PE Week Wire: Wednesday, July 16, 2008

Today’s guest columnist is Charley Lax of Grandbanks Capital.

There is no denying that our Boston is a winning town. Since last year, John Henry’s Red Sox won another World Series title… we are now leading the Yankees 2-0 in world championships during this Millennium, the Patriots were one Asante Samuel missed interception away from winning another Super Bowl and Red Auerbach’s smoky ghost reappeared in a smoke free Garden to allow the Celtics’ new owners Wyc Grousbeck and Steve Pagliuca to return the championship to Beantown.

Red used to smoke a Hoyo de Monterey “Governor”, which is nearly impossible to come by these days. JR Tobacco still has a supply if your Celtics fan at home is in need. What I am pondering these days when I light up my Rocky Patel “Decade” is how much longer it takes us venture capitalists to build our world class companies and how we keep our founding team and managers motivated to stay in the game. If it takes 86 years to eradicate the curse of the Bambino and 21 years to win a smoke free NBA championship, it now takes at least 5-8 years to build the type o! f world class companies that LPs have come to expect from us.

Stock option vesting has long been an area of contention between entrepreneurs and venture capitalists. Having worked in the venture capital business for over 18 years, I’ve learned first-hand the important role vesting plays at fragile start-up companies where engaged executives, value-add shareholders and uncluttered capitalization structures are required to succeed in today’s ultra-competitive technology environment. I’m going to add some fuel to the fire and argue not only that vesting is absolutely a good thing, but that five year vesting should be the new norm in today’s market.

Vesting is a necessary evil. Not only does it motivate founders to create large and valuable businesses, but it also helps protect start-ups’ delicate ownership structures to ensure shareholders are active participants in creating a successful company. Vesting ensures that founders can’t leave a start-up shortly after its funding and retain significant ownership. I’ve seen situations where former employees no longer involved in a company have significant ownership stakes because the VCs involved didn’t appreciate the importance of vesting. In those situations, it’s hard to motivate current employees and even harder to hire new executives because there are fewer shares to go around. Just as detrimental, during exit discussions those “dead wood” shareholders can distract companies and boards from determining what is best for a company and can even derail potentially l! ucrative deals.

The exit outlook for start-up companies has changed significantly in recent years, and I would argue that today’s typical vesting schedules don’t reflect the demands of the new market environment. VC financings today often employ four year vesting with a one-year cliff. However, according to Thomson-Reuters, it now takes an all-time high median of seven years for venture-backed companies to achieve an M&A exit and more than eight years on average to achieve an IPO exit. That means that while many founders vest fully in four years, a company needs at least three additional years to provide returns to its shareholders. During those three plus years, the importance of stock options to motivate employees and hire new executives is more pronounced than ever. Four years after funding, a company might need to hire a CEO who has s! ignificant experience in finessing M&A deals, or it might need to hire a CFO who can navigate the public markets for an IPO transaction. But when inactive founders own a meaningful slug of a company, it’s almost impossible to provide enough ownership to current employees and new executives who are often so important for attaining significant exits.

Do the math and you’ll see the difference between four year vesting and five year vesting is not onerous for entrepreneurs. For example, assuming a one-year cliff, founders with four year vesting will vest 25% of their shares after year one, and founders with five year vesting will vest 20% of their shares after year one. After two years, they will vest 50% and 40%, respectively; after three years, they will vest 75% and 60%; and after four years, they will vest 100% and 80%. As you can see, five year vesting doesn’t have much effect in the first few years; it’s in the later years where the difference becomes more pronounced. Given today’s treacherous exit environment, I believe that’s exactly how it should be.

I assure you, I want each and every one of my companies to succeed, and I want every entrepreneur to be fairly and fully compensated for his or her accomplishments. But venture investing today requires bigger checks and more patience than ever. For the sake of entrepreneurs, employees, investors and all other parties involved, I encourage venture capitalists to take a hard look at five year vesting for today’s new investments. Even if you drop the fourth quarter pass that could have ended the game and won the championship for the Patriots, the Krafts’ still lost their star cornerback to my former hometown Eagles for $57 million when he became fully vested (a free-agent) with the Patriots. Now it’s back to building a winning NFL franchise for Boston and another billion dollar portfolio company for our LPs.

Reminder: I (Erin Griffith) am filling in for Dan during his vacation, so send your press releases, feedback and news to erin.griffith@thomsonreuters.com.

Top Three

PCCW, the Hong Kong phone company, will provide a shortlist of bidders still in the running toward acquiring its subsidiary, HKT Group, in the coming month, Reuters reported. According to Dow Jones, TPG Capital and Providence Equity Partners are frontrunners for the media and telecom business, which is expected to sell for more than $2.5 billion. The Financial Times reported that MBK Partners, a South Korean private equity firm, joined bidding. Previous reports tagged Macquarie Group and Blackstone Group as planning offers as well.

TrustE, a San Francisco-based Internet private technology company, secured an undisclosed amount of funding from Accel Partners, marking the firm’s first private investment and move from non-profit status.

Sentinel Capital Partners, a private equity fund based in New York City, raised $740 million for Sentinel Capital Partners IV LP, surpassing its $700 million cap, according to a regulatory filing. Credit Suisse served as the firm’s placement agent.

VC Deals

Eleme Medical, a Merrimack, N.H.-based cellulite treatment business, raised $18 million in Series C financing led by L Capital Partners. New investor Hambrecht & Quist Capital Management and returning investors Three Arch Partners and EDF Ventures participated.

TrustE, a San Francisco-based Internet private technology company, secured an undisclosed amount of funding from Accel Partners, marking the firm’s first private investment and move from non-profit status.

Wadonda Technologies, a Boston-based solar cell manufacturing development company closed a Series A financing. ATV (Advanced Technology Ventures) led the round together with General Catalyst Partners, Polaris Venture Partners, Applied Ventures, and the Massachusetts Green Energy Fund.

Dexela, a UK-based 3D imaging technology company, secured £2.6 million ($5.2 million) from Close Ventures and London Technology Fund in its second round of funding.

Cognition Technologies, a Culver City, Calif.-based search engine company, secured $2.7 million from Draper Associates and Fingerhut Ventures and the company’s CEO Scott Jarus.

Cytheris SA, a French biotherapy company, received a €1.5 million ($2.3 million) loan from OSEO, France’s national agency for industrial innovation.

Trackvia Inc received Series A funding of an undisclosed amount from FlyWheel Ventures and Access Venture Partners. The Denver, Colo.-based company database applications for small and mid-sized businesses.

Laru Corporation, an El Dorado Hills, Calif.-based secured risk and compliance management software developer, saw its Series A funding increased by investor Velocity Venture Capital after meeting its financial targets.

Iogen Energy Corp, a technology venture between Royal Dutch Shell Corporation and cellulosic ethanol maker Iogen Corp, will receive an increased investment from Shell. The company said it may invest in a commercial plant for the Iogen technology. Iogen is based in Canada.

Buyout Deals

Loring Ward International’s board has recommended shareholders approve buyout firm Friedman Fleischer and Lowe’s amended bid for the company. The firm raised its bid to around $134 million after Canada-based Loring Ward received a rival bid from Werba Reinhard Inc, its largest shareholder.

Avista Capital Partners and Nordic Capital Fund VII gained approval from the European Commision to for the $4.1 billion buyout of ConvaTec. The approval requires Nordic Capital to divest its holdings in wound care and ophthalmic needles.

BlackEagle Partners, a turnaround buyout firm, acquired Eurodesign Cabinets Inc, a California-based maker of custom cabinets, for an undisclosed price.

Axa Private Equity, a French buyout firm, purchased a 57.1% stake in Altares Group, a business-to-business information services company.

PCCW, the Hong Kong phone company, will provide a shortlist of bidders still in the running toward acquiring its subsidiary, HKT Group, in the coming month, Reuters reported. According to Dow Jones, TPG Capital and Providence Equity Partners are frontrunners for the media and telecom business, which is expected to sell for more than $2.5 billion. The Financial Times reported that MBK Partners, a South Korean private equity firm, joined bidding. Previous reports tagged Macquarie Group and Blackstone Group as planning offers as well.

Xella, a German industrial products manufacturer backed by Franz Haniel & Cie., sold to Goldman Sachs’s private equity arm and PAI Partners for €2 billion ($3.2 billion).

North Castle Partners and Golden Gate Capital’s bankrupt portfolio company, Leiner Health Products has asked for more time to negotiate terms with creditors. Its assets are being sold to NBTY Inc for $371 million.

Cinven is in talks to back a purchase of GfK AG by strategic buyer Taylor Nelson Sofres. The merger plan between the strategic companies fell apart due to financing issues. GfK, a German market research company, is attempting to ward off a hostile bid from WPP, the Daily Telegraph reported. Dow Jones reported today that GfK is seeking a partner but is unlikely to take on financial assistance from a buyout firm.

PE Exits

Madison Dearborn Partners-backed Pierre Foods filed for Chapter 11 Tuesday. The Cincinnati-based food processing company has secured a $35 million DIP loan from LBO firm Oaktree Capital Management.

Carlyle Group has sold its interest in Kuhlman Electric Corporation, a Versailles, Kentucky-based transformer company to ABB, a Swiss engineering group. The business had revenues of around $250 million.

Co-operative Group has agreed to purchase Apax Partners-owned UK supermarket operator Somerfield for £1.57 billion ($3.2 billion).

PE-Backed M&A

Remedi Senior Care, a senior health care pharmacy services business backed by Sterling Partners, purchased HealthCare Pharmacy, based in Covington, Ohio for an undisclosed price.

Norwest Productions, an audio service provider backed by Australian private equity firm Anacacia Capital, made two bolt-on acquisitions. The firm purchased New Zealand-based Oceania Audio and Melbourne-based McLean Audio for an undisclosed price.

Twitter has purchased search engine developer Summize for an undisclosed amount, news reports confirmed. The San Francisco-based blogging company has received funding from Bezos Expeditions, Union Square Ventures and Digital Garage. Summize was estimated by reports to be worth $15 million.

Cadent Energy Partners, a Rye Brook, N.Y.-based buyout firm, closed the acquisition of Texas-based energy service company Cougar Pressure Control. The deal, announced April 28, is an add-on for the firm’s portfolio company, Torqued-Up Energy Services.

Firms & Funds

CapitaLand Limited, a property developer in Southeast Asia, has created a $1 billion private equity fund to acquire property and invest in new projects.

Conversus Capital, a UK-based funds of funds manager which is publicly traded on Euronext Amsterdam, hired ABN Amro to provide it liquidity in an effort to boost its shares and reassure new investors.

Madison Dearborn Partners is planning to tap sovereign wealth funds for its $10 billion sixth fund, according to The Daily Deal. The firm hosted a first close on $4 billion in April

Reference Capital is raising a $10 million fund dedicated to sustainable energy marketing toward to high-net-worth individuals, family offices and foundations, VentureWire reported. The Oregon-based firm is also planning a medical device fund.

Sentinel Capital Partners, a private equity fund based in New York City, raised $740 million for Sentinel Capital Partners IV LP, surpassing its $700 million cap, according to a regulatory filing. Credit Suisse served as the firm’s placement agent.

Human Resources

CrossLink Capital has promoted Maureen Offer as its controller, hired Mihaly Szigeti as its CFO, and hired Jerome Contro as COO and general partner. Szigeti previously worked with Pricewaterhouse Coopers; Contro worked with private investment firm Tango.

Alpha Associates, a Zurich-based private equity funds of funds manager, hired Henry Potter as a partner from the European Bank for Reconstruction and Development in London.

KKR has hired William Sonneborn to develop a traditional asset-management business and work with the firm’s credit investing business, according to the Wall Street Journal. Sonneborn is the president of TCW Group.

Morgan Joseph has appointed Ronald J. Zimmerer as a Director and Michael Holland as a Vice President in the firm’s Miami office. The appointments serve to expand the investment bank’s Southeast practice.

Redwood Capital Group hired Andrew Moore as a Partner based in the investment banking firm’s New York office. Moore previously worked as a managing director at CIBC World Markets in the media & entertainment investment banking group.

Sanford B. Kaynor Jr. has joined law firm Jones Walker as special counsel in the Corporate & Securities Practice Group in its New Orleans office. Kaynor previously worked at Ropes & Gray.

GIMV, a Belgian investment firm, hired Koenraad Dejonckheere, managing director and head of corporate finance at KBC Securities, as its CEO. Dejonckheere replaces Dirk Boogmans.