Homeland Defense Spawns New Fund

Against the backdrop of impending war, Paladin Capital Group has launched a new private equity fund devoted to investing in homeland security-related businesses. The firm, whose Pennsylvania Ave. offices are located just blocks from the White House, has already held a first close and hopes to reach – or exceed – its $300 million target sometime in the third quarter.

“We think of the framework for this [fund] as prevent, defend, cope and recover,” says Ken Minihan, a principal with Paladin and former director of the National Security Administration (NSA). “We need to think about homeland security in a global operating environment.”

To that end, Minihan and company (including former CIA director James Woolsey), intend to invest in companies across a broad spectrum of industry sectors – from computer network security infrastructure all the way to antibacterial products. The fund’s minimum transaction size will be $5 million, with its sweet spot between $15 million to $30 million.

One type of company that will be largely absent from the Paladin Homeland Security Fund, however, is startups. Mark Maloney, a principal with Paladin and a 20-year financial industry veteran, explains that the market opportunity is now due to the lingering post-9/11 atmosphere and recent formation of the Department of Homeland Security. “Something that’s just in beta would have to be truly exceptional for us to be interested,” he says.

This expansion-stage mentality is further articulated in some of the fund’s marketing literature, which argues that its investments will benefit from “an anticipated fundamental change in the government’s procurement practices in the area of homeland security.” While such an assumption certainly seems to make sense, some are questioning whether or not that change will be as sweeping as Paladin says it will be. Moreover, there is also some skepticism as to the sway people like Minihan and Woolsey will hold with government procurement contractors.

“It is of some benefit to portfolio companies to have those guys [Woolsey and Minihan] around when it comes to getting their feet in the door for initial meetings with the top brass. However, you need to recognize that the top brass in the federal government are not the ones making purchasing decisions,” says a former senior White House and Pentagon official. “A presidential appointee must avoid even the perception of a conflict of interest, and it could be seen as such should he or she favor a vendor who was introduced by a former official or acquaintence.”

He adds that even if the government procurement process is streamlined, it will take several months, or perhaps longer, until it’s figured out exactly what it has under its own consolidated nose.

Perhaps for those reasons, Paladin is not putting all of its million-dollar eggs into the government contract basket. Instead, the group is stressing commercial applications for its portfolio company technologies, as evidenced by a recent investment in ClearCube Technology Inc. The Austin, Texas-based company, which last month raised $20 million in a fourth round financing led by Paladin, has developed a “blade” computing system that allows users to move the essential parts of a PC from the desktop over to a secure data center. In addition to clients like NASA, the U.S. Department of Justice and NORAD, ClearCube has signed up such buyers as the Chicago Board of Trade, Morgan Stanley and Pittsburgh Children’s Hospital.

Commercial interests also are responsible for approximately 60% of Paladin’s deal flow, with the rest coming from relationships with such organizations as CIA venture fund In-Q-Tel and the Defense Advanced Research Projects Agency (DARPA).

“There is a leadership issue here in terms of private equity investments in homeland security,” Minihan says. “Investors have been understandably conservative in the past year, but you’d like to have some arrows in your quiver when it comes to homeland security.”

Minihan adds that the firm’s investment staff will grow as the fund grows, and that many of its investments will continue to be made alongside a $208 million Paladin Capital Partners fund raised in 2000. Neither Minihan nor Maloney were willing to discuss fund-raising details, but an SEC document dated Nov. 22, 2000, lists $40 million in LP commitments, with a minimum investment size of $5 million. More money is said to have come in since that filing.

Email Dan Primack