Exits Down 75%, IPOs Non-Existent, Secondaries Rising The markets they are a-changing

According to Pitchbook:

 “PE exits in the US dropped from $876.7 billion in 2021 to $295.8 billion in 2022, according to PitchBook's 2022 Annual US PE Breakdown, as investors held onto assets longer to ride out rising inflation, geopolitical turmoil and public market volatility. At the same time, the IPO market almost completely dried up, with public listings accounting for only 2.5% of exit value last year.

 The secondary market—specifically continuation vehicles and GP-led secondaries—offers alternative exit opportunities for GPs hoping to satiate investor demand for liquidity. A GP can retain an asset through a continuation vehicle by moving a trophy asset from one fund to another. In this type of transaction, LPs have the option to liquidate on the secondary market and GPs can retain the asset until the market becomes more favorable for a sale.  Lazard pegged 2022 as the second highest year on record for secondaries issuance and 2023 is setting up to be even bigger.”

 The capital markets are finding ways to continue to fund deals through the double-barrel gutshot of increasing interest rates and higher inflation.

 What does this mean for Main Street (Middle Market) Businesses?

 While deal volume is certainly down from the record levels of 2021, PE firms report a decrease in reserves of only about 10%, meaning there is still about $800B of liquidity in the system.  The question is how much is earmarked for new deals and how much is available for new platform acquisitions and add-ons?

As the graphic above shows, the 2021 vintage year has the greatest remaining bucket of cash followed by 2022.  Funds in these vintage years are still in their deployment phase so most of that capital is available to new acquisitions whole older vintage years will see fewer add-ons with the majority of cash reserved for operations.

While it makes sense to time an exit during a period of low interest rates, low inflation and relative economic stability, there is still plenty of capital available for quality businesses with consistent performance. 

The professionals at Vertical Capital Advisors have experienced many market cycles and can help you realize the maximum value for your business if now is the time consider an exit.

https://files.pitchbook.com/website/files/pdf/2022_Annual_US_PE_Breakdown.pdf

Hear that 7,567% crunching sound?

Has John Paulson smashed his crystal ball on a pile of gold?

Credit Crunch Phase 1

 The first phase of the credit crunch is rates and spreads increasing resulting in higher cost of borrowing.  Liquidity abounds, but at a decidedly higher cost of capital, especially in the credit markets.

 Part 1 of borrowing cost is the relevant index that rates are based on and all of the indices are higher now than a year ago.

 A 7,567% increase – from 0.03 to 2.27

 One year ago, rates were extremely low - as they had been since 2008, with the overnight SOFR at 0.03%.  Today SOFR is 2.27% - a whopping 7,567% increase.  All-in pricing for the most creditworthy borrowers is 2% - 4% higher than a year ago, the result of Fed actions to increase short-term rates and cool the economy, spreads widening with the cost of borrowing for lesser credit borrowers widening significantly over last year’s spreads.  All interest rate indices have increased.

Part 2 of the borrowing cost is the spread the individual borrower is charged over the index and those spreads have widened – increasing by 25bp to 50bp for the most creditworthy borrowers to 200bp or more for lower quality borrowers.  A year ago the most creditworthy borrowers might expect to pay 25bp-75bp over the relevant index with senior non-bank lenders in the 75bp-150bp range and junior lenders in the 150bp-200bp range, meaning there was very little risk premium in the market.  Today the lower range of spreads is 50bp-125bp over the index for strong performing $50M EBITDA middle market companies and 300bp-400bp at the higher end for average performing $10M EBITDA middle market companies. The spreads have increased and risk premiums have returned.

Credit Crunch Phase 2

The second phase of a credit crunch is an increase in covenants, terms and conditions.

 This takes many forms.  Prime among them are higher cash flow to debt ratios and lower debt to equity requirements for new/renewing deals.  Lenders want to see more cash flow cushion in monthly budgets simultaneous to the monthly borrowing cost increasing.  It is a two-fanged viper.    New deals see lower debt to cash flow ratios,  higher debt yield covenants and higher equity requirements with lessened reliance on management roll and greater demand for cash equity.

Lenders want to see more cash flow cushion in monthly budgets simultaneous to the monthly borrowing cost increasing… It is a two-fanged viper!

John Paulson has smashed his crystal ball on a pile of gold…

Credit Crunch Phase 3 

The third phase of the credit crunch is credit drying up.

 We are at the stage where lenders do not yet know if we are heading into a recession-lite, The Great Recession Part Deux (or worse) or a small speed bump.  During The Great Recession liquidity dried up seemingly overnight.  Companies that had working capital lines drew them down fully if they could.  Very quickly lenders started cancelling credit facilities of all types, calling existing loans and not renewing outstanding balances on even performing matured loans.  Hard money lenders, the lenders of last resort, affectionately referred to as vultures in the industry, were the only option for many. 

Credit will become increasingly less available over time until a clear direction for the economy and that is because markets, lenders in particular, hate uncertainty, and...

Uncertainty reigns.  Markets generally abhor VUCA = Volatility Uncertainty Complexity Ambiguity.  But that is exactly where we are today.  Bankers who can sleep at night wake up fearing the morning financial press headlines.  They wilt at the thought of Fed Chair Jerome Powell giving a speech at some college where he might announce MF LRI, many future larger rate increases.  They tremble as they scour the markets for any early warning sign of defaults or regional instability or supply chain disruptions or their shadow unexpectedly appearing on the ground beside them, a fresh batch of Ursula’s poor unfortunate souls. 

 This is where having a really good crystal ball pays off.  John Paulson smashed his on a pile of gold after personally making $4B on the 2008 housing market crash, leaving us all in the same predicament: guessing for now and saying with hindsight in a year “I should have known that was going to happen”.

What do I do today?  Buckle in, build cash supplies and if you are thinking that you want to sell your business in the next few years, act quickly or plan to wait it out.  Vertical Capital Advisors will debut a new valuation tool this month that will enable us to provide anything from a quick snapshot to a comprehensive analysis of your company’s current value.  There is still a record amount of debt and equity capital available but multiples have softened this year so don’t wait too long if you are serious about exploring a possible sale.

The Problem with Bitcoin (and all cryptocurrencies) – The Greater Fool Theory

A Lesson From Jimmy Buffet

The subtitle is just eye-candy to catch readers who, upon seeing Warren Buffett’s name, would click on to the next item of interest.  Warren Buffett’s 2011 shareholder letter is a classic.  You have no doubt heard of it and probably even quoted or misquoted from it.  Page 17 begins Buffett’s musings on gold.  Buffett writes:

“The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future… The major asset in this category is gold”

In banking we called this the Greater Fool Theory.  If a loan became a problem asset, we began the process of managing the borrower out of the bank, hoping that another “hungry” bank/banker would take the problem off our hands.  But the problem with cryptos goes farther than that because, unlike gold, they have no commercial or decorative uses AND, this is huge, you can lose them - forever!

Back to Buffett:

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.”

We have all read stories about crypto owners losing their keys or their cold wallets or hackers stealing their quarry – sometimes into the hundreds of millions of dollars.  It would be hard to lose a 68 square foot of gold.  The problem is that you would have to store, protect and insure the gold, meaning you lose value unless the price per ounce continually rises. 

“True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”

Prophetic, Warren!  In January this year, 11 years after Buffett’s letter, you could buy an ounce of gold for less than the $1,750 per ounce that Mr. B wrote about in 2011. 

So, as a store of value, cryptocurrencies are exactly like gold without the key benefit that Buffett mentions: “You can fondle the cube, but it will not respond.”

But all of those shortcomings of Bitcoin are not the primary problem.

The problem is the price.

The problem with every cryptocurrency is that it is a currency that trades like a stock.  Its value for everyone is set by the single most recent reported transaction.  It is subject to supply and demand, fear and greed – the same motivators of every stock purchase and sale.  Harvey Salkin, my portfolio management prof at Case Western Reserve University, equated stock investors to a psychotic neighbor who, as soon as you step out the front door, starts screaming that he wants to buy your house alternating with shouts of wanting to sell you his house.

Buffett illuminated the shortcomings of gold and, in corollary, I am drawing the same inference for cryptocurrencies:

“Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobil (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?”

One share of XOM would have cost you about $90 on the day that Buffett’s shareholder letter was published in 2012.  In the 10 interceding years you would have received about $30 in dividends and still have your original investment.  Gold and cryptos can only sit idle until exchanged for something else.

Cryptocurrencies trade like stocks – their price is set by the last reported transaction – the price for everyone is set by the single most recent reported transaction.  And unlike gold, there is no intrinsic value at all.  Cryptos produce nothing.  Cryptos have no earning capacity.  The only value cryptos have is value that the next person who wants it is willing to pay.  And cryptos have unique risks.

Until and unless cryptocurrencies have an independent intrinsic value separate and apart from the most recent reported transaction, cryptos will fluctuate wildly in value, until the last person with the last Bitcoin loses their key and Bitcoin passes from existence. 

Tina’s Back…

I know you think you understand what you thought I said

Vertical Capital Advisors Blog

March 3, 2021

Actually, TINA never left.  TINA is an acronym for “there is no alternative”.  We blogged about it in August 2016 and although we have had a world of changes since then, the fact remains that there is no alternative to low yields now just as there was no alternative then and, according to Fed Chair Jerome Powell, there will be no alternative for years to come.  The Fed minutes from their September meeting revealed their position to “keep interest rates near zero until 2023”, a far cry from the days of Fed Chair Alan Greenspan who famously said “I know you think you understand what you thought I said but I'm not sure you realize that what you heard is not what I meant” and “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I said.”

With Congress and the U.S. Treasury adding trillions of dollars to the existing supply and the Fed pumping trillions of dollars into the economy, economists are left scratching their heads about inflation or the lack of inflation more precisely.It seems much of the flow of funds has gone into global stock markets, propelling them to the greatest highs ever with the total market capitalization of the U.S. stock market surging 34.8% to nearly $51 trillion as of December 31, 2020, total U.S. household assets topping $140 trillion and total U.S. household net worth reaching nearly $124 trillion.

This month we will enter the second year of the recovery, a year where the markets typically experience a temporary 10% pullback but end the year 10% higher. 

With the Fed, Treasury and Congress cheerleading expansionary economic policies, at least for the next three years, we are likely to see continued growth in the value of financial assets and real estate assets meaning smooth sailing ahead – unless…

* * *

ABOUT VERTICAL CAPITAL ADVISORS

Vertical Capital Advisors is an Atlanta-area boutique investment banking firm built on creating tangible value for our clients, serving clients in just about every industry.  Our clients are both capital growers and capital allocators.  How can Vertical help your firm maximize value?

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108
678-591-0273

Your pitch deck is not intended to raise capital, but you can’t raise capital without one. 

Isn’t this contradictory? 

Not really. Keeping in mind that investment decisions are rarely (if ever) decided in the first meeting, expecting a ‘yes’ right after the initial pitch is probably unrealistic. So what should the goal be?

The immediate outcome you want from a pitch is not an investment in your business but the opportunity to provide more information and continue the dialogue with future meetings that will lead to a commitment of capital.

It is your only chance to make a first impression, so it needs to be good. You and your business will be judged on the quality and content of your pitch; everything you do from that moment on will be colored by their first impression. 

Finally, the slides in the pitch deck are simply there to guide the conversation and emphasize your key points. The real presentation should be verbal and be focused on telling a story. In the human brain, decisions are not made with the ‘left/logical’ hemisphere, decisions are made in the right/creative side where stories reside and resonate.

Don’t try to crowd everything you’d like to say on a slide; it’ll just muddle the message and take attention away from you and your narrative. Make the audience listen to you and not just look at the slides.

However, a pitch deck is vital for helping the story along, and there are certain slides you must have for a great pitch deck. These include: 

1.     Vision & Value Proposition

• Ideally, this is a one-sentence summary of your business and the value you provide to customers. 

• If you can’t Tweet it, it’s too long.

• This slide is extremely important since you are telling investors exactly what they will be getting when they invest in you.

2.     Statement of the Problem

• Be very clear about the problem you are solving – no ambiguity should be allowed. 

• Have a story ready that illustrates the problem in human terms.

• Be very clear about who has this problem (this will lead into the next slide) but don’t spend too much time on the competitive landscape (you’ll address this later on).

3.     Target Market and Opportunity

• Use this slide to explain in a bit more detail about your ideal customer(s). Who are they, and how many of them are there? 

• Total market size, positioning, what is the current spending in the segment, etc… You can divide the market into segments if that makes sense for your business,

• However, it’s important to approach this particular slide with caution since it’s tempting to define your market too broadly. Remember, investors want to see realistically approachable markets and not ‘pie in the sky’ segments.

4.     The Solution

• Finally – the guts of the thing. Here you get to describe your product and service, the idea that you’ve been working on for a long time.

• You can use two slides here if you want since you not only want to describe the product/service, but how your customers will use it. 

• Don’t succumb to the temptation to put this slide up front. Instead, rely on tried and true storytelling methods that build up to the solution by communicating how bad the problem is.

• It’s also important to remember that you always have to focus on your customers and how your idea helps them. Do not focus on the idea no matter how cool it. 

• Where possible use pictures and stories to illustrate the solution,

5.     Revenue & Business Model

• How do you make money? Who do you charge, and who pays the bills? Give as much detail as possible, but don’t try to fill in all the gaps. You can leave the details to the Appendices or – even better – a separate spreadsheet.

• You could ease into the competitive landscape to describe how others in your line of business make money – but be sure to emphasize how you are different, and how your offering fits into the landscape.

• If you have an innovative business model, it’s often worth adding an additional slide to show how you plan to operate. 

6.     Validation Roadmap

• If you already have customers, this is the place to talk about them. Nothing validates a business model or plan like customers! Investors always want to see that you’ve proven aspects of your plan – or even all of it! 

• It’s also important here to outline key milestones, KPI’s and targets for validation. 

7.     Marketing and Sales Strategy

• Finding and keeping customers is always one of the hardest and most expensive parts of building your business so this is a vital part of the presentation.

• How will you find new customers, and what will the sales process/sales funnel look like? Tactics? Channels? 

• If your marketing and sales approach is different to the competition, highlight that here.

8.     Team

• You need to have the right people in the right roles to scale the company up.

• Even if you don’t have a full team just yet, be sure to identify the key roles that need to be filled and explain why those positions are so important.

9.     Summary Financials

• Don’t try to be too detailed on this slide since you’ll be providing detailed financials separately after an NDA. 

• You’ll have to provide: Pro forma P&L, sales and cash flow forecasts for at least 3 years. 

• Instead of data-heavy tables, use simple and easy to understand charts and graphs as the summary method.

• Be realistic – investors have seen way too many ‘hockey stick’ projections to take them seriously. If you can explain your projections based on past experience and growth, then that is the best way to approach it.

10.  Competition

• Even if you can’t find a direct competitor, you still have competition. If you are opening an entirely new market, all that means is that customers are using other methods to solve the problem. 

• How do you fit into the competitive landscape? How are you different? What’s your secret sauce? 

• Why should customers choose you instead of a competitor or another solution? 

11.  Investment Needed & Uses of Funds

• This is ‘the ask’, where you ask investors for their capital. 

• It is vital to explain in as much detail as possible how their investment will be used, how much you need, and your rationale for asking for that amount. How are investors’ funds going to be used to achieve your business goals?

• If you have other investors on board, it’s a good idea to have them explain in their own words why they’ve chosen to invest.

Other slides to consider might include the following if they are relevant:

• Exit Strategy – this is something investors are always interested in knowing, and the subject will come up at some point.

• Partnerships – if you have any partnerships, disclose them. They can sometimes be critical for success in both the business and the fundraising process. 

• Demos & Screenshots – but only if relevant.

After you’ve pitched, be sure to have the following documents available. It’s usually best to send them by email rather than as a hard-deck since this gives you a great reason to reach out. Key documents include:

1.     Executive Summary: I call this a ‘tear sheet’, a 1-2 page summary of the presentation that provides an overview of your business. In fact, I recommend that you develop this as soon as possible and use it as a marketing tool to help secure pitch meetings.

2.     Detailed Financial Model: Detailed pro formas are absolutely required and form a key part of any business plan. You need include forward looking P&L, Cash Flow, and Balance Sheet statements for at least 3 years into the future. Also, if you have current financial statements, include those as well. 

3.     Detailed Market Research: If you have third party research, include this. If not, provide as much of the 

4.     Technical Documentation: This isn’t always necessary, but if you are a tech business or startup, it’s vital. Investors will want to vet your technical claims. Even if you aren’t a tech business, a business/operations flow document that describes how things will work is going to be helpful. 

Besides having a tight pitch deck, it’s also important to shape your presentation in a way that will be effective. Some of the best advice and guidelines for a great presentation are:

Keep it simple. Don’t go chasing rabbits into the weeds and get lost in the detail. When it comes to investors, less information is often better than too much.

Avoid using bullet points. These are distracting and don’t help the narrative flow as it should. Use larger fonts and limit the content on each page. Wordiness = lost opportunities. 

 Tell a story. People love to listen to stories; numbers don’t inspire people, but stories do. All you need to do is to generate interest in your idea, so don’t go for full disclosure in the pitch deck. People will just turn off and stop listening. 

Keep it short. The maximum attention span for most people is – at most – 20 minutes. 

Keep it open to questions. Be sure to let investors ask questions as you go along but be disciplined by not chasing rabbits. If you treat investors with respect by letting them get involved in the presentation, they will appreciate it. Importantly, they will also make inferences from your approach and demeanor in the pitch about how you plan to treat your customers!

Don’t go overboard with the market opportunity. Focus on bottom up analysis and forecasts that provide realistic expectations for growth. 

 Ask for the investment. You’d be surprised how many entrepreneurs don’t do this, but you have to be ready to talk about how the money will be used. 

Keep the pitch deck current. There’s nothing worse than going into a pitch with stale data and out-of-date information. 

Send the deck as a PDF, not as a PPT file. Not only does this let you control the branding and appearance, but it also ensures that the information in the deck can’t be altered. 

Be certain that the pitch deck stands alone without a presentation to back it up. In other words, it should tell the story clearly even if you aren’t there to narrate it. 

Be willing to think laterally and be flexible. A straight line isn’t always the best way from Point A to Point B, so be willing to go sideways in order to go forward. Don’t be afraid of being creative. 

Finally, and most importantly… be relentlessly positive!