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 than anticipated.

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: LBO (Leveraged Buyout).