economic times, since they possess the cash to complete transactions, whereas the financial private equity buyers have been restrained from borrowing in the wake of the credit crisis.
• Acquisitions completed during recessions are twice as likely as upturn deals to produce long-term returns in excess of 50%, and, on average, create 14.5% more value for acquirer shareholders.
• The best type of company to buy during a recession is one with strong finances and relatively weak profitability.
• Corporate buyers can also increase their returns and likelihood for success by acquiring relatively small targets.
• Surprisingly, acquirers can also create value by paying above-average premiums, provided the underlying rationale for the deal makes sense.
• Acquirers in difficult economic conditions are better at identifying targets with unrealized potential, probably because of the disciplining power of downturns, when every dollar counts.

Yet, despite the promise of adding value from a discounted acquisition, the reality is still that the majority of acquisitions will fail to result in any cost savings or merger synergies. So, how do the top value creators in downturns pick the best targets? Read the rest of this entry »

It was just last year that the Senate Finance Committee conducted a few hearings about the controversial tax treatment of “carried interest.”  The website, Investopedia.com, provides us with the following definition for the term, carried interest:

“A share of any profits that the general partners of private equity and hedge funds receive as compensation, despite not contributing any initial funds.  This method of compensation seeks to motivate the general partner (fund manager) to work toward improving the fund’s performance.”

Given the recent election results and ongoing debate about executive compensation in the midst of the current financial crisis, it should not be a surprise that the tax treatment of income associated with carried interests could be changed as early as 2009.

Under current federal tax law, the character of the income to the carried interest is the same as the income earned by the fund.  Therefore, if most of the profits of the fund consist of Read the rest of this entry »

Down economic cycles can offer excellent buying opportunities for well positioned companies but they may create funding challenges to getting a deal closed.  When credit is easy and senior debt lenders are liberal with leverage and terms, most buyers don’t need additional help in funding their deals.  In a down economy, it’s quite a different matter and mezzanine financing may be the solution.

Mezzanine financing is also known as subordinated debt and is junior to the security interest of senior debt while ahead of equity stakeholder rights.  Many of the features of a mezzanine loan are similar to a bank loan.  There will be provisions for interest payments, an origination fee, amortization terms, covenants, potential liens, default definition and remedies, and other items.  Additionally, mezzanine investors craft warrants into their structures to compensate for their risk as junior lenders.  Warrants provide the right to purchase equity at a later date.  Don’t worry, mezzanine investors don’t want to own your company so they will include “put” options, which when exercised, require the borrower’s company to buy-back the stock at a pre-determined price often tied to a valuation formula based on a multiple of the company’s earnings.  In short, it’s an in and out transaction designed to augment their return. Read the rest of this entry »