KPP Diversifies LP Base With Third Mezz-LBO Fund

Key Principal Partners has held a second and final close of its third fund, KPP Investors III, thanks to a more diversified cast of limited partners that it had on previous funds. With the $500 million pool the Cleveland firm plans to make value-oriented, non-controlling mezzanine and control-equity investments in middle-market companies.

This time around only half of the money raised for KPP Investors III came from parent company KeyCorp., Cleveland, according to Leland Lewis, a managing partner at KPP. For its first two funds—Regis Capital Partners, a $125 million fund closed in 1998, and KPP Investors II, closed in 2002 at $520 million—the team took in about 85% of its funding from KeyCorp. The balance of Fund III came from a mix of pension funds, insurance companies and wealthy family offices and European funds of funds —the “normal cast of characters” for KPP funds, Lewis says, adding that most prior investors re-upped.

“I think that it’s just prudent for us to have a wider base of investors,” says Lewis. “That allows all related parties to our firm to know that we will be around for a long time to come. KeyCorp is a public entity and has to make its own decisions and at some point in time could, for regulatory reasons, or because the public market might like it to, exit our business.”

KPP invests in companies generating EBITDA in the $5 million to $20 million range with the potential to do better. “We more improve companies than turn them around,” Lewis says. It favors a broad array of fields, avoiding only highly specialized areas such as health care, certain areas of technology, financial services and real estate.

The firm has made one investment with the fund, putting $26 million into Clover Technologies, Inc., an Illinois remanufacturer of printing supplies such as toner and ink cartridges. KPP expects several new investments from Fund III to close later this quarter and in the first quarter of 2007. Indeed, the firm is working on three management buyouts at the moment, one a services company, another a distribution company, and the third a manufacturing company, Lewis says. Two of these deals involve equity investments of $25 million to $30 million, while a third is “somewhat smaller and will be mostly subordinated debt,” Lewis says. At least one of the three involves an LP co-investment, in keeping with the firm’s tradition of offering such opportunities to investors.

KPP has offices in San Francisco, Cleveland and Greenwich, where Lewis is based. The firm also has a small office in Shanghai, and Lewis says that because of KPP’s focus on manufacturing, it has “quite a lot of experience operating in China.” He adds: “If you’re going to invest in the manufacturing sector these days, you have to have some Asia expertise.” Clover Technologies, for instance, does some of its manufacturing in Vietnam, and one portfolio company out of the second fund is based in Beijing.

KPP’s first fund generated gross returns “in the mid-30% area,” Lewis says, while its second was “more in the mid-20’s.” KPP’s target for gross returns for the third fund is more in line with the second fund’s performance, he says. The firm expects to have the third fund fully invested within three years.

KPP’s legal counsel on the fundraising is O’Melveny Myers LLP—E.B.