Less Leverage Has Little Local Impact

September 24, 2007
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RAND RAPIDS — While the turbulent credit market is slowing down investors' ability to leverage transactions, the resulting market changes could be an overall benefit for private capital sources operating in the local market, leading to fairer valuations and higher premiums.

"I think the market is full of lather right now and it's going to fall off soon," said Tim Masek, principal of private equity firm CODI Investments LLC in Grand Rapids. "With the credit markets acting so differently than what they were six months ago, things are tightening up, and deals that were announced earlier in the summer are all of a sudden finding they can't get the transaction financed today."

Last month, for instance, Home Depot was forced to provide a nearly $2 billion discount to a group of private equity firms acquiring its wholesale distribution business. The acquisition of Big 3 automaker Chrysler by Cerberus Capital Management hit similar snags.

Banks are becoming much more conservative in terms of advance rates and the percentage of equity that can be leveraged, explained Masek, whose firm recently invested in a Texas-based maker of energy drinks and chewing gum. The increased scrutiny is already having an impact on larger and medium-sized deals, and, anecdotally, there appears to be hesitation among investors in the smaller transactions more commonly seen in West Michigan, but not enough to create a measurable impact.

"Certainly those investment managers (who) were looking to take advantage of the ability to borrow money are feeling that impact," said John Meilner, managing partner of Bridge Street Capital Partners LLC in Grand Rapids. "From our perspective, it's had no impact whatsoever."

Launched in 2004 by Grand Rapids businessmen George Jackoboice, Mike Jandernoa and John Kennedy, Bridge Street Capital has not leveraged any of the five companies in its initial $41 million fund. The credit market has not slowed it down whatsoever: It has hopes to close on two acquisitions in the coming month, and if all goes well, could begin raising capital for its second fund in the near future.

"I think it's a positive," said Masek of the credit crunch. "It depends on whether you're a buyer or a seller. The biggest obstacle in any transaction is making sure that people have realistic expectations of what their businesses are worth. When the banks are loaning money hand over fist, people can spend like drunken sailors, and all of a sudden valuations go up. … There was a lot of easy money out there, and that's being pulled back."

As such deals are, by and large, private, it is difficult to measure how many private equity transactions occur in West Michigan in a given year. There are only a handful publicly reported each year, and it is sometimes difficult to distinguish between these and normal ownership transitions. Last year, Southfield private equity firm Wind Point Partners acquired then publicly traded Knape & Vogt. Masek's former employer, TMB Industries, acquired Grand Rapids automotive supplier Miller Industries last year. Earlier this summer, Milwaukee-based Mason Wells acquired fourth-generation Grand Rapids manufacturer Oliver Products.

There has certainly been no decline in investment opportunities, Masek and Meilner agreed, with several buyout offers on any given day. Meilner expects an additional surge in opportunities over the next few months, as historically business owners seek to exit ventures immediately before and after the New Year. He said that Bridge Street — which seeks small to medium-sized companies with strong management, growth potential and a defined exit strategy — has the luxury of being choosey.

"There are quite a few deals in the market looking for capital," said William Kleven, founder of DaVinci Capital in Cascade. "There are always more entrepreneurs in West Michigan who want money than there is capital available, and not every company qualifies for private equity financing."

DaVinci Capital represents businesses seeking capital in a range from $250,000 to $5 million. Past clients include NuSoft Solutions, RFIDentics and Surge Medical Solutions. The firm has also worked with local angel investment group Grand Angels.

"I haven't seen much of an impact from the credit market or the stock market," said Kleven. "Generally, if you feel richer you're more likely to make an investment, but I think the thing that keeps interest in this type of investing is that it offers a higher return than they might be able to get in the public markets."

Kleven's clients are more likely to seek venture or angel capital investments as opposed to private equity acquisitions, which are more common for established, lower-risk companies, usually as an exit strategy. Candidate companies are early-stage ventures with novel technology or an otherwise unique business model. Companies in the life sciences, technology and advanced manufacturing fields are particularly popular among these investors. In a successful venture, investors can expect up to a 50 percent return on investment.

"It is expensive money," Kleven said. "So a business has to have high growth potential."

The venture capital market should see significant gains as leveraged transactions become more difficult. Already, venture capital is at its highest point since the dot-com era. Venture capitalists invested $7.1 billon in 977 U.S. deals in the second quarter, according to the PricewaterhouseCoopers/National Venture Capital Association MoneyTree Report. Of that, the Midwest saw $295 million in investment in 47 deals — $96 million of that was invested in eight biotechnology ventures.

The market is on track to eclipse last year's total of $26 billion nationwide, the highest total investment since 2001, the tail-end of a 500-percent downturn to end the dot-com era.

Venture and angel capital firms prefer to invest locally, Kleven explained, and, with far fewer investors in West Michigan than Silicon Valley, Manhattan or other major entrepreneurial centers, the local market is dominated by a select number of familiar faces.

"It's a quietly competitive market," Kleven said.  "If you're talking with an investor, they're going to have other people approaching him or her about other investments at the same time — a real estate project, a new restaurant, another one of these young technology firms — and the competition makes everyone better."    

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