Private Capital Markets E-Book

Robert T. Slee

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 1097

Veröffentlichungsjahr: 2011

Beschreibung

Praise for Private Capital Markets Valuation, Capitalization, and Transfer of Private Business Interests SECOND EDITION "In the years since publication of the first edition of Private Capital Markets, the concepts and ideas that it presents have been widely accepted by progressive members of the business valuation community. Now with the Second Edition, author Rob Slee has included empirical data on capital markets for midsized businesses. This book remains a must for everyone involved in appraising, buying, selling, or financing privately owned businesses." --Raymond C. Miles, founder, The Institute of Business Appraisers "The Graziadio School of Business has used the Private Capital Markets book for several years with great success. This course, along with the Pepperdine Private Capital Markets Survey project, has helped our students better prepare for careers in middle market companies." --Linda Livingstone, Dean of the Graziadio School of Business and Management, Pepperdine University "Our international association of independent M&A professionals recommends this text as the most comprehensive foundation for understanding the private capital marketplace. This book is essential reading for middle market M&A advisors, investors, and other decision-makers in the private capital markets." --Mike Nall, founder, Alliance of M&A Advisors A practical road map for making sound investment and financing decisions based on real experiences and market needs Now fully revised and in a second edition, Private Capital Markets provides lawyers, accountants, bankers, estate planners, intermediaries, and other professionals with a workable framework for making sound investment and financing decisions based on their own needs and experiences. This landmark resource covers: * Private business valuation * Middle market capital sources * The business ownership transfer spectrum * And much more Private Capital Markets, Second Edition surveys the private capital markets and presents the proven guidance you need to navigate through these uncharted waters.

Leseprobe

Contents

Cover

Title Page

Copyright

Dedication

Foreword

Preface

HOW TO READ THIS BOOK

MAJOR GOAL OF THIS BOOK

Acknowledgments

CHAPTER 1: Capital Markets

MARKET STRUCTURE

INFORMATION

WHY ARE MARKETS SEGMENTED?

CHAPTER 2: Middle-Market Finance

MIDDLE-MARKET FINANCE THEORY

TRIADIC LOGIC

MIDDLE-MARKET FINANCE THEORY IN PRACTICE

OWNER MOTIVES

AUTHORITY

TRIANGULATION

PART ONE: Business Valuation

CHAPTER 3: Private Business Valuation: Introduction

PRIVATE INVESTOR EXPECTATIONS DRIVE PRIVATE VALUATION

PRIVATE BUSINESS VALUATION CAN BE VIEWED THROUGH VALUE WORLDS

VALUATION AS A RANGE CONCEPT

TRIANGULATION

CHAPTER 4: Market Value

LEVELS OF PRIVATE OWNERSHIP

TRIANGULATION

CHAPTER 5: Asset Subworld of Market Value

STEPS TO DERIVE NET ASSET VALUE

TRIANGULATION

CHAPTER 6: Financial Subworld of Market Value

SPECIFIC INVESTOR RETURN

SPECIFIC INDUSTRY RETURN

GENERAL INVESTOR RETURNS

TRIANGULATION

CHAPTER 7: Synergy Subworld of Market Value

SYNERGIES

CAPITALIZATION OF BENEFIT STREAMS

DISCOUNTING OF BENEFIT STREAMS

SELLER/BUYER MARKET VALUATION

NONENTERPRISE MARKET VALUATIONS

TRIANGULATION

CHAPTER 8: Fair Market Value

APPRAISAL ORGANIZATIONS

BUSINESS APPRAISAL STANDARDS

FAIR MARKET VALUE PROCESS

KEY STEPS TO DERIVE FAIR MARKET VALUE

DOES THE FAIR MARKET VALUE PROCESS MAKE SENSE?

TEARING DOWN THE BUILDUP MODELS

TRIANGULATION

CHAPTER 9: Fair Value

DISSENTING AND OPPRESSED SHAREHOLDERS

TRIGGERING EVENTS

DETERMINATION OF FAIR VALUE

TRIANGULATION

CHAPTER 10: Incremental Business Value

NATURE OF INCREMENTAL BUSINESS VALUE

PROBLEMS WITH USING TRADITIONAL METHODS

VALUE-BASED APPROACHES

NET PRESENT VALUE

INCREMENTAL BUSINESS VALUE

PRIVATE COST OF CAPITAL MODEL

RAMIFICATIONS OF USING PCOC

INVESTMENT

PROJECT DECISION MAKING

PROBLEMS WITH INCREMENTAL BUSINESS VALUE

VALUE-CREATION STRATEGIES

INCREASE RECAST EBITDA

REDUCE RISK

EMPLOY HIGH-YIELDING CAPITAL

INCREMENTAL BUSINESS VALUE VERSUS MARKET VALUE

TRIANGULATION

CHAPTER 11: Insurable Value

RISK AND INSURANCE

BUY/SELL AGREEMENTS

VALUATION MECHANICS

TRIGGERING EVENTS

KEY PERSON INSURANCE

BUSINESS INTERRUPTION

TRIANGULATION

CHAPTER 12: FASB Value Worlds

FASB FAIR VALUE (ASC 820, FORMERLY FAS 157)

BUSINESS COMBINATIONS (ASC 805, FORMERLY FAS 141R)

IMPAIRED GOODWILL (ASC 350-20)

VALUATION

TRIANGULATION

CHAPTER 13: Intangible Asset Value

SUBWORLDS

INTELLECTUAL PROPERTY

INTELLECTUAL CAPITAL

TRIANGULATION

CHAPTER 14: Other Value Worlds

INVESTMENT VALUE WORLD

OWNER VALUE WORLD

COLLATERAL VALUE WORLD

EARLY EQUITY VALUE WORLD

BANKRUPTCY VALUE WORLD

PUBLIC VALUE WORLD

TRIANGULATION

CHAPTER 15: Private Business Valuation: Conclusion

PRIVATE INVESTOR RETURN EXPECTATIONS

VALUE WORLDS

PRIVATE BUSINESS VALUATION IS A RANGE CONCEPT

TRIANGULATION

FINAL THOUGHTS ON VALUATION

PART TWO: Capital Structure

CHAPTER 16: Capital Structure: Introduction

PUBLIC CAPITAL MARKETS

PRIVATE CAPITAL MARKETS

PEPPERDINE PRIVATE CAPITAL MARKET LINE

KEY ISSUES REGARDING THE PEPPERDINE PRIVATE CAPITAL MARKET LINE

CAPITAL STRUCTURE TREATMENT

TRIANGULATION

CHAPTER 17: Bank Lending

TYPES OF FACILITIES

INTEREST RATES

INTEREST RATE HEDGES

LOAN COVENANTS

HOW BANKS DEAL WITH COVENANT VIOLATIONS

LOAN COSTS

RISK RATINGS

NEGOTIATING POINTS

TRIANGULATION

CHAPTER 18: Government Lending Programs

INDUSTRIAL REVENUE BONDS

BUSINESS AND INDUSTRY LOAN PROGRAM

SMALL BUSINESS ADMINISTRATION PROGRAMS

7(a) LOAN GUARANTY PROGRAM

CERTIFIED DEVELOPMENT COMPANY 504 LOAN PROGRAM

CAPLINES LOAN PROGRAM

EXPORT WORKING CAPITAL PROGRAM

NEGOTIATING POINTS

TRIANGULATION

CHAPTER 19: Equipment Leasing

TYPES OF LEASES

LEASE RATE FACTORS

LESSOR TYPES

COMPARISON OF LEASING AND PURCHASING

NEGOTIATING POINTS

TRIANGULATION

CHAPTER 20: Asset-Based Lending

HOW ASSET-BASED LENDING WORKS

ASSET-BASED LENDERS

TIER 1 ASSET-BASED LENDERS

TIER 2 ASSET-BASED LENDERS

TIER 3 ASSET-BASED LENDERS

NEGOTIATING POINTS

TRIANGULATION

CHAPTER 21: Factoring

HOW FACTORING WORKS

MECHANICS OF FACTORING

FEES AND TERMS

NEGOTIATING POINTS

TRIANGULATION

CHAPTER 22: Mezzanine Capital

LOAN STRUCTURE

MEZZANINE INVESTORS

TARGETED INVESTMENTS

PRICING

DEBT MEZZANINE CAPITAL

EQUITY MEZZANINE CAPITAL

OTHER DEAL TERMS

NEGOTIATING POINTS

TRIANGULATION

CHAPTER 23: Owners, Angels, and Venture Capitalists

STAGES OF PRIVATE EQUITY INVESTOR INVOLVEMENT

PRIVATE PLACEMENTS

FINANCIAL BARN RAISINGS

WITHIN EXISTING BUSINESS RELATIONSHIPS

WHY PRIVATE PLACEMENTS FAIL

PRE- AND POSTMONEY VALUATION

NEGOTIATING POINTS

TRIANGULATION

CHAPTER 24: Private Equity

STAGES OF PRIVATE EQUITY INVESTOR INVOLVEMENT

HEDGE FUNDS

FAMILY OFFICES

TERM SHEET

NEGOTIATING POINTS

TRIANGULATION

CHAPTER 25: Capital Structure: Conclusion

CAPITAL PROVIDERS MANAGE RISK AND RETURN IN THEIR PORTFOLIOS

THE PEPPERDINE PRIVATE CAPITAL MARKET LINE COMPRISES EXPECTED RETURNS

PRIVATE COST OF CAPITAL EMANATES FROM THE PRIVATE CAPITAL MARKETS

HIGH COST OF CAPITAL LIMITS PRIVATE COMPANY VALUE CREATION

INTERMEDIATION IS RELATIVELY INEFFECTIVE IN THE MIDDLE MARKET

TRIANGULATION

PART THREE: Business Transfer

CHAPTER 26: Business Transfer: Introduction

PUBLIC MANAGER AND OWNER MOTIVES

PRIVATE BUSINESS OWNERSHIP TRANSFER SPECTRUM

EMPLOYEE TRANSFER CHANNEL

CHARITABLE TRUSTS TRANSFER CHANNEL

FAMILY TRANSFER CHANNEL

CO-OWNER TRANSFER CHANNEL

OUTSIDE, RETIRE, TRANSFER CHANNEL

OUTSIDE, CONTINUE, TRANSFER CHANNEL

GOING PUBLIC, GOING PRIVATE TRANSFER CHANNEL

EXIT PLANNING

TRIANGULATION

CHAPTER 27: Employee Stock Ownership Plans

OVERVIEW

LEVERAGED ESOPS

ESOPS IN S CORPORATIONS

SETTING UP AN ESOP

POINTS TO CONSIDER

BOTTOM LINE ON ESOPS

TRIANGULATION

CHAPTER 28: Management Transfers

DIFFERENCES BETWEEN MANAGEMENT BUYOUTS AND MANAGEMENT BUY-INS

LIKELY DEAL STRUCTURES

DEALS

POINTS TO CONSIDER

TRIANGULATION

CHAPTER 29: Charitable Trusts

STRUCTURE OF CHARITABLE TRUSTS

CHARITABLE REMAINDER TRUSTS

POINTS TO CONSIDER FOR CRTS

CHARITABLE LEAD TRUSTS

POINTS TO CONSIDER FOR CLTS

COMPARISON OF CRTS AND CLTS

TRIANGULATION

CHAPTER 30: Family Transfers

STOCK GIFTS

PRIVATE ANNUITIES

SELF-CANCELING INSTALLMENT NOTES

GRANTOR-RETAINED ANNUITY TRUSTS

FAMILY LIMITED PARTNERSHIPS

INTENTIONALLY DEFECTIVE GRANTOR TRUSTS

COMPARISON OF FAMILY TRANSFER METHODS

ROLE OF INSURANCE IN FAMILY TRANSFERS

TRIANGULATION

CHAPTER 31: Co-Owner Transfers

BUY/SELL AGREEMENTS

BUY/SELL TYPES

TRIGGERING EVENTS

FUNDING TECHNIQUES

WAYS TO HANDLE DEADLOCKS

WHEN NO BUY/SELL AGREEMENT EXISTS

TRIANGULATION

CHAPTER 32: Outside Transfers: Retire

PREPARATION FOR A TRANSFER

TRANSFER PLAYERS

MARKETING PROCESSES

NEGOTIATED TRANSFERS

PRIVATE AUCTIONS

TWO-STEP PRIVATE AUCTIONS

CLOSING THE DEAL

AFTER THE TRANSFER

TRIANGULATION

CHAPTER 33: Outside Transfers: Continue

CONSOLIDATIONS

ROLL-UPS

BUY AND BUILD OR RECAPITALIZATIONS

RECAPITALIZATION POINTS TO CONSIDER

TRIANGULATION

CHAPTER 34: Going Public, Going Private

DIRECT PUBLIC OFFERINGS

WHICH COMPANIES ARE PUBLIC?

INITIAL PUBLIC OFFERING TEAM

IPO PROCESS

ADVANTAGES OF GOING PUBLIC

DISADVANTAGES OF GOING PUBLIC

GOING PUBLIC KEY POINTS TO CONSIDER

GOING PUBLIC ON FOREIGN EXCHANGES

REVERSE MERGERS

GOING PRIVATE

GOING PRIVATE KEY POINTS TO CONSIDER

TRIANGULATION

CHAPTER 35: Business Transfer: Conclusion

SEGMENTED TRANSFER ACTIVITY AND ARBITRAGE

OWNER MOTIVES CHOOSE THE RANGE OF VALUES

CREATING VALUE IN A PRIVATE BUSINESS REQUIRES PLANNING

TRIANGULATION

CHAPTER 36: Conclusion

THEME 1

THEME 2

THEME 3

THEME 4

THEME 5

PRIVATE CAPITAL MARKETS

WHAT WE DO NOT KNOW

A FINAL THOUGHT

Appendix A: Corporate Finance Theory: Application to Private Capital Markets

Meta-Financial Theory

Corporate Finance Theory

Application of Corporate Finance Theory to Private Capital Markets

Summary

About the Web Site

Index

Copyright © 2011 by Robert T. Slee. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Slee, Robert T.

Private capital markets : valuation, capitalization, and transfer of private business interests / Robert T. Slee.–2nd ed.

p. cm.

Includes index.

ISBN 978-0-470-92832-5 (hardback); ISBN 978-1-118-07542-5(ebk);

ISBN 978-1-118-07545-6 (ebk); ISBN 978-1-118-07544-9 (ebk)

1. Corporations. 2. Private companies--Finance. 3. Capital investments. I. Title.

HD2731.S6 2011

332′.041–dc22

2011002026

To my girls

Foreword

Until the inaugural edition of Private Capital Markets: Valuation, Capitalization, and Transfer of Private Business Interests was published in 2004, private market players had only corporate finance theories to explain the behavior of the private capital markets. They were left to assume that corporate finance theories explain and predict actions in the private markets. As a corporate finance professor, I too was content to believe that public and private capital markets were substitutes.

An early skeptic, I have come to realize that private markets must be explained using theories tailored to experiences in those markets. This conclusion took me several years and active investigation to realize. I recall sitting in a business appraisal class in 2005 when an instructor introduced a relatively new and innovative book: Private Capital Markets. The instructor made several provocative claims about the book: (1) It contained an integrated theory that described the body of knowledge that applies to valuation, capitalization, and transfer of private companies; (2) businesses have more than one value at any point in time; and (3) it would ultimately change the way that business valuation for privately held companies would be performed.

Although these were interesting comments, I was unmotivated to investigate further. After all, I had a Ph.D. in finance and had been teaching corporate finance for nearly ten years. I was very confident that what I learned and taught in class about corporate finance also applied to privately held companies. Of course the capital asset pricing model applies to privately held companies. And capital structures of privately held companies mimic those of their publicly traded counterparts. And last but not least, companies have but one value. And why not: MBA finance books clearly state that the goal of all privately held companies is to go public!

Fast forward to one day in 2007 when I was reading a comment posted in a business valuation chat room by Rob Slee. Rob indicated that a goal of surveying the various segments of the private capital markets was to obtain a better understanding of the behavior of those providers and cost of capital for over 99% of businesses in our economy. My initial thought was “How silly.” After all, we all know we can derive private company cost of capital by using public data as a proxy. And thankfully we have very rich data from the public markets to use for those kinds of projects. I then started to think about the private company business valuation consulting engagements I had over the preceding several years and realized that behaviors are unique with regard to business owners and capital providers and are not necessarily consistent with behaviors in the public markets. Furthermore, upon reflection, I started to doubt that the goal of every privately held company was to go public. Now I was motivated to investigate further.

After more contemplation, I replied to Rob that it was something in which I was personally interested and believed that I would have the support of the Graziadio School of Business and Management at Pepperdine University to pursue such an initiative. After getting the nod from Dean Livingstone and Associate Dean Smith, the Pepperdine Private Capital Markets Project was born and a proposal to teach a new class, “Private Capital Markets,” was under way.

Now that I have taught the class for three years and have run the project for over four, I see things much more clearly. The Pepperdine Private Capital Markets Project hosts a semiannual survey that explores the behaviors exhibited by the major capital provider types and costs of capital on a simultaneous and comprehensive basis. The survey has grown from just 5 segments when originally launched in 2009 to 12: angel investors, venture capital, private equity, mezzanine, limited partners, cash flow lenders, asset-backed lenders, factors, investment bankers, business brokers, business owners, and business appraisers. The surveys, which are available at http://bschool.pepperdine.edu/privatecapital, ask questions about prior returns, expected returns, credit box parameters, acceptance rates, general behaviors, and industry and economic outlooks. With four reports now published, I am convinced the behavior in the private capital markets is unique–not only by capital type, but also within each capital type.

I have had many “Aha!” moments with regard to the behavior in the private capital markets that is addressed in this book and corroborated with survey data. For instance, unlike the way that investment opportunities are evaluated in the public markets, I learned that investments in the private markets are not made primarily with net present value analysis. That is, privately held business owners invest based mainly on payback and supplement their investment analysis with gut feel. To my surprise, gut feel was acknowledged by over 90% of survey participants. Activities like “being able to look the management team in the eyes and get a feel for their motivation” and “a general feeling that a particular product or service will gain market traction” are among many items that emerged as support for using gut-feel analysis. This contrasts considerably with behavior in the public markets, where investment decisions are made using a more formal and structured process.

I also learned that estimates of cost of capital by private business owners and private capital markets participants are very different. Interestingly, business owners have a tendency to see things more optimistically than those writing investment checks. Alternatively stated, the typical business owner frequently neglects to objectively assess all the risks on the horizon and therefore is unable to arrive at an appropriate risk-adjusted cost of capital.

I also learned just how segmented the capital providers are in the private capital markets. Each has investment preferences based on geography, industry, and size of investee companies. The implication is that a company may be worthy of financing, but if it does not approach a funding source that specializes in its industry, location, or size, the business is quite unlikely to obtain potentially vital growth capital.

Perhaps the most interesting observation is with regard to the use of earnings before interest taxes depreciation and amortization (EBITDA). It is the language of the middle markets and is the primary foundation upon which capital structures are built and value is determined. Senior lenders will lend at some multiple of EBITDA; mezzanine investments also will be extended at some multiple of EBITDA; and of course the same goes for investments by private equity groups. And to determine the value–you guessed it–capital providers in the middle markets also look to multiples for guidance.

Fortunately I have been able to leverage the survey findings in my private capital markets class as well. The foundation of this class is built on the Private Capital Markets book. Students in this class who have not been exposed to the middle markets often are shocked at the way business is done in this space. It seems that after even one corporate finance course, students grow accustomed to the efficiency and precision of the public markets and paint the economy in broad strokes. They frequently are amazed at many of the nuances of the private markets; for instance, the use of EBITDA as the driver for capital formation and valuation, the fact that a business can have more than one value at a singular point in time or that capital solutions are unique and not generalizable or transferrable from provider to provider. Initially they are immobilized by the subjectivity involved in evaluating capital prospects, arranging capital, and dealing with value relativity. Many feel as though they are “offroading” after becoming accustomed to driving on the “corporate finance freeway.”

Now that four years have passed, I realize just how much of a transformation I have made with regard to my understanding of the private capital markets and just how convinced I am that the behaviors described in this book are unique and cannot always be explained by corporate finance theory. Private Capital Markets is a foundation for many of my professional activities. It is the primary source of information in my private capital markets class; it is the foundation upon which the Pepperdine Private Capital Markets Project surveys are built; and, most important, it has changed the way I view the private capital markets and the middle market in particular.

JOHN K. PAGLIA, PH.D., CPA, CFADenney Academic Chair and Associate Professor of FinanceSenior Researcher, Pepperdine Private Capital Markets ProjectPepperdine University

Preface

Private capital markets rely on a holistic body of knowledge that describes the valuation, capital structure formation, and transfer of private business interests. Far from the noise of Wall Street, this book focuses on Main Street and its business dilemmas and opportunities.

Private companies, particularly those with annual sales of $5 million to $350 million, have unique capital market needs. The key to understanding private capital markets is to realize that valuation, capitalization, and business transfer rely on each other for definition and support. Only by understanding each of these areas, and their connections, or triangulation, is it possible to use this body of knowledge.

This book is written with three groups of readers in mind:

1. It is a useful road map for owners of middle-market businesses.

2. It can guide professional advisors of middle-market business owners.

3. It may be used by academics who currently have no other book dealing with these large and dynamic markets.

Other potential readers include lawyers, trade association members, CPAs, estate planners, appraisers, intermediaries, investment bankers, capital providers, and various management consultants.

Owner-managers of private companies are the primary audience for this book. These people have built substantial businesses based on their market knowledge, their ability to manage operations, and lots of hard work. After dealing with owner-managers for more than 25 years, I recognize that they are an unusual group of people. They are driven by a vision. The fact that this vision is not apparent to anyone else, or that it might take a lifetime to realize, is not an impediment. They are out to prove something to somebody. Owners often view monetary rewards as the final effect of their efforts rather than motivation. They understand the link between money and learning, in that nothing really is learned in life until a checkbook appears. Finally, owner-managers are prudent. They believe it is easier and less risky to make money by controlling costs rather than by investing and earning. Ultimately, most owner-managers remain prudent even when they can afford to be otherwise. I am a big fan of owner-managers.

However, most owners are ill-prepared to deal with valuation, capital structure, and transfer issues. The private capital markets are sophisticated enough to be beyond the reach of part-timers. Owners, and most of their professional advisors, do not spend a majority of their time dealing with this body of knowledge. Lawyers, accountants, bankers, estate planners, and other professionals may know one facet of the private capital markets but are deficient in another area. The owners’ professionals are the second group that this book is intended to help. Finally, this book is aimed at academics, who are just warming to the idea that middle market finance is a separate and important field of study.

HOW TO READ THIS BOOK

After Chapters 1 and 2 introduce its framework, the book is broken into three parts: Valuation, Capital Structure, and Business Transfer. Each part contains an introduction and conclusion chapter. Chapter 3 introduces business valuation, Chapter 16 introduces capital structure, and Chapter 26 introduces business transfer. Subject matter chapters immediately follow each part's introductory chapter. A conclusion chapter summarizes the main themes of the book and raises a number of questions that are yet to be answered.

To obtain the proper perspective of middle-market finance theory, the main theory developed in this book, and the private capital markets, readers should first read the foreword, Chapters 1, 2, 3 and 36, and Appendix A. Readers interested in a particular subject, such as bank lending, should first read the introductory chapter for that part. The part conclusion chapters–15, 25, and 35–are also vital. These chapters reinforce information presented in each part and also extend the discussions in interesting and provocative ways.

Triangulation, the concept introduced in the book that refers to the use of two sides of the middle-market finance theory triangle to help fully understand a point on the third side, is dealt with in two ways. First, most chapters contain one or more constructs that relate the chapter topic to the broader body of knowledge. These constructs are called longitude and latitude for the valuation chapters, capital coordinates for the capitalization chapters, and transfer matrix for the transfer chapters. Second, each chapter concludes with a discussion of triangulation, which allows the reader to consider the impact of the body of knowledge on the topic at hand.

Several formatting conventions are used throughout the book to enrich the presentation. First, the exhibits depict charts, diagrams, tables, and examples that are pertinent to the specific discussion. Finally, a fictitious company called PrivateCo illustrates most of the mechanics presented herein. In a sense, information is presented and analyzed through the eyes of Joe Mainstreet, PrivateCo's majority shareholder.

MAJOR GOAL OF THIS BOOK

Middle-market finance theory organizes a holistic body of knowledge and requires a general understanding of the major constructs before specific techniques can be properly considered. For example, it makes little sense to raise venture or other equity capital before reviewing the relevant credit boxes and the Pepperdine Private Capital Market Line to determine if a less expensive form of capital is available. Likewise, selling the entire business may not meet the goals of the owner. Other transfer methods might be more appropriate.

Understanding the private capital body of knowledge enables owner-managers and their professionals to solve difficult financial problems. This book provides enough information on private capital markets for owners to consider their possibilities. For the first time, owners can review an independent source of information on private capital markets and ascertain the best approach toward meeting their goals. Private business owners need, and deserve, this support. If this book helps owners take one step in that direction, the effort has been worthwhile.

Acknowledgments

It is fortunate that prospective authors and parents do not start out with perfect information. If they did, there would be fewer books and possibly fewer kids on the planet. In both cases, the initial notion quickly turns to a journey and finally a saga. I am still not sure what follows saga, but I remain hopeful that my grandfather was wrong when he described life to me 20 years ago: “Life, it's bad for a while, then it gets worse.” He died at 89 years of age, insistent to the end that his situation had not materially improved throughout his life: only his ability to cope had improved.

A number of people definitely improved my ability to cope with this saga. The next “Chapter Champions” helped update subject matter content plus breathed life into otherwise inert technical matter.

ChampionChapterTitleGary Fodor8Fair Market ValueJim Lurie9Fair ValueChris Cope11Insurable ValueDat T Do12FASB Value WorldsChris Mellen13Intangible Asset ValuePhil Hamilton14Other Value WorldsJohn Graham17Bank LendingBob Humber19Equipment LeasingDan Shaw20Asset-Based LendingBrandt Brereton27Employee Stock Ownership PlansWalter Putnam29Charitable TrustsDan Prisciotta30Family TransfersTim Rhine34Going Public, Going Private

Many people helped with the book beyond the subject matter champions. John Paglia not only wrote the foreword but helped with many conceptual issues throughout the book. Phil Hamilton provided great edits and much-needed spiritual support when it was desperately needed. Chris Cope and Dan Prisciotta both went beyond the call of duty. Ultimate thanks go to Sheck Cho and the editors at Wiley who patiently transformed something readable into something worth reading.

In alphabetical order, the next people provided insightful comments: Wayne Ackerman, Chris Blees, Ed Calt, KC Conrad, Ed Giardina, Chuck Knox, Frank Mainville, Kenneth Marks, Mike Nall, Randy Schostag, Sherry Smith, Dr. Stephen Spinelli, Tommy Thompson, Vincent Wolanin, and, last but not least, the Slee twins.

CHAPTER 1

Capital Markets

This book explores private capital markets, the last major uncharted financial markets. Private markets contain millions of companies, which generate more than half of the gross domestic product (GDP) of the United States and the world. Yet these markets are largely ignored, partly because of the difficulty obtaining information and partly because of the lack of a unified structure to approach them. This work offers such an approach. It provides a theoretical and practical framework that enables readers to make sound investment and financing decisions in the private capital markets.

A capital market is one in which businesses can raise debt and equity funds. Since the 1970s, public capital markets have received almost all of the attention from academics in the literature.1 In 2004, the first edition of this book challenged the assumption that public and private capital markets are substitutes, showing instead that the two markets were different in most meaningful ways. Specifically, 12 factors differentiate public and private markets:2

1. Risk and return are unique to each market.

2. Liquidity within each market is different.

3. Motives of private owners are different from those of professional managers.

4. Underlying capital market theories that explain the behavior of players in each market are different.

5. Private companies are priced at a point in time, while public companies are continuously priced.

6. Public markets allow ready access to capital, while private capital is difficult to arrange.

7. Public shareholders can diversify their holdings, whereas private shareholders cannot diversify.

8. Private markets are inefficient, whereas public markets are fairly efficient.

9. Market mechanisms have differing effects on each market.

10. Capital market lines (costs of capital) are substantially different for each market.

11. The expected holding period for investors is different.

12. The transaction cost of either buying or selling the interest is different.

Several of the major differences between public and private markets require further discussion. Specifically, public and private markets differ in structure and behavior, which necessitates unique capital market theories to better organize and predict behavior.

MARKET STRUCTURE

All markets are comprised of commercial activity where parties undertake an exchange because each expects to gain. In a free market, participants are able to meet and exchange for a mutually agreed price. Markets mechanisms are organized sets of activities enabling people to exchange or invest. Exhibit 1.1 depicts several market mechanisms as gears in a market that is greased by information and liquidity.