There's a lot of talk about how demanding limited partners are these days, requiring proof of performance before they invest. It's considered especially tough for a new firm to raise a fund. And yet some of the biggest LPs are actively seeking nascent PE firms, and some new funds are actually flourishing in their first-time fundraising efforts. (Watch the video below.)
The California State Teachers' Retirement System (CalSTRS) is one LP that is paving the way when it comes to investing in new and next-generation private equity managers. CalSTRS, along with Invesco Private Capital, has launched a program with $550 million to invest in new and next-generation PE managers--those that are raising their first, second or third institutional fund.
Other LPs embracing the trend are the Illinois Teachers' Retirement System and the New York State Common Retirement Fund. Illinois Teachers recently approved an investment in Great Point Partners Fund II and invested in Siris Capital Group as part of its emerging managers program, while the New York fund has allocated $250 million to Farol Investment Advisers for private equity co-investments with the fund's new and emerging managers program.
Here is a trio of firms benefiting from the trend.
Siris Capital Group
In March 2011, the founders of Siris Capital Group LLC launched their first institutional fund with hopes of raising $400 million. By September 2011, the firm had $130 million in commitments. The New York firm then signed a deal to take private Tekelec, a publicly traded software company.
Closing the deal during the fundraising process turned out to be an advantage. "Many LPs became more intrigued with us when they saw us executing on our strategy," says Frank Baker, co-founder of the firm.
Siris' strategy is to invest in technology companies that are in distress. Baker and his partners have focused their careers on technology. Baker and Siris co-founder Jeffrey Hendren worked together in the mergers and acquisitions group of Goldman Sachs Group Inc. (NYSE: GS), where they met. The two left to join Ripplewood Holdings LLC, where they met their third partner, Peter Berger, and ran the technology investing efforts, says Baker.
In 2006, the trio left Ripplewood to invest on behalf SAC Capital Advisors, the hedge fund manager. Four years later, they decided to go out on their own. "We completed three transactions and had a significant liquidity event. Having developed a great track record, independent of Ripplewood, we felt like we were finally ready to raise our first institutional fund," says Baker.
Today, Siris is putting up to $250 million of equity into deals and looking to invest in companies with enterprise values of between $250 million and $1 billion. The firm focuses on "take privates" and employs about 20 people.
Tekelec, for example, developed technology for 2G and 3G networks, which was an issue when the world was already moving toward a 4G network. Siris restructured the company and implemented operational and structural improvements. After holding the company for just over a year, Siris sold it to Oracle Corp. (NYSE: ORCL) for $780 million.
In December 2012, Siris held a final close on its first institutional fund with $641 million, causing the firm to extend its hard cap. What's more, an investment that the Siris founders had made for SAC was exited by the hedge fund firm for a triple-digit return. That impressed potential Siris investors.
"We bought one business and sold one at an attractive return. LPs were really excited not only to see us in action, but because we have a unique strategy for investing in distressed technology companies," says Baker. "We were concerned about launching our first fund. I went to a handful of conferences for emerging managers and started meeting investors. It was totally bootstrapped in the beginning. The people I met at the conferences got us to our first close. No one in our first close was a Ripplewood investor."
The capital for the fund's first close came from limited partners that focus on new and emerging managers, including Credit Suisse Customized Fund Investment Group, Illinois Teachers, BAML Capital Access Funds, Muller & Monroe Asset Management and StepStone.
After that, the firm hired placement agent Greenhill & Co. to help diversify the investor base and raise additional capital. "The buying and selling during the fundraising underscored our strategy and gave us something interesting to talk about in the meetings. It helped the LPs get their arms around what we were doing," says Baker. "Instead of getting the standard pitch book, they felt like they were under the tent with us."
After working together for more than a decade at Insight Equity, Conner Searcy recruited four other Insight Equity co-workers to launch Trive Capital in 2012. The firm closed on its first institutional fund, Trive Capital Fund I LP, with $300 million in July 2013. The Dallas firm's strategy is to invest in lower middle-market companies that have been under-resourced.
"We are industry-agnostic, but we are deep value investors," says Searcy, a managing partner with Insight. As a deep value investor that buys companies that are deeply below their intrinsic value and often below cash on hand, Trive gravitates to companies in manufacturing, distribution and business services.
"At our core, we are hands-on with our portfolio," Searcy says. "We are operational partners more than finance professionals."
Trive's fundraising experience is evidence of limited partners' interest in new firms. Trive was able to score commitments from wealthy families and endowments as well as the traditional players such as pension funds. Additionally, Trive was able to bring in European investors without even leaving the U.S. All told, the firm has roughly two dozen LPs globally, reached its hard cap in five months and was oversubscribed from the initial $250 million target.
"We were fortunate to close out our fundraise in five months above our hard cap at $300 million," says Searcy. "We got some lucky breaks. Folks signed up early, and we benefitted from that. We also benefitted from the fact that our team had worked together and had a successful track record."
"With 1 percent (gross domestic product) growth, investors are trying to find angles for investment returns that aren't tied to broad market growth. We are counter-cyclical investors, which is appealing today," he said.
Trive has completed three deals and is close to a fourth. Its first purchase, in September 2012 before it closed on the fund, was of Southern Towing Company. The deal exemplifies Trive's strategy. Headquartered in Memphis, Tenn., the inland tank barge operator specializes in transporting bulk liquid fertilizer products throughout the Mississippi River System and the Gulf Intracoastal Waterway. Trive bought the company for a price it says was much lower than its intrinsic value and has increased the company's run-rate Ebitda by more than 20 percent.
In December 2012, Trive bought Precise Packaging, a Fall River, Mass.-based manufacturer of miniature aerosol and pump stray product. And in February 2013, the company bought Huron, a Lexington, Mich.-based supplier of precision-machined products for the automotive industry.
Trive is now buying an aircraft parts processor that could benefit from its operational expertise.
"It was daunting to go out on our own at a time when LPs are consolidating their commitments. But we had worked through industry cycles before and felt very confident about our strategy. The time was right to strike out on our own. We are an entrepreneurial bunch, and we had a vision of what we wanted a firm culture to look like," says Searcy.
Partners Private Equity
Launched in January 2013, Partners Private Equity LLC (PPE) is still raising its first institutional fund to do lower-middle-market, old-economy deals. "We will be looking at companies with $2 million to $8 million in Ebitda with a primary focus on business services and niche manufacturing," says John Mueller, a founder of the Cleveland firm. "The key is we will invest only in companies where we, or our investment partners, have domain expertise that can help us be more strategic."
Although the firm has yet to close a fund, it does have backing from a handful of high- net-worth families and already has a full deal pipeline. The firm is currently reviewing seven potential transactions that range from a manufacturer of rubber products to a turnaround of a die-casting business.
PPE is hoping to close on a formal fund with $50 million by the end of the year. Mueller says he and the team are raising the capital on their own and are exclusively focused on high-net-worth individuals and families as investors.
"In general, we find that people are more risk-averse than they used to be. Entrepreneurial investors are more inclined to invest with us than passive investors, but in many cases they want more control over investment decisions regarding the individual deals we are looking to invest in," says Mueller. "Our best reception is from people who understand the size and nature of the company we are investing in and have made money doing something in a similar vein to the companies we are looking at."
"We tend to be fairly value-conscious," reports Mueller. "There are no hard and fast rules, but because of our investment philosophy, we rarely pay more than six times cash flow for a company and no more than four times total leverage." Once the fund is raised, the firm expects to invest it within four years, with $4 million to $8 million of equity per deal.