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Utah FoF Seeks Funds To Back, Adviser

Backed by tax credits from the state and fueled by a mission to boost capital available to in-state entrepreneurs, Utah Fund of Funds LLC’s second vehicle is poised to deploy a minimum of $100 million to buyout and venture capital funds. The firm also is searching for a non-discretionary adviser to help identify, research and recommend investment opportunities.

Created in 2003 by the Utah Legislature, Utah Fund of Funds LLC is an economic development program designed to back private equity funds that will, in turn, make investments in Utah businesses. Deutsche Bank ponied up the $100 million for the program’s first vehicle, and a host of deep pockets, including Deutsche Bank, Merrill Lynch & Co. and Morgan Stanley, are vying to commit at least that much to Utah Fund of Funds II, according to Jeremy Nielson, Utah Fund of Funds’s managing director.

The fund is different from conventional funds of funds in that Investors provide lines of credit with which to make fund commitments. In a move that virtually eliminates the risk for the fund’s backers, the state provides refundable, transferable tax credits; if the program can’t pay off the line of credit used to invest the fund, the tax credits can be used to make investors whole. Of course, the hope is that the limited partnership be profitable enough that the tax credits will never be used. The Utah Legislature is considering a $200 million increase in the tax credits, suggesting that Fund II could eventually reach $300 million.

Though it’s an economic development program, Utah Fund of Funds is not limited to backing Utah-based buyout or venture capital funds. But general partners are required to visit the state frequently, attend entrepreneur-focused forums and conferences, and shop local deal flow. In selecting firms to back, the fund-of-funds manager also looks for those planning to invest in Utah businesses.

Given the plethora of entrepreneurs in the state, roughly 80 percent of Fund I was committed to venture capital firms with the remaining 20 percent going to buyout shops, a breakdown that will be repeated with Fund II, Nielson said. However, early distributions returned to the fund will be reinvested exclusively in buyout shops, amounting to roughly $10 million over the next six years, he estimated. That pattern will also be repeated with the second vehicle.

So far, Fund I has backed a total of 18 private equity funds. The vehicle’s largest commitment was $8 million, and the average slug was $5 million, Nielson said. On the buyout side, Fund I made commitments to Apax Partners, Fenway Partners and Sorensen Capital. Venture Capital shops such as Foundry Group, Frazier Healthcare Ventures and Shasta Ventures as well as growth equity funds managed by Cross Creek Capital and Rosewood Capital also received commitments. Fort Washington Capital Partners served as investment advisor for Fund I and has responded to the request for proposals to work on Fund II.

The program has already created roughly 1,000 jobs, and 26 Utah companies have received investments from private equity firms, according to Nielson. Although Utah’s program is modeled after Oklahoma’s fund of funds and is similar to other state-focused initiatives, the refundable tax credits allow Utah to cast a much wider net for investors than other state programs can. Refundable tax credits can reduce a tax obligation to less than zero, or a negative amount, thus resulting in a payment from the government to the holder of the tax credits. If the tax credits weren’t refundable, the tax obligation can’t be less than zero, meaning refunds cannot be granted. In that case, investors would have to have a local tax obligation to realize a benefit, limiting the pool to local utilities, smaller corporations and regional banks that pay taxes to the state. “And when you do that you don’t get any of the big boys, and you’re relegated to [backing] small, regional funds,” Nielson said.

While Utah Fund of Funds LLC is open to capital from traditional institutional investors such as public pension funds and endowments, Nielson’s not holding his breath. “We’re building something that’s meant to [generate] both a strong return and [to be] economically viable for Utah, and that typically doesn’t sit well with an institutional [investors]. They would want us to just focus on returns,” he said.—J.P.