Mezzanine debt, sometimes referred to as junior debt or subordinated debt, came into vogue during the “go-go” 1990s buyout boom.   The origins of mezzanine debt are rather cloudy, but the instrument was invented to allow private equity firms the ability to limit the amount of equity dollars they put at risk in a deal.   Once a purchase price was agreed and senior debt (bank financing secured against the assets of the company) was arranged, buyers would offer mezzanine debt funds the opportunity to get 15% – 20% return by taking an unsecured position ahead of the equity slug.   Interest rates on mezzanine debt was in the low teens with 66% – 75% of the interest being cash pay and the balance paid-in-kind interest (interest that accrues and is added to the principal and then paid when the debt is retired).  The balance of the targeted returns were achieved by issuing at-the-money or penny warrants to the debt provider.

Limited partners (pensions, endowments, and the like that make up the capital used by institutional funds) liked the mezzanine concept as it enabled them to get attractive risk adjusted returns, with the cash interest protecting them on the downside and the warrants juicing their returns on the back end.  In a strong bull market of rising tides, mezzanine funds did very well as default rates ran very low and equity returns exceeded expectations.  Many hedge funds got into the act by making similar investments in operating companies with a more risky profile.  These investments targeting slightly higher returns than institutional mezzanine.

Shortly after the Internet bubble burst, mezzanine debt, in its traditional form, went in to decline.  A flood of cheap bank debt made mezzanine less attractive to sponsors and the emergence of publicly traded Business Development Companies, offering one stop financings (senior debt, junior debt, and equity — often referred to as unitranche debt) , cut into mezzanines traditional markets.   Any gaps between purchase price multiples and bank availability was bridged through the emergence of second lien notes (debt that took a second position on fixed assets and real estate), which offered a lower cost of capital relative to mezzanine debt.   Traditional lenders, including second lien, were offering to cover as much as 95% of the purchase price, so there was no need to offer excess returns to anyone.  Between 2005 – 2007, mezzanine debt went in to hibernation.

By 2007, mezzanine began to make its comeback.   As purchase price multiples reached into the stratosphere mezzanine returned to filling its initial mission.  Any incremental dollar of debt meant an incremental $0.50 – $0.75 of purchase price.  Based on this improving demand function, mezzanine debt funds raised $15.7 billion in 2007.  In 2008, nearly 60 funds raised over $34 billion.  These funds were meant to fund the last mile on leveraged buyout transactions but then the music stopped.  By 1Q2009 the buyout market was bone dry.

Flush with capital, mezzanine debt providers were left to contemplate a “buyoutless” world.   In response to these changing circumstances funds separated into two camps — those determined to define their own identity (Camp I) and those intent to wait out the storm (Camp II).

While Camp II sat dormant, Camp I’s initial response was to seek to make stand alone mezzanine investments.  After all, mezzanine looked like a good tool to achieve short term liquidity relative to taking equity at depressed prices, if it was even available.   However, these funds were not well situated to do de novo deals, having historically relied on the diligence of their equity partners to get comfortable with a transaction.  As a result, targeted returns spiked and mezzanine debt became visually and economically unpalatable.   Lenders began targeting returns of 25% – 30% to compensate for their diligence risks (after all there was no equity to save them).   Many awesome deal stories followed.

However, as the buyout market has roared back to life, Camp I has shown that its evolution has staying power, while Camp II has returned to business as usual.   In fact Camp I is pitching itself as an alternative to institutional equity — faster, cheaper, without the governance hangover.  Notably, terms sheets from Camp I funds look much like those from the old public traded business development corporations, only without the senior debt.   Today a typical mezzanine term sheet will have a subordinated debt component, with cash and paid-in-kind interest and dollars allocated to an equity investment in lieu of warrants.   These mezzanine funds can stretch far on valuation because they have the downside protection of the coupon and no private equity partner to be beholden to.  The script has flipped.

As we enter into a period of uncertainty with respect to how this cycle will build and how long it will last, mezzanine debt players are better situated than their counterparts to take deal volume from other parts of the capital structure.   As a result, I expect to see standalone mezzanine debt volume grow dramatically through the balance of the year.


2010 was expected to be a blowout year for liquidity transactions among privately held lower middle market companies.   A modest economic recovery coupled with a significant private equity capital overhang and looming capital gains changes gave many owners the belief that conditions were reasonable enough to warrant a dialog with buyers.

Through the first half of 2010, domestic mergers and acquisitions experienced a near 200% year-over-year increase and the market was on pace to reach levels not seen since 2000, according to Dealogic.   However, private equity deal volume (a significant sub-set of overall M&A and a barometer for the broader market) fell in the third quarter, according to the Pitchbook Platform, as fears related to changes in the tax code dissipated leaving us to wonder if the year had fizzled.  Based on fourth quarter Pitchbook data, private equity rebounded nicely, as 376 private equity deals closed, the second best quarter in the past two years.   For the full year, private equity transactions volume rose 9% relative to 2008; a modest but material improvement.  Based on announced strategic M&A, we expect those full year figures to also come out favorably when published.

As the calendar turned, transaction professionals began looking for signs as to how 2011 might break.  Based on January private equity data it looks as if we are off to a strong start.   Through the first three weeks of the year 114 private equity transactions totaling $8.35 billion closed, according to Pitchbook; the best start to the year since 2000.  The question that remains is whether this deal volume represents deals that missed year end deadlines or conditions are in fact that favorable for sellers.

From the pet industry perspective, 2011 is off to the best start on record.   Today’s announcement brings January-to-date figures to five major private equity/debt backed deals (buyer/target):

January 24, 2011 – WindPoint Partners / Petmate (terms not disclosed)

January 7, 211 – PNC Mezzanine Partners / Pet Partners ($21.5 million mezzanine debt financing)

January 7, 2011 – HIG Capital / Pro-Pet (terms not disclosed)

January 6, 2011 – MidOcean Partners / Freshpet (undisclosed equity investment)

Unannounced – Swander Pace Capital / Merrick Pet Care (terms not disclosed)

Notably, these transactions span a number of major segments of the pet industry — food (3), hard goods,  and veterinary care, the later of which had been rather dormant over the past 24 months.    Further, within food you have the gamut of contract manufacturing, branded, and raw/fresh.  Diversity, in my opinion, is a sign of health.

According to Pitchbook, 46 investors had completed transactions involving 44 companies in the pet industry since 2007.  They put 2010 transaction volume at a 11 transactions, relative to my count of 13 private equity backed deals (both of us exclude angle capital backed transactions).  If January is an indication of what is to come, I would estimate that 2011 could bring us 20 major industry deals sponsored by private equity backers.   However, with the announcement of the Petmate sale, the majority of the known backlog has been cleared.  Only a stronger economic recovery, coupled with a better valuation environment, could push us to those levels.   Undeterred, I expect private and growth equity firms to continue to scour the landscape for deals.

While little has been disclosed about the above deals, the Swander Pace / Merrick Pet Care transaction is notable.    It is my understanding that the transaction multiples associated with this deal represent a significant departure from the multiples associated with key transactions in the 2007 – 2008 timeframe.   Look for an article on this subject from me in the March issue of Petfood Industry Magazine.


(p.s. the picture at the top is the basic Newtonian Physics proof for velocity)


“Dozens of people spontaneously combust each year.  It’s just not really widely reported.”

— David St. Hubbins, Spinal Tap

During the period spanning 2H2008 to 1H2009, I enjoyed a steady stream of inbound calls from companies seeking debt.  About half of those calls were from people thinking that I had something to do with a bank that made loans; the balance were from businesses, large and small, seeking additional capital to fund their operations.   Most of them were beyond help, due to the state of their business and/or collateral.  However, a small handful were beyond help, not because they were bad credits, but because the national banking system achieved a level of gridlock not seen in my lifetime, or probably anyone’s for that matter.

The market panic caused a significant contraction in available debt.  Market prices for even high quality credits trading on the secondary market plummeted (30% – 40%); default rates spiked (a 400% increase to ~ 13% in December 2008); spreads widened materially (+400 BPS on Commercial Paper, one of the lowest risk financial investments); capital ratios increased (Tier 1 capital requirements for lenders increased from 4% in May 2009 “Stress Test” to 7% at Basel III); and bank numbers contracted (active cash flow lenders went from 154 in 2007 to 18; FDIC has closed approximately 300 banks as a result of the recession).   No wonder people could not get a loan.

The above should be no surprise to anyone who follows the financial news.  However, today, some 12 months removed from those panic induced calls, people look at me quizzically when I tell them that debt is in fact available.   The looks I receive are a cross between “what you talking about Willis?” and the glare my grandfather bestowed on me when he thought I was pulling his leg.   Yes, debt is available, but like spontaneous combustion it’s not really widely reported.

To be clear, a significant portion of the business ecosystem is still unable to access debt.  Asset based loans remain widely available, with lower advance rates, but there are a lack of lending institutions that write check sizes under $5 million.  For those banks that remain in this market, many of them continue to be saddled by under performing real estate portfolios and credit standards that are harder to crack then getting into the wine cellar in the presidential war bunker.   As such, loans for small business remain very hard to come by, and this will continue for some time.  However, debt for large middle market businesses is not only widely available, but the trend has turned silly as banks seek to invest (no loans no loan revenue) as much of their available capital with the highest quality credits.  Eventually, competition will drive these banks to begin moving down the size and quality stack until the lower echelons are again able to access cost effective debt capital.

One prime example of debt market health is the availability of leveraged dividends.  A leveraged dividend involves taking out debt to pay, as you might expect, a dividend.   In short, a significant percentage of capital is not remaining in the business, it’s going in to the pockets of shareholders (often times private equity funds) with the liability remaining at the corporation.   When leveraged dividends are widely available, it is the first sign of debt market excess.   Now consider that over $40 billion of leveraged dividend recaps have been declared in 2010, according to S&P.   These levels exceed 2005 totals and are competitive with 2006/2007 volumes, the base of the last market peak.  The shareholders of HCA, Dunkin’ Brands, Burlington Coat Factories, Ascend Learning, Getty Images, Pelican Products, and Petco have been the chief beneficiaries.   While many of these companies operate in attractive industries that are “recession resistant” (health care, education, pet retail), many of them are not owners of highly predictable recurring revenue streams that would put a lenders credit committee at total ease.

Likely a better measure is what I am seeing in the market as it relates to debt issuance.   Based my purview, the credit market remains bifurcated.  However, as a company’s trailing twelve months (“TTM”) Earnings Before Interest Taxes and Depreciation (“EBITDA”) approaches $10 million, it becomes much more widely available.  Further, in the last 6 months, we have seen a trickle down effect.  In 1Q10 the benchmark was $15 million in TTM EBITDA, while today it is in the +/- $8 million range and goes lower, albeit not much, for companies that are in non-cyclical industries and have predictable recurring revenue streams and performed well throughout the recession.  A caveat is that if EBITDA has spiked materially over the last twelve months, a three or four year average is applied to establish “baseline” EBITDA.   It also helps if the company is backed by a third party equity provider.

What is also notable is that bank hold sizes have gone down considerably.    What this means is I am seeing syndicate deals on transactions that we would traditionally see a lender signal source.    Companies seeking $100 million loans are ending up with 5 – 7 banks in their credit versus 1 – 2 pre-meltdown.  This means it is actually easier for $10+ million TTM EBITDA businesses at the lower end to get credit than at the higher end, as you don’t need to get the entire credit industry on board with your transaction.    I realize this is backwards, but welcome to the current credit market reality.

Finally, availability does not necessarily correlate to volume.    Currently, lenders are seeking a minimum of 40% of enterprise value be in the equity account.   Therefore a company that is valued at 6.0x TTM EBITDA can only get up to 3.5x leverage, and more likely 3.0x.   Thus, no meaningful EBITDA means no meaningful debt.

Net net, we are not in a flush lending environment by any means, due in part to government imposed capital requirements, but debt is available if you fit in the current sandbox.






Rewind 18 months and the outlook for the private equity world looked rather bleak.    Debt financing was drier than the Sahara in July,  the economy was pulling down the financial performance of portfolio companies causing defaults at alarming rates, and limited partners were actively looking at ways to pull commitments to avoid over allocation to the alternative asset class.   You didn’t need to be Goose to see that “this is not good Maverick”.   Further, you did not have to roam far within the financial services community to find someone who thought the party was over.

As a general rule, the investment banking community has never been overly sympathetic to the private equity cause.  There is not a private equity pro who does not believe that every banker is pining for their job.   However, in the run up to the financial meltdown, equity investing had become a hustle game resulting from too much liquidity in the system.  Private equity pros lived on the road in search of “proprietary deal flow”.   They would willingly drop in on any banker that would take a meeting.  It was tough not to have a least a little sympathy as purchase price multiples reached unprecedented levels making it hard to believe fund IRRs were going to make these guys more wealthy than their predecessors.   Further, private equity, was driving deal volume, and therefore banker bonuses, accounting for nearly a third of all domestic M&A transactions in 2007.

Today, and with the benefit of a little hindsight, it is clear that the demise of private equity was grossly exaggerated.  In fact the financial buyer community has rebounded quite nicely.  While financial buyers do not enjoy the  full economic advantage that they did 24 months ago — really cheap  limited or non-recourse debt — they are well situated for success and the market appears to be coming back to them.  Consider the following:

  • Survival of Mega Buyouts.  When the economy began to unravel many thought that the mega-LBOs of the prior 24 months would unravel, leaving private equity with a tremendous black eye.   Considering that mega buyouts, while only 5% of deal volume, accounted for 61% of private equity investment in 2008 and 2009, it was safe to assume that as they go, so goes the industry.  That said, save for the demise of Chrysler, the mega-buyouts have withstood the brunt of the storm.  Yes it is true that banks have had to work with many of these credits out of self interest, but this does not account for the  mere trickle of private equity backed bankruptcies that we are currently seeing.   Likely more applicable is that private equity purchased significant amounts of debt on the open market, at a discount, to preserve equity value in their portfolio companies.  As the economy stabilized they benefited from the rising prices for this debt, thereby juicing returns.  While there have only been two $1+ billion deals announced in 2010, the fact that any can get done shows that there are “green shoots” on the private equity transaction landscape.
  • Credit Returns.  While credit may not be as abundant as it once was, certain classes of companies are enjoying access to leverage at attractive rates within favorable structures (e.g., covenant lite, PIK toggle, etc.).    Companies that generate more than $10 million of annual EBITDA are the prime beneficiaries of banks loosing their clutches on credit.   Facing competition for these credits from the high yield market, banks are increasingly willing to loan to companies perceived to be “safer”.   Garnering 3.5x – 4.0x leverage appears to be straight forward, while we have even seen a 6.5x stapled financing (senior plus subordinated debt)  on a consumer non-cyclical company.   Debt drives private equity’s ability to pay, as every dollar they can borrow is a dollar they can kick in as equity, assuming a 50%/50%  debt/equity split.    Given that the majority of LBO deals involve companies that breach (in a good way) this EBITDA hurdle, one would expect to see private equity deal volume spike as a result.
  • Deal Stats Trending Favorably.  For the third straight quarter, private equity deal activity posted a gain both in terms of number of transactions and dollars deployed.   Private equity completed 300 investments totaling $14 billion.  This is up from 238 deals for $13 billion in 4Q2009.  Notably, 1Q2010 saw the first deal greater than $2 billion completed since the prior year period — CPP/TPG/Leonard Green acquisition of IMS Health ($5.2 billion).

Private equity is also enjoying the benefit of overreaching strategic buyers.   Strategics, possessing flush balance sheets, and lacking competition in the M&A markets have failed to embrace sellers in a way that casts them in a favorable light.  Instead they have assumed a very conservative approach, as evidenced by the increasing use of earnouts, the expanding size of deal escrows, and the elongation of transaction timelines.    Net net, private equity in its core market is alive and well.


There is a growing belief – and it’s slowly being supported by market data – that the economy is improving. Traditionally, we would take this to mean that key indicators are accelerating; and, in some cases, such as manufacturing activity and worker productivity, they are. But the term “recovery” has also come to mean something akin to “not as bad as last time”; or, talking more like an economist, it’s become code for “a deceleration of the decline.”

So, whether we’re using lay language or professional parlance, we need to confront the fact that service sector activity, on which our economy is now largely based, continues to contract, and unemployment figures remain near historic highs. Both of these signposts should serve as a clear reminder that all is not well. And, despite professing that the current recession is “likely over,” Federal Reserve Chairman Ben Bernanke continues to urge caution with respect to the domestic economy.

If we move beyond the macro-indicators, there are also signs that a bottom in the transaction environment is imminent.

The most obvious key indicator is the public equity markets, where we have seen a very healthy recovery. The current bull market rally has driven the Dow Jones Industrial Average up 46%, the third-largest six-month rally in history. As a byproduct of the run-up, corporations have been able to pry open a new issuance window not seen in years. Further, credit spreads have tightened and issuance volumes of both investment grade and high yield debt will surpass 2008 figures. These have enabled corporations to access capital and much needed exits for financial investors, both of which are important to transaction velocity because liquidity drives the lifecycle.  In addition, CEO confidence, as measured by The Conference Board, surged in the second quarter into an “optimistic” reading. This means more views to the positive than to the negative. A favorable market outlook correlates strongly with corporate and financial buyer appetites.   Finally, there has been a spate of large deal announcements, driven primarily by large cap public companies seeking to capitalize on strategic synergies. These deals have changed the tone of the M&A market.

Based on available data, peak-to-trough contraction in M&A transaction volume has typically taken two years. The recessionary period of the late 1980s and the period at the outset of this century both conform to this pattern. As such, given that the current contraction began in late 2007, we would expect to see a bottom late this year. That said, we’ve seen improvements in market conditions, but we don’t believe circumstances are right for a quick return to normalcy for a number of reasons:

Sponsors on the Sidelines. While we have seen an increase in sponsor inquires regarding ongoing mandates, we have seen only a handful of term sheets and even fewer closed deals from this community. On the whole, the private equity industry is still struggling with problems within its existing portfolio. A lack of cheap debt capital to underwrite new deals has resulted in depressed sponsor-backed activity volumes. Year-to-date, global private equity activity is off over 66%, though.   The trailing four quarters have been slower than any four quarter period since the twelve months ended June 2002. Until sponsors are able to access cost-effective debt, total transaction volume will be muted.

Mezzanine Debt Not Solving the Last Mile Problem. Mezzanine debt was touted as the means through which leveraged buyouts were going to be effected when lenders scaled back on transaction leverage. It’s true that mezzanine fund-raising has reached unprecedented levels and subordinated debt has grown as a percentage of the deal capital structure, but company performance has declined significantly, rendering mezzanine of limited use for the buyout community. Further, lender return expectations have exceeded a level buyout professionals deem reasonable.  While mezzanine debt will be part of the solution during the recovery, company operating performance must improve in order for it to be accessed as intended.

Deal Velocity Absent in the Middle Market.  The composition of 2009 deal activity is heavily skewed toward transactions that are greater than $5 billion in value; but deal volume has dropped by approximately 23% in this segment. Even more telling, volume for deals involving companies valued at less than $1 billion (a traditional definition of the middle market) has fallen by over 50%. We’re seeing that most high-quality middle-market companies in the Pacific Northwest seem content to sit out the current market cycle. And deals that have gotten done, like RW Beck / SAIC, occurred at premium-market multiples that were justified by high levels of strategic value. The middle market makes up the largest percentage of transaction volume (33% in 2008); but until valuations improve, a true recovery in the transaction environment cannot be realized.

Strategic Buyers Continue to Show Caution.  While premiums paid for transactions in 2009 are well above the long-term historical average, this figure is skewed by a handful of large public deals. As an example, Dell offered a a 68% premium to the prior-day close to acquire technology services company Perot Systems. In reality, we are finding that strategic buyers are quite cautious with respect to tuck-in acquisitions. Most buyers views this as an opportune market to buy companies at cost-effective prices. But we don’t see these buyers stretching on valuation until operating results improve and financial buyers are able to provide a realistic alternative for sellers.

Ultimately, deal volume will return when the buyer’s ability to pay  and the seller’s expectations again converge. We now recognize that the market eroded so precipitously that a very large chasm was created; it’s also clear today that it will take time to build a solid and lasting bridge over that abyss. An improvement in the macro economy is definitely good for deal activity, but economic growth has to be reflected in the income statements of traditional middle market companies before we experience a return to normalized conditions.

We Ask the Lenders—But Nobody Knows for Sure

broken-bankIt has long been our view that the economic recovery will begin when some liquidity returns to the lending markets. Businesses rely on the ability to borrow cost-effective capital to underwrite their daily operations, and debt is an essential cog in leveraged transactions; purchase price multiples rely on it.

With debt generally unavailable, the transaction and capital markets have dried up. On a micro-level, many companies we talk to are currently unable to pursue compelling opportunities because of a lack of credit that that would have been available a year ago. Other firms are facing tougher “survival mode” decisions in which cash is squeezed from any and every available source.

We don’t anticipate a rapid return to normalcy, but we are seeing signs that the market is making incremental gains.
High-yield issuance volume has remained robust; premium-quality second lien deals are starting to find interested buyers; the Federal Reserve’s intervention at the long end of the yield curve has diminished the opportunity for banks to buy loans on the secondary market at yields more attractive than those on new issuances; and The Toxic-Asset Relief Plan will also better position major lending institutions to recapitalize their balance sheets and begin new originations.

Unfortunately, these macro viewpoints are not much help to companies that need to make tactical decisions on how to fund their operations. In an effort to deliver better actionable information, Cascadia decided to go directly to the source and ask lenders what they’re up to, how the world has changed and, most importantly, when they think the market will improve.

As you might expect, some lenders were reluctant to make predictions or disclose information due to the fluctuating condition of the market and their business. Others were only willing to speak to us on an anonymous basis. Both of these factors are telling and, in our mind, do nothing to diminish the value of the content in the attached.

Read on for greater insight and—as always—let me know what you think.


When Will It End?

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.