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Access to Capital

Following the Money… If access to public markets is tricky, private funds are huge.

In a concise, state-of-the-capital-markets declaration, Robert Greifeld, president and chief executive of The Nasdaq Stock Market, declared that access to money may be too healthy. “We’re awash in capital and liquidity today, and maybe there’s too much capital chasing too few productive business concepts,” Greifeld told a roundtable sponsored by Nasdaq.

Most of the attendees agreed with Greifeld’s observation, noting that everything from angel investors and venture capitalists to equity and debt markets offer remarkable opportunities to companies seeking capital. But some executives argued that the good times could be shortlived unless potential danger signs were addressed.

The lack of transparency among some sources of capital was one concern. Secretive hedge funds and the unregulated complex financial instruments they design were singled out for their ability to wreak havoc throughout the capital markets if one or more of them failed. It’s a shadowy world of interwoven activities that could tumble like dominos, warned Dennis Shaughnessy, chairman of FTI Consulting, a financial restructuring specialist. “I don’t think any of us understand the behind-the-scenes linkage in the hedge fund industry of who’s lending whom money at any given time,” Shaughnessy said. “There is not a lot of transparency and it also involves the murky world of derivatives. And the way it’s run, somebody eventually holds the derivative, but to try to find out where it is is always a challenge.”

His fear is that one or two of these derivative bets could come unstuck. “All of a sudden, you wake up one morning and see cascading around the world people running around trying to cover a bunch of interrelated margin calls,” Shaughnessy said. “And some guys at the end of the chain letter can’t do it.”

The best chance to explore the possibility of requiring hedge funds to be more open about their investments and financial condition was probably in 1998 when Long-Term Capital Management, the fund headed by all-star bond trader John Meriwether, nearly went under. International banks, brokerages and currency traders recorded huge losses. To stem a global financial panic, the Federal Reserve put together a $3.5 billion rescue package that was funded by private industry. But the agency’s leadership didn’t seize the opportunity to probe the activities of hedge funds, Greifeld noted.

“Saying we don’t need to regulate that marketplace, [Fed Chairman Alan Greenspan] shut down that debate fairly quickly,” Greifeld said. “So it is unregulated, and it is somewhat unknowable right now.”

The opposite could be said about the equity markets, the largest capital investment pool. Many panelists felt that public companies are hamstrung by too many rules from regulators and Congress. Sarbanes-Oxley, the post-Enron legislation devised to ensure the accuracy of financial reports and improve corporate governance, received the most scorn. One problem cited was that it costs companies millions of dollars to overhaul accounting systems to meet SOX standards, and that expense has scared off many from the public markets.

“In our polling, we asked chief executives about a year ago what was their preferred choice in terms of accessing capital, public versus private,” said Edward Kopko, CEO of Butler International, the publisher of Chief Executive magazine. “And 80 percent of the CEOs said they’d rather be private than public.”

CEOs of privately held companies said they were surprised by what their counterparts in publicly traded companies are enduring as a result of SOX. “They seem to be suffering the pressures of the Sarbanes-Oxley world, the fear that one tiny misstep will result in very dire consequences,” said David Tilford, chief executive of Minneapolis- based insurance company Medica, which is privately held. “So as hectic and demanding as my life seems to be, theirs seems to be a whole lot more so.”

Sentiments like those could harm companies that, frightened by the public markets, turn to private sources of capital, which often demand large stakes and strategic control. Ceding so much influence to investors could stymie the long-term growth of these companies. “Nobody talks about what exactly is the [private investors’] exit strategy and the timing of the exit strategy and the expectations at the beginning, because the company is happy to get access to the capital,” said Christie Hefner, chief executive of Playboy Enterprises. “As much as possible, people like [at] Nasdaq [should be] aggressively educating the small- and mid-cap companies about why they needn’t be fearful of playing in the public markets, why actually there may be a better alignment in terms of long-term capital for them there than anywhere else.”

While Greifeld agreed that educating  companies about public markets is important, he took a less pessimistic view about the number of companies seeking private market funding. “I don’t see this as a systemic, long-term issue,” Greifeld said. “Every one of those firms [backed by venture or private equity firms] wants to access the public markets.”

Greifeld listed two benefits of being public: liquidity for investors and employees, and higher multiples as a result of that liquidity. “Plus, there is ease of access in the equity markets for additional capital,” Greifeld said. “So it could be that we have a delay with respect to companies coming public, but they will come public. And if you wanted to be optimistic, you can say that they’ll come public and in a more mature fashion, and ready to withstand the scrutiny.”

Executives also were troubled by the demands of Wall Street analysts who force public companies into focusing on quarter-by-quarter results instead of long-term strategic growth plans. To limit the negative impact of that short-term thinking, some attendees said that they refuse to provide the quarterly estimates that analysts prefer. That, however, doesn’t stop Wall Street from guessing, and the company’s stock inevitably is punished if the analysts are wrong. “We only give annual guidance, very broad annual guidance, because the last thing you want to do is be changing guidance,” said W. Alan McCollough, chairman and chief executive of Circuit City Stores. “But whether you give guidance or not, there are expectations on The Street. It’s just most interesting whether you exceed or beat expectations that you didn’t provide.”

Frustrated by this process, Playboy’s Hefner said that she would “get rid of the whole quarterly report card, understanding that you can’t go silent for a year-that’s not a fair partnership with your investors. But I would have some mechanism short of going silent for a year. For us public companies, that would lead to better decision- making. It’s hard not to feel that this is a report card every quarter and to spend time that might be better spent thinking about the year, the three-year, the five-year horizon.”

Yet for all the complaints about the equities markets, there was widespread agreement that they remain the vibrant center of global capital investment and that the availability of high-quality capital in all forms hasnever been greater. If the capital market wasn’t “functioning incredibly well,” said Greifeld, “it [wouldn’t be] the envy of the world.”


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