Measuring the intangibles: the subjective side of investment decisions
Anthony C. Schnur
The Woodlands, Tex.
Big and small companies alike, at some point, desire to grow beyond what their existing resources allow
and must seek additional capital. The quest appears to be a challenging, but short-term endeavor.
Simply find and convince the right source that your company is a solid investment offering a fair return,
hammer out terms, and move to close. The process is then complete.
In reality, the closing is just the beginning. From the provider’s standpoint, once the agreements have
been signed and funds transferred, it has only begun.
There are three distinct phases in the use of external capital, most prominently displayed in privately
placed transactions: the Acquisition of Capital, the Life of the Investment, and finally the Exit of the
Investment. Most providers of private capital use the acquisition stage to judge the viability of the
producer as a worthy client company.
Throughout this process, replete with meetings and negotiations, subjective assessments are being
made about the company, its management, and ultimately the ability to perform.
Capital providers endlessly “audition” potential candidates or companies in which they might invest. What
are they looking for?
Providers think in terms of tangible, measurable, and quantifiable data that they can analyze and
forecast. These criteria generally rely upon engineering reviews, historical cash flows, and other
verifiable data to support the case. They are also, however, measuring intangibles. Often these
intangibles determine the final decision of whether or not to proceed with the transaction. The capital
seeker should understand that this subjective evaluation is intended to measure how the company-
investor relationship will play out during the life of the investment and the exit stages.
Companies seeking funds often do not audition capital providers in the same way. But they should. The
negotiation and closing process usually provides a window into a provider’s expected management style
of the facility through the entire life cycle of the investment.
Capital groups consider the presentation of a producer’s request, or investment memorandum, as the
first indication of how that producer will perform as a client company. For example, in the last three
months of 1999, I was sent more than 60 investment memorandums. If I could not be lured into a harder
look in the first 10 minutes, the memo was discarded.
During a time of heated activity, such as today, a well-constructed, precise investment overview is
critical. The investment request provides initial insight into management capability, where the producer is
subjectively judged on the following:
• Can they do what they say they can do?
• Are they organized and comprehensive?
• Do they have a clear goal?
• Do they know where they are going?
• Does the path forward demonstrate a clear plan?
• How are they going to execute?
• Have they thought about the exit strategy, and can they pull it off?
Inevitably, several meetings, face-to-face negotiations, and the sharing of data take place. Unspoken
judgments are being formulated throughout this process, although those judgments are rarely discussed
between the parties. Furthermore, assertions regarding integrity, work ethic, responsiveness, and fair
dealing are factored in.
The capital provider is forming impressions about what the future may hold: What kind of client will this
company be? Will they be an easy credit or difficult credit? If the chips are down, who is doing the work-
out? These first impressions, once formed, are difficult to overcome.
Several years ago, as a mezzanine lender, I had the opportunity to review a complex and difficult
transaction. The project was significantly underwater and required a refinance to replace bank debt with
a more highly structured facility. The current state of the company was bleak and heading for foreclosure.
Even if successful, it looked unlikely that the management team would garner much, if any, personal
The president of the company, however, would not let go of the keys. He refused to quit, refused to give
up, when all looked lost. He was intent on returning all funds to those who had showed confidence in him
several years prior.
That attitude, the assertion of responsibility, and willingness to work to the end buttressed his case within
our organization. The refinance eventually closed, and development activity commenced in a much more
favorable commodity environment to the benefit of all involved.
How then does a company convey these intangibles that most providers look for? First, understand that
these opinions are formulated from the first contact, and quite possibly beforehand, and continue at
every turn in the process. Always conduct business with the view that a capital provider will one day want
to know why certain decisions were made, or upon review, judge them at his or her discretion.
While no manager can conduct daily operations with that as the primary focus, it should be at work in the
background. There are four intangible concerns that cause discredit or kill deals: inconsistencies and
inaccuracies, the inability to present a concise internal view of the project or company,
unresponsiveness, and a history of litigation.
Inconsistencies and inaccuracies
It sounds sophomoric to mention this as a primary cause for concern, but it happens with more frequency
than you might expect. Inconsistencies occur in more subtle ways than you may think. These may not be
deal killers, but they can chip away at a company’s credibility.
Often, as the odds of funding from a particular source increase, the company provides more and more
detailed information. An example might be in the area of transportation and gathering charges. At the
outset a producer provides an estimate that these charges amount to 60 cents per Mmbtu. When the real
numbers come out, the per-well average is indeed 60 cents. However, in the field representing 30
percent of the production and 70 percent of future development, the charges are $1.05 per Mmbtu.
This can easily happen. The producer wants to respond quickly and pulls a number from the top of his
head, which represents the arithmetic per-well average. By this time, the provider has already made
some indication of what deal terms can be offered - assuming all data provided is correct.
In light of the “real” data, providers need to adjust the terms of the deal to meet their hurdle rates and a
little resentment and mistrust creeps into the relationship. If this type of circumstance recurs, you can see
how both parties may begin to question the motives and fair dealing of the other. Be vigilant in the
consistency and accuracy of the data that is shared.
Independent company view
Have a fundamental, defendable “own view.” You will probably need to provide a third-party engineering
report or other external source of asset base confirmation. When your company’s internal evaluation
differs from that of the third party, you must construct a reasonable argument as to why the two differ -
and why your case is more believable.
Accept differences of opinion and criticisms with grace, but be firm in what you believe. Reliance by a
producer solely on a third-party report, or worse, outright acceptance of an investor’s view is a warning
sign that the company has not done its homework.
Many times, companies have come to me with a third-party report (often from the seller’s reserve
engineer) and asked how much I would lend on that property. I would first ask: do you, Mr. Producer,
believe the report? And, what do you think it is worth? Have a firm belief built upon firm reasoning. If the
producer doesn’t believe it - no one else will.
The number of questions and laundry list of data requests is long and arduous. I keep a list that I share
with my clients that outlines the items that need to be addressed in the process of acquiring capital.
There are 51 separate items on the list, not including the closing check-list the attorney will require to
close the transaction or the transitional items, if purchasing an asset.
A capital provider will continue throughout the life of the investment to make requests of your time and
information. Therefore, how a producer approaches the barrage of requests during the pre-closing stage
is a strong indicator of how responsive a producer will be as a client. While responding to these requests
is no doubt burdensome, a company seeking capital must respond in a timely and upbeat manner.
Again, the attitude portrayed in the process is seen as a benchmark of the type of client the company will
be after closing.
Companies with a history of litigation have a lesser chance of finding acceptable capital than those who
do not. Why? In the capital community, litigation is equivalent to risk. The risks a provider may presume
about a litigious company are, at the least, lost time and productivity (i.e., cash flow) while fighting it out
in the courthouse. Worse, the provider may presume management has a character flaw in that
disagreements cannot be rationally resolved.
During the life-of-investment stage, the question becomes what kind of relationship will we have: collegial
or combative? If the provider believes there is a high probability that he may become a litigant, he will
avoid doing business with the company based on history alone - no matter how justifiable the reasons.
Many good-looking proposals have died due to an unfavorable evaluation of management. Be wary of
the “It doesn’t fit our portfolio at this time” answer to an investment request. The investment under
consideration may not be a fit in their shop. However, it is worth digging into a little deeper.
Capital providers are loath to discuss these issues, but since their reason is a “lack of fit,” they may
provide some insight into better presenting the company’s case. Asking questions can assist with a
reformulation of the strategy or uncover a flaw that the capital markets perceive, but of which the
company is totally unaware. Either way, the capital seeker can refocus and select a more effective
course to achieve the funding goal.