Recently, MSFG was engaged by a wholesale diamond manufacturer who was seeking to reverse-merge with an existing fully-reporting public company that subsequently would go private, while at the same time consummating an outright acquisition of a larger competing diamond wholesale manufacturer.  It is a complicated structure that is typically referred to as a “Triangulated Reverse Merger”.

The challenge presented to MSFG however, involved copious reorganization of the company’s internal financial management and activities to correct highly acute operating inefficiencies that would meet GAAP presentation standards, and ultimately achieve a successful Audit response and compliant incorporation with SEC registration filings later.

Although it may seem like a daunting proposition, the core issues were something that MSFG is very adept at dealing with.

Most traditional businesses are founded and developed by individuals with a passion for what they do.  They’re job is to focus on their product and their clients above all else, but often at the expense of some administrative affairs.

To compound problems, errors that often develop in the natural course of day-day business go unchecked and can become very stubborn to uproot, when the time comes to do so.

In the case of our wholesale manufacturer, the company had enjoyed solid growth since inception and was aggressively seeking to expand by way of the capital markets.  Although that was an admirable and legitimate goal, the underlying fundamentals of the business were inconsistent with GAAP financial presentation and compliance.  The company had been run to that point, by its original founder and CEO.  This gentleman was a fine operator, but a poor strategist.  It’s entirely natural.  He is an expert at what he does, not at preparing Audits!

The company had never contemplated or considered going public before, and all of the common administrative errors were present, as a result.  Notably, his personal financial situation was completely intertwined with the business’ finances.  Personal credit cards were used regularly for business purchases and vice versa, checks were made out to cash for himself and friendly vendors, and taxes were filed by a single CPA on his and his businesses’ behalf in compacted form.

The core of MSFG’s work involved the disaggregation of the owners’ personal financials, from those of the business, in a manner that would be flexible, conscientious and compliant with GAAP presentation and PCAOB public company audit standards.

MSFG’s goal was to respect management’s operating protocols and limit the need to implement changes in work-flow that are typically very difficult to enforce, while coordinating everything in such a fashion that the owners’ activities were contained within the context of GAAP financial presentation strictures and the requisite transparency that it provides.

Further goals included arriving at a solution that could be maintained easily by existing staff on an ongoing basis, and one that did not give the impression from the financial statements that a large cash sum was due to the owner, potentially at the business’ and any prospective investors’ expense should the contemplated transactions be achieved.

MSFG’s solution included a unique and highly flexible accounting technique that included the establishment and active utilization of a specialized Shareholders’ Loan Payable account.  The net effect was essentially a revolver of the owners equity into, and out of, his business.  This enabled MSFG to compact and integrate all personal cards, expenses and investments (proprietors are always adding personal cash to their businesses, of course!) into a single line item that net the owner’s financial transactions within his business against the equity portion of the Balance Sheet, without encumbering or confusing the liability section.

In other words, the ‘shareholder’s loan’ became an active account that expanded and contracted in concert with the owner’s activities.  Purchases and investments that he made personally on behalf of the company were thus realized in the balance sheet and not the income statement, where the consideration was equity to the owner and not necessarily a firm loan amount at specific terms.  Withdrawals, direct payments, blank checks, etc., regardless of the ultimate recipient, were thus realized as returns of capital to the owner, which have the added benefit of being tax-free to the owner, as opposed to such dispositions being realized as taxable income.

This is a classic case where MSFG’s ingenuity and experience enabled us to resolve the needs of management with the needs of the company, in a compliant and scalable manner that ensured the audit process and subsequent registration could proceed without delay.

You however, won’t get away with it.

Luckily, we have great news for all you executives of sub $100 Billion valuation companies:  You can do it, too.

ManageSource routinely employs strategic elements that are highly effective at enabling key executives to maintain out-sized voting control, as well as various other unique covenants, even when they’ve conceded outright equity control of the organization to  various stakeholders.

This may seem like we have some diabolical plan, but we don’t.   Employing a strategy that affords out-sized voting control to key officers is often essential to maintaining core strategic focus in company activities that drive to a singular purpose, during the early stages of a company’s development.  Fearlessly unfettered decisions in the face of extreme adversity, are the hallmark of truly successful leaders.

After all of the various factors and recommendations are taken into account, strong leadership and the ability for that leadership to be able to make resolute decisions without compromise, we believe, is essential to long term strategic success for many young companies.

One tool in our structural toolbox that we have utilized to great effect is the Series Preferred Stock.

A Series Preferred is a form of equity, but it incorporates the hybrid elements and covenants of a debt instrument.  Therefore, we can design and implement any number of Series Preferred instruments that keenly balance the necessity of management to maintain strategic operating control of the company’s activities, with the strict terms and requirements demanded by the capital investment.

ManageSource always seeks to align interests and overcome differences between the needs of management and the needs of  stakeholders, with concise, clear solutions that enable successful transactions.

In today’s Wall Street Journal, Andrew Ackerman writes about the SEC’s plan to inject new legislation to, presumably stabilize, the nearly $3 trillion Money-Market industry in the event of future financial calamities, and subsequent ‘bank runs’, if you will.  Mr. Ackerman highlights a number of excellent points, including touching on the critical concept of ‘uncommitted capital bearing no return’, albeit indirectly, as well as the potential to erode investor returns and access, under the currently proposed new regulations.

However, we feel that the article misses the fundamental possibility that the Money-Fund industry may be merely a hapless bystander to otherwise much deeper, systemic problems facing the contemporary global markets.

ManageSource holds that ‘Access’ and ‘Concentration’  are the primary systemic risks facing not just individual investors today, but also facing smaller regional banks, public and private wealth management firms, as well as corporate fiduciaries and qualified plan  managers.

• Access.  Or more specifically, ‘investor access’, refers to the ability of a stakeholder to participate in the global markets and engage a chosen transaction efficiently in a wholly egalitarian structural environment.  As we all know, this grand ideal is merely a fantasy. Mechanical features of the capital markets’ transaction methods are outdated and anachronistic in some cases, and poorly manipulated in others.  ECNs and the proliferation of enhanced direct, and anonymous, global electronic platforms ensure that massive pools of wealth are able to effectively circumvent many of the protective covenants intended to ensure transparency and equal access to stakeholders.  Of course, there’s no way to believe that any market will function with absolute efficiency and equal access; there are simply too many disparate vested interests at play. But, we think the SEC should be focusing on addressing the enormous disparity and lack of transparency created by the systemic structural failings of our capital markets, and not on products of them.  Incidentally, Money Market Funds in this case, are a ‘product’ in the purest sense.  They are a product of the system, not the cause of it.

• Concentration.  The massive disparity in Investor Access is exacerbated by the extreme concentrations of wealth that our largely unregulated private wealth management industry wields in the capital markets, and throughout the professional community  to completely self-serving ends.  Greed is good, however.  Private capital investment from Hedge Funds, Private Equity Funds, Venture Capital, et. al., is an absolutely essential component of our contemporary economy.  It fills the void that government economic promotion cannot even dream of providing for, while assuming risk and pursuing opportunities that the public sector simply cannot, whether by charter or simply because these types of private investments represent risks that far exceed reasonable risk parameters to the fiduciaries.  The issue to us, is not their existence or their characteristics, but rather a problem of mathematics.  Institutional Investors love to refer to the term: “Alpha”.  Indeed, entire schools of thought are dedicated to strategies of ‘seeking alpha’.  In fact, ‘Alpha’ simply means ‘total return’.  Why is this metric so key to the private wealth manager?  Because that’s what the performance component of the managers’ compensation is predicated upon.  And as any good manager will explain to you, the more investors that are employing a given strategy or investment technique, the lower the total return becomes for all the managers or participants employing the same or similar technique or strategy.   Therefore, with fewer and fewer heads managing greater and greater concentrations of capital, comes the complete inevitability of the deterioration of Alpha for all market participants.  Coincidentally, the investors experience extreme volatility, blunted access and fewer possible outcomes.

Like most of SEC’s actions, the Money-Fund regulations currently being contemplated seem short-sighted and reactionary.  We support our financial services peers and hope that the Ms. Shapiro will soon redact the SEC’s current position in lieu of more clinical and effective strategies of addressing systemic failures in the system, and not just shoot the Money Fund messenger!

WSJ Article: U.S. Sets Money-Market Plan

Drawing from the lessons learned through those tumultuous times, and combined with uncommon insight  from the capital markets’ perspective, we ManageSource has defined the phased cyclicality of our contemporary bubble economy.

Accordingly,  we believe that there are 5 key phases which catylize the business cycles of our contemporary economy.

• Phase I:  Bank Competition (‘BC’).
• During this phase, banks compete with each other for the key consumer deposits that will drive Phase II, with competitive loan pricing, relative to their peers.  The Bank Competition phase typically lasts anywhere from 6 months to 2 years, often overlaps the Institutional Investment phase, and sets the stage for broad capital-driven economic expansion.

• Phase II: Institutional Investment.
• Institutional investors and investment firms are the primary beneficiaries of the capital expansion that occurs during Phase I.  This capital is used to fuel capital investment at transactions at national and global levels.  These investments lead to corporate growth and typically result in a period general prosperity lasting approximately two, to three years.

• Phase III: Coincidental Investment & Expansion
• The Coincidental Investment & Expansion phase is very much an extension of the Institutional Investment phase. It is typified by a period of generally low relative unemployment, stable inflation, and consistent corporate performance. Tier II and Tier III investment and banking firms perpetuate the economic momentum set in motion by the bank and institutional phases, but on a much more broad basis.  This serves to mitigate concentrations of risk within the economy, while generally affording a period of domestic and international prosperity.  Phase III typically lasts 3 years.

• Phase IV: Press and Media.
• The Press & Media phase and the Institutional Exit phase, below, are intrinsically linked.  Driven by a confluence of results achieved from the prior three capital development phases, and guided by high profile vested interests, the Press &media phase is key to enabling financial institutions the opportunity to realize gains and rotate their portfolios.  This is the phase where you see business leaders on the cover of Vogue.

• Phase V: Institutional Exit.
• The Press & Media phase typically drives out-sized interest and participation in relevant corporate investments that effectively serve 2 purposes:  1. A short-term surge in asset pricing, which gives the perception that the expansion is in fact accelerating, and will continue unabated for an indefinite period of time; and, 2. the volume to afford the institutional capital participants from Phases II and III the liquidity to unwind substantial positions and realize gains, without negatively affecting share price and depleting outright returns to the investment community.  The Exit phase can last 1 day to 1 year.  The Exit phases is the most challenging phase for our corporate clients to navigate.

ManageSource relies upon a clear, concise, experientially driven knowledge base to guide clients through even the most daunting strategic initiatives.

Here are a few tips on how to effectively develop key asset and equity components of your balance sheet, during the early phases of corporate development:

1. Acquire assets, not services.
2. Protect Intellectual Property.
3. Anticipate Future Capital.

Structured products for business owners can often be an effective means of unlocking hidden cash reserves that can be deployed to stimulate performance returns and expand the total capital reinvested in your organization’s growth.   The financial services industry offers a wide range of structured products, such as LIBOR-pegged asset loans, factors, receivables lines and equity enhancement offerings.

Determining which structured product may be right for your business, is a simple matter of applying basic cost-benefit and alternative investment analysis.

Hello, and welcome to the ManageSource Business Intelligence Blog.

ManageSource Business Intelligence will offer cutting edge dialogue on state of the art financial and operational strategies that can help corporations, their executive management and capital stakeholders achieve the core value objectives in their business.  Although Business Intelligence articles, discussions and materials  will be actively moderated by, and frequently contributed to by ManageSource staff, it is intended to act as a platform for expert financial, investment and administration executives to publish their views, analysis and samples of best practices.

We welcome your participation.  If you believe that you have a subject matter that is topically interesting in the areas of corporate finance,corporate  investments, law  or operations, and you are an experienced professional with demonstrative specialization in the topical area, please let us know.