Hedge funds are privately held investments that use resources pooled together from investors to capture a particular market segment that offers high returns. Investors are therefore required to commit their monies for a minimum period after which they can redeem their investments. These funds are aggressively managed and are only open to select investors with a minimum set net worth.
The original purpose of creating hedge funds was to capture equity securities investments and to utilize leverage and short selling to monitor the movements of the equity market. This purpose has however been overridden to accommodate other investments that can offer higher returns. Aggressive managers observe the market trends and make speculative investments that at times carry a bigger risk to that of the overall market.
Hedge fund strategies
Their approach to the market structure can take any of the following forms:
- Short selling
Short selling commonly referred to as shorting is a strategy whereby stocks that are not in use are sold and then bought later at a discounted price thereby making real returns. Only a few hedge fund managers can be entrusted with this high-risk venture.
- Equity market neutral
This is an asset stock-picking with the aim of hedging against volatility in the market using the long-short method. The hedge-manager can buy one stock and, on the other hand, short another stock in the same asset class. Regardless of the performance of the individual markets, the investors will still make some money from the investment.
- Market neutral arbitrage
This technique exploits the imbalances in the pricing of different securities. For instance, a manager may short sell a company’s stock and still buy the same companies bond.
- Merger arbitrage
Merger arbitrage focuses on the companies on the verge of an amalgamation. For instance when a corporation Y announces that it is buying company Z at $100 per share, the stock price for company Z will rise by a margin let’s say at $105 by share. The difference between the two stocks is called the spread. A hedge manager can use this chance to make a short term profit from the spread.
- Convertible arbitrage
It’s a corporate bond that is redeemed for a company stock in the future. The price of this bond can fall when the credit ratings fall or when the interest rates shoot up. Profit is achieved from the difference between the price of the bond and the stock it can be redeemed for.
Hedge funds are like a double bladed sword. When you make the right bet, then you are sure to smile all the way to the bank. If you are not lucky, then your lifetime savings can be swept with the speed of the lightning. In the 1990’s, Manhattan investment fund clearing through Bear Stearns lost close to $400 million of their investors assets. The firm, however, collapsed in the 2000s having made $2.4 million and with losses of up to $160 million which the court ordered they should pay.
There may come a time when the management of one company considers giving a buyout offer to another company. There will probably be many advantages and disadvantages on both sides. Several things must be taken into consideration for this to be successful. The agreement should be structured so the needs of both companies are met. Neither side will get everything they want or be required to give up everything. All the pros and cons of a company buyout need to be carefully considered on both sides.
ADVANTAGE: Gaining New Products Or Technology
There are situations where an established company desires to purchase a smaller company that has developed a very promising new product or technology. This can quickly benefit each company. The smaller business will have access to more and better resources. It will also be able to offer its products or technology to a larger customer base. The larger business will be able to incorporate new products or technology into their existing product line. This can be done without paying to license the acquired company’s product or technology.
DISADVANTAGE: Increased Debt
It’s possible the larger company may have to borrow money to acquire the new company. This will change their debt structure and increase any loan payments on the books. This also can require a company to make drastic cuts in their expenses. It may require layoffs or selling another part of the business to remain profitable. The money a company uses to buyout a business also takes funds away from any in-house product development.
ADVANTAGE: Reduced Competition
When a business is able to purchase its competition, it is able to increase its profits. The buyout will provide them with an increased scale of economics. It will also eliminate the need to participate in a price war with the competition. This can have a positive impact on customers if they experience decreased prices for a company’s products or services. Less competition means a business can spend more time expanding.
DISADVANTAGE: Loss of Key Personnel
Company buyouts can be viewed as a time for founders or key personnel to leave for a new challenge or retirement. Depending on their contract with the business, they may sell their interest to the company or an outside business. It can be a challenge for a company to find individuals with the same level of knowledge and experience. This may cause a period of adjustment that could be hard on the business.
ADVANTAGE: Increased Efficiency
A buyout may do away with any areas of product or service duplication between businesses. This could lead to a raise in profits resulting from a decrease in expenses. The companies involved in the buyout will be able to compare their processes and choose the best one. The newly formed company will be able to get better prices for products, insurance and more. Office spaces and other working areas can be combined for additional cost savings.
It will take time to integrate the procedures and personnel of one company into another. The two companies may do similar things but have very opposite corporate cultures. Resistance to change is a very real thing in the business world. It has been known to cause serious problems. Unless there is a plan to address integration issues, it could take a long time and become costly. It could lead to a loss in productivity and have a negative impact on the newly formed business.
With billions of people flocking to the Internet for shopping, news, entertainment and communication, users have taken to the Web at an incredibly fast pace. This technological revolution has changed the way people work as well. Many Internet users have found ways to make money with their websites and create businesses of their own.
Making money with blogs and web videos
Websites who are successful have been creating a slew of great content that compels readers to come back every time they update their site. This type of content is valuable and useful to the reader of the site. It can be easily shared and distributed amongst a network of friends, family members and colleagues.
Readers of these successful websites tend to consume useful and entertaining content on a regular basis. By giving content away for free, the owner of the website is building an audience who digests and expects more content in the future. There is a relationship between the content consumer and the content creator that is strong and secure. This can quickly turn into a string of revenue if the website owner knows what to do.
Successful websites that begin collecting revenue tend to have advertisements on their site. They will also try to use affiliate links. The website owners may recommend specific services or products to their audience. When the reader buys the product, the website owner will receive a cut of the profits.
Website owners who monetize their business will also create their own products and services for their audience. Since the readers already know and trust the website owner, they are more likely to buy from them.
Making a sustainable business
Bloggers and website owners who make their living this way plan their strategy carefully. Creating a balance between free content and paid content, they give back to their readers generously before asking them to buy a product or service.
These creators pursue partnerships with businesses, and businesses ask to partner with them as well. From large to small corporations, the website owner takes their relationships with companies seriously. They tend to partner with companies their readers will like.
Website and blog owners who are successful will also go on to sell books, membership sites and high-end services. They may also be featured in blogs, magazine and television shows.
Websites that create revenue
With this business model, many websites have found a way to make the projects they’re passionate about into a lucrative company. Here are a couple of websites that made their hobbies into a business.
The blog “Oh Joy!” has made its own success with partnerships and products that celebrate color and artistry. Joy Cho is a graphic designer, author and blogger, and posts free content regularly on her blog and video channel.
Collaborating with companies, she creates products, recipes and party ideas for them. She sells items like bowls, serving plates and cake platters for celebrations. She has also written the books, “Blog, Inc.” and “Creative, Inc.”
Pemberley Digital is a digital media company. It produces popular web video series on their website like “Emma Approved” and “The Lizzie Bennet Diaries.” Allowing the videos to be free online, these videos have gained an incredible amount of attention from their avid fan bases.
Now both of these web series shows are featured on larger sites where fans can buy episodes of the series whenever they want. Pemberley Digital also gains money by selling merchandise affiliated with their web shows.
The term “corporate inversion” has been in the news, with the recent announcement of Burger King buying a Canadian company called Tim Horton’s. The deal brought to light the corporate tactic of purchasing another company to acquire its favorable tax status, and has provoked considerable discussion about whether the practice should continue to be permitted.
Understanding Corporate Inversion
Corporate inversion sounds like an exercise practiced in the company gym, but in fact, it is a financial term that is used to describe the process of purchasing a company in a foreign country to access that company’s favorable tax status. The “inversion” aspect can occur when a larger company buys out a smaller firm and changes its headquarters to the country of the smaller firm. Generally, in a corporate inversion, one company purchases a smaller company in a country that has a lower corporate tax rate. Although the practice isn’t currently illegal, many people feel that corporate inversion smacks of a lack of patriotism, at best, and a slick method of tax evasion, at worst.
History of Corporate Inversion
The practice of corporate inversion has gone on for at least thirty years. It is believed that McDermott was the first company to engage in the practice, announcing it would become a part of a Panamanian corporation. It subsequently re-incorporated in Panama and moved its headquarters there, allowing the company to avoid paying U.S. taxes. Since that time, the number of U.S. companies that chose to implement the practice has steadily increased. As many as 76 companies have employed corporate inversion since 1983, and 19 companies have announced their intentions to re-incorporate overseas since January 2013 alone. This exodus of American companies to foreign countries has prompted the U.S. Treasury and U.S. Congress to consider revising the laws governing corporations to limit the practice.
Why Corporate Inversion Is Bad
As a result of these companies changing their incorporation to other countries, less tax is collected, increasing the burden on other U.S. taxpayers. Meanwhile, these corporations reap the benefits of lower taxes and higher returns on investment. The Congressional Joint Committee on Taxation estimates that these inversions would have brought in an estimated $19.5 billion to the U.S. Treasury over the next decade. In addition, tax experts note that the corporate inversion process itself causes a taxable event that could affect shareholders. Even holders of mutual funds that include stock from the company could take a sizeable tax hit. These problems have prompted the U.S. Treasury to begin looking into corporate inversions.
The Crackdown on Corporate Inversions
In September of 2014, the U.S. Treasury, in cooperation with the Internal Revenue Service, announced steps targeting the practice of corporate inversion. They hope to eliminate the specific techniques that allow companies to make the inversions, as well as diminish the ability to avoid taxes by doing the inversion. They intend to strengthen the requirement that former owners of the U.S. company own less than 80 percent of the new, combined entity. These actions will make inversion less financially lucrative.
In his budget for 2015, President Obama included a legislative plan to help curtail the practice of corporate inversion and make such inversions much more difficult to accomplish. Recent efforts by the Democrats in Congress have initiated legislation to stop the practice, but it is unclear whether Republicans will support such legislation.
In my previous blog entry, I discussed the key areas of a covenant not to compete that need to be negotiated, and how to negotiate them. Today, I will discuss the key areas of negotiation in covenants not to solicit and covenants not to disclose; if you are unfamiliar with these two covenants, I recommend following the links to read my past posts on the subjects.
Negotiating a Covenant Not to Solicit
With respect to a covenant not to solicit, often there will be little to no effort by the seller of the business to contest the buyer’s wording of this covenant. The general thought is “I am retiring”; this thought is prevalent even among persons who can work for another 20 years (such as the 50 year old). However, only so much golf can be played. Going back into business likely means going back into a business that is just different enough from the business sold as to avoid a violation of a covenant not to compete. Doing something you know, but slightly different. Many of your old employees have skills that can be valuable in your new endeavor.
The key factor to negotiate in a covenant not to solicit is the length of time within which one cannot solicit. This usually falls within one to three years. Much more than that, and you will run into the Texas common law on restricting an employee’s right to work. Another feature to negotiate is the situation in which an employee comes to you for a job, even though you did not attempt to recruit him or her. If this clause is in the buyer’s draft of the covenant, I recommend arguing for a term that is shorter than the one for solicitation. And you know what argument I will use: chilling an employee’s right to work. You should also attempt to negotiate the definition of solicitation.
Negotiating a Covenant Not to Disclose
In the past, I often did not find covenants not to disclose in the deals I helped to draft or negotiate. However, this circumstance is becoming less and less frequent.
With respect to a covenants not to disclose, it is important to negotiate the definition of the term “confidential information”. If you are a seller, this term should be limited in scope. The definition of “disclose” also has to be negotiated; there should be exceptions for certain circumstances of disclosure (i.e. the information having been previously disclosed by the buyer). For the seller leaving retirement, it is almost impossible to do so without using confidential information in building his or her new business. After all, the seller generated the knowledge in the first place, and you cannot tell someone not to use the general knowledge he developed in his prior business experience. But, this is precisely what a broad definition of “confidential information” means. I do the best I can to limit the scope of this definition. Ultimately, my client will use some of the information that is still protected anyway. Then I rely on the fact that proving the use of the information, and the value of the information, is difficult.
To continue my previous discussion of buying and selling a business, I will now discuss several covenants that are typically written into a contract, and which need to be negotiated. If you have not yet read my previous posts, you should reference both blog posts. The first examines the process of buying a business, and the second examines the process of selling a business.
In this entry, I am going to discuss the negotiation of the terms in a covenant not to compete. If you are unfamiliar with a covenant not to compete, I recommend reading a previous blog entry of mine which examines the topic; you can read that entry here.
Three Aspects of Negotiation in Covenants Not to Compete
The reasoning behind a covenant not to compete when buying or selling a business is fairly simple. The seller of the business finds a potential buyer. However, before buying the business, the buyer may arrange an agreement which restricts the seller from operating a similar, competing business within a specific area and for a specific length of time. This will protect the buyer from losing potential customers to the seller.
Thus, within this covenant, there are three key aspects that must be negotiated: the competition, the length of the covenant, and the geographical area the covenant applies to.
Competition in a Covenant
What does the word “competition” mean in a covenant? One can compete in many different ways. The main purpose of a covenant not to compete is to prevent competition between your own business and the business of another person in the marketplace. Losing a sale because a similar business was chosen, instead of yours, is the essence of competition.
Within the covenant, what exactly is considered off-limits in terms of competition? It is understood that any portion of the existing business at the time of purchase and sale of the business is off-limits. However, you could also include any element of the business or any product of the business that is simply being considered for potential production and sale. As a buyer, it is important to tie the seller to a list of such potential elements if possible. Enforcing a covenant not to compete between your potential products and the seller’s products is very difficult when one must prove that the seller did not think of it, before closing.
Length of a Covenant
There are statutes on the books with respect to the reasonableness of the length of time that a covenant not to compete can be enforced. Obviously, the length of time that a buyer wants is as long as possible. The seller will likely agree to a reasonable length of time which is necessary for the buyer’s business to be solidly in the marketplace. Of course, that length of time is subject to opinion and negotiation. In my own experience, I have seen negotiated covenants not to compete from one year to five years. Three years is typical.
The Area of a Covenant
There are also statues on the books with respect to the area in which competition may not occur. This area typically includes at the very least the area in which the seller’s business is being operated at the time of closing. One can negotiate as to what this area is.
Obviously, the buyer will want a no competition clause in as broad of an area as possible, and at least the area in which the buyer plans to expand. It is not unusual for the defined area to include areas where sales are occurring, plus additional counties that are close by. Or even the states that are close by. But you must be careful. Saying the “USA” when only a few states are involved may be stricken by a judge.
In my next entry, I will point out the key points in covenants not to solicit and covenants not to disclose that should be negotiated.
The best way to complete a discussion of how to buy a business, is to discuss how to sell a business. If you have not yet read my blog post about buying a business, I recommend you do so for reference.
Representations & Warranties in the Sale of a Business
There are aspects in selling a business which are in direct conflict with what a buyer wants when buying a business. This situation calls for a negotiation of the extent to which Representations and Warranties are made: are they to be thorough, or limited in scope? You need an attorney with experience in drafting purchase and sale contracts, and, even better, who has experience in litigating the consequences of alleged violations of the Representations and Warranties.
When a buyer inspects a business to determine whether to buy, the buyer will address many of the same circumstances that are covered by the Representations and Warranties. Typically, the buyer will ask questions about the business. While the seller will tell the truth, it is also important that the seller is careful to give complete answers. Sellers should not be tempted to conceal negative facts about the business. Otherwise, the seller may find himself or herself in the midst of a lawsuit. Of course, the buyer wants broad Representations, to catch what the seller did not mention, and to get what the seller said in writing. On the opposite side of the coin, the seller wants narrow Representations, as the more the seller says, the great his or her chance is for unintentional error.
There is some safety, however, in adding a certain provision to the purchase and sale contract. These provisions may state that the buyer may not rely on anything said or written before the contract was signed. The Representations and Warranties are the sole basis for litigation. What is in the contract is enforceable. What is a different, pre-contract representation, or omission, is unenforceable. This is especially important when the buyer alleges that the seller committed fraud in the pre-contract representations.
My next post will discuss other aspects of selling a business, such as covenants not to compete, not to solicit, and not to disclose.
If you want to buy a business, there is no substitute for a thorough, detailed inspection of every matter related to the business in question. Parts of the inspection will be to review written materials; parts of the inspection will be visual; and parts of the inspection will be conversational.
However, do not completely rely on what the seller of the business tells you. If you are given access to the employees of the said business, talk with them about it. The seller’s goal is to make his or her business look as good as possible to potential buyers. As a buyer, your goals are entirely different — you want to find out the flaws of the business.
Representations and Warranties in a Contract
However, for any flaws that you do not find, there are ‘representations and warranties’–the heart of your purchase contract. The representations and warranties in your contract guarantee that there are no flaws (other than those disclosed in writing) with respect to each aspect of the business. A good lawyer will see that you have the seller make solid representations and warranties in your contract.
That said, representations and warranties are no substitute for your initial inspection of the business. You really should complete a thorough inspection before signing a contract. You want to discover any negative aspects or flaws before signing the purchasing agreement.
Buying a Business with Prohibitive Covenants
You should also get prohibitive covenants when buying a business, such as: a covenant not to compete, a covenant not to solicit, and covenant not to disclose, from the seller. I have discussed each one of these covenants in preceding blog entries; click the links to read the corresponding entry.
I will have more on buying a business in my next post.
In 1984, Cirrus Logic began developing high-precision integrated circuits for a broad range of innovative customers, according to their web site. Cirrus Logic seemed to have dominated innovation, with its more than 1,000 patents, 700 products, serving more than 2500 end users around the globe.
This month, however, marks new beginnings for their Apex Precision Power business as the sale of that division has officially happened. The new business is called Apex Microtechnology and is to be based in Tucson, Arizona. Actually, Apex Microtechnology was founded in 1980, but was acquired by Cirrus Logic in 2007. Now after spending five years as a part of Austin based Cirrus, Apex Microtechnology has come full circle and will once again be returned to its stand-alone corporation status.
Apex Microtechnology is now a privately held company manufacturing precision power analog monolithic, hybrid and open frame components for a wide range of industrial, test and measurement, medical, aerospace and military applications.
This doesn’t mean that Cirrus is going away though. The business will now focus on a high-voltage, high-power integrated circuit design team in Tucson as well. Of the 676 employees, more than half of them are based in the Austin location.
With profits down slightly from the same time period last year, Cirrus reported a $6.9 million profit from their $99 million in revenue in the first quarter of 2012. During that time, they reported $9.2 million in profit on $92.2 million in revenue.
The Apex division was purchased for $26 million by a private investor.