Equity: Risks, Types, and Sources

Last week we discussed the risks, types, and sources of debt for business owners exploring the sale of their business. The biggest risk around using debt in a transaction, as we have seen in the private markets lately, is that it is contingent on the lender's ability to provide funding at the time of close. This risk is reduced as more equity is used to fund a purchase. This week, we'd like to examine various sources of equity and the differences between types of financial sponsors. 

Typically, financial sponsors can be broken down into four groups: private equity, fundless sponsors, search funds, and permanent capital sources. Each type of buyer comes with different sources of capital, different time horizons, and different leverage profiles, so it is important for sellers to think about what their ultimate goals are when considering selling their business. Looking for the highest possible payout up front? A firm that uses tremendous amounts of non-recourse debt will likely win the bidding war. What about sellers who care about the business’s health post-close? All things being equal, a buyer who employs less debt or no debt would be a better choice.

Certainty of close always matters, so it's important to note where each group sources their capital, both debt and equity, and what type of leverage they will employ. During economic expansions, capital flows are strong and transaction risk is lower. Said differently, when it’s relatively easier to procure both debt and equity, certainty of close is less of an issue. But during tougher economic times, like we’re in today, being able to close is far more important than the price or the terms. Without the ability to close, nothing else matters.

Traditional private equity groups are largely dependent on their lenders to finance levered transactions. Search funds are beholden to their limited partners to commit additional capital once they have identified an attractive acquisition target, and often employ meaningful amounts of bank debt. Fundless sponsors, by definition, need to source both equity and debt for each transaction. 

But the final group - permanent capital sources - have cash equity ready for investment. At Permanent Equity, we don’t have to source capital, equity or debt, to close a transaction. Our funds are committed and available, and we rarely use debt. In good times this allows for speed of close and greatly reduces headaches for sellers who normally must get “checked off on” by the buyer’s investment committee, outside accounting firm and law firm, and lenders. In challenging times, it means we’re one of the few groups that can close a transaction. 

Private Equity Sponsors
- Large number of Limited Partners commit capital to a fund which is deployed into operating businesses
- Typically use moderate to high levels of debt mixed with low to moderate amounts of equity
- Holding period ranges from 1 to 7 years

Fundless Sponsors
- No committed equity behind the individual(s) or group looking to acquire a business
- May have a plan to hold the business long term, but most likely will look to sell to harvest their investors' capital 
- May or may not want to operate the business, and may be looking to simply purchase the business with existing management or provide new management post-close
- Typically uses moderate to high amounts of debt, as well as seller financing

Search Fund Sponsors
- Have intended, but not committed capital from typically smaller limited partners including family, friends, and family office capital
- Will typically operate the business post-close
- Typically uses moderate levels of debt to fund the transaction and may ask for seller financing
- Small number of Limited Partners who invest with the 'searcher(s)'

Permanent Capital Sponsors
- Family Offices, conglomerates, permanent capital investment groups
- Typically have longer time horizons and are able to fund transactions with cash equity and little to no financing risk, although style is buyer-dependent

Supply studies syllabus - a primer on the logistics industry (Supply Studies)

+ "This document, intended for collaborative iteration, presents a series of readings in areas of interest to the critical study of logistics. It begins with an opening “Stage Setting” section and continues on to topics in: Logistical Media; Mining and Extraction; Production and Assembly; Shipping, Storage, Distribution; Speculations on Supply; Activism and Resistance; Logistical Histories; Commodity Communications; Migration, Mobility, and Movement; Corporations and Capitalism; Computational Production; Infrastructures and Spaces; and Consumers and Consumption. The goal is to present a broad selection of texts from which more specialized seminars can be developed, or which could be incorporated into other courses."

Ben Thompson on competition and niches in the internet era (Stratechery)

+ "Again, though, the fact that this is a one-person blog doesn’t mean that my competitive situation is any different than that of the New York Times or any other media entity on the Internet. In other words, to the extent that the New York Times has been successful online — and the company has been very successful indeed! — it follows that the company is well-placed in terms of both focus and quality, and in that order."

The looming bank collapse (The Atlantic)

+ "Just as easy mortgages fueled economic growth in the 2000s, cheap corporate debt has done so in the past decade, and many companies have binged on it."

COVID's impact on ad pricing (IAB)

+ IAB takes a look at the recent impacts on ad pricing for programmatic ad sellers and ad publishers due to COVID-19.

Expect store closings to soar throughout the rest of 2020 (Coresight Research)

+ "According to its recently released U.S. Store Closures 2020 Outlook, Coresight predicts that from 20,000 to 25,000 retail stores will close in 2020. The midpoint of that range — 22,500 closures — is a significant jump from Coresight’s previous estimate of up to 15,000 retail store closures. Not all retail sectors will be hit equally hard, though. Coresight predicts that about 55 percent to 60 percent of all store closures this year will be mall-based."

42 million jobs are supported by the American Retail Industry (National Retail Federation)

+ "Anyone whose job results in a consumer product – from those who supply the raw materials to factory workers to the truck drivers who deliver goods to stores – counts on retail for their livelihood. With 3.6 million stores drawing on a vast array of suppliers, retail supports 42 million jobs and represents $2.6 trillion of annual GDP in the United States."

Recruitment in the age of coronavirus (Yello)

+ "Even without COVID-19, candidates are looking for organizations with cutting-edge technology. A Yello survey revealed that one-quarter of Gen Z job seekers prefer to communicate digitally. More than half responded that they would not apply to a company if they considered their recruiting methods to be outdated. A Yello client, BDO found using pre-recorded video interviews helped them screen twice as many candidates in less than half the time: saving as much as $1,000 per candidate."

Forrest Fenn confirms his treasure has been found (Santa Fe New Mexican)

+ "An estimated 350,000 people have hunted for Fenn’s treasure. Some quit their jobs to do so. But it’s had deadly consequences. At least five people have died while searching for the chest."

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