Growthink Blog

Windfalls and Pitfalls: Private Equity and the Individual Investor


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How many times have you heard someone say, "Don't put all your eggs in one basket"?

When it comes to any kind of investing, this is very good advice.

But, if this is the case, why don’t private equity investors diversify?

Unfortunately, most individual investors in private equity significantly under-diversify their portfolios -- investing in one or only a handful of companies.  By so doing, they both greatly increase their risk profile and greatly decrease their probabilities of seeing investment return.


Investment Fundamentals: 3 Illusions and What To Do Now


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As the investing month of October mercifully draws to a close, there is now a palpable sense of calm in the financial markets.  While the horrific damage – in both value and psychological terms – is very, very real, and may take years from which to recover, there has been a healthy mindset transition to a “what is to be done” thinking, feeling and acting.


Preparing for a Recession? Don't Make These 3 Common Mistakes


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In times of economic crisis, far too many business owners revert to “safe mode” as panic spreads. A "responsible" course of action typically includes one (or more) of the following:

  • Tightening purse strings
  • Laying off key employees
  • Putting growth plans on the backburner

Doing anything different may be seen as “risky”.

But this conventional wisdom couldn't be more wrong.

An old adage states, "Only dead fish swim with the current," and that philosophy applies to your growing business as well.

Here we highlight the three biggest business mistakes made in tough economic times, and the implications of each:


Mistake #1: Shrinking your marketing budget

When there is less money to go around, budgets get cut. But it's a bad idea to take too many of those dollars away from marketing initiatives.  Actually, if you have the resources, now is the appropriate time to continue (or  expand) your marketing.  Why? Most of your competitors will cut their budgets, out of a “knee-jerk” reaction to the economic downturn -- leaving you a greater window of opportunity to get your message across to your market.  Business owners who “stick it out” during tough times will likely enjoy increased market share once the economy rebounds.


Mistake #2: Laying off key employees


Another, often more challenging decision, is whether to cut staff.  Whatever you do, don’t lay off your top talent. Great people are your most valuable resource -- hold onto them.   In fact, if you’re in a position to hire, now is a great time to hire, because so many other businesses will be shedding their top talent.  


Mistake #3: Putting growth plans on the backburner

Possibly the most damaging long-term effect of a troubled economic climate is when a business chooses to put its growth strategy on hold to "weather the storm."  If you cut back on new product development and innovation today, you will have fewer product offerings when the market bounces back.


Warren Buffet’s recent advice to investors is also great advice for entrepreneurs:

Be fearful when others are greedy, and be greedy when others are fearful.


At Growthink, we advise our clients to pursue their growth initiatives despite the downturn. There is no better time to grow than today.

 


Growthink Launches Turnaround Consulting Service


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If you’ve glanced at newspaper headlines, turned on a television, or read any of our blog posts within the last several weeks, you know that this is a turbulent time for the global market. This brave new world has lead to widespread and palpable effects on small and middle market companies everywhere. The credit crunch, the volatility of the stock market, and the uncertainty of the new political landscape have left many entrepreneurs and small business owners experiencing emotions ranging from mild trepidation, to full-fledged panic.

As scary as the landscape can appear right now, we believe firmly that businesses that look for the opportunities provided by the current climate can position themselves to experience success.  In order to help companies achieve that success, Growthink has launched a new service: Turnaround Strategy Consulting

Simply put, there are numerous steps businesses can take right now to turn the corner. Our decade of experience working with a broad spectrum of firms, from start-ups to Fortune 500 companies, has allowed us to develop comprehensive, analytical methodologies that indentify the cause of financial failures as well as realistic solutions that can be quickly implemented to turn businesses around.

Since 1999, Growthink has provided strategic guidance to companies through rapidly changing markets and economic climates, including the wake of huge economic crises, such as the end of the dot-com bubble and the post 9/11 financial landscape. Even in light of the 2008 “Credit Crunch,” Growthink is able to find opportunities within the chaos and create solid strategies for our clients.

Even businesses that have not experienced dramatic shifts, but have felt a recent downward trend can benefit from Growthink’s consulting.  Improving margins, identifying the right customers, and implementing effective management are all areas that can make a significant difference for any firm in this economic environment.

Additionally, as a full-service firm, our turnaround strategy solutions can examine and assist with all aspects of business growth, from branding, public relations, business planning, web development, internet marketing, and investment banking.

If Turnaround Strategy Consulting can be of use to your business, please visit our service description page here or contact us by phone at 1-800-967-6419.


An Interview with Ron Feldman, CEO of kwiry.com


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Here's a download of a fantastic conversation Growthink co-founder Dave Lavinsky recently had with Ron Feldman, Co-Founder and CEO of Kwiry.com. Funded by Hummer Winblad Venture Partners, kwiry is a service that turns text messages into reminders you retrieve online.

You can click here to view the PDF transcript. You can also listen to the MP3 file (below) or right click here and select "Save Link As..." to download it.


The interview focuses on how Ron raised capital for Kwiry. Dave got him to reveal key points on how he used Advisors to his advantage and how a networking event that his girlfriend convinced him to attend ultimately resulted in his initial round of venture capital.

 


The Current Market Conditions


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The extreme malaise in the financial markets is unlike any of us have seen in our lifetime. It is discouraging and disconcerting on many levels.

As Americans it is gut-wrenching to see so many proud institutions and the country as a whole take such a hit in prestige, wealth, and reputation.

For the private equity and venture capital world's as a whole, the erosion of stock market value reduces the likelihood and size of prospective acquisitions and the buoyancy of the IPO market - which in turn drives down earlier-stage deal valuations and the general "doing deals" excitement levels. We have already seen the shrinking of the hedge fund world these last few months - look for this contract to start hitting the private equity and venture capital markets.

But certainly by no means is all bleak nor are we at the end of days. As we know, at the end of dry desert, green grass grows. Without question, from the seeds of the current market correction will grow the great opportunities of the next 5-10 years.

So, for those with creativity, resilience and persistence, now is a great time to start and/or grow successful, lasting businesses.

 


It's a Brave New World


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We are living through one of the most tumultuous periods in the history of the financial markets.  It is rattling even the most steadfast and optimistic of investors.   For better or for worse, we can only look with misty memory to the halcyon, golden, go-go market and investment days of the 1980's and 1990's.   We are truly in a brave new world - one where the old assumptions and dogmas are truly on the dustbin of history.   

A few takeaways:

Big is Not Safer Than Small.   Whatever the results of the government mortgage bailout, both in terms of the House vote and its market impact, for equity holders of the big banks and mortgage and insurance players caught up in the mess (Bear Stearns, Fannie, Freddie, Lehman, AIG, WaMu, Wachovia, and to a lesser but still painful extent, Merrrill, Goldman, and Morgan), it is misery.   For the big financials, if there wasn't horrendous news these last few weeks, there would have been no news at all.  It is absolutely astounding – though not necessarily surprising when viewed through the prism of the dysfunctional and way over-blown incentive systems of key executives and traders at these firms – that so much value could be wiped out so quickly.   Investors for a long time will have serious hangovers and reservations regarding investing in these entities in any form – stock, debt, and/or derivatives.   Quite simply, the whole sector is tainted.

Cash Is Not Safe.  Never in U.S. economic history have there been as many question marks as there are now around the security of cash – passbook savings, checking accounts, money markets, certificates of deposits and other cash-like instruments.   

The question marks are threefold:

  1. The underlying entities holding cash are more sick than not, and, as such, their liabilities (i.e. your deposits) are exposed.
  2. The FDIC backstop/guarantee – as it gets stretched by Congress in terms of amount and type of cash instrument – is getting spread thin across an unprecedented number of defaults and in too tight a time frame.
  3. Inflation.  The old truism is that governments never actually “default” on their debts.  Rather, as expenditures for bailouts, wars, transfer payments between generations, and bridges to nowhere mushroom the budget deficit aside the enormous trade deficit the inevitable outcome has to be the government simply printing more and more money.   Thus inflation.


So cash, our old friend – whether in the bank or under our mattress – is both under parking risk of default (a low risk for sure but much more so than just a few weeks ago) and under systemic, significant inflation risk.  .

Executives Good, Traders Bad.  In 2007, venture capital firms invested approximately $26 billion in startup and emerging companies.   These companies were the best of the brightest stars in dynamic new industries like green/alternative energy, medical technology, digital media, and Internet software.   In Washington, the nation's political leaders are committing more than 25 times this amount, effectively, in bailing out the residential mortgage market.

Now don't get me wrong, the housing and foreclosure crisis is real and painful in this country.  But let's take a step back and think about priorities for a second:

  • Would it be better to have more non-fossil fuel startups and technologies and fewer McMansions?Would we rather have more medical researchers and scientists or Wall Street derivatives traders?
  • Who should be rewarded: the executives and visionaries working to build real operating companies, or the Wall Street whiz kids that made billions trading leveraged “house of cards” sub-prime mortgage portfolios?
  • Quite simply, do we want to be a nation and a society that rewards entrepreneurship and business-building or one that rewards financial instrument manipulation?


Thinking about it for only a minute, the answer is obvious.   It is even more obvious to the biggest investors in this toxic debt: the Chinese, the Koreans, the Japanese, the Russians, and the Arabs.   Certainly, owning U.S. mortgage-backed securities now looks like a losing hand for these folks and far more disturbingly, owning U.S. treasury securities is far from being, as they say in the finance textbooks, a "riskless" investment.

So where is this foreign capital now going to go?  Well, most of it will now in all likelihood stay home, or be invested in emerging/developing economies.  But here is the key point: while the U.S. investment climate looks very, very unattractive compared to what it once was it is still by far the best place in the world to invest in startups, to invest in entrepreneurs, and to invest in operating companies.  And it is not even close.

While most Americans – terrified by the hysterical financial media that the end of days are near – are increasingly blind to this fact, the more detached foreign investment players know the real deal.  There are both uniquely and insanely great American operating companies all in our midst.  Some are publicly traded, most are not.  In the coming years, watch for a return to this kind of back-to-basics business-building/value creation investing.  It can’t come soon enough.


The Bailout: 4 Reasons Why Congress Should Vote "NO"


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"Helping Main Street by Helping Wall Street" is a false claim for which there is no need or rationale.

Acting hastily and out of fear on a bailout plan of highly uncertain efficacy, of a size that will constrain options for other remedies, is irresponsible. Congress is engaging in the same reckless lack of analysis that brought us a prolonged Iraq War, and in the same financial industry wishful thinking that brought us the mortgage crisis.

 

1. The bailout is irrelevant and unnecessary.

a. U.S. consumers, businesses and governments simply have too much debt. The economy is in the process of reducing leverage through write-downs, bankruptcies, constrained spending and contraction of credit availability. The government is not big enough to stop this inevitable and healthy shift.

b. The private markets are fully capable of recapitalizing deserving institutions. Witness the approximately $30BN raised by JP Morgan, Goldman Sachs and Morgan Stanley in a few recent days. Private capital is perfectly capable of purchasing "toxic" assets by using the same reverse auctions that the Treasury wants to use to deploy public funds.

 

2. The bailout is far too big given the complete lack of evidence for its efficacy.

a. It is highly illogical to commit to a massive plan whose benefit to Main Street is utterly unclear and historically unstudied. The Treasury and the Fed, like everyone else and through no fault of their own, have been thoroughly ineffective at predicting the outcomes of interventions.

b. What assurance do we have that removing toxic assets from bank balance sheets will result in increased lending by our new, highly concentrated, banking sector? The other Federal Reserve action to promote lending, injecting enormous amounts of liquidity into the banking system, hasn't improved Main Street lending conditions. Nebulous claims about "improving confidence" are no justification for risking hundreds of billions of public money.

c. Let's keep the government's financial powder dry for uses where the effect of the spending is more clear and predictable, including directly helping individuals impacted by any economic fallout.

 

3. The bailout is un-American

a. There are numerous healthy, successful banks, many at the local level and some national (e.g. San Francisco's Wells Fargo). If you insist on spending government money, why not invest in these institutions in return for their commitment to increase lending? At least, let's help by rewarding success and prudence, rather than recklessness.

b. Our financial institutions are a product of recent human endeavor. They are replaceable. American entrepreneurship, with its hundreds of years of successful track record, is fully capable of quickly replacing institutions that have shown once-in-a-century incompetence and avarice. Why reward failure when so much entrepreneurial energy and capital is available to sweep these institutions aside?

 

4. The bailout is immoral

a. "We made massive amounts of money making what turned out to be terrible, destabilizing decisions, and now Main Street better save us for its own sake." This is industry's argument for holding up the taxpayers. The only moral path is to show these people the door.

b. Without any direct evidence or certainty of benefit to Main Street, it is immoral and mind-bogglingly circular logic to help the institutions and professionals at fault by taking money from generally faultless taxpayers who are likely soon need help as a result of the perpetrators' actions. In other words, Congress is taking a pot-shot at a plan to help Main Street avoid financial pain in the near future by sticking it with a bigger financial bill today, with the only certainty the benefit to the perpetrators.


Harder for Debt, and Easier for Equity


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Amidst the extraordinary, mournful crisis in the financial markets these last few weeks, a few truths have become painfully evident:

  • Leverage is a far more dangerous mechanism than any probable scenario models had predicted.
  • The very ephemeral concept of public and market trust is the core asset of financial and insurance institutions. Even the slightest weakening of this trust can almost instantly cause a cascading effect – driving down asset and equity values, which in turn further erode trust and confidence.   This negative feedback loop can quickly cause panic mindsets even among the most sober and experienced Wall Street hands.
  • Financial markets and instruments – fundamentally transformed by the information technology revolution of the last 25 years – have and continue to morph at a far faster rate that both self-regulatory and government oversight bodies are equipped to handle.


From Growthink’s entrepreneurial economy perspective, a few more truths are less readily evident, but fundamentally more profound.  Quite simply, Wall Street finance has lost connection these past few years with its core purpose and intent – namely to provide intelligent advice and capital to operating companies. While significant efficiencies (and correspondingly wealth-building) can be achieved from trading platform and instrument innovation, the value of this “innovation” is vastly over-rewarded in the marketplace.   

The very fact that the most highly compensated roles in our economy over the past few years have been hedge fund managers, derivatives traders, and sub-prime mortgage hypsters points to the heart of the problem.  While these folks serve a role, for sure, the combination of their almost comically (if it were not so anger-inducing) inflated compensation structures, combined with the systemic risk to which they exposed both their fellow workers and the economy as whole, is a failure of priorities for which we are all paying the price.  

Where do we go from here?  My hope is that finance and general marketplace incentive structures revert to more wholesome, “vanilla” dynamics.  Traders are rewarded less, and company-builders rewarded more.   Capital is more difficult to come by for hedge funds, and easier to come by for entrepreneurs.   Harder for derivatives traders, and easier for scientists and engineers.   Harder for debt, and easier for equity.   

The fundamental good that can and should come out of this market cataclysm is a cleansing and a re-ordering of priorities.   Provide a milieu and an incentive structure for operating companies to access capital and grow.  And contrastingly – devalue activities that simply move capital as opposed to creating it.  


It Takes Many Good Deeds, and Only One Bad One...


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"It takes many good deeds to build a good reputation, and only one bad one to lose it."  -- Benjamin Franklin.

Fannie Mae.  Freddie Mac.  Bear Stearns.  Countrywide.  IndyMac.  Lehman.  Merrill.  Once strong and even great corporate and financing nameplates now sullied by significant business reverses.

On the flip side: Apple.  Google.  Berkshire Hathaway.  Goldman Sachs.  Firms with gilt-edged reputations and prestige, admired the world over.


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