2008 Capital Markets Report
June 2008Venture Capital/Private Equity
At a time when even the once-lionized economic sage Alan Greenspan is forced to defend his legacy as former Federal Reserve chief, no one can fault Tennessee's private capital warriors for a little hesitation. Though most of them agree that good deals are still out there, they also consider the slow-down inevitable. "There is not much venture money in Nashville funds today," says one out-of-state player. The banks have tightened their lending practices, making it tough for early-stage and public companies to access financing. And who can blame the banks? Having written gazillions of debt in going-private and other transactions of the years past, they feel much safer clubbing their resources together these days to fund less risky middle-market deals of $500 million and less.
The biggest news of the recent past, aside from the overnight evaporation of Bear Sterns, of course, was the announcement that Chicago private equity heavyweight Bryan Cressey was joining forces with local business titan and former U.S. Senate Majority Leader, Bill Frist. Known for the strict division between its San Francisco and Chicago offices (with the former focusing on technology, the latter, strictly health care deals), Thoma Cressey Bravo decided to raise separate funds. Shortly after the Frist announcement, Cressey & Co. recruited Ralph Davis, a health care mergers and acquisitions expert and chairman of Nashville law firm Waller Lansden Dortch & Davis. Nashville desperately needs a billion-dollar buyout firm specializing in health care, and Cressey & Co. certainly raises the stakes there, given its typical investment size of $50 million, a ten-fold increase from the local firms' investment habits. While a step in the right direction, it remains to be seen whether Cressey & Co. will establish a meaningful presence in town. And if it does, many wonder whether Frist will be present there in name only, as he preps for the next political race. (Think Al Gore, who joined the ranks of celebrated Silicon Valley venture capital firm Kleiner Perkins Caufield & Byers almost a year ago but has yet to fund a single local tech startup).
Of much less significance, yet notable for different reasons: the entrance of the Angel Network of Sumner County elicited a collective scratching of heads and biting of tongues. (No one wanted to comment on the record, but many questioned the absence of an successful track record of the firm's 28-year-old chief Rachel Qualls, formerly of Edward Jones.)
As for the fundraising activity, there wasn't much of it.
The exceptions are Claritas Capital and Solidus Co., which have raised money in 2007 and are actively investing. Council Ventures is still looking to raise at least a $100 million fund. Petra Capital Partners also raised additional money, as did First Avenue Partners. Pharos Capital Group continues to deploy capital from the fund it raised in 2006. Memphis-based MB Venture Partners is staying busy in the medical devices niche. Two recent arrivals on the Memphis VC scene, Mercury Technology Labs and Innova Inc., are in the very early stages of raising small funds that target scientific research—themed endeavors. Sante Health Ventures, which has offices in Brentwood and Austin, Texas, raised a sizeable $130 million fund targeting health care investments (with Fred Goad in the advisory seat).
Not everyone is that lucky. Having effectively merged last year with SSM, Coleman Swenson is in a quiet period. Richland Ventures decided against raising a fund after its partners couldn't allocate the amount of money they could manage comfortably. Massey Burch continues to wind down, while its top talent migrated to other firms. (Don McLemore went to Claritas several years back, while Vic Gatto left for Solidus.) Delta Capital Management's Don Mundie started an executive search firm while his partner, Joel Wood, became CFO at RemitDATA. The duo made their last investment in 2005 and have no plans for further portfolio development.
Though highly leveraged transactions will be tough to execute for the foreseeable future due to the absence of cheap debt, one can still count on more activity in 2008 among private equity/venture capital firms than among Tennessee investment banks.
Phoning in from Houston, where Nashville private equity shop Claritas Capital has re-invested in Empyrean Benefit Solutions (which finds, creates and delivers innovative benefit programs for employers, associations and individuals), managing partner John Chadwick says today's worries include the progress of existing companies' models, refinancing risk and how much capital to set aside, since accessing new capital is better delayed in this type of market. "We try to balance all those," he says. "The great thing about Houston is that there is plenty of stuff going on." During the past year, the company made an investment in Nashville-based gift card company Facecard. And that's not all. "There will be a lot more to talk about in the next months," Chadwick adds.
This management-led buyout firm is proud to say that it has made money on every deal it has ever closed. "Venture capital is wonderful, but you have to be prepared to lose money," says Gen Cap's executive vice president Don Napier. "I recently learned that Warren Buffett's rule number one is: Don't lose money. And rule number two is—see rule number one." To that effect, Gen Cap reports that its Southvest V fund, now in its third year, is 50% invested. Adding to two acquisitions highlighted in last year's report, Gen Cap has closed deals in Miami and near Atlanta. "We're doing other stuff, refinancing various things, and we'll probably be fundraising in another year or a year-and-a-half," Napier says. "I don't know when it's going to be. I'll cross that bridge when I get there." Perhaps in another sign that leveraged finance is not in vogue at banks these days, Gen Cap hired a new vice president, Matt Lane, formerly of Banc of America Securities, where he ran such transactions for private equity and corporate clients.
If anyone can feel comfortable in the doldrums of the current lending market, it's the mezzanine financing firms that make business loans in return for interest and warrants to buy stock in the borrowing company. The typical borrower is a company too mature to give up equity stake to a venture capital firm, but not yet ready for initial public offerings. With bank vaults now shut tighter than ever, Harbert's John Harrison (formerly of Sirrom Capital Corp.) says his firm is staying busy on the East Coast, doing roughly 10 financings a year. "We funded a number of deals, and we like them all," he says, choosing as example Orlando-based software company Highwinds, provider of network management, distributed file systems and advanced routing methods.
There may not be much venture capital money in Tennessee, but there is plenty of private equity money available, observes Morgan Keegan's Memphis chief, Chip Grayson. "The lack of venture capital in Tennessee should not adversely affect good companies from getting funded." Much like Harbert Management Group, Morgan Keegan's mezzanine group in Nashville is experiencing an uptick in activity. On the investment banking front, Grayson reports few transactions in the state last year. (Among them, the firm represented the sellers of Approved Cash of Cleveland, and participated in the sales of Shoney's and Back Yard Burgers.) "We're optimistic that 2008 is going to be a good year," says Grayson, who is betting on Morgan Keegan's ties to oil services companies to pay off. "With oil prices where they are, everybody is going full-tilt out there."
While many are inclined to say that the sources of early-stage capital are dry these days, NCN's Sid Chambless found a way to tap some of his 60 angel investors and cobble together a $5.2 million sidecar fund focused on early-stage companies in the Midstate. "There's an opportunity in early-stage capital market to fund great new companies," says Chambless, who co-founded the organization four years ago. Among the recipients of the $35 million it helped place in Tennessee businesses are Spirit Broadband, Tricycle, MyOutdoorTV.com, TrackPoint Systems, Protein Discovery, Smartvue and Pathfinder Pharmaceuticals. In another recent development, NCN announced corporate heavyweights among its new sponsors, including law firms Baker, Donelson, Bearman, Caldwell & Berkowitz and Bone McAllester Norton, as well as private equity firm First Avenue Partners.
Well-capitalized and actively pursuing new deals, this private equity group has one highlight to report for 2007—its leading role in the buyout of Nashville eatery chain Back Yard Burgers. Joining in that deal were Cherokee Advisors of Atlanta and Steve Lynn, former head of Shoney's Inc. and Sonic Corp. "We were able to get the financing closed, even though the markets shut down for a lot of deals," says Mike Devlin, Pharos co-founder and managing partner. Among significant out-of-state transactions for Pharos are the sale of VeriCenter to Sunguard, the purchase of Nursefinders, and the providing of add-on financing to the Medical Care Consortium of Miami.
Supporting the thesis that more than half of Tennessee private equity dollars go into out-of-state firms, Petra bought a $3 million stake in T2 Systems of Indianapolis, which provides parking management services. This is the first investment from the Petra Growth Fund II, which the company hopes to eventually triple in size from the current level of $50 million.
Memphis-based SSM Partners participated in the funding of local business incubator-bred RemitDATA, which provides software for doctors and other health care clients. The opportunity to participate in the $5 million infusion opened up after a Boston firm bailed on the deal led by Noro-Moseley partners of Atlanta.
Fortified by the recent arrival of Vic Gatto from Massey Burch, head of Solidus Townes Duncan is busy looking after the five early-stage deals his firm struck during the past year. Among those investments are TrackPoint, Dalcon Communications, Change Healthcare, MedFusion and SouthComm Communications. Solidus provided additional financial support to Plumgood Food, Motricity, Documentary Channel and American Hometown Publishing. Amid all this activity, Duncan, an investor in the company that publishes BusinessTN magazine, is unfazed by the recent market turmoil: "I have been doing this for too long to be affected by the doom and gloom," he says.
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