Investing in Existing Portfolio Companies

Business investment can take many forms.  Hiring or upgrading personnel, purchasing additional equipment, expanding IT systems, etc.  Each business is different and has different needs at different times.

Hadley Capital understands that businesses need continued investment to succeed.  Two of Hadley Capital’s portfolio companies (PSI and ISS) recently moved into new facilities custom designed and built for their specific needs.  These facilities will help each company continue to expand and serve their clients for many years to come.

Occasionally you hear stories about private equity owners that stop investing in companies and strip them of assets and sweep every penny out of the business.  That might work in the short-term, but not in the long-term.  Hadley Capital wants to create true long-term value and we recognize that continued on-going investment in portfolio companies is an important part of the equation.

SBD

Most Small Businesses Need To Increase Their Online Marketing Budget

The Boston Consulting Group issued a report* this week about how small businesses are lagging larger businesses in moving their marketing budget online.  The main takeaway from the report is that small businesses only spend 3% of their advertising budget online while larger businesses spend 15% of their advertising budget online.  Getting small businesses to think about marketing online is something I feel passionate about.  Unfortunately many small business owners don't have the time to learn how to effectively market their product or service online.  It's a shame because 1) once you learn a couple basic things it's a very time efficient way to market your product or service and 2) the importance of understanding online marketing will only increase overtime as more buyers (both consumers and businesses) come online via desktops, tablets and mobile phones.  
For those small business owners interested in learning more about how to acquire customers online I encourage you to focus on two basic strategies a) inbound marketing and b) paid search marketing.  HubSpot has some great marketing kits that can teach you the basics on inbound marketing.  Search Engine Land is a great resource for paid search marketing.  Google also has some great tutorials on paid search.  I actually learned paid search 5 years ago from watching and reading everything I could about paid search that Google shared.  

For those business owners who have thought about online marketing, but haven't made time yet to do it please take some time to learn more.  There's a good chance you should be spending more of your marketing dollars online.  

*The report was conducted at the suggestion of Yelp but the findings and conclusions are solely the work of BCG

Taking Advantage of Early Pay Discounts

Our magazine business, Open Sky Media, receives “2/20 net 45” payment terms from our printer. In plain English, OSM receives a 2% discount for paying in 20 days on a net 45 invoice. OSM’s CFO recently worked out whether the business should more regularly take advantage of this early pay discount.

OSM’s printer is its largest vendor so the early pay discount amounts to a lot of money over the course of a year. However, the amount of money OSM can save does not help inform whether it is a good decision to take the discount. OSM must determine the rate at which it will save and whether there are better uses for this capital in the business.

Here’s what OSM decided:

On a $50,000 invoice OSM receives a $1,000 discount for paying 25 days in advance. That is the same as depositing $50,000 in a bank and receiving $1,000 25 days later at a whopping 28.8% annual interest rate. Calculated as 2% x (360/25).

OSM can borrow on its line of credit at 4.5%.  It looks like a good idea to take the early pay discount even if OSM does not have excess cash available and needs to borrow on the line of credit. I would happily borrow at 4.5% to earn 29%...

But, it is not that simple. OSM needs to compare its total cost of capital, not just the cost of borrowing on the line of credit. Understanding cost of capital helps determine if there are better places to use cash than on the early pay discount. OSM’s cost of capital is high, greater than 20%, but still lower than 29%.

OSM is taking the early pay discount.

The same math can be used in reverse to determine if a business should provide early pay discounts to customers.

______________ 

A caveat for finance and accounting types…the calculation of interest rate above is not the effective interest rate. It is presented above as a simple rate for, well, simplicity. The effective interest rate calculation is 2%/(100%-2%) x (360/25) or 29.4%.

How To Make A Hiring Decision at a Small Business

Earlier this month a handful of our portfolio company CEOs joined us in Chicago for a summit of sorts that involved strategy, brainstorming, issue resolution, etc. As part of the meeting we invited some folks from ghSmart to share some insights into how ghSmart helps companies implement a process for improving hiring outcomes.

The ghSmart process is covered in the book Who. It’s a really quick read and worth the effort for a small business owner that is struggling with building an effective team.

There are four steps in the ghSmart process: Sourcing, Scorecarding, Selecting and Selling. The Scorecard process is the most interesting to me because it requires a hiring manager (or owner) to apply some discipline to what is often a vague and loose process (think about your average job description). A Scorecard includes quantifiable, measurable and specific outcomes that the ideal candidate must achieve to succeed in the role. An effective Scorecard requires the hiring manager to clearing define what is needed and how it applies to the broader business strategy. Potential candidates are then rated against the probability that they can achieve the outcomes described in the Scorecard. The rating process involves a very comprehensive and focused examination of a candidate’s prior record of successes and failures - often as far back as high school. Pick up the book to learn more about rating and the rest of the process.

We spend a lot of time with our portfolio companies trying to optimize business processes in manufacturing, operations, fulfillment, financial reporting, etc. I like the ghSmart process because it provides a framework for implementing a process around developing a company’s #1 asset. It’s people.

PDW

Print is Dead

I'm tired of this refrain. The mainstream media loves to report on it and devote ink to guys like Marc Andreessen (founder of Netscape, now a digital media VC) who suggest print media “burn the boats” and stop printing (his recommendation for the New York Times). Not to be out done, his partner, Ben Horowitz, believes that “babies born now will never read anything in print.” Seriously?

Mainstream media is doing a terrible job of telling the other side of the story. So I will shout into the noise but you should know I am biased. Hadley Capital owns a collection of city magazines that we publish in places like Austin, TX; Marin County, CA; and Naples, FL. My mom and I also publish a couple of community newspapers. (Check out my mom’s thoughts on this topic.)

Strong media brands succeed because they provide compelling, quality content to consumers who, because they are human, are interested in themselves, their homes (or business), their communities (or industries), the activities of their friends, family and enemies (or customers, suppliers and competitors). The result is an engaged consumer that is valuable to advertisers. There was a good story in the NYT about this “fundamental” aspect of media (with a cartoon as the example, no less):

The success of “South Park” is a stark lesson in the fundamentals of entertainment: if you tell stories that people want to hear, the audience will find you.

This is true no matter how fundamentally the paradigms shift, or how many platforms evolve. (emphasis added)

“We’ve been doing it long enough to figure out that content will ride on top of whatever wave comes along,” Mr. Stone said.

The print platform is evolving. More than 20 years ago, Warren Buffett highlighted the challenges facing print media: fragmentation of audience (lower demand) and a proliferation of content choices (higher supply). Elementary economics suggests this is not good. As a result, print media is no longer the franchise it once was...but neither is Yahoo.

Despite these challenges there are sectors of print media that are (gasp!) growing.  Consumer magazines in fashion, shelter and local are all doing pretty well. B2B titles are also holding their own as is custom publishing. Even in the newspaper sector there are bright spots as community newspapers continue to grow and new community papers are launched. (Buffett recently acquired a bunch of community dailies and weeklies).

The content in these sectors all share similar attributes: it is associated with experiences that do not translate well in current digital media platforms, it is highly targeted and won’t drive sufficient page views to make it worthwhile for digital media companies to rip it off (there, I said it), and/or there are few or no substitutes for the consumers that want the content...the moats are deeper.

Leveraging successful print operations allows publishers to innovate and serve readers and advertisers “on top of whatever wave comes along.” Print publishers are developing new distribution channels for telling stories that people want to hear and providing experiences that they value. For example, our city magazines are building profitable events that connect our readers with unique experiences while providing advertisers with valuable event marketing opportunities that are packaged with traditional advertising and/or sponsored content to deliver effective integrated marketing results. B2B publishers are growing digital communities with members that are passionate about their industry and are sharing knowledge, questions and ideas with each other. These communities offer advertisers targeted marketing opportunities and membership databases are excellent direct marketing avenues. Heck, even some embattled news providers are finding digital business models that work – evidence NYT’s success with paywalls and digital subscriptions.

Print is not dead. Is it the money fountain franchise that it once was? No. But a lot of print will remain to provide valuable content to passionate readers that experience high switching costs while delivering advertisers an engaged audience.

And I’m willing to bet that babies born today WILL read something in print.

Structuring Health Insurance Benefit Plans

Over the past two years, we have been spending more and more time working to balance quality health insurance benefits with ever rising costs within our companies (sound familiar?). Our friend and advisor, Mark Gurda, has helped us achieve this balance and continues to educate us on structuring effective health insurance plans. We asked Mark to share some thoughts on how to structure small business health insurance plans. PDW

Starting with benefits = bad management

Over the past 20 years, I have found very few employers that have developed and sustained a reliable health insurance strategy that satisfies both the CFO and employees. Most employers, especially small employers with less than 200 employees, act in a reactionary mode as opposed to being proactive, resulting in increased costs, higher deductibles, and greater dissatisfaction from employees. It doesn't need to be that way. There are several steps that employers can take to manage costs without acting adversarial towards employees:  

Step 1:  Maintain reliable historical data. The first step in designing cost effective strategies is to examine your history. While every company can look at their tax returns to understand insurance costs in previous years, there is a consistent detachment from what the benefits may have been and how cost shifting in previous years may mask the real underlying trends. Write a one or two line summary of what your benefits were in that year, then track the gross cost of each line of benefits, and compare employee versus employer contributions. 

Step 2:  Analyze the data in relation to total payroll, not the prior year cost of insurance.    Looking at insurance as a line item like FICA or FUTA can provide much more valuable data than simply comparing premiums to last year. When a company is adding staff because of growth, they may be adding younger, healthier, lower wage service people, or they could be adding highly experienced, older, highly compensated people. Companies with 0% changes in their premium could be heading down a slippery slope of deferred future liability, more than a company whose premium rose 35%. The details matter.   Analyzing the net employer and employee cost, as a percentage of total salaries (not SALES, SALARIES) will provide much more valuable insight into managing future costs.  

Step 3:  Give employees incentives to choose cost effective healthcare.  Consider some flex dollars for employees. If you grew up in the 50's, 60's or 70's and you got acne, your mom may have bought you some Clearasil. Today, adults and children are choosing faster, more expensive options and that $25 of Clearasil could be more expensive to employees than going to a dermatologist and being prescribed a $500 tube of prescription cream. Drug manufactures often have brochures in doctors' offices telling members that the manufacturer will rebate all or part of any prescription copayment based on the individual having income of less than $100,000. Your health plan should not incent employees to consume unnecessary, and costly, benefits. 

Step 4:  Start with protection.  When choosing a benefit program that earns employee loyalty, it's best to start with worst-case scenarios. Start with PPO or HMO network strength, then look at a cap when the insurance pays 100%, then build down from there with plan deductibles, coinsurance, and copay’s (but be wary of copay’s). Over the past 20 years, employees have become accustomed to copay’s for ER, doctor visits, and prescription. Copay’s separate the employee from knowing how much they consume (and at what cost) and are a driver of profit and revenue for insurers. While it is convenient for employees to know exactly what they will pay at the time of service, that convenience results in much higher premiums.  It's easy for employees to figure out what deductible or coinsurance they may have paid in a year, but it's very hard to keep track of all those $10, $20, or $50 copay's. Consider High Deductible Health Plans, HSA eligible, as an option. 

Step 5:  Implement responsible and sustainable employee cost sharing.  I tend to advise that employers should focus their benefit expenses on the employee, with dependent costs shifted to the employee. If you pay a high percentage of cost for both the employee and dependents, ask yourself if an employee that is married with kids is worth $6k, $10k, $15k more than a single employee. Key people tend to have families so consider increasing their compensation to cover family benefits and then deducting the increased salary.

While each employer has a different set of circumstances that result in wide variations of plan designs, the key elements of a successful management strategy should not vary. Implementing Steps 1 & 2 both historically, as well as on a pro-forma basis, when considering any change, are management tools that should always be considered.

Mark Gurda, President

Castle Group Health Inc. 

What Do You Want To Be When You Grow Up?

My son sprung this question on me at the breakfast table this week.  As I fumbled with an answer my daughter declared she wants to be "Ariel the Mermaid with a red wig" and my son followed up with "a worker man with a rusty truck". When I was their age I wanted to drive a semitruck.

At Hadley Capital we ask our companies essentially this same question. Answering the question seems pretty straight forward: "We want to...grow...meet our customer's needs...increase market share...expand into new markets..." The tricky part is to more clearly define these outcomes and  then develop strategies to achieve them.

We work closely with the management teams at our companies to develop plans to fund and execute the strategies that will achieve the desired outcomes.  Once the implementation plans are in place and execution begins we also provide a sounding board for addressing areas where the plans aren't working (or as cheerleaders when they are!). Finally, we provide structure and accountability for management to regularly report on the outcomes, both the successes and the failures. As all small company managers are aware, it's easy to become distracted from the big picture when the day-to-day requirements of running a small business get in the way.

All of this sounds easy in 400 word blog post. The reality is that this requires a lot of time, trust and hard work. We have a lot of experience working with small company managers to develop and execute strategies to help them be what they want to be when they grow up. 

Online Marketing Tips For Small Businesses

Part of my responsibility at Hadley Capital is to help our portfolio companies with their online marketing strategies.  In my previous experience I have worked with both B2B and B2C companies to acquire customers online.  Most small businesses lack the necessary time and resources to develop and execute an online strategy.  However, it is our belief that online marketing is often a very capital efficient way for SMBs to separate themselves from the competition.  This belief is supported by a combination of trends.  First, it has become increasingly cheaper to create and maintain a website.  Second, the number of people online only continues to increase.  Small Business can benefit from these trends by spending time and money on online marketing.  Two very simple strategies every small business should consider are 1) creating great content online and 2) online customer acquisition.

Creating Great Content
As a small business owner you should ask yourself 5 years from now will there more or less people searching online for my products?  The answer is always more. I encourage small businesses to play the long game. The trends are in your favor.  Every small business is solving a problem with a solution.  Focus on creating great content that helps your potential customers understand the problem and your solution.  If your content is of high quality and helpful it will likely rank well in Google and be shared by others.  As a small business owner it's hard to make time for everything, but when building your online content take a few extra minutes to make sure it is the best you can make it.  It will pay off over time.  

Customer Acquisition
Small business owners often don't think of their website as a tool for customer acquisition.  Some basic questions to consider about your website:  1) is your product or service clearly explained 2) do you have calls to action on your website 3) do you make it easy for customers to contact you.  Answering these questions can mean a variety of things.  For example:

• Make sure your product information is not in a pdf or included as an attachment on your website.  Search engines have difficulty indexing information out of PDFs and as a result when people are searching for your products online they often can't find them.
• In addition to creating great content (see above), you need to convince your customers to do something.  For example, right next to the part on your website about how your equipment is awesome and how it can solve a problem be sure to leave room for calls to action like, "Need equipment? Call us at 800-123-1234".  It seems simple, but many companies don't do it. 
• Finally, make it easy as possible for potential customers to contact you.  This includes both having an easy to find phone number and having easy to complete online forms.   Your forms should have as few fields as possible while collecting as much information as you can.  It's a fine line to achieve both, but you should try.  Often times customers don't want to talk to someone on the phone right now, but they are interested in your products.  Make it easy for them to sign up for your monthly newsletter or send you an email.  

Hadley Capital Supports Management Team in Acquisition of Bluff Manufacturing

Hadley Capital and Bluff Manufacturing’s senior management team acquired the assets and business of Bluff Manufacturing from a family that had owned the company for nearly 20 years but was inactive in the day-to-day management.  Bluff Manufacturing represents Hadley Capital’s third acquisition of 2012 where Hadley Capital partnered with management to acquire their respective companies.

Bluff Manufacturing was founded in 1968 and is a leader in the fabrication and design of high quality material handling, dock and warehouse equipment, storage structures and safety barriers.  Bluff Manufacturing serves its customers through a national distributor network and has 10 distribution warehouses to ensure quickly delivery of orders.  The company is based in Fort Worth, Texas.

We are excited about our partnership with the management and employees of Bluff Manufacturing and look forward to building on the company’s long history of growth and success in the material handling market.

Hadley Capital is actively seeking additional acquisitions of profitable, small companies that will benefit from our management partnership model.

PDW

3 Ways to Make it Easier to Get a Small Business Loan

Since "list blogs" seem to be the new fad in blogging, I thought I'd try to mold one of my existing blog ideas into a list blog.  Rather than "7 Ways to Increase Productivity”, "5 Innovations that are Changing the World" or "10 Steps to Financial Freedom", I thought I might address a topic that’s been vexing small business owners over the last couple of years with “3 Ways to Make it Easier to Get a Small Business Loan”.

When we acquire a small business, we raise debt financing to help cover the purchase price.  In most cases, multiple lenders will compete to lend us money.  Small business owners are often surprised at the ease at which we are able to raise debt financing, particularly given the difficulty many small businesses have had in securing debt financing in recent years.

There are three primary reasons why we are successful at raising debt financing.  Small business owners can easily adopt our Preparation, Pricing and Partnership approach to increase their chances of getting a small business loan.

1.     Preparation - Prepare a detailed package of materials that the banker will require to get approval for a loan.  This package should include an overview of your business, why you need the loan, how you plan to use it (and pay it back!), support for loan collateral such as fixed asset appraisals,  and detailed financial history including income statement and balance sheets as well as a financial forecast.  Providing all of this information will make it easier for your banking contact to do her job.

2.     Pricing - Know the "market" for bank debt for small businesses - rates, terms, etc.  As this is a critical part of my job, this one comes easy for me. It’s less easy for the average small business owner but not impossible.  Before asking for a loan,      call around and talk to bankers about current rates, standard terms and special programs that may be available to small business (such as SBA loans).  In the current environment, we can typically raise senior debt financing that represents 1x to 2x the EBITDA of the target company at an interest rate of 4% - 7%.

3.     Partnership – We treat the bank as a true partner. We invite them to regular board meetings or update meetings and communicate frequently, timely and honestly.  Communicate good news and, more importantly, bad news. And, when communicating bad news, we have a plan to address the issue and keep the bank informed on our progress.  We also invest hard dollars in each of our acquisitions in order to provide the bank with additional comfort that we have skin in the game.  Most banks require small business owners to personally guarantee a loan in order to ensure the small owner also has a lot of skin in the game.

How can the fiscal cliff affect sellers?

The 2013 United States of America Fiscal Cliff is coming down to the wire.  If an agreement is not reached, there will be automatic spending cuts and an increase in taxes starting on January 1, 2013.  From these measures, there is a very high probability that the United States will enter into another recession.  Many Americans and small business owners are fearful that this will happen.  This is a bad environment for investors and small business owners, because there is too much uncertainty in the marketplace.   

These changes directly affect privately-held businesses, because companies will be paying more taxes to the government.  Generally, the private sector is better at allocating capital for investment reasons than the public sector.  Small business owners would have some of the following tax increases relating to themselves and their businesses as a result of the fiscal cliff. 

·      The long term capital gains tax rate will increase from 15% to 20% for high income earners. 

·      New 3.8% Medicare tax on net investment income.

·      The ordinary income tax rate will increase from 35% to 39.6% for high income earners. 

Let’s do an example of a privately-held sale in 2012 versus 2013 to illustrate some of the tax increases.  A small business owner sells the business for $10,000,000 and has owned the business for 20 years.  Therefore, this will be treated as a long term capital gain.

As you can see in this example, a small business owner would likely prefer to sell their business in 2012, because they can save $880,000 in after-tax proceeds.  This will leave more money for the small business owner.  The effective tax rate increased 8.8% or 59% on a relative basis.    Many investors and small business owners will be trying to sell numerous assets for tax reasons, because they don’t want their effective tax rates to increase over 50%.  The total impact of the fiscal cliff, if unaltered, will be detrimental for the global economy.  The inaction of Washington carries considerable risk.  We will see what the current administration will do with the pending fiscal cliff in the next 30 days.  

What is a capital expenditures and how does it affect my company valuation?

Understanding capital expenditures (or CapEx) is important for small business owners because CapEx can have significant affects on the value of your business.  First, a brief definition, a capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of an existing fixed asset.

Capital Expenditures typically occur with manufacturers.   Here is an example:  Company ABC uses heavy machinery to manufacture widgets.  Each year the company spends $250,000 to maintain their equipment.  The $250,000 in annual spend would be the considered capital expenditures.  Now how does that capital expenditure affect the company's valuation?  Well if Company ABC generates $1,250,000 in annual EBITDA and the buyer of company ABC has agreed to buy the company for the 4x EBITDA (less CapEX) the valuation would be calculated as follows:

Now lets assume that ABC company has the same amount of annual EBITDA, but is a different business and does not have $250,000 in annual CapEx.  What does its valuation look like at an agreed upon 4x multiple?

As you can see the difference in valuation is $1,000,000, which is a meaningful difference.  That’s why it is important to understand capital expenditures and how they affect your business. If you are a business owner and you want to know where you can find annual capital expenditures, you can find them in the cash flow statement of your annual financial statement.  Specifically you will find them under "Investment in Plant, Property, and Equipment" or something similar in the Investing subsection.