PE Week Wire: Fri., March 9, 2007

The convergence of hedge and private equity funds has been one of the most overplayed stories of the past few years, but the linkage seems to have beencemented in the minds of folks like Senator Chuck Grassley (R-IA). This isn’t to say that Grassley can’t distinguish between hedge and private equity (he can), but rather that his obsession with the former could eventually lead to misguided tax changes for the latter.

Grassley has spent a lot of wind-power trying to get hedge fund registration to sail, even introducing such an amendment earlier this week as part of an unrelated homeland security bill. “The secretive way that hedge funds operate might not be an issue for the super rich who first invested in hedge funds, but today the average Joe has a stake as pension funds are invested in hedge funds,” Grassley said Wednesday on the Senate floor. “Right now a hedge fund isn’t required to report even basic information about who runs the fund.”

Unfortunately, the amendment didn’t make muster, in part because Grassley doesn’t really have any authority over hedge funds. Not only is he now part of the Congressional minority, but he sits on the Senate Finance Committee instead of on the Senate Banking Committee. That latter group is chaired by Chris Dodd (D-CT), whose nutmeg state is the de facto home of hedge fund opulence (official mailing address is in the Caymans). Since all politics is local, Dodd has taken a laissez fair attitude toward any sort of hedge fund regulation – including registration.

But Grassley is one of those old-school conservatives who actually believes in pragmatic conservation (as opposed to dogmatic GOP groupthink). He is against increased taxes on the general populace, but also knows that the government needs to raise revenues to fund things like AMT relief and our various military entanglements. So he continues to look for what he considers to be tax loopholes (i.e., don’t raise taxes, just strengthen existing law).

As Grassley’s search has progressed, the hedge fund/private equity convergence drumbeat has only grown louder. Not coincidentally, Grassley’s tax loophole search has broadened to also consider private equity.And it is in here that Grassley – or at least his staffers — believes he might have found such a loophole: The categorization of carried interest as capital gains.

Carried interest is the 20%-30% capital slice that private equity firms keep after selling portfolio company positions at a profit. Since such gains are completely based on long-term investment success, they have traditionally been classified as capital gains and therefore taxed at 15 percent. But Grassley and his staffers apparently are floating a notion that they should instead be considered compensation for services, and therefore taxed at income rates closer to 35%. This would be a huge change not just from an accounting perspective, but also from a take-home pay perspective. After all, it would be more than a doubling of taxation on PE firm profits.

Now you and I are free to think this is sophomoric. Raising government revenue is indeed necessary, but it should be done via honest tax increases and reduced pork (and a reduced war). Don’t pretend that carried interest as capital gains is a tax loophole. It isn’t. Carried interest is generated by profitable investment, and is not at all guaranteed at the time of initial disbursement. I’m not saying Congress doesn’t have the right to change the classification (it does), but rather that it would be disingenuous to do so without a wholesale change in the definition of capital gains.

It is important to emphasize that there is no pending legislation on this matter, but enough rumors have been swirling that at least two separate law firms have issued client alerts. It also has prompted the first public comment from the newly-formed Private Equity Council, and yesterday the National Venture Capital Association sent out its own members alert (saying not to worry… yet). Finally, there is a semi-strong counterargument that GPs put very little of their own skin into funds – and in some cases even offset any commitments altogether by waiving management fees – so what appear to be capital gains are indeed more accurately described as income. I’ll keep thinking about this while lounging around Kennebunkport over the next two days (birthday present from J), and encourage your comments here… Have a great weekend.

New at

• Jeremy Harrell of Buyouts was the first to report that the possible tax change was coming out of Grassley’s office. Here’s his report from yesterday.

• Former UTIMCO chief Bob Boldt has agreed to launch a new asset management platform for Perella Weinberg Partners. My take on why he’s an unsung private equity hero, and then Boldt sits down for 5 Questions.

• A couple of new jobs in our Careers section

And, as always, plenty of news and analysis throughout the day…

Top Three

Proteogenix Inc., a Portland, Ore.-based developer of proteomic and genomic tests to detect and monitor fetal disorders, has raised $20 million in Series B funding, according to a regulatory filing. Backers include Burrill & Co., New Leaf Ventures and TPG Ventures.

Jazz Pharmaceuticals Inc., a Palo Alto, Calif.-based drug development and commercialization company focused on neurology and psychiatry, has filed for a $172.5 million IPO. It plans to trade on the Nasdaq under ticker symbol JAZZ, with Morgan Stanley and Lehman Brothers serving as co-lead underwriters. The company has raised around $265 million in VC funding since its 2003 inception, from firms like KKR (46.25% pre-IPO stake), Thoma Cressey Equity Partners (10.72%), Beecken Petty O’Keefe & Co. (7.15%), Prospect Venture Partners (6.65%), Versant Ventures (6.65%), Golden Gate Capital (5.36%), Lehman Brothers (5.13%), Adams Street Partners, EGS Healthcare Capital Partners and Oak Hill Capital.

Centerbridge Partners is the latest private equity firm to express interest in acquiring Chrysler, according to The Detroit News. PE Week Wire has since confirmed the news with a source close to Centerbridge.

VC Deals

Gemini Mobile Technologies, a San Mateo, Calif.-based developer of wireless software infrastructure, has raised $20 million in second-round funding from Goldman Sachs. The company had raised first-round funding in 2001 from Japanese backers Mitsubishi-UFJ, Mizuho and Tokyo Marine.

Adaptive Planning Inc., a Mountain View, Calif.-based provider of collaborative business performance management software, has raised $7.5 million in Series C funding (deal closed last December). Cardinal Venture Capital the round, and was joined by return backers Monitor Ventures and Onset Ventures.

Ahura Scientific Inc., a Wilmington, Mass.-based developer of optical systems for the detection of unknown and suspect substances, has raised $7 million in additional Series B funding, according to VentureWire. This brings the round total to $17 million, including a $10 million first close from early 2005. Return backers include ARCH Venture Partners, Castile Ventures, ComVentures and GF Private Equity.

Mxp4, a France-based developer of an interactive digital music format, has raised $6.5 million in first-round funding from Sofinnova Partners and Ventech.

Vollee (f.k.a. Game Stream), an Israel-based mobile gaming company, has raised $4 million in Series A funding. BlueRun Ventures led the deal, and was joined by seed backer Benchmark Capital.

TapaTap Inc., a San Mateo, Calif.-based operator of a mobile 2.0 application hub, has raised around $2.5 million in Series A funding from Gabriel Venture Partners, according to a regulatory filing.

LiquidTalk Inc., a Chicago-based maker of enterprise business applications for digital media devices, has raised $2.43 million in Series A funding led by Meakem Becker Venture Capital, according to a regulatory filing.

Buyout Deals

Crestview Partners has acquired Key Safety Systems Inc. (f.k.a. Breed Technologies), a Sterling Heights, Mich.–based supplier of automotive safety systems and components, from Ewing Management. No financial terms were disclosed for the deal, which was done in partnership with KSS management. Crestview also announced that Nick Scheele, former president and COO of Ford Motor Co. and chairman of Ford Europe, will join KSS as chairman of the board. Morgan Stanley advised KSS on the sale.

Direct General Corp. (Nasdaq: DRCT) shareholders have voted to approve a $21.25 per share buyout by Calera Capital (f.k.a. Fremont Partners) and TPG. The total transaction price is $628.2 million (including leverage). Direct General is a Nashville, Tenn.-based insurance company.

Summit Partners has agreed to acquire an 85% stake in Life of the South Corp., a Jacksonville, Fla.-based provider and administrator of payment protection products. Senior company management will retain approximately 15% of the company. No financial terms were disclosed.

TI Automotive has completed the sale of its Industrial Group businesses — Bundy Refrigeration, Walbro Engine Management and VARI-FORM – to Sun Capital Partners. No financial terms were disclosed.

Cypress Semiconductor Corp. (NYSE:CY) has completed its sale of Silicon Valley Technology Center to Oak Hill Capital Partners and Tallwood Venture Capital for approximately $53 million in cash. SVTC gives startups and established companies the opportunity to develop and characterize novel silicon-based technologies cost effectively using a shared R&D environment.

General Atlantic has completed its acquisition of Network Solutions, a Herndon, Va.-based provider of online solutions for small businesses, from Najafi Cos. (f.k.a. Pivotal Private Equity). No financial terms were disclosed for the deal, which did not result in a change of senior management.

PE-Backed IPOs

Aecom Technology Corp., a Los Angeles-based provider of technical and management support services, has filed for a $200 million IPO. It plans to trade on the NYSE under ticker symbol ACM, with Morgan Stanley, Merrill Lynch and UBS serving as co-lead underwriters. Shareholders include U.S. Trust (29.86% pre-IPO stake), GSO Capital Partners (10.68%), J.H. Whitney & Co. (10.68%), CalPERS/PCG Corporate Partners (3.74%), JPMorgan Partners and Weston Presidio.

Sourcefire Inc., a Columbia, Md.-based provider of network security solutions, priced 5.77 million common shares at $15 per share ($12-$14 range), for an IPO take of approximately $71.8 million. It will trade on the Nasdaq under ticker symbol FIRE, while Morgan Stanley and Lehman Brothers served as co-lead underwriters. SourceFire had raised around $55 million in total VC funding since its 2001 inception, from firms like Sierra Ventures (28.8% pre-IPO stake), New Enterprise Associates (18.1%), Inflection Point Ventures (8.8%), Core Captal Partners (7.6%), Sequoia Capital (7.5%) and Meritech Capital Partners.

Safestore Holdings PLC, a provider of self-storage services in the UK and Paris, has priced its IPO on the LSE at 240 pence per share, for an initial market cap of £449 million and an enterprise value of £661 million. Citigroup UK and Merrill Lynch International served as co-lead underwriters. Bridgepoint held an 81.5% pre-IPO stake, and has a 41.3% post-IPO stake.

PE-Backed M&A

Mattress Firm, a Houston, Texas-based mattress retailer recently acquired by J.W. Childs Associates, has agreed to buy Mattress Discounters Corp., an Upper Marlboro, Md.-based mattress retailer and manufacturer with more than 140 stores across the Northeast. No financial terms were disclosed. Mattress Firm last month acquired Las Vegas-based retailer Bedtime Mattress Co.

2nd Wave Software, a Minneapolis-based acquisition platform for B2B software companies, has been formed by CIBC Capital Partners and veteran software executives Chris Heim (former HighJump Software CEO) and Dan Mayleben (former CFO of both HighJump and Adaytum Software). No financial terms were disclosed.

PE Exits

Veronis Suhler Stevenson has agreed to sell its majority stake in German newspaper and online media publisher BV Deutsche Zeitungsholding to Mecom Group PLC for approximately €160 million.

Taleo Corp. (Nasdaq: TLEO) has agreed to acquire the assets of JobFlash Inc., a Fremont, Calif.-based provider of telephone-based automated recruiting software and services. The deal is valued at approximately $3 million in cash, and is expected to close later this quarter. JobFlash had raised around $6.1 million in VC funding since 2003, from firms like Band of Angels, Maveron and Mosaic Venture Partners.

Firms & Funds

The Fire & Police Pension Association of Colorado has selected Hamilton Lane Advisors as its new discretionary private equity consultant. Other finalists included incumbent Pacific Corporate Group and Franklin Park Associates.

Human Resources

ABS Capital Partners has promoted Mark Anderson to the position of general partner. He joined the firm’s San Francisco office in 1998, and focuses on opportunities in the healthcare sector.