February 2009

tim-gOn February 10, 2009, Secretary of the Treasury Timothy Geithner announced the new administration’s plan for stabilizing the U.S. financial system.  The following day, Congress agreed to a compromise on the pending economic stimulus bill aimed at providing consumers with both economic relief and opportunity.  When the cost of both programs is added to the capital committed to date for the financial bailout, the total bill being assumed by the U.S. government and its tax payers climbs to $9.7 trillion (including the Federal Reserves loans and guarantees).

Despite calls for political leaders to come together to help our nation avoid an economic “catastrophe,” as President Obama characterized it, the political tenor in Washington has been disappointing, providing Americans with little comfort that anything will be done quickly or correctly.  We have little assurance that these programs, both individually and cumulatively, will stem the decline.  The Federal Reserve and our political leaders lack true historical parallels and are working from a playbook that is being written and re-written on the fly.  In addition, lawmakers seem intent on presenting their voters with pork barrel projects and punishing people for past transgressions rather than focusing on the core mission of the programs and the timeliness of their implementation.

No Quick Fix

While we agree that quick action is imperative – especially as jobs continue to be shed and production continues to fall – we must not be naive about the consequences of our actions.  There is no quick fix and there are substantive pitfalls inherent in the path our leaders have chosen.  For example, based on historical precedent, the endless printing of money will result in downstream inflation and protectionist approaches to trade that have historically undermined our long-term industrial competitiveness.  Unfortunately, our political system encourages short-term myopia at the expense of improvement in future generations’ standards of living.

Even with all this negativity, we take comfort from the resistance that has been shown by the Dow Jones Industrial Average.  It would have been our expectation that the endless barrage of bad news and a general lack of faith in our government’s path thus far would have driven us well below the November 2008 lows. Further, we note the recent re-test has largely been caused by the financial sector, as only two of 10 S&P 500 sectors are negative since November 2008. A decline of this nature, which lacks market breadth, to historical lows, does not preclude the creation of a firm bottom.  That said, if industry breadth expands we will have to revisit our thesis.

Notably, the number of 52-week lows has diminished significantly since last November.  Further, corporate debt issuances also continue to improve as spreads narrow, though these offerings have largely been confined to large cap market leaders who are offering investors a compelling risk-reward tradeoff.  In January, issuances more than doubled the previous record for the same month.

As the prospects for a turnaround in 2009 fade to black, we offer family-owned middle-market companies the following advice for managing through the recession:

Plan, Monitor and Re-plan

While most organizations engage in an annual budgeting exercise, those that utilize scenario planning are the exception, not the rule.  Given the economic environment, we would encourage companies to revisit their financial plan on a monthly, if not weekly, basis.  While creating accurate projections in turbulent times can be challenging, updating your view on forward financial performance is essential to identifying capital needs (size and timing) and eliminating waste.  Further, it will help identify when it is prudent to pursue hiring and growth opportunities.

Understand Source and Uses

Substantial business value is often lost when companies require capital on an expedited basis.  Lacking flexibility and options, the cost of short term debt and equity solutions can be exorbitant and put personal finances at risk, let alone the future of the business.   Avoiding these scenarios requires a company to understand at a very granular level how it creates cash flow and where it consumes resources, and what flexibility it has on either axis.  Economic contraction will elongate receivable and payable cycles and change the terms on inventory purchasing.  A well-run company will engage in frequent dialogue with parties throughout its supply chain in order to determine how the flow of cash is changing.  If there are downstream needs, they must be identified and aggressively dealt with, and will often require difficult decisions.  Companies that are proactive in the management of their capital needs stand the best chance of weathering the storm.

Seek Counsel

These are unprecedented times, but you need not navigate them alone. Most family-owned businesses value their privacy, especially when it comes to financial matters.  While we understand and appreciate this view, a company does not necessarily need to disclose all critical information about its operations in order to benefit from valuable insight from third parties.  Similarly situated business executives, lawyers, accountants, family planners and commercial and investment bankers can all be great sources of ideas and information.  These parties are situated on the front lines of deal activity and capital formation.  We are seeing smart, well-run family business seek our counsel and those of our partners, and many of these companies are trying to understand how they can take advantage of this downturn.  If you have ever considered instituting a board of directors and advisory board, now would be an ideal time to surround yourself with people who will give you candid and actionable advice.

Consider Creative Alternatives for Liquidity

While a number of traditional liquidity avenues are closed or are offering low valuations to owners, viable options do exist for creating owner liquidity in the current environment.  Mezzanine debt continues to be an avenue for companies generating at least $3 million of EBITDA.  We are also seeing a limited number of leveraged buyouts and take-private transactions being consummated at attractive valuations utilizing debt from Canadian financial institutions, who seem to be lending more liberally.  Finally, we expect ESOPs to make a strong comeback as the valuation of contributed equity is based more on technical parameters as opposed to recently observed market multiples.  Both private equity and debt alternatives remain available to underwrite ESOPs.

There is no panacea for our economic ailments, but family-owned middle-market companies can take steps to ensure their long-term future. Doing this, however, means embracing a more open and proactive approach. Companies that adopt prudent and decisive action will be poised to prosper when a recovery takes hold.


Last in the series I had been working, which you can download it here.

The contraction of the U.S. economy has resulted in upheaval in the middle market transaction environment. Both private equity and strategic buyers are facing challenges in getting deals done. That said, we believe the popular press has gone too far in their characterizations in an effort to remain relevant.

While we see 2009 as a challenging year at best, opportunities remain available to attract capital and achieve liquidity for shareholders. The capital markets are not closed and M&A is not dead. That’s not to say that everyone will enjoy the same alternatives.

In the final piece of our three part series, we provide insight into the deals that will get done in 2009 and how companies can best situate themselves to take advantage of those opportunities. In short, this is an availability of capital market, not a cost of capital market.

/bryan jaffe