Editor’s Note: Today’s guest column comes from David Tom of secondary buyer VCFA Group.
When governments embark on large-asset sales there are often opportunities for smart investors to profit in unexpected ways. With the U.S. government liquidating a $2.9 billion private equity portfolio we believe that such an opportunity may exist.
In order to appreciate the opportunity, you must first understand some history of the federal government’s foray into private equity. In 1994, the U.S. Small Business Administration (SBA) created a program to increase the flow of capital to startup and growth capital businesses called the Participating Securities program.
Unlike the Debenture Program, which was established by the SBA in 1958, the new program did not require a current pay and could therefore target earlier stage and unprofitable ventures. Unfortunately, like many early-stage investors, the program suffered after the dot-com bubble burst, leading to losses of $2.7 billion.
In 2004, the SBA made the decision to cease issuing new licenses for the Participating Securities program and has been liquidating the portfolio over time. In our experience restructuring these funds, three structural problems contributed to the failure of these funds.
First, the securities that the SBA issued were essentially debt instruments with covenants tied to the profitability of the fund. Since venture funds are typically unprofitable in their early years, even the best funds might violate the covenants at some point. Second, in order to promote diversification, the program imposed concentration restrictions in excess of a typical fund agreement. As a result, SBIC funds were often precluded from continuing to invest in their best companies.
Finally, the program had a massive set of arcane and confusing rules. The complex mechanics of operating an SBIC fund led many fund managers to focus on complying with the program’s requirements rather than optimally investing capital.
Given the continuing restructuring of the Participating Securities program, is it possible to purchase assets from the SBA at fire sale prices? Unfortunately for investors and fortunately for taxpayers there is no free ride. The SBA has assembled a smart and tenacious team that advocates strongly for the highest prices. They generally require intermediaries, third-party valuations and multiple competing offers.
The larger opportunity for general partners of venture and small buyout funds lies in the second reason for the failure of the program. The concentration restrictions coupled with the general instability in the Participating Securities program left many strong companies funded by SBIC funds largely under-capitalized. Smart general partners can provide growth capital to these companies at valuations that often do not reflect their future potential.
A new media company in VCFA’s portfolio provides a window into this opportunity. Existing investors, several of whom were SBIC funds, were unable to fund the continued expansion of the company. A well-respected venture capital fund provided over $30 million in growth capital leading to future financings at substantially higher valuations. In this case, we expect all investors to receive a high multiple return on invested capital, with the best returns for the fund that provided the growth capital.
When I explained to a friend that we were working with SBIC funds, he questioned whether it was like Russia after the fall of Communism, where the Russian government essentially gifted private assets to political cronies, creating a new wealthy class. Thankfully, the U.S. government works quite well and the SBA is most certainly not creating a new set of American oligarchs.
Nevertheless, there continue to be opportunities for general partners to generate outsized returns by investing in strong under-capitalized companies from the SBA Participating Securities program.
David Tom, CFA, works in business development at VCFA, which is investing a $250 million buyout secondaries fund and a $250 million venture secondaries fund. Reach him at dtom@vcfa.com.
Top Three
Dubai International Capital asked creditors for more time to repay a $1.25 billion loan. It is seeking an extension until the end of November, two people familiar with the situation said. Dubai World, one of two other state-linked businesses, plans to sell its prized assets over a period of eight years to pay off creditors, according to the restructuring proposal document obtained by Reuters.
Bertram Capital announced Wednesday the final closing of Bertram Growth Capital II with $500 million in LP commitments. The San Mateo, Calif.-based PE firm invests in industrial manufacturing, technology, business services and health care.
Financial Transaction Services LLC secured a $50 million growth equity commitment from FTV Capital. FTV is the first institutional investor for the provider of electronic transaction processing services.
VC Deals
Conviva Inc. has closed a $15 million Series C round of funding. The San Mateo, Calif.-based provider of streaming solutions has raised a total of $44 million since its launch in 2006. GGV Capital led the financing round. Foundation Capital, New Enterprise Associates and Pelion Venture Partners are all returning investors.
SpringCM secured $15 million in financing. It plans to use the capital to develop its cloud enterprise content management platform and solutions. The financing round includes existing investors Foundation Capital and North Bridge Venture Partners. Silicon Valley Bank is a new investor in the San Mateo, Calif.-based provider of on-demand document management and workflow solutions.
TuneUp Media, a leading plugin for iTunes, has raised $4.3 million via a Series C round of funding that was led by IDG Ventures. KPG Ventures, an original seed funder, also participated. IDG Ventures is an early-stage VC firm.
Lantos Technologies Inc. closed a Series A financing with $1.6 million. Catalyst Health Ventures led the round. Excel Venture Management and Mass Medical Angels also participated. Lantos Technologies is developing an intra-aural (ear) three-dimensional scanner that would have applications in audio equipment such as hearing aids, earphones and noise-canceling devices.
Buyout Deals
Metro-Goldwyn-Mayer’s lenders agreed to extend a deadline for debt payments as the film studio prepares to be handed over to film company Spyglass Entertainment. Last week, Spyglass founders signed a letter of intent to take over MGM. Providence Equity Partners, TPG, Quadrangle Group, DLJ Merchant Banking Partners, Sony Corp. and Comcast Corp. own the trouble studio.
Vodafone may sell its 25 percent stake in Polish mobile operator Polkomtel, which could spur the sale of Polkomtel shares by its Polish owners, PKN’s deputy CEO said on Thursday. Last week, Polkomtel’s chief executive told Reuters private equity groups including Apax Partners and Blackstone Group were interested.
Vestar Capital Partners V LP affiliates (Mountain Acquisition Corp. and Mountain Merger Sub Corp.), along with Health Grades Inc., agreed to extend the offer period for proposed $8.20 a share tender offer for all Health Grades’s shares. The offer’s new deadline is October 7 at 9 AM, New York City time.
PE-backed Exits
GTCR, a 30-year-old private equity firm, just announced plans to sell payments company National Processing Company to Fifth Third Processing Solutions, which develops electronic payment solutions for small and midsize businesses.
United Business Media Ltd. agreed to acquire Canon Communications LLC for $287 million. The transaction was arranged by Apprise Media LLC and Spectrum Equity Investors. Apprise and Spectrum bought Canon in 2005.
Wright Express Corp. completed its acquisition of Retail Decisions’ Australian assets, including its prepaid card businesses. The sellers were Palamon Capital Partners and its co-investors Morgan Stanley Alternative Investment Partners and AlpInvest Partners. In July, Wright Express agreed to acquire the assets for A$353 million ($318 million).
Clearwater Paper Corp. agreed to acquire Cellu Tissue Holdings Inc., a maker of tissue products, in an all-cash transaction that values Cellu Tissue at about $502 million, including roughly $255 million of debt. The deal is expected to close in the fourth quarter. Weston Presidio V LP, which acquired the Cellu Tissue in 2006, agreed to vote in favor of the transaction.
Human Resources
Crosslink Capital hired Eric Chin as a partner. Chin will focus on Internet, software and technology startups, investing in early stage and later stage companies. He previously worked as a general partner at Bay Partners. Crosslink Capital has more than $1.5 billion in capital under management.
Kane Biotech Inc. named Philip Renaud to its board of directors. Renaud is managing director of Church Advisors, a European investment advisory firm involved in private financing. Kane Biotech is a Winniped, Manitoba-based biotechnology company.
Marsh, a New York-based insurance broker and risk advisor, adds five new hires to its private equity and mergers and acquisitions practice. It named James O’Brien, Jason Hawkins and Craig Warnke as managing directors. Jim Beatty and Machua Millett join the firm as senior vice presidents.
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