October 2008

Time is a great equalizer.  As time passes we gain perspective.  We look back on things we did, experiences we had, and view them through a different lens.  I don’t have much affinity for mulligans in real life and I don’t wish one in this instance.  However, now I look back at the implications and recognize that a deal, a single deal, could create a paradigm shift for an industry.  To recognize that I was part of it gives me pause.  However, to now recognize the negative implications makes me think; maybe that wasn’t such a good idea.

You will have to forgive me, I was born into the wrong era for my personal value system.  I was born into a era of excess.  Continual stock market movements in the up and right direction.  Real estate valuations which doubled and then doubled again, and then again.  Greed was good.  Millikan, Boesky, Kravis, these were my childhood idols.  You were only as good as the last deal you had done, and if that deal was not mentioned above the crease on the front page of the Wall Street Journal than it wasn’t a real deal and you should not pass go or collect $200.  For a Jewish kid from Utah, those were long odds.  Then along came Ben & Jerry’s.

Ben Cohen and Jerry Greenfield were childhood friends born four days apart in Brooklyn, New York, in 1951.  Twenty-four years later, the duo would take a correspondence course on how to make ice cream.  With an initial investment of $12,000 the iconic brand was launched in Burlington, Vermont in May 1978.  From there the business took off, largely on the backs of the founders personalities and the social mission that under lied the business against the backdrop of the feel good ’80s and go-go ’90s. In 1985, the company went public on the NASDAQ for $13.00.

The social mission of Ben & Jerry’s was largely oriented around sustainable consumption and a symbiotic relationship with its partners and employees.  In effect, it was the first double bottom line company to go public.  Each Ben & Jerry’s was to be made of recycled materials and the company made a clear commitment to reducing solid and dairy waste, recycling and water and energy conservation at the company’s facilities.  Further, it gave 7.5% of pre-tax profits to charitable organizations.   Ben & Jerry’s offered employees generous benefits and a living wage.  Notably, in 1988, the company ceased production of its popular Oreo Mint flavor as it disliked doing business with the owner of the Oreo brand, RJR Nabisco. A  good summary of Ben & Jerry’s social responsibility program can be found here.

The company was not without its issues both inside and out.  Ben & Jerry’s entered into a number of unions that it thought were beneficial to the communities in which they served, but that turned out not to be the case.  “Swinegate” and the “Rainforest fiasco” were but two examples.  However, it might be hard to find fault with the company as these endeavors seemed to undermine the mission of the company due to a lack of due diligence, as opposed to bad intention.  More troubling was the use of toxins by milk suppliers in the Vermont region in which Ben & Jerry’s sourced, running counter to their “all natural” claims.  The company also resisted attempts to unionize subsets of workers and removed a salary cap so it could pay its senior management more money, though the later was necessary to attract professional management to the enterprise.

However, the real problem with Ben & Jerry’s was that it took capital from individual investors.  With that reality came the expectation of a return on their capital contribution.  After flying out of the gate, BJIC lost 66% of its value between 1993 and 1995, with the precipitous decline coming in the second half of 1994,  as a result of flagging sales, an inability to solve mounting distribution challenges and significant asset writedowns at its manufacturing facilities.  The stock languished at those levels for the next 4 years at or below the initial public offering price.

By 1997, investor unrest was mounting and criticism of Ben & Jerry’s operating practice was growing among stockholders.  While losses were mounting, social activism funded by the company and charitable giving continued with little restraint.   In need of a turnaround, Ben & Jerry’s tapped Perry Odak, a proven operational manager, who, ironically, had run, among other things, the Browning and Winchester operations of Fabrique National Corporation, to refocus the business on profitability and realign the business strategy. Odak in turn, hired Gordian Group, LLC (Gordian), my previous employer, to help it evaluate its options.  Despite the market realities, Ben and Jerry had no interest in selling the company.

Over the course of several years, Gordian assisted Ben & Jerry’s board in a variety of transactions, including a sale of the company, an investment in the company, distribution joint ventures and product line expansion.  Ultimately, the company was sold to Unilever in April of 2000, for $38/share or $360 million, twice the initial indications of interest.   To assure that the social mission of Ben & Jerry’s carried on, pursuant to the definitive agreement, Ben & Jerry’s was to operate as an independent entity and its board would remain in place to ensure that it’s social mission was upheld. In addition to the consideration to shareholders, Unilever agreed to contribute $5 million to the Ben & Jerry’s Foundation, create a $5 million fund to help minority-owned businesses and others in poor neighborhoods and distribute $5 million to employees in six months.  In short, Ben & Jerry’s board thought they won — achieving value and liquidity for shareholders and getting its acquiror to buy in to the social mission of the enterprise.  Gordian felt they had won as well, and were awarded Merger & Acquisitions, Middle Market Deal of the Year for 2000.  Ben and Jerry, however felt ill.

Much has been written about what Unilever did to Ben & Jerry’s post close, but that is not the central issue that I want to focus on.  Rather, I’m concern about the precedent it has set for socially based operating companies to take capital from the public or private markets.  In short, there are dozens of really great natural and organic food companies that will never trust the capital markets as a means for liquidity based on what happened to Ben & Jerry’s.  I’m not happy to say, I participated in the deal that created the barrier.

Some days I wish Ben or Jerry were more like Gary Erickson, CEO of Clif Bar.  Erickson said in this article that he would never be tempted to sell the company or take it public.  “They’ll want to do it more about the one bottom line: money,” Erickson said of people who want to buy Clif Bar. “Going public — just shoot me. Having to talk to Wall Street every day?”  However, unlike Clif Bar, a subset of these companies need capital to take themselves to the next level or secure the financial futures of their shareholders.

So for a society which is increasingly becoming green and socially responsible in our consumption patterns, how do we fund enterprises who put their ethos ahead of the profitability? I don’t think that its too much to ask for a socially acceptable solution to emerge. For these companies to compete with better funded multi-nationals, we will have to find a way.

Have any ideas? Inquiring minds want to know.


The term debtor-in-possession, refers to a company that has filed for bankruptcy, but continues to operate, controlling its assets for the benefit of creditors and shareholders.  The current borrowing environment is the “un-debtor-in-possession”.  Borrowers, despite strong balance sheets, healthy collateral, and even strong cash flow are being left high and dry by the lending community.  Their assets are at the mercy of the banks, not management.

I guess $750 billion in bailouts, including $250 million of direct investment, does not bridge the gap between debtors and creditors.   How bad is it?  The White House went on the offensive today, chiding banks receiving financial aid for not lending.  The harsh reality, until the lending environment improves, and companies and consumers starved for cash can get some assistance, economic expansion will not occur.

I don’t blame the banks for their actions.   If I had money, I’m not sure I would lend it either.  Sure lending at LIBOR + 1466, last weeks all in yield in B/B2 credits, seems juicy, but not relative to buying back your own stock, or purchasing senior paper at 70 cents on the dollar in the secondary market and holding it to maturity.  After all, if I am a bank officer, I’m probably incented using options on my underlying equity, not my good Samaritan IQ.

In light of the above, I thought I would go in search of some answers in the debt markets about what is going on and what will be going on over the next 60 – 90 days.  What I found was is summarized it below.  We will work from the bottom of the capital to the top.  Let’s leave out mezzanine as I think I have flogged that concept for now.

Unitranche Debt

Unitranche debt is a fandango instrument invented by the publicly traded business development corporations (BDOs) (Allied Capital, American Capital, Gladstone, etc.).  Unitranche debt combines the terms of senior and junior debt into one single debt facility.  BDOs have the ability to provide a one-stop-shop for all your capital needs.  Historically, unitranche was very attractive for sub-$15 million EBITDA companies.  Issuers targeted a 12% – 14% total return, making them an attractive alternative to mezzanine debt.

Unfortunately, the unitranche model is broken.  Very.  Consider the following yields on the equities of publicly traded BDCs (after a day when the market climbed 10%): a) ALD ~ 43.8%, b) ACAS ~ 39.4% and c) GLAD ~ 17.3%.   These stocks are trading under the assumption that their dividends are going to be slashed.  The BDC model relies on their ability to issue new stock in the equity markets to raise capital,  lend that captial at attractive rates and get equity kickers, pay your dividend with return from equity kickers.  Small problem — equity returns are in the tank, new issuance’s are at a standstill and these companies can’t issue equity to fund forward commitments.   The model is broken.   The best use of capital for these companies is to buyback their own stock or, as previously noted, purchase senior loans on the secondary market.  Unitranche debt is an endangered species until yields on corporates come down to reasonable levels.

Cash Flow Loans

We can keep the section on cash flow loans quite short.  There are more Do-Do birds than cash flow loans right now.  However, unlike our extinct friend friends, cash flow loans will eventually return.  I would not wait around however.

Other Senior Debt

On the senior debt front, I spent some time with a Senior Vice President from GE Financial Services.   He told me, that contrary to popular belief, and potentially only viable for this week (since things are so fluid), they remains open for business.  However, what he said was stunting their business was their ability to syndicate deals.  In fact, the entire GE syndication team was working on only a small handful of deals at this time.  Here is what else he told me:

> Equity contributions in private equity deals had reached 50% – 60% as collateral rates of asset based financing’s (ABL) had contracted 10% – 15% from historical norms.

> Syndications are near impossible right now.  The commitment terms on deals are not firm or even best efforts but rather “might fly” with partners.  The market flex language is bigger than a material adverse change clause in a traditional leverage buyout.

> When asked about equipment loans I was met with the following response, “I’m not sure who is going to take those.”  Enough said.

> Strong deals are going for LIBOR + 650 with upfront fees 4% – 5%.  That’s expensive money for a solid operating business.  Businesses are bypassing deals because the cost of funds takes them from accretive to dilutive.

> Facility extensions for add-on acquisitions are resulting in a full renegotiation of facility terms and conditions.  Given the cost of funds that issuers are now facing, this a market reality.

Net, net the debt market is on life support.  Despite the best efforts of the government, the velocity of money through the system has not increased.  The reality is most lenders are trying to gauge how deep and how long the current recession is going to be.  No one wants to be caught on the wrong side of a credit decision in the near term.  As a result, grid lock will prevail until the equity markets show signs of life.  While today was a step in the right direction, after hours trading shows profit takers are selling off.

Anyone want to loan me any money?  I’m good for it.  I swear.


I’ve enjoyed the past week, which has largely been spent in the company of economists.  Some of considerable market reputation, some who worked for the Fed and some who operate on much smaller platforms.  I’ve heard rosy outlooks and I have heard gloom and doom, but more that would be characterized as cautiously optimistic.  I question some of the conclusions and others I buy into whole heartedly.  Rather than give you my personal interpretation, which would be worth less than the paper this blog is printed on, I thought I would homogenize the views of the smart people whose aura I got to orbit in this week.  Use information wisely.

Recession vs. Depression

Positives:  I did not hear anyone say that we on the precipice of a depression.  In fact, all of them laughed off this very notion (which should scare us all); most of them chalked it up to the media and their recent penchant for sensationalist headlines.  Further, most of them pegged the state of the current recession to between December 2007 and February 2008.  The FRB Chicago National Activity Index, which many believe is the best proxy for true GDP, indicated we were in a recession late last year.  The longest post World War II recession was 16 months, which would therefore lead one to conclude that, perhaps, this one is mostly behind us…that remains to be seen.

Negatives: The worst is still ahead of us.  That much is agreed.  Further the road ahead will be quite painful, characterized by significant market volatility, pain for the middle class and uncertainty.  Many predicted the worst holiday season ever.  Doom and gloom will likely prevail through this period.  Credit spreads will remain at all time highs, lending standards will remain at never before seen levels and consumer sentiment will continue to erode.  In short, fear will win in the short run.  Further, a small percentage of people believe the world has somehow bent on its axis and a new paradigm has emerged, a mutation of sorts, that government intervention cannot resolve.  After all leading indicators are still bleeding (OECD Leading Indicators are running at a seven year low).

Risks:  The real risk is that we come out, only to go back in.  Call it a double dip, call it a “W” double recession, or call it something else.  Government intervention will be slow to thaw the credit environment and the consumer mentality will be thoroughly tested.

The Domestic Consumer

Positives: Despite all the value degradation caused by the stock markets collapse, the U.S. consumer population remains extremely wealthy, commanding more than $50 trillion in purchasing power.   The spiraling of consumer credit and penchant of Americans to purchase houses they could not afford, has resulted in total liabilities of this populous at all time highs, it is only $14 trillion, a small amount relative to total stored wealth.   Yes, consumers need to delver and re-liquify, but we remain in strong balance sheet position.  Additionally, the government is again contemplating stepping in to help the consumer in the form of additional stimulus and has increased the FDIC limits to provide depositors greater comfort with respect to the security of their excess cash. Finally, a significant deflation of energy prices have given consumers some breathing room.  Oil and petroleum have come down over 40%.  Finally, the dollar is expected to rally against the Euro, rebounding off significantly depressed levels, enhancing U.S. consumer purchasing power abroad. Strong dollar cycles, on average, have lasted over 5 years.

Negatives: The consumer is expected to assume the turtle position for the next 12 – 18 months, which will slow our ability to recover quickly.  While many home owners have already faced foreclosure roughly another 15% – 20% have no equity left in their property.  Further equity portfolios are down 25% – 40%.  The expected recovery period for both is 3 – 5 years, depending on the pace of any economic rebound.  Further, tight credit policies will limit access to expansion capital and depressed asset prices will exacerbate the ability to get liquidity in the housing and stock markets.  Credit card lending standards are now tighter than they were during the 1991 recession and mortgages credit standards are 300% tighter (Federal Reserve Senior Loan Officer Survey).  Further, unemployment continues to climb.  If history is any barometer, unemployment in the recession will peak at 7% – 8% sometime early in 2009.   Christmas will be a disaster and will receive substantial publicity.  The psychological catch up period will be slow and lengthy (12 – 24 months).

Risks: The consumer will be significantly tested over the next 12 – 18 months.  If the recovery is slow and painful, confidence will be exacerbated.  As the consumer is 75% of GDP how they behave will significantly influence the course of any recovery.

Business vs. Out of Business

Positives: Based on recent earning reports, business is not off as much as anticipated.  However, again, the worst ma be yet to come.  That said, businesses are in a great a cash position relative to historical norms.  Further, U.S. businesses are adroit at cost cutting and putting the clamps down on spending and controlling inventories.  Further, wages have been flat for the last four years, which means they won’t necessarily have to enact cuts, exacerbating the consumer situation.  Long short, businesses seemed to be ahead of the curve and balance sheet quality may not deteriorate further as companies turn to self funding operations in light of the availability of credit.  Stock buybacks should come in spades as soon as the light at the end of the tunnel becomes apparent, which will add a lift to depressed S&P 500 company stocks.

Negatives: The middle market stands to get killed in this credit crunch due to the tightening of lending standards.  Getting letters of credit is nearly impossible right now, which will stunt global commerce as evidenced by collapsing Baltic Freight Rates. Further, the demand side for consumer goods will be depressed for at least the next 12 months.  Further, government intervention in the lending system will not provide much help to these companies for some time, as they tend to operate on the long end of the yield curve.   Defaults should escalate and a lack of debtor-in-possession financing will lead to more liquidations than restructurings, especially in the service sector where there are no hard assets to securitize.

Risks:  A global slow down will hurt big cap multiantionals as the U.S. pulls the rest of the world into the abyss.  So much for decoupling.  If the dollar rallies too quickly then our trade imbalance will get stunted on the demand side.

Inflation vs. Deflation

Positives:  For the past 12 months we have been hearing about the risks associated with inflation and the potential for “stagflation” to return.  No one is talking about that any more.  Commodities are in a virtual freefall.  In some cases, such as oil, demand has been decelerating for the past 4 years, and therefore price spikes have been a function of speculation and market manipulation.  A re-liquifying of the banking system and consumer bank accounts is resulting in a significant deflation on the commodity side.  If the government can inject large amounts of liquidity, increase the velocity of money, but pull that liquidity out of the system before it becomes inflationary, that would be the best of all worlds.

Negatives: The government has never been successful at putting in and pulling out without inciting an inflationary spike.  The U.S. monetary base has spiked, despite its necessity.  In fact, most economists expect inflation to resume after a 12 – 18 month hiatus.  Additionally, a recession in the asian markets will only temporarily stunt their appetite for consumer goods.  Once demand resumes overseas, commidty prices will turn upward.

Risks:  A resumption of the normal expansionary course in China could send commodity prices skyward in a hurry.  Further, commodities will likely overshoot on the downside, and then return to the norm.  This reflation will cause another panic to the system.

Stocks vs. Fixed Income Securities

Positives:  Yields in the fixed income market have reached levels not justified by the risk associated with the market.  Money good corporates are yielding 10% – 12%.  Money good munis are yielding 7% – 8%.   These are positions that are fully cash collateralized.  Preferred equities that have no link to the financial crisis have been decimated.  MLPs as well, despite rising distributions.  For those who have the courage to enter the market, the likelihood of long term capital appreciation is very good.  We have just come through the worst 10 years of performance in the equity market ever.  Historically speaking, when yields have spiked at these levels, the market has followed with strong performance in the period immediately following the recoupling.  Volatility levels are great for bull market conditions.  Stocks now appear cheap on a relative yield basis.  On a Q-Ratio basis (stock price to relative asset value) stocks are undervalued by 35% relative to the 20 year average.

Negatives:  Government intervention has been on the short end of the yield curve (commercial paper, treasuries).  Until the long end of the yield curve (corporate bonds) collapses, equities are unlikely to rally.  In the near term we will have infection sessions where strong selloffs in a single market will follow-on around the globe.  Upward breadth is in fact anemic.  Forty percent of S&P 500 companies are more than 40% off their 52-week highs.

Risks:  It takes a fair amount of financial sophistication to navigate the changing value dynamics in public market instruments.  Shiting assets classes at the right time will be essential to driving excess returns.  This will result in missteps and tax implications for many.

Finally, most of the economists I heard this week expect TARP to be net asset positive to the government.   Further, bank stock lending should also create gains due to the depressed levels for valuations and the ability to command preferred returns on government positions.  Further, a subset strongly advocated that the government intervening on the long end of the yield curve to drive even further gains and accelerate a return to normalcy.

Good luck. God speed. And happy birthday to me.


I’ve never wanted this blog to be out linking around or posting others content, but from time-to-time I find that the written words of others do a better job than I could, or provide strong validation of a point I have made in a previous post.

The article below details how angel investors are going later stage and how companies are looking at angels as an alternative to traditional venture/private equity for expansion stage funding amounts up to $10 million.  The article also points out that angel funding was actually up in 1H08, despite the turbulent economic backdrop.

Interesting times.



CHICAGO (Reuters.com) — Fiberstar Inc., a small company that converts orange juice pulp into a line of food ingredients and other products, is no longer a start-up. Founded a decade ago, it now has a customer base of loyal multinationals and annual revenue in excess of $5 million.

At this point, the company might seem an unlikely candidate for funding from angels, the private investors who back start-up ventures with typical commitments of less than $1 million.

But that’s exactly who Minneapolis-based Fiberstar, which in the past has relied exclusively on angel investors for private equity, is going after to help raise up to $10 million for working capital and new production facilities to keep up with increasing global demand.

“Our goal is to continue to raise funding from angel investors and angel groups,” says Dale Lindquist, Fiberstar’s president and chief executive. “We’ve respected the investment that they’ve made and as management we’re trying to protect it.”

“It’s very unusual for a company to go as far as we have working solely with angels,” he adds.

It’s becoming less unusual, says Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire. Investing in more established companies is just one of several signs that angel investors are seeking a higher degree of comfort as they look for safer bets in a volatile economic climate, he says.

“The angels are doing post-seed – more later-stage work than they normally would,” says Sohl, noting that venture capital groups, which frequently fund private companies higher up in the development food chain, have also boosted their investment thresholds in recent months.

In a highly unpredictable economy, when credit markets are tight and traditional sources of capital such as bank debt have dried up or become increasingly difficult to obtain, angel investors are taking on more prominence as a source of alternative financing.

Total angel funding during the first half of 2008 has been surprisingly steady, rising 2.1 percent to $12.4 billion, compared to the same period in 2007, according to first half data released by the center earlier this month.

Sohl points out that the numbers also show that angels, who typically take preferred stock or other equity in exchange for their investment, are exhibiting increasingly cautious behavior.

The total number of deals funded in the first six months – some 23,100 according to data collected by the center – has fallen 3.8 percent. Meanwhile, the average size of each deal is up 8 percent, and along with it, the number of investors behind it. The center notes that the total number of angels participating in the first half grew 2.l percent to some 143,000, investing either individually or as part of angel groups. Fiberstar, the food and beverage company, has 152 angel investors.

“What this is telling us is that the angels are spreading out their risk a little more,” says Sohl.

Marianne Hudson, executive director for the Lenexa, Kansas-based Angel Capital Association, notes that she saw this trend begin to take hold last year. Her organization, comprised of more than 170 angel groups, saw average deal size in 2007 rise 10 percent to $266,000. At the same time, Hudson, whose members self-report their investing results annually, saw the average number of investors per deal rise to 55 from 44.

And while Hudson expects that trend to continue in the current economy, she sees another important signal of skittishness among her member groups: the increased use of loosely formed syndicates to jointly fund deals.

“We are seeing more and more angel investor groups co-invest with each other,” she says. “The angels are minimizing their risk.”

Angels will clearly remain an active source of capital as the economy worsens, say these and other experts on alternative sources of financing. Data show an increased appetite for sectors such as software, health care, manufacturing, green technology and other energy-related concerns.

But for start-ups and later-stage private companies alike, the latest numbers signal what will also likely be a very competitive field for a limited supply of investment capital.

“There’s more demand for us – we can pick and choose,” says Knox Massey, executive director of the Atlanta Technology Angels. “Somebody out there is not going to get funded.”

By Deborah L. Cohen
(Deborah Cohen covers small business for Reuters.com. She can be reached at smallbusinessbigissues@yahoo.com)

On behalf of my firm (Cascadia Capital, LLC), I am authoring a four part series on the changing landscape for transactions in the middle market.  The first piece (below) is about the current environment.  Some of the material below you will recognize from earlier posts, however I wanted to begin in the beginning, because after all context is important.

The second piece, which I hope to publish in late November, will be a gallery of insights from my conversations with the private equity community.  I’ve posed three questions to a group of 15 private equity practitioners from across the country — a) How will private equity cope with a lack of cost effective debt capital to underwrite transactions over the next 12 months?; b) What will the private equity business look like in 2 years? In 5 years?; and c)  What will private equity’s legacy be after all the financial dust clears?.  This should produce great timely market insight.

The third piece will be on the viable alternatives we are seeing in light of the implementation of various government programs to stimulate the economy and lending environment.   Finally, we will do an update on market conditions during 1Q09.

For compliance purposes, I am posting all communications in the same form as they are released by Cascadia, including the company commercials.   Hopefully you will not find that too intrusive.


Redefining the Transaction Landscape in the Middle Market

Part 1 – A Broad and Chilling Effect

Bryan Jaffe, Senior Vice President, Cascadia Capital

Market Overview

The recent weeks and months have seen unprecedented change in the global financial system.  Not only have we witnessed record volatility and steep declines in market indices worldwide, but also government intervention at levels not previously contemplated.  A historic de-levering and re-levering of the U.S. and European banking systems is ongoing. In short, the pipes of the world’s financial infrastructure have become clogged. If businesses cannot gain access to cost-effective capital to fund their growth, our economy will contract sharply. And a depression – defined as three consecutive quarters of economic contraction as measured by GDP growth – seems possible, if not probable.  The markets are reacting negatively to these prospects.

While our first concern is with the national and regional economy, and the health and wellness of our local businesses, we believe that the current lack of debt capital will have a broad and chilling effect on the middle-market-private-equity-backed transaction environment.

In this multi-part communication series, “Redefining the Transaction Landscape in the Middle Market,” we will assess current market conditions, offer views from investment professionals on how the industry will adapt, and provide our advice and counsel as to how business owners might navigate the changing terrain.

Against this backdrop, there has been a precipitous decline in the amount of lending activity, which has negatively impacted deal valuations and volume. A contraction of both capital sources and products has hung deals and left businesses hamstrung.

Loan volume in the middle market was $4.6 billion in the first half of 2008.  At this pace, we will likely not crest the levels seen in 2001 ($11.9 billion), the previous low of the last 10 years.

In light of declining credit quality, loan volume has dried up within certain products. While loan default rates thus far pale in comparison to 2001, they have spiked off the lows seen in January 2008.

The percentage of leveraged loans in payment default or bankruptcy currently stands at 2.0%, far below the 10.0% peak levels of 2002.  However, a tidal wave of defaults, workouts and bankruptcies is sure to follow any significant economic contraction.

Sources of capital have also declined and, as a result, cost of debt capital has increased – in part due to less competition. Notably, the senior debt market has changed dramatically. Cash-flow loans for sub-$10 million EBITDA companies are gone. Syndicating loans has become increasingly difficult and deals include market flex language, which means that terms and conditions are not set until the deal is fully clubbed. Amortization schedules have accelerated with increasingly tight covenant packages. And leverage multiples have naturally declined.

Asset based and mezzanine financing have become critical tools in the leveraged buyout capital structure as equity as a percentage of total capitalization has reached an all-time high.

Debt multiples in leveraged buyouts have fallen to 4.9x, down from a peak of 6.6x in 2007.  As a result, average purchase price multiples for sub-$50 million EBITDA companies have fallen a full two turns to 6.4x from 1Q ‘08 and almost three turns from the peak in 2007.

The Impact

A lack of debt capital will fundamentally alter the middle market transaction landscape in the near term.  Leveraged buyouts at high water marks in terms of price and leverage are in the rear-view mirror.  Volume has come to a standstill and won’t pick up through year-end.

Private equity funds will rely on asset based, mezzanine and sell senior and subordinated financing to underwrite transactions. However, valuations must be reconciled for majority deal volume to pick up.

Parties who have no immediate need to engage in a transaction are likely to stand on the sidelines for the next two quarters, if not longer. But we caution companies to be proactive with respect to understanding the health of their lenders; this is important so companies aren’t thrust into situations where capital is required with limited time to plan or react.

That said, there remains significant capital accumulated in the hands of private investors. And while majority recapitalizations are under duress as a product, appetite for minority growth equity and recapitalizations in middle market companies appears strong in sectors that are still growing.   Leveraged dividends are also alternatives for those needing liquidity.

Deals will continue to get done.

Outside of the private capital realm, strategic buyers and foreign buyers remain active in consolidating industries that are not impacted by the banking crisis. The pendulum has shifted, and these buyers welcome the change of conditions.

How We Can Help

Cascadia Capital takes a long term approach to our clients corporate finance challenges, which includes advice and counsel well in advance of a transaction.  We are experts in raising capital and advising our clients in M&A transactions across a broad range of middle market industries.   At Cascadia Capital, we understand what options are available today and how to implement them.

We would welcome the opportunity to learn about your company and objectives and help you understand how the current market environment may impact your business.


Cascadia Capital, LLC is a national investment bank based in Seattle

I’ve had the opportunity over the past week to spend a considerable amount of time with lenders, private equity investors and transaction lawyers in a variety of settings.  Notably, we appear to have rapidly arrived at a period of openness with respect to what we all are seeing in an effort to calibrate our own observations.  Historical experience has been characterized by a “I’m smarter than you” air.  Maybe self preservation has sobered us all up, made us willing to share.   Here are some of the key themes of my conversations.

Bank Bonanza

Opinions on the TARP program and direct bank investment plan are wildly divergent, but there is universal agreement that something had to be done to calm the markets.  Now that that has happened and a bucket of money has been set aside for the plan, a workable solution will be found.  Opinions on what will ultimately be successful show very little homogenization and do not exist at any level of granularity.  Said differently, lenders know they need to go to rehab, but no one can agree on the type of treatment, the duration and prospects for success.

People I spoke with vary in their belief as to how the injection of capital and the cleansing of  financial institutions balance sheets will ultimate manifest itself.  There are those who simply believe banks will horde the cash and take a very risk averse view towards the lending market.  Others believe the IRR in buying up senior loans in the secondary market at 70 cents/dollar is a better use of capital than making fresh forays into the corporate lending market.  Finally, there are those who believe that banks will simply use the capital to buyback their own stock.  I’m not sure I disagree with the later two assumptions.

At a panel discussion where bankers were to be talking about deal structuring, lenders who had agreed to be on the panel found themselves having an entirely different conversation — discussing the state of their loan portfolios.  Some unsuspecting folks were hit with a new question that not many people are talking about — fraud.  The question was “What percentage of your loan portfolio do you expect to find malfeasance in?”.  The question was met with silence, and then a soft “we don’t know”.  There are “Four Cs” in lending — collateral, cash flow, credit quality and character.  Much has been said about the first three, but not much about character.  It is quite conceivable that a considerable amount of fraud was spawned by the glut of cheap money and limited due diligence on behalf of lenders.

On the flip side, I’m seeing a lot of talk about de novo banks and lending institutions.  Hedge funds, individuals and new lending institutions are seeking to fill in the gaps in the lending landscape.  Who can blame them?  For smart lenders you can find fully collateralized obligations and pretty juicy interest rates.  I take this as a positive sign that there will be stop gap alternatives.

On the plus side, LIBOR has fallen for the past 4 sessions, indicating that people are moving out of treasury instruments and into equity or corporate securities.  With senior credit going for LIBOR + 650, and LIBOR previously hovering at 4.5%, you can see how the equation stopped the whole prospect in its tracks.  Pay 11% for a collateralized loan or pay 12% – 14% plus warrants for unsecured.  Relative to depressed equity prices,  that decision is still easy.

Let’s Make a Deal

On the transaction side, the world went dark for the past two weeks, but equity sources are starting to re-emerge and re-calibrate.  I’ve found equal parts who believe the earth has bent on its axis and those who think the world is just fine.   That said, I’ve seen a number of private equity parties with term sheets outstanding either pull those term sheets, renegotiate (or attempt to) on the basis that “the world has changed” or take a financing out (if they had one).  For those of you not familiar with the Hexion/Apollo Management/Huntsman Chemical situation, the concept that a down market does not make for a material adverse change (MAC) out, will have far reaching implications on the transaction landscape over the long haul.

On the private equity side, I’m also seeing a number of hung deals based on the lack of debt.  In most of these deals, we are seeing a counter of seller subordinated, and in some cases seller senior paper.  What will be interesting is whether sellers can consent to a pre-packaged bankruptcy as an impaired consenting class where they receive the lions share of the NewCo in a restructuring.  These are the things that keep me up at night.

However, where private equity buyers have pushed the pause button, strategic buyers have, thus far, stepped into the void.  Strategics are enjoying their moment in the spotlight, brought on by the absence of private equity alternatives.  That said, some of them are approaching the situation from a rather draconian perspective.  A public company buyer recently served us with a definitive agreement as a take it or leave it proposition.  I’m not sure indemnity in excess of the purchase price and 100% shareholder consent are realistic asks, yet, if ever.

Stay tuned.  I’m sure there will be chapter two in this saga.


In April 2003, TSG Consumer Partners (which, at the time, was known as The Shansby Group) invested $40 million for a 30% stake in a company named Energy Brands, Inc. Energy Brands was the parent company of Glaceau, the maker and marketer of vitamin and herb infused waters.  At the time of the investment, flavored water, as a drink category was in its infancy, but TSG was on to something.   On August 23, 2006 TSG sold its stake in Energy Brands to Tata Group for a reported $677 million, or ~ 6.4x Trailing Twelve Months (TTM) Revenue.   TSG’s return amounted to over 17x after dividends.  Not bad for a lifetimes work, let alone three years.

The chapter has a second verse,  between August 2006 and May 2007, the value of Tata Group’s stake nearly doubled from $677 million to $1.2 billion, when Coca-Cola purchased the company for $4.1 billion.  The deal valued Glaceau at 11.9x TTM Revenue, an unprecedented multiple for a beverage company.  Despite the astronomical price Coca-Cola paid, it was hailed by industry analysts as a paradigm shifting move in the battle with Pepsico.

It turns out the Pepsico was not the only one listening to Coca-Cola.  Since that fateful date there have been hundreds of alternative beverage companies launched.  Most were thrust into the market in hopes of being bought by one of the big beverage conglomerates, who had been prolific acquirers over the past three years. Strategies have ranged from ready-to-drink beverages with super fruits, to tea based beverages, to energy drinks to affinity concepts.   At a 2007 beverage trade show I attended, there were literally hundreds of energy drinks being launched in hopes of being the next Red Bull, the homegrown parallel to Energy Brands.

Fast forward to today, I’m sitting in an office with an “A-list” consumer investor and a strong private beverage company.   Beverage company is interested in taking growth equity to launch a handful of new products and a moderate amount of recapitalization.  Very solid operating company meets very solid investor.  As I am watching the back and forth, it dawns upon me, beverage investing is dead, at least as we know it.

I came to this conclusion, not necessarily from the above meeting, but rather over the last 60 days as I have met with a number of beverage companies seeking capital.  What I have seen during my meetings can be summarized as follows — revenue ramps are not being met, marketing spend to realize those ramps has been 2x – 3x budget amounts, expensive packaging is a serious drag on profitability and value relative to invested capital is under water.  Long short, the beverage case at Whole Foods and other natural markets has become increasingly crowded.  Marketing spend to rise above the chafe has been much more costly than originally anticipated.  Grocery store cut-ins have exacerbating the problem, and will continue to do so.

The unstated reality, is also that Coca-Cola and Pepsico have slowed their pace of acquisition (see chart below).  The reality is a number of the bets these companies have made over the past 24-months are just not panning out at the expected rate.  As an example, Coca-Cola’s investment in Bassa Nova is often referred to as a “dog”.  As a corollary, deals that should have gotten done in relatively short order remain in the balance.  Sambazon, a leader in the acai based beverage category, has been actively raising money for more than six months, despite a threshold level of financial traction ($20+ million in revenue), a solid position in the marketplace, an asset goldmine locked up (they control much of the acai that flows from the Amazon rain forest) and what appeared to be well thought out valuation expectations.  The last major equity private placement into a beverage company was Oak Investment Partners minority investment in FRS on June 2007 (see chart below).

I’m not worried about financial investors, they are smart people they are paid to put money to work and benefit from the upside.  I fear for the angel investor who does not see the down stream reality, funding money into a company that faces increasingly dim near term prospects for capturing a threshold institutional equity investment.   As an example, the recent winner of an angel event I attended was a better-for-you beverage company.

Have a drink, but put it on ice, beverage investing is going into a period of deep freeze.  Smart investors will wait out the inevitable market rationalization.


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