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The Art of the Private Deal – Redux

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A couple of months ago I wrote about a deal that Chris and I were participating in.  That post served as a brief summary of some of the thought processes we go through when assessing a deal.

After that post we ran an interview with a serial entrepreneur and deal guy, a friend of a close associate, that we felt was very instructive and helpful for both seasoned and novice investors and speculators.  We had to remove that post because one of the company’s that was mentioned was afraid that the information that was disclosed was a little too proprietary, and for competitive reasons they asked us to take it down until further notice.

We still can’t run it in its entirety, but I have re-posted the bulk of it here.  The company in question is still mentioned, but with much of the detail taken out. Nonetheless it’s a great interview, and we are even more excited about the company in question than we were a couple months ago.  There is a private placement that is about to close, and there may be a seat at the table if there is some interest from this community.

Below is the original post, slightly modified so as not to disclose too much about the company’s technology platform.

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Mark: How did you get your start investing in private companies and taking companies public?  What is your background?

I was always an entrepreneur.  In 1985 I started a small consumer health care products company.  I met an investment banker who specialized in funding and taking early stage companies public as a more efficient and less costly method of getting access to capital.  He worked with me to raise the capital I needed to launch my company’s brands, and then worked with me to take the company public on the Vancouver stock exchange.  While that was a good market, the limitations of VSE soon became apparent, so I worked to get the company listed on the NASDAQ small cap exchange and we had a pretty good run.  I ran that public company for eight years and during that time realized the limitations of being the CEO of a micro-cap company; trying simultaneously to run a company, raise capital and create demand for your stock.  So I eventually left that company to become an adviser for other start-ups and early stage public companies to help them focus more on running the business, and allow me to bring the capital resources required to start, grow and sustain their companies.  I’ve been doing that in one form or another for the past 17 years and have been fortunate to work with some very successful ventures.

Mark: How would you describe the current market for private deals?

The market is full of tremendous opportunity.  I am always amazed at the energy, creativity, focus and drive of the founders of the companies I look at.  I see hundreds of business plans a year and while most will not enjoy ultimate success, they are almost always business opportunities that have found a niche and have a compelling story.  Most have gained some traction but the key is to extrapolate where they are today and determine where they could be with access to capital.

Mark: What are the 3 most important factors you look for when deciding to invest your capital in a deal?

The first factor is management.  I invest in people.  It sounds like a cliche but its true, investing in an average business model with great management will outperform the greatest business model in the world with average management.   Business models are always, and I mean always going to change.  It is the lack of personal ego, the incisiveness, the commitment to excellence and the drive to succeed within the management team that determines success.

After that, I look at the business model.  My greatest concerns are first, what are the barriers to entry by a better funded competitor?  You have to expect that if your business is a good one, others will emulate it sooner than later.   Second, what sustainable competitive advantage do they have; what is going to keep them ahead of competitors; third, what is the operating leverage in the model, that is, how do you achieve growth but maintain a low fixed-cost infrastructure.

Along with all of those factors I look at the size of the market and how they are positioned within the market.  I like companies that address huge markets but have found a unique position that will help ensure that they can obtain a small but meaningful segment of the market.  I once funded, and eventually joined an eCommerce software and services company.  That is a very crowded field, but they had a unique model in the market that afforded them the ability to meet face-to-face with small business owners, develop a bond and sell them a premium product.  They carved out a tiny fraction of small business eCommerce sales, but it is such a large market that they were able to build huge revenues and profits from their unique position in that market.

Today, I am focused on social media and gaming.  There is no better operating leverage than a great social media model.  Once the platform is in place, revisions and modifications will be frequent and ongoing, but the platform is infinitely scalable, with the profit margins increasing as the user base grows.   The key is to find the right niche and an affordable way to attract users through leveraging all of the existing social media tools that are out there.

Mark: How do you utilize professionals like attorneys and accountants when structuring a deal?  How much of the “deal” is structured by you personally – in other words when do you bring in outside assistance?

I work with a network of very talented people.  I usually get involved with deals that have already established a foundation, have made some progress on its business model and are looking for that nearly-impossible-to-find round of funding that comes right after they have exhausted all the angel investor avenues.  I have several relationships with other advisers that I team up with depending on the opportunity, the financial requirements, etc., but first and foremost, I spend a great deal of time on due diligence – first on the management, and then on the model.  After that, and once I have taken on a project, I go to work to find the capital resources.  Usually I will advise the company to lead the next round without the benefit of a banker.  The company can raise capital directly with a network of high net worth groups that I have worked with for the past 20 years.

I play a key role in finding the right valuation for the transaction that is a win-win for the company and the investors.  Valuations are always challenging in the early stages but there is a lot of comparative information out their, and again, I work to make it fair for both sides.  This has worked well.  I explain to management that this capital, coupled with focused execution will create a much greater valuation when it comes time to engage a bank and seek the next round of larger equity or debt financing.

Investors who come in at this stage expect that liquidity will come in the form of a public listing either through an IPO or a reverse takeover into a public company.  Almost every company I have worked with has eventually been listed on the NYSE, NASDAQ or AMEX stock exchanges, and the ones who are not yet listed are on their way.  Of course a company could always be acquired before they reach the public markets, but the valuations would be much lower.  Knowing the end game is a public listing, and that early investors are coming into the company at a very fair valuation, is key in attracting this type of capital.

Mark: To finish up, do you have any industries you are involved in right now, or would like to be involved in, where you think the opportunity to put capital to work is exceptional?

I am now funding a new social media company.  It basically is a social media platform for the entertainment industry that allows fans to select and follow their favorite entertainers.  The model is brilliant, and the platform utilizes all of the most potent social media tools out there today.  Unfortunately I can’t say much more than that for now, as the company is deep in beta testing and about to launch the first version.  We don’t want to clue the competition in to what we have here, which we believe is big.  I have modeled this company and can envision several million users doing $5-$10 a month in micro transactions, a la Farmville, etc. It is one of the best and most practical social media and gaming models I have seen.

There’s even more to the story, but you see the point, this meets all my criteria – great management, large barriers to entry (development time would take at least a year for a competitor), scalable, fixed-cost model, unique position in a huge market (and an obvious public play) and in this case, several potential acquirers.

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Mark again… The company he mentions above is closing a private placement as we speak.  Chris and I are involved as investors, but we are not consultants, advisers or in any way employed or compensated by the company.

- Mark

“An investment in knowledge pays the best interest.” -Benjamin Franklin

The post The Art of the Private Deal – Redux appeared first on Capitalist Exploits - Frontier Markets Investing, Private Equity and IPO's.


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