A New York state of mind

As limited partners across the US become enamored with in-state private equity investment programmes, a recent investment by the nation’s third largest pension fund highlights the benefits and potential pitfalls of investing in your own backyard. By Paul Fruchbom.

Earlier this week, New York-based private equity firm Founders Equity led a $15 million investment in Stone Source, a Manhattan-based distributor of decorative stone for use in residential and commercial projects. In the high-powered world of the global private equity industry, such a deal, given its relatively small size and stature, is not entirely significant. But the transaction was nonetheless notable for another reason: the latest example of in-state private equity investments among the largest limited partners in the US.

In addition to Founders Equity, the transaction also received equity capital from the New York State Common Retirement Fund (CRF), which invested $8.2 million in the company. The commitment, which came from capital invested in both Founders Equity and the Hudson River Co-Investment Fund, was part of the CRF’s In State Private Equity Investment Program, which was created in 1999 by the New York State legislature to foster investment in New York companies.

My primary objective is to obtain an appropriate risk-adjusted return…. It is first and foremost an investment program.

Alan Hevesi, New York State Comptroller

Earlier this year, New York State Comptroller Alan Hevesi released a report on the programme, which noted that $425 million in capital had been made available to 15 different funds, a significant increase over 2003. In total, 64 companies have received $920 million in capital from the CRF and its private equity partners. Private equity firms that have received capital from the program include Founders Equity, NY Softbank Capital and Rochester-based private equity firm Trillium Group.

In-state private equity programmes have grown significantly in popularity over the past several years as limited partners are able to not only increase their commitments to alternative assets but also satisfy constituencies clamoring for local investment and, at the same, time hopefully generate significant returns. Earlier this year, the Oregon Investment Council, one of the largest investors in private equity, approved investments in three private equity and venture capital firms via the Oregon Investment Fund, a $105-million state sponsored vehicle established in 2004 to foster small businesses in the region—to receive the funding all three firms had to set up an office in the state. Similar programs exist in Ohio, Massachusetts and California.

Alan Hevesi, New York State Comptroller

Critics contend that such programs are political tools used to garner votes rather than sound investment strategies to benefit actual pensioners. Countering such critics, Hevesi noted that while New York’s programme “had provided significant economic benefits to the state’s economy, my primary objective is to obtain an appropriate risk-adjusted return comparable to what would be available for other investments with similar characteristics. It is first and foremost an investment program.”

Given the youth of many of these programmes, it is still too early to measure their relative success. The CRF’s investment in Stone Source, for example, seems to highlight both the benefits—and potential pitfalls—of investing in small, local businesses. A small, entrepreneurial company, Stone Source will no doubt benefit via the cash infusion, which should trickle down to its local employees, suppliers and clients. And given the resurgence in the housing market and the movement towards high-end materials in home decoration, the company is well-poised to generate a profitable return on its investment.

Yet the company is also using its new capital to expand into new markets such as California, which may benefit New York indirectly, but is likely a bigger boon to the citizens of the Golden State. And the company’s client list, according to Stone Source’s website, includes such celebrities as Robert Deniro, Al Pacino, Gwyneth Paltrow and Jerry Seinfeld—New Yorkers, definitely, but not necessarily the constituency that needs assistance from the state government.

Nevertheless, given the rapid growth of the private equity industry, in-state programmes appear likely to stay. And as limited partners look to put more and more capital into the asset class, look for a private equity investment programme to come to a state near you.