Private equity: driving growth and competitiveness

By Maureen Aylward

We are focusing this week on business financing and the economy. We asked our Zintro experts how private equity investments are driving or influencing competitiveness in the global economy.

Konstantin Karabanov, an economic development consultant, says from the resource-based perspective there are three main factors by which private equity investments drive firm competitiveness that capital, knowledge, and network of contacts. “Private equity enables capable founders and managers to realize their bright business ideas by providing long-term financing to companies,” says Karabanov. “Google would not have become what it is without Sequoia Capital. Capital resources can develop entrepreneurial potential, improve the managerial skills, train existing employees, attract new talent, get access to modern technology, and act on opportunities for horizontal and vertical integration through merger and acquisitions.”

Karabanov says that private equity investors usually have business intelligence and knowledge of local, regional, and international industry trends and markets. They provide company managers with valuable contacts and international exposure. “Private equity can also ensure that the best corporate governance practices are in place, and this is especially important with emerging market companies. This is vital for enhancing competitive position in the eyes of potential shareholders and regulators worldwide,” he says.

Michael Hirschberg, an investment banker, says that private equity’s impact on business structure and competitiveness is powerful and beneficial. “Private equity investments are constantly criticized for a couple of reasons, namely adding debt and cutting costs. Much has been made of the use of leverage in private equity transactions, but the proof is in the returns firms deliver to their clients and investors. By focusing on cash flows instead of solely profits and revenues, the firm increases efficiency and cash turnover,” Hirschberg says. “Portfolio firms under private equity influence generally cut costs through trimming of redundant positions, meaning loss of jobs. There are frequently divestitures or sales of underperforming or non-related divisions and product lines. Although there are temporary job losses at the parent company or through a merger or acquisition, the long-term benefits to existing employees and stakeholders clearly outweigh the criticism.”

DBodenstein, a corporate attorney, says that investments by private equity firms have played an increasingly important role in global corporate finance since the financial crisis began in 2008. Revelations of sloppy lending practices by commercial banks resulted in a credit crunch that left many businesses unable to obtain lines of credit or similar traditional commercial debt financing. To some extent, private equity firms have stepped in to fill this gap.

“One point worth noting is that private equity investments are not necessarily made in the form of equity investments; rather, private equity firms are acting as senior or even mezzanine lenders as well as equity investors, thereby diversifying the industry’s offerings to cover a far broader playing field,” explains Bodenstein. “As a result, the private equity industry has played an increasingly larger role in driving competitiveness, mostly through improving the efficiency of their portfolio companies.”

Bodenstein says that private equity firms typically seek to improve efficiencies in their portfolio companies by a variety of means, depending on the industries in which the companies operate. One of the most common means is through achieving efficiencies of scale. This can be effected through consolidation of operations or, increasingly, by aggregating purchases from suppliers in order to obtain volume discounts and cut supply costs.

Anil Bansal, an expert in business planning and private equity, says that private equity firms and venture capital companies seek to invest in developing industries, economies, entrepreneurs, and nations to improve rates of return on available funds. “Private equity firms are the largest source to enhance capital to needy business. They tap innovative business products and practices and enhance entry to existing and new markets with existing or improved designs, technologies and ideas,” says Bansal. “Apart from products, there is enhancement of new corporate practices, new jobs creation, and connecting available resources to enter markets with fresh concepts and ideas.

Bansal say that private equity funds:

• Support the due diligence in underdeveloped businesses;
• Provide existing, underutilized, or young talent to nurture business ideas and develop market competition on price, product, and promotions to allow choices to consumers;
• Bring capital as well as strategic, technical, and commercial support to develop the organization and compete in open market with existing challenges;
• Make small businesses into next generation, global businesses and enhance the speed of expansion; and
• Drive global practices to gain advantages and ensure efficiencies.

DMA Consulting, a private equity consultant, says that private equity allows investments to take place on a much more personal level. That is, accredited investors can get belly-to-belly with entrepreneurs and see their investments at work, as opposed to a cold, distant, arms-length transaction on the stock exchange. “This is particularly compelling when the investor and investee are in different geographies. By giving investors the opportunity to directly connect with businesses, it gives them a new appreciation for what quality deals exist out there and perhaps gives them a different perspective over the more traditional markets,” he says. “If an investor has the appetite for private equity deals, and can find one of the solid, lucrative opportunities that exist, it is a far more interesting and rewarding experience. The more this occurs, the greater the competition for traditional markets.”

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Experts comment on recent US downgrade in credit markets: Part 3

  By Maureen Aylward

We asked our Zintro experts to comment on the recent S&P downgrade and its impact on the global markets. Clearly the markets are still reeling and shaking. Here is the first in a three part series on the issue as seen from a multitude of perspectives.

Mahesh Kotecha, a capital markets expert and an executive who once ran S&P’s sovereign ratings group, provides the following analysis:

• US Treasury securities have tightened today by five to ten bps, not widened and borrowing costs thus may fall for the US. They may of course rise in the longer term.
• The S&P rating is unsolicited and thus not paid for by the US. “I have a proposal to fix the conflict of interest in the current issuer pay rating agency model that may have contributed to the ratings debacle in the structured finance markets. It is published in Journal of Structured Finance and is on SEC website,” he says.
• Whereas it is true that rating agencies rely largely on public information for sovereign ratings, the value addition is in using public information to reach credit conclusions based on an analysis of the ability and the willingness to pay a particular borrower, taking into account appropriate peer group comparisons.
• The agencies have some access to confidential information as they do hold discussion with policy makers on plans and options. The value of this can vary from country to country and over time. In the US, it may be less valuable than in other countries as the policy makers in the current administration have clearly been unable to make policy due to the gridlock in Congress.
• It is a pity that S&P flubbed it on the $2 trillion issue. “I used to run the sovereign ratings group at S&P and would not necessarily have used such projections in the rating analysis/rationale as the main point is that US has no plan to cut the deficit long term, not that debt will be $2 trillion lower or higher,” Kotecha says
• It is debatable whether S&P is right or Moody’s and Fitch are right on the US rating.

Joshua Feldstein, a market data analyst, thinks the downgrade will adversely affect the US credit market. “Although the downgrade is unprecedented for US securities, these securities still represent the safest haven amidst uncertainties in the European markets, with the European Central Bank printing additional money to cover the debts for Italy and Spain in the near term,” he says. “Theoretically, the Federal Reserve could do the same. The difficulty is not whether we would default, but that buyers of our debt would be paid back with depreciated dollars. S&P put themselves in a box, having announced that the grand bargain in the debt ceiling deal had to be $4 trillion. When the deal fell well short of that figure, they had no choice but to downgrade or suffer the indignity of losing further credibility than they already from their errors in rating structured products that led the financial debacle in 2008.”

Chris Toney, a money market manager, reports that prior to the S&P downgrade there were articles on the major news outlets such as Reuters, Bloomberg, and the Wall Street Journal says that the Bank of New York was telling large clients that it would be charging them a fee to hold their cash. “This was in conjunction with the Dow drop of about 500 points and around the time that the one month Treasury bill during intra-day trading fell into negative territory,” he says. “It was the first time in a few months that people were willing to pay or take zero returns just to leave it in a place and not invest it.”

Toney says that actions like this speak a great deal to what banks and investors fear these days. “The bottom line is that banks are a business. They are meant to churn out profits. The good news is that banks are showing strength in that they can walk away from this type of financing, as unstable or less sticky as it might seem,” he says. “The really bad news is that this type of action is indicative of current liquidity fears and the dangers of a painfully low rate environment.” He points out that S&P’s assessment and eventual downgrade, rightly or wrongly, is its opinion. “It is S&P’s analysis. If one believes the rating is flawed, that calls into question the value of S&P as a research source.”

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Experts comment on recent US downgrade in credit markets: Part 2

By Maureen Aylward

We asked our Zintro experts to comment on the recent S&P downgrade and its impact on the debt markets and other global markets. Clearly the markets are still reeling and shaking. Here is the second in a three part series on the issue as seen from a multitude of perspectives.

Kinuthia Karanja, a financial services expert, says that the S&P downgrade was ill advised and seems to have had ulterior motives. “The credit agency acted after the vote in Congress, not before. Nevertheless, on a timing basis, it provided a turning point in global stock markets and will surely cause concern amongst both Democrats and Republicans,” he says. “Main Street plunged into the chasm of economic depression after the real estate crash of 2007. And the Debt Crisis is an additional nail in the coffin, just as it was in 1931 when the European and South American Debt Crises cemented the depression. Great Britain defaulted on its foreign obligations in 1931. Could the United States be headed for the same fate by 2016?”

Al Rio, a risk analyst consultant, says that the extreme volatility in the markets is forcing many investors (individuals and corporations) to park their money in idling accounts that yield little benefit. See BNY Mellon, which last week announced that some depositors above $50 million will be charged for keeping the money there,” he says.

“It will take a time to clearly see the effects (months, maybe a year) on consumers. Changes in monetary policy (e.g., new rounds of so-called quantitative easing due to concerns of slowdown) can increase inflation. With positive inflation surprises come redistribution of wealth from lenders to borrowers; negative inflation surprises do the opposite. Such redistributions will increase bankruptcies, which means some providers will not get paid and some financial institutions will see loan quality worsen.”

Rich Bialek, a strategy consultant, says that the US downgrade is a reality check for the US and global economies. “It is a case where perception is reality. S&P’s perception of a weaker US economy is correct given the ratio of US government debt to equity, ineffective fiscal policy, slow to no growth, high unemployment, and even higher underemployment. In the immediate term, stocks will continue to fall in the US and other global equity markets,” he says. “The downgrade is not likely to increase interest rates for Main Street. Although our economic house is in need of repair, it is still the best house in a global neighborhood that has suffered. If the US economy of today is rated AA+, it is still stronger than any other economy. The downgrade is not relative to other current economies, but only to the US of five years ago.”

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Experts comment on recent US downgrade: Part 1

By Maureen Aylward

We asked our Zintro experts to comment on the recent S&P downgrade and its impact on the global markets. Clearly the markets are still reeling and shaking. Here is the first in a three part series on the issue as seen from a multitude of perspectives.

Donald Cummings, a fixed interest investment manager, address specific fallout in the bond holdings area as it pertains to portfolio management: “First, this downgrade was minimal, a shot across the bow. Not only have US Treasuries been downgraded, but there are some municipal bonds (pre-refunded and escrowed municipal bonds for example) that will get downgraded too because they rely on US Treasuries for payment of principal and interest,” explains Cummings. “For portfolio managers that keep a certain percentage of a fixed income portfolio in AAA, a percentage in AA, a percentage in A, this will cause portfolio trading and reallocating.”

Cummings says that if the downgrade had placed US Treasuries into a non-investment grade category there would be widespread disruptions in the market. “Banks need to have a certain percentage of their portfolios in riskless assets, and if US Treasuries lost that category place they might have to be sold. Banks are not able to take on additional risk assets like loans until their ratios go back up to legal requirements,” he says.

On the trust side, Cummings says that there are millions of trust accounts managed for people and the fiduciary (a bank trust department or other money manager) most likely has a fiduciary duty to investment grade securities. “If US Treasuries had fallen to non-investment grade, potentially every trust officer in the country would have to sell Treasuries and move assets into something more riskless. The same goes for pension funds, which are subject to strict laws about investment categories,” explains Cummings

Nashish, an expert in fund management, thinks that the impact of US credit rating downgrade is going to be huge for the markets. “It will have both positive and negative impact, but what we need to look at is the downgrade coupled with the European crisis, so the impact will be more far reaching,” he predicts. “First looking at the negatives, the world economy will head for further slowdown, especially in developed economies. This will affect corporate earnings and lead to equities markets turning volatile.  Commodities prices will also tank, so it will have some positive impact especially for emerging markets that are desperately fighting inflation.”

Nashish says we will see the strengthening of emerging economies as they become the drivers of global economic growth. “There could be liquidity issues in the capital markets, but I do not expect the central banks globally to act in a coordinated fashion like they did in 2008 to pump in liquidity.

On the positive side, Nashish says the fixed income market will see an economic slowdown, but lower inflation. “You can expect bonds to rally, equity markets to remain volatile, and commodity prices to correct further,” he says

Ankit Arora, a financial markets consultant, thinks the S&P downgrade of US bonds from AAA to AA+ will have a short- to medium-term impact on the world economy.

“An example is the IT industry. For example, with the downgrade the US may get less fund flow, and organizations may find it difficult to raise money. This will impact the capacity to implement IT solutions and lead to a reduction in IT spending, hurting IT vendors across the globe,” he says. “Investors will now move to a safe haven like gold and other metals. The prices of these commodities will definitely rise as more investment flows in these asset classes.”

Arora says there is cause for concern in economies that are heavily dependent on US for exports. For example, Japan exports around 16 percent of its total exports to US. Taiwan exports around 10 percent of its total exports to US. These export driven economies that have high dependency on the US will need to reduce exposure by diversifying exports and by making domestic consumption better.

“China, followed by Japan, is the highest holder of US treasury securities, which means that these countries will have a huge concern over the downgrade of treasury. In the long run, I feel that the BRIC nations will be less affected compared to other economies,” says Arora. “There is definitely impact on shares of Indian corporations, but this offers an opportunity to buy blue chip stocks at throw-away prices. One should look for investment in those companies that have strong fundamentals and whose stocks are available at low prices.”

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What are Venture Capitalists interested in right now?

By Maureen Aylward

Even though the economy is taking a beating yet again, money is still flowing through venture capital firms to businesses. We asked our venture capital experts on Zintro what they think are the most interesting investments right now.

Michael Felman, a portfolio fund management expert, believes that technology is still a hot area especially cloud computing, search analytics, and financial and business service technologies. “However, the investment trend is toward later stage companies where those companies are profitable. There is a big funding gap between the seed or A-Level and all subsequent levels,” he says

DBodenstein, a lawyer with expertise in venture capital financing, says that industries of particular interest include alternate energy, green tech, and, to a lesser extent, various health care and Internet-based media technologies. However, many people who work with early stage growth companies know that in the wake of the financial crisis the venture capital industry became far more conservative in its investing habits, eschewing the types of early-stage investments traditionally associated with venture capital. Instead, it sought to invest primarily in companies that were a bit further along in their development curves. “We heard things like, ‘We need to see at least $3-5 million in revenue and at least $1 million of EBITDA,’ or ‘We’re looking for companies that can go public in a year or so,’” recalls Bodenstein.

This still holds true in many cases and, in view of the volatility of the public markets over these last weeks, there may be some retrenchment back in that direction. “At a recent venture capital symposium held in New York, the panelists – all representatives of VC firms and/or independent investors – actually started using the word angel in the same breath as venture capital. Angel investments generally refer to investments in earlier stage companies,” Bodenstein reports.

Bodenstein says that the most popular industry mentioned by far was digital media, including social media sites and advertising and mobile media technologies; however, this preference could in part be reflective of the local economic landscape. “Much of the digital media industry has been based in New York, while Silicon Valley has seen more activity in alternate energy and green technologies of various sorts covering everything from recycling and gasification to high-tech building materials. In addition, we are seeing somewhat of a feeding frenzy in the online coupon/group purchasing space. The sector is undergoing a lot of consolidation with startups being swallowed up by pioneers, and the resultant proliferation of quick exit opportunities should hold a strong attraction for equity investors,” says Bodenstein. Other sectors that have been garnering increased attention from VCs are for profit vocational and higher education (both on- and off-line) and cloud computing services and software that improve efficiencies in health care delivery and research.

“Of particular interest are businesses that, either through their development and use of proprietary technologies or through inventive business models, are able to gather vast amounts of data from target markets and audiences,” says Bodenstein. “Thus, entrepreneurs in the social media space are being advised that the volume of traffic their sites attract is a crucial, if not the weightiest determinant used by the investment world in assessing the value of their companies.”

Bodenstein says that the most common theme he sees is an emphasis on offerings that focus on data-gathering and process and facilitation or enhancement development of existing products and services. “You’re likely to get people’s attention with a new software or technology that facilitates and streamlines the research, development, and testing of new drugs than you are with your own new experimental drug,” says Bodenstein. “Perhaps this is due to a perception that it is faster, less risky, and requires less capital investment to develop processes or enhancement technology that is disruptive than it is to develop a truly unique, novel, and disruptive product or service never before available. In any event, though various industries or sectors may fall in or out of favor from time to time, the basic mantra of the true VC remains the same: Ideally, look for truly disruptive and visionary technologies and management teams that can bring them to market and monetize them before losing their competitive advantage to the ensuing stampede.”

Michael Hirschberg, an investment banker, says that venture capitalists are still focused on technology and business services. “Technology’s Web 2.0 bubble has continued to fuel VC investments across various stages with potential to land big returns through both public offerings and buyouts from established firms,” he says. “Outsourcing continues to attract interest, investment, and customers; therefore, business process outsourcers are extremely well-positioned to attract capital and investments in the early and growth stages.”

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Impact investing is gaining traction and believers

By Maureen Aylward

One of the fastest growing asset classes in institutional investing is impact investing. We asked our Zintro experts to tell us what they see as the real potential of impact investing.

Gordon Upton, an expert with 30 years experience in corporate and project finance, impact investment, and venture and capital markets, says that the challenge facing impact investment right now, despite growth in the supply of impact investment capital and the increased demand for it, is that there is only a trickle of capital flowing from investors to actual projects. “Established financial services providers generally believe that all capital should either be invested to maximize profits, with little or no regard for social or environmental effects, or simply donated to charity to maximize social or environmental returns. These beliefs do not serve impact investors,” says Upton.

Upton points out that the absence of effective market mechanisms, such as market clearinghouses, rating agencies, and syndication facilities seriously hamper investment. “On the supply side, high sourcing costs and lack of information, especially on social returns, leave potential impact investors wary of entering the field,” he says. “On the demand side, fragmentation of investment supply together with the inability to syndicate start-up and expansion finance opportunities, sets off an inefficient capital sourcing process that stifles the launch and expansion of new projects.”

The opportunity is to build a system that will allow impact investment to flow into broader areas of public interest, such as agriculture, provision for basic services, energy, housing, and healthcare in emerging markets. This will enable the impact investment movement to expand opportunities and ensure the shared benefits of globalization. “Impact investment can create and maximize value by blending corporate social responsibility, social enterprise, social investing, strategic and effective philanthropy, and sustainable development while addressing the cross-cutting issues of capital, performance metrics, leadership, organizational development, public policy, and tax and regulatory questions,” explains Upton.

Bulankov, a financial advisor and planner in investment and asset management, says certain investment strategies that were once the exclusive prerogative of select ultra-high-net-worth families and institutions are now making their way to Main Street. “Nowadays, most any investor with as little as $5,000 can establish a philanthropic fund through a donor- advised vehicle, invest in a socially responsible way, or provide micro-loans through the internet,” he says. For those not content with purely philanthropic pursuits, impact investing is the next logical step in this evolution.

“Voting with your wallet is taking a whole new, quite literal meaning,” Bulankov says. “It is only logical that an area that allows investors to align their values and desires for good with their desires for gain is one of the fastest growing areas.” He believes that impact investing gives the investor an avenue to lobby and further the cause that the investor deems worthy by putting money behind that cause, knowing that the full investment due diligence and analysis has been performed and there is no need to sacrifice gain to do good. “In my opinion, this is a very strong driving force behind impact investing, a force that may propel the industry to grow tenfold over the next decade,” Bulankov predicts.

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