SunTx gets more time to exit older fund through preferred-equity deal

SunTx Capital Partners, a Dallas middle-market buyout shop, earlier this year completed a transaction to provide liquidity to LPs in its 16-year-old debut fund and growth capital to three remaining portfolio companies, people with knowledge of the deal told Buyouts.

The transaction involved SunTx’s Fulcrum Fund, which raised $230 million ($140 million in external capital and $90 million of Small Business Association capital). Fund I closed in 2004 but had been investing since its first close in 2001. Fund I was generating a 12.02 percent internal rate of return as of June 30, 2017, according to a person with knowledge of the situation.

Preferred-equity investment

Crestline Investors, leading a group of investors, made a preferred-equity investment in the fund, buying out partial stakes from existing LPs and providing SunTx with additional growth capital to support the three remaining Fund I investments. Sixpoint Partners was adviser on the transaction, according to regulatory filings.

The preferred-equity investment is like a loan to the fund. The preferred-equity investors are first in line to get paid back principal and interest when SunTx sells the remaining portfolio companies or makes distributions. Anything above that will flow to existing LPs as profit. The interest rate on the preferred-equity investment is unclear, though it’s in line with the low-interest-rate environment, one of the people said.

Investors had to feel comfortable with the current portfolio value and its prospects for monetization, one of the people said. The same goes for existing LPs, who, if they feel confident in the prospects of the remaining portfolio companies, want to stay in the fund and reap those profits. This type of transaction is one way to do that, as opposed to simply selling out of their interests through a secondary sale.

The risk on a deal like this is the prospect that one or more of the companies falter into bankruptcy, or earnings fall below the interest rate on the preferred investment. But original LPs in the fund have already been paid back their commitments and received distributions beyond their initial investments, one of the people said, so any profit on the remaining portfolio is all upside for those investors.

As part of the deal, the three remaining investments — Construction Partners Inc, Interface Security Systems and NBIS — as well as remaining earnouts from several businesses that have previously been sold were transferred to a newly created vehicle called SunTx Fulcrum Fund Prime, the people said.

SunTx expects to have paid back the preferred-equity investors within the first three years of Fulcrum Fund Prime fund’s life, one of the people said. The total term on the new fund is five to six years, the person said.

The deal values the entire remaining portfolio — the three businesses and the remaining earnouts — between $550 million and $600 million, according to people with knowledge of the deal.

Another way

A secondaries adviser unconnected to the SunTx deal said preferred-equity transactions are best for investors who have confidence in the portfolio.

“For an investor who doesn’t want to sell because they have great conviction in the portfolio, this is a great way to generate some liquidity,” the adviser said. LPs who see little upside in an aging portfolio probably just want to sell on the secondary market, the adviser said.

One firm, Whitehorse Liquidity Partners, earlier this year raised $400 million to make preferred-equity investments in PE portfolios. Whitehorse was launched by Yann Robard, head of secondaries and co-investments at Canada Pension Plan Investment Board.

SunTx closed its second fund on $256 million, with $150 million of additional capital in a sidecar vehicle, in 2010. The firm has been raising its third fund, which had collected about $94.7 million as of January, according to a Form D filing.

The firm is led by Founder and Managing Partner Ned Fleming III, who started his career with Texas investor Richard Rainwater. Other senior executives include Partners Mark Matteson and Craig Jennings, who is chief financial officer.

SunTx had about $1.2 billion of discretionary assets under management as of March 31, 2017, according to the firm’s Form ADV.

Action Item: Check out SunTx’s Form ADV here: http://bit.ly/2tXJqsr

Photo of Ned Fleming sourced from SunTx Capital website