Measuring the intangibles: the subjective side of innvestment decisions

July 4, 2005
Big and small companies alike, at some point, desire to grow beyond what their existing resources allow and must seek additional capital.

Anthony C. Schnur
Capital Advisors
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 value.

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.

Finally, companies seeking capital have an equal opportunity to evaluate the intangibles of potential sources of capital. Consciously evaluate the ability of the provider to meet the needs of the company beyond dollars. Will the provider under consideration not only supply the necessary funds, but also do so in a manner and style the company can readily accept - or, at a minimum, adjust to?

The acquisition-of-capital process IS the audition. How presentations are made, negotiations are handled, points of contention resolved, and attitudes conveyed are all factored into the total impression of the producer as a client company and partner for the next several years. Different providers weigh these intangibles differently, but they all include them in the decision process.OGFJ

The author

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Anthony C. (Tony) Schnur provides capital structure analysis and advice, acquisition and divestiture services, and fund-raising information to companies in the energy sector. As an independent advisor, he arranges capital funding and re-financing for small- to medium-sized E&P and other energy companies. Before starting his own business, Schnur was employed by Aquila Energy Capital Corp. as a director of structured transactions. Prior to this he was with Aquila Energy Marketing in Chicago. Previous employers include Cargill Inc., National City Bank, and PNC Corp. Schnur holds a BS degree in business administration from Gannon University in Erie, Pa., and an MBA from Case Western Reserve University’s Weatherhead School of Management in Cleveland.