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Les Nemethy
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Les Nemethy is the CEO of Euro-Phoenix Financial Advisors Ltd. ( a Central European corporate finance company focused on Mergers & Acquisitions.
My company:
Euro-Phoenix Financial Advisors
My blog:
Corporate Finance / M&A Corner
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  • Alliances as an Option to Acquisitions

    Many investors often think that acquisition is the best or fastest way to achieve a strategic objective such as entering a particular market or acquiring a certain technology.  An alliance, however, may be at least as good an option in certain circumstances (e.g. where a company lacks a budget for acquisitions).  Alliances are very common:  there are many tens of thousands of them negotiated every year, most of them across borders.

    Types of Alliances

    An alliance may be defined as a association among two or more parties which involves a sharing of resources and coordination among parties to achieve common objectives.

    The three main types of alliance are contractual, cross-ownership or setting up a special purpose vehicle (SPV).

    A contractual alliance is generally a pure commercial agreement that sets out the objectives, the resources contributed by each partner, the division of the spoils, as well as in many case the puts and calls, the representations and warranties, etc.

    Cross-ownership may involve one party taking an ownership interest in the other, or parties taking an ownership interest in each other.  The relationship may be cemented through representation on the Board, or the contribution of capital.  Most alliances do not require cross-ownership.

    Setting up an SPV (a company, a limited partnership, etc.) may be a good way to structure an alliance.  A Board of Directors provides a direct way of making decisions concerning the alliance.  A shareholders’ agreement may be used to regulate the corporate governance of the SPV.  The parties should also regulate who contributes what resources to the SPV, and how spoils are distributed.


    The Rationale for an Alliance

    Alliances have several advantages over acquisitions: 

    ·         They are much faster to negotiate and implement than acquisitions.  They typically do not require due diligence of the acquired firm (although considerable research on the strategic or commercial opportunities available at hand is usually necessary).

    ·         There is much less risk that the management of the alliance partner will depart (which often happens with acquisitions).  This generally means that there is a more committed team in place.

    ·         There is no need for the huge investment that typically accompanies an acquisition.  If, for example, two alliance partners join forces to develop a certain product, technology, or geographic region, each alliance partner contributes thehuman, financial, or other resources necessary to achieve the joint objective.

    a Elements of a successful alliance include the complementarity, compatibility and commitment of the alliance partners.

    Drawbacks of an Alliance

    Alliances are not appropriate in all circumstances, however.  They have a number of important drawbacks, which include:

    ·         CEOs often like having resources under their direct command - but alliance partners do not respond well to commands.  They expect to be treated like partners.  Hence, achieving strategic objectives requires constant communication and effort put in to maintain the relationship.

    ·         There is always a risk that the alliance partner will not hold their side of the bargain, which may jeopardize the efforts and investments of the partner that does hold their side of the bargain.  (This risk may generally be mitigated by good project management, for example using benchmarks for what objectives are to be achieved by certain dates), as well as including representations and warranties in the alliance agreement).

    ·         One of the most surprising tendencies of alliances is for them to unravel once they have been successful.  While alliance partners may work together for many years to achieve their joint objectives, once these objectives have been achieved, and the venture has been declared a success, the partners have a tendency to go in different directions.  One may wish to sell, the other may wish to expand the scope of the venture (e.g. expand into additional countries or related ventures).  As a result, it is advisable to have good conflict resolution mechanisms built into the alliance agreement (e.g. mediation).

    Most authorities on the subject estimate that only 40 to 50 per cent of alliances achieve their objectives in the long run.


    Alliances are often not considered or given sufficient weight as a viable option for achieving corporate objectives.  While they are not appropriate in all circumstances, they are generally one of severable viable options.  Despite the relatively low track record of success for alliances, companies are facing increasing pressure to enter into  them as a means of bolstering competitiveness. Proceed carefully!

    Disclosure: No positions
    Aug 11 8:45 AM | Link | Comment!
  • Why equity can be so much more expensive than debt

    I was recently leading a seminar for CEO’s and business owners, where a large number of participants could not understand why the cost of equity was so much higher than the cost of debt.  I had mentioned that the cost of debt (e.g. interest rates) were typically in the range of 4% to 8% for most mid-sized companies in Central Europe, denominated in euros, and the cost of equity (e.g. Internal Rate of Return) required by most private equity investors, was in the range of 25% or higher.   A number of seminar participants could simply not fathom why equity would cost four or five times as much as debt.  As one of the seminar participants said, “I could understand if equity were 40, 50 or 60% more expensive than debt; I cannot understand why it might be four or five times as expensive”.   This article attempts to explain this phenomenon.  There are three major reasons:

    First of all, debt is typically secured by assets, whether real estate, machinery, receivables, inventory, or other things of value, which may be seized by the lender in case of default by the borrower.  Equity ownership, by contrast, is not accompanied by any kind of security interest in the company financed by the equity holder.  The equity holder cannot seize anything, the sole remedy of an equity holder generally being the right to vote at a shareholders’ meeting.   The aforementioned 4 to 8% interest rate generally assumes that there is significant security for the lender.  An unsecured loan would have a much  higher interest rate, assuming a lender would be willing to lend on an unsecured basis, (which is probably not the case).

    A second reason why the cost of equity is typically much higher than the cost of debt is that in the event of bankruptcy of a company, debt holders are satisfied in full before equity holders receive any proceeds of liquidation whatsoever.  In other words, even an unsecured holder of debt will receive 100% of what is owed to him or her, before equity holders see a penny

    Thirdly, a company must pay holders of debt an interest rate, even if the company is loss-making (and failure to pay interest or to achieve debt coverage ratios may put the company into default and force a liquidation).  Equity holders, by contrast, are paid dividends only to the extent that the company has been profitable, once all obligations in the ordinary course (e.g. servicing of interest payments) have been satisfied. 

    So it boils down to a tradeoff between risk and reward.  Debtholders have far lower risk (for  the three aforementioned reasons).  If a company is highly profitable, on the other hand, such profits or rewards will typically accrue to exclusively to the equity holders.

    I once had a client, the CEO of a publically owned telecom company, for whom we were carrying out a capital raising exercise, who kept insisting that he wanted to raise equity because equity was cheaper than debt.  It required a number of multi-hour sessions to understand his logic and convince him of the contrary.  Essentially, he saw that his company had to pay debt holders huge amounts of interest every month, whereas equity holders only sporadically received relatively modest dividends.  (The company was still reinvesting cash generated from operations in an expansion program).  Raising additional equity would have had a dilutive effect on earnings of existing equity holders, as any private equity firm willing to invest equity would have demanded a percentage of equity which would have allowed them to achieve a minimum 25% Internal Rate of Return on their investment.

    In short, the fact that equity is much more expensive than debt comes back to the principle that the higher the risk, the higher the expected rewards.  And the risks associated with equity are significantly higher than the risks associated with debt.

    Disclosure: No positions
    Jul 08 10:35 AM | Link | 1 Comment
  • Unlocking your Company’s Value, A CEE Perspective

    I began publishing the “Corporate Finance / M&A Corner” through Seeking Alpha a little over a year ago, and have since expanded the syndicated column into nearly every market in CEE.

    To mark this occasion, I am pleased to announce the publication of a book entitled “Unlocking your Company’s Value: The Keys to a Successful Business Exit” (available at The book has drawn considerably upon material used in these articles, and is written with Central European context, in which many of the case studies presented in the book originate.

    In the same way as planning a mountain climbing expedition, a company owner should plan not only for reaching the summit, but also for descent (which can be at least as treacherous).  In the corporate world, we should strategize not only on how to make our companies bigger and better but, from the beginning, also for eventual exit and succession.  

    The value that corporate owners create is never in the abstract or according to their own tastes; it must be created with a view to what investors are likely to value.  A homeowner might think that he or she is improving the value of a house by adding a swimming pool, but it is actually a fact that they will almost never recover the incremental value of that swimming pool when selling the house.  Similarly, every decision made by shareholders during the course of building a company will either add to or detract from the future saleability of a company—such decisions are seldom neutral.  What I am driving at is that building a company and selling a company are not two separate acts but part of a single continuum.   From the beginning, value will be optimized if one builds a company with at least one eye on how investors are likely to perceive its value. 

    It is unfortunate that the word “exit” has something of a negative connotation in Central Europe.  Often it is associated with failure, with giving up.  Yet it is interesting how in some cultures, exit is associated with success—particularly the Latin cultures.  (In Spanish, “exito” means success, or in Italian “riuscire” (to succeed) comes from the word “uscire” (exit)). 

    Getting into a war (think of Afghanistan or Iraq) is easy—it is the exit that is the trick, and the event which will ultimately decide whether the intervention was successful or not. Similarly, it is difficult to judge the ownership of a company as a success or failure until after it has been sold. One explanation for the success of private equity investors is that they generally have an exit strategy even before they invest in a particular company.

    Of course, buying shares is easy; it’s selling at a profit (the exit) that is the challenge.  As Henry Kravis, the American financier, once said:  “Don’t congratulate us when we buy a company.  Any fool can buy a company.  Congratulate us when we sell it and when we’ve done something with it and created real value.”  The book covers many ways to create value, ranging from corporate governance to risk management.    

    “Unlocking your Company’s Value” deals with two major subjects:  Business Exit Planning (a subject that has been popular in North America for one or two decades, but is only now starting to become known in Central Europe), and how to manage a transaction (e.g. raising capital, finding a strategic partner, selling a minority or majority interest).  The subjects are dealt with not from the perspective of a corporate finance professional, but so as to outline what business owners should know about these two subjects in order to unlock the theoretical and illiquid value of his or her business.  I have done my best to distil the thousands of conversations I’ve had with business owners over the past 25 years into one easy-to-understand book and I hope you will find it useful. 

    Disclosure: No Positions
    Jun 02 8:49 AM | Link | Comment!
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