The recent cancellation of the Collateralized Debt Obligation (CDO) offering from JPMorgan Chase and Morgan Stanley has provided another signal that the market for synthetic structured finance products remains moribund, largely due to the lack of interest from large institutions whose participation is required for successful placement. There are several issues that continue to hang over the CDO market five years after the near financial meltdown in 2008, in which structured finance investments played a significant role.
These issues include:
Once burned, twice shy – Big institutions, such as pension funds and insurers such as AIG, are the typically the buyers of the senior tranches of structured finance deals. Positioned and rated as the least risky aspects of these types of investments, the implosion of these vehicles in 2008 pushed the global financial system to the brink of a major crisis. Like then, the deal which was recently cancelled came with the same assurances that the senior tranche was secure, but institutional buyers weren’t having it.
Potential public outcry – The financial crisis resulted in the bank bailout, formally titled the Troubled Asset Relief Program (TARP), which averted a financial collapse using billions of dollars of public funds. The banks then used the funds to increase profitability while fostering the foreclosure crisis. Needless to say, the banking industry has not been held in high regard for some time and going back into the very investments that failed so miserably five years ago would virtually eliminate the scant goodwill that remains for the group.
An unstable interest rate environment – As if the first two factors aren’t enough, interest rates are starting to show some volatility after a long stay at or near historic lows. This volatility tends to wreak havoc in terms of valuing CDOs, with prices making huge moves on some days and buyers disappearing completely on others.
For businesses seeking funding through a structured finance vehicle, packaging and selling a Collateralized Debt Obligation looks like a tough option. Rather than fighting the current market conditions, considering other debt options will likely lead to a faster offering that generates more capital.
Your business plan is probably the most important document in the materials that you’ll present to potential investors, so make sure that you avoid the mistakes that can kill a deal within minutes.
These mistakes include:
An amateurish document with spelling and syntax errors – Your business plan will have several purposes, one of which is to convey professionalism and expertise. A sloppily assembled business plan will immediately defeat that purpose.
Hockey stick projections – The promise of exponential growth may be alluring, but unless you can prove in detail why your revenues are going to take off like a moon shot, your projections are going to seen as unreasonable at best.
Taking an “us too” position – Investors typically aren’t looking for companies that have positioned themselves as just another player trying to carve out a piece of the pie. If your business is not going to be a force to be reckoned with in its industry, investors will look for another company with loftier objectives.
Heavy salaries – Having salaries that command a large percentage of incoming investment funds can lead the perception that the investors are assuming all the risks while the company’s employees take home guaranteed money. This perception will work against your company in a big way.
The best business plans are crafted toward building the trust of investors and presenting the distinct advantage that investing in the company presents. By avoiding the above-mentioned mistakes, you can ensure that your potential investors see your company’s value and aren’t turned off by the typical deal killers commonly found in business plans.
One of the more surprising resurrections in the current low interest rate environment has to be that of structured financial products. Largely seen as the leading villain in the financial crisis that started with the undoing of Lehman Brothers, still the largest corporate bankruptcy ever filed at $600 billion, these products were disavowed by institutions at the time in a manner resembling the disposal of bad fish.
Four and a half years later, according to The New York Times, “Banks are turning out some types of structured products as fast, or faster than they did before the bottom fell out.” Data from Thomson Reuters supports this claim, saying that the $33.5 billion in structured financial products that have been issued so far this year, representing a faster pace of issuance than the halcyon days of the real estate market in the first half of 2005.
One of the other issues that has raised the eyebrows of industry watchers is that these products have largely escaped most of the regulatory changes that were supposed to have made them more transparent, easier to understand, and less subject to unforeseen events. Regardless, these vehicles are being issued at a pace indicating that investors have been in forgiving mood in an otherwise low interest rate environment.
For business contemplating participation, the first priority is to get a handle on all the moving parts that are part of the investment. Whether the vehicle can suffer from minute changes in interest rates, is subordinated to other tranches, or has a potential maturity that no one will live to see, it will pay off to know the contingencies and the results before writing the check for the product.
When interest rates were being reduced around the globe as a response to the deepening recession beginning in 2008, the consensus was that the rate cuts would be a temporary fix and that they would rise to historic norms as economies recovered. Almost 5 years later, interest rates around the world remain at basically the same levels, an unprecedented run with the potential to last a bit longer as rates in the low single digits become the new normal.
With over $2 trillion on bonds issued by corporations in 2012, the rush is on to take advantage of cheap money. Here are just some of the ways in which corporations are operating in this environment:
Using corporate debt instead of issuing equity to raise cash – Debt does not dilute shareholders or per share earnings.
Reducing the float of outstanding shares – The flood of cash into corporate coffers has allowed them to buy back over $400 billion of their own shares off of the open market in 2012. The buy-back pace has continued into 2013, with $111 billion in buybacks announced three weeks before the end of the first quarter.
Acquisitions – Another way to deploy cash is to make acquisitions, an example being American Airlines’ purchase of US Airways. The acquisitions market has seen other high profile names such as Heinz and Dell receiving bids as well.
If your company requires additional capital, debt issuance may provide a viable solution. The proceeds can provide numerous options and locking in low rates while they’re available will look like a wise decision after rates return to their historic norms.
While export financing transactions can carry numerous risks, the current situation in the European Union (EU) and specifically the turmoil in Cyprus highlight two of the primary risks in export finance; political instability and currency risk. The euro, which is the common currency between the 17 countries that make up the EU, has been under varying amounts of pressure since 2009 when financial issues for several member countries started to surface. Distressed member countries include Greece, Portugal, Ireland, Spain, Italy, and most recently Cyprus.
The financial issues for these and other beleaguered countries start with sovereign debt levels that make it difficult to access capital without paying above market rates. The excessive sovereign debt of these countries has in turn put pressure on the banks, which in many cases are much larger than the economies of the struggling country.
While the situation in Cyprus has largely been contained, it appears to be only a matter of time before the next financial crisis hits another member of the EU. This also means that businesses that rely on export finance should remain vigilant against potential volatility.
Measures that can serve to mitigate the inherent risks include currency hedges, shortening payment terms, having payments made in a currency that is not exposed to the level of volatility as is being experienced on either side of the transaction, and/or a combination of these options. In any case advance planning for these events, even in times of relative quiet, can make the difference between having a pre-set plan to put into action and scrambling to understand and react to volatile circumstances while wondering how much money is at risk of being lost.
Companies can wait for a long time to go public as they receive the last rounds of venture capital funding and then start the grooming process of getting ready for an initial public offering (IPO). In fact, new statistics show that, on average, a company will wait about decade between the time it receives venture capital funding and going public via an IPO, versus a wait of only four years during the 80’s. This average waiting period could actually be extended if, like the number of venture capital backed IPOs in 2012, the next few years average only 50 per annum.
That being said, there are still IPO’s being done, so here are 4 events you can plan on if you have an IPO on the stock market tarmac:
The sale of stock – Once the preparation for the IPO is completed and underwriters have determined the amount and price of the stares to be offered, the company stock that will be offered publicly is sold to investors. This process is usually handled by a group of brokerages, the number of which will be determined by the number of shares offered as well as the demand for them.
The company bank account gets a big deposit – For selling a pre-determined percentage of the company to its new shareholders, the business will have what is probably its largest single deposit put in the bank by the underwriting firm. The use of these funds will have largely been defined in the road shows that took place during the pre-IPO process; now is the time to put them to use toward further product development, expansion, hiring new employees, etc.
The shares hit the market – The initiation of trading on a public exchange such as the New York Stock Exchange (NYSE) the American Exchange (AMEX), or NASDAQ can serve as a validation for the growth of the company as well as its introduction to a new group of investors. One of the big surprises of trading on a major exchange for newly public companies is often the amount of communication that is required to keep up with information and questions can come in through both new and existing shareholders.
Increased attention – In addition to the communications that relate to investor relations, a newly public company will get lots of attention from the media, brokerage analysts, and their direct competitors. Much like being a celebrity, many of the people paying attention will be looking for weaknesses and flaws, which can be another surprise to companies that have only dealt with private investors in the pre-IPO days whose communications were primarily about wanting the company to do well.
The brave new world of being a public company after going through the pre-IPO process brings with it both positives and negatives. Companies should prepare for both sides of that equation as recognition and large amounts of cash in the bank are met with increased scrutiny from regulators as well as the investing public.
When you have decided that it’s time to entertain the possibility to selling your business you will quickly learn that you have a host of options with one of those being the sale of your company to a private equity firm. In terms of the changes that a company can go through in this type of liquidity event, it’s very possible that the greatest transformation for a business will occur after being purchased by a private equity firm. The reason behind this highly transformative process is that the typical private equity firm looks at its acquisition targets in a much different way than businesses seeking strategic partnerships or shareholders seeking long term growth.
The sole objective for most private equity firms is to buy at the lowest valuation possible and then sell at highest possible price in as short a timeframe as possible. For many businesses that end up selling to private equity firms, the process of overhauling finances, management, and operations can come as quite a shock as the new owners cut costs, lay off employees, and pare the company down to its most profitable divisions. Because many private equity firms specialize in buying businesses that are underperforming in total but have profitable assets or divisions, the changes that an acquired company experiences can be stunning.
For these reasons, it is imperative that businesses that are being courted for acquisition by private equity firms take these three steps prior to signing on the dotted line:
* Do a deep dive with due diligence – One of the first things to do is to start researching the potential acquirer. Contact the firm’s past acquisitions to see whether the new owner brought only money and attorneys or actually provided resources that improved the operations and revenues of the business. In short, find out whether your potential new owner acted as a partner or as a dictator with previous acquisitions and decide if that works for you and the rest of your company.
Assess their objectives – This step in your due diligence can determine whether you are being packaged for a quick sale, which will in turn play a large role in the day to day operations of your business post-acquisition.
Define your objectives – An objective of cashing out versus one of providing long-term security to your employees will most likely put your company on distinctly different paths. Being sure of what you want can help to ensure that you choose the most optimal path to a liquidity event.
While each type of liquidity event for a business event will bring changes, it’s important to know in advance what those changes will involve. Only then will you be able to make a choice that matches your objectives for you, your business, and your employees for both the short and the long term.
Many businesses, especially when an initial public offering (IPO) or reverse merger has been ruled out, must make a decision to sell to either a private equity firm or to a strategic partner. Because the differences in objectives of these two types of acquirers is often quite extreme, the decision between one or the other can have a drastic effect on the operations of the business for both the short as well as the long term.
Here are 4 considerations which can reveal that selling to a strategic partner will be more beneficial than being acquired by a private equity firm:
A similarity in business objectives – If you have long term objectives for your business that are important to you, finding a strategic partnership that can help you reach them is the start of a positive union. On the flipside, if the acquiring company’s objectives are diametrically opposed to yours, such as a quick sale of profitable assets for example, look for another suitor.
The prospective partner requires the expertise of your employees – Strategic partners often make acquisitions of businesses that are complementary to theirs but operate in areas where they have no expertise. A need for your employees’ experience and knowledge can help to ensure that their jobs will be safe as opposed to subjecting them to the risk of cutbacks by a firm solely focused on the bottom line.
The due diligence process is one where the acquiring company seeks out the strengths of the business as opposed to its weaknesses – A strategic partner may have an exhaustive due diligence process but you’ll know right away whether they’re looking for strengths that can improve their operations or weaknesses that might serve as negotiating points to lower the purchase price. Be wary of a price oriented due diligence process as everything that follows will likely be about price as well.
A similarity in values beyond that of the business – While it’s true that businesses are financial concerns, what often makes them better companies are their values in terms of their integrity, their employees, society as a whole, etc. Partnering with a company that shares your values can build a synergy that is greater than the separate parts.
Lastly, having firm grasp on what is important to you will be one of the most important aspects of this process. Because your priorities will play a large role in how you select an acquiring company, make sure that the values, ideals and objectives you have set forth will be respected and acted upon by the acquiring firm. With that, you’ll have a partnership that can benefit from the synergies of a new partnership while allowing you to sleep at night as well.
If you, and possibly your investors, have decided that it’s time to pull some cash out of your business there are 4 basics options, also known as liquidity events, in which all or part of the business can be sold. Depending on the development stage and size of your business, some of these options may or may not be available and each one has advantages and disadvantages.
Here are the typical liquidity event options for a business including key characteristics:
Private sale of the company to an outside acquirer – An outside acquirer will most likely take either one of two forms; strategic investor or private equity firm. A strategic investor will make the acquisition because your business possesses technology, products/services, or a target market that complements and improves the operations and revenue potential of the acquirer. On the other hand, a private equity firm will be looking to liquidate this acquisition as soon as possible for a return on its investment.
Public offering – A public offering can occur through either an initial public offering (IPO) or a reverse merger. The requirements to quality for an IPO include minimum revenues of $1 million, shareholder equity of $15 million, or a variety of other benchmarks. Additionally, meeting requirements does not ensure an IPO as evidenced by the sum of the initial public offerings that were completed in 2012, which numbered less than 50. Reverse mergers are typically executed by smaller companies that end up trading on the pink sheets or the bulletin board, as opposed to the major exchanges. In both cases, the company will be in communication on a regular basis with new shareholders, and should make preparations for a lot more transparency to the outside world.
Sale of a division or part of the company – Much like a private sale, the acquisition of a part of the company is generally made as either a strategic or investment move. Whether this type of sale makes in large part depends on whether the part of the business that remains can function as a viable business.
Sale to the employees – In terms of a “feel good” solution, the sale of a business to management or to employees through an Employee Stock Option Plan (ESOP). This basically eliminates the sales process but also results in a lower valuation than would result from other liquidity events. In terms of a timeline, the ESOP version will probably take longer to complete, which isn’t a bad thing if the ownership isn’t in a rush to leave the business or is not in need of a lump sum payment.
In each form of liquidity event there are several advantages and disadvantages depending on the structure of the company as well as the relationship between the owners, management, and the employees. With all the variables involved, taking a long look to decide the optimal format for pulling out cash will be one of the best investments you can make, even though it will occur before you have the money in hand.
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