Business Growth and M&A Issues--By Dickinson Bransford

It's Corporate Acquisitions Time

2011-03-30T22:28:00.000-07:00

Link to referred article in Mergers & Acquisitions Magazine

More and more private and publicly held corporations are using their assets to acquire companies.

As the linked article indicates, corporate balance sheets are holding $1.5 trillion in assets (actually, I've previously seen $1.84 trillion cited, supposedly attributed to Federal Reserve estimates). What the article does not say is that corporations are holding more cash than at any time in almost half a century.

Why? It's the result of several years of paring costs, squeezing out inefficiencies (and labor force), improving productivity and a fear-of-the-unknown driven paralysis. When businesses do not have confidence in the economy and there are many perceived unknowns, they are reluctant to re-invest their assets.

Meanwhile, institutional and many sophisticated individual shareholders are getting restive as they realize idle assets are not making them any money.

"Free it up and pay it out as dividends if you're not going to use it! Make acquisitions! Just do something other than rat hole it away."

Hmmm, let's see...make acquisitions. Now there's an idea we can get behind! In fact, the gist of the article is that our industry is expecting a lot more of those idle assets to result in new acquisition activity. A lot of it did just that in 2010, but there's every reason to expect a lot more acquisition activity in 2011.

At least daily, we get a communication from a corporate or private equity acquirer announcing deals and/or seeking deals of a specific type and/or within certain financial parameters. If you are a company owner contemplating your options, now would be a good time for us to discuss them.

www.tranzequity.com

Selling Your Business to Warren Buffett

2011-02-01T17:19:00.000-08:00

To most entrepreneurs, that sounds like a pretty attractive idea. Everyone knows that his company, Berkshire Hathaway, Inc., has plenty of money to do the deal. But, of course, that fortune was not built on dumb luck.

For the first twenty years of Buffett's career, he built wealth through investing, producing one of the best long term track records of any money manager in history. Since then, the focus shifted to producing value in the companies Berkshire has taken interest in, and the higher growth in Berkshire's book value per share over time (reflective of all activities, inclusive of canny buys and value-producing activities that generate earnings along the way) relative to growth in Berkshire stock price testifies to the organization's success in building great companies.

Whether buying publicly-traded companies in the "auction market" or private companies in the "negotiated market", Buffet is known for effective risk management, a foundation of successful investment.

Of course, no amount of research and due diligence can reveal all risk surrounding investment in a company, so he strives to secure a "margin of safety" in the price he'll pay. That means that the price is so far below a business's underlying value that severe loss is improbable.

Still want to sell your company to Warren? Perhaps it's better to concentrate on thinking like him. The more that you, the owner of a privately-held company, think like Warren Buffett, the higher the price I likely can get for you when I represent your company for sale. (Of course, I'll help with this)

Berkshire Hathaway will evaluate an investment very carefully, but generally "wants to understand how the enterprise generates cash, how well-managed it is, and whether its customers would still stay loyal even if it raised the prices of its goods and services." If the company is publicly traded, none of those factors are contingent upon the current price of the stock. Even if privately-held, the same principle applies.

Part of Berkshire Hathaway's success is due to Buffett's and partner Charlie Munger's ability to think like both a businessman and an investor. As Buffett said in the Wall Street Journal,

"being a businessman makes me a better investor, and being an investor makes me a better businessman. Most businessmen limit themselves to their own field, and most investors don't really think about businesses. And, most businessmen are semi-oblivious to the yardsticks other people use outside that field."

When I take on a client, I help them think like an investor, too, so that we can identify ways in which to improve the company's attractiveness, and reduce risks to acquirers. We do not want prospective buyers of your company to feel the need to make a "low ball" offer to account for unknown risk.

Obama Proposes to Eliminate Some Capital Gains Taxes -- Yes!

2011-02-01T16:22:00.000-08:00

I saw in today's Wall Street Journal that the Obama Administration yesterday proposed the elimination of capital gains tax "on investments in eligible small businesses held for more than five years. The provision, which Mr. Obama has been promoting since he ran for President, was enacted last year on a temporary basis and expires at the end of 2011."

This is clipped from the White House web site:

Administration Will Propose Permanent Elimination of the Capital Gains Tax on Certain Small Business Stock: The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 provides a 100-percent exclusion from tax for capital gains realized on the sale of certain small business stock held for more than five years. The amount of gain eligible for the exclusion is limited to the greater of $10 million or ten times the taxpayer’s basis in the stock. This provision applies to qualified small business stock issued after December 31, 2010, and before January 1, 2012. The Administration’s FY12 budget proposal would make this provision permanent, increasing private sector investment in small businesses.

The Wall Street Journal goes on to say that only C Corporations, which unlike other small businesses pay corporate taxes, are eligible. They also must have less than $50 Million in assets, and certain businesses such as law, accounting and investment firms are excluded.

Almost all larger corporations with more than 100 shareholders and virtually all publicly traded companies are C corporations. Most companies that are considering going public, seeking venture capital, or taking on equity investors are C corporations. I run across a fair number of them in Silicon Valley.

I do not yet know any specifics of the proposal beyond what's stated here -- and the devil's in the details -- but I think that this is a step in the right direction. I hope that Congress approves it, or at least some version of it, for a number of reasons, cited below: (People will quibble with the details of the President's proposal, and suggest other tax changes. I am not evaluating or commenting on overall tax issues in this posting, only cap gains, and have many other questions, such as about dividend treatment, level of corporate taxation, etc.)

This change will address what I perceive to be an inherent unfairness in the tax code, affecting the outright or partial sale of a company. While this change only affects smaller companies, it will offer relief and stimulus to a large number of them. The existing taxation on C corporations is onerous, as the corporation itself is taxed, then the shareholders are taxed personally. This results in a "double taxation" effect for the owners of a C corporation, such that when a C corp. is sold, if the transaction is not structured in such a way to shield shareholders from the full brunt of this taxation, C corp. shareholders may pocket a third less than what S corp. shareholders would pocket, net of taxes. Shareholders of corporations that have made a "Sub-chapter S election," so called "S corporations," are not subject to double taxation.
Economic studies have shown time and again that low capital gains tax treatment serves as a stimulus to the economy and builds employment. We want to stimulate investments in new businesses, and the level of cap gains tax treatment is an important lever, as low rates encourage investment.
In the past decade, small businesses -- those with fewer than 500 employees -- have created 60-80% of the nations net new jobs each year . More than half of Americans are employed by a small business, and these companies generate over half of the U.S. GDP. (WSJ, Recession Batters Small Businesses, 26-Dec-2008)
But, let's drill deeper. That "Small Business" definition of under 500 jobs is too broad to really be useful. Categorize that under the "Conventional Wisdom of Job Creation." So, where do the jobs really come from?
It's not so much business size that matters. It's business age. According to the U.S. Census Bureau, nearly all net job creation in the U.S. since 1980 has occurred in firms less than 5 years old. A 2009 Kauffman Foundation report shows that as recently as 2007, 2/3 of the jobs created were in such firms. In other words, to reduce unemployment, we want capital to flow toward entrepreneurial endeavors.

In sum, favorable capital gains treatment, and the certainty that Congress will not change that in the foreseeable future, will have a directly beneficial effect on new venture creation and job growth, while providing a more fair tax treatment for shareholders of C corporations in comparison to S corporation shareholders.

M&A tops $2.2 trillion in first yearly rise since 2007

2010-12-17T11:34:00.000-08:00

According to a just released Thomson Reuters report, it appears that the global M&A cycle may be back on an upward trajectory, after plummeting in 2008-9. According to the report, "that means 2011 could be the second of several years of rising deals -- earlier this year Citi analysts said the world was "in the foothills" of a new M&A cycle. These cycles typically last years: the last peaks came in 2000 and 2007."

While the companies we serve operate at the lower end of the Middle Market, and smaller companies are not called out in this report tallying the world's mega-deals, there is a clear connection between M&A activity among the largest and smaller companies. While the particulars vary, the main drivers of deal activity are the same:

Economic performance improving - companies' revenue and earnings improving. Public companies have shown overall consistent improvement. Quality private companies that have survived and gotten their financial house in order should now be able to demonstrate at least several months or a year of strengthened profits, which increases their appeal to buyers.
Pent up demand - depressed market has suppressed normal amount of activity driven by companies' strategic needs to acquire, consolidate, divest, refinance, etc.
Demand from emerging markets - the increasing success of developing nations provides them the financial resources and strategic rationale underlying M&A activity. This situation creates more competition to buy American companies. According to the Thomson Reuters report, "most deals from newer markets were aimed at securing resources or technologies."
Debt market improving - lenders are slowly - and hesitantly - making loans available again to borrowers with low credit risk, and furthermore...
Interest rate is very low, making that debt inexpensive for those who qualify for loans
Equity market is cash rich - corporations are holding more cash than at any time in almost a half-century, and private equity group (PEG) investors have approximately $425 B of money they have raised on behalf of other investors to buy and build up companies. All this money needs to be invested. Shareholders and PEGs' investors will not be patient forever, as their money is tied up, but not working for them.
Taxes - Today, the President will sign the bill now passed by both the Senate and the House to delay the previously legislated increases to the capital gains and ordinary income tax rates for two years (those are the rates that most directly affect sellers of stock or entire companies). Notwithstanding the inevitable political fracas that will ensue during the 2012 election year and sew more economic uncertainty, the M&A market will assume that income taxes will probably rise on January 1, 2013. This new deadline will drive deal activity to be completed prior to this date. Start your engines!

While these factors drive the overall market, M&A demand for specific industries and companies within them is influenced by myriad other factors. That topic will be discussed in other posts.

Federal Capital Gains Rates – Where Are They Headed? - Implication for Selling a Business

2010-05-15T01:16:00.000-07:00

Since 2003, the top tax rate on most capital gains has been 15% for people in the 25% or higher tax bracket. Although a lower level tax rate has also been in place since 2003 for people in the 15% or lower tax bracket, this lower rate seldom applies to people incurring a capital gain from selling a business.

The current capital gain rates are scheduled to expire effective December 31, 2010 due to a time lapse built into the regulations associated with the 2003 gain reductions. This time phase-in is known as a sunset provision. Thus, starting in 2011, the top 15% rate is scheduled to revert to its former pre-May 6, 2003 level of 20%.

The President was relatively safe making the campaign pledge that his administration would not raise taxes, because the sunset provision was already going to cause the rate to increase.

The big question now is; Will the top rate only rise to 20% or will Congress raise it higher?

Background
For the past 30 years, the top tax rate on long-term capital gains has been below 30%.

The top tax rate on most long-term capital gains was reduced from around 35 percent to 28 percent in 1978 and was further reduced to 20 percent in 1981. It was raised to 28 percent in 1987, reduced to 20 percent again in 1997, and further reduced to 15 percent in 2003.

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) extended the 15% rate through 2010. But, in 2011, the top long-term capital gain rate for most long-term capital gains is scheduled to revert back to the 20% rate that applied prior to the Jobs and Growth Tax Relief Reconciliation Act of 2003 (2003 Tax Act).

The pending tax change is well within the range of changes experienced in the last 30 years.

What To Expect

On September 25, 2009, in a letter to Representative Brian P. Bilbray (R-CA), the Congressional Budget Office (CBO) stated that when assessing the impact of the increased tax rates on economic growth, it is important to keep in mind that taxable capital gains account for a small portion of all capital income. Much capital income is paid as dividends, interest, rent, and proprietors' profits. In addition, most capital gains are not taxable because they are held in tax-exempt accounts or are held until death. As a result, CBO does not anticipate that the pending increase in the capital gains tax rate alone will have a large enough impact on the rate of return to capital overall to change significantly the magnitude of saving and capital investment.

But the CBO did further state that higher capital gains taxes could have an additional effect by discouraging innovation and risk-taking, but there is insufficient evidence on which to base a quantitative estimate.

Congress depends on the CBO to help corroborate the financial and tax results of congressional decisions. In this case the CBO is uncertain as to the full impact to be realized by an increase in capital gain rates. This indecisiveness opens the door for Congress to support an increase in capital gain rates, saying that the CBO did not expect the increase to be harmful.

Observationally, It is notable that when Congress cut capital gains tax rates in 1978, 1981, 1997 and 2003, capital gains realizations and tax revenues increased. When the cap gains rate was raised in 1987, the opposite occurred.

Also it is important to keep in mind that with the recent Health Care Reform, people classified as "wealthy" (earning over $200,000/year) will experience an additional 3.8% Medicare tax on unearned income (cap gains, dividends) beginning in 2013. Because the new tax on investment income won't take effect for three years, that leaves more time for Congress and the IRS to tinker with it. So we can expect lots of refinements and "clarifications" between now and when the tax is actually rolled out in 2013.

When considering the financial impact resulting from the War on Terrorism and the overall increase in congressional spending, it is very reasonable speculation that the issue of raising capital gain rates even higher will be introduced by some member of Congress.

Furthermore, in 2011, the top Federal tax rate returns to 39.6%.

So, should a person trigger a capital gain in Year 2010, such as selling a business, if at all possible?

Since most business sales incur a blend of capital gain and ordinary income taxation, when considering the known capital gain rate increase, the potential for additional capital gain increases, the income surtax and the fact that the top federal tax rate returns to 39.6% in Year 2011, a clear answer certainly emerges.

If an entrepreneur wants to experience the lowest tax impact possible from selling the business, selling before the tax rates increase is the way to go.

Based on current regulations, 2011 capital gain tax rates will be at least 20% with the health care surtax likely causing some people to exceed a 25% aggregate rate. If congress decides to implement further increases, anyone who waited until 2011 to sell a business will wish they could go back in time to 2010.

This article was adapted from one written by Walker Advisory Associates, with minor additions and revisions, and used by permission. Walker Advisory Associates is a national business transactions tax advisory and accounting firm. As a specialist, they concentrate on the field of business transactions advisory work to minimize the taxable impact of the transaction and assist in tax-advantaged deal structuring. Walker Advisory is a preferred partner of ABI-Tranzequity Advisors, and we will recommend that clients planning the sale or acquisition of a business engage their services early in the process.

Silicon Valley Deal Volume Up in Q1, 2010

2010-04-08T10:23:00.000-07:00

According to technology investment research firm 451 Group, the number of technology mergers and acquisitions announced in the first quarter of the year rose to its highest level since the financial crisis first gripped the market.

There were 841 deals announced, the highest number since the second quarter of 2007, but only 12 exceeded $1 billion in transaction value. The majority were seven to eight-figure deals (between $1 million to just below $100 million).

Furthermore, many technology companies are still sitting on the sidelines with large cash reserves, so deal activity could increase as the economy improves.

Private Equity Mergers & Acquisitions

2010-04-06T16:43:00.000-07:00

Mergers & Acquisitions (link to article mentioned in this discussion)

The mainstream news media love to beat up on private equity. Silly stereotypes craft "Gordon Gecko-like" images of greedy financiers whose sole objective is to bleed the financial soul from hapless companies and cast desperate employees to a hungry, cold fate of fending for survival.

I think that the temptation to tear down others who experience what appears to be a huge windfall profit is hard to resist, as if to say "how can they possibly have 'earned' that much money?" Also, I don't think that many in the mainstream news media really understand what those who manage private equity funds do and how they do it.

When a private equity investment firm acquires or invests in a company, they do so with the intention of improving that company's operation, profitability and earnings. Doing so is in their economic interest, obviously resulting in greater rewards to the owners along with growth and job stability for employees. All too often in today's economy, improving the company's operation involves finding ways to stabilize shaky companies (thus preserving many jobs that would cease to exist if the company went under).

At a future date, often targeting 5-7 years later, the private equity investor will sell the company, and make a windfall -- hopefully, or at least a decent profit! -- from the sale of a much stronger company than they bought originally.

Over time, I have been collecting stories like the one attached that show private equity-owned companies are typically better run and more successful than peer companies. While there are many innings left in the game of this recession, this story indicates that at least so far companies owned by private equity firms are less likely to have defaulted on their debt than peer companies.

Private Equity Investors Hungry For Add-On Acquisitions

2010-02-11T19:22:00.000-08:00

I get regular bulletins from PitchBook, a company which tracks investments that private equity groups ("PEG's) make in businesses. Today's bulletin really caught my eye, and it seems to support many merger and acquisition advisors' expectation that the market for M&A activity will build rapidly this year, for a number of reasons.

To put this information into perspective, a few terms may help.

Definititions: Private Equity, Platform Acquisition, Add-on Acquisition
Private equity - Equity capital that is not quoted on a public exchange. Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from retail and institutional investors, and can be used to fund new technologies, expand working capital within an owned company, make acquisitions, or to strengthen a balance sheet.

The majority of private equity consists of institutional investors and accredited investors who can commit large sums of money for long periods of time. Private equity investments often demand long holding periods to allow for a turnaround of a distressed company or a liquidity event such as an IPO or sale to a public company. (definition courtesy of Investopedia)

Add-on Acquisition vs. Platform Acquisition - an "add-on" is an acquisition made by a PEG because it is a strategic fit for something else in their portfolio of companies. Here's an example.

A PEG may buy all or part of a company that manufactures electronic controls and sells them to an industrial market. If they have no prior investment interest in this type of company, it would be considered a "platform" investment, in other words an initial investment in a category from which they will build other investments.

Now suppose that I bring them a company for sale that manufactures electronic controls also, but this one is serving the consumer market for residential energy efficiency, such as solar water heating, pool and hot tubs, kitchen and bath water heat control, etc. That PEG may elect to buy this second company, and "add it on" to the first investment, based on the synergies that they may anticipate achieving from both complementary investments -- thus, the term "add-on acquisition."

Often, add-on's are smaller investments than platforms in terms of the transaction dollar value.

Rapid 2010 Growth Rate in Add-on Acquisitions
Excerpt from today's Pitchbook bulletin:

"According to the PitchBook Platform, there have been 41 add-on acquisitions completed by private equity-backed companies so far in 2010. An amount already equivalent to 70% of 4Q 2009's total of 59 completed deals. The 41 deals represent 29% of all buyouts so far in 2010, a portion well above the 23% that add-ons represented in 4Q 2009. It is also very suggestive of the fact that private equity firms are finding a wealth of opportunities in the current market to grow their portfolio companies acquisitively in addition to organically." (my emphasis)

Implications for Business Owners

We work with many private equity groups. I get at least one daily inquiry from a PEG who seeks to buy something specific, or just maintain contact so that I remember them when I am representing a company for sale that matches their buying criteria. Additionally, as an active member of The M&A Source and the Association for Corporate Growth (ACG), I meet with 50-60 PEG's at two to three national conferences per year.

Just this past week alone, I met with many of them at the Sustainable Capital Forum, and then at the ACG Capital Connection, two back-to-back conferences held in San Francisco.

If you are a business owner and/or major shareholder in a privately held company with cash flow of at least $500,000 annually (in some cases, add-on acquisitions may not be subject to this floor) and any of these points apply to your situation, please contact me to discuss it.

You are even remotely considering your exit plan, either now, or over the foreseeable next few years
Your company needs additional capital to grow
Your company could benefit from having the additional resources of highly educated, accomplished, professional management

There is plenty of private equity capital seeking good companies in which to invest. For many company owners, this translates into the optimal recapitalization and/or exit strategy.

Cautionary Note
At the risk of seeming self-serving -- OK, it is -- be very wary of negotiating directly without the professional representation of an investment banker-merger & acquisition intermediary-business broker. Part of the way a PEG, or any corporate buyer for that matter, delivers high returns to investors is buying the company as inexpensively as possible. Their success rate in doing so is much, much greater when the owners of the company do not have professional representation (and no, a lawyer is not what you need for this).

M&A Client/Intermediary Engagement Agreements

2010-02-11T16:01:00.000-08:00

I am on the conference planning committee for the June, 2010 M&A Source Conference in Orlando, and wrote the following description of a workshop to be conducted for approximately 150 M&A intermediaries from across the country (and some international). I have lined up two dynamic M&A attorneys, one from Dorsey & Whitney in Palo Alto, CA and the other from Shumaker, Loop & Kendrick in Tampa, FL, to conduct a workshop on establishing the proper legal framework for the relationship between M&A intermediaries and their clients.

Right From the Start: Negotiate the M&A Client/Intermediary Representation Agreement You Want – And Need

The M&A Process Flow begins with positioning the Client/Intermediary relationship, and that first step culminates with signing the engagement agreement. While some intermediaries use very short, generalized letters of agreement to define the terms of the engagement, others will use a detailed, multi-page contract that not only details the relationship, it addresses contingencies in the event of specified occurrences. Regardless of approach, there are certain elements that should be in all representation agreements, and others that the prudent intermediary will want to have. Further complicating the picture, what may begin as a straight asset sale engagement can change forms through the course of a deal, such as to a securities transaction and/or to a short term joint venture with a later option to purchase (more likely when intellectual property is involved). Advance planning at the beginning stage can avert later difficulties.

This instructive session will discuss standard elements that all representation agreements should include, and many optional elements that may be prudent to secure the intermediary’s income, by reducing risk and wasted time. Among the issues discussed will be:

Retainers and/or upfront fees for services rendered prior to transaction close
Fiduciary duties to principals
Whether to describe the services that will be rendered and the implications of doing so
Implication of representing both parties, e.g. “dual agency”
Assignment to broker-dealer (if applicable)
Anticipating non-sale outcomes, like interim joint ventures, licensing and operating agreements
Indemnification implications
Mediation, arbitration and litigation
Back-out fees, and more

Important Considerations About The Economy And Implications for Merger & Acquisition Activity

2010-02-10T13:25:00.000-08:00

There are a lot of opinions being floated about what is happening in the economy and what to do about it. How much would tax cuts help? Would they even help? What about small business stimulus for hiring, such as payroll tax reduction?

I do not pretend to have the answers. I did attend a very informative, thought provoking address last week by Brian Pretti, Senior Vice President and Chief Economist, Mechanics Bank. Most of the content below was inspired by Brian Pretti, with some of my own comments sprinkled within. Mr. Pretti made it clear that he does not purport to have the answers, but suggests that we ask the right questions and think about the key economic questions of today in the right context.

The reality is that nobody in government, academia or business really know definitively what the best path is, because we’ve not taken it before. This is not a business cycle-induced recession – that is pretty widely agreed – it’s a recession induced by a financial and “credit cycle implosion.” We’ve not seen that in modern economic times. The experience base and forecast models don’t provide much guidance.

Collapse of a Credit Cycle

Our economy depends on borrowing and credit, for better or worse, and that has been the lifeblood of the economy since the 1950’s. According to Federal Reserve data going back to 1953, there has been quarterly growth in private sector (consumer + business, which accounts for around 85-90% of GDP) use of credit for 60 years.

Two years ago there was $3.5 Trillion per quarter being borrowed. Now, for the first time in 60 years, the quarter to quarter rate of credit growth is negative! The private sector stopped borrowing and is both working down and defaulting on its debt, “deleveraging.” In ways, we should be grateful, in ways fearful.

So to counterbalance it, the Federal govt. is “leveraging,” adding a whole lot of debt to prevent further collapse – another good reason to be fearful (my opinion).

The Fed. Reserve web site showed last week that the banks are easing up credit restrictions on both large and small borrowers, but the borrowers aren’t borrowing. This isn’t like the early 1980’s when people didn’t borrow at stratospheric interest rates, they’re near zero and there's still little borrowing. This isn’t just a supply problem, it’s a problem of demand for credit, too.

The last de-leveraging cycle was in the 1930’s. Notably, the last time adjustable rate mortgages were used widely in the U.S. was the 1920’s, after which they fell into disuse for about 60 years. Perhaps you’ve heard the old saying that we don’t repeat the mistakes of our parents, but instead repeat the mistakes of our grandparents…

After The Depression, the credit base grew between 1950-1980, but slowly compared with 1980 onward (the collective memory of The Depression was common, so people were unwilling to take on much debt). During that time we had shorter economic expansions (business cycles) and the economy was more volatile.

By the 1980’s the Baby Boom generation came of age, and started buying houses, flipping them, doing it again and again, enabled by what Mr. Pretti called “maniacal credit creation.” House prices just kept rising, and people believed it would always be so. So long as the credit to do so is easily obtained, it's easy to keep perpetuating that cycle. Think of the period between the early 1980's and just recently as a wild, drunken party – now, all that's left is a vicious hangover. Mr. Pretti noted that the “build up over long credit cycles is virtuous, the end is vicious.”

Economic Volatility

Favorably, economic expansion cycles started to lengthen and become less volatile, which was of course a great thing for everyone globally. I personally remember writing about the reduced volatility somewhere back around 2004.

An important question: now that the private sector is de-leveraging, will economic expansions shorten again and become more volatile? Vast fortunes will be made and lost as people test hypotheses to answer this question.

The picture of the Federal Government piling on debt is not pretty and nobody likes the idea. The hope is that it can be short term only, then reversed before long – and before inflation kicks in and the dollar devalues against international currencies.

It’s a tactic with huge downside risk that can last for a generation. But, is there another choice to keep the economy from deeper problems and higher unemployment, since the private sector is not spending? The thinking goes that the Federal Government is all that's left to spend money (a notion that is very frightening to most of us).

The Federal Reserve can’t stimulate economic activity by dropping interest rates – they're already near zero. Tax cuts would only reduce federal tax revenue and increase the deficit if businesses and consumers don’t spend the money, but instead save it (what many economists expect to happen, especially in light of the credit issue above).

Side note: I have been an advocate of payroll tax cuts on new hires for over a year, but for some reason this never got traction in Washington. I understand the reticence to offer it on existing employees, but new hires wouldn't cost the government, as it would be cheaper than having people on unemployment.

Unfortunately – and it’s creating a political firestorm – the stimulus money is not trickling down from Wall Street to Main Street. Main Street has gotten very little benefit from it, but there are those Wall Street bonuses waived in everyone’s face on the evening news. We citizens have a lot of valid questions and concerns.

There will be a lot of expected and unintended consequences for the govt. leveraging to replace the private sector. Everyone knows that some will occur, but what will they be, and when? Inflation and a U.S. dollar devaluation are concerns, but not universally agreed inevitabilities for the short term.

In Japan we saw a credit cycle bust in the 1990’s. In the 1980’s they were buying some of the world's favorite trophies like Pebble Beach and Rockefeller Center, until the market peaked in 1990 -- then K-Boom. When they went through the reconciliation, the business cycle shortened and got more volatile. So, in a post credit cycle bust economy, is this what we can expect? Maybe, maybe not. Fortunately for us, Japan's experience is not necessarily indicative of our fate, as there are other differentiating factors.

Complicating the picture is the fact that we’re now just one country in a globalized economy, and not only is a lot of American industry gone for good, but when the economy improves, American industry is unlikely to build new plants in the U.S.

In short, easy answers are not apparent.

Implications for Merger and Acquisition Activity
Increased uncertainty and increased business cycle volatility may reduce valuations. The Good Old Days of 2006-2007 peak valuations may not be seen again for 25-30 years. Business owners who are contemplating transactions do themselves no favor by waiting, unless they can use the time to improve the business's operation and/or buy out competitors.

There is ALWAYS high demand and valuation for the best companies in their industry. This factor is perhaps more acute now, since the good ones are few and far between and thus more desirable.

Consolidation of competitors will be increasingly important as the market "rationalizes" (eliminates) the excess of supply in certain industries that exceeds the demand. In other words, in many industries, there are just too many companies doing the same thing for the level of current demand, and in many cases, considering the economic factors above, that demand may not return to recent years' levels .

Just as the Baby Boomers helped fuel the housing bubble, a Baby Boomer retirement wave is expected that will bring a lot of Boomers' businesses on the market this year and in coming years. This may also depress valuations by introducing more competition for the given pool of buyers (not to mention with constrained access to credit).

Resources:
Deleterious Effect of Government Spending on Economic Growth, 2005, The Heritage Foundation http://www.heritage.org/Research/Budget/tst102505.cfm

The Necessity of Obamanomics - Labelling the president a tax-and-spender is facile given the challenges he faces. Wall Street Journal (must be subscriber to read full article)http://online.wsj.com/article/SB10001424052748704022804575041751435808716.html?KEYWORDS=necessity+of+Obamanomics

How to Close Difficult Deals Using M&A Insurance Products

2010-02-09T12:28:00.000-08:00

As a deal maker, we need many tools in our kit to bridge the gaps between buyers and sellers. The price is only the first hurdle, and agreement on that may be complicated by the terms of the sale. In fact, there's an expression in our business "You tell me the price, and I'll tell you the terms." A subset of terms involves risk management for both parties, and disagreement on elements of that can kill a deal.

I am on the conference planning committee for the June, 2010 M&A Source Conference in Orlando, and wrote the following description of a workshop to be conducted for approximately 150 M&A intermediaries from across the country (and some international). I have lined up a dynamic attorney/instructor from AON Risk Services to talk about using insurance tools to meet both parties' need for risk mitigation in M&A transactions.

How to Close Difficult Deals Using M&A Insurance Products

The allocation of risk between buyer and seller is one of the myriad ways deal negotiations can fall through, and is often the fulcrum for deal success or failure. In today’s economic climate, acquirers are even more risk averse and getting to the close may be even more challenging. Buyers want to hold sellers responsible for post closing claims or liabilities and financial statement authenticity, whereas sellers want to create as much certainty and finality about their consideration as possible. This struggle is typically over legal mechanisms like representations and warranties, indemnifications, holdbacks and baskets.

Insurance mechanisms to address representations & warranties, tax indemnities and other transaction related issues may provide the tools needed to manage both parties’ needs for risk mitigation – and save the deal. This workshop is derived from a series of Continuing Legal Education lectures, but tailored for The M&A Source:

Insurance products available in merger and acquisition transactions
Case studies on buyer/seller representations and warranties insurance, tax insurance, litigation buyouts and contingent liabilities
Considerations in negotiating a transactional insurance policy

Microchip To Buy Silicon Storage for $284 Million - WSJ.com

2010-02-06T13:33:00.000-08:00

Microchip To Buy Silicon Storage for $284 Million - WSJ.com: "Microchip To Buy Silicon Storage for $284 Million"

This announcement, on the heels of the December 15 "On Semi to Buy California Micro" for $108 Million announcement, shows that Silicon Valley M&A in the semiconductor sector, and related industries, is roaring back to life. This is not a surprise to me, as I have been tracking the global semiconductor industry for some time now. After an almost nuclear devastation, this industry has been experiencing a month to month return to growth for perhaps close to a year now.

Furthermore, a semiconductor index of publicly traded companies' performance has led the S&P 500 by a significant margin for several months.

Tech Spending Bounces Back

2010-02-06T13:11:00.000-08:00

Tech Spending Bounces Back

This article is bound to bring smiles to Silicon Valley. Even the beleaguered global semiconductor market has been turning around for months, showing consistent growth.
Excerpt:
Business spending on technology goods and services is returning as the economy mends, pumping new life into suppliers such as Cisco Systems Inc., though it has been slower to reach other sectors. The big maker of networking gear Wednesday posted a 23% jump in quarterly profit and 8% gain in revenue, its first such increases in a year.

The economy has entered a new "phase of the recovery," said John Chambers, Cisco's chief executive, in a call with analysts, adding that he planned to hire up to 3,000 workers in coming quarters. "This is one of the most robust positive turnarounds I've seen in my career," he added.

Cisco's results add to a growing body of evidence that companies are starting to open their wallets after the recession. The Commerce Department last week said business spending on equipment and software rose at a 13.3% annual rate in the fourth quarter, adjusting for inflation. That was the fastest growth since early 2006.

Strategic Plans Lose Favor

2010-02-06T12:56:00.000-08:00

Strategic Plans Lose Favor

This Wall Street Journal article on strategic planning recycles a recurrent theme: when the economy is down, or when there is high volatility, media stories will quote people making rash statements like strategic planning is dead. (the lead-in paragraph ends with the statement "...executives discovered that strategic planning doesn't always work."

Danger. Warning. Do not take this stuff too literally. Unfortunately, many people will do just that. If the read nothing further, and take away only that nugget, they may decide to toss strategic planning overboard.

I remember hearing a lot of that stuff in the late 1990's. It was often stated after the pronouncement that "the Internet changes everything." Or "things are happening so quickly, that strategic planning is now irrelevant." Hah! Even venerable Michael Porter, the Harvard Business School professor considered one of strategy's greatest luminaries -- a rock star -- was considered by many who drank that cultural Kool-Aid as no longer relevant.

While Porter felt challenged for a while, his strategy guru reputation was vindicated and remains quite intact (unlike the flag bearers for such notions, like Webvan).

Unfortunately for Walter Shill, head of the North American management consulting practice for Accenture, he was quoted in this article as saying "Strategy as we knew it, is dead." Well, as who knew it? He then goes on to say "Corporate clients decided that increased flexibility and accelerated decision making are much more important than simply predicting the future." Well, OK, sure -- especially in times like these. Or wait, wouldn't that be the case even in stable, growing times? Sure, it would.

I am sure that if Shill had more ink with which to explain his thoughts, he probably would have made it clear that strategy itself is still very important, however shorter feedback loops to update that which needs to be updated regularly are critical. He might have emphasized how important it is for companies to compress their planning cycles to ensure greater responsiveness to current conditions. And, to consider more alternative scenario analysis to contemplate different outcomes.

At least, that's what more sophisticated companies do, and they have been moving that direction for years. Further compression of the plan>evaluate>re-plan feedback loop in today's uncertain environment makes plenty of sense. The article cites a few companies whose ability to ride out this economic storm has been aided by such advice.

Only unsophisticated and/or desperate to survive companies will toss planning out the window entirely.

NABE Tele-Conference “Recent Fed Action” Wednesday, January 23, 2008

2008-01-23T13:01:00.000-08:00

As a member of National Association for Business Economics (NABE), I attended a teleconference this afternoon in which highly esteemed NABE members discussed
the topic “Recent Fed Action.” Following are my notes from the conference in hopes that they help provide perspective on the daily market gyrations, panicky newspaper headlines -- and calm jittery nerves.

I tried to capture all this accurately, but sorry if I've made any errors.

“Recent Fed Action” Wednesday, January 23, 2008 4:00-4:45 PM Eastern
Speakers:
Michael Moran, Daiwa Securities America
David Resler, Nomura Securities International
Chris Varvares, Macroeconomic Advisers, moderator

Consider that Fed cut discount rate 75 basis points on Tuesday (now is 3.5%)...
What's the context of this action and what's going to happen?

Must consider the motivations, stock markets melting down is obvious, general principles important to consider for a deeper analysis.
Bernake bias is "financial accelerator," and this has been the basis of much of his career work and research. When shock to real sector [consider sub-prime mortgages], feeds into financial sector [consider global effects on markets, credit], which feeds back to real sector, creating a circular downturn to the economy that can accelerate decline. This is his sensitivity and the lens that he's watching today's market through.

What's happening now?

Shock to real sector (real estate) leading to financial sector shock
2nd factor -- current status of inflation expecations. Now well behaved TIPS spreads (Treasury Inflation Protected Securities). Fed saw that as a green light to go ahead and be agressive now.
If tick upward, will change pace of easing of monetary policy from Fed.
Fed statement -- aggressive, sees little inflation risk
Expects them to reduce Fed Funds rate by another point by April, 2008.

What about next week? Markets are still very volatile...
Expectations of the markets matter!!! Since expectation of additional easing next week, they may do so to avoid disappointing the financial markets.

Overall, his outlook: He's not optimisitic, but thinks there's a pronounced disconnect between result and financial press coverage. Thinks press is distorting situation. Thinks 1/2 % point growth in 1st half of year, then 2-2 1/2 % in 2nd half. 4 reasons not going into recession:
1) Drag from housing will lessen, but will remain a (-) sector
2) Not excesses in business sector , no overhang, business inventory OK
3) Slow down in import growth will help U.S. economy, shields domestic production with favorable effect on jobs
4) Sees consumer sector slowing, not declining. Acknowledges that this is controversial, not an economists' consensus opinion. But consider the real estate market. As bad as it looks and feels, it's only a 5% drop after a 70% run-up over prior 4 1/2 years. Doesn't think that overall will cut back drastically, except those who did buy at peak will certainly feel more pain.

On the other hand, he's nervous because equity market is declining after real estate, and the combinaton is not good.

Media coverage creating fear may become self fulfilling and depress the market [My comment: I remember this effect vividly just prior to the 2002 market crash.]

Doesn't see a deep seated credit crunch, but there is some softening. Bond market is still moving along, but recent slow volume compared to past two years range. Bank lending is still happening, but slower.

Agrees mostly. Will dance on edge of recession for 1st half, see few months of reduced industrial production, and slowing consumer spending.
How big is the hole in credit market, how much will large bank impairment
Consumer spending, in his 35 yrs in business can't recall another time when so much pessimism about C.S. with so little evidence to back it up. It's true that real retail sales in Q4 was slowest growth in 4-5 years, but certainly not at the level that creates (-) growth. Doesn't forecast outright decline in consumer spending thru 2009.
So, why Fed changed policy so radically and surprisingly just prior to FOMC mttg? Some think Fed has other info rest of us don't. Not a persuasive argument. Doesn't buy it.
Fed dares not disappoint the mkt, so may cut further next week. Futures mkt by far is expecting action next week. Quoted market expectation of 96% expect some cut.

Employment report week from Fri, normally would be preferred course to wait. Now, mkt is so primed for further cut, so they may drop rate to 3% 5 days earlier than employ report anyway.
Slower growth will probably keep inflation in check
Thinks OPEC will increase production to drop oil price to maintain market stimulus. It's far more in OPEC's interest to maintain market stability than to keep oil $90-100/barrel.

Neither forecaster was considering stimulus package being proposed by White House and Congress now in his forecasts discussed above -- so those forecasts not dependent upon stimulus.

Thinks that stimulus package being proposed will bump GDP growth 0.3 point (Dave) Bit more for Mike), not enough to really help the economy but more of a political sop than anything to help the economy. There are select political forces that would benefit the most from this, especially the incumbent party.
Virtually all growth will be concentrated in the 2-3rd quarters. Will learn 3rd Q result about 5 days before the election...[my comment: hmmm, think of the implications of that!]

Thinks important for Fed to keep eye on inflation -- expects them to back off accomodative policy ASAP if economy better in 2nd half when they think that things getting back on track. Rapid productivity growth in 90's - 2000's kept inflation in check. Now that's slowed and inflation is more of a sensitivity.

2007-12-14T18:16:00.000-08:00

Market activity is one of the most important factors to consider when deciding when to sell a company. When the economy is healthy, there are more buyers, who can afford to take on more debt, all of which translates into a more rapid sale at a higher price, generally.

Favorability of Market Conditions
The favorability of market conditions for transacting the sale or acquisition of privately-held companies is largely a function of a few key factors:

Availability and cost of debt to finance a portion of the transaction
General condition of the overall economy and its likely effect on the industry(ies) in which the company operates or to which it sells
Availability of qualified, funded, motivated buyers
Availability of solid companies to acquire
Debt Availability

Buyers, whether high net worth individuals, corporations or private equity investors, depend on the availability of debt to fund acquisitions. Seldom are companies purchased with a 100% equity investment.

The current difficulty in the mortgage market, which is likely to continue well into 2008, has reduced the availability of debt to fund the mega-deals discussed in the daily newspapers. There have been recent news stories about some very large deals cancelled in process, due to new contstraints on debt availability. So far, there has not been tightening of debt availability to fund the acquisition of middle market companies or small businesses, and this is not anticipated unless the entire economy takes a signficant downturn. Even then, there will be plenty of capital to invest, it just may come with more contraints and at a higher price.

If interest rates rise, debt will be more costly to acquirers, resulting in an unfavorable effect on cash flow to service it, and reducing the amount of money that acquirers can borrow.

General Economic Conditions
According to approximately 50 economists polled by the National Association for Business Economics (NABE) in November, 2007, “While the U.S. economy faces a higher risk of recession from credit markets, housing, and energy prices, NABE’s panelists still do not see recession as the most likely outcome,” said Ellen Hughes-Cromwick, NABE president and chief economist at Ford Motor Company. “Our panel of forecasters sees growth gradually picking up from the sluggish pace projected for this quarter even without further easing by the Federal Reserve.”

If you are interested in free, monthly updates on the U.S. and global economy, please sign up for the Tranzequity economic report. As a NABE member, we can access the full report not available to the public, and excerpt this information for Tranzequity economic report subscribers.

Availability of Buyers and Eligible Companies to Acquire
Typically, there are more buyers than good companies eligible to be acquired, and there is no current exception to that rule. We receive communications from numerous buyers weekly seeking to purchase companies of many types, from software to heavy manufacturing and distribution.

In summary, the market remains favorable for lower middle market and small business transactions, though if the overall economy slows, many companies that may be attractive acquisition targets today may become less so.