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UNDERSTANDING THE CAPITAL MARKETS IN AG'S CHALLENGING TIMES
Surviving the turmoil of the financial and consumer markets has become a daunting challenge over the past 18 months. The sluggish economy, tight credit markets, uncertainty in the consumer sector and concerns about the safety of the food system have forced many companies in agriculture and food to either postpone or scale back growth initiatives. Despite this market instability, companies with a sustained growth strategy, reasonable track record and identifiable market demand for their product are successfully accessing capital.

There are two critical keys to accessing continuous capital in today's economy. First, relationships and the credibility of the business will provide the basis. Second, obtaining capital that can be counted on as future needs arise often depends on matching the risks of the industry and business with the reward expectations of the capital partner.

Beyond the Basics

When taking on capital, a company that understands the markets has an advantage when negotiating with lenders and investors. It also helps to have an insider's perspective.

The capital markets are traditionally defined as the spectrum of transactions and financial investors that assist companies with public and private offerings of corporate debt, traditional bank financing, mezzanine financing, mergers, acquisitions and private equity. In the public markets, the bursting of the tech bubble in 2000 put the markets in triage. Initial public offerings are at a virtual standstill, and opportunities that existed 36 months ago have evaporated. This inactivity will likely linger for the near term.

Traditional private placements are often accomplished with investors such as insurance companies, pension funds and banks. Like other types of capital, institutional capital from private placements is priced in correlation to the financial condition of a company and its ability to achieve projections. Institutional investors in the private placement arena expect to remain in the credit for five to 10 years, with prepayment penalties if the borrower prepays the loan before its maturity. Lenders require covenant restrictions on additional debt, financial performance requirements and ongoing reporting requirements. Currently, institutional market conditions are tight and tend toward very high-quality deals.

Since private equity capital poses significant risk to the investor, the cost of this capital is commensurate with the risks. The investor will likely demand performance benchmarks, board representation and an ownership interest. Investors will expect a clear exit for their investment through a recapitalization (replacement of debt and equity), strategic sale or public offering once the company has achieved momentum in the marketplace.

Many venture capital funds were casualties of the dot-com train wreck, with only a small number of new venture capital investments in the marketplace in 2002. Private equity beyond venture capital can offer flexible structures. Several private equity funds are currently investing in food and ag companies with clear growth strategies and sound management teams as a defensive hedge in a weak economy.

Angel capital is the most expensive funding available. Angels are typically friends, family and private individuals willing to invest in a business based upon personal reputation or personal relationships. Angel investors are common in very early stage and high-risk companies that have not proven their market or financial viability.

Getting Comfortable with the Credit

Regardless of the type of financing, capital will likely follow a company if the investor can get comfortable with the promise of a return. There are many avenues to building a successful company, but investors will likely concentrate on companies demonstrating some of the following characteristics:

Great management

Control of a valuable brand

Diverse market channels

Defensible, low-cost or unique technology

Unique supply of raw materials

Transportation advantage

Unique customer niche

Dominant position in a distribution channel

Market Distress

Circumstances in the marketplace have strained previously healthy companies, placing them in distress. These situations often arise due to borrower default, management missteps, lender fatigue (the existing lender or investor wants out of the credit) and problems caused by a soft economy. In this type of situation, engaging a third-party advisor may allow the company to explore alternatives and possible recapitalization and/or sale options.

Lessons Learned

Perhaps the most important lesson of the past 18 months is that even though capital is cheap right now, lenders and investors have raised the bar and are demanding higher quality deals and increased compliance requirements. An understanding of capital market expectations can go a long way when you need to grow, contract or survive the turbulence of a challenging economy.

Tom Steen is managing partner for Cybus Capital Markets, Des Moines, Iowa.


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