The ideological backlash to Enronitis is threatening to stifle America’s entrepreneurial spirit, with potentially dramatic consequences not only for the country’s venture capitalist community, but also the economy as a whole. Polemic from Joseph W. Bartlett.
Joseph Schumpeter noted that capitalism depends on the “animal spirits” of the entrepreneurial class. Today, absent the turbo charge that the United States’ entrepreneurial culture projected into its economy, we are in for an indefinite slide to economic stagnation.
Can we, as the current administration hopes and plans, grow our way out of the slow if not no growth box? Taking the long view, we can – or at least we have been able to in the past. But the essential impetus, the sine qua non ingredient in our success, has been our system of generously rewarding risk takers, from William Penn to William Gates.
If, as current trends suggest, our cultural mandarins, our press, our law enforcement personnel, our academics, our opinion makers – if all these groups, driven by their internal metabolisms and/or perceptions of their personal advantage, are bent on making business failure at least a tort and perhaps a crime, on raising the bar of managerial responsibility until it is insurmountable, of bureaucratising the private economy, of, in a word, reintroducing the longdiscredited theses of command, top-down economies, we are on our way to a difficult economic and social outcome in the years ahead.
The historical evidence, any way you look at it, is compelling. The extraordinary post-war performance of the US economy has been driven, in large part, by small businesses. And the jewel in the crown of that growth, that element of the post-war economy which distinguishes the United States from the rest of the industrial world, has been that activity loosely labeled “venture capital”, helping small businesses to become world leaders. To pick some obvious examples of venturebacked company success, and its impact on the US economy: in 1990, Microsoft, Dell, and Cisco already had combined sales of $2bn; in 2000, their combined sales were $80bn.
Initial Public Offerings (IPOs) historically have been a pillar of US venture capital investing, tapping an open and liquid public market receptive to high tech companies in relatively early stages of their development. Traditionally, venture capitalists have used the IPO exit to construct their pricing models, using IPO-driven liquidity as the basis for their assumed terminal values. And, again historically, IPO exits are typically an order of magnitude larger than company sales. Use of IPOs in the standard models invigorates the process up and down the line, justifying a portfolio of risky investments on the theory that, if some percentage of these investments turn out to be “portfolio makers” as a result of IPOs, the VCs can take risks they would not be in a position to take if company sale were the only way to monetise their investments.
Moreover, IPOs add to the choice of available public securities for investors to review. And they allow venture-backed companies to grow as independents, e.g. Microsoft as an independent and not a division of IBM. Without venture capital support, Apple Computer, Intel, Lotus, Yahoo, Amazon and eBay would still be ideas, not mega-corporations. The IPO market comes and goes, of course. However, so far at least, even though it shuts down every now and then, it has always returned. But now, I am not so sure. With litigation a constant thorn in the side of every manager and board member of a public company, the attractiveness of public registration is beginning to approach zero. Furthermore, the impact of the new certification rules, congruent with some other unpromising factors, threaten to squelch the possibility of the IPO window ever reopening wide.
Finally, the undeclared war on the analyst community will inevitably reduce coverage further, below the unsatisfactory level that exists already. Many newly public companies, if not covered by analysts employed by the investment bank which brought the company public, are not going to have any coverage at all. This means a berth in the so-called orphanage, with the stock price trailing off, liquidity diminished to the “trading by appointment” level and hence the benefit/burden analysis tilting strongly against the IPO at an exit mechanism.
Add in the geometric increase in strike suit litigation by the plaintiffs’ bar, the most powerful end of the US legal profession and well funded to take on new assignments, and you have a situation where an increasing number of issuers in the venture space will simply turn their back on the IPO prospect and sell out to a trade buyer at the first opportunity.
Stalling the engine
This is bad news all around for the venture industry. Worse still, in addition to making the IPO window stickier and harder to open (perhaps, I fear, impossible), the companion assault on equity-flavoured compensation is disturbing. Stock options are about the only method early stage companies can use to attract the experienced and high quality management they need. The Luddites attacking the very concept of stock options are, based on the published analyses I have seen, essentially clueless. I would love to take any one of them on in a public debate: they do not understand the economics, the tax aspects, or the critical psychological aspects, and the “cures” they propose are infinitely worse than the disease.
My fear, in short, is that the lynch mobs of prosecutors, politicians and commentators, many of whom have little understanding of the stakes they are playing with, will permanently depress a vital engine of the US economy. And a slow growth model is ominous. Think of the resulting loss of jobs and international economic competitiveness; of creditor insistence that we pay the due bills we have run up with the rest of the world; of solvency problems with Social Security, Medicare and other public services as tax revenues shrink and the population ages; of social unrest as more and more people fight for pieces of a shrinking pie – the list goes on.
There is no going back, of course, on improved corporate governance. No civilised society can tolerate economic shenanigans of the sort the reforms are designed to remediate. However, my fear, as I say, is collateral damage. We need to look at the wave of reform to make sure it doesn’t go too far.
Accordingly, we need to work on counter measures and come up with reforms that are positive, not negative. We need reforms that, for example, facilitate IPO exits, well considered public flotations for deserving companies, plus practical as opposed to otherworldly adjustments to equity compensation regimes.
Recommendations in this vein are being developed by myself and other practitioners with long experience in this business. If any reader would like an update on the works in progress, please contact me by email.
A regular contributor to Private Equity International, Joseph W. Bartlett is Of Counsel in the New York office of Fish & Robertson P.C. He is also Founder Chairman of VCExperts.com, the US information provider for entrepreneurs and venture capitalists. He can be reached at firstname.lastname@example.org.
Deals & Exits
One Equity Partners sells rehab supplier for $575m
New York-based One Equity Partners, the private equity arm of Bank One Corp, sold its rehabilitation supply company AbilityOne Products Corp to publicly traded Patterson Dental Co. for $575m. The firm bought the AbilityOne division of Bissell, known for its vacuum cleaners, in March 2000 and added on with the acquisition of Smith & Nephew Rehabilitation in March 2002. AbilityOne offers rehabilitation to hospitals, nursing homes, rehab clinics, schools and other dealers, and has forecasted sales of $220m for 2003.
Fremont acquires $132m plastic packaging asset
San Francisco-based Fremont Partners has completed a $132.5m addon acquisition for its plastic closure portfolio company, Kerr Group, following a $1bn recapitalisation of medical device portfolio company Kinetic Concepts. The firm acquired the operating assets of Setco and Tubed Products from spice company McCormick & Co.
Kerr paid $132.5m in cash for the businesses. Setco and Tubed Products develop and manufacture plastic bottles, squeeze tubes and other closures for the vitamin, spice, pharmaceutical and personal care markets. Kerr was acquired by Fremont in 1997 and specialises in tamper-proof packaging for the over-thecounter drug marketplace.
American Industrial completes industrial products IPO
San Francisco- and New York-based American Industrial Partners has exited Great Lakes Carbon Income Fund via an initial public offering of units as a Canadian Income Trust on the Toronto Stock Exchange. The firm will continue to own approximately $150m of securities directly convertible into units, representing approximately a 2.3 times return on its original investment.
Great Lakes Carbon is the world’s largest producer of both anode and industrial grade calcined petroleum coke, a material used in the production of aluminum and other industrial materials including titanium dioxide
Advent sells Latin America Money Services
Boston-based Advent International agreed to sell money transfer portfolio company Latin America Money Services (LAMS) LLC and an operating subsidiary, DolEx Dollar Express, to Global Payments for approximately $200m. Under the terms of agreement, Global Payments, a provider of electronic transaction processing services to merchants, financial institutions, government agencies and multinational corporations in the US, Canada, the UK and Europe, acquires 100 per cent of the outstanding equity interests in DolEx from Advent (the majority owner of LAMS) and other LAMS and DolEx shareholders.
The transaction, pending regulatory approvals and customary closing conditions, is expected to be completed before the end of the year.
Clarion Capital acquires nursing company for $113.5m
New York-based Clarion Capital Partners has bought Nursing Corp., the largest privately held provider of travel nurse staffing in the US, in a $113.5m buyout. Clarion funded the acquisition through a combination of equity, senior bank debt and subordinated debt.
Post-transaction, Clarion will own 80 per cent of US Nursing, with management and former owners retaining the balance. Companies operating nursing and home care outsourcing services have been attracting buyout interest recently. US Nursing, headquartered in Denver, Colorado, was sold for estate planning purposes.
Hicks Muse makes $350m profit on Pinnacle Foods
Dallas-based Hicks, Muse, Tate & Furst has sold branded consumer food company Pinnacle Foods to JP Morgan Partners in a transaction valued at $485m, realising a profit of more than $350m on its investment. JP Morgan Partners, previously a minority shareholder in the company, teamed with Pinnacle’s chairman and chief executive officer C. Dean Metropoulos in the transaction. He will remain in those positions going forward.
Pinnacle Foods is made up of Vlasic Pickles, Open Pit barbecue sauce, and Swanson frozen dinners. Hicks Muse formed Pinnacle in 2001 to buy the assets of Vlasic out of bankruptcy for approximately $370m. Hicks Muse contributed about $130m into the deal. Pinnacle generates about $600m in revenue annually.
Blackstone, Cypress lead buyout of GE’s financial guarantee business
The Blackstone Group and The Cypress Group, leading a syndicate also comprising mortgage insurer PMI and buyout firm CIVC Partners, have bought out FGIC, General Electric’s financial guaranty business, for approximately $2.16bn. The firms signed a definitive agreement to acquire the business after news of the deal first broke in May.
FGIC, which provides financial guaranty policies for public finance and structured finance obligations, will operate as an independent company once the deal is completed. PMI will have a 42 per cent ownership interest, with Blackstone and Cypress each owning a 23 per cent interest. CIVC will own a 7 per cent interest and GE will retain a 5 per cent stake. PMI has the option to buy out the other parties over time.
The deal, which was auctioned by Bank of America, will be funded with a $1.44bn equity investment, $225m of senior debt, $235m of mandatorily convertible participating preferred equity held by GE and a pre-closing dividend of $260m. Bank of America is a major limited parent to CIVC Partners, which is based in Chicago.
Pequot makes solid return on Netgear IPO
Westport, Connecticut-based Pequot Capital Management has secured a solid return on the initial public offering of portfolio company Netgear, a provider of branded networking products for small businesses and home users. Netgear, based in Santa Clara, California, raised $98m by offering 7 million shares through underwriters Lehman Brothers, Merrill Lynch and UBS Warburg.
Netgear was launched in 1996 as a unit of Bay Networks and later acquired in 1998 by Nortel Networks. Pequot led a $15m management buyout of Netgear when the company spun out from Nortel in March 2000. Netgear subsequently filed for an IPO in September of that year, but abandoned the plan the following February as market conditions soured.
Pequot, with a 34 per cent stake, is Netgear’s biggest single shareholder. Shamrock Capital Growth Fund owns 23 per cent, and Blue Ridge Limited Partnerships has a 12.4 per cent stake.
Harvest Partners builds up siding asset
New York-based Harvest Partners has agreed to acquire vinyl siding and window manufacturer Gentek Holdings for approximately $118m in cash. Harvest Partners purchased Gentek through its Associated Materials portfolio company. Gentek, whose brands include Revere and Gentek, manufactures and distributes vinyl, aluminum and steel siding, and vinyl windows. The products are sold to contractors on a wholesale basis through company-owned distribution centers and independent wholesalers. Net sales for 2002 reached $260.1m.
Harvest Partners privatised Associated Materials in March 2002 for a total of $436m. Associated Materials also makes vinyl siding and windows for the residential market. The company’s operations include AmerCable, a manufacturer of electrical cable for mining, transportation, offshore drilling, and other industries.
Berkshire Hathaway wins shareholder approval for $1.7bn mobile homes buyout
Warren Buffet’s Berkshire Hathaway secured shareholder approval for a $1.7bn public-to-private acquisition of Tennessee-based mobile home manufacturer Clayton Homes. Berkshire Hathaway agreed to buy Clayton on April 1.
Although the $12.50 per share sale price represented a 12 per cent premium to Clayton’s recent stock price, several large investors said it undervalued the company. Despite a 52.4 per cent vote of the company’s shares outstanding in favor of the deal, Tennessee labour groups have held up the merger in the local judicial system. Clayton Homes is appealing the court’s decision not to block the plaintiffs’ legal actions.
Clayton manufactures, sells, finances and insures mobile homes. The company, which has 20 plants, also has companyowned stores and independent retailers, and provides mortgage services through its Vanderbilt finance subsidiary.
Funds & Buyside
JP Morgan cuts $1.4bn private equity fund commitment
New York-based JP Morgan Chase has slashed $1.4bn from its commitment to captive private equity arm JP Morgan Partners’ record-breaking JP Morgan Partners Global 2001 fund. The Global fund closed in November 2002 on $8bn, making it the largest single fund ever raised in private equity history, eclipsing the previous record holder, New York-based The Blackstone Group’s Blackstone Capital Partners IV, which raised $6.45bn.
The Global fund still holds the record, barely, despite its reduction of 18 per cent to $6.5bn. JP Morgan originally agreed it would invest three dollars for every dollar of third-party money that was invested each year over the fund’s projected five-year lifespan, and the fund’s original target was set at a gargantuan $13bn.
When the investment climate soured during the 2001 recession, the target for third-party commitments was revised to $3bn from $5bn after limited partners coughed up only $1bn six months after the launch of the fundraising. J.P. Morgan ultimately raised only $1.7bn from third parties, barely more than half of the revised total. At the same time, the firm revised its internal commitment to $6.2bn from the originally proposed $8bn. J.P. Morgan will now contribute less than $5bn.
The Global fund’s limited partners include the Canadian Pension Plan Investment Board, the California Public Employees’ Retirement System (CalPERS), Caisse de dép^t et placement du Québec, the State of Michigan Retirement Fund, and the New York State Common Retirement Fund.
Darby acquired by Franklin Templeton
Washington, D.C.-based Darby Overseas Investments, the emerging markets investment firm, has sold itself to Franklin Resources, a division of Franklin Templeton Investments, for $75.88m. Franklin Resources already owned 12.66 per cent of Darby, which manages $700m in private equity and mezzanine funds. The firm will continue to operate as Darby, and Nicholas Brady and Richard Frank will remain chairman and chief executive officer, respectively.
Last month, Darby Asia Investors announced its Asian Infrastructure Mezzanine Capital Fund made a $35m investment in Filipino power and infrastructure development company First Philippine Holdings Corp. The fund purchased $35m of 8-year term notes with call options to First Generation Holdings Corp., a majority owned subsidiary of First Philippine Holdings.
INVESCO combines fund-raising efforts
Two fund of funds capitalraising efforts overseen by INVESCO Private Capital are combining to form a partnership with a target of $500m, according to sources close to the firm. INVESCO Partnership Fund IV will absorb the current and future capital commitments of Sovereign New Millennium Fund III, which previously had a target of $150m.
In May 2002 INVESCO Private Capital, a division of publicly traded financial company AMVESCAP, merged its private equity fund-of-funds division with Denver-based fund of funds manager Sovereign Financial Services. At the time of the merger, the firms announced their two respective vehicles would be managed separately. Since then, a source said the firms decided “it didn’t make sense to have two products in the market.” The source added that the two teams had “very little overlap” in terms of general partner relationships.
INVESCO Partnership Fund IV will invest globally in private equity funds. The combined investment team includes five professionals devoted to limited partnership investing.
Bear Stearns, Giuliani launch security investment vehicle
Bear Stearns Merchant Banking, the private equity unit of financial services group Bear Stearns, is teaming with former New York City mayor Rudolph Giuliani’s Giuliani Capital Partners to invest $300m of Bear Stearns Merchant Banking’s recent $1.5bn fund in private equity opportunities in the security and public-safety sectors. Giuliani Partners will serve as a source of deal flow as well as play an advisory and oversight role on portfolio companies. Giuliani himself will have a senior advisory position on the fund, according to a source familiar with the situation. Richard Perkal, a partner at Bear Stearns Merchant Banking, will lead the venture for Bear Stearns.
The fund, which will be drawn from Bear Stearns Merchant Banking Partners’ $1.5bn second fund, will primarily look for companies with solid cash flow instead of early-stage opportunities, the source said. The partnership will evaluate the fund after about a year and assess whether more capital should be committed to the venture. The new fund will be able to make equity commitments of up to $75m per transaction.
UBS builds US placement team
At a time when many major US funds are gearing up to fundraise in 2004, UBS has made a series of appointments at its US private equity funds group to increase its presence in what the firm considers a core market.
Richard Allsopp, managing director and global head of the UBS private equity funds group, has relocated to the US as part of the team’s focus on securing US business, joining Jake Elmhirst, head of origination, who has been in the US since 2000. The pair will head US operations out of Stamford, Connecticut, which will also serve as the unit’s global headquarters.
Ken Freeman joins the team as an executive director, heading up the firm’s West Coast operations. Freeman joined the firm from Citigroup and will be based in San Francisco. The fund also hired Mark Schroeder, who served as a managing director at CSFB’s Private Funds Group, and Naren Srinivasan, who worked at Rothschild. Marty Voelker, formerly of Citigroup, joins the group’s deal origination team.
UBS now has 25 professionals in the U.S. and Europe, where UBS is among the leading fund raising organizations. The European team now comprises eight placement professionals, including Alexander Bance and James Moore.
Summit Partners names Miller GP of venture arm
Boston-based Summit Partners rehired Harrison Miller as a general partner of Summit Accelerator Fund, the firm’s venture capital arm. Miller was an associate at Summit Partners from 1988 to 1990. Prior to rejoining Summit Partners, Miller served as vice president and general manager of platform services at Amazon.com.
Miller helped create the enterprise services business and led the children’s products division. He was also responsible for the company’s alliance with Toys’ R’ Us. Prior to Amazon, Miller was on the founding management team of learning software company Lightspan.
Prometheus Partners hires commercial finance specialist
Prometheus Partners, an Atlanta-based smaller middle market private equity firm, named Tim Eichenlaub a managing director. Eichenlaub joins the firm from GE Commercial Finance, where he served as a managing director. While there, he oversaw a team that covered private equity firms and provided equity and senior and subordinated debt for middle market buyouts. His prior duties with the firm had him responsible for the mezzanine capital and syndications team. He joined GE Commercial Finance after the firm’s acquisition of Heller Financial, where he had been an executive vice president.
“We are delighted to welcome an executive with Tim’s transaction experience and record of successfully investing with our team,” Nicholas Peters, founder, president and chief executive officer of Prometheus Partners, said in a statement. “Tim really understands our niche and how to grow these smaller middle market service businesses.”
US Venture Partners appoints Tim Connors GP
Menlo Park, California-based venture capital firm US Venture Partners announced Timothy Connors’s promotion to general partner. Connors joined the firm as an associate in June 2001.
Connors came to US Venture Partners after spending three years with Sequoia Capital. Prior to launching a career in venture capital, Connors spent seven years in engineering, marketing, manufacturing and sales roles at C-Cube and Tandem Computers. Connors specialises in building enterprise software and semiconductor companies, with a primary focus on seed and early stage companies.
Fremont Partners promotes Lenihan to managing director
San Francisco-based Fremont Partners promoted Bill Lenihan to managing director after hiring him as a principal in 1998. Prior to joining Fremont, Lenihan worked for Goldman Sachs, where he pursued investment opportunities for GS Capital Partners II, a $1.7bn fund. Lenihan currently serves as a director of Nelson Nutraceutical Inc., a manufacturer of functional bars and powders and a Fremont Partners’ portfolio company.
Bear Stearns hires TD Capital’s Lattanzio
Paul Lattanzio joins Bear Stearns Merchant Banking, the private equity arm of Bear, Stearns & Co, as a senior managing director and will lead the newly formed Bear Growth Capital Partners to focus on investments in middle market companies with values between $10m and $100m. The group will receive its capital from Bear Stearns and will target companies considered too small for the investment parameters of Bear Stearns Merchant Banking’s $1.5bn second fund.
Lattanzio comes from TD Capital, where he served as managing director, and brings TD Capital colleague Joe Scharfenberger, who joins Bear Stearns as a vice president.