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An exclusive monthly news report for private company CEO's
September 8, 2005
Sign of the Times
Did You Know
Ask the Expert
Market Stats
Helpful Links
Quote of the Month:

"This film cost $31 Million. With that kind of money, I could have invaded some country."

----Clint Eastwood


Sign of the Times

A monthly market commentary

“And The Private Equity Groups March On...”

Of all the questions, comments or opinions directed to me about?various investment groups, nothing is more misunderstood than the general roles of?venture capital and private equity firms.

First, for established middle market firms looking at their exit options, there really is no role for a typical venture capital firm--unless, of course, they originally funded the company. And that's the long and short of it. Venture capital firms invest in new companies, new ideas with the hope they will be the next Google or Skype. Most will fizzle but that is the nature of the business. One big hit can make up for a lot of misses. And there are certainly more misses than hits.

The situation is reversed when you look at the typical role a private equity firm plays. As a rule, they are not looking to invest in new ideas, new companies or?wanting to?provide seed money to several companies in hopes of landing the next?Microsoft. They are interested in established companies with a track record and from there, each private equity firm concentrates on what they think they know best. The net is that they do acquire companies in whole or part and their participation in the merger and acquisition market has grown astronomically in the past 10 years. It's estimated that in 1995 there were around 200 active?PEG's----and now the number is closer to 1,800. Why is that? The simplest answer is that there is a thirst for investments in established companies that can outperform cash sitting on the sidelines or?investments in the stock market. It's not too hard to delineate that sitting on cash or having money in the stock market over the past 3 years has not exactly been a windfall for most of us. However, the most significant element in the rise of popularity with PEG's in the past few years has been their success in drawing experienced investors to invest and?establish funds to acquire companies. Again, why? Simple. For the most part, the majority of these firms consist of very bright guys who know how to take companies to the next level of growth or profitability. And that's the bottom line objective when a PEG acquires or makes an investment in a company.

Now, important in all of this is to understand what these 1,800+ private equity groups might have to do with any particular company. The answer rests in what type of companies an individual private equity firm tries to target or as it is known in the industry, "Investment Criteria". I get many calls from private equity groups inquiring about companies I may know of that fit their criteria. Where one private equity group may have an interest in food related companies, another group may have no interest in that type of company. In the end, it is a matter of matching up the right private equity group with the right company.

To that continuing point, another very important element?in matching up the right parties is the revenue/profitability framework. As an example, assume you own a company with $35M revenue?and $3.5M in EBIDTA. This would be considered?a lower middle market company and approximately 10-15% of private equity groups invest in these types of firms. Conversely, this means that 85-90% of private equity groups DO NOT look at companies in that revenue range. Of course, there are exceptions such as buying a firm as part of a buy and build strategy but, in general, that's not the typical situation.

Again, it is a matter of doing the correct matching when assessing possible partners. Other factors private equity groups use in their assessment are geographics, willingness of current management to stay on after an acquisition, projected growth of the company, the industry itself and where the particular company fits in, as well as strategic opportunities.

Timing is critical. When a PEG is actively searching for companies and they get in deal mode where they have submitted offers for a company or companies, it very well may preclude them for looking at new opportunities, at least until they finish the current business at hand. This is always a moving target and one that many CEO's of individual companies misunderstand. A PEG that expresses serious interest in acquiring a company will often times simply move on if they don't see an opportunity for an acquisition in a reasonable timeframe. The most common theme is the CEO that drags his feet about being acquired only to find that when he or she is finally?ready to get serious, the private equity group has moved on to other investments.?The takeaway is simply that when a private equity group knocks on the door, they are in interested in the here and now, and the here and now for them may be entirely different in 6 months.

The last edition of this section was written?as summer was closing so I chose to?recommend a?few books and movies rather than the typical column. I got more positive feedback from that than any other monthly commentary I have written. Go figure.?At least?3 of you mentioned you went to see "March of the Penguins" as a result of my comments---thanks for those kind words.

March On....



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Did You Know

“Phones That Work Overseas”

Traveling overseas a lot? Here is a rundown on various phone options.

Of the four major?carriers?in the U.S., two-Cingular and T-Mobile-use the same technology that is used in most of the rest of the world, called GSM. (However, about 10 million of Cingular's customers still have phones that use an older technology-TDMA-that won't work in most of the world.)

Sprint uses a technology called CDMA, which is increasingly common?in some countries, such as South Korea, but is still rare in most of the world. Verizon Wireless also used CDMA, but sells a pair of phones that use both GSM and CDMA. Nextel uses a technology called iDEN, which is also used in a few countries around the world, but is generally pretty rare outside the U.S.

However, that's not?all you have to think about. To work overseas, your phone also has to operate on the same radio-frequency band that overseas networks use. So you must?make sure you have a "tri-band" of "quad-band" phone, which can operate on an overseas band in addition to a U.S. band.

You must also consider cost. Even with Cingular's special international-traveler plan, for example, calls cost 99 cents a minute from most places in Western Europe. The plan also carries a $5.99 monthly fee.

For Verizon Wireless's combined GSM/CDMA phones, meanwhile, you must pay at least $349 just to buy the device, and then fork over $1.29 per minute in Europe or $2.49 per minute in Asia.

That said, it's my thought that the best bet is none of the above. Instead, consider buying a second phone for traveling. Go on eBay or CraigsList.com and look for an "unlocked" GSM phone, which can accept an international SIM card. This is a chip set that you slide inside the phone, allowing it to work with the local wireless carrier-meaning you can avoid the stiff per-minute fees for using a U.S. carrier overseas.

After you've got the phone in your hot little hands, go online once again and find a site that will sell you a SIM card for the country you're traveling to. Prices for the cards vary widely depending on the operator, the country and the amount of minutes you're buying. Shop around a bit and compare. A site called www.cellular-abroad.com?sells cards for dozens of countries. The initial price will likely be steep, but the refills are much cheaper. For example, a $69 card for calling in France will get you 11 local minutes; refills, however, can be about 50 cents a minute. You could also wait until you arrive overseas and buy an SIM card locally.



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Ask the Expert

“Top 10 (okay, 11) Tips for CEOs”

Hang on now, this is not your typical top 10 list....This was written by the highly revered entrepreneur and founder of Southwest Airlines, Herb Kelleher. For those of you who have read about his personal habits, you would know that Herb is?a chain smoker who likes his whiskey. So, with that as an opener, here is sage advice from Herb:

1) Don't act like a CEO.

2) Take the competition seriously, but not yourself.

3) Put your people first.

4) Hire for Attitude; train and educate for skills.

5) Judge people's credentials on the quality of their ideas, not their credentials.

6) Take credit for every mistake; give credit for every success.

7) Celebrate! Celebrate! Celebrate!

8) Drink good whiskey.

9) Have lots of smokes available.

10) Buy stain-proof shirts and ties.

11) Drink good whiskey.



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Market Stats

“Doing a 1031 Tax Exchange? Be Careful”

In a 1031 exchange--also known as a "like-kind" exchange--a person who sells a business or investment property can defer capital-gains taxes by immediately rolling the gains into a similar piece of property. Real estate speculators have made section?1031 of the Internal Revenue Code a very popular choice.

The trouble, tax experts say, is that many people (particularly amateur "flippers") don't understand the rules. Many trust the advice of real estate brokers, who often aren't well versed in tax law. Some amateurs are buying and selling properties too quickly, running the risk that the Internal Revenue Service may deem the transactions a person's trade or business, with gains taxed as ordinary income and subject to self-employment taxes.

The attraction of flipping is undeniable: A study released this week by First American Real Estate Solutions, an Anaheim, Calif., data provider, found that the practice can reap big returns. The study looked at sales in three hot markets--Las Vegas, Miami, and Orange County, Calif.--between 1999 and June 2005 and found that the annualized rate of return for three-to-six-month flips was usually 20% to 40% or more above the market appreciation rate.

Real estate speculators who attempt to flip properties should make sure they understand the rules before they are ensnared in an audit, or faced to pay more than they bargained for come tax season. The best way to avoid a problem is to consult a CPA or tax attorney before beginning the real estate transaction, as mistakes can be costly.

"The IRS hasn't looked at the like-kind exchange before," says Eric Kea, a tax partner in the real estate practice at BDO Seidman in New York. "We're assuming they're going to, seeing what the market is."

The IRS won't speculate on whether they will investigate or conduct more audits of like-kind exchanges. In general, the agency dedicates more resources if there are concerns of noncompliance in a particular area, the spokesman said.

In a like-kind exchange, if you replace a property used for business or investment with a similar property, no gain or loss is recognized at that time. Most people do a "deferred" like-kind exchange, where a seller has 45 days to identify a replacement property and 180 days to close on the new asset.

The big mistake occurs when the seller takes possession of the cash proceeds of the sale. Under IRS rules, the money must be placed in escrow or held by a qualified intermediary (such as a trust company) until the replacement property is acquired. If you take possession, you are essentially disallowed the use of 1032.

To avoid taxes, you have to roll the proceeds into a similar property, which generally would be a business property or raw or developed land. You can't swap an investment property for a personal asset, such as a primary residence or vacation home.

In a like-kind transaction, real estate must be exchanged for real estate, a rule that sometimes trips up clients who have set up a single entity to hold property and shift them from liability. Often, experts recommend that clients liquidate the entity a day before the real estate transaction so the swap qualifies for the 1031 treatment.

Probably the next most common mistake investors make is not holding the property long enough. You must keep the investment for at least a year before selling to qualify for the preferential 15% capital gains rate.

You can avoid the capital gains rate altogether if you own and use the home as your primary residence for 2 years. Gains of as much as $250,000 for an individual and $500,000 for a couple filing jointly are excluded. Of course, the obvious Catch-22 for many California homeowners is that appreciation in many areas has made those exlusions less tantalizing that they were?at one time.



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Helpful Links

“50 Coolest Websites 2005

Normally, I devote this section to one unique website that I find useful..However, TimeOnline just recently released their choices for the 2005 50?Coolest Websites and it seemed like a good idea to provide a link and let you take a look yourself. Happy hunting! Click the link below..

www.time.com/time/2005/websites/



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