I wanted to give one last update in 2011 on my running commentary on the Commodity Price for arabica coffee. I have been predicting a drop in price all year and expected the price to approach $2.00 by the end of the year. As I type, the price is $2.2090 and pushing up against the resistance set up at $2.20. Time will tell when it breaks through and accelerates down, but the main reason for my post is to shed some light on the conditions within the BRIC nations (Brazil, Russia, India, China) who were credited early in the year by many "experts" as being the reason demand for arabica was exceeding supply. While I completely disagree with this characterization of their current influence (rather than their potential) I thought I should share some actual data which reduces even their potential impact on the price.
Year to Date, the BRIC nations economic vibrancy as expressed through their Equity Indexes have shrank by the following percentages:
Brazil: -18%
Russia: -23%
India: -23%
China: -18%
Given that discretionary consumption is fed by increases in wealth, and that the relative prosperity of those wealthy enough to invest surplus cash in equities has diminished in BRIC nations, the likelihood that coffee will be able to significantly increase market penetration under these conditions is doubtful. While I have read many experts and publications are predicting coffee will again test the $3.00 level, I'd be very happy to invest against that prediction based on current crop predictions and current consumption levels.
Monday, December 12, 2011
Monday, November 21, 2011
Peak Coffee and other BS
Recently there have been a couple of articles (and here)referencing Peter Bakers claim that we are on the cusp of exceeding our planets capacity for coffee production, or Peak Coffee. The term Peak Coffee itself is a nod to M. King Hubberts 1956 paper which suggested that man had discovered all of the oil reserves which were viable, and that mankind was inevitably destined to run out of fossil fuels before long. Of course, the notion of running out of something depends on the levels of consumption which are never fixed, and don't always rise. But coffee is a very different commodity than fossil fuels because it is a crop, and is replenished every year with some regularity.
Lending credence to the idea of Peak Coffee is distasteful and even this blog post gives it more attention than it deserves. For Peak Coffee to be even remotely possible in context the following must be true:
1. Coffee is grown and harvested at levels of efficiency so high as to be impossible to improve. Of course we know that coffee growing is notoriously inefficient, and massive gains in productivity are possible with even small changes in farming techniques.
2. All available land suitable for coffee growing is presently engaged in coffee production. As advances are made in understanding how to grow coffee in a truly sustainable way thanks to organizations such as Rainforest Alliance, more land for sensible, sustainable and productive coffee farms becomes viable
3. Coffee consumption is inelastic to price movements, and higher prices will not effect the volume required. Coffee prices are relatively inelastic, but consumers look for alternatives at prices rise beyond historical level, most often choosing lower cost options. Coffee has always been considered a loss leader in many retail chains feeding support to the elasticity argument
4. There are no improvements to be made through genetic modification of coffee. (Distasteful but a factor non the less) While this option is likely a nuclear option, if sustained prices and increasing demand were not compensated for by other advances, this would be explored
5. The demand curve volume for coffee will be fed by developing nations who have yet to discover coffee as a beverage, but will eventually overwhelm the marketplace. This is predicated on the assumption that consumers in developing nations consumption habits are particularly inelastic to high prices. Coffee is not tobacco, and overcoming cultural preferences is more difficult than we are being led to believe.
6. Consumption growth in the Specialty Coffee segment has no ceiling, and will surpass commodity coffee in commercial importance. Of course Specialty Coffee can be proud of being the fastest growing segment, as did Fair Trade at one point in recent history. But Fair Trade has never achieved wide acceptance even in markets highly sympathetic to Fair Trade such as The Netherlands and there is no reason to believe that Specialty Coffee will enjoy better results. The idea that Specialty Coffee is somehow impervious to price spikes over the long run is foolish and dismissive of the power and influence of the large commodity operators. Even taking wildly inflated figures of 20% of all coffee sold being Specialty Grade, commodity speculators could quite easily commoditize the Specialty Grade trade by purchasing in quantity should stocks somehow approach Peak. For example: If ALL Specialty Grade coffee in the world were to be commoditized, assuming it represents 20% of production, it would only move the commodity price by: ($2.35x.8)+(4.7x.2)=$2.84 or an increase of $0.47 per pound using todays close.(I am assuming a Specialty Grade Price 2x the "C" which is generous on average)
There is much to be said for the possible negative impact of climate change on harvest yields, but it is all speculation and statistically inconsequential on a macro level to date. Equally, there is much to be said about the impact of the possibility of capital markets freezing in Europe reducing liquidity in the commodity trades and increasing the spreads. I think it fair to say that financial markets and currency factors have moved the coffee market far more often than harvest or weather events in the past 2 years. For now, lets put the words Peak Coffee out of our lexicon, and stick with variables which are within the realm of the reasonable.
Lending credence to the idea of Peak Coffee is distasteful and even this blog post gives it more attention than it deserves. For Peak Coffee to be even remotely possible in context the following must be true:
1. Coffee is grown and harvested at levels of efficiency so high as to be impossible to improve. Of course we know that coffee growing is notoriously inefficient, and massive gains in productivity are possible with even small changes in farming techniques.
2. All available land suitable for coffee growing is presently engaged in coffee production. As advances are made in understanding how to grow coffee in a truly sustainable way thanks to organizations such as Rainforest Alliance, more land for sensible, sustainable and productive coffee farms becomes viable
3. Coffee consumption is inelastic to price movements, and higher prices will not effect the volume required. Coffee prices are relatively inelastic, but consumers look for alternatives at prices rise beyond historical level, most often choosing lower cost options. Coffee has always been considered a loss leader in many retail chains feeding support to the elasticity argument
4. There are no improvements to be made through genetic modification of coffee. (Distasteful but a factor non the less) While this option is likely a nuclear option, if sustained prices and increasing demand were not compensated for by other advances, this would be explored
5. The demand curve volume for coffee will be fed by developing nations who have yet to discover coffee as a beverage, but will eventually overwhelm the marketplace. This is predicated on the assumption that consumers in developing nations consumption habits are particularly inelastic to high prices. Coffee is not tobacco, and overcoming cultural preferences is more difficult than we are being led to believe.
6. Consumption growth in the Specialty Coffee segment has no ceiling, and will surpass commodity coffee in commercial importance. Of course Specialty Coffee can be proud of being the fastest growing segment, as did Fair Trade at one point in recent history. But Fair Trade has never achieved wide acceptance even in markets highly sympathetic to Fair Trade such as The Netherlands and there is no reason to believe that Specialty Coffee will enjoy better results. The idea that Specialty Coffee is somehow impervious to price spikes over the long run is foolish and dismissive of the power and influence of the large commodity operators. Even taking wildly inflated figures of 20% of all coffee sold being Specialty Grade, commodity speculators could quite easily commoditize the Specialty Grade trade by purchasing in quantity should stocks somehow approach Peak. For example: If ALL Specialty Grade coffee in the world were to be commoditized, assuming it represents 20% of production, it would only move the commodity price by: ($2.35x.8)+(4.7x.2)=$2.84 or an increase of $0.47 per pound using todays close.(I am assuming a Specialty Grade Price 2x the "C" which is generous on average)
There is much to be said for the possible negative impact of climate change on harvest yields, but it is all speculation and statistically inconsequential on a macro level to date. Equally, there is much to be said about the impact of the possibility of capital markets freezing in Europe reducing liquidity in the commodity trades and increasing the spreads. I think it fair to say that financial markets and currency factors have moved the coffee market far more often than harvest or weather events in the past 2 years. For now, lets put the words Peak Coffee out of our lexicon, and stick with variables which are within the realm of the reasonable.
Friday, September 16, 2011
Trading Coffee Options Part II
Identifying a "strike" price for your option is a fairly simple process of asking your broker for all of the price variations relative to expiry dates. The strike price can be thought of as a derivative of the volatility and probability relating to the "C".
The costs attached to purchasing options are affected by the amount of liquidity in the market (for coffee the liquidity is low and therefore expensive), the time period related to the contract, and the price volatility (volatility increases the price of the option).
Liquidity or lack of liquidity means the amount of active open interest in a series of option contracts. In practical terms, if you are offering something for sale and there aren't many buyers, the "spread" between the asking price and the bid price increases. This is important in situations where you may want to sell a position quickly and be forced to take a lower price than you paid because of a lack of buyers. This type of loss is referred to as "slippage", or the loss taken on the gap between bid and ask on a quick transaction. Conversely, as the price moves either up or down such that it approaches in the money, the spread between bid and ask narrows as interest spikes. Purchasing options on the "C" may be less attractive due to the fact that there is relatively low open interest in coffee options contracts and the price premium for many is unattractive.
Determining the value or cost of time attached to an option is as simple as identifying options with the same strike price, but different expiration dates and recording the value of the extra time. The more time left on the option, the more time for move to occur to put it in the money, the more expensive the option price is.
Volatility or conversely price stability affect the prices of options as well. Price movements which routinely alter the price of the contract in and out of the money, sometimes several times during the period of the contract, will be much more expensive than options on commodities or shares with stable pricing. Lately coffee has experienced some pretty wild fluctuations in relatively short periods of time and therefore the time premium can be expensive in these situations. Currently, the price premium on a coffee contract costs a premium of $0.10 over/under the "c" with a November expiry. For a $37,500 lb contract, the option will cost approximatley $3,750 before you get in the money. This contract works if we are confident that the price for coffee will either increase or decrease more than 10 cents per pound over the next 8 weeks or so.
Remember, as the contract approaches the expiration date, the value of the contract decreases if it is not in the money with each day. The key when trading options on goods with low open interest, high volatility is to stay on top of the pricing and get out of your position the moment you feel it is in the money with transaction costs plus your target premium. Also, with options, someone either wins or loses on every contract. With each option, there is always a counterparty who is betting the exact opposite of what you believe is going to happen will happen. Don't underestimate the intelligence of your counterparty!
I'll take a week and knock off another post on options trading, next time dealing with the process to place an actual order for purchase or sale.
The costs attached to purchasing options are affected by the amount of liquidity in the market (for coffee the liquidity is low and therefore expensive), the time period related to the contract, and the price volatility (volatility increases the price of the option).
Liquidity or lack of liquidity means the amount of active open interest in a series of option contracts. In practical terms, if you are offering something for sale and there aren't many buyers, the "spread" between the asking price and the bid price increases. This is important in situations where you may want to sell a position quickly and be forced to take a lower price than you paid because of a lack of buyers. This type of loss is referred to as "slippage", or the loss taken on the gap between bid and ask on a quick transaction. Conversely, as the price moves either up or down such that it approaches in the money, the spread between bid and ask narrows as interest spikes. Purchasing options on the "C" may be less attractive due to the fact that there is relatively low open interest in coffee options contracts and the price premium for many is unattractive.
Determining the value or cost of time attached to an option is as simple as identifying options with the same strike price, but different expiration dates and recording the value of the extra time. The more time left on the option, the more time for move to occur to put it in the money, the more expensive the option price is.
Volatility or conversely price stability affect the prices of options as well. Price movements which routinely alter the price of the contract in and out of the money, sometimes several times during the period of the contract, will be much more expensive than options on commodities or shares with stable pricing. Lately coffee has experienced some pretty wild fluctuations in relatively short periods of time and therefore the time premium can be expensive in these situations. Currently, the price premium on a coffee contract costs a premium of $0.10 over/under the "c" with a November expiry. For a $37,500 lb contract, the option will cost approximatley $3,750 before you get in the money. This contract works if we are confident that the price for coffee will either increase or decrease more than 10 cents per pound over the next 8 weeks or so.
Remember, as the contract approaches the expiration date, the value of the contract decreases if it is not in the money with each day. The key when trading options on goods with low open interest, high volatility is to stay on top of the pricing and get out of your position the moment you feel it is in the money with transaction costs plus your target premium. Also, with options, someone either wins or loses on every contract. With each option, there is always a counterparty who is betting the exact opposite of what you believe is going to happen will happen. Don't underestimate the intelligence of your counterparty!
I'll take a week and knock off another post on options trading, next time dealing with the process to place an actual order for purchase or sale.
Saturday, September 10, 2011
The Event
I'm feeling more than a little frustrated lately at the direction the Specialty Coffee Association of America is taking our industry. This post was inspired by a visit last week to our roastery by a Montreal based packaging equipment manufacturer who sang a familiar refrain, "we don't do SCAA anymore because it's not worth it and we're not welcome". This statement reminded me that last year in Houston I had the opportunity to chat with several attendees of the Specialty Coffee Association annual trade show dubbed "The Event". These folks I would characterize as long time members of the SCAA and exhibitors who purchase booth space on the trade show floor to display their products. Their opinions about the quality of the show for exhibitors was uniformly negative owing in their opinion to the SCAA's focus on "vanity hall" where baristas display various coffee preparation techniques in competition. Others suggested that entire categories of exhibitors were considering pulling out of the show due to the lack of support or respect for their segment of the industry. Others still were disappointed in the actual paid attendance once complimentary, exhibitor, attendees below decision maker level, etc numbers were removed. Finally in Houston, the competition area was physically removed from the trade show floor and served to pull attendees away from the paying exhibitors, making matters worse. I believe the fact that the SCAA has received "an offer it can't refuse" relating to the facility in Seattle, makes the revenue stream from exhibitors less a concern going forward and will lead to further alienation of trade floor businesses.
I have been attending SCAA shows for approximately 14 years, and have observed changes that, in my opinion, make the show less of a compelling event for some. Certainly the training available now through SCAA is exemplary and full credit goes to the Professional Development staff. The addition of a comprehensive Instructor Development Program, standardized lesson plan formats and guidelines and engaged volunteers makes this part of the organization stellar and reason alone to attend any SCAA trade show. However, for the business directors and decision makers with established business plans and formats, there are better options and events to direct your resources.
Years ago, every sector of the coffee business was welcome, exhibiting and in attendance. Packaging machinery and products in abundance, many more green coffee brokers, authors, photographers, Chain Stores and Micro Chains, Tin Suppliers, Mints, Candies, espresso and coffee equipment manufacturers to name a few. It is not lost on the allied members and manufacturers who sell to the industry that the voices that are amplified by the SCAA within it's own publications, in executive positions determining policy, and directing the distribution of SCAA resources are invested in promoting the competition barista and the micro lot roaster/importer as the "Face of the Industry". The failure to recognize that most Specialty Coffee customers do not purchase their coffee from competition inspired baristas, and a complete lack of recognition for operator (collective) excellence within the SCAA leaves me wondering how long the organization can exist with such a narrow focus on the individual.
The SCAA itself will deny any bias, and claim that all segments of the industry are welcome. While this may be their intention, in practice what happens is the equivalent of inviting everyone to your house party, but speaking a language that most of your guests don't understand, playing party games they don't know how to play, and making them pay for the beer and nachos. The people at your party who speak the language, and know the games have fun, but the rest of the party goers eventually leave if they feel snubbed, or are not able or interested to learn to play the games.
I have been attending SCAA shows for approximately 14 years, and have observed changes that, in my opinion, make the show less of a compelling event for some. Certainly the training available now through SCAA is exemplary and full credit goes to the Professional Development staff. The addition of a comprehensive Instructor Development Program, standardized lesson plan formats and guidelines and engaged volunteers makes this part of the organization stellar and reason alone to attend any SCAA trade show. However, for the business directors and decision makers with established business plans and formats, there are better options and events to direct your resources.
Years ago, every sector of the coffee business was welcome, exhibiting and in attendance. Packaging machinery and products in abundance, many more green coffee brokers, authors, photographers, Chain Stores and Micro Chains, Tin Suppliers, Mints, Candies, espresso and coffee equipment manufacturers to name a few. It is not lost on the allied members and manufacturers who sell to the industry that the voices that are amplified by the SCAA within it's own publications, in executive positions determining policy, and directing the distribution of SCAA resources are invested in promoting the competition barista and the micro lot roaster/importer as the "Face of the Industry". The failure to recognize that most Specialty Coffee customers do not purchase their coffee from competition inspired baristas, and a complete lack of recognition for operator (collective) excellence within the SCAA leaves me wondering how long the organization can exist with such a narrow focus on the individual.
The SCAA itself will deny any bias, and claim that all segments of the industry are welcome. While this may be their intention, in practice what happens is the equivalent of inviting everyone to your house party, but speaking a language that most of your guests don't understand, playing party games they don't know how to play, and making them pay for the beer and nachos. The people at your party who speak the language, and know the games have fun, but the rest of the party goers eventually leave if they feel snubbed, or are not able or interested to learn to play the games.
Thursday, August 25, 2011
Trading Coffee Options Contracts
Everyone who roasts, buys, sells, wholesales, pours or grinds coffee needs to have an understanding of the factors that drive the commodity price for coffee. I have posted several times on my predictions for the price of coffee by the end of the year, and the factors that will make those predictions happen. As I type, the "C" has appreciated approximately 18% since the credit downgrade of US debt, and the realization that the likelihood of another recession is increasing. European sovereign debt issues and the search for safe havens for capital have contributed to the appreciation of the commodity price for coffee. These factors were all identified in my earlier posts as game changers for the price to move down, but fear not, what goes up, goes down again. It is with this in mind that I wanted to start a series dedicated to profiting from the volatility of the coffee market, focusing on Options Trading. The reason I want to focus on Options Contracts rather than futures contracts, is that there is much less risk associated with Options, and no need to employ leverage. Options contracts are also very useful when there is a lot of volatility in the underlying commodity. Coffee has been a very volatile market for the past two years, and promises to continue for the foreseeable future. The upside of a well executed options contract is nearly unlimited, but the downside is limited to the purchase price of the Options Contract, therefore you'll never receive a margin call.
Coffee Options are contracts written based on the commodity price of coffee and whose price is derived from the underlying value of the market price. This type of instrument is a derivative.
There are two different types of options, Calls and Puts. And understanding of these terms is crucial to participating in Options trading.
Option Owner Rights:
Call Option holder has the right, but not the obligation, to purchase a specific number of future contracts at a set price (strike price).
Put Option holder have the right to sell, but not the obligation, to sell a specific number of future contracts at a set price (strike price).
Option Seller Rights:
Call Option holder has the obligation to sell a specific number of future contracts at a set price (strike price).
Put Option holders have the obligation to buy a specific number of future contracts at a set price (strike price).
*Selling a Call Option (Put Option) on a Contract you don't own (Naked Call/Put) obligates you to sell at predetermined price and exposes you to unlimited loses if the Commodity Price increases (decreases). Example: Selling a Naked Call Option with a strike price of $2.39, and the commodity price moves quickly to $2.70, you are obligated to sell a contract for $2.39 when you are forced to purchase the contract to cover at $2.70 resulting in approximately $11,000 loss on a single contract. This effectively saddles the Seller with the same downside potential as if you were shorting the contract.
The important thing to remember is that Option Sellers have obligations, Option Purchasers have Rights, but not obligations.
I would recommend purchasing Options rather than Selling (Creating) Contracts. Purchasing Options requires less investment, less downside, with equal upside.
If you expect the price of coffee to increase over the course of time that the contract is valid, you would purchase a Call Option, which becomes more valuable as the price increases.
If you expect the price of coffee to decrease of the course of time that the contract is valid, you would purchase a Put Option, which becomes more valuable as the price decreases.
Options expiration dates occur on the Saturday following the third Friday of each month, which effectively means you have until the third Friday to exercise your rights. I would not recommend trading out of a contract on the last day before expiration as the value of an options contract reduces as it approaches expiration. Exiting an Options Contract is as simple as calling your broker and supplying them with instructions to sell your Option, or exercise your rights.
What I've covered in this post is by no means sufficient to arm you with trading skills, but try to grasp and understand these terms and definitions and we'll expand the topic in a comprehensive way over the next few posts. Next time I'll cover identifying strike prices and costing break even points for Options Contracts using current market prices, and follow some hypothetical trades in real time.
Coffee Options are contracts written based on the commodity price of coffee and whose price is derived from the underlying value of the market price. This type of instrument is a derivative.
There are two different types of options, Calls and Puts. And understanding of these terms is crucial to participating in Options trading.
Option Owner Rights:
Call Option holder has the right, but not the obligation, to purchase a specific number of future contracts at a set price (strike price).
Put Option holder have the right to sell, but not the obligation, to sell a specific number of future contracts at a set price (strike price).
Option Seller Rights:
Call Option holder has the obligation to sell a specific number of future contracts at a set price (strike price).
Put Option holders have the obligation to buy a specific number of future contracts at a set price (strike price).
*Selling a Call Option (Put Option) on a Contract you don't own (Naked Call/Put) obligates you to sell at predetermined price and exposes you to unlimited loses if the Commodity Price increases (decreases). Example: Selling a Naked Call Option with a strike price of $2.39, and the commodity price moves quickly to $2.70, you are obligated to sell a contract for $2.39 when you are forced to purchase the contract to cover at $2.70 resulting in approximately $11,000 loss on a single contract. This effectively saddles the Seller with the same downside potential as if you were shorting the contract.
The important thing to remember is that Option Sellers have obligations, Option Purchasers have Rights, but not obligations.
I would recommend purchasing Options rather than Selling (Creating) Contracts. Purchasing Options requires less investment, less downside, with equal upside.
If you expect the price of coffee to increase over the course of time that the contract is valid, you would purchase a Call Option, which becomes more valuable as the price increases.
If you expect the price of coffee to decrease of the course of time that the contract is valid, you would purchase a Put Option, which becomes more valuable as the price decreases.
Options expiration dates occur on the Saturday following the third Friday of each month, which effectively means you have until the third Friday to exercise your rights. I would not recommend trading out of a contract on the last day before expiration as the value of an options contract reduces as it approaches expiration. Exiting an Options Contract is as simple as calling your broker and supplying them with instructions to sell your Option, or exercise your rights.
What I've covered in this post is by no means sufficient to arm you with trading skills, but try to grasp and understand these terms and definitions and we'll expand the topic in a comprehensive way over the next few posts. Next time I'll cover identifying strike prices and costing break even points for Options Contracts using current market prices, and follow some hypothetical trades in real time.
Friday, August 12, 2011
New Location Design Exercise
It's been a little while since I posted last. This is not due to any lack of interest or subject matter, but a family illness that has almost completely consumed my mental attention.
Rest assured I have a cranium filled with relevant topics that I hope will benefit anyone out there interested in starting their own coffee shop.
What I've decided to do is to let all of you in on the exact details involved in the design and build out of my company's new location. The space was chosen after many failed attempts at securing lease that met the following criteria:
1. Affordable Rent
2. Minimum 10 years term
3. Geographically removed from our existing locations so as not to cannibalize sales
4. Located in what is to referred to as "downtown" in my city
5. A corner or equivalent location of high visibility and traffic
6. Existing interior features that would be attractive to customers
7. The possibility of fully operational windows to permit an indoor/outdoor feeling
8. A reputable landlord who cares for their buildings and chooses their tenants carefully
9. Minimum 800 square feet, maximum 1500 square feet.
10. Suitable masthead to accomodate visible outdoor signage
The space we chose is directly across from the oldest continually operating outdoor market in Canada, which serves as an outdoor skating rink in the winter. The square is also home to antique markets, concerts, outdoor movie nights, buskers, water fountain, Christmas tree in Winter and city provided free cafe tables. It is one block from the waterfront, and directly behind our historic City Hall which served as Canada's first capital. The location is not a corner, but the open space across the street permits broad visibility and prominence.
In addition to these features, the interior space has 14' ceilings, exposed brick on one wall, and exposed limestone on the other. The front of the building will be re-pointed this fall, and new operational windows and doors installed that meet strict historical standards enforced in our city.
I have included a JPEG of the layout of the raw space listed as "322" on the drawing, and am encouraging readers to copy the image and sketch out their own versions of what they think the space should look like. Each attempt should include 2 washrooms, seating for at least 20, a service counter (cash and espresso bar). The dividing wall between 318 and 322 is exposed red brick, and the angled wall is exposed limestone. The front windows swing in to open.
Have fun and please respond with your designs in the comments. Don't worry about doing anything overly technical, just draw on it, scan it, and submit it. I hope some of the submissions will spark interesting debate, and will ultimately end up in the finished drawings. As we progress I will produce an equipment list, and budget that will adhere as close to possible to my 50 Grand Business Plan. Impossible you say! Well let's see.
Tuesday, May 31, 2011
Structuring the Sale of a Company
I wanted to create a quick and timely post to fill in some blanks about how a company might structure an investment from say, a Private Equity Fund. Reading my description of a Balance Sheet may help.
First, let's assume that if you are large enough to attract the attention of a PE Fund, then you are already Incorporated with an existing Share Structure. This Share Structure typically has two classes of shares, Common and Preferred. Common Shares are voting shares and usually where the value of a company is reflected as price per share.
Preferred Shares are non voting shares, but in some instances (especially involving outside investors) can contain all of the company value in the form of asset backed interest bearing shares that must be paid before any dividends are paid to common shareholders.
If a PE Fund wanted to invest in an existing incorporated coffee company, they would set up a separate corporation with a common share structure that reflects the final ownership percentage. The fixed assets of the original corporation would be held within this company as security to offset the cash investment of the PE. For example, if the ownership is 50/50, and the value of the company is determined to be $1,000,000 and the PE fund wanted to invest a further $1,000,000 , the common shares would be split 50/50, and the preferred shares would be set up so the cash infusion of $1,000,000 would be offset by a balance sheet entry of equal Preferred Share Value, and the Fixed Assets brought into the new corporation would also be offset by $1,000,000 balance sheet entry of Preferred Shares.
If the PE fund wanted to invest more than the value of the company, but the existing owner didn't want to give up more than 50% ownership, the common shares could still be distributed 50/50, but the PE fund could have more (even all) Preferred Shares. The value of the Preferred Shares would be secured by the balance sheet assets and a Shareholder Agreement drawn up to protect the investment by precluding dividends until Preferred Shares are converted to Treasury Shares or retired. The original owner could also completely cash out the value of the original company balance sheet by selling the assets to the PE fund, and the transaction reflected by placing the whole value in Preferred Shares owned by the PE fund. The common shares could still be distributed 50/50. In this instance, the PE fund may also have provisions written into a Shareholder Agreement that would permit the conversion of Preferred Shares into Common Shares if some "triggering" event should occur. Last, some investors may look to have a "shotgun" clause written into a deal which permits either party to submit an offer to purchase the other party's shares which must either be acted upon, or the recipient of the offer becomes compelled to purchase the other party's shares under the same terms that were offered.
Believe me, the Devil in any deal is in the details. No matter what anyone says, only the parties involved actually would know how any deal is structured, but more often than not, the stroke of a pen leads to unintended consequences.
First, let's assume that if you are large enough to attract the attention of a PE Fund, then you are already Incorporated with an existing Share Structure. This Share Structure typically has two classes of shares, Common and Preferred. Common Shares are voting shares and usually where the value of a company is reflected as price per share.
Preferred Shares are non voting shares, but in some instances (especially involving outside investors) can contain all of the company value in the form of asset backed interest bearing shares that must be paid before any dividends are paid to common shareholders.
If a PE Fund wanted to invest in an existing incorporated coffee company, they would set up a separate corporation with a common share structure that reflects the final ownership percentage. The fixed assets of the original corporation would be held within this company as security to offset the cash investment of the PE. For example, if the ownership is 50/50, and the value of the company is determined to be $1,000,000 and the PE fund wanted to invest a further $1,000,000 , the common shares would be split 50/50, and the preferred shares would be set up so the cash infusion of $1,000,000 would be offset by a balance sheet entry of equal Preferred Share Value, and the Fixed Assets brought into the new corporation would also be offset by $1,000,000 balance sheet entry of Preferred Shares.
If the PE fund wanted to invest more than the value of the company, but the existing owner didn't want to give up more than 50% ownership, the common shares could still be distributed 50/50, but the PE fund could have more (even all) Preferred Shares. The value of the Preferred Shares would be secured by the balance sheet assets and a Shareholder Agreement drawn up to protect the investment by precluding dividends until Preferred Shares are converted to Treasury Shares or retired. The original owner could also completely cash out the value of the original company balance sheet by selling the assets to the PE fund, and the transaction reflected by placing the whole value in Preferred Shares owned by the PE fund. The common shares could still be distributed 50/50. In this instance, the PE fund may also have provisions written into a Shareholder Agreement that would permit the conversion of Preferred Shares into Common Shares if some "triggering" event should occur. Last, some investors may look to have a "shotgun" clause written into a deal which permits either party to submit an offer to purchase the other party's shares which must either be acted upon, or the recipient of the offer becomes compelled to purchase the other party's shares under the same terms that were offered.
Believe me, the Devil in any deal is in the details. No matter what anyone says, only the parties involved actually would know how any deal is structured, but more often than not, the stroke of a pen leads to unintended consequences.
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