CapitalSource Nets Largest-Ever Series A Round

Like David taking on the corporate lending Goliaths, CapitalSource Holdings LLC became the most highly capitalized venture-backed start-up in history yesterday, scoring a $540 million Series A financing that translates into $2.5 billion in funding capabilities for the Washington, D.C.-based firm.

Although the deal is formally closed, another $15 million of venture financing may come to the table in the weeks ahead. CapitalSource is in discussions with potential rival Heller Financial for an equity investment, according to firm Founder and Chief Executive John Delaney. Delaney last did business with Heller in 1999 when he sold them his previous upstart, HealthCare Financial Partners Inc., for approximately $500 million. HealthCare Financial went public in 1996.

Ready to take on lenders like GE Capital Corp. and Heller, CapitalSource shopped the deal through the summer before securing its venture partners.

“John Delaney founded HealthCare Financial Partners [in 1992],” said Timothy Hurd, managing director with Madison Dearborn Partners, a firm which co-led the financing. “That industry was depressed, but he made about 1,000 loans and never lost money on one of them,” one investor said.

San Francisco-based Farallon Capital Management joined Madison Dearborn as a co-lead on the deal, dividing up a $300 million equity stake between them.

First Union Capital Partners, Friedman Fleischer & Lowe LLC, Highfields Capital Management, Och-Ziff Capital Management Group and Rosewood Venture Group split the remainder.

The issuer, with affiliate offices in Boston, Philadelphia and San Francisco, plans mezzanine and debt financings for small- and mid-size businesses between $5 million and $40 million. Most of the capital will take the form of loans and asset-backed securities for companies operating in the consulting, health care, specialty real estate and technology sectors. More sectors will be identified as the business develops.

To date, the firm has already completed recapitalizations and expansion deals for a health club, a retailer and a consulting firm, among others.

“This is a great market opportunity because if you look at the lending environment, there is a dearth of liquidity for small- to medium-sized businesses,” Hurd said. “Spreads may have been as low as 325 [basis points] as recently as two or three years ago, but they?re now at 550 [basis points].”

Meanwhile, the company will continue to lend, holding assets on its balance sheet for up to two years. The loans will be made on a weighted average basis of 14%.The company does not plan to dip back into the private equity markets before it considers a public offering over the next two to three years.