Looking For Trouble
While many of the nation's leading venture capitalists are feverishly stalking high-technology start-ups, the fact that other seasoned money experts are angling to buy plants in troubled, mature industries seems, at the very least, an anomaly. But for some investors, including three former senior officials of the Carter Administration, this orientation toward "low tech" is far from mystifying. The trio consists of former Treasury Secretary G. William Miller, deputy secretary of commerce Sidney Harman, and assistant secretary of commerce for industry Frank A. Weil. With nearly a dozen limited partners, they have put $2 million into a new investment fund whose principal objective is to foster business turnarounds in basic industries.
Instead of targeting businesses that are already healthy, the limited partnership fund, called Harvest Equities, will buy and arrange to recapitalize ailing businesses in so-called sunset industries. And that includes businesses for which the prognosis, at least for the current owners, may be bleak. But after buying distressed private companies or subsidiaries of big corporations at favorable prices, Harvest plans to revitalize them through assorted turnaround tactics. The investors have every intention of making money on Harvest Equities, and therefore "we're not interested in businesses in permanent decline," says Miller. "Our task as investors is to see that the businesses are well managed."
Harvest, which was evaluating initial investment prospects last November, intends to provide more than just new capital for the companies and corporate spinoffs it buys. For example, the partners expect that some of the businesses will need restructuring on "softer" levels, to improve relations between workers and management or to take advantage of new markets for existing products. "A deal has to be evaluated in terms of both hard and soft factors," Harman says.
Such multilevel involvement in poorly performing businesses -- more or less a rescue operation -- isn't often initiated in large conglomerates where management often has other investment priorities. But the Harvest partners feel that their own readiness to tackle a company's weaknesses will provide handsome payoffs in terms of profitability and preservation of jobs. Says Harman: "We think we can bring significant improvements to investments that look quite marginal."
The Harvest fund itself may be brand new, but its operating ideas are drawn from the principals' recent experiences in Washington, D.C., as well as from their successful and diverse private careers before Jimmy Carter became President. Before serving as chairman of the Federal Reserve Board and then as Treasury Secretary, Miller, now 57 was chairman and chief executive officer of Textron Inc., a $3 billion conglomerate headquartered in Providence. At Treasury, he had a key role as the chief negotiator with Chrysler Corp. The talks resulted in the extension of federal-loan guarantees of $1.2 billion in exchange for stiff concessions from the auto maker and its banks. Weil, a 52-year-old attorney, was a government strategist and negotiator on trade and industrial matters, after 15 years as an investment banker on Wall Street, most recently at Paine Webber Inc.
While the deal-making skills of these two men will no doubt be essential to Harvest's success, the best indication of how the fund will operate may come from Harman's experience as an entrepreneur and businessman. Before joining the Commerce, Department, Harman, 64, buiIt Harman International Industries Inc., a company he founded in 1953, into a successful manufacturer and distributor of high-fidelity equipment (featuring such products as Harman-Kardon receivers and JBL speakers) with sales of about $200 million. During his tenure, the company innovated personnel programs for fostering cooperation between workers and management -- initiatives that, Harman says, resulted in exceptionally high productivity for the industry.
Harman International was purchased by Beatrice Foods Co. in 1977. But soon after, the company's profits and productivity began to sag -- at least partly, says Harman, because of technological problems, general softening of the hi-fi industry, and an absence of entrepreneurial spirit that once characterized the company. Nevertheless, he was so sure the slide could be reversed with new rounds of incentives for workers and rnanagers that in 1980, as senior investor, he enlisted other investors to help him buy back most of the original company through a leveraged buyout (see "Going Private," page 41).
Harman won't discuss the details of the buyback transactionBut he does say it demanded only "a modest amount of equity."
While many leveraged buyout deals require investors to put up about 20% of the value of the deal as equity, with the remainder financed through secured or subordinated debt, Harvest is hoping to stretch its funds through some deals with smaller equity investments -- possibly even arranging purchases for which money isn't needed up front. In those types of transactions, the partners say, the sellers or current creditors might agree to be paid over a period of years based on a percentage of the cash flow of the business, much the way banks would treat a problem loan. In fact, Harvest is also willing to consider stepping into a bankruptcy situation temporarily in exchange for an option to purchase equity control from creditors once the business is more stable.
The advantages to Harvest of such deals are clear. But such creative financing, notes Miller, can help the selling companies and creditors as well. In addition to whatever cash they receive, they might also qualify for favorable tax treatment, cut their short-term debt, or be able to start applying scarce working capital to areas with potential for higher profit.
In contrast to many funds, Harvest's investment criteria seem broad. The fund is essentially looking for labor-intensive manufacturing businesses in the United States that make established products for which an unexploited marketing opportunity exists. Product areas that are constantly changing, such as high tech, are thus outside Harvest's focus as are service companies and industries overly dominated by a few big manufacturers. And while a business valued at much more than $20 million might be beyond the resources of the $2 million fund, the partners, who plan to devote only part of their time to Harvest and won't receive a management fee, say they aren't apt to buy anything too small, either. The fund intends to have at least working control in everything it buys, but it seeks only operations that are solid enough to support professional management.
Harvest was legally set up as a limited partnership just last October, although preliminary plans were known by word of mouth earlier last year. As a more formal way of introducing the fund and its goals however, the Harvest partners mailed letters iii September to executives at about 100 large corporations, banks, and insurance companies. Although response from these and other would-be sellers has reflected considerable interest, Harman says, "most of the situations we are presented with are rejected out-of-hand."
Recently, for instance, Harvest rejected an opening in industrial valve manufacturing after determining that improvements in the marketing effort would be too difficuIt. And a consumer products manufacturing subsidiary of a conglomerate was turned down because of the price, despite Harvest's judgment that the business could be greatly improved. As with high-tech investments, Miller notes, "many deals just don't look right."
But once the appropriate investments are identified, Harvest's partners feel sure their fund will have compounded annual returns typical of those that other venture capitalists seek. "We visualize returns of at least 30% a year," Harman says. With such results, Harvest's partners expect the fund to be a catalyst for other private investors to put money into troubled situations, and they expect to establish future funds of their own. Besides generating profits, Harvest's backers see successful participation in turnarounds as a way of injecting vitality into troubled areas of national and local economies. "We shouldn't be so fast to throw away our smokestacks," says Harman.