Bankers, venture capitalists do more homework on clients

WASHINGTON (Dow Jones/AP) — Eager to avoid the
next corporate scandal, investment bankers and
venture capitalists are increasingly taking some
age-old advice to heart: The only stupid question is
the one you didn’t ask.

The Mercury News

As such, they are asking more questions, making
more impromptu visits, and even checking out the
price tags on prospective clients’ office furniture
before committing to a deal.

Take, for example, HPC Capital Management, an
investment bank based in Atlanta and Miami that
specializes in private placements for small- and micro-cap companies.

The investment bank recently laid off several employees and moved the money saved on their salaries into its travel
budget so that investment bankers could have more face-to-face meetings with potential clients. One visit, to a North
Carolina technology firm seeking $2 million in financing, sounded alarms for the bankers after they decided the tech
company’s office furniture was too opulent.

“You look at their costs and say, OK, you’re burning money, but you have $25,000 in chairs sitting around that
conference table. I don’t want to fund their chair purchases,” said Andy Reckles, HPC Capital’s chief executive. He
said HPC Capital is now considering giving the company less money and including terms that make management
accountable for the use of the proceeds.

It turns out that individual investors aren’t the only people gun-shy about committing capital to corporate America in
the wake of six months’ worth of news of bad governance and questionable accounting at some of the country’s
largest companies.

Professionals who earn their living arranging financing and mergers for public and private companies say they won’t
touch deals now that might have passed muster in 1999, and have increased their due diligence — a system of
fact-checking a company’s claims on everything from its revenue to officers’ criminal records — on the clients they do
accept.

Their aim: To avoid investing in or representing the next Enron Corp. or WorldCom Inc.

“Two to three years ago we were investing in a business model. Now we’re investing in management,” said Erik
Brown, president of brokerage and venture capital firm CGI Capital in Mundelein, Ill., which is probing deeper into
prior work and funding experience of managers of companies the firm may invest in.

Brown said newcomers to a company’s management are scrutinized; previous funding rounds that could result in
another investor wresting control are also cause for pause. Local companies are far more likely to garner money
from CGI Capital, because it’s easier to arrange visits. CGI Capital is also more inclined to seek out other venture
capital firms as partners in a funding round, rather than shouldering all the risk itself.

“That way, we’re relying not only on our own guidance, but on that of other qualified firms,” Brown said.

It’s not as though investment banks didn’t do due diligence in the past before handling stock offerings for corporate
clients. But they are now asking more targeted questions, lawyers said.

Where they used to ask what material information wasn’t being reflected in financial statements, now they are
inquiring specifically about joint ventures and off-balance-sheet transactions, for example.

Peter Loughran, co-head of the capital markets group at Debevoise & Plimpton in New York, said his clients are
focusing more specifically on issues that have recently come under the microscope, such as how to treat capital
expenditures and off-balance sheet partnerships.

The assurances of auditors may no longer be enough. “It’s going to look more and more like medicine. If the issue
is serious, you get a second opinion,” said Joseph Bartlett, a partner at Morrison & Foerster LLP in New York.

Bartlett also sees greater scrutiny of companies that use earnings before interest, taxes, depreciation and
amortization — a measure of cash flow.

The “EBITDA number is getting a lot of analysis, whereas before it was viewed as pretty much a given.” Now people
are saying. “ ‘Oh, that’s EBITDA? Well, prove it to me.’ “

Other changes? Marc Weingarten, a lawyer at Schulte Roth & Zabel LLP in New York who works with leveraged
buyout funds, said that at some point buyers may refuse to shell out all the extra money for due diligence unless
they’re sure they’ll be the winning bidder.

On the mergers and acquisitions front, Meredith Brown, co-chairman of the mergers and acquisitions group at
Debevoise & Plimpton, said the recent atmosphere has affected the confidence of chief executives and the
willingness of boards to take chances in cases where they don’t know the company intimately. This has added to the
“greater infrequency of hostile acquisitions,” he said.

Another change is that venture capitalists and bankers are once again spending more time with management at
companies they’re helping finance, a practice that waned during the Internet go-go years.

http://www.siliconvalley.com/mld/siliconvalley/business/financial_markets/venture_capital/3640588.htm