The Inhospitable Hospitality Suite Feels the Wrath of Alfidi Capital

Here's a special message for one enterprise I encountered at a recent conference.  I won't name them to save them the embarrassment.  That is a rare instance of my generosity.  I'm pretty sure the arrogant chief of this outfit, or at least the human-shaped cardboard cut-out he employs as his public face, will read my screed.  Here it comes, dude.  You can't sue me if I don't identify you.

You people were marketing private placements in natural resource extraction to a wide audience that included both accredited and non-accredited investors.  Transparency and reliability really matter in such an effort but your enterprise doesn't have a clue what those words mean.  Being cagey about your data did not help your case at all.  Failing to reveal serious questions about your operating history will furthermore be an eventual detriment.  Your entity has run afoul of your state's securities board before, and I easily located hard-copy proof.  I don't think you've changed your ways since then based on the behavior I witnessed in your hospitality suite.

Opening a hospitality suite is supposed to be a generous way to introduce investors to an opportunity.  It is not an opportunity for a senior executive to sulk while a junior flunkie gives the analyst community a straight-arm deflection.  It is also unwise to brag about your supposed desire to avoid publicity while you're speaking at a freaking nationally-advertised conference.  The cognitive dissonance on that score is amusing.  No wonder you people generate such dissatisfaction.

Get your memories straight.  I did not encounter you people in a different city last year.  We may have crossed paths in San Francisco if you attended the same conference I did in recent years, aside from the conference this year.  There's a good reason I did not give you my business card this year.  The script you use on the idiots in your local dirt patch doesn't fly with yours truly.  There are no suckers at Alfidi Capital.

One of my contacts spent some time in your hospitality suite after we spoke.  Would you like to know what he discovered?  If you are dumb enough to sue me, it goes on record in court and your investors will find out all about it.  Do yourself a favor and stay away from future conferences in San Francisco.  I'm surprised you even found your way from your hotel room to the conference, since some of your team members didn't even know where your hospitality suite was located.

Finally, the words "best" and "gut" do not rhyme.  Neither does anything in your pathetic sales pitch.  Good luck probing those dry holes, idiots.  You'll find more such dry holes wandering on two legs late at night around your favorite run-down urban district.  They're a lot cheaper than the holes you want to drill and the result might even be more enjoyable.

Venture Capital and Private Equity Around the Glorious Roundtable

I get invited to the most mind-blowing events.  My definition of "mind-blowing" is highly intellectual and does not involve anything illegal or unethical, so most human beings probably won't want to hang out with me.  That's okay.  They'd cramp my style anyway.  Check out how I roll.  Yo!  I attended a Silicon Valley roundtable event last Friday that must remain nameless because it was organized by private parties who do not seek publicity.  There wasn't even a round table in the room.  Several entrepreneurs and investors attended by invitation only and the organizer allowed me to attend as a guest.  Wonderful topics lined the agenda and I shall discuss them in oblique terms.  Prepare to be entertained.

Flying cars have been on the dream list of inventors since the Jetsons were on TV.  I got to examine real working prototypes of flying cars at the US Army Transportation Museum in 1995.  None of them ever had serious capabilities.  Entrepreneurs are now developing flying cars that convert from ground mode to airborne capability.  Modern contraptions remind me of the Bell-Boeing V-22 Osprey program with propellers to switch from VTOL to horizontal flight.  Rotary wing aircraft can autorotate into the ground in the event of a mechanical failure, which saves lives but isn't pretty to experience.  Twin-rotor aircraft have no such option if something fails while hovering during a VTOL event.  A ballistic parachute that deploys automatically upon engine failure may solve the problem.

I no longer believe the bull story for further miraculous economic growth in China.  Many others still do and that's okay.  Someone needs to be long in case I ever go short.  China joined the WTO in 2001 and is now inextricably linked to the world market.  Its role as the world's factory is ending because its increasing wages have priced it out of low-cost manufacturing.  China needs to pay more attention to WIPO if it wants credibility.  San Francisco may become the first renminbi trading hub in North America once China makes its currency fully convertible.  Western investment banks are opening offices in Shanghai and that city is the first in mainland China to have a free trade zone.  My MBA alma mater USF has a strong interest in China and it is hosting a conference on China's financial reform in a couple of weeks.  I have already registered to attend because I love learning stuff.  The conference is free to USF-affiliated people.  Stolen Valor frauds who prey on veterans will not be allowed to enter the event.  You know who you are, and so do I.

There are such things as credentials in business valuation.  NAVCA offers certification in business valuation and appraisal.  This knowledge comes in handy for business brokers who buy and sell privately owned businesses.  I think it also comes in handy for fraud investigators.  I'm not saying there's any fraud in Silicon Valley.  No sir-ee-bub, not me.

Santa Clara University has a Global Social Benefit Incubator (GSBI) that launches non-profits.  One such non-profit is Literacy Bridge.  They distribute single-touch audio books loaded with knowledge of agribusiness and sanitation in developing countries with low literacy levels.  The device is meant to be shared via a local subscription.  Literacy Bridge collects use case data on the number of activations, volume level, and playback times from each audio book.  This proves that big Data can reach rural areas that do not have WiFi or landline telecom infrastructure.  Societies with oral traditions have different connectivity speeds.

Executives from large publicly-traded companies will share their growth lessons with pre-revenue stage startups.  Non-dilutive financing options include licensing and royalties, but my readers have heard me mention that in other blog posts.  The caveat is that non-dilutive financing takes longer to grow a company.  The IPO must have a good rationale; it can't be just to return capital to early investors.  Entrepreneurs must tell early investors that growth takes a long time, to set their expectations for a realistic timeline.

Freedom House near San Francisco provides a refuge for victims of human trafficking.  Poverty is a supply-side problem driving women into servitude and exploitation.  California law now recognizes underage solicitors as victims rather than criminals.  Freedom House's aftercare referrals come from law enforcement.  They do important work.  I believe Somaly Mam would approve.

Space . . . the final frontier.  It won't be that way for long.  Space Tango is an incubator for space-oriented startups, although it's quite a ways from where I hang out in NorCal.  The Silicon Valley Space Center is hosting a conference on "Launching Commercial Space Enterprises" this coming weekend.  I can't attend due to prior commitments and I don't normally pay entrance costs higher than zero.  It's probably worth the time of some VCs.

I would like Venture Capital Journal to publish more stories on the unfulfilled promise of the mobile / Big Data / cloud trifecta.  If they don't, I certainly will.  My theory as of today is that the Holy Grail of Big Data remains unrealized because too few IT practitioners have applied ROI-type metrics to compare their investments in Big Iron and the cloud.  It's like my experience with portfolio managers in finance.  Almost all of them rely on folk wisdom, unguided guesswork, and rumor instead of applying the metrics I read in Buffettology books on Warren Buffett's deep value investing.  I think the IT crowd is the same way.  IT pros rely on their subjective preferences for technology instead of the hard metrics of Cloudonomics.  Buffettology and Cloudonomics are often cited, sometimes read, and rarely implemented.  That's why Wall Street holds as much unfulfilled promise as mobile Big Data in the cloud.  That's also why the few people who do read those books can win in life.

These topics appear to be unrelated.  Entrepreneurs and their investors can track them all and make sense out of unrelated matters.  That's just how we think.  Great minds are divergent and polyphasic.  Genius investors in venture capital and private equity discuss these things all the time, even when we're not around a glorious roundtable.  

Placement Agents Are Mostly Useless

I was flipping through the marketing brochures of a corporate law firm when a fancy-sounding term caught my eye:  "placement agent."  What's that, I wondered?  Is it like some kind of sports agent running around yelling "show me the money" like in Jerry Maguire?  My impression was actually pretty close.  A placement agent is literally some private party who finds investments for investors.  The more I read about this unique function in the finance sector, the more it seems like a total waste of money for investors and a liability for fiduciaries.

Legitimate placement agents should have no permanent financial relationship with either party they introduce and should play no role in negotiating a deal or in subsequent operations.  I just think that's obvious but not everyone in finance thinks like me.  Greedy people will have a hard time living that philosophy.  Some placement agents get sued and imprisoned for the damage they do to clients.

Placement agents can cause breaches of trust for fiduciaries and conflicts of interest for money managers.  They may have a limited role to play by introducing two separate private parties but they can cause innumerable problems for retirement plan sponsors, endowments, and other fiduciaries who are subject to strict legal controls.  Most of these agents are probably an unnecessary middle-person in the allocation of capital.  They are quite different from business brokers who perform a needed function for privately held businesses seeking liquidation.  Alfidi Capital is not a place for unethical placement agents.

Standby Equity Purchase Agreement (SEPA) And Equity Line Funding

I recently discovered an innovative financing arrangement for young companies called the Standby Equity Distribution Agreement, sometimes also called the Standby Equity Purchase Agreement (SEPA).  Please don't confuse this acronym with the Single Euro Payments Area, Solar Electric Power Association, Science Education Partnership Award, or Southeastern Power Administration.  None of those things have anything to do with a SEPA financing agreement.  I only mention them to keep my readers away from distractions.

The company must first register with the SEC by filing the appropriate forms.  Companies that execute a SEPA sign a term sheet with a private investor that allows said investor to buy shares in predetermined dollar amounts.  The term sheet defines the funding formula under which the company will sell shares to the investor to net its desired amount of capital.  That's why this type of deal is also called an "equity line," because it resembles a credit line that draws predefined amounts of capital in tranches.

My concern with this type of arrangement is that it may resemble a floorless convertible debenture that becomes toxic.  The term sheet must define a floor price that prevents an investor from bidding down the public trading price of the company.  This protects the company from an unscrupulous investor who shorts the stock into a death spiral and prevents it from raising further rounds outside the SEPA.  The investor can then buy a controlling interest for very little money and the pre-SEPA investors are diluted into irrelevance.

The SEC knows that convertibles pose risks of dilution.  I won't let this death spiral happen to any company in which I hold an early-stage equity stake.  I want to see covenants in the term sheet that prevent it from becoming a toxic convertible.  The company must define the price floor using a convention like the volume-weighted average price (VWAP) that will enable it to cancel a draw down if the price moves adversely during the funding window.  The term sheet should limit the SEPA to the growth period of the company, say two or three years.  Beyond that time the company should have sufficient cash flow that it won't need to return to private investors to seek more capital.  I also want a covenant that prevents the outside investor from short-selling the stock once they purchase it under a SEPA.  The threat of legal action for violating this covenant should be sufficient to scare away SEPA investors who secretly covet total control after cramming down the stock.

Term sheets for equity line SEPAs limit the funding window to a number of days after the company issues the private investor a draw down notice.  I am agnostic as to how long this window should be open.  It would seem that a company with a very volatile stock should keep the number of days the window is open in the single digits.  Less volatile stocks allow the company a longer period during which the VWAP is not expected to deteriorate.  Volatility is difficult to anticipate during the pre-registration phase when the term sheet is being drafted and the stock is not trading publicly.  The length of this window comes down to trust between the company and investor.  I typically don't trust anyone, so my incubated company had better get a longer window for more flexibility.  Investors who want to negotiate anything shorter should be prepared to give up something favorable, like fewer shares for the dollar amount invested in each tranche of the equity line.

I can do only so much as an angel investor who does not own a majority stake in a startup.  The entrepreneurs need the services of a good securities attorney to help draft the term sheet for a SEPA.  I could probably find a few here in the SF Bay Area.  I'm not an attorney and my blog articles do not constitute legal advice.  The SEPA is useful if its term sheet protects companies from exploitation by predatory investors.  

The Haiku of Finance for 01/17/13

Insider buyout
C-suite thinks they add value
After they add debt

Cerberus Makes Hasty Exit From Freedom Group

Investment decisions should always take fundamentals into account.  I say "should" because sometimes a portfolio manager's fiduciary duty to satisfy a client's whims take priority over a sound investment in a healthy, market-dominant company.  Cerberus is selling its stake in Freedom Group because that will satisfy CalSTRS' demands.  This decision has nothing to do with whether the investment in question has been a winner.  The chief product of this particular sector has seen record-breaking sales in 2012.  Cerberus is a middle step between institutional investors and the capital markets.  It has to pay as much attention to future rounds of fundraising as it does to the performance of present holdings.  Satisfying CalSTRS now assures a future audience for Cerberus' fund offerings.

Some investors let emotions rule their thinking.  Big news events that hit close to home have an impact that financial models can't measure.  Bad news about one school can upset teachers anywhere, and their plan sponsors' money managers are paid to listen.  A state pension plan forcing its money manager to leave a healthy firm should be able to explain to its pensioners why it won't be able to pay their benefits if it can't achieve its target discount rate.

Full disclosure:  No positions in entities mentioned.

Financial Sarcasm Roundup for 12/17/12

It's been some time since my last blast of outright sarcasm.  That's too long.

The U.S. has finally enacted permanent normal trade relations with Russia, more than two decades after the Cold War ended.  Uncle Sam sure takes his sweet time recognizing reality.  The Jackson-Vanik legal regime was a Cold War blunt instrument intended to hold the Soviet Union and its Warsaw Pact allies accountable for their human rights violations.  Now Russia's internal freedom is on par with that of the West, which says more about the West than it does about Russia.

Uncle Sam will probably be just as slow in recognizing the weak demographic assumptions underpinning entitlement spending.  The slowdown in legal immigration due to the prolonged recession is probably offset by the large numbers of illegals who remain here and have kids.  The irony of illegal immigration is that our own government encourages illegals to apply for benefit payments while they are paid off-the-books income that can;t pay into Social Security or Medicare.  Illegal immigration makes the unfunded entitlement problem worse and no one in our business or political elite even cares.  My solution is simple.  If you apply for benefits, please include your U.S. birth certificate or naturalization papers with your application.

Meanwhile, private equity firms have learned nothing since 2008.  They are using more leverage than ever to buy companies whose earnings will be destroyed in the next round of the recession.  Borrowing at record-low interest rates isn't such a great idea when the earnings needed to pay back those debts won't be there.  I'll be watching the headlines for the first private equity firms that go bankrupt next year.

Sell-side analysts have learned nothing from last decade's master settlement.  Some Morgan Stanley banker got his firm smacked for coaching Facebook on how to materially mislead analysts.  That $5M fine is peanuts, so this is hardly going to hurt anyone other than that one banker.  State regulators are paying attention while the SEC is asleep.  My readers should be grateful that all of my articles reference facts already in the public domain.  Anyone idiot can mislead analysts on a conference call.  Only a genius like me can tell the truth.

I think I'm losing my touch.  These boring news items aren't getting me fired up enough to be truly sarcastic.

The Wonderful World of Crowdfunding

Crowdfunding is here to stay.  This is the brand new way for startups to raise capital in small increments from many sources online.  The National Crowdfunding Association has some basic information on this growing market.  I'm pleased they're developing a certification credential for crowdfunding advisors and have programs for underrepresented business owners.

Crowdfunding is related to microfinance in that it funds small projects, but the difference is that a microfinanced transaction is sourced from a single institution like Grameen Bank.  It also differs from peer-to-peer (P2P) lending, which enables loans from a single nonfinancial private lender to a private borrower through online portals that enable credit checks.  I am intrigued by the possibility that some crowdfunding platforms may become so successful that they can expand their brand into a one-stop shop that includes microfinance and P2P lending.

I had the chance to hear from crowdfunding pioneers at last August's Money Show in San Francisco, and my interpretation of what they discussed is intended more for entrepreneurs than charities.  The key element for entrepreneurs to consider is how much to raise.  Raising more than a few million will probably have to go to angel investor clubs and then VCs, but startups that only need a million or two can use crowdfunding portals once they've exhausted the friends and family route.

Some crowdfunding portals use a pledge system for non-profit clients, so if a startup doesn't raise the full amount of its proposed total it must return the balance to donors.  I have a hard time believing whether that would be viable for a for-profit startup, because investors would have to read the startup's prospectus online and understand they are contributing a legal form of consideration (a cash investment) in exchange for a security representing ownership.

The JOBS Act will be a tremendous enabler of crowdfunding by lowering barriers to raising capital that previously allowed only accredited investors to subscribe to an offering prospectus.  The SEC is formulating rules for implementing the JOBS Act but they need to hurry it up before state regulators start issuing their own legal opinions.  Once the SEC has its complete rules in place, the crowdfunding portals that adhere to them and attract investors stand a good chance of being acquired by broker-dealers.

I challenge the conventional wisdom that a secondary market isn't likely for securities sold in crowdfunding.  Facebook's lengthy pre-IPO drama broke the mold on trading private shares in a secondary market.  Crowdfunding a hot startup that later grows into a Facebook-type behemoth will force a secondary market into existence whether the SEC is ready for it or not.  Mutual fund companies will see the value in crowdfunded shares on the secondary market, and they will probably launch actively managed funds that invest in first-round capital raises on crowdfunding platforms and shares available in the secondary market.  I don't foresee an index fund or ETF ever developing for the crowdfunding sector because the potential universe of enterprises to track is simply too large to be worth pursuing.

Crowdfunding can test an idea (a tech startup, a film project, a non-profit fundraising campaign) to see if it has a catchy theme that will go viral.  Reaching beyond friends and family for investors will IMHO require a social media campaign to get the word out.

Let's do a quick run-down of some crowdfunding platforms.  IMHO the most successful platforms will allow potential investors to view a startup's full business plan, prospectus, and term sheet online without requiring them to sign a non-disclosure agreement (NDA).
Kiva is early name that merged microfinance with peer-to-peer lending.
Kickstarter is getting a lot of attention and credibility in Silicon Valley, and is a portal for film finance.
Indiegogo is making a name for itself in non-profit funding.
Health Tech Hatch focuses on raising capital for the biotech sector.
CircleUp enables consumer products startups to raise equity capital.
Invested.in adds CRM data mining and mobile apps to its portal (a smart value-adding move IMHO!)
Streetfunder is focused on equity raises.
Launcht has platforms for non-profits and social entrepreneurs.
Funding Launchpad enables offers that include a complex capital structure (equity, debt, and other options).

Crowdsourcing explains the whole phenomenon of mass-generated online content.  I am convinced that crowdfunding can fund human-scale enterprises like makerspaces, biohacking laboratories, and permaculture installations that will enable resilient communities.  This is the future of finance.   Capital markets were originally intended to raise money for productive enterprises, but in recent years they have degenerated into massive gambling parlors that waste capital in high-speed trading.  Crowdfunding and its related concepts will hit the reset button and return finance to its role as servant of product enterprise.  This is the future of civilization.

Full disclosure:  The author has no ownership interest in any of the crowdfunding platforms mentioned in this article, although he reserves the right to use any and all of them as an investor in enterprises and/or donor to causes.  

Europe Has No Plan For A Post-Greece Euro

The Eurocratic elite has been in love with itself for so long that it can't see how far the continent has fallen out of love with them.  The experiment with a unified Europe worked best when it was just Germany, France, and their tiny neighbors in a coal and steel community.  The long-held assumption of the inevitability of unification means there has never been a backup plan for dis-unification.  Planning for this imminent disorder will be ad hoc and will add to the crisis atmosphere just when calm is needed most.  The Davos crowd is in for a shock because they had it too good for too long.

Multinational corporations are the most foresighted supranational entities taking prudent precautions for a stampede out of the euro.  The lack of contingency planning among other relevant parties is sadly unsurprising.  The UK is a happy exception, so perhaps the Crown relishes the prospect of returning to its historic role as the balance of power on the Continent.  The Brits may have their work cut out for them.

I for one relish the prospect of many stupid European private equity firms going out of business.  A lot of LBO operators are very precariously overleveraged.  That is music to my ears.  It means that anything they own will be available at fire sale prices once they go bust.  It also means that there won't be as many Euro-trash wanna-bes making snide remarks about my lack of a pedigree at black-tie events in San Francisco.  They won't be able to afford tickets if they're out of work.  I have no plans to go hunting right away for bargain properties in Europe, although I suspect the dollar will go a lot farther over there this summer.  I'd rather wait for the follow-on effects here in the U.S. if European LBO shops have to exit U.S. equity positions in a hurry.  Investors are already shutting off the flow of capital into the high yield debt that LBO shops prefer and redirecting it into the no-yield bond havens that won't outlast hyperinflation.

Successfully navigating a government through a political crisis boils down to the character of top leadership.  I suspect that only Angela Merkel and Christine Lagarde have the requisite nerve to stay the course.  Everyone else is going to bail.  Whatever new leaders Greece elects in June will be the first to head for the exits.  The single currency isn't ready to become a museum piece just yet.  It's been a boon for Germany and still has a role in deterring French irresponsibility.  The most realistic end game is the one I sketched out months ago, with a devolution to a "rump euro" roughly contiguous with the original Holy Roman Empire.  

Carlyle Group (CG) IPO Disappoints Market

The Carlyle Group (CG) has returned a stunning performance for its founders and private investors since the 1990s.  Its performance today in its IPO was not so stunning, trading below the first estimates of its filing price range.

Carlyle's investment performance has a lot do with the health of its favorite sectors:  defense, aerospace, and health care.  Growth in those sectors has been driven by big factors (like government spending) out of Carlyle's control for much of the firm's existence.  Those fire hoses are going to run dry in a couple of years.  U.S. defense spending will decline as our land wars in the Middle East and Central Asia wind down.  Aerospace is on the ropes again thanks to high oil prices and perennial bankruptcies (here goes AMR through Chapter 11).  Health care spending will be whittled down by some combination of government-imposed cost controls and a probable hyperinflation attempt by the Fed.

More importantly from my perspective is that Carlyle is one of the private equity firms that wouldn't hire me years ago went I sent them my resume.  I thought at the time that my knowledge of finance and military affairs would have made me a shoe-in for one of their analyst jobs.  It turns out that my expertise was less relevant than my lack of a pedigree.  The one Carlyle employee I've ever met was a junior analyst with a bachelor's degree from Notre Dame, my alma mater.  His response to my inquiry for an informational interview was to brush me off.  The dude was two years younger than me and had no MBA (I had just finished mine) and considered me to be a loser.  That told me more about what Carlyle values in their employees than any formal interview would have revealed.

My pedigree and connections didn't meet Carlyle's expectations.  My industry knowledge and academic credentials were irrelevant.  Carlyle built a successful business model on inside connections to big shots who understood where government spending goes.  Now that government spending has peaked in the face of an inevitable decline, Carlyle's performance is starting to disappoint Mr. Market.  This lackluster IPO is the first sign.

Full disclosure:  No position in CG or any of its portfolio companies at this time.  No position in AMR either.  

Impressions From VEDC Access To Capital Business Expo In SF

I can't resist free conferences on financial topics.  I saw an ad for the third annual Where's The Money? Access to Capital Business Expo in one of San Francisco's weekly magazines.  I signed up for a free pass out of curiosity, wondering what the Valley Economic Development Center from SoCal was doing holding an event so far up north on Nov. 19, 2011.  Don't they have enough SBA lenders in SoCal?  It was worth attending for the free lunch (thanks Chase Bank for sponsoring) and yours truly even learned a couple of new things. 

The winner for me was the panel discussion on "Sources of Unconventional Financing."  The stars of the show were Greg Salomon of Capital Partners, Dave Kocharhook from Riviera Finance, and Alan Tratner of Green2Gold and the California Coast Venture Forum.  Thanks to moderation from Antonio Pizano of Pacoima Development FCU, Dave and Greg were able to explain the nuances of asset-based finance (primarily factoring accounts receivable and merchant cash advances) and vendor finance (primarily purchase order financing).  Fully utilizing asset-based finance is a must for businesses moving physical goods.  Entrepreneurs need to check out ABF Journal for tips.  Retailers need to know that factoring breaks down into recourse and non-recourse factoring, where recourse factoring leaves the company liable for unpaid receivables.  I'm not a retailer, so I enjoyed hearing for the first time that a factoring transaction is priced according to sales volume, average invoice size, payment timing, and other elements. 

Alan wowed the crowd with awesome tips, as follows . . .
   - Forming a C-corp structure provides flexibility when you need to grant sweat equity to minority investors or get funding from VCs or angels.  VCs don't like to invest in LLCs or partnerships. 
   - The financial food chain for entrepreneurs includes both debt and equity funding.  It runs from the 3Fs (friends, family, fools) through crowd funding, VC/angel backing, and even licensing and co-ventures.  I had always considered licensing to be a form of revenue for a mature product rather than a financing option for something unproven, but some startups can apparently make a go of things by inventing stuff just to license out production.
   - The success rate for businesses that spring from a formal business incubator is 90%.  That got my attention.  You can find an incubator focused on your business's sector at the National Business Incubation Association. 
   - Doing a patent search before you file for a patent of your own will help determine whether you'll end up reinventing the wheel.

I did hear one other comment during the panel discussion that I had never heard before.  Alan said a business's brand identity counts as intellectual property.  This is a twist on the old definition of a brand as an intangible asset.  Apparently academic thinking on the subject of brand identity and ways to protect it has matured since I got my MBA nine years ago.  Copyrights, trademarks, and service marks can now constitute a brand portfolio.  How about that. 

I needed to talk to a few of the banks who staffed expo booths here because I'm wargaming whether I'll need a small loan to fund a business project I have in mind.  Please note that this project is super top secret and I will reveal it when the time is right.  Let's just say it's a practical application of the resilient community paradigm.  Anyway, Wells Fargo and TMC Financing were particularly informative.  Wells Fargo offers cash-secured commercial and consumer loans that are useful for equipment purchases, and TMC Financing offers SBA 504 loans for purchasing real estate.  I asked specifically if the SBA 504's requirement that a business facility be 51% occupied referred to the human proprietor's physical presence or merely the presence of continual business activity.  It appears that mere activity is sufficient; if correct, that will be key to execution of the 24/7 presence my remotely-monitored project will involve.  Hey reader, please don't take this as legal advice.  Check with your own banker and lawyer when you start investigating loan terms and requirements. 

I mentioned the free lunch already, but I will state for the record that the Hyatt Regency San Francisco prepares a decent chicken with risotto.  I went nuts for the cheese biscuits and I would have scored a second apple tart if some latecomer hadn't sat down at the last minute.  The keynote speaker, Dane Boryta of Bottle Cap restaurant, implored us to respect the cooking by cleaning our plates.  Entrepreneurs know good stuff when they see it.  VEDC needs to invite me to be a panelist next time so I can score some more free food. 

Nota bene:  None of the companies or institutions mentioned have given me any compensation or consideration for this blog post.  My recollection of this conference is provided as a public service. 

CVAC Goes To Alabama!

The CVAC sensation is sweeping the nation.  Check out this video from a brand new wellness clinic in Alabama founded by an enthusiastic CVAC client.

Word of mouth from satisfied customers is how a revolutionary product gains acceptance.  Go CVAC!

Full disclosure:  Anthony J .Alfidi is an early-stage investor in CVAC Systems. 

Dumb Money Chasing Retail Buyouts

Private equity firms used to have a reputation as being the smartest folks around.  I think we can now take issue with that, based on their stated desire to pursue buyouts among retailers:

Private-equity firms looking to buy retail and consumer companies said they’re now able to finance deals and pay reasonable prices after the credit crisis and global recession triggered a buyout slump.

These folks are salivating over . . . what exactly?  Consumer credit card debt is at an all-time high, so any increases in retail activity from more consumer indebtedness will be difficult to impossible to realize.  Data on actual consumer behavior is mixed at best, with consumers both spending more on retail and worried more about their ability to sustain future spending. 

Maybe the private equity folks weren't so smart after all.  Maybe they were just adroit with leverage while the stock market bubble inflated in the last decade. 

Buyout Hunger and I-Bank Starvation

PE firms think they can find public equity bargains even in a stock market rally driven by hype:

Buyouts are finally returning for the deal-hungry private equity industry, which is looking at 2010 to deploy huge cash reserves into deals that buyers hope could get back up to double-digit billions.

Good luck with that search. Plenty of investment banks will jump at the chance to help, given the paucity of merger deal flow headed their way:

Advisory fees generated by M&A deals totaled $18.9 billion, down 46 percent from 2008 -- the worst annual level since 2003. For the first time in six years, M&A was not the main source of fees for investment banks, representing just 27 percent of all fees earned this year, according to Thomson Reuters.

The time is ripe for a bunch of fee-starved i-bankers to push questionable deals to PE managers desperate to show off for their clients. Gotta look busy to earn those fees. Deal pitchbooks in the near term will be long on optimistic growth assumptions (headwinds: declines in consumer spending) and short on explaining how PE firms can wring operational efficiencies out of public firms that are already cutting to the bone.

Sovereignty Crunch Forces U.S. Tech Subsidies Overseas

The U.S. government, instead of supporting innovation at home to help its economy out of recession, instead chooses to launch a new subsidy for innovation elsewhere:

The White House said the US Overseas Private Investment Corporation (OPIC) had issued a call for proposals for the fund, which will provide financing of between 25 and 150 million dollars for selected projects and funds.

The Global Technology and Innovation Fund will "catalyze and facilitate private sector investments" throughout Asia, the Middle East and Africa, the White House said in a statement.

Anyone who thinks this is solely a foreign policy outreach to give disillusioned Muslim youth an alternative to becoming suicide bombers is welcome to make me an offer on the bridge I own in Brooklyn. The real backstory is more complicated, and like an iceberg we can only see what's on the surface. Uncle Sam's creditors are beginning to flex their muscles. Sovereign wealth funds in Asia and the Middle East have probably begun to demand assurances from Uncle Sam that they won't be left out in the cold in the event he defaults on his sovereign debt. U.S. willingness to fund technology transfer is one such assurance, with the expectation that foreign creditors will continue to buy U.S. government debt (or least not sell their current debt holdings in a panic).

Civilization's center of gravity is gradually moving eastward.

Carlyle Group Going After Banks?

This one's a case of right idea, right time, wrong strategy:

Carlyle Group LP, the world’s second- largest buyout firm, has lined up about $1 billion to invest in banks as the Obama administration seeks to attract private capital to troubled financial institutions, according to two people familiar with the matter.

Bank stocks have been beaten down a lot, so bargain hunting in the sector should be proceeding apace. The article mentions restrictions on private equity ownership of banks, but that may be about to change big time. Carlyle's principals don't authorize moves into a sector unless their well-connected friends in government know that major changes in regulation or procurement are afoot.

I do question Carlyle's approach of doing piecemeal banking transactions. Their $75mm investment in Boston Private Financial holdings looks like a PIPE rather than a complete buyout. What gives? The strength of a private equity deal is its ability to take a company completely off the market and make sweeping changes. Incrementalism with PIPEs doesn't bring that strength to the fore.

Come on, Carlyle. I know you've got it in you. Find some nice regional banks with lots of overhead, decent cash flow, and no TARP participation.

Nota bene: Anthony J. Alfidi does not have any investments with the Carlyle Group.

Private Equity Prepares for Economic Annihilation

Private equity investment partnerships have enjoyed quite a run this decade, much like venture capitalists in the 1990s. Debt-driven corporate reorganizations look great in bull markets but are harder to pull off when credit gets tight. Things may soon get even harder:

The industry uses borrowed money to make leveraged buyouts of companies, improves their operations and sells them back to public investors at a profit. Private-equity firms are facing the gravest crisis in their 40-year history after the credit bubble they helped inflate burst.

Unfortunately Bloomberg isn't specific on how PE firms will be economically annihilated. Here's a little exposition. A bear market for equities means there are very few exit opportunities for restructured private firms, so PE partnerships have to fund debt repayments from limited cash flows instead of with a huge lump from an IPO. The share prices of publicly-traded PE firms like Blackstone and Apollo have seen massive haircuts since their peaks in mid-to-late 2007. The principals of some well-known PE firms can see the handwriting on the wall:

At least two private equity veterans at the World Economic Forum, Joseph L. Rice III of Clayton Dubilier & Rice and David M. Rubenstein of Carlyle Group, said at the time that the era of giant leveraged buyouts was over, at least for the moment — and indeed, buyout deals topping the $1 billion mark were extremely rare in 2008.

A lot of "highly talented" people in PE firms that didn't want to look at my resume are going to be unemployed soon. The coming PE bloodbath will also change the politics of your financial advisor's branch office. It knocks one more leg out from under wealth management firms' fixation on "alternative investments," all highly-leveraged versions of a black-boxed promise to outperform good old-fashioned buy and hold investing. Remember hedge funds? They were supposed to provide absolute returns and "portable alpha" through thick and thin until they imploded from one-sided bets or Madoff-style Ponzi fraud. Don't worry, your broker will find something else to push on you in a bear market. Watch out for anything charging a premium for a low "downside capture" ratio.

Private equity as a prepackaged product for the HNW brokerage channel will disappear, but private equity as an investment style will always be around in some form. It will simply revert to its roots in limited partnerships that execute small and mid-sized turnarounds in local markets. Just pick your partners carefully. I certainly will.

Nota bene: Anthony J. Alfidi has no holdings in BX, AINV, or any private equity fund at this time. He is of course actively looking for private equity exposure. General partners are welcome to contact him. Carlyle Group, this means you, because defense technologies are well understood at Alfidi Capital.

Private Equity Dethroned

The rationale behind participating in private equity transactions - MBOs, LBOs, spinoffs, carve outs, etc. - is that the ability of investor/managers to reorganize a company away from the quarterly scrutiny of the capital markets will add enormous value. The ultimate purpose is that competent managers will make an unprofitable company healthy and deliver outsized returns to private investors. This theory is going to be seriously tested by the credit crunch.

Take a look at the latest results from one of the mack daddies of private equity investing, the Blackstone Group:

The Blackstone Group said Thursday that it lost $502.5 million for its third quarter, a sharp reversal from last year as the private equity firm’s investments were buffeted by the market turmoil that swept the world.

I generally agree with Blackstone's contention that mark-to-market rules shouldn't be applied to private equity firms, but the problem here is that Blackstone surrendered its right to call itself a "private" firm when it went IPO last year. Sorry, guys, but if you want access to the capital markets you have to live with transparency and all of its disclosure requirements.

They're not the only private equity firm in trouble. Cerberus is grasping at straws for a way out of its malinvestment in GM and Chrysler:

Cerberus is weighing a plan to distribute its GMAC stake to investors in its private-equity funds, according to the people, who declined to be identified because the deliberations aren't public. The tactic, one of several options under discussion, may enable Detroit-based GMAC to become a bank and get funding from the U.S. Treasury and Federal Reserve without subjecting Cerberus to banking regulations.

Maybe Cerberus learned something from Blackstone's headaches with mark-to-market accounting. Treating GMAC like a bank will make it subject to accounting rules for publicly held companies without exposing the rest of Cerberus' holdings to forced writedowns. Pretty crafty, guys, if you can pull it off.

Private equity ventures are yet another casualty of excessive leverage. Too much liquidity was force-fed into deals that shouldn't have been executed. I intend to eventually engage in private equity transactions via Alfidi Capital LLC, but I've learned my lessons from the problems above. My firm will never go IPO, borrow several multiples of its earnings, or give up control of its holdings in exchange for government assistance. My private deals will be just that: private.

Business Busts Will Be Booming

A specialist in winding down failed startups drops some hints on why the IPO market will stay comatose for several years (end of article):

During the bubble, something like 1,600 companies were funded. I hear in recent years there’s between 1,200 and 1,300, including some older investments. I see VCs clearing out a minimum of one-third plus of those investments. The banks will tell you the same thing. It’s why you have to keep your powder dry. You really have to watch what’s going on.

Startups that want to survive will hopefully heed Sequoia Capital's advice and have a year's worth of cash on hand. On the other hand, there's money to be made in business liquidation services. Maybe all of those unemployed homebuilders and mortgage brokers can find work packing up the assets of bankrupt startups.

The good news is that serial entrepreneur Jason Calacanis thinks that zero-cost online startups have enormous advantages in a recession. We here at Alfidi Capital couldn't agree more.