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Water for Profit

By Alix Nyberg Stuart

CFO Magazine, February 01, 2007

When most CFOs think about liquidity, they’re calculating how fast they can turn assets into cash. But Aqua America finance chief David Smeltzer is just as likely to be concerned about how smoothly water is flowing through the 10,000 miles of pipes his company owns. As the largest among a handful of publicly traded companies in America that are in the business of purifying and delivering tap water, Aqua America has operations in 13 states from Maine to Texas. Having kept up a steady pace of acquisitions – 25 to 30 per year for the past five years – Smeltzer says his company will continue its aggressive expansion. “There are unlimited targets out there,” he says.

Water, a utility that most people take for granted, is suddenly hot. “It’s not usually looked at as a sexy industry, but its long-term prospects are probably more favorable now than they’ve ever been,” says Stewart Scharf, an equity analyst for Standard & Poor’s. Cash-strapped municipalities need help in updating and operating their aging waterworks, and deep-pocketed companies like Aqua America are offering their services. Most of the pipes and other infrastructure in this country are in dire need of replacement, requiring an investment of around $500 billion from 2000 through 2019, according to Environmental Protection Agency (EPA) estimates.

Despite its rapid growth, Aqua America, with a market cap of $3 billion, will likely soon be displaced as number one in the market by American Water, whose parent company is planning to spin it off in an initial public offering in the range of $4 billion to $6 billion this year. Investors are so eager to get into the space that price/earnings ratios have doubled from 10 to 20 over the past two decades, as the industry’s 20-year returns outperform Exxon, Wal-Mart, and Home Depot. Private-equity firms are making their first forays into the industry, with AIG Highstar buying Utilities Inc. in 2005 and Australian giant Macquarie Bank currently awaiting regulatory approval for the purchase of Connecticut-based Aquarion Water Co.

Those companies that successfully make the plunge into the water business are likely to produce “above-market growth for a number of years to come,” says Debra Coy, an analyst with Janney Montgomery Scott. Once they dip a toe in the water, they can look forward to a virtual monopoly for as far as their pipes will stretch.

But it isn’t easy getting started. Most waterworks are owned by municipal governments, which tend to be fiercely protective of their franchises since water is viewed more as a birthright than a salable commodity. “Municipalities need the outside help, but from a customer standpoint, some don’t feel as comfortable turning to the private sector,” says Scharf. When they do seek help, most prefer to have private companies operate their systems without owning them, a business model that typically carries lower profit margins than owning the assets. Still, many analysts think cities and counties may loosen their grips as investment needs become more pressing.

Wringing Out Returns

How water companies produce profits and shareholder returns is much more complex than the product they deliver. First, they must pour millions of dollars into capital expenditures. American Water, currently a division of German utilities conglomerate RWE, spent about $600 million to upgrade systems last year and expects to maintain or increase that amount going forward, according to senior vice president and CFO Ellen Wolf. Aqua America plans to spend at least $250 million per year over the next five years, says Smeltzer, and more depending on what future acquisitions require.

“It’s such a capital-intensive industry that it’s always negative free cash flow,” notes Coy. Indeed, “we have to invest $3.45 for every $1 [in revenue] we get back,” says Peter Cook, director of the National Association of Water Companies (NAWC), an industry group for private water companies. That compares with $1.61 of revenue per dollar of investment for electric utilities, $1.11 for telephone, and 94 cents for natural gas, according to a 2006 report by AUS Consultants.

This model of spending money before you have it is hard for outsiders to grasp, says Coy, but ironically, it’s what keeps shareholders interested. “Positive cash isn’t a point we look forward to, because then it’s harder to get growth in net income,” explains Smeltzer.

That’s because water companies recoup their investments and earn profits through various types of rate increases that come only after the money is spent. And rate increases must be approved by state utilities commissioners, a process that varies from state to state and can take up to a year. However, unlike most municipalities, private companies rely on appointed, rather than elected, officials for rate increases, which generally makes it easier to get the requested boosts. “If you couldn’t rely on regulators to let them keep raising rates, the business model wouldn’t work,” says Coy. (Not surprisingly, this is also why most towns balk at privatizing their pipes.)

Currently, experts say that regulators in many states are favorably disposed toward rate hikes in exchange for infrastructure improvements. “We’ve never had a regulatory commission disallow a [reimbursement for] capital expenditures we’ve made, meaning we’ve never had to argue over whether the money we put in the ground [for pipes and other equipment] was prudent,” says Wolf of American Water, which operates in 29 states. While nothing is guaranteed, says Pennsylvania Utilities Commission chairman Wendell Holland, “we generally grant all prudently incurred costs.” In about 12 states, including Pennsylvania, companies can even take a portion of their costs through surcharges, giving them some cash up front.

Expenses for interest on debt used to finance the projects are also covered, usually without much debate, since they are easily quantified. Still, regulators like to see that “we are getting the best possible borrowing rates,” says Smeltzer, making it important to maintain strong credit ratings and to mine opportunities for tax-free or low-interest-rate borrowing through towns and counties. Aqua America’s weighted average cost for the $917 million it carries in long-term debt is below 6 percent, thanks to about $300 million borrowed tax-free at 5.2 percent and another $80 million at a 2.1 percent interest rate funded through the Pennsylvania Infrastructure Investment Authority. That’s down from 7.4 percent in 1999.

At Connecticut Water, CFO David Benoit says that “virtually all our debt has been issued through the Connecticut Development Authority as tax-free debt,” making for a weighted average cost of 4.9 percent on its $77 million in long-term debt.

Floating New Shares

But rate hikes that just cover operational expenditures and interest costs are not enough, since that would bring a water utility only to the break-even point. A crucial element in making a profit is to have equity in the mix, since most state laws allow for a “fair” or “reasonable” rate of return on equity, or the cash that companies use for projects.

“The purpose of the equity return is to compensate investors for taking a risk,” says Smeltzer. While the definition of “fair” is debated, it usually translates into about 10 to 11 percent on the cash portion of the investment. “Private water utilities are not going to be allowed to earn outrageous returns,” says the NAWC’s Cook. Indeed, Connecticut Department of Public Utility Control commissioner John Betkoski says all of a company’s expenses, from executive salaries to T&E budgets, are rigorously scrutinized by auditors before any decisions about returns are made.

With the equity return the sole opportunity for profit, at least in terms of the regulated business, a CFO’s ability to work the capital markets can be the lifeblood of a water company. Aqua America has done eight equity offerings in the past 10 years, with the last one for $80 million using an innovative structure known as a forward sale. That structure means that Aqua America’s banking group, led by UBS Warburg, converts a set number of shares to cash, which it turns over only as the company needs it, thus minimizing share dilution. It also helps Aqua America’s debt ratings, says Smeltzer. “We’ve got the money sitting there, so if S&P asked how we’re going to finance the $51 million acquisition of New York Water, I could say I’ve done it already.”

Clearly, American Water’s giant impending IPO could saturate investors’ demand for water stocks, making it harder for other companies in the industry to raise funds. Smeltzer says he’s hoping the $80 million from the forward sale lasts until 2008 so that he won’t be in direct competition for capital. Connecticut Water’s Benoit says he has managed to avoid a secondary offering for more than 11 years and doesn’t foresee the need to issue stock, although with a 45/55 debt-to-equity ratio, he would likely have to tap the markets again in order to do a major acquisition.

So far, though, it seems investors can’t get enough of water. California Water, another publicly traded utility, initially filed to float 1.8 million shares for its October 2006 equity offering, according to CFO Marty Kropelnicki, but since the deal was “well oversubscribed,” the company ended up issuing a total of 2.3 million shares.

For water companies, growth options beyond capital investments and rate hikes are limited, since most customers aim to conserve water, not use more of it. Hence the race to acquire companies, ideally in areas that adjoin existing operations to provide economies of scale.

Both Aqua America and American Water say they aim for between 20 and 30 acquisitions per year. Smaller players are more targeted. California Water looks at 30 to 50 potential deals per year, Kropelnicki says, but pulls the trigger on only 1 or 2. The targets are usually other private companies, mostly nonpublicly traded, that are perhaps too small to make infrastructure investments (some mobile-home parks have their own water utility) or that have been poorly run. In a highly fragmented industry, such targets are easy to come by, say water CFOs, giving acquirers growth potential for years to come.

However, “we’d like to consolidate the municipals as well as small private companies,” says Wolf. Indeed, if the municipally owned waterworks that serve 85 percent of Americans were to open up to privatization, the horizon for private water companies would expand exponentially. Such privatization deals are rare but not unheard of. For American Water, taking over municipal systems represents less than 1 percent of annual growth, according to Wolf.

Enter Private Equity

Publicly traded water companies are not alone among the private entities vying for the public systems. A private-equity arm of Macquarie Bank has already added Thames Water in Britain to its utilities portfolio, even as it awaits approval to take over Aquarion, which operates in four New England states. Highstar, an AIG private-equity fund, acquired Utilities Inc. with a similar strategy in mind. “We have long considered water infrastructure as an attractive investment opportunity and an excellent complement to Highstar II’s existing energy-infrastructure portfolio,” said AIG Global Investment Group chairman and CEO Win J. Neuger in a public statement regarding the purchase.

Not surprisingly, industry veterans are wary of such buyers, which are often known for pumping and dumping companies. “There’s a [business] model mismatch,” says Smeltzer. Not only equity firms usually budget for, the debt-heavy capital structure favored by most firms would reduce their profit potential in any case. “You usually capitalize a water utility with 50 percent debt and 50 percent equity, but private-equity firms tend to use only 20 percent equity,” Smeltzer says, and given that profits hinge on equity, they would likely be cut by 50 to 60 percent using that structure.

As with all potential buyers, when it comes to private-equity firms, regulators are “concerned about whether they’re adequately financed, whether they have managerial and technical experience, and most important, whether they’re in it for the long haul,” says Holland of the Pennsylvania Utilities Commission, which ultimately approved AIG Highstar’s bid for Utilities Inc.‘s Pennsylvania properties. Connecticut Department of Public Utility Control commissioner Betkoski says that Macquarie’s decision to keep current management at Aquarion, along with its investment in other U.S. utilities, was a factor in his decision to approve its purchase of the Connecticut-based water company.

Some in private equity agree that they’re not a good match with the business model. Paul Schaye, a managing director of Chestnut Hill Partners in New York, says his firm has looked at large water companies but decided not to buy. Unlike manufacturing, where plants can be consolidated, “you can’t relocate water. The only way to grow is through acquisition of other water utilities, so your added value is not as great” as it could be in other industries, Schaye says.

Private equity may yet have a role to play in revamping America’s water system, though, if Michael Deane has anything to do with it. In a newly created position at the EPA, which sets the standards for water quality, Deane describes his mission as “developing innovative, sustainable, and market-based solutions for infrastructure financing and management.”

“We’re looking at what can be done to open up more capital,” he says, “particularly as private equity comes into this space not just buying companies but investing in projects, like a massive pipe-replacement plan.” He cautions that the EPA is in the early stages of working with private equity but is hopeful that it can find some new sources of capital.

In fact, some believe that municipally owned waterworks will learn how to finance their systems without turning to new owners. “Public utilities have greater flexibility in the way they can finance infrastructure” than for-profit firms, says Tom Gould, national technical director of finance and rates for HDR, an architectural, engineering, and consulting firm. That’s thanks to their easy access to low-interest state loans, known as state revolving funds, and to the possibility of raising rates or borrowing funds in advance of, rather than in reaction to, a big capital investment. Unfortunately, Gould says, the public utilities “look at [rates] from a political perspective, and that’s why we’re in the hole that we’re in, because locally elected officials are afraid to raise local rates by $1 a month.”

That may change, says Deane. He thinks water rates need to go up across the board to cover the full costs of investments, regardless of a utility’s ownership structure. “As a scarce resource, water should be priced to the markets, so people understand the value of what they’re getting,” says Deane. Highlighting the true value of tap water can only help publicly traded water utilities when it comes to rate boosts and possibly even acquisitions. “The fact that people can’t live without it creates a pretty good economic incentive” to be in the business, says Cook of the NAWC.

As more investors pour money into the sector, look for companies to grow and consolidate even further, with privatized water becoming more common. With a seemingly endless stream of available “tuck-in” acquisitions and investor-friendly regulators, water companies like Aqua America and American Water are riding the crest of a wave that shows no sign of crashing.

Alix Nyberg Stuart is senior writer at CFO.

The Changing Face of Private Equity

The credit crunch has resulted in fewer financing options for big buyout firms. Now they’re having to reinvent themselves.

What a difference a year makes for private equity.

About this time last year, the industry was inking deals at a dizzying pace and raking in massive profits, making it the hottest game on Wall Street.

While private equity shops are still raising massive amounts of money, tight credit market conditions are forcing large buyout shops to rethink the business model that brought them so much success in years past.

“It is clear they are going through the process of reinventing themselves,” said Josh Lerner, a professor who specializes in the study of private equity at Harvard Business School.

Private equity firms buy companies – mostly with borrowed money – with the aim of overhauling their businesses and selling them at a profit or taking them public, usually within three to five years.

Some things stay the same, but changes underway

Big investors like pension funds and foreign wealth funds seeking sky-high returns are still flocking to private equity.

During the first three months of the year, buyout shops raised nearly $164 billion – the second biggest quarterly haul on record, according to the London-based research house Private Equity Intelligence.

But in order to finance their deals, private equity firms still have to secure funding from banks. That has proved difficult in recent months as lenders have been unable to find investors willing to take on the risky loans these deals entail.

So far this year, buyout deal volume has reached just $82 billion worldwide, according to deal tracker Dealogic. That’s down 68% from nearly $261 billion during the same period in 2007.

“Sales are down, margins are [lower] and costs are up – everything is being squeezed,” said Paul Schaye, managing director of Chestnut Hill Partners, a boutique investment bank in New York that works with private equity firms.

In addition to turmoil in the credit markets, getting sellers and buyers to commit to a deal is now layered with challenges, experts say.

Many companies are less willing to accept buyout offers. “People still have in their mind – ‘Two years ago I was offered X for my business’ – so there is that residual frothiness in the market,” Schaye said.

At the same time, there is a reluctance by some private equity shops to go shopping – even with the number of undervalued firms seemingly on the upswing, said Howard Spilko, a partner and head of the private equity group at the law firm Kramer Levin Naftalis & Frankel LLP.

“Just because something is cheap or cheaper than it was six months ago doesn’t mean it’s a value,” said Spilko. “They might be catching a falling knife.”

Adjusting their game

As a result, private equity heavyweights like Blackstone Group (BX), the Carlyle Group and KKR are having to adapt.

For instance, since late last year, buyout firms have increasingly targeted smaller acquisitions, experts like David Brophy, a finance professor at the University of Michigan’s Ross School of Business, said.

“The drum that keeps beating steadily is the middle market,” said Brophy, who also directs the school’s Center for Venture Capital and Private Equity Finance.

In January, Bain Capital announced plans to buy Bright Horizons Family Solutions, a provider of employer-sponsored child care, for $1.3 billion. That same month, an affiliate of Blackstone announced plans to partner with Wellspring Capital Management to purchase the food distributor Performance Food Group for $1.3 billion.

The size of those deals pales in comparison to last year’s blockbuster deals, such as the take-private of utility firm TXU Corp. by KKR, TPG and the private equity arm of Goldman Sachs for $44 billion, or Blackstone’s acquisition of Hilton Hotels for $26 billion.

In fact, buyouts announced worldwide so far this year have averaged $210 million in size, according to Dealogic, less than half of what the average was in 2007.

Private equity firms are also increasingly considering alternative investment options like acquiring stakes in public companies.

Last month, an investment group led by the private equity giant TPG acquired a $7 billion stake in Washington Mutual (WM, Fortune 500). In a similar move, National City (NCC, Fortune 500), another bank hit hard by the meltdown in the housing market, sold off a chunk of the firm to a group of outside investors led by the New York-based private equity firm Corsair Capital in exchange for a $7 billion cash infusion.

At the same time, the big private equity players are increasingly scouring the globe for investment opportunities, said Paul Schnell, a partner in the U.S. and international mergers and acquisitions group at the law firm Skadden, Arps, Slate, Meagher & Flom LLP.

Firms like the Carlyle Group have ramped up staffing in emerging markets like India, China and Latin America as part of an industry-wide push to find companies with strong growth prospects, he said.

“Increasingly private equity funds are looking outside the U.S. because they are finding a lot of companies with much greater prospects of significant growth,” said Schnell. “They can do these deals with less leverage but with significant returns.”

EASY DOESN’T DO IT – Forget a quiet game of golf. Some folks make business networking a real adventure

By EILEEN P. GUNN

Posted Sunday, November 5, 2006

Stephanie Forte, a marketing consultant in Las Vegas, was trying to get down to business with a client not long ago, and it wasn’t working.

The client, the owner of a company that helps produce trade shows and films, was launching a new business line and negotiating a partnership. He wanted to get Forte’s input on some big-picture issues. But a steady flow of phone calls and other interruptions stalled the conversation. So Forte, a skilled rock climber who had met her client while scaling nearby Mount Charleston, suggested they reconvene for an early-morning climb.

“It worked perfectly,” she says. “My client was able to detach, and we were able to come to some conclusions about his company’s plans.”

Business people used to head to the nearest golf club when they needed to network or get colleagues and clients away from the office for some quality time together. But these days, for executives and entrepreneurs who are too active and over-scheduled for a leisurely and time-consuming day on the fairways, adventure sports are a better fit.

“There is still a need for social, interactive activities outside of the office that allow for relationship building. But golf takes a lot of time, and you don’t get much exercise,” says Maurice Schweitzer, an associate professor at the University of Pennsylvania’s Wharton School, who studies business relationships. “People are more active, more health conscious, and more individualistic today. They want to do things that reflect their own personality. And [adventure sports] can give you an intense experience without taking the entire Saturday.”

These sports have become more mainstream, accessible, and upscale in recent years, making them more conducive to being used for business. Americans’ participation in kayaking grew 23 percent between 2003 and 2005, according to the Outdoor Industry Foundation, a trade group. Rock climbing was up nearly 6 percent, hiking 5 percent, and trail running just under 5 percent. Moreover, more than half of the Americans who participated in outdoor sports in the United States in 2005 were older than 35, according to the foundation, and 27 percent had household incomes that exceeded $80,000 a year, compared with only 10 percent in that group in 1999.

Some of these folks are discovering adventure sports as adults, but many pursued them when they were younger and haven’t given up being active as they’ve grown older. They also don’t feel the need to fit a certain mold the way all those men in gray flannel suits did once upon a time. “I don’t feel like because I hit a certain age I have to become a grown-up and play golf instead of climbing,” says Forte, 39, who learned to climb while spending a few years after college working at a resort and snowboarding in Aspen, Colo.

No distractions. The sports that provide the best opportunities for networking and relationship building share one common aspect with golf. They buy people time to get to know each other better and to talk about business on a deeper level. They might even do a better job than golf does of getting people away from the petty distractions of the office, the cell-phone, and the BlackBerry. As Paul Schaye, 54, the managing director for Chestnut Hill Partners, a private equity firm in New York, puts it, “You’re not answering your cell-phone when you’re going downhill on a bike at 40 miles per hour.”

For many executives, that’s a good thing. Cathey Finlon, 60, the CEO of McClain Finlon, an advertising agency in Denver, has always been active and outdoorsy. Her husband plays golf, but she finds it “too slow” and instead prefers skiing and bike riding. She’s taken a series of long-distance rides during vacations where she’s met other business owners and executives. On one ride in Vietnam from Ho Chi Minh City to Hanoi, she hit it off with another entrepreneur whose cycling pace matched her own, and she recalls, “We would go for miles talking about business books we were reading, decisions we were making, ideas we were working on.”

But the attraction for some is that you don’t have to be away for days at a time on a distant continent to have a satisfying experience practicing these sports or to use them to grease the gears of your business relationships. A climber with a mountain nearby can get out of bed early, do a series of short climbs, and still be in the office at 9 a.m. A surfer in Southern California can catch a few waves on the way home from work to release the day’s stress and run into other surfers doing the same thing.

Additionally, these sports are highly individualistic, require discipline, and tend to inspire intensity in their adherents. So practitioners see them as not just things they do but reflections of who they are, and they readily identify with others who share their passions.

Forte settled in Las Vegas so that she would have mountains nearby and went into business for herself so that she would have the time and flexibility to climb whenever she wanted. She says her clients who are also climbers understand her lifestyle choices more easily than those who aren’t, and thus “a significant chunk of my business are people I meet through climbing.”

Schaye recounts a weekend in the Hamptons on Long Island, N.Y., when he saw someone cycling alone and invited him to join his group. It turned out to be another banker whom he’d talked to on the phone but had never met. “We talked and got to be friends, and by the end of the ride we said we should find a way to work together,” he recalls. They haven’t ridden together since, but they did reconnect during a few investment deals their firms shared. And when Schaye wanted to start Chestnut Hill a few years later, this fellow rider persuaded his firm to put up the seed money.

Trust. Then there’s the team-building aspect of adventure sports. “We interact with more strangers and have to get to know each other and build trust quickly,” Schweitzer says. “Maybe after 10 years of golfing with you I’ll feel a great bond with you, but it might only take two rappelling trips or a handful of rafting trips to feel really close with someone.”

The bonding happens so quickly, he says, because whether someone is helping you change a flat bicycle tire in the middle of nowhere or holding your belaying ropes on a cliff face, “you’re relying on the other person to keep you safe. That builds instant trust, and the trust transcends the experience.”

Bill Hinz, the CEO of Western National Bank in Phoenix, excels at creating these kinds of experiences for his employees and clients. He and other members of the local Entrepreneurs Organization have mountain biked in Colorado, ocean kayaked in California, and shot along zip lines way above the jungle floor in Mexico. “When you push yourselves to the limit in these situations where you have to trust each other,” Hinz says, “you break down barriers and can really talk about your business in a more in-depth way.”

These situations also let you know quickly what a person is made of and if you want to do business with him or her. “I’ll see someone fall off a wall and start yelling at their belayer and blaming the sun or the weather or the equipment instead of just admitting they need to focus better or practice more,” says Forte. She will steer clear of that person both as a climbing buddy and as a business associate.

Similarly, Schaye says his rule is “on a long-distance ride, if I start with you, I finish with you. I don’t leave anyone behind” when a tire pops, gears fail, or there’s an injury. If fellow riders “leave you in the lurch to finish a bike ride, what are they going to do in a business situation when stuff really hits the fan?” he asks.

But aside from the character factor, there’s also the sheer intensity of experience these sports provide. Between business and family obligations, overstretched executives feel guilty taking any recreational time out, even if they’re mixing business with pleasure.

“Golf is structured in such a way that there is no chance anything incredible will happen during a round,” says Hinz, so while he grew up playing the game in Arizona, he aims higher when he wants to impress someone. The CEO, whose bank puts together real-estate investment deals, brought several investors together last winter to buy land in Utah. To give them a look at the property, he flew them there in a small plane and had snowmobiles waiting. There was 3 feet of snow on the ground, and while it took these Sun Belt business people an hour or so to get the hang of the vehicles, once they did, “they were zipping around the property at 60 miles an hour and talking about it for days afterward,” Hinz recalls. “I guarantee they’ll be investors in anything else we do from now on.”

It’s become easier to do these activities in high-end ways that convey status and are gentle on the bones, both of which appeal to business people.

Andrea Nierenberg, the author of Million Dollar Networking and a consultant on building business relationships, routinely brings business cards with her when she hikes and-no surprise-has struck up several business relationships that way. But she usually does her trekking during spa weekends around the country.

When Hinz’s group of entrepreneurs went to California last year, they spent their days ocean kayaking and hiking along seaside cliffs. But at night they rested their weary bones in featherbeds at the Ritz-Carlton, Half Moon Bay.

“I make it a point to budget a considerable amount of my income toward these activities,” he says. “We’re not trying to suffer; we’re just trying to put together events that are active and memorable and amazing.”

Small Business, Big Impact

By Catherine Fredman

In the dotcom era, the formula for success was called “flipping burgers.” Start a business, ramp up growth to a point that attracts attention from big money, then sell to the highest bidder and go on to the next idea.

For many entrepreneurs, that business model still represents the American dream. But not for Laury Hammel, the founder and president of the Longfellow Clubs, a group of four health clubs in the Boston area. “If someone said, ‘I want to do a franchise and build your business to 100 clubs,’ I would say no,” says Hammel. “I don’t feel compelled to grow any faster.”

Hammel has a different aim in mind, one that turns the burger-flipping formula on its head. “We’re trying to develop an institution that meets the needs of the community. If that’s your goal, you have a different strategic plan than trying to cash out.”

Hammel represents a growing number of business owners who are guided by “the double bottom line.” In addition to calculating the conventional bottom line of financial profit, more and more entrepreneurs are paying attention to a social bottom line: having a positive impact on their employees, their customers, and their community.

“We feel there’s a shift afoot in capitalism,” says Don Shaffer, the executive director of Business Alliance for Local Living Economies (BALLE), a San Francisco based network of 14,000 entrepreneurs and owners of small companies across North America. “As opposed to maniacally driving forward with quadruple-digit growth each year just for the sake of growth, many entrepreneurs are making conscious decisions about the kind of life they’d like to create. Many are saying they would like to spend more time with their families and their communities, rather than striving for the 26-room house in Lake Tahoe.”

Where the Money Is

“The big businesses get the press and the bragging rights,” says Paul Schaye, the managing director of Chestnut Hill Partners, a New York mergers and acquisitions firm specializing in small- and middle-market companies. “But the real drivers of the economy right now are small businesses.”

According to the U.S. Small Business Administration (SBA), firms with fewer than 500 employees have generated 60 percent to 80 percent of net new jobs annually over the past decade. They produce 13 to 14 times more patents per employee than large firms and create more than 50 percent of nonfarm private gross domestic product.

The number of small businesses in the U.S. reached a new high of roughly 26 million in 2005, according to the SBA office of Advocacy’s annual report. More small businesses were started in 2005 than were closed, resulting in an estimated 6 million firms with employees and about 20 million sole proprietorships.

A variety of trends are converging to debunk the “bigger is better” myth. One of the most powerful is the backlash against big-box chain stores and impersonal corporations. “When you ask people what’s missing in their lives, it’s rare that they say, ‘a big store to shop in,’” says Michael Kanter, a co-owner with his wife, Elizabeth Stagl, of Cambridge Naturals, a health products store in Cambridge, Massachusetts. “They usually talk about neighborhoods and community.”

Recent statistics certainly make a compelling economic case for locally owned and operated businesses. Civic Economics, a Chicago-based consulting firm specializing in sustainable economic development, performed a series of “Livable City” studies in Austin, Texas; Toledo, Ohio; and Maine’s midcoast region. They found that local merchants routinely generated three times as much local economic activity, adjusted for revenue, as chain stores.

If local merchants need further validation, Civic Economics’ 2004 study of Chicago’s Andersonville neighborhood offers dollars-and-cents confirmation. For every $100 consumers spent with a local firm, $68 remained in the community, compared with $43 from a chain firm. For every square foot occupied by a local firm, the local economic impact is $179, compared with $105 for every square foot held by a chain firm. More than 70 percent of consumers surveyed on the streets of Andersonville strongly preferred the neighborhood shops over agglomerations of common chain stores.

At the same time, Shaffer says, the perception of these small business owners as “hippie throwbacks” who just want to get out of the mainstream is off the mark. Many are sophisticated entrepreneurs who are balancing financial and lifestyle concerns and are beating the big guys on their own turf.

“This is by no means a starving artist approach to entrepreneurship,” says Shaffer. He likes to quote BALLE’s unofficial motto: “No margin, no mission.”

The Benefits of the Double Bottom Line / Still, for many proponents of conservative growth, the mission is as important as the margin. They may not make a mint, but the intangible benefit of being able to dictate their daily schedule is priceless.

“Managing your own club is a dream job,” says Hammel. “You have a meeting, eat a healthy lunch, play some tennis, take a quick swim, and go back to work. It feels a little like cheating.”

Hammel estimates that he spends half his time on nonprofit work. Many local owners similarly devote their extra hours to community organizations, and they find that in their efforts to live a more meaningful life, they get back as much as they give.

Jay Graves, whose six Bike Gallery shops dominate the market for recreational cyclists in Portland, Oregon, is convinced that restricting growth is the secret to the success of the $10 million family-owned business. Graves regularly entertains offers to expand. Just as regularly, he and his board of advisers turn them down. “The idea of going outside our local market is not appealing,” says Graves. “I like to be able to visit any of the stores any day of the week. That wouldn’t be possible if we were in a community two or three hours away.”

He invests the hours he might other-wise spend on the road in a number of cycling-related nonprofits & activities that bring both personal and professional satisfaction. “Customers have said that my work in the community is one of the reasons they shop with us,” Graves says.

Small as a Strategic Advantage Business students have long been taught that bigger is better, but small can be a strategic advantage, argues Michael H. Shuman, the author of The Small-Mart Revolution: How Local Businesses Are Beating the Global Competition. Hometown businesses can leverage local knowledge to provide personalized goods and services. The result is customer relationships built on trust that last longer than those dependent on deeper discounts.

Last year, Cambridge Naturals moved to a new location in the Porter Square shopping center, which brought with it the benefits of a larger space, proximity to subway and commuter rail lines, and plenty of parking. The new location also added new competition: Four chain stores within a two-mile radius, a discount vitamin shop a mile away, and a supermarket in the same shopping center all carry many of the same products.

That’s more than enough to make any solo proprietor quail, but Kanter believes he has a secret weapon. “We train our-selves really well on the product. We have between 8,000 and 10,000 units in our store, and we require that our staff know every single one of them. We get to know our customers and their health issues from head to toe.” The result: “We have grown tremendously since our move,” says Kanter.

Proponents of “bigger is better” like to preach the benefits of economy of scale: The larger the organization, the more leverage it has to demand discounts from its suppliers or raise the prices it charges consumers. For the Wal-Marts, Toyotas, and Intels of the world, economy of scale is hard-baked into the business model. But, claims Hammel, “economy of scale is highly overrated.”

Certain businesses do not succeed at gigantic proportions, says Eric Flamholtz, who, as a professor of management at UCLA’s Anderson Graduate School of Business and the author of Growing Pains: Transitioning From an Entrepreneurship to a Professionally Managed Firm, regularly advises small businesses on how to manage growth. A company that makes its mark with a high-quality product or service is most at risk. “Past a certain point, it gets diluted and may lose its core customer base,” he says.

Service is what enables Argo Tea to thrive despite a chain coffee shop sitting smack across the street in Chicago’s Lincoln Park neighborhood. “People come to us because we’re a smaller business that has to work harder for its customers,” says Arsen Avakian, Argo Tea’s founder and president. Sometimes, a simple “Thank you” can be reason enough for customers to return.

It’s not just service that suffers when a company decides to focus solely on the amount of sales. “It means hiring additional supervisory staff, adding to the overhead, and taking on lower-margin work to cover fixed costs,” says Murray Low, the director of the Eugene M. Lang Center for Entrepreneurship at Columbia University’s business school. Flamholtz says, “You can actually double in size and make less money in the bottom line, while dealing with more headaches and getting a lower return for it.”

Graves learned that lesson a few years after opening a second Bike Gallery. “We were fat and happy, and we weren’t watching our expenses. We were busy watching our sales grow without understanding how much profit you have to have to fund growth.”

In 1985, the company crashed. Sales flattened. The bank called in its notes. Graves’ father was forced to sell the family’s home to cover the loans. “It took us years to dig out of that hole,” Graves recalls.

Since then, Graves has been a disciple of modest growth, expanding only as much as he and his board of advisers feel provides the ideal balance: enough profit to train and pay a professional staff, but not so many stores that they lose the personalized feel of neighborhood bike shops. For now, six locations seems just right. “It’s allowed us to be big enough to have a general manager,” says Graves. “If we had stayed smaller, I would be involved in the day-to-day operations, and, frankly, that would give me less flexibility. This gives me more freedom.”

And isn’t that the ultimate American dream?

Catherine Fredman has collaborated on five best-selling business books, including Use the News with Maria Bartiromo and Direct From Dell with Michael Dell.

Private Equity Firms Probe For Hidden Corporate Gems

Following a Bain Model, Sponsors Build Businesses from Orphan Divisions

By Martin Sikora

Corporate orphans increasingly are popping up on the radar screens of value-driven financial buyers. A number of private equity firms are actively pursuing adoption of neglected businesses that have been stunted inside major corporations and are willing to give them good homes.

A single division by itself may not be particularly appealing. But in a twist on the buy-and-build strategy, LBO sponsors are trying to snap up two or more undermanaged, under-resourced yet compatible units from different companies and blend them into one stand-alone player. With proper care and feeding, experts say, the resulting roll-up can be a formidable enterprise with the potential to become a tempting acquisition candidate or an IPO down the road.

Bain Capital Inc. has been a longtime practitioner in both buying and rolling up orphan divisions and managing director Steve Pagliuca said, “It remains a fundamental core practice for us.” Among others, Boston-based Bain has created Dade Behring Inc., in medical diagnostic equipment and materials’ Wesley Jessen Visioncare Inc., in contact lenses, and Gartner Group Inc., a market research and information services firm.

The concept is catching on with other sponsors as well. A recent addition to the ranks is LifeStream LLC, a specialist in profusion equipment that is used in operating rooms to help in heart surgery. LifeStream, backed by Banc One Equity Capital, sprang from the trl-partite combinatlon or prlvately owned Surgimedics Inc. the cardiopulmonary unit of C.R. Bard Inc. and the cardio-surgery business of Minntech Corp.

Unlike tne contemporaneous process used in creating LifeStream, Bain’s model was involded acquiring a platform and doing sequential add-ons. The platform for Dade Behring was the Dade international unit of Baxter International Inc. Aad-ons brought in the medical diagnostics division of Du Pont Co. and the Behring diagnostics division of Hoechst.AG. Sales are running in the area or $1.5 billion a year. There is a tie-in between the two firms. Scott Garrett. The veteran health care industry executive who engineered the formation of LifeStream, had been CEO of Dade Behring. Wesley Jessen was a neglected part or Schering Plough Inc. when it was purchased by Bain and was expanded by the acquisition of Barnes-Hind, the contact lens unit of British-based glassmaker Pilkington PLC. Gartner was losing money when it was bought from former U.K.-based advertising giant Saatchi & Saatchi PLC. Both companies later were taken public and recently Wesley Jessen was targeted for acquisition by optical goods firm Bausch & Lomb Inc.

An “orphan division” doesn’t mean a bad company

More company formations built around the transfer of orphan divisions are expected and they are forecast to cover a wide range of industries as well as health care.

Paul Schaye of Chestnut Hill Partners, a New York-based M & A intermediary that represents financial buyers, says that he is seeking out additional opportunities for clients and thinks that the prospects for creating premier performers are enormous. Preferred targets, he says, are good businesses that just haven’t been allowed to flower.

“Orphan doesn’t have to mean downtrodden,” Schaye said. “It just means it doesn’t hang in there. Orphan doesn’t mean it’s a bad company.”

Financial buyers historically have been major purchasers of divested divisions and subsidiaries from major public companies and have even dabbled in neglected properties. But they are hitting on formal programs to harvest and combine orphan divisions as the pressures mount to develop innovations for channeling the huge, untapped hoards in their equity funds into deals.

Buy-and-build programs provide sale options

These projects also mirror the way in which private equity operatives are increasingly adopting fundamental business strategies atop their financial prowess. Additionally, buy-and-build programs provide new avenues for restructuring companies to shed their hard-to-sell operations. They are, however, not easy to execute. It’s a tough job to find promising operations, convince the corporate owners to part with them, structure the deals, and then produce companion businesses that can provide the mass or diversity that makes it worth creating the new stand-alone company.

Garrett himself says that while he is pursuing other projects built around orphan divisions, they principally will follow the Bain model of buying a platform and augmenting it with add-one. There may not be others “as complex as LifeStream,” which was created in one swoop, he said. He credited the network he developed through 25 years as a health care executive (at the former American Hospital Supply and Baxter prior to his stint as Dade Behring CEO) with helping him pull it off. Long-established contacts helped surface the Bard and Minntech opportunities while Surgimedics came into the mix through Banc One Equity Capital. “I was experienced in the ways of getting things done,” he commented.

Shaping strong features into a complete company

He also had good strategic sense working for him. Each of the constituents enjoyed a leading characteristic that helped shape a complete organization. The deal married the sales and marketing capability of the Bard unit, the manufacturing infrastructure of Surgimedics, and the product line of the Minntech business. Subsequently, LifeStream acquired Polystan, a Danish producer of cardiology equipment. The newcomer will broaden LifeStream’s distribution in Europe and give the company access to some important Polystan products that it can bring into the United States, Garrett said. “I am now trying to find the corporate orphan that has the ability to grow but doesn’t have the right support,” Garrett said. “That will make a good platform.” He said he expects to have a few more platform companies in place this year. Financing also can be a tough nut. Like many corporate sub-units, orphan divisions may not have specific breakdowns on cash flows and other key financial measures. Historical data often have to be constructed and utilized as bases for forecasts so they can be presented to lenders in a businesslike fashion.

In fact, a key ingredient in forming LifeStream was the ability to obtain attractive financing from Fleet Capital Corp. Allan Allweiss, senior vice president at Fleet who supervised the LifeStream project, noted that most lenders are gun-shy about lending into roll-ups in their formative stages. They “shy away from the implied information gap and implied credit risk,” he said.

However, Allweiss said that LifeStream passed his credit screen because all of the characteristics added up to a good story. In particular, he was impressed by the management assembled from the three constituents, the combined positioning of the product lines in the health care market, and the strategic synergies formed by melding the different strengths of the founding units.

Schaye said he is trying to unearth subsidiary businesses that are running well but haven’t been supplied with growth capital because they don’t fit the corporate owner’s core operations.

“We have the technology to look at a corporation’s holdings and divisions and see if there’s a fit or a disconnect,” he said. The business that doesn’t fit, he added, is fair game for approaching corporate management about a sell-off.-

A problem with the orphan inside a huge corporate house, Schaye said, is that it often is trapped in a no-win situation. It may not get the investment it needs because it isn’t growing as fast as other operations or because it is generating considerable cash that the parent wants. In either case, Schaye said, the orphan is not running at an optimal rate.

“It may be starved for capital, but sometimes the management will say, “There’s that cash cow over there, why muck it up?” he noted.

By contrast, he said, the private equity firms that take over the former orphans are willing to invest in new product development, expanded marketing, increased production, and other elements of growth.

“It’s not a question of cutting costs, it’s empowering the business,” Schaye said.

Schaye said he thinks it will become easier to extract the orphans because of mounting pressure to enhance performance. “Everybody’s under pressure to fix their balance sheets and increase earnings,” he stated. “They are going back to the basics and asking themselves what their core competency is. If there are little pieces that don’t hang well, they will get rid of them.”

While opportunities in health care are expected to continue as major players “get out of some of the businesses they don’t want to be in,” Schaye believes there is no limit on the number of industries that will contribute unwanted operations. “I think it’s going to be across the board,” he said.

Schaye even sees some prospects developing out of the ongoing consolidation of the auto parts industry which has been driven by the automakers’ demands for fewer suppliers of the myriad products they buy to put together a vehicle. While the assemblers have pushed one-stop shopping from suppliers offering a diversity of wares, Schaye believes that they will partially reverse course and ask the vendors to concentrate more on specialization, e.g., “the maker of interior trims will go back to making interior trims.” This will put non-core businesses on the block, Schaye predicts. “The automakers just don’t want one guy providing all their products,” he said.

Pagliuca said that Bain Capital has additional orphan-based roll-ups in the works. “We are looking for noncore businesses that will benefit from scale and from consolidation,” he said. While the firm has chalked up several successes, Pagliuca acknowledges that it can be tough to make the roll-ups pay off. He said that the businesses have to be integrated (a problem that usually doesn’t arise in one-off acquisitions) and that “it takes a lot more capital” than most single acquisitions to get them into value-creating territory.

An early jump is important in selling business

by Marc Meltzer, Daily News Staff Writer

“There are some things you should know before you sell your business. If your business isn’t a hot Internet company, you’ll probably have a hard time selling it through a public stock offering. You might have more luck selling to another company or a private equity fund in the current market” said Paul Schaye, a partner at Chestnut Hill Partners, a merger and acquisition specialist in New York.

Ideally, you should start planning years in advance for the sale. This will give you time to adjust your accounting practices to show a three- to five-year track record of maximum profitability.

That may be a big switch for many entrepreneurs who operate their companies to minimize their tax liability. That practice might save on taxes, but it usually minimizes the value of a business as well.

“You need to run your company like a public company,” Schaye said. “That means getting your uncle or spouse off the payroll and any other personal expenses.” Be prepared to justify your reasons for selling.

“After the buyer asks, ‘How much?’ the next question is ‘Why is the seller selling?’ “ Schaye said.

Buying travel tickets on-line, which has been touted as a great way to get cheap fares, can cost more than you think. A study by Consumer Reports magazine found that 12 big on-line travel providers charge fees that can add up to 85 percent to the advertised price of your ticket.

More than half the sites polled charged from $4 to $30 to book and mail paper tickets rather than issuing electronic tickets, which often involve no more than a reference number being issued to a traveler. Most discounters won’t mail paper tickets without charging a fee.

Once you have a ticket, changing your itinerary could cost you more than the ticket itself.

While airlines tend to charge a $75 penalty for altering travel arrangements, some on-line sites charge double or even five times that amount, up to $375.

A formula called the “Four P’s” can help you sound smart at office meetings and further your career, says Alberto Paz, president of Robert A. Becker Inc., a marketing firm based in New York.

The first P is for purpose – always know the reason a meeting is being held, so you can plan for it. The second is for participants. If you know who will be at the meeting, you’ll be better able to define your role at the gathering.

The third is for prepare – know what is expected of you at the meeting, and be sure to have with you the information you’ll be asked for. And fourth is the P for participate.

Follow these tips to get the most out of the sale of your small business.

By Barbara Marquand

When Mario and Bonnie Coelho bought Arizona Power-Vac in 1991, they were already planning how they’d sell the Tucson ventilation-system cleaning business five years down the road.

With a business strategy focused on broadening their client base, the Coelhos first increased advertising and began bidding on local and state jobs, as well as residential and commercial work. Then they upgraded old equipment to increase efficiency and lower overhead, while also avoiding any long-term debt that wasn’t essential to growing the business. In just five years, when annual revenue climbed from $100,000 to $500,000, the Coelhos decided to sell their investment for a tidy profit.

The time to start thinking about selling a business isn’t when you’re burned out or ready to retire, say experts. It’s now.

“Generally, you should be planning an exit strategy from Day 1. That ought to be part of the business plan,” says Michael Harris, vice president of Tucson Business Investments, a business brokerage in Tucson, Ariz.

So where do you start?

Clean the Books

“Straightening out the business’s financial records is essential” says Paul Schaye, managing director of Chestnut Hill Partners, a New York mergers and acquisitions firm. “That often means resisting the greater short-term benefits of maximizing questionable or liberal tax deductions. You may be able to squeak it by the IRS, but taking iffy deductions can shrink the business’s bottom line” he says. “Having relatives on the payroll, for example, is fine as long as they’re legitimate employees. Paying your husband $100,000 to work as a secretary will lower your net and your tax bill. But it may bite you down the line”

Schaye adds. “The job should justify the salary. Likewise, extravagant deductions with only thin ties to the business multiple cars, country club memberships and Hawaiian vacations should be eliminated”

Schaye says. “Ask yourself, ‘How would a public company operate this business?’ Then think like a public company.”

Consider that the typical business sells for three to eight times its annual profit, so every deduction you take cuts the selling price by that multiple, says Russell Brown, author of “Preparing Your Business For Sale” and president of RDS Associates Inc., a Niantic, Conn., appraisal firm. Suppose, for instance, you deduct $4,000 to go to a weeklong convention in Florida. If you skip the convention, you’ll pay roughly another $1,000 in taxes that year. But your annual profit will jump $4,000, which would translate into an additional $12,000 to $32,000 in the selling price.

So why not take the deduction for the convention and just tell the buyer that the trip isn’t necessary for running the business? You can try that, but a buyer will never be sure that’s really the case, Brown says.

Meanwhile, it’s not unusual for owners of tiny businesses to skim cash. Harris strongly urges that they keep their hands out of the till. Not only is skimming illegal, but it makes it difficult to show the company’s true income. Why should a buyer trust sellers who claim that a business generates more cash than what you show on the books? That’s a big turnoff to a buyer, says Mario Coelho, who, with his wife, Bonnie, buys small businesses, fixes them and sells them for a profit. “You have to declare all income. You don’t try to hide it,” he says.

How Much Is It Worth?

Once you’re sure you want to sell, Brown says, contact a business appraiser to determine the value of the business. Business brokers, who bring buyers and sellers together, can also help you determine value, but keep in mind that they have an interest in the business selling so they can collect their commissions. Some brokers may give a high-ball figure to get you to list the business with them, and some may give a low-ball figure to sell the business quickly. “Go to an independent source before you go to the business broker,” Brown suggests.

Try to get the business appraised at least two years before you want to sell, so you have time to make any changes suggested by the appraiser, Brown adds. But if that’s not possible, an appraiser can write an estimate of what the business is worth Ñ taking into account expenses that a new owner could eliminate. A business broker then can show that independent report to buyers.

Ideally, however, you should plan far enough ahead to follow an appraiser’s guidance for making the business as profitable as possible to appeal to buyers.

That’s what Bob and Cindy Marn did after they decided to sell their Atlanta-based business, Allegra Print & Imaging, about two years ago. They made double payments on all the short-term leases on equipment to reduce their debt, and they avoided buying new equipment that wasn’t necessary. “There are a lot of toys you see and think, ‘Wow, I’ve gotta have one of those,’ but you don’t really have to have them,” Bob Marn says. The couple also gave their employees bonuses for reducing paper waste, and they cut the staff to six from eight. They laid off one manager and left a position open when someone else quit.

To boost revenue, the Marns increased direct mailings and offered incentives to customers to refer others to the business. By the time they put the business on the market, the numbers looked really good, Marn says. Through a broker they found a buyer who paid just under the asking price last January.

Treat It Like Your Baby

Unlike the Marns, however, many owners start to slack off after they decide to sell because they’re burned out. “Among sellers, the biggest mistake I see is they get it in their heads they want to get out of this now, and they tend to put in less effort,” Bonnie Coelho says. “They’re bored. They’re tired.”

Owners should treat the business as if they’re never going to sell it, Harris says. “Treat it as if it’s their baby,” he suggests while reminding sellers that a deal isn’t done until it’s done. The phrase “DFT” (deal fell through) is all too common among business brokers.

Dana Kline, who sold Pittsburgh-based Dana Kline Catering, about a year and a half ago, says a key to the successful sale of her business was maintaining the same high standards that had helped build her company’s solid reputation Ñ even though she knew she wanted out. “It was very important that I not let it show,” she says. “I don’t think my clients ever knew. We spent big bucks on advertising, and we certainly kept up quality control. We always kept our standards very high.” That allowed the business to line up enough jobs to help ensure its success after the sale. Like many small-business sellers, Kline financed part of the deal, so she had a vested interest in the success of the new owner.

Sellers should also write down ideas of how a new owner could expand the business, Brown says. “Start thinking of those things you’d do if you had the capital or energy, and make them part of the strategic plan,” he advises. That may include, for instance, adding a product line or selling goods online. Details like those can spark potential buyers’ interest and help the new owners after they take over.

In addition, Pittsburgh broker James Reitz, of Reitz Business Ventures, suggests turning more of the daily operation over to a hired, nonfamily employee to ease buyers’ worries that the business can’t operate without you. “See if you can step back a little, have others take more of the calls and do more of the bidding, pricing and purchasing,” he says. “Buyers will be greatly encouraged by that.”

Be Careful Out There

Once potential buyers come knocking, don’t rush to close a deal. The Coelhos made that mistake years ago when they sold a Los Angeles printing business started by Bonnie Coelho’s father. After her father retired, the couple ran the company for several years, quadrupling its annual revenue to $1 million. But after moving to Arizona, they had difficulty managing the business long-distance and placed it on the market. “When you’re wanting to sell quickly, you’re willing to accept deals you otherwise wouldn’t,” Mario Coelho says.

The couple accepted a deal that sounded too good to be true, failing to check out the buyer carefully, Bonnie Coelho says. The new owner skipped out on the bills and defaulted on the loan. The Coelhos, who financed the deal, got the business back, moved the equipment to Arizona and started a new printing business nearby.

So what if you don’t have a few years to plan your sale? Do everything you can to maximize the look of the business, equipment and facilities. Then, have a colleague or consultant go over your books and operations. Sometimes an outsider can spot problems an owner wouldn’t notice, Harris says. But it’s probably too late to do much else. In the long run, planning pays off, he says. The more preparation you do now, the smoother and more profitable your “retirement” will go later on.

Is It Time to Go Private? Leaving the brutal public market behind may be an option for some smaller healthcare companies.

by Paul L. Schaye, Managing Director Chestnut Hill Partners, LLC

Even with solid performance and excellent growth prospects, you may find the door to the public equity market slammed in your face.

FEELING UNAPPRECIATED on Wall Street? Struggling to boost shareholder value? Searching in vain for growth capital?

If you head a public healthcare company of small to medium size, the answer to all three of those questions may very well be yes.

Over the last year, healthcare has suffered from modest growth relative to other sectors, and many small cap stocks are out of favor, too. Even with solid performance and excellent growth prospects, you may find the door to the public equity market slammed in your face.

Your troubles may not be limited to secondary offerings of stock. A depressed share price leaves you little room to maneuver. With your currency devalued, acquisitions become difficult or impossible. Lacking the lure of valuable stock options, you may also have trouble attracting the kind of employees you need. And all the while, of course, you have to listen to dissatisfied shareholders clamoring for better quarterly results.

If your IPO champagne has long since lost its fizz, you may want to think about going private. There are currently more than 800 private equity buyers nationwide, who currently hold more than $85 billion in investment capital. The money comes primarily from institutional investors, who are hoping for annual returns on the order of 25 to 30 percent.

Some of this capital will doubtless flow to dot-coms and biotech firms, but a substantial amount of money will also head to strong but neglected players in the old economy. Where stocks have been beaten down, some private equity firms see good companies going for what they consider to be reasonable prices.

Sheridan Healthcare makes an interesting case in point. This Miami-based physician practice management company went public in 1995 and private again in May 1999. Sheridan’s management and board did not set out with this second goal in mind, but they arrived there on the road to maximizing shareholder value.

Bear in mind that PPM stocks were in very deep trouble at the start of 1999, following some highly visible failures in this sector. Sheridan was one of the babies the stock market threw out with the bathwater. Despite a record of meeting its financial projections for seven consecutive quarters, Sheridan’s stock was down to $6 a share from a high of $17.

A deal with Vestar Capital Partners, a leading private equity firm, turned out to be the right move for Sheridan. Together with Sheridan’s management, which took an equity stake, Vestar and its partners acquired the company at a healthy premium to its stock price. While still well below the company’s all-time market high, this was, in the current environment, an attractive price.

Equally important, Vestar agreed to provide Sheridan with the capital it needed to grow.

“We’re contrarians,” explains Mitchell Eisenberg, M.D., Sheridan’s CEO. “We’re acquiring some practices, growing our existing practices, and starting other practices from scratch. All of this takes capital, and Vestar has come through, just as it said it would.”

Although management must still provide the company’s owners with extensive financial data, it no longer needs to do so in a public forum where competitors can see all. Relieved of quarterly earnings pressure, management is also freer to focus on long-term goals. As Eisenberg tells it, the benefits are emotional as well as financial. “I just feel better! I wake up in the morning with a smile on my face. It doesn’t have to work out this way, but our private equity partner has the same views as management.”

Eisenberg notes that other Sheridan executives seem to share the sense of relief. “We kept pretty much the same management team,” he says. “They performed superbly when we were public, but I think they also feel a burden lifted. They don’t have to live quarter by quarter. Now they can live year by year.”

Would a private equity deal be right for your company? If you are an established business with strong upside potential and a capable management team, you should probably explore the possibility.

Private equity firms are particularly interested in companies neglected by the public market.

Valuation, of course, may become a stumbling block if an actual sale becomes imminent. Your board members may balk at a share price well below the peak your company once hit in the public market. You can anticipate some collective soul searching on this score. Try to bear in mind that market realities change, whether for better or worse, and that there is little you can do to fight them. You can expect your company to fetch a premium to its current share price, but not an extra ordinary premium.

In its day, your IPO was an occasion that set corks popping. But today, your best financing opportunities may well be found in the private equity market. It is no longer the season to drink mass market bubbly. It is time to start drinking private reserve.

Buying Into Growth – Acquiring another business may be the best — or only — strategy for quickly expanding to meet marketplace demands.

By Shari Caudron

Dick Blaudow launched Advanced Technology Services Inc. (ATS) in 1985. His strategy? To grow the Peoria, Ill.-based industrial- and computer-services company as quickly as he could through internal growth. His approach worked well for a number of years, but by 1993 growth at ATS had leveled out. To get back on the fast track, Blaudow, president, changed his strategy. His new tactic? To add products and services, expand the company’s geographic presence, and obtain specialized management talent by buying other companies with those capabilities.

He completed his first acquisition in 1994, his second in 1995, his third earlier this year, and the ink is now drying on his fourth strategic acquisition. By purchasing other companies, Blaudow has been able to grow his company from 325 employees and $35 million in revenue in 1993 to approximately 1,100 employees and $100 million in revenue today. The plan for growth has worked so well that Blaudow is now negotiating to purchase two other companies and he expects to complete between one and three acquisitions per year for the next several years at least.

Why has acquisition worked so well for Blaudow? “I can sum it up in one word,” he says. “Speed. The market is changing so rapidly that in order to achieve a leadership position we need to broaden and build depth in our product lines and we need to achieve critical mass with a nationwide presence. The only way to do this quickly is to find other companies that already have the strategic elements we need.”

In a highly competitive marketplace, Blaudow is one of the many small-business owners who have discovered that the best fare for a growth appetite is acquisition. In fact, when it comes to manufacturing companies, acquisition may be the best growth strategy going — for two reasons. One, although there is a mania surrounding IPOs for technology-based companies, the public currently does not have much interest in buying stock in small manufacturing firms. Because small manufacturers cannot look for an infusion of cash from stockholders in order to grow, they have to find other ways to expand the company’s capabilities. Increasingly, they’re looking to buy other businesses in order to meet growth demands.

The second reason acquisition makes sense for small manufacturers is that the market is going through a period of consolidation in many industries. This leaves business owners in those industries with a choice: to either be a consolidator or be purchased by one. Furthermore, consolidation begets consolidation, explains Patrick Winters, vice president of Duff & Phelps LLC, an investment-banking firm based in Chicago. “If your customers are consolidating and getting larger, they are going to be demanding more from their suppliers,” he says. “For example, they may want national as opposed to regional suppliers.” Consequently, even if your own industry is not in a period of consolidation it may soon be driven to it by customer demands.

Given these pressures, it’s not surprising that acquisition activity has been running at fever pitch for the last couple of years. We’ve all heard plenty about such megamergers as the $13 billion Honeywell-Allied Signal deal or Berkshire Hathaway’s $2.14 billion acquisition of MidAmerican Energy, but even small industrial companies have gotten into the acquisition act in a big way.

According to Mergerstat, a division of Houlihan Lokey Howard & Zukin, a Los Angeles-based investment bank, in 1998 there were 866 deals announced that were worth $25 million or less. This is a 275% increase from just five years ago, and these numbers represent only acquisitions that were made public. Countless other small companies have gobbled up competitors without gaining the attention of merger watchers.

With all the buying and selling that is going on, you may wonder if now is a good time to make an acquisition or not. In a good market, wouldn’t values be overly inflated? “It is regarded as a good time to sell,” Winters explains, “but that doesn’t mean it is a bad time to buy. There is a tremendous amount of capital coming into the private-equity markets so it is not a difficult time to get private financing for these ventures. In fact, if you’re looking for an equity partner to help you make an acquisition, it is a pretty healthy market.”

Given that money is available, sellers are eager to cash out, and competition is intense, you may be feeling pressure to start playing the acquisition game. But be forewarned: Popular wisdom has it that only one out of three mergers is successful in achieving strategic objectives. This is because too many executives rush into the process without completing the due diligence required to make these unions work.

Making a sensible and strategic acquisition requires careful forethought and planning just like any other major business decision. Here, then, are 10 things you’ll need to do in order to make acquisitions that add value.

1. Determine the strategic reason for the acquisition. Photon Dynamics Inc., based in San Jose, is a $31 million company that makes flat-panel display equipment for sale to customers in Asia. In 1998 the Asian economic crisis caused the company’s sales to plummet from $8 million to $400,000 in just one quarter. The crisis was a wake-up call, explains CEO Vincent Sollitto. To survive, the company had to geographically diversify its revenue stream and find other markets that could take advantage of Photon’s technology and research-and-development capabilities. The most efficient way to do this, Sollitto explains, was to acquire a company that already had these capabilities. Armed with a clear understanding of its needs, in August Photon acquired CR Technology, a $9 million X-ray and optical inspection equipment company that offers “clear synergies” for both companies.

As Sollitto’s experience indicates, the first step in making a sound, strategic acquisition is to know exactly what kind of company you are looking for and why.

“Don’t buy something for the sake of buying something,” explains Paul L. Schaye, managing director of Chestnut Hill Partners LLC, New York. “Buy something that fits and makes sense.”

Some of the reasons for acquiring companies are to accelerate growth, add product lines, diversify into new markets, expand your geographic presence, acquire capable management, gain new technical capabilities, and garner a larger slice of the existing market.

2. Establish an acquisition team. “Conducting an acquisition involves many steps and phases,” explains Z. Christopher Mercer, CEO of Mercer Capital Management Inc., Memphis. “Targets have to be identified, qualified, and contacted, and you have to present your case to potential sellers.” Because of the time and attention necessary to complete a successful acquisition, experienced buyers suggest forming an acquisition team that includes several representatives of your executive staff as well as consultants who have knowledge about the industry.

“Just as a company needs marketing, technology, and operations people to run effectively, it also needs all those sciences and schools to be involved in evaluating potential purchases,” adds Duff & Phelps’ Winters. “Different professionals are going to raise different concerns and issues.”

3. Differentiate yourself from other buyers. Because small-business owners have strong emotional attachments to their companies, they tend to closely scrutinize potential buyers. And why shouldn’t they? In today’s market, sellers have the luxury of being picky. “Virtually all of my clients are contacted by someone on a fairly routine basis to assess their interest in selling,” Mercer explains.

To differentiate yourself from other buyers, he suggests making your company look as attractive as possible. “An attractive acquirer is profitable and has a good reputation, strong management, a solid strategy, and good operations and technology,” Mercer says. Successful buyers also maintain consistent contact with executives at companies they are interested in purchasing. “Even if an ideal prospect told you ‘no interest’ six months ago,” he adds, “she will one day change her mind. Stay in touch and be there when she does.”

4. Research compatible companies. Once you’ve determined the strategic reason for an acquisition, you can develop a list of criteria for judging potential companies. The list might include such things as financial size, geographic influence, technical capabilities, and management experience. The best way to find companies that fit your criteria is to use your existing personal and professional networks. Talk to customers, call consultants, ask suppliers for references, and make inquiries at trade shows. “When looking for private companies to acquire, a lot of research comes by word of mouth,” explains Winters.

5. Conduct the necessary due diligence. Once you’ve compiled a list of companies that meet your criteria, the real work begins. Finding a company that would be a good fit requires careful investigation, analysis, and assessment. Some of the questions you’ll want to answer are:

What is the culture of the company? Is this a family-owned business where the boss knows everybody by name and policies are developed only on an as-needed basis? Or is this a professionally managed firm where business-minded employees follow strict guidelines and procedures? Is this a union or nonunion shop? How will this impact your company? What do suppliers, customers, and employees think of the company? What is the existing technology base? How broad is the customer base? What are the financing arrangements like? Does this company have significant financial arrangements with banks or is it free of debt? Will the purchase of this company affect your own customer base? By merging with a competitor will it decrease the likelihood of a customer using your company as a sole supplier? “You want to make sure there is no cannibalization of customers when you bring two companies together,” Winters says. Why is the seller selling? Owners of small businesses often care about more than money when selling their companies to others. Discovering those concerns will help you determine whether or not the company would be a good fit with yours.

While much of this information can be gathered by talking to company owners, you’ll want to verify it with customers, suppliers, and, if possible, employees.

“The importance of due diligence cannot be overstated,” says Tom Horgan, former CEO of Maxwell Technologies Inc., San Diego. In the last three years Maxwell has acquired seven companies, growing from 550 employees and $101 million in revenue in 1996 to 1,200 employees and $179 million in revenue today. “The true test of a solid acquisition strategy is the ability to say no, he says. “After establishing your criteria and researching a potential company you should be able to know for sure if a deal will work or not.”

6. Acquire an accurate valuation. Obtaining an accurate valuation of a company is not something you should do yourself. An investment banker, CPA, or appraiser should be retained to help with the valuation process, even if the seller has already determined an asking price. Even though you’ll want to seek assistance in determining the value of a business, you should learn how business values are determined.

According to Mercer there are six factors that are weighed in business valuation decisions. These factors are growth potential; risk/reward characteristics; alternative investments, which involve comparing private companies to publicly traded securities to determine a realistic alternative investment; the present value; expected earnings; and the underlying rationality of the markets as a whole.

7. Prepare your own company for growth. As you move through the acquisition process, you’ll want to be thinking about what the newly combined company will look like, and whether or not your company will have the ability to accommodate the increased capacity. “If you’re a $10 million company and you want to make a $5 million acquisition, you need to be thinking what a $20 million company will require two years from now,” Mercer says. When companies double, virtually every management, financial, and operational system has to change.

8. Have a business plan for integration. The work involved in acquiring another company does not end when the papers have been signed. In fact, the hardest work of all comes when it’s time to integrate the companies. “During the buying process everyone is on their best behavior,” Chestnut Hill Partners’ Schaye says. “But there is a big difference between dating and marriage.”

People who’ve been through the acquisition process a few times say that integration is made much easier when all the details regarding integration have been specified and agreed upon in advance. Questions that should be answered include: Will the selling company be integrated into the parent company’s existing structure, will it operate as a wholly owned subsidiary, or will it run as an autonomous business unit? What will happen to the management talent of the selling company? Will any department or functions be phased out of the existing company? How quickly will this occur? How many people will lose their jobs? Will they be offered assistance in finding new ones? How will salaries and benefits be managed? Who will be responsible for day-to-day business decisions?

While technical and operational details like these can be managed with relative ease, it’s much harder to deal with the cultural integration of two companies. The process can be made much easier, however, if you purchase a company that has similar values and operating styles.

“When we purchase a company, we make it clear that our culture will predominate,” explains Rick Travis, vice president and general manager of ATS’ computer services division. “We don’t focus on integration. We focus on assimilation. By thoroughly assessing companies upfront we make sure that we are buying companies whose cultures are already similar to ours.”

9. Communicate. Even if you have acquired a company with a similar culture and developed a rock-solid plan for integration, employees will be nervous about the merger. The best way to manage the uncertainty is to communicate completely and often. “The second we sign a deal, I make myself available at the seller’s workplace to answer questions,” ATS’ Blaudow says. “My HR and operations people are also there to provide face-to-face communication. Furthermore, we instantly link employees at the company to our intranet and internal e-mail systems.”

It’s also important to maintain extensive communication with customers and suppliers — not just after the sale has been complete, but during the entire acquisition process. “In the past, we did not manage customers expectations well and we learned that customers can drop off quickly if you do not stay in touch with them,” Blaudow says. “The customer might have been very loyal to the selling company, and if they don’t know ATS they might not transfer that loyalty to us.”

10. Don’t be in a hurry. Looking back over the last six years of acquisition activity, Blaudow says the number one lesson he has learned is not to be in a hurry. “When you [are] in a hurry you hear what you want to hear and tend to overlook things,” he says. “I did this during my first acquisition, and I’ve since had to close down the company because it was not a good fit for us. Now we have a very extensive due diligence checklist for all aspects of a business we are considering.”

How long should an acquisition take? “We’ve done acquisitions in weeks, and we’ve done them over a period of several months,” Maxwell’s Horgan explains. “It varies a lot.”

But Horgan and other small-business executives with acquisition experience agree that regardless of how long an acquisition takes, now is a good time to consider one. “Many entrepreneurs have been building value in their businesses and are looking for an exit,” he says. With the right timing and approach, your company can provide that exit opportunity while also adding to your company’s growth potential.

Paul Schaye, Investment Expert Financing Your Business

Q&A with Paul Schaye

AmexVoices: We are delighted to have with us tonight Paul L. Schaye, a founding partner in Chestnut Hill Partners, a boutique investment banking firm in New York City. Having spent 22 years in investment banking and management consulting, he can offer considerable insight on how small businesses can position themselves to take advantage of the tremendous financing opportunities that exist today, even after the April stock market correction. For many entrepreneurs, finding startup and growth capital is an incredible challenge because they don’t have much experience in that area. If you’re looking for advice on how to make your business more appealing to investors, you’ve come to the right place. . Send your questions to Paul Schaye. You can also read Paul’s advice to other entrepreneurs in the Answer Men column, which appears Monday and Wednesday on www.FSB.com. You can find Paul at www.chestnuthillpartners.com Welcome, Paul!

Paul Schaye: Welcome everybody to the chat on Small Business. This is Paul Schaye in New York City, I welcome you to ask questions with respect to financing your business, exit strategies and opportunities for growth.

Paul: I am interested in starting a business. I would like to know what steps should I take to get the process going.

Paul Schaye: Well, I think the first thing you need to do is decide the business plan, and there are some very key steps to think about in terms of what factors are going to affect your sales. How do these factors interact in terms of competitors? How are you going to pay for the business – how are you going to capitalize the business – is very important. Before you start a business it’s always good to test it. See who else is doing it. It’s a lot easier to copy someone than to reinvent the wheel. When one is starting a business one should be patient.

Jet: I just heard of a book called “Rich Dept, Poor Dept”. Are you familiar with it, and if so what do you think of it?

Paul Schaye: No I’m not familiar with it. There are books I highly recommend for people in business. One is “Built to Last”. Another book I think is important is “Word of Mouth Marketing.”

Beffie: How can entrepreneurs interest investors in their business ideas?

Paul Schaye: That’s an excellent question. The most important thing is to think of yourself as positioning your business to be sold. You want to come with a very strong strategic plan of how you package your business. So if you think of selling your business, package it well. That is, you should clean up your financial statements. Make sure you have 3 to 5 years of audited financial statements available. If you’ve down-played your profits for tax purposes, you’d want to address that. Also, you want to clean up your financial statement so that personal expenses aren’t running through the business. You want to physically improve the looks of the facilities. Pay down debts if you can. Very important when selling your business is to document your business process. What I mean by that is many entrepreneurs have a tendency to put all their time and attention to growing their business, as opposed to documenting procedures. But many buyers will expect you to produce a business manual that details how your business runs. So it’s very important to take the time to document all the steps involved in your business cycle, your design processes, ordering processes, manufacturing, shipping, mails, billing, customer service, etc.

Locklear: I want to sell some of my multimedia collage work as well as my woven work. What would be a good way to start out doing this?

Paul Schaye: I don’t know your business or collage work, but what is the channel of distribution used by other people in the same business? If it’s a cottage industry such as crafts, maybe a flea market might be the appropriate channel. A trade show of some type might be a possibility to gain exposure.

EZGuest: what sort of sources are there online for information on getting funding?

Paul Schaye: The markets are not efficient to allow for funding through the internet for businesses, as opposed to getting a personal loan for auto loans or mortgages. The amount of monies that are generally available for business loans are greater than someone would want to trust on a CRT.

AriesRising: How is it best to start a consulting business?

Paul Schaye: Again, it’s the same way you start any business. You have an excellent business plan. Identify your target market, your network. You create promotional materials that differentiate you from someone else. And think of yourself as a consumer product. Positioning yourself, promoting yourself, pricing yourself as a product.

Mauricio: Hello Paul. I just attended the Latin Venture Conference in Miami. One of the hottest questions that were made to VCs was if they are looking to invest only in companies that are already up and running – it seems this is the positions of all VCs after the crash. What is your position?

Paul Schaye: I think generally that people want to invest in something that has an ongoing enterprise. A company that is already executing in the market place. There are a lot of ideas in the market place but very few people execute them well. And because of the volatility of the marketplace, both public and private, investors are leery of green start ups. With one proviso if a person has done it before, and is an offshoot of something that’s already been done successfully, then monies are available.

Valerina: What do you think of all the money investment bankers threw at internet companies like the breakfast cereal portal? Do new internet startups have a harder time since the market correction?

Paul Schaye: Absolutely! I think there are multiple components of the internet/e-commerce. One is the business to consumer, also known as B2C, has shown very little legs. The other side of that is business to business, or B2B, has done reasonably well, but that too will see a shake-out as we go forward. The other side of e-commerce which investment bankers have thrown a lot of money at is the infrastructure, also known as the plumbing, of the Internet. That will continue to prosper and grow.

Curious1: What are warning signs that would cause you to stay away from investing in a business?

Paul Schaye: Sales trends. There are 2 issues, top line and bottom line. If the top line is declining, that’s a red flag. If the top line is not declining, but the bottom line is declining, that’s another red flag. Management flight is another red flag. Constricting markets such as a company that is selling buggy whips, the market could be declining. You go back to basic fundamentals of looking at any business – sales down, earnings down, debt up.

Mauricio: Regarding the question on how to start a consulting business, I will add, how to decide on what to consult?

Paul Schaye: What’s your core competency? Establish it. ‘cause you can only teach what you know. Join professional organizations that support that core competency. Networking is an excellent way for consulters to start businesses.

Andrea: How did you become a venture capitalist?

Paul Schaye: What we do is, we are really financiers. It’s not a question of venture capital. We provide capital to later stage companies. We do look at a lot of venture capital opportunities on an ongoing basis.

DrRevenue: Paul, are most VCs only interested in ventures that can go public within a few years?

Paul Schaye: No. Exit strategies have changed now and many times, because the market has been so volatile, the exit strategy could be selling to a strategic buyer, a financial buyer, or the public markets.

EZGuest713: Are venture capitalists continuing to fund companies like Napster, where the model is to undermine the ability of content creators to maintain their copyrights?

Paul Schaye: Well considering today’s ruling, I think it’s questionable. More importantly, investors will fund viable businesses. No one is looking to undermine the integrity of another company.

Kat: Are there any business sectors where it is especially hard to raise capital?

Paul Schaye: It all depends on the business cycle. Currently, because of the abundance of semiconductors, it is hard to raise capital for semiconductor businesses at the same time, it is hard raising capital for classic rustbelt businesses. It is an ever changing landscape, and as of as short as 4 months ago the dotcom craze had everybody’s attention. Today you see Amazon.com being downgraded by analysts.

EZGuest: What sort of companies should I be partnering with to position my business properly?

Paul Schaye: You should partner with those businesses that have some synergy with yours to support your business. If vertically integrated that can support your supply chain of distribution, or horizontal in terms of adding a product line such as complimentary products or a complimentary sales force.

DebbieD: How much of a business should an entrepreneur be willing to give away to investors in exchange for funding?

Paul Schaye: That’s a great question. It’s such a wide range because there’s a give and a get there – what you’re willing to give up depends on what you’re going to get. Sometimes if you give up a lot at the beginning you have a big bite of the apple, but the apple is actually worth more later on. What you decide to take for your business is what you think it’s worth not, but more importantly, what you think it will be worth later. And most importantly, creating a win-win for everybody involved.

Ghector: Given today’s market, have your investment criteria changed for Internet companies?

Paul Schaye: Yes. It has to be proven, as I tried to address before, the B2C dynamic is not as attractive as it used to be. The Internet and the new economy is going to change the dynamic of business. The attention towards the B2C is definitely waning and the reason being that the barrier to entry is very low. It’s important to look – you’re gonna see that in different types of products – how will the Internet affect getting money. You can now buy insurance over the Internet. We’ll see consumers with the ability to get their car loans, their insurance on the Internet. There will be some segments radically affected by the Internet.

FillMore: How can an entrepreneur tell when it is time to take a company public?

Paul Schaye: You have to see if the markets are receptive to that type of business. Recently we have seen companies with sales in excess of $500,000,000 languishing in the market because there is no interest in that industry or segment. So going public is not the panacea it used to be. You can have some companies with no profits and no sales doing very well in the public markets, and you can have billion dollar companies again languishing.

Mauricio: How do you see B2B startups? Would you invest in their businesses (or ideas!)?

Paul Schaye: There is an interest in B2B, it depends on who is behind it – is there an existing business foundation. The Internet is an enabling tool to move things through the market place. B2B is strictly a way to move product more efficiently that is already being exchanged.

Hank: What method is the easiest to find risk capital?

Paul Schaye: There is no easy method. Go to friends and family first. Those are the angels that you can address. If you have a track record, obviously it’s much easier.

MARV: What elements should every business plan have?

Paul Schaye: A mission, how it’s being executed, financial projections, marketing, competition, who’s going to be running the business. Go to the library and there’s great resources on writing business plans.

Bels: If an entrepreneur lacks contacts in the business world, how can he or she build them in order to obtain capital?

Paul Schaye: If there are industry conferences, if there are trade groups, trade shows, chamber of commerce, small business administration. Simply going to the yellow pages and picking up people who are doing it. People like to talk about their business – pick up the phone and talk about their network.

Locklear: What is the best way to get out of debt?

Paul Schaye: Generate cash flow from your business and pay it down. Look at what type of debt it is, and see if you can convert some of that debt to equity.

GetMyGoat: In your opinion, what causes so many small businesses to fail?

Paul Schaye: Undercapitalization. What that translates to is unrealistic expectations as how long it takes for the business to sustain itself.

Katrina: Are there any common characteristics you’ve observed that are shared by businesses that succeed in the long haul?

Paul Schaye: Yes. That’s a great question. Excellent management, strict execution of the business plan, and sticking to their core competency. Also, being flexible enough to recognize that change is imminent. Focusing not on competition, but focus on beating themselves and always, constantly improving what they are doing.

Miss Q: Okay, no friends or family with free capital like that, so where next to look for a small one person business?

Paul Schaye: If you are a minority, there are minority funding, grants. Some people have financed their business on their own personal credit cards.

LYNN: What entrepreneurial businesses today are run in a way that you admire?

Paul Schaye: Well, you know, let’s look at those business that have been very successful that you think of as big business, but operate as an entrepreneurial environment. 3M runs an entrepreneurial environment – a very visionary company. Corning went from a glass company to now in high technology. Granted these are public companies, but they all started at the roots of an entrepreneur.

Valerina: What are the key factors you look for in selecting businesses for investment?

Paul Schaye: Strength of the management team. Sales history. Market niche. Prospects for growth.

Scoop: What can the government do to help me with my small business, financially?

Paul Schaye: The government can support you with market information, can support you with the Small Business Administration, with subject matter experts, and in some cases, if you’re a minority, start-up capital for funding. And depending on your business, there could be tax credits available to you. And government is just not federal, there are city and state empowerment areas available.

Teri: If I would like to start my own business, how would I get investors/backers to listen to me? I’m sure they hear from LOTS of business hopefuls. How do I stand out

Paul Schaye: Develop a very concise and defensible business plan and differentiate yourself from other people seeking money.

Nickel: Would you be willing to invest in a brand new dotcom company, or has the bubble burst?

Paul Schaye: Depends on what the dotcom is. If it’s a B2B, a lot of people are waiting on the sidelines waiting for the shake out.

Investr: How can a small business owner determine how much money to raise during an initial round of funding? Is there any formula?

Paul Schaye: There’s no formula, but as with any budgeting process there are ongoing operating capital requirements, and then there are growth capital requirements. You need enough capital to support the business through the start-up phase, to the point where it can stand on its own.

StartUp: Some investors are more helpful to entrepreneurs than others. How can small business owners spot the good guys?

Paul Schaye: I think you have to use the same diligence as you would in identify who your doctor, lawyer or banker is. Establish their credibility, their credentials, and most importantly, their references.

Misty: Which way do you think the market will go for dotcoms this Fall?

Paul Schaye: As I mentioned before, dotcom is really bifurcated in 2 segments B2B and B2C. The B2B is projected to do very well on an ongoing basis. The shake-out will happen at the consumer level, also known as the B2C. It is anybody’s guess which ones are going to survive.

Mombo: How should I start investing for the future, since I have just recently started living on my own?

Paul Schaye: Since I’m not an investment advisor I’m not a good person to ask.

ASKAmexVoices: Thank you Paul! This has been very informative and helpful. But sadly we are almost out of time, any last minute advice for us?

Paul Schaye: Businesses succeed when you have a disciplined, focused approach. Stick to your core values. If you do, you’ll do well.