Cherrytree Group LLC Blog

• What type of legal structure do I have to have to invest with other people’s money?
• What are my options for compensation for myself from the fund?
• What sort of equity should/can I retain?
• What rules or regs do I need to be aware of before I start soliciting investors for funds?
• Who can (or should!) invest with me?
• How do I determine what I should set for a minimum level of participation?
• What are some acceptable ways to find investors? Who can help me with that?
• What happens if an investor wants out?
• What does it cost to put this all together?

Capital is capital, it doesn’t matter if you’re looking to raise it to buy real estate, notes or other assets, what we talk about in this podcast likely applies.

It’s important to note that we are not providing legal advice. You should seek out personal advice from Warren or someone like him before you attempt any of the things we talk about in this podcast.

How is a Distressed Asset Investment Fund set up? First, you need legal advice and consultation throughout the entire process. The laws, disclosure requirements, and particulars of each Fund are different. However, here is a legal guide. This is only a guide and should not be considered legal counsel.

This Legal Guide is meant to be educational and informative and discusses general legal principles; however, it should be used for informational purposes only.

Many assets have become distressed due to high vacancy rates, inability to refinance existing debt, depletion of reserves, and disrepair. This, along with the decline in the real estate market, have made these assets more affordable. But the capital funding needed to acquire, rehabilitate and reposition these assets is more difficult to obtain. Here are the basic steps and principles involved in the set-up of a Distressed Asset Investment Fund.

Step 1: Know your purpose.

In the current credit market environment, the traditional means of financing an acquisition of distressed assets have become difficult. Consider a strategy that includes successfully completing a private equity offering into a fund-type entity that will utilize its assets to acquire, rehabilitate and reposition distressed assets for cash flow (rentals) and residual proceeds (sales). These ownership entities have a greater chance of obtaining financing than individual or corporate borrowers, and are also able to occupy a better position as a buyer of distressed assets due to the fund's capitalization.

Step 2: Create a Set of Offering Documents.

What needs to be achieved is a private equity offering that meets the requirements of the 1993 Securities Act, and the applicable state securities statutes, also referred to as the Blue Sky laws. These are the "securities laws", that require you to prepare a set of offering documents that clearly lay out your plan, the risks involved, your financial assumptions, and the projected returns investors could achieve. They should also included a series of full and adequate precautions ensuring that the investment is appropriate for the investors, and that the investors are appropriate for the particular investment, given their financial sophistication, net worth or earnings capacity, size of investment, and the relativity of the risk to their tolerance for such risk. This is where you separate investors as either "accredited" or "non-accredited" as that term is defined in the Statute. You should also create a corporate structure that will receive the funds, and hold the investments.

Step 3: Raise Capital.

This is easier said than done. You need a full and legally adequate set of offering documents that will present the investment to accredited investors so  that have a clear understanding of the investment, your business plan, the risks involved, and whether or not they will be able to have access to their capital. Your business plan needs to be well thought out and detailed.  It is also helpful to have identified, and secured the commitments of the people who are to act as your management team.

Step 4: Identify appropriate investment opportunities.

Stick to the parameters that you identified in your business plan and the asset investment requirements that you committed to in your offering documents. Use industry sources, and other such information to source and identify appropriate investment opportunities for your fund.

Step 5: Make sure that you are capable of rehabilitating the assets and repositioning them in the marketplace.

Most distressed assets are deteriorated and will need rehabilitation. You will need to have access to a general contractor and construction related expertise, and an attorney to draft contracts that define the process, the payments, and the job. Eventually, you will either be holding the property for rental and will need a property manager, and a leasing staff, including your business attorney to draft leasing documentation; or you will be looking to sell the property and reinvest the proceeds in another appropriate asset, which will require finding a buyer and closing the sale.

Step 6: Keep your investors informed and create a compliance/administrative operation.

You will need to manage investor disbursements if this was promised in your offering documents, investor and property tax considerations, ensure you have adequate working capital for property repair, management, and additional capital investment, and ensure that you are in compliance with property management requirements, tax payments, investor questions and reports. This will require adequate management and compliance skills, as well as professional accounting and legal assistance, for both purchases and sales of assets, as well as for leasing, eviction issues, disputes, insurance issues, injuries, and other daily property management concerns.

...by Warren Kirshenbaum


There are numerous cities across the United States which can be considered "cleantech capitals." With a large array of renewable resources, a dedication by businesses and homeowners to become more energy efficient, and a large hub for research and development, a lot can be accomplished when it comes to creating new, efficient and sustainable clean technologies. There are many factors that make up a "capital for cleantech," and although there are more than ten cities around the nation that are involved in clean technologies, here are six of the top cities.

1) Boston, Massachusetts. Boston is said to enjoy some of the most supportive policies in the United States for energy efficiency and renewable energy. After California, Boston is second in clean technology venture capital investments. With an environment that is ripe for cleantech startups, numerous companies are moving their business to Boston. The MIT Clean Energy Prize is a venture and innovation creation competition that encourages clean energy innovation. Its objective is to provide educational opportunities and supply incentives to ventures demonstrating the clean energy affordability. As well, the development of MIT's cleantech incubator will provide Boston with more access to cleantech flow, increasing the demands for all future building to be constructed in accordance to LEED standards set up by the U.S. Green Building Council.

2) San Jose, California. San Jose, part of California's Silicon Valley, has been very productive in clean technologies. The city has expanded a number of clean technology investments and because of the research and development institutions in the area, many cleantech companies are coming to make their home in San Jose. San Jose's, "Long-time leadership in engineering know-how, combined with semi-conductor, nanotechnology and optics R&D gives it a leg up in renewable energy development, particularly in solar energy applications." San Jose is also home to the Environmental Business Cluster, a non-profit technology commercialization center assisting startup cleantech companies developing goods and services to positively impact the environment.

3) Austin, Texas. Austin has long been Texas' hub for solar, wind, geothermal, and biomass power, as well as fuel cell technologies. Its commitment to the environment and sustainability has made it not only a national cleantech player, but a global one as well. Austin is home to some of the largest cleantech companies on a global level. A large research and development hub, the University of Texas at Austin has created several research expenditures to elevate research into energy efficiency and renewable energy. This includes a project by the College of Natural Sciences to create biofuel from blue-green algae and hybrid-electric automobile programs developed by The Center for Electromechanics.

4) San Francisco, California. California is one of the top cleantech states in the United States and it is cities like San Francisco that makes it happen. Currently, San Francisco is well on its way to becoming the first city to be completely run by renewable energy by the year 2020. With projects like Sunset Reservoir Solar Project, which is the largest municipal solar facility in the state, and a new $250,000 grant to increase renewable energy capabilities.
 
5) Seattle, Washington. Seattle has been leaving its mark in cleantech society by increasing the need for green standards. The Green Building Sustainable Communities Program, for example, creates city projects that meet sustainable outcomes. Tax breaks and loans are provided to businesses and residences that utilize green practices. Seattle has been a leader in using their garbage to get electricity. They have invested into electricity from garbage landfills.
 
6) Chicago, Illinois. Over 20 percent of total power in Chicago is coming from renewable sources. Due to the increase in the need for renewable energy and energy efficiency, Chicago has been able to create numerous job opportunities while, at the same time, increasing solar power and saving on CO2 emissions. Chicago is also becoming one of the major investment locations for international businesses. Chicago also has a number of green initiatives, including the Chicago Green Office Challenge.

Kirshenbaum Law and Cherrytree Group LLC can help you structure your tax credit transaction. Let us guide you through the process of applying for and securing renewable energy tax credits. These transactions typically require a lawyer, a consultant, and a syndicator, and Cherrytree Group and Kirshenbaum law can act in all three capacities, saving you time and money on your transaction.

The original article was written by Shawn Lesser, and can be seen at http://www.reuters.com/article/2011/03 /28/idUS317857292020110328

... By Warren Kirshenbaum

Baltimore Area Institutions to Receive Over $155 Million in New Markets Tax Credit Awards

BALTIMORE, MD - In an effort to highlight the Obama Administration’s key investments in broad-based economic growth and commitment to the revitalization of communities stricken by the economic crisis, Community Development Financial Institutions Fund Director Donna Gambrell today visited a job training and human services organization in Baltimore benefiting from private sector investments made possible through the New Markets Tax Credit (NMTC). Speaking alongside Representative Elijah Cummings, Director Gambrell announced the selection of 99 organizations nationwide to receive NMTC allocation awards under the 2010 program round. These 99 awards will leverage billions of dollars of investment into businesses and real estate projects to create jobs and promote growth in communities with high rates of poverty and unemployment.

“The New Markets Tax Credit continues to be a tool for job-creation and economic revitalization in areas that struggle to attract investment because of poverty, unemployment and a lack of opportunity” said Director Gambrell. “I am honored to announce the 2010 New Markets Tax Credit Award allocations with Representative Cummings here in Baltimore, where our partners have demonstrated why this tool has been so effective in making literally thousands of projects possible across the country and give Americans a chance to make a living, to start a business and to build a better future in areas that need it most.”

The NMTC, established by Congress in December 2000, permits individual and corporate taxpayers to receive a credit against federal income taxes for making equity investments in investment vehicles known as Community Development Entities (CDEs). The credit provided to the investor totals 39 percent of the cost of the investment and is claimed over a seven-year period. CDEs must apply to the Treasury Department’s Community Development Financial Institutions Fund (CDFI Fund) to compete for this allocation authority. The 99 organizations receiving awards were selected from a pool of 250 applicants that requested over $23.5 billion. They are headquartered in 27 different states and the District of Columbia; but have identified principal service areas that will cover nearly every state in the country, as well the District of Columbia.

“By helping our partners in community development secure critical funding for job-creating projects, the New Markets Tax Credit is helping to bring opportunity and drive investment in our local businesses and communities,” said Representative Cummings. “In these tough economic times Baltimore welcomes the support of the CDFI Fund, and we will continue working to ensure that we're reaching the hardest hit.”

Director Gambrell’s and Representative Cummings’ announcement was made today at Humanim Inc., a nonprofit organization that provides workforce development and rehabilitation services to individuals with disabilities and other barriers to employment. An award winning human services organization, Humanim provides a ground-breaking model for delivering expanded employment services that gives those individuals in greatest need the opportunity to build a career and attain financial independence. Over $14 million in NMTC financing provided by City First Bank of DC and the National Trust Community Investment Corporation allowed Humanim to convert a large brewery that sat abandoned for 35 years in one of the poorest neighborhoods in Baltimore into its headquarters. Humanim reaches individuals of all ages with comprehensive vocational services.

Having benefitted from funding under the NMTC, Humanim highlights the effectiveness of the NMTC in leveraging private investment to complete economic and community development projects that help revitalize communities with high rates of poverty and unemployment. In total, five institutions in Maryland will receive funds in this NMTC award round to invest in development projects.

To date, over $20 billion of private-sector capital has been invested through the NMTC into urban and rural communities throughout the country, helping to create or retain hundreds of thousands of jobs and to provide low-income community residents with access to quality education, health care, job training, housing and critical retail services in their communities.

2010 NMTC Program Awards

2010 NMTC Program Award List
2010 NMTC Program Highlights
2010 NMTC Program Allocatee Profiles
2010 NMTC Program Award Booklet

A complete list of the 99 organizations selected and additional information on the NMTC Program can be found on the CDFI Fund’s web site at: http://www.cdfifund.gov.

Rob Bennett for The Wall Street Journal

... By Warren Kirshenbaum

Construction is nearly complete on a $37 million classical music center for Orchestra of St. Luke's slated to open in Hell's Kitchen in March.

Complete with rehearsal and recording space to accommodate a full symphony orchestra and chorus, a music library café and even showers for musicians, the 20,000-square-foot building will be the orchestra's first permanent home since its debut in 1974.

The center will also serve dozens of arts groups that rent space in the city's increasingly crowded rehearsal and performance spaces, including the New York Pops and the American Symphony Orchestra.

Raising money for building projects in the past few years hasn't been easy for the city's nonprofits. Decreases in donations and a tightening grip on public dollars have hurt funding for capital projects by charities in particular. Many donors also have focused their attention on emergency programs for the hungry and homeless.

With traditional funding harder to obtain, the Orchestra of St. Luke's became one of a growing number of nonprofits turning to a federal tax program for capital financing. This week, it will announce it has received a $4.6 million equity infusion from financial institutions including Goldman Sachs Group Inc.'s Urban Investment Group, Solomon Hess and United Fund Advisors through a federal program that provides tax credits to investors putting money into community development projects.
[ORCHEST2] Rob Bennett for The Wall Street Journal

Street view of the center at 450 W. 37th St., which is also home to the Baryshnikov Arts Center.

"We needed these tax credits to ensure the project would happen on time and as planned," says Zev Greenfield, the orchestra's vice president of finance and Operations. "While we received $4.6 million directly, we saved millions more on financing and fund-raising costs."

In 2008, the orchestra and the Baryshnikov Dance Foundation closed on a three-party deal for 450 W. 37th St., which formerly housed a consortium of theaters. The orchestra paid $16.6 million for 20,000 square feet, taking on a $7 million mortgage and a $5 million line of credit from M&T Bank.

To fund the deal, the orchestra had received multimillion-dollar pledges from donors including financiers Joe DiMenna and Victor Elmaleh, and an $8.5 million pledge from the city's Department of Cultural Affairs. However, when the financial crisis deepened, additional fund-raising slowed and donations were delayed.

"Donors were supporting the project but needed to do it over a longer period of time, and that's why the credits became such an essential piece of the puzzle," says Katy Clark, the orchestra's president and executive director.

To fill the funding gaps, the orchestra hired a consultant and applied for the federal New Markets Tax Credit Program, rushing to close on financing before the end of 2010. Created in 2000 to spur economic revitalization through private sector investment, the program allows financial institutions to provide equity to projects in depressed neighborhoods and receive federal tax deductions in return.

The interest in tax credits heightened after the financial crisis hit, leaving cities eager for ways to tap the federal funding faucet to spur economic growth.

The New York City Economic Development Corp. partnered with financial-services company United Fund Advisors in 2008 to stimulate more projects using tax credits in the city.

Since then, they have financed more than $500 million of development costs, utilizing $89 million in New Markets tax credits.

The credits have allowed the city's nonprofits to raise financing for other large capital projects such as a new 75,000 square-foot museum and condo for the Museum for African Art on Fifth Avenue.

Slated to open this year, the museum received $18.8 million in New Markets tax credits. Other projects include a $13 million conversion of warehouse space in Lower Manhattan into a recreational sport facility called Basketball City USA, to be completed this summer.

The city and United Fund Advisors hope to obtain an additional $135 million allocation in tax credits later this year.

Still, nonprofits say qualifying for the tax credits generally requires the use of paid consultants, months of paperwork and complicated financing structures.

"It's an incredibly complex set of processes," Mr. Greenfield says. "You have to really spend the time to delve into the details."

State Auditor Suzanne Bump intends to review public subsidies for Evergreen Solar, the energy company that recently announced plans to shutter its Devens plant and move more 800 jobs elsewhere despite receiving millions of dollars in public funds, as part of a broader review of the state’s entire system of tax incentives.

With the Patrick administration saying it could recoup $13 million of the $31 million the state invested in Evergreen Solar, the News Service asked Bump if she was considering an examination of the public subsidies in the company.

Bump’s press secretary Christopher Thompson responded with a statement noting that before she took office, Bump had described reviewing the state’s broad system of tax incentives as a priority.

“She has developed an internal team and a strategy to evaluate these investments with a focus on accountability and tax payer [sic] benefit,” Thompson said. “The Auditor’s review will take a broad look at many different tax incentives, and the tax incentives granted to Evergreen Solar will be reviewed in this broader context.”

On the campaign trail last year, Bump talked up plans to examine tax incentives, saying they should be measured by the benefits provided to Massachusetts citizens and taxpayers and that accountability for public investments “must be built into state government.”

As a candidate, Bump said that all state tax incentives and credits should be reviewed for effectiveness and that she would begin with economic development tax incentives. She estimated state government would forego $1.7 billion in fiscal 2011 due to tax incentives and credits.

Bump also pledged to conduct audits of agencies charged with providing or documenting tax incentives to determine whether agency managers used appropriate procedures, provided objective analysis, measured outcomes as intended, and held recipients accountable for performance.

State Housing and Economic Development Secretary Greg Bialecki said last week that Evergreen had received $21 million in cash grants - $20 million to help build its facility and $1 million for workforce training - $7.5 million in investment tax credits and a long-term lease on state land valued at $2.7 million.

Evergreen has received other forms of public aid, but Bialecki said he did not count in his estimate $13 million in state grants used to build road and utilities infrastructure at Devens and some state taxes the company avoided when paying for equipment.

Bialecki estimated the state can recoup $13 million, including the $7.5 million investment tax credit, which he said won’t be claimed, $3 million in state grants that were tied to a job creation formula, and land costs.

"We’re looking very carefully at what happened here and what lessons can be learned," Bialecki said last week. "This wasn’t so much an investment in Evergreen Solar as it was in the clean energy sector. The purpose wasn’t to benefit a company but to grow an industry and the investment really put us on the map."

In announcing its Devens plant closing plans, Evergreen Solar President Michael El-Hillow said the firm’s production costs in Devens were “much higher than those of our low cost competitors in China.”

“Solar manufacturers in China have received considerable government and financial support and, together with their low manufacturing costs, have become price leaders within the industry,” El-Hillow said in a statement. “While the United States and other western industrial economies are beneficiaries of rapidly declining installation costs of solar energy, we expect the United States will continue to be at a disadvantage from a manufacturing standpoint.”

MassGOP Chairman Jennifer Nassour has called the state’s investments in Evergreen “reckless policy” and urged the Patrick administration to offer a more broad-based approach to economic incentives for companies.

House Minority Leader Brad Jones has said that the Evergreen case should serve as a “lesson to Governor Patrick that throwing money at companies in industries he approves of won’t necessarily translate into success.” Jones said Patrick and Lt. Gov. Tim Murray “should turn their attention to creating an economic climate where all businesses can succeed and thrive.”

Gov. Deval Patrick has defended his administration in light of the Evergreen controversy, saying the process of doling out incentives to individual companies or industries "works well."

"I am disappointed that we are losing these manufacturing jobs to China, but Evergreen produced over 900 jobs for each of the years in question (two or three times what they promised) and that was good for the workers who got those jobs," Patrick said during a recent online chat.

"Evergreen did not use about half of the benefits that were offered to them and we have recovered or will recover most of the rest. Beyond that, we need to ask ourselves whether we are serious about competing for jobs on the same playing field as other states. Far more often than not, we win in a competition. But we have to compete to win."

Senate President Therese Murray told WCVB-TV Sunday that Evergreen “paid us back” $11 million based on an initial state investment of $2.5 million. “I think that’s pretty good,” Murray said.

But Murray added, “Probably their five or ten-year plan was a little aggressive . . . It’s still a loss. There should have been a bit more due diligence. I would have had a bigger clawback - that if the jobs left that the money came back.”

Murray said she’s been told that “solar doesn’t make a profit,” adding, “I’m still grappling with that.”

House Speaker Robert DeLeo, who has also called into question the Evergreen investments, on Wednesday reiterated his support for tax incentives aimed at stimulating film industry business. DeLeo noted that “The Social Network,” “The Town” and “The Fighter,” which all have a Massachusetts connection, tallied 16 Oscar nominations this week.

“These movies, filmed right here in Massachusetts, are a good reminder of how important the film tax credit has been to our state’s economy in these challenging times,” DeLeo said in a statement, referencing House votes from nearly a year ago to block efforts to reduce incentives available to the film industry.

A Department of Revenue report released this month found that the film tax credit cost the state $82.4 million for productions filmed in 2009 and generated $319 million in spending, of which $104 million was spent in Massachusetts. Of the $215 million spent outside of Massachusetts, $82 million paid salaries of $1 million or more to actors, according to the report.

Over the four years in which the tax credit program has been on the books, the total credit-eligible spending for 449 productions claiming the tax credit was $1.047 billion, with 32 percent or $335.5 million paid to Massachusetts residents and 68 percent or $712.3 million paid to non-residents or out-of-state businesses, according to the Department of Revenue.

On Wednesday, Patrick said his newly unveiled budget proposal included a continuation of the film tax credit program.

...By Warren Kirshenbaum

Renewable energy is not yet able to be produced in quantities that will satisfy global energy demand, and renewable energy is more expensive than energy produced from fossil fuels, but great strides have been made in recent years in these areas. Furthermore, the costs that the production of fossil fuels are imposing, both on our environment, and financially on the companies producing oil and gas are not factored into the cost per gallon or kilowatt hour of energy production, and perhaps this is a line item that we should start to factor into the cost of the production of energy from fossil fuels if we are going to make a push toward serving the world’s energy needs with renewable resources.

This year, the Deepwater Horizon oil spill (which was both the biggest oil spill in U.S. history and the largest accidental marine oil spill in the history of the petroleum industry) released 185 million gallons of crude oil into the Gulf of Mexico for about three months and has inflicted devastating environmental and psychological damage on the coastal communities in the Gulf, affecting tourism, fishing and drilling, as well as subjecting residents to ongoing restrictions on fishing and shrimping that have affected the livelihoods of thousands of people. BP’s Gulf Oil Spill resulted in the deaths of 11 workers on the rig and injuries to 17 others. BP’s financial expenditures from the oil spill have so far reached $3.12 billion, excluding the $20 billion compensation fund they have set up to reimburse residents and businesses for their losses. Also this year we endured the Copiapo mining accident in Chile, which occurred when the copper/gold mine owned by San Esteban Mining Company collapsed and 33 men were trapped 2,300 ft below ground for 69 days. Fortunately, all of the 33 men were rescued with only one man suffering from pneumonia, and a few others experiencing dental problems. The cost to rescue the men was $20 million. The San Esteban Mining Company has allegedly violated mining regulations previously, and 8 of its employees have died at the mine in 12 years. Adding to the year’s disasters at fossil fuel production sites is the Pike River Mine accident in New Zealand where an explosion at the coal mine has left 29 miners trapped 4,900 feet from the mine’s entrance. The miners are still trapped in the mine and may not be alive. Gas sampling is being tested to ensure that any accidental spark will not ignite the mine when search and rescue operations are undertaken. The Gulf Oil Spill, Copiapo mining accident, and Pike River Mine accident were stark reminders that our pursuit of energy derived from fossil fuels is causing an irreversible deterioration of our planet, its natural resources, our environmental balance, and is subjecting us to unacceptable losses in human life.

There are a multitude of renewable resources, but this post will focus on solar and hydro energy production, as these methods of renewable energy production are, in my opinion, poised to experience significant growth in the next few years.

Solar energy production is significantly more expensive than hydro, due to the cost of the solar panels themselves. Hydro has languished for decades as a method of creating renewable energy, mainly due to the environmental objections that a hydro project creates, and the expensive federal regulatory requirements of such projects. However, both forms of renewable energy are attractive. Solar projects, unlike wind projects do not create a danger to birds, cattle, and other animals, solar fields are not large and aesthetically displeasing, and do not generate loud whirring sounds that intrude on people’s quality of life. Consequently, as solar installations have very little negative environmental effect, they are generally easy to permit. Solar energy is, however, expensive to produce, as the technology that underpins the solar panels have traditionally made the installation of solar fields expensive enough to impede their development as a commercial enterprise. As with all technology, as solar technology develops, its cost has begun to decline, which should make solar projects more viable. Hydro, is very clean and unobtrusive to the environment, and is relatively safe to produce, but it can affect the migratory pathways of fish, and a dam breach could be detrimental to downstream human habitats. Consequently, new dams have not been constructed in many years. In fact, the stock of dams has decreased over the decades. Moreover, the prospect of new dams being built is relatively slim (due to the environmental challenges and the time period involved in getting Federal Energy Regulatory Commission (FERC) approval). Inorder for hydro production to increase, the capacity of existing facilities would need to be expanded. Legislative changes that limit environmental objections to the process of FERC approval, renewal, and re-licensing would need to be implemented to help to stimulate hydro production, this will require intensive lobbying, but it can be done.

Nevertheless, the point being made here is that, despite the higher cost of producing renewable energy, the cost of energy production from fossil fuels is enormous,not only the monetary cost, but the environmental cost as well as the cost of human life. This is more of an IOU being tagged to the planet than a current cost, which leads to the conclusion that we have no choice but to pay the higher monetary price for renewable energy now and retire the bigger IOU that future generations will inherit.

By Warren Kirshenbaum

The Federal Reserve's plan to purchase $600BN in US Treasuries has wide ranging consequences, including the devaluing effect that the influx of such a large amount of dollars will have on the dollar itself. A devalued dollar makes US produced goods cheaper, causing exports to rise. As a deficit nation, the US benefits from an increase in exports, but it comes at the expense of other countries. Therefore, this plan has been roundly criticized by many countries who claim that the US is manipulating its currency, and as the issuer of a global reserve currency such as the dollar the US has a responsibility to keep the dollar fairly valued. It is certainly an interesting position for currency manipulating countries like China to take, but nonetheless this is the position they are taking, and as we will discuss below their influence on our domestic interest rate environment is significant.

So, what effect will the Fed plan have on mortgage rates? As the Federal Reserve's monetary policy has been to keep the Federal Funds rate at less than 1% for some time now, long term interest rates have remained low. Mortgages are generally priced off the 30 year Treasury bond, which is currently yielding 4.25%. Average 30 year fixed mortgages are pricing at 4.625%. In that a bond's yield increases as the price of the bond decreases, if the prices of US Treasuries decline, then yields will increase. Bond prices have been trending higher for several days now on concerns of inflation and uncertainty about the Fed's plan to buy treasuries.

So let us analyze this situation. As a deficit nation, we spend more than we receive. The only way to sustain such behavior is to borrow funds to finance the shortfall. Many nations have large stockpiles of US dollars from trading with us, and many more hold their reserves in dollar denominated assets. These dollars need to be put to work, and the value of dollar denominated assets need to remain steady for these countries to continue to run surpluses which are need to finance their economic growth, provide infrastructure and provide basic services for its citizenry. Therefore, there are a large number of countries buying US debt in the form of US treasuries. If other countries, like China decide that the US economy is shaky and they reduce their purchases of treasuries, or even begin to sell off the treasuries they currently own, bond prices would fall and yields will increase. That would mean that other countries would be unwilling to finance our debt at the same levels as they have been. In that case, with the Fed itself buying US treasuries, there will not be an excess supply of treasuries, which will keep their prices steady, or even cause an increase in bond prices. It would appear, however, that if we were in a deficit to begin with, the only way the Fed could buy treasuries would be to print more money to do so, which will improve the cash position of the US but deflate the dollar, and obligate us to greater borrowing costs. An increase in the US cash position, together with an increase in exports could have a formidable effect on our current account surplus and reduce our deficit, but clearly we are devaluing the dollar and annoying our trading partners whose point is well taken. They say that the US should be able to increase its exports by improving its competitiveness not devaluing its currency. Nevertheless, this seems to be a short term plan on the part of the Fed. Basically, increased export production can lead to the creation of jobs, and a lowering of the unemployment rate, which leads to a rise in consumer confidence. Mortgage rates and other borrowing costs could increase, which would lead to manufacturing price increases and, therefore, an increase in the prices of consumer goods, i.e. inflation.

So we are trading deficit reduction and job creation for inflation and higher borrowing costs. What all of this will do for our businesses and economic outlook is anyone's guess, but it is certainly shaping up to be a challenging time period.

... by Warren Kirshenbaum

It is my opinion that banks really do not have much incentive to lend money. Banks can borrow money from the Fed at rates that approximate zero, and they can then purchase US Treasuries and return a 3 point spread with little to no risk. Accordingly, why would they be willing to incur the time consumption of due diligence, the transaction expenses, and the inherent risk of loaning money to consumers and businesses when they can be profitable borrowing from the Fed, lending to each other, and engaging in hedging transactions. Nevertheless, as their apparent mandate is to take in deposits and then loan those funds out to borrowers while maintaining a reserve of funds to maintain net capital requirements, they need to put some money out to work in loan transactions but their documents, loan covenants, underwriting requirements, equity requirements, and debt-service coverage ratios are very restrictive, and in some cases are either unprofitable for borrowers or are putting businesses in the position of having to run business decisions by their bankers prior to accessing necessary working capital or credit line funding. I have been promoting for some time now that businesses need to create their own sources of funding, in order to decrease their reliance on bank financing, which is fast becoming a scarce resource. Private equity or corporate debt issuance is a viable option in these economic times, and I urge businesses of all sizes and levels of growth and development to formulate a plan to tap their non-bank resources for capital funding.

Interestingly, a midterm election that changes the majority party in Congress, such as the 2010 Midterm elections did can have a profound effect on the business plans of many different types of companies. For example, those businesses that supply the defense industry may find that under a Republican controlled Congress there are more dollars appropriated to defense spending, and will benefit from such a political change. Those businesses that are non-unionized may find that a Democratic Congress or state administration would be more favorable to union labor and open-shop employers may find that the cost of labor would dramatically increase, effectively turning a company’s cash flow upside down. Any of these factors would cause a company to need to seek financing to smooth out the edges while it re-formulates its business plan and carves out new market niches for itself.

My message is that if you are hoping to seek bank financing, you should add to your quiver of options the possibility of raising funds using private equity, or by issuing corporate bonds or debt instruments. As you are setting the terms of the offering or issuance you are in more of a position to control and accept provisions, terms, covenants and this will be beneficial to your business interests, and that will spur, and not hamper or restrict growth. We, as small business people are in need of capital and funding to execute many, if not most of the objectives of our business plans, but the sources of capital have become restrictive, unwieldy, and stifling. It is time to change the terms of this game, and look for alternate sources of funding.

Private Equity as a Banking Alternative ... by Warren Kirshenbaum

Banks are approaching lending practices with a stranglehold mentality.  Not only have underwriting practices tightened since the financial meltdown began in 2007, making it more difficult for businesses to secure financing for their operations and acquisitions, but banks are inserting and enforcing loan covenants that are causing business owners to reevaluate their use of bank financing.  

Recently, potential clients have requested meetings to discuss the possibility of raising private equity in order to pay off existing bank credit facilities, and for use as working capital and for acquisitions.  The necessity to extract one’s banker from becoming an unwitting business partner is an inbred business owner mentality.  Because bank credit facilities sometimes contain loan covenants that require a company to maintain certain pre-determined profit levels, limit a company from accepting new business from a large client, require the maintenance of a high level of raw materials or inventory, and discourage new equipment financing, the successful operation, growth and sustainability of an enterprise is being choked by the banks' credit facilities, rather than such capital acting as a growth engine for business.  It is a paradox for institutions that have existed in principle to provide capital to facilitate entrepreneurial growth and development to be having a restrictive effect on business, but that is the way it has become in today’s economy.  Banks are forcing business owners to convince its banker to fund routine business activities, such as those that result in an increase in business because the banker is concerned that the increased business is coming from one large customer rather than several smaller customers.  Such a discussion is heresy for a business owner --- these are business decisions, not banking decisions!  Moreover, securing financing for acquisitions has also become difficult, and with the economy as it currently is, expansion by companies is more likely through acquisition than it is through job creation.  

Accordingly, private equity is becoming more attractive as a source of funding for many businesses.

Structuring and completing a private equity offering is a complicated, but worthwhile endeavor.  Private offerings are exempt from Federal and State securities laws so long as the issuer (i.e. the company raising the funding) complies with the statutory exemptions of Regulation D of the 1933 Securities Act, and its State counterparts.  Some characteristics of Reg. D offerings are that they are limited in size and investor type; must identify accredited vs. non-accredited investors, and can only include a maximum of 35 non-accredited investors; must fully disclose all salient terms of the offering as well as applicable disclaimer language for forward-looking statements; and cannot use general advertising and solicitation.

The Cherrytree Group and Kirshenbaum Law Offices have extensive experience in advising clients on structuring and completing private equity offerings.   We can assist with many different types of private equity transactions, including mergers and acquisitions, financing and formation of funds, as well as tax and employee benefits. The Cherrytree Group, LLC can provide creative solutions to the most complex issues in evaluating, structuring, negotiating, and consummating private equity transactions.