Government Remains Path Into, Out Of Profession

The ever-spinning revolving door between government and private equity churned out a note of harmony earlier this month.

One firm may soon find its days numbered after its star investor decided to move into a life of public service, while another will soon be formed by a public servant looking to enter the private sector. Both kinds of moves have become increasingly common, as general partners leave their potentially lucrative posts to help shape public policy, and as accomplished public servants attempt to convert their hard-won experience and influence into private-sector wealth (see accompanying table).

Lawrence Schloss, co-founder, president and CEO of Diamond Castle Holdings, has agreed to leave the firm to become the next chief investment officer for New York City, as first reported on Jan. 5 by peHUB, a sister publication of Buyouts. The move raises questions about the future of the New York-based firm.

Meanwhile, on Jan. 7, peHUB broke the news that former Federal Communications Commission Chairman Kevin Martin will launch a new private equity firm called Carmichael Partners to make equity investments in family-owned and closely-held private businesses.

Schloss’s his departure from Diamond Castle is sure to dull the buyout shop’s luster. If he leaves to serve the New York City’s new Comptroller John Liu, his exodus would trip a key-person provision with the buyout firm’s first fund, the $1.8 billion Diamond Castle Partners IV LP, according to The Wall Street Journal. Citing a source familiar with the situation, The Wall Street Journal said Diamond Castle has a 45-day window in which to suggest a replacement for Schloss and to present a valuation of the fund’s portfolio companies. According to the Oregon State Investment Council, a Diamond Castle backer, Diamond Castle IV had generated a -9.7 percent IRR through Sept. 30, 2009. Phone calls and emails to Diamond Castle and Schloss were not returned.

Key-person provisions vary, but often a triggering event is followed by automatic suspension of new platform investments (with the exception of deals already in the process of closing). The moratorium lasts until limited partners hold a vote on whether or not they have confidence in the sponsor to continue making new investments. During the timeout, the GP bears the burden of convincing LPs that it is still a viable franchise. These suspension periods can last 60 days on the low end and half a year on the high end, according to Morri Weinberg, a partner at Ropes & Gray LLP who is focused on fund formation.

Weinberg, who is not familiar with Diamond Castle’s key-person provision, said that if the voting LPs are ultimately not on board with the GP’s plans, they often have the power to permanently shut down the investment period of the fund in question. If this is done, the sponsor group can continue to manage the existing portfolio and make follow-on investments to maintain their viability. But investments in new portfolio companies are theretofore off limits. “Essentially, the firm is in monitoring-and-harvesting mode,” Weinberg said.

Schloss and four senior managing directors—Ari Benacerraf, Michael Ranger, Andrew Rush, and David Wittels—founded Diamond Castle in 2004. Prior to Diamond Castle, Schloss and the rest of that core team all worked together at DLJ Merchant Banking Partners, which was later acquired by Credit Suisse. LPs flocked to Diamond Castle’s $1.8 billion inaugural fund, which held a final close in late 2006 and is now more than 70 percent invested. Backers include the Canada Pension Plan (CPP), the Ontario Teachers’ Pension Plan, and the State of Minnesota. CPP and Ontario Teachers’ declined to comment for this article. Oregon State and the State of Minnesota did not return phone calls.

As for the formation of Carmichael Partners, Martin, who held his post at the FCC from March 2005 through January 2009, intends to team up with Brian Bailey, who recently left his post as a senior advisor at mid-market buyout shop Carousel Capital, to launch the new Charlotte, N.C.-based firm, according to peHUB.

In an email to colleagues, Bailey said that Carmichael Partners would keep its investments limited to a small number of companies so it can effectively devote its time to active portfolio management, peHUB reported. This would be attractive to families and founders looking for an equity partner that can provide an engine for growth while preserving the original company culture, Bailey reportedly wrote.

Michael Powell, Martin’s predecessor at the FCC from 2001 to 2005, also took to private equity after leaving his post. Powell, son of former Secretary of State Colin Powell, joined Providence Equity Partners LLC as a senior advisor in 2005.