Flip . . .
refers to the practice of selling a company or an
investment made in a company soon after the purchase to make a quick
gain. They are most often seen in leveraged buyouts or other whole
company acquisitions where circumstances permit a bargain purchase.
When this is so, the opportunity sometimes exists for the purchaser to
resell or "flip" the company in a short period of time to
another buyer at a higher price.
Flips can be costly to management in a leveraged
buyout if the investor uses debentures or preferred stock as a primary
investment vehicle but takes his equity interest in common stock. This
is because management typically acquires the smaller equity interest
in the transaction and the investor’s structure requires the
debenture or preferred stock to be paid out before moneys are paid to
shareholders. Until the company’s value exceeds the debt by a
significant margin, management’s share in the equity may be less
In a leveraged buyout that cost $5,500,000, for
example, management might own 20% of the company’s common stock to
the investor’s 80% interest. If the investor structured $5,000,000
of his investment in debentures, a flip of the company in six months
for $10,000,000 will pay out $5,000,000 to the investor on the
debenture and another $4,000,000 on his common stock. Even though the
company nearly doubled in value, management will receive only 20% of
5,000,000 or $1,000,000 instead of 20% of the total $10,000,000
purchase price. The investor, by contrast, makes a neat $4,000,000
profit on a $5,000,000 investment made for six months.
This problem can be effectively addressed in the
financing agreements. If it is not, it can create a powerful incentive
for the investor to flip the company for a quick profit in
circumstances where management might be better served by growing the
company for a longer period of time to a higher value. See: