Babson Banks –

A Billion


Firm: Babson Capital Management

Fund: Tower Square Capital Partners II

Placement Agent: Charles Rial & Associates

Size: $1 billion

It helps to not be a first time fund. That was the lesson learned by MassMutual Financial Group’s Babson Capital, which recently closed on $1 billion. its second mezzanine fund, Tower Square Capital Partners II, in relatively short order.

Babson’s latest fund has a total of $600 million from MassMutual and $400 million from outside investors. It will invest 85% in mezz and 15% in equity co-investments. Of the $600 million, $475 million of MassMutual’s commitment is structured as a side-by-side fund where it is the sole LP. The size of the fund is a step up from Fund I, which had $265 million in commitments. For that fund, MassMutual had no side-by-side fund of its own, but would match investments on a deal-by-deal basis.

Babson was anticipating a six- or nine- month process for Tower Square II, but it went much more quickly-four months.

“Once we proved we could operate under the M.O. of a fund, people were very, very enthusiastic about what we had to sell,” said Babson managing director Mike Hermsen. “The doors opened much more quickly in ’05 than they did in ’02.”

Part of the story that LPs heard in this road show was that even if there is only a roman numeral II, this is by no means a new team. The team of Hermsen, Mike Klofas and Rick Spencer have been working together in mezz and private equity for 15-plus years at Babson and MassMutual. MassMutual, for its part, has been investing in mezz since the 1950s.

But Tower Square I was their first third- party investment vehicle, and for that reason it was hard to make some LPs bite, they said. “Many weren’t prepared to invest in a first time third-party fund,” said Hermsen.

For Fund II, though, not only did old LPs re-up, new ones jumped on board as well. Within the $400 million that came from new LPs, about $125 million came from existing Tower Square I investors and a whopping $275 million came from new investors.

Tower Square II invests between $10 million and $40 million per deal on the mezz side, while the equity co-investments, which will be made alongside mezz investments, will be for between $5 million and $15 million. Tower Square II’s sweet spot is transactions with enterprise value of around $150 million. Over the last two years, Babson has been averaging investing around $400 million per year whereas during the down period of 2002 and 2003, that figure was about $250 million. Tower Square II has already invested a good chunk of its capital.

Through its first fund, Babson invested in 57 portfolio companies and there have been eight realizations, which have returned in excess of 40 percent. Babson is quick with the caveat that this is not representative of the returns the entire fund might have, but they have been pleased with the results so far.

Babson premarketed Fund II in the early summer and officially launched fundraising the day after Labor Day, with a first close at the end of September. The final close on the fund was last month. The target was $375 million with a hard cap of $475 million for outside investors. Hermsen said Babson is trying to build up its staff to help manage the large fund. The firm is currently adding at the associate and analyst level. It has 11 investment professionals now, up from six in 2002.

Meanwhile, on the co-investment side, Babson has also broadened the base of sponsors it works with. In 2002, the number of LBO shops it partnered with was about 35, while now it is close to 50. The shops Babson likes are not those that raise billion-dollar-type funds, but the ones with more modestly sized funds in the $150 million to $300 million range. Firms it has worked with on numerous occasions include Linsalata Capital Partners, Brazos Partners, Long Point Capital and Riverside Co. Spencer added that Babson, unlike the LPs that were gun shy about Tower Square I, doesn’t discriminate against first-time funds.

As for targets, Spencer said the companies Babson likes are “not particularly enamored by high growth equity platforms. We are looking for a slow and steady value added plan.”

Competition in lending has been increasing, the Babson pros acknowledged, notably from hedge funds. But, other than pricing, Babson doesn’t consider hedge fund lending an unmanageable threat. “Their coupons have trickled down but we have a long-term investment strategy, not a lending strategy. We play more of a partner role,” said Spencer. “We’re not necessarily the low-cost provider, but we’re not the guy that’s going to trade our paper when there’s a sign of risk or a bump in the road.”

Among other mezz funds that raised capital last year were Oaktree Capital Partners which raised $1.25 billion, Lehman, which closed on $1.1 billion, and Welsh Carson, which raised about $1.3 billion.