You raised your first fund in 2005 with $275 million and closed on $425 million in 2008. Could you talk about the fundraising environment at the time?
The first half of 2008 was OK but by the end of the year fundraising was essentially impossible. The financial crisis following the collapse of Lehman Brothers in September really shut down the fundraising market. In some sense we were fortunate. We launched fundraising in May at our annual meeting, and the majority of the investors from the existing Fund I base re-upped for slightly larger commitments. We were able to close the fund raise in two months (in July 2008). We added two new investors where we had cultivated relationships over time: Washington State Investment Board and Guardian Life.
So you got in just under the wire ahead of the worst of the 2008 financial crisis. How did you navigate the coming months?
Discipline would be the key learning, both with our existing portfolio and new investment opportunities. With our existing portfolio companies, we worked closely with strong teams who applied disciplined management to get through the crisis. We always knew the importance of management to drive successful growth. We learned during the downturn that the cream really does rise to the top. For some people it was too challenging, but the best managers really did a good job. Discipline also helped us with new investments. We could be very selective and choose to partner with teams that did a fantastic job during the down cycle that we felt could really grow the companies going forward. The key for us was getting into situations where the purchase prices were appropriate, where the capital structure was prudent and most importantly where we could partner with strong teams to drive revenue growth. Our returns come from revenue growth, because that generates cash flow growth, which results in top-performing returns.
What are some of the deals that drove performance in the fund?
Radiant Zemax (a design, test and measurement business for creating optical systems and measuring light and colors) is a very successful deal in Fund II. It’s been a fantastic investment. When the economy was bad, we bought two companies based in the Pacific Northwest that were complementary. Each company had a very strong product portfolio and a strong basis in technology from their founders and owners. We acquired the two, combined them and brought in a new CEO focused on the commercial side of the business. We refocused our sales effort. Previously, our products were sold primarily into research and development functions. We were able to penetrate the manufacturing sector, which buys in more volume. We were able to quickly increase order size to 50 or 100 systems, up from one to three systems previously. While we grew it, we were able to distribute dividends to our investors and provide a multiple return based on significant cash flow growth while maintaining the company’s leadership position in its industry. We maintain 100 percent of our intial ownership in the company.
NCM, a demolition company. We did three large acquisitions and combined them to form NCM. That one has grown significantly into the largest demolition company in the country. We continue to grow NCM.
How did this fund contribute to the evolution of the firm?
Fund II really helped us to institutionalize our strategy and our process. We’ve had a consistent strategy from when we started the firm. We think it’ll be consistent for our next fund and the next fund. We focus on the lower end of the middle market on the West Coast and traditional companies. Within that, we look for situations where we can partner with strong management teams and drive revenue growth. We focus on direct origination with what we believe to be appropriate purchase prices. We focus on disciplined transaction execution with prudent capital structures. And we focus on really partnering with founders, with mangers, to drive revenue growth in the company.
Does the regional focus of the firm help your deal origination efforts?
Based on our deep roots in the Pacific Northwest, we see most of the deals pretty early on. People know what we’ve done in the past, so we tend to see many of the West coast deals on a direct basis. Success in origination is to see all the deals and narrow it down where you can really make a difference.