Tonka Bay Equity Plans Third Fund

Firm: Tonka Bay Equity Partners

Fund: Bayview Capital Partners III

Target: $125 million

Tonka Bay Equity Partners, a small buyout shop in Minnetonka, Minn., is poised to begin fundraising for its third fund.

Steve Soderling, a principal at the firm, said Bayview Capital Partners III probably will come in around $125 million, structured as a small business investment company, about the same size as its predecessor. Investors are expected to be institutions and the wealthy.

That tally, incidentally, would encompass $50 million to $60 million of private capital, plus a roughly equivalent amount of leverage. SBICs, which by law invest small amounts in small business, are allowed to raise up to $75 million in equity capital, then apply two turns, or “tiers,” of leverage to produce a total fund size that typically tops out around $225 million.

Tonka Bay Equity takes a different approach, Soderling said. “We have not raised the maximum amount of private capital nor have we maximized the leverage.”

The firm differs from common SBICs in another way, he said. While these companies generally operate as mezzanine funds, providing subordinated debt to their borrowers to drive small-business growth, Tonka Bay Equity buys control equity stakes in the companies it invests in. The firm anticipates a first close by mid-fourth quarter, Soderling said. “We hope we would have a fairly efficient and fast fundraising process.”

The firm invests in U.S. companies, preferably based in the Midwest, usually generating $10 million to $60 million of sales and EBITDA exceeding $2 million. It has three areas of focus: niche manufacturing, with an emphasis on highly engineered products; value-added distribution; and business services companies that can deliver economies of scale.

Tonka Bay Equity is investing now out of its $125 million Bayview Capital Partners II, the firm’s 2005 fund, that included some $60 million private capital. That fund is 85 percent invested in 11 portfolio companies. The fund had its first exit in December, earning a 3.3x cash return with a 47 percent IRR, Soderling said. He said he hoped the fund would make one or two more platform investments in 2011.

The firm’s debut vehicle, Bayview Capital Partners I, a $78 million pool, including $50 million in private capital, vintage 1998, is fully realized, Soderling said. Over the course of its 15 investments, Fund I returned 2.7x return on cash invested with a 19.2 percent net IRR, he said.

Added Soderling: “We have the same team attempting to employ the same strategies in Fund III as we did in Fund I and Fund II.”