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Misled business plans limiting Private Equity ROI on revitalizing older technology

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Today often Private equity groups raise capital for firms under three possible scenarios.  First, a new technology, second a small cap company which has gained traction and now needs capital to accelerate and lastly firms who require capital for an acquisition to expand their balance sheet seeking to change their valuation for shareholders for successive financing in the future.  On occasion, sometimes more often than one would believe, the latter is frequent among small cap firms who are seeking mezzanine financing by acquiring a losing firm with outdated technology. With these firms the usual M.O. involves several techniques, 1st using tax loop holes to re-appreciate asset value of the targeted acquired firm, 2nd leveraging the multiple vested participants in the acquisition; the selling firm, the municipal location facing a huge loss of employment and the private equity group taking on the sale.

Part one is easy as the selling firm would be happy to hold 1/3 of the paper if they can find a buyer for their losing business.  Part two is even easier.  Usually the city or town is facing the loss of several thousand employed local residents (and the tax base from this business) is more than willing to float a bond issue to keep the business alive in their community.  Last, for the private equity bank managing the last 1/3 raise of the required equity it’s able to utilize IRS regulations by moving assets into different locations offering new value in their new environment, constituting the IRS permitting re-appreciation of the assets up to 40% of their original value, even if they are more than 10 or 20 years old, to complete 100% of the financing.  This last maneuver enables the investment banking group to go investors, demonstrate a significantly higher balance sheet which in turn facilitates an easy raise for the VC group to raise the final 1/3 equity for the mezzanine round.

In the above scenario it is clear Venture Capital groups can get this business financed but at issue is not how easy it is to obtain the financing but rather how to legitimately take a losing single technology product business into real growth verses staying in the constant capital pyramid game. This type of Wall Street mechanism does in fact work but often this transaction is a 1st financing leading to a 2nd financing and then a 3rd financing until the entity appears to have enough value to be sold with the winners only being the financiers verses creating a company and product with real value benefiting society’s welfare and our nations GDP

This scenario is all too common in the world of Venture Capital.  However revitalizing old technologies need not be enigmatic but rather just refocusing on alternative markets with different demands.  Private equity would find a much easier capital raise by offering a more dependable ROI if business plans incorporated market economic analysis on realigning product functional value.

Let’s look at the ubiquitous manufacturers of the Luteinizing Hormone (LH) OTC tests which are marketed in the 1st world developed nations to women who seek assistance on determining fertility.  These products are ubiquitous in pharmacies with so many brands that the market price is fixed with so many buyers and sellers. Without value added discrimination, profitability is driven to lowest input costs in a mature market.   Some manufacturers attempt to spend a great deal of money identifying their products with special features to gain sales positions but growth in margins can only be minimal given the expense with the number of suppliers in the market.

What if Smart Economic Global Consumer Behaviour Models were put into play?  Could this change a single old technology product into a new accelerated demand market?

Suppose these LH tests were used to assist women to advert pregnancy. In Latin America, where contraception is deemed as immoral by the church, Economists could use consumer behavior models to predict quantity increase of consumption for LH tests to advert pregnancy.  Using Economic Consumer Behaviour Models, considering risk of pregnancy as a risk adverse situation, a model correlating utility to budget constraints can demonstrate significantly increased revenue with a new revitalized demand in a different market. Correlating geography, demography and theology is just that simple in identifying reversed value in purpose of an old technology utilizing 21st century economic behavior models.

 

By Ken Peters PhD
Principal, Analytic MedTek Consultants
Professor of Economics, CUNY, Baruch College

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