In Reel Time

2010.47 Inside Job screening and my review

What should have been an important movie is marred by a slanted and biased attack.

First, thank you to The Wrap for inviting me to a screening of Inside Job (click Inside Job for webpage) last night in Sherman Oaks. And thank you also to director Charles Ferguson for speaking about the film and answering questions after the screening.

I wasn’t able to articulate the question I would have liked answered last night but now can: Why lose such an important message in mean spirited and malicious attacks?

The movie starts with some quotes from finance professionals and commentators that set up the audience for the tone of the movie. I’m okay with that; the documentary needs a mission statement and this one’s is clear from the beginning.

And the first half or so of the movie is great. A lot of these questions should be asked and the answers exposed. Many Wall Street and other firms did a lot of questionable things during the time frame covered and the public deserves answers. Ferguson spares no administration from Clinton, to Bush, to Obama…which I admire. He treads softly around certain governmental participation in the factors leading to the bubble then skewers them in others. For example, when regulating derivatives was proposed, the poor lawyer who suggested it was attacked from industry and government both. Ferguson’s clips of executives from various firms evading questions, even very direct ones, while in front of various government panels is painful to watch. Sure, answering some questions honestly exposes your firm to potential liability but a certain level of ethics and acceptance of responsibility when presented with facts would have been reassuring. The lead up to the financial crisis is informative, concise and understandable.

The film’s photography and imagery are beautiful. Technically the film is lovely. It follows a coherent narrative flow and explains complex issues in a way understandable to many. I especially loved the sweeping aerial shots of Manhattan. Ferguson is a very skilled film maker.

Ferguson does get a few facts wrong – for example, while Wall Street CEOs earned high numbers, much of this compensation was in the form of stock, deferred comp and other illiquid (in the short term) payments…and in some cases was only paper money that melted away during the financial crisis. And he also makes a few puzzling arguments (the increasing distribution of wealth to the top 1% of the population may be relevant when analyzing the financial meltdown but he doesn’t explain the tie…which makes it puzzling). I can forgive him these points; he is clearly using facts selectively to support his mission statement. Ferguson doesn’t owe us a fair minded portrayal…he’s been clear from the start in defining his agenda.

But Inside Job veered off course completely when the personal attacks began; both in not substantiating them and in the mean spited way many interviewees were attacked after agreeing to speak (leading questions with no answer being shown on film, accusations, assumptions…). I was puzzled when he criticized professors who had advised and been in government for getting paid for their work and public speeches (and, in like spirit, is Ferguson getting paid for the documentary or any related paid speeches he is asked to do?). Economic theory is just that – theory. Only in actual application can we see if it will work. I don’t understand why academic economists shouldn’t do advisory work inside or outside government.

And having Elliot Spitzer as a moral high ground making indirect accusations/innuendos about prostitution and sex in the industry seems bizarre. First, I have my own issues with Spitzer as I believe his actions directly contributed to the financial meltdown. Next, his innuendos are tied in with direct (but unsubstantiated) accusations of rampant drug use and prostitutes as a part of Wall Street culture by a madam and psychologist with “Wall Street clients”. With no direct information just sweeping statements the tactic appears to be a trick meant to deflect from the real issues and just smear the industry.

Interestingly, Ferguson uses interview clips with Raghuram Rajan, who wrote Fault Lines and was at the IMF during the time in question and warned of the risks, to support his argument. Yet Rajan’s excellent book is more moderate and realistic and much more powerful than this biased movie.

The question and answer period after the film revolved around a wall street bashing free for all so Ferguson clearly found his audience last night. Too bad he didn’t aim for a serious discussion of the issues instead of sensationalism. I thought the first half of the movie was excellent and was disappointed with the ending. Perhaps that’s what it takes to get big studio support in this day and age. But, I wonder if, had his viewpoint not been pre-determined and antagonistic, he would have gotten access to a broader range of key potential interviewees and been able to provide a more rounded picture.

That movie is still waiting to be made.

2010.45: 17 words not to use in a business plan

We’ve all heard them – the words that make us cringe. Worse than that, I can tell a few lines into a business plan (offering document, etc) that the related company doesn’t “get it” (oh, and, don’t use quotation marks like I just did – too cute). The below words don’t sell your story and may end up doing the exact opposite.

1. “Next big thing”. Please, someone give me a dollar for every time I’ve seen or heard that one and I’m retiring. Proof on that is in the numbers: show me traction in building your business and I’ll see it. I’ve known people that built the next big thing and they were always too busy working (and scared of competition) to boast along the way.

2. “Bigger than Facebook”. Or Google. Or pick your company. Please never compare yourself to or value yourself off the best winning companies. Ideas are comparatively easy; implementation requires real work.

3. “Game changer”. Life (or business) isn’t a game. I don’t know what this means.

4. “Guaranteed”. Then why are you sharing the opportunity?

5. “Paradigm shift”. Again, I don’t know what this means or why it matters. Proof on this one is in the implementation. Paradigm shift was the PC or browser. You?

6. “Next level” (or “next generation”). Is that necessary?

7. “Unique”. Not a big offender in my book but I’m probably in the minority. Everything and nothing is unique. The word is overused.

8. “Unparalleled”. Um, no.

9. “Ad supported”. Only? So, I heard that in the late ‘90’s and I’m hearing it now. What changed (other than Google is the rare company to make it work well)?

10. “Viral marketing”. Works wonders in the gaming world but where else today? Define what you mean but don’t use the term unless you really understand it (at which point I’m okay with it).

11. “Free”. Ouch. Ad supported? Explain to me how that is working not that it will?

12. “Really”, “very” and “a lot”. No.

13. “Opportunity”. No thanks. Opportunity is easy; explanations (and monetization) matter more.

14. “Leader”. To where?

15. “Best” and “top”. Says who? You? No. Prove it; don’t say it (if you were there you wouldn’t need to look for money – it would find you).

16. “Great”. See 15.

17. “Solution”. Okay, if you can walk me through it, I’ll follow it. Otherwise, you aren’t saying much.

Reality: when you are pitching an early-stage opportunity, you are also pitching yourself. If you are talking to quality investors, most of the above words don’t tell them anything about your business. But they do tell the investor something about you – you are prone to exaggeration, to vagueness, to hype, to lack of depth. Those words are setting you back.

2010.43 Business valuation: the intangibles

Business valuation is – at its core – essentially numbers driven and many models exist. For indications of value, we can look at comparable company valuations either based on the price of publicly traded stock (adding a premium for liquidity) or a recent fundraising valuation for a similar company. We can use a discounted cash flow model, looking at future expectations of a company’s free cash flow and applying an appropriate discount rate. LBO (leveraged buyout) models, liquidation analysis and industry parameters (number of stores, etc.) can also be analyzed. All of the resulting valuation numbers or ranges can then be aggregated and a reasonable valuation based on the range can be estimated.

The models above are somewhat driven by company projections of future results; as is valuation. A company growing quickly and more profitably will be perceived as having a higher value than will a slower growth (and less profitable) one. Yet, valuation indications are only as good as initial assumptions and projections are often wrong. They also don’t add in surprise events.

What ultimately won’t matter much: the last round valuation (ask anyone who has ever done a down round or been de-listed from an exchange for not maintaining a share price as per exchange rules), unsupportable management or shareholder expectations and the valuation of a high profile, heavily pursued company.

Other less quantifiable factors also need to be considered in any business valuation exercise.

1. How much cash you have left and your burn rate. If a potential investor can figure out that you are out of cash (or when you will run out of cash and it’s soon) your valuation will be lower.
2. Whether you are cash flow positive; the quality of your customers and how concentrated they are.
3. Management: quality, proven results, how well the team presents, their experience and how well they are respected.
4. The market size for your product.
5. The company stage (product completed, customers, revenues, profits, etc.).
6. Growth rate of revenues and EBITDA.
7. Margins.
8. Competition, and how well funded it is.
9. The overall market – in 2009 fundraising valuations plunged in part due to the much lower public company valuations (with private companies having a harder time raising money; public companies were trading at what was traditionally lower private company valuations but with added liquidity).
10. The availability of credit. Financial buyers generally need to leverage a purchase; if credit isn’t generally available they can only afford pay a lower multiple (to make the requisite return on their investment).
11. The general confidence level of investors – with the current VC market being more conservative due to ten years of negative industry returns, concerns about continuing to fund – or save – existing portfolio companies and less money being raised.
12. How crucial a component you or your product is to a potential buyer or their competitor.
13. How scarce and desired what you offer is.
14. How much interest there is in your industry.

Certain of the above factors are less quantifiable yet are ultimately very influential. Realistically, all of the above factors impact valuation. Investment bankers always aim for the best valuation for their client. But we, like the rest of the world, are subject to market realities. The process you pursue and the quality of your deal team does help determine valuation.

2010.42 ESOP: an alternative to a traditional company sale or outside investment

An ESOP is a tax qualified retirement plan in which the ESOP becomes a shareholder of the company and also provides retirement benefits to employees. Unlike most retirement plans it can borrow money to buy company stock while also providing tax benefits to business owners selling stock to the plan. Essentially, in a leveraged ESOP the ESOP or its corporate sponsor borrows money and provides the lender with a guarantee that it will make contributions to the trust enabling the trust to pay back the loan on schedule. Related Internal Revenue Code provisions include 1986 provisions Section 401(a), Section 4975(e) and Section 407(d) (6).

As a defined contribution plan the ESOP must comply with certain requirements. It must meet minimum eligibility and participation levels. It must be non-discriminatory with respect to highly compensated employees relative to those not highly compensated, and meet related limits on contributions. It must be designed to invest mainly in the company’s securities . The purchased stock is held in trust to be released to employees over time. For existing shareholders the plan provides liquidity and a favorable tax treatment when the ESOP buys over thirty percent of the company’s shares. As stock is vested to employees the company gets a tax-deductible compensation expense. Thus existing shareholders can cash out and other employees can purchase company shares. This structure is an alternative to an outright sale of the company and especially useful where the founders or other shareholders want to achieve liquidity while other shareholders want to retain or expand their ownership (but can’t necessarily fund the related share purchases upfront).

Investment in the company’s securities, should, on balance, be over 50% of the holdings. Permissible securities are typically most classes of public and private stock (the latter subject to voting right and dividend preference requirements), with certain debt sometimes making the grade. An independent appraiser must value the securities once a year. The securities of S corporations qualify but the sponsor loses certain tax benefits (and state law must be checked: California, for example, imposes a 1.5% income tax on all S Corporations).

If the requisite conditions are met, capital gains on non-publicly tradable stock of a C corporation can be deferred or permanently avoided. Since ESOP contributions are tax deductable, a corporation which repays an ESOP loan can essentially deduct principal and interest from taxes. And, dividends paid on ESOP stock passed through to employees or used to repay the ESOP are tax deductible if the corporate sponsor is a C corporation. If the sponsor is an S corporation, dividends can be used to pay the ESOP but there is no tax deduction (an S corporation doesn’t pay corporate income tax).
Typically annual contributions of 25% of eligible payroll are allowed, the funds being used to pay off debt principal and interest. Exception on interest payments (allowing them to be paid with contributions above the 25% above) exist.

A participant reaching 55 years old with at least ten years participation in the plan must be given the option to diversify his/her assets outside of the company stock. The percentage goes up over a defined period of years. The diversification can either be done within the plan or cash distributed to the individual for outside diversification.

Some common uses of ESOPS in ownership succession planning:
-Minority interest stock purchase in which only a minority of shares are sold to the ESOP
-100% ESOP leveraged buyout where existing shareholders cash out entirely

This explanation is a very simplified overview of a leveraged ESOP. Check with your advisors for specifics on the applicability for your company.

This data is based upon a more detailed piece written by lawyer Laurence A Goldberg, Esq. of Sheppard, Mullin in San Francisco. Feel free to email me for more information at jones@hadleypartners.com

2010.26 California elections June 2010: top ten things elections have in common with investment banking

Heading into our state elections tomorrow are a few thoughts on the truisms that cross politics and business (the advice we give our clients).

1. Study the numbers (especially projected numbers) because they may be based more on “best case” scenarios or hubris than reality

2. Management matters: competence, common sense, integrity, work ethic, leadership, empowerment and intelligence

3. You can write any business plan, management presentation or speech you want; results are quantifiable by, well, demonstrated results

4. You can’t spend money you don’t have

5. Marketing does matter; he with more funds may not win but he does have an edge

6. Negative campaign slurs by your opponent do hurt; protect and defend your reputation

7. You can fool some of the people some of the time but eventually the truth comes out

8. Confusing the issue leads to less predictable results

9. Being good at one job doesn’t ensure success in a different role. But adaptability across a broader career is an indicator that you’ve made such shifts before. Some people have demonstrated results in a variety of situations

10. Clarity of message is key; know and articulate your story. Keep it simple so voters (funders, employees and customers) understand it. Too many talking points clutter the message

Please vote.

2010.20 Digital Hollywood halftime highlights

Longer blog post to come … but after two (out of four) days at Digital Hollywood at Loews Santa Monica, a few comments, inputs, ideas and debates stand out so far.

1. The best comment of the show so far came from Paul Colichman, co-founder and CEO of Here Media, who articulated a core belief of his company, “If you make it too expensive or too difficult for consumers to get, they will steal it from you. So make it so that they don’t want to steal it for you. If they are going to steal it, make it from you and not someone else (so you can at least make some advertising revenue off it).”

2. My personal second favorite insight came from Kevin Yen – YouTube’s Director of Strategic Marketing (and at Google for years before that). After not answering many questions (to be fair, he was asked to provide some very specific, thus far undisclosed numbers – not something the representative of a public company can just do) he came out with a worthy insight. Asked about what he was surprised to hear so little covered in the press, he answered the inevitable interface changes that would occur when television and other content was delivered mainly (or increasingly) over the Internet. Deflected momentarily from the point, he then added a comment about social networks such as Facebook and other types of customization (so no Google search for a TV listing) perhaps forming a base for such interface.

3. A panel called “Beyond Avatar” discussing 3D was surprisingly unattended (after the 3D buzz at both ShoWest and NAB). The panel included John Ruby, AEG Live; Greg Foster: IMAX; Buzz Hays, Sony 3D; Angela Gyetvan, 3ality Digital; Chuck Comisky, 3D Stereo VFX Supervisor on Avatar; Keith Melton, director; Jonathan Dern, Cinedigm Entertainment Group; Jim Hannafin, Reliance MediaWorks; and Marty Shindler, The Shindler Perspective. It was an amazing panel and full of highlights. My favorite (and it’s so hard to pick) is that current screen capacity for upcoming movie releases is less than half the 10,000 needed. A second was that many of the technical production givens had to be thrown out with 3D because the visuals are so different (such as that you can’t break the plane since 3D has no screen plane).

4. Ross Levinsohn of Fuse Capital said that he loves advertising and ad based businesses. Media has been ad based in the past to the tune of $85 billion a year ($40 billion untargeted). That’s a lot of dollars to shift. The ad networks – centered around remnants – have destroyed the Internet.

I don’t traditionally like ad only supported business models (Google being, as always, the exception) but Levinsohn made a great point. No one can ignore the shift of so many billions of dollars spent (or discount it too much even if it doesn’t result in a dollar for dollar end game shift).

5. Sharon Waxman, Editor in Chief of TheWrap (which just raised $2 million in funding) said she realized network news was dead when she was interviewed in an over the top deluxe Beverly Hills hotel suite with cameras, lights etc. and asked the same type of questions she asks using her Flip video camera. End conclusion being true or not, she raised a good point.

6. With about thirty pages of notes in my pad I started asking people I met at the show what I should write about on the blog. Two recurrent answers: customization of the consumer experience (a crime it isn’t being done more yet) and that no one yet has figured out a working business model to monetize content (we bundle up a disparate bunch of revenue streams and hope it is a business model; at least now people have had some time to test what works and what doesn’t and some things seem to be working – even if only on a limited scale)

7. I prefer conferences in Santa Monica to those in Vegas (I live in Santa Monica).

More to come later in the conference and upon further reflection. These are the few immediate thoughts that stuck.

2010.09 To VC or not to VC

Why not take venture money? You don’t need to pay it back (well…), the VCs don’t initially get a majority stake in your company and the money removes short term cash flow problems allowing you to focus on your business. Association with the right VC adds prestige and validation. Where do I sign to jump start my business?

I agree that taking VC funds is a good way to grow faster – but you’d better be aiming for the moon.

VC’s frequently write about this topic (a good posting is by Mark Suster, who uses a rocketship analogy, at: VC post. What about the investment banking perspective, since we’re frequently asked about this topic and have worked with numerous VC-backed firms? Well, here goes…

First, can your company reach $100 million+ in revenues in a few years? Top of mind for any (good) VC is the potential size your company can realistically reach, quickly. Profitability is the next question. VCs need a big return on their investment and valuations depend on these core numbers. Venture capital is risky and many portfolio companies won’t make it. Risk and return do have a correlation and building a new company or a new industry is never a given.

Good ideas will generate copycat companies (ask Alta Vista about Google) or are already being implemented by someone else with intelligence, experience and connections (look at some VC portfolios and you’ll see a lot of duplication in company types). Your company had better have the potential for significant upside (future posting: key elements that signify such potential).

What’s a big return? Not a few times on their investment. Rather, think Facebook or YouTube. And both those companies ramped up in a few years time. Venture money isn’t for funding payroll, it’s for scaling quicker than any competitor, deep pocketed or not, can match.

Do you have an exit strategy? An exit strategy is either the sale of the company or an IPO. Investment bankers handle both types of transactions so I’ll sketch out the realities for both in the current environment. If your company is worth less than $15 million you probably won’t be able to hire an investment banker to sell the company and you’ll have to do it yourself. It’s very difficult to do.

Larger than that? Ideally you’ll get scooped up by a deep pocketed strategic buyer or private equity group. Regarding the former, I just read a great article on how the largest tech firms have a lot more cash than do their smaller competitors and they’re using it to buy other companies (knocking the competition out of the process). See Tech companies

That deep pocketed suitor concept does extend to media service companies and private equity groups. But to get a rich multiple today you better be ramping in a hockey stock pattern or be the missing link. Otherwise, forget it. Debt is hard to get and everyone is being careful with cash (corporations because they’re unsure about our economy and banks’ willingness to lend; private equity groups because many took big portfolio losses, are hoarding cash for existing and potential obligations and haven’t been able to cash out of existing investments as expected). Multiples are still down from a few years ago.

Indeed, if you want to read a case study of how hard selling a less than pristine company can be read about MGM with its James Bond franchise and decades of history – MGM story and for an update see MGM update

And, the IPO market remains down. Sure, it’s picked up from last year (which was down 90% plus from the years before). But the reality is that since Sarbanes Oxley in 2002 going public is limited to fewer, larger and stronger companies. Less than $100 million valuation? You won’t get good trading support, research coverage, many institutional investors and the burdens on management will be a pain.

So, VCs need a viable plan for your company to bulk up…

Fast. VCs run investment funds with an expected life (often around five years to invest their capital).
And I’ll repeat the profit concept. VCs get paid to return more (often much more is expected) than they’re given and companies which make money are worth a lot more than those who don’t (or can’t). If the fund doesn’t make money neither do they. Ultimately, VCs run their business for a profit too; if not they won’t be able to raise future funds.

Next, some VCs are under real pressure. For the first time since results have been recorded venture capital (in the aggregate) has had negative returns over the past ten years (after having outperformed most other asset classes prior). In practical terms that means most VCs are being careful and looking for companies which are less concept and more applied (and already a going concern).

Do you want to be your own boss? Then don’t take VC money; or, if you do, hold out as long as you can before doing so. Most companies don’t stop at raising one round of funds. Once you accept VCs investors you get VC board members who want you to scale the business fast. To do so, you’ll need more capital (hence more investment) and your stake and control of the company will get diluted further.

In an ideal situation, you’re Google but even those founders brought in a professional CEO – at the urging/demand of their VCs. Less ideally, you realize that your equity stake has been diluted such that your idea no longer belongs to you, nor do you have much control over the company. And, you could lose your job if your VC owners don’t believe that you’re doing it well. VCs also get a vote in a company sale. Trivia fact: Google and YouTube shared the same VC.

Practically speaking an idea is only the first step in building a company. Long term success is more about execution (ask Lotus or Netscape about Microsoft).

But if you believe that your company fits the criteria detailed above then the only way you’ll likely beat out your competition is by raising outside funds. Venture capital is probably your best option (later post: different types of money). Almost all companies that go public now either had VC or private equity backing, or they were the division of a large company. For a company in a billion dollar market, with a unique and proprietary product, a distinctive market advantage, strong management and clear growth and profitability potential VC money is the best option to grow quickly and beat out your competition.

Obviously, the above is a cursory summary of the issue … as befits a blog. Feel free to email me for more detail or company specific advice.

For more information about Hadley Partners Incorporated please visit our website.

2010.01 Without further ado, welcome to our blog!

As Polonius said in Hamlet, “brevity is the soul of wit.”  We’ll aim not to waste your time.  Exhibit A: we won’t introduce ourselves now.  If you know us, that’s great and thanks for visiting.  If you don’t know us, great to meet you and our biographies are one click away.  If you are here by mistake, exit is the last door on the right but stay a while and you might be glad you did.

Most of the time, this blog will live in the following neighborhoods (and at the intersections thereof):

• Media services – the hardware, software, system, application, service, equipment rental and related companies that support the content creation ecosystem (and the subject of our periodic newsletter also named In Reel Time, click if you would like to be receiving).

• Media, new media and technology – we may be media service bankers, but we know the media service companies and investors that we serve live in a landscape shaped by content and the technologies that create, distribute and manage that content.

• Financial markets, dealmaking and investment banking – our day jobs are as investment bankers.  We each have 20+ years of advising companies in connection with M&A, financings and strategic alternatives, that is the seat from which we watch the movie of business.

• Industry gossip – who doesn’t want to hear it from time to time?

We also reserve the right to comment on whatever we want, just as you reserve the right not to read it!  We like to think that we are interesting, well-informed people with thought-provoking things to say about other subjects too.  So be warned.  We will try to spare you posts about our kids, golf scores and other topics that are of vastly greater interest to us than they are to you.

We have added a User’s Manual for the blog that will give you some rules of the road and maybe answer a few questions that come up.

So on with the show, and we really welcome your feedback!  Please email David or Megan at any time, in response to these postings, in connection with business opportunities, or just to catch up.  And if you like what you see here, please tell your friends.

For more information about Hadley Partners Incorporated please visit our website.