Talking Points

Hadley Capital Acquires StorFlex

Hadley Capital has completed the acquisition of StorFlex Fixture Corporation. We are excited for Storflex to join the Hadley family and look forward to working with the StorFlex management team. You can read more about the acquisition here.

We continue to seek new platform acquisitions. If you are an interested seller that meets our investment criteria, please contact us.

Improving Small Businesses

This week’s issue of BusinessWeek has a good article about how Monomoy Capital Partners, a private equity firm, uses operational improvements to improve underperforming companies.

Despite the misleading cover, the article details how Monomoy rapidly implements lean manufacturing practices (based on the Toyota Production System) through a series of management “boot-camps”. Monomoy’s goal is to make their companies more efficient – to use less capital to produce more goods or services. Capital includes hard capital like equipment, fork lifts, and buildings; working capital like inventory and receivables; and human capital or payroll. When less capital produces more goods, profits rise and cash flow increases, resulting in increased value for Monomoy.

Hadley Capital has the same end goal – increasing the value of our companies. But, because we focus on small companies, we tend to take a different approach to achieving the end goal. First, we tend to buy high performing businesses so we apply a “first do no harm” approach to our early periods of ownership. Later, we work directly with management to design and implement 1–3 strategic initiatives per year. These strategic initiatives may focus on operating efficiencies, much like Monomoy’s, or improving sales force management or developing new market strategies.

As the article suggests, improving any small business involves a solid plan, a focus on results and a lot of hard work. Hadley Capital works in partnership with the management teams at our companies to design and implement plans for improvement. And so do a lot of other private equity firms. The notion that private equity buyers are simply slash-and-burn owners is worn-out; the days of buying bloated companies, streamlining and then “flipping” them are long gone. The BusinessWeek article does a nice job of capturing one private equity firm’s modern value creation strategy.

Senior Debt

In recent months, there has been a fair amount of press about the practices of private equity firms and their use of debt when buying companies (thanks in no small part to Mitt Romney’s presidential campaign).  Much of this press is focused on how private equity firms use ‘too much’ debt while buying companies, sometimes resulting in the failure of target companies.  There have certainly been plenty of private equity acquisitions that relied too heavily on debt financing and ended poorly.  However, there are also a number of private equity firms (including Hadley Capital) that use conservative capital structures when acquiring small businesses. At Hadley Capital, we try to use a prudent amount of debt and equity financing, allowing a small business the flexibility to grow while maximizing its capital structure. Through the years we have found that small businesses often don’t have a complete understanding of the types of debt and equity used in a small company private equity acquisition.  As a result we would like to do a small blog series to 1) help explain leveraged finance to small businesses and 2) create a counter argument to the sentiment that “PE firms always over leverage”.  In general, there are three primary capital sources that we use when acquiring a small business: traditional bank debt, mezzanine debt, and equity.  We are going to start with traditional bank debt.

Hadley Capital generally uses types of traditional bank debt when acquiring a small business: a senior term loan and a revolving line of credit.

In a private equity acquisition a senior term loan is generally a cash flow based term loan.  This means that instead of physical assets the bank is lending against a company’s consistent cash flow (or EBITDA).  Senior term loans also frequently involve personal guarantees from business owners; however, Hadley Capital operates without personal guarantees.  The term (or duration) of a senior term cash flow loan is usually around 5 years.  The rate of interest for a cash flow term loan is typically higher than an asset based term loan but pricing depends on current market rates and the company’s financial performance.  The principal on senior term loans is typically paid in equal monthly (or quarterly) installments over the term. For example here is a typical amortization schedule for a $3 million term loan with a 5 year term:

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The second type of traditional bank debt that we use in an acquisition is a revolving line of credit. A revolving line of credit is considered an asset-based loan because the bank has a lien on the assets that support the line of credit. The assets on the company’s balance sheet dictate the size of the line of credit. The lien on the assets, and the ease to realize the lien, allow banks to lend the money at lower rates than cash flow term loans.  The two main assets that support a line of credit are accounts receivable and inventory. Banks protect themselves when issuing lines of credit by requiring borrowers to submit a borrowing base certificate. The borrowing base certificate determines how much money is available to a borrower on an asset-based revolving line of credit by 1) using advance rates and 2) excluding assets that cannot be turned into cash quickly.  Advance rates are the amount of money a bank will lend against the face value of an asset – typical advance rates are 80% on Accounts Receivable and 50% on Inventory.  Excluding assets from a borrowing base means banks will not lend any money against the asset. A typical exclusion for Accounts Receivables is receivables that are 120 days past due.  A typical exclusion for inventory is “work in process” inventory, meaning inventory that is between a raw material and a finished good. Below is a simplified version of a borrowing base certificate:

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A typical Hadley Capital transaction will use a cash flow term loan to fund a portion of the acquisition, leaving a revolving line of credit to help the company manage its’ working capital and to provide some financial flexibility. We typically borrow about twice a company’s annual EBITDA on a cash flow term loan – if the target company has $1 million in annual EBITDA, we borrow $2 million in senior term debt via a cash flow loan.  In finance lingo this is called “2x senior leverage”. This amount of leverage is much less than the types of transactions that show up in the press. During strong economic times, large private equity acquisitions were using senior term debt of 7x or more!

Next up Mezzanine Finance.

Assisting Family Businesses in Generational Transitions

We have worked with a number of families to pass a family business from the first generation to the second generation. In each case, the families faced a familiar but intractable problem: generation one needs to sell the business for cash in order to comfortably retire but generation two does not have enough money to buy the business.

In our experience, the second generation also wants to keep growing and improving the business and, in many cases, has good, concrete ideas but lacks a partner that can help them execute the ideas.

Hadley Capital has helped multiple family business address this dilemma:

1. We partner with the second generation to acquire the business, funding the transaction with substantial cash at closing. The first generation is able to comfortably retire and the second generation participates as meaningful equity owners.

2. We work with the second generation to develop and implement a growth plan; as equity owners, the second generation benefits from the resulting increase in value.

3. The family business identity and legacy is perpetuated and the second generation gains an experienced and rational partner in Hadley Capital.

Hadley Capital has more than a decade’s experience buying, owning and improving small businesses. Our ownership model is well aligned with many family businesses: we are good stewards of our companies with a long-term focus and an interest in improving and growing our companies, creating opportunities for management and employees and equity value for owners.

I was at dinner last night with a second generation family business owner. She said that she didn’t know that “guys like you were out there” and that we might be able to help her family business. If you are an owner of a family business that is facing this dilemma, we are out here, give us a call and we can discuss how we might be able to help you.

What is EBITDA?

EBITDA is a term that people use all the time but it can’t be found on a financial statement. So what is it?

EBITDA = Earnings (net income) + Interest + Taxes + Depreciation + Amortization. It’s a shorthand way to determine how much cash a company generates in comparison to other companies.

Interest – The amount of interest a company pays is dependent on how much debt it has. If a business has a lot of debt it will have a lot of interest expense. The identical business without any debt will have zero interest expense. Because the debt structure of a company is not related to how much cash its operations generate (only where that cash goes) interest is added back in EBITDA.

Taxes – Much like debt, the amount of income tax expense a company pays is highly dependent upon such things as corporate form (S Corp v. C Corp), accounting practices, the amount of debt it has, and other factors not related to its operating performance. This is why it too is added back in EBITDA.

Depreciation & Amortization – Depreciation and amortization are non-cash charges against earnings. Depreciation reflects the declining value of a tangible asset (like a piece of equipment) as it wears out or becomes obsolete. Amortization reflects the declining value of an intangible asset (like a patent) as its useful life declines. The accounting treatment of depreciation and amortization rarely reflect the real “costs” associated with acquiring/owning these assets and, since they are non-cash charges, adding back depreciation and amortization better reflects current-period cash flows.

There is one important caveat related to Depreciation and tangible assets: Buying tangible assets (like equipment) is a real cash costs (typically referred to as capital expenditures or ‘capex’). Capex shows up on the balance sheet (in the form of additional fixed assets) instead of the income statement (as an expense). So we often refer to a company’s ‘EBITDA less capex’ instead of just its EBITDA.


P.S. Check out Warren Buffett’s letters to shareholders for an entertaining sidebar on the topic of EBITDA – 2000 letter (page 16) and 2002 letter (page 20).

Open Sky Media Acquires Marin Magazine

The news is out regarding Open Sky Media’s second add-on acquisition – Marin Magazine, a regional magazine serving Marin County, California.

Marin Magazine serves an affluent readership that is attracted to the magazine’s high quality content centered around local arts and entertainment, food, home & design, fashion, social and feature stories.

Nikki and Jim Wood, founders of Marin Magazine, will continue to lead Marin Magazine’s experienced and talented team of writers, photographers, artists, designers and account representatives.

Marin County is good fit with Open Sky Media’s desire to operate in healthy, affluent markets with strong local economies. Marin County has the second highest median income west of the Mississippi River and the second highest median home value in the United States. The county is also a major tourists destination thanks to its proximity to San Francisco and Golden Gate Bridge, abundant retail and dining options, and rich outdoor attractions including Muir Woods and Point Reyes National Seashore.

Open Sky Media was introduced to Marin Magazine by a buy-side intermediary. Open Sky Media paid a success fee to the intermediary at closing.

Open Sky Media continues to seek additional city/lifestyle magazines with strong brands that serve healthy, affluent markets and that compliment Open Sky Media’s other titles including Austin Monthly, Austin HomeSan Antonio MagazineSlice Magazine, and now, Marin Magazine.

Hadley Capital Sells Portfolio Company to Public Company

Hadley Capital portfolio company, Kelatron Corporation, a leading provider of bioactive mineral nutrients, has been acquired by Innophos Holdings, Inc., a publicly traded provider of specialty phosphate products. Hadley Capital acquired Kelatron in 1999, making us a member of the “decade-plus club” according to the WSJ. Check out the Innophos press release and stay tuned for more information.

Networking with Small Company Intermediaries

A couple weeks back I was in Richmond, VA to attend the local Association for Corporate Growth (ACG) Capital Connection conference and last week Clay was at the Chicago Association for Corporate Growth (ACG) Capital Connection. We attend these conferences in both smaller cities like Richmond, Cleveland, Phoenix, etc. and in larger cities like Chicago in order to meet investment bankers, intermediaries and business brokers that are actively selling small companies.

These groups show us a large number of acquisition opportunities and represent our single largest source of deal flow. We track nearly 3,000 investment bankers, intermediaries and business brokers in our contact management system. Together, these folks represent more than 1,400 different firms.

If you are an investment banker, intermediary or business broker and we haven’t met, please pick up the phone or shoot us an email. We’d enjoy getting to know you and learning more about your practice.

Finder’s Fee Agreements in Small Company Acquisitions

Earlier this week, I submitted a Letter of Intent to acquire a business that was introduced to us by an intermediary. We had engaged this intermediary under a finder’s fee agreement to target small businesses on our behalf.

Finder’s fees are also used when an intermediary is marketing a business for sale but the intermediary has not entered into a sell-side fee agreement with the business owner.  Earlier this year, Hadley Capital acquired a small business under this type of arrangement.

Our standard finder’s fee agreement is based on a Lehman structure – roughly 5% of the first $1.0 million of value, 4% of the next $1.0 million, 3% of the next $1.0 million and 2% of the next $1.0 million and 1% of the remainder. The “value” of the acquisition is typically the consideration to the seller at closing – cash, notes, assumption of debt, etc. – plus employment/consulting agreements, leases and other payments that are above fair market value. Our standard agreement also includes a minimum fee to the intermediary. Shoot me an email and I will send you a sample of Hadley Capital’s basic finder’s fee agreement.

When we enter into a finder’s fee agreement with an intermediary we promise a quick evaluation of the target and feedback to the intermediary regarding our level of interest. If we are not interested, we tell the intermediary quickly so he can market the opportunity to another buyer.

Please contact us if you are marketing a business for sale and seeking a buyer-paid fee or a success fee.

Open Sky Media Acquires Oklahoma City Magazine

Earlier this week Open Sky Media made its first add-on acquisition – Slice Magazine, a city/lifestyle magazine serving the greater Oklahoma City market with a specific focus on the Nichols Hills, Edmond, Norman and Oklahoma City neighborhoods.

Slice Magazine serves an affluent, educated readership that is highly engaged with the magazine. Advertisers recognize the benefits of reaching these engaged readers. Slice Magazine is also a nice compliment to Open Sky Media’s other titles including Austin Monthly and San Antonio Magazine.

Oklahoma City is consistent with Open Sky Media’s desire to operate in top 50 MSA’s. The metro area was recently ranked as the 2nd fastest growing large metro area (based on GMP) and  as the #5 top job creation city in the U.S. The greater metro area benefits from the strength of the oil & gas industry, a growing number of large employers, the state government presence in Oklahoma City (capital of Oklahoma) and The University of Oklahoma in Norman. They are also very proud of their Oklahoma City Thunder (the late Seattle Supersonics).

Slice has a dedicated and experienced team that is energized to grow the magazine and to benefit from OSM’s resources.

Open Sky Media  continues to seek additional city/lifestyle magazines with strong brands that serve healthy, affluent markets.

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