Over the last year and a half, Charterhouse Group International, a group
that until recently has been known primarily for its buyout investments o=
ver
the last 20 years, has made several investments that more closely resembl=
e
venture capital deals. The New York-based firm last year backed Interlian=
t,
a Cambridge, Mass.-based provider of outsourced Internet hosting services.
After an initial start-up round of more than $40 million, Charterhouse
brought in venture capital firm SOFTBANK Technology Ventures as a partner=
in
a second round of financing that brought in approximately $13 million.
Last month, Interliant filed for an initial public offering that priced
seven million shares at between $9 and $11 per share. The stock opened at
$15.56 and, after having gone through the recent ups and downs of technol=
ogy
stocks in the public market, at press time closed at $12.75, valuing
Charterhouse's stake at more than $321 million. According to Charterhouse
Managing Director Thomas Dircks, depending on how the firm's investment i=
n
Interliant ultimately fares, Charterhouse likely will pursue a similar
course for Onstream, a developer of information storage systems for
computers. The firm last year backed Onstream Chief Executive Officer
William Beierwaltes-alongside GE Equity, formerly GE Capital Equity Capit=
al
Group-in starting the new venture, largely because of Beierwaltes'
experience in the sector.
While Dircks notes that his firm always has considered itself a private
equity group rather than a buyout firm, he does admit that Charterhouse h=
as
been pursuing and completing far more deals that resemble venture capital
investments in the last two years than it had prior to this period. "I th=
ink
there are opportunities out there that are intriguing, and you have to
evolve over a period of time," Dircks says. "It used to be the economy wa=
s
based on manufacturing companies, and that has now evolved into a service
economy. When you look at the Web you have to see opportunity." Charterho=
use
is not the only firm that recently has begun to pay more attention to the
venture capital market than the buyout realm. A slew of groups that, at
least over the course of the last five years, had focused most of their
intentions on buyouts increasingly are beginning to troll the waters for
minority stakes-many of which bear a striking resemblance to venture capi=
tal
deals, in that the equity is placed earlier in the company's maturity tha=
n a
traditional buyout.
"It is a tough decision to know on which deals to keep going and which to
stop funding. It is a nail-biter when you are the only one that is left t=
hat
is willing to continue to contribute capital." For example, the first six
months of 1999 saw such groups as Berkshire Partners, Cornerstone Equity
Investors, Wasserstein, Perella & Co., and Chase Capital Partners making
investments in Internet companies, according to Venture Economics
Information Services, a division of Thomson Financial Securities Data and=
an
affiliate of BUYOUTS. Moreover, sources say the last six months have seen=
an
increasing number of buyout firms launching private equity funds that wil=
l
target minority stakes in companies and will look at some later-stage
venture capital deals. In addition to the recently launched TH Lee, Putna=
m
Capital that later in the year will begin fund raising for an Internet
investment vehicle targeting as much as $1 billion (BUYOUTS Aug. 2, p. 3)=
,
buyout firm Saunders, Karp & Megrue this month finalized plans to launch =
a
new effort that will be managed by one of its partners and will focus on =
the
small deal market-comprising equity commitments between $5 million and $1=
5
million (see story, p. 3).
Likewise, Boston-based Summit Partners, which originally cut its teeth in
the venture capital market but has increased its buyout activity over the
years, now is marketing Summit Accelerator Fund, a $150 million effort th=
at
will look to invest between $2 million and $10 million in growth-stage
companies. Meanwhile, groups that always have employed a hybrid approach =
to
private equity-investing in both buyouts and venture capital deals-
increasingly are finding more all-equity investments in young companies o=
n
their plates. "We are venture-oriented in that two- thirds of the compani=
es
that we invest in are companies that we start in partnership with
management-using only equity initially-and build," says David Donnini, a
principal at GTCR Golder Rauner. While GTCR has no imminent plans to laun=
ch
a venture capital fund, Donnini says the group has discussed the possibil=
ity
of raising an effort that would look exclusively at small, later-stage
deals.
In fact, very few general partners-even those at the mega-firms- seem
willing to dismiss this new investment trend out of hand. "We are very
sensitive to expanding into too many areas and not diverting our focus fr=
om
our primary business areas," says Ken Whitney, a senior managing director=
at
New York-based The [Blackstone Group]. "We don't have any current
intentions {to target Internet companies}, but it is an area that, given =
its
increasing importance, we will stay on top of and continue to reassess."
Heated Market Sparks Novel Approach
Several sources attribute the growing interest in venture capital by buyo=
ut
firms to the Internet IPO market; until recently, the lofty returns that
could be had, at least on paper, have made more than a few private equity
investors, and consequently, sources say, general partners, rethink their
stances on venture capital investing. To date, private equity investors s=
uch
as The Washington State Investment Board, the Los Angeles County Employee=
s
Retirement Association (LACERA) and [Delta Airlines] among others all
recently have stated they will be focusing more on increasing their
commitments to venture capital vehicles.
In an earlier interview, Terry Blaney, who heads Delta's private equity
program, said his pension would be skewing its investments toward venture
capital funds because he believed these vehicles would offer the best
returns for the near future. He also noted, in the same interview, that m=
any
buyout firms will have to adapt new models of investing in order to compe=
te
in the current economy.
In spite of the rush of buyout G.P.s looking at the realm of venture
capital, at least a few sources have questioned whether LBO shops possess
the skill sets to compete against venture capital veterans. Sources
attribute the move toward venture capital investing by limited partners t=
o
venture capital funds traditionally having had fewer L.P.s than buyout
funds. Because of this, and because until recently most venture capital
partnerships had been far smaller in size than buyout funds, sources say
most large private equity investors have become heavily weighted toward
buyout partnership commitments.
Competition in the deal market, as well as the fund-raising market, also =
may
be fueling at least some of the shift in strategy by general partners.
Several sources note that the interest by traditional LBO players in vent=
ure
capital has coincided with a spike in multiples and an increased
sophistication on the part of sellers in the private market. David Locke,
LACERA's investment officer for private equity, says the trend of buyout
firms looking to become venture capitalists is mirrored by the movement o=
f
U.S. LBO groups to Europe, and that both trends reflect attempts to inves=
t
money during a competitive time. "We used to have classic buyouts and
venture capital," Locke says. "Now it seems to be progressing to where we
are seeing the venture capital guys moving up and buyout fund guys moving
down {in deal size}. Whether they can be successful, well, that is the
question."
G.P.s Begin to Test the V.C. Waters
Most partners at buyout firms that have invested in Internet- or
information-technology-related companies attribute the investments in the
short-term as being important steps in insuring the future viability of
their other portfolio companies. For example, Berkshire partners in March
teamed with BancBoston Capital to back iDeal Partners, a company that wil=
l
attempt a platform play in the information technology sector. While
Berkshire Managing Director Richard Lubin says his firm backing iDeal Chi=
ef
Executive Officer Paul Walsh was based on prior dealings with the CEO and
not by a desire to begin an Internet play specifically, he notes that the
Boston-based firm is trying to familiarize itself with Internet investmen=
ts.
"There certainly does seem to be an element of interest in this area, and=
it
could represent a paradigm change {for the buyout industry}," Lubin says,
adding that, at least initially, the interest in IT deals likely will com=
e
from firms attempting to ensure that their portfolio companies will be ab=
le
to compete in an on-line world.
Apollo Advisors employed a similar modus operandi in April when it invest=
ed
$75 million in Rare Medium Group, a publicly traded Internet incubator
company. The New York-based firm quickly bolstered its investment in June
with an additional $12 million commitment. Until recently, the lofty retu=
rns
that could be had, at least on paper, in Internet IPOs have made more tha=
n a
few private equity investors rethink their stances on venture capital.
According to Andrew Africk, an Apollo Partner who worked on the deal, one=
of
the reasons his firm invested in Rare Medium was to buttress the Internet
presence of Apollo's other companies. "We saw within our own portfolio of
companies, which total about 50, an increasing benefit of focusing on
Internet opportunities, and we wanted to make sure that our companies are
maximizing the opportunities on the Internet."
However, in addition to assisting Apollo-controlled companies to step up =
to
the forefront of the information age, Africk notes that Rare Medium holds=
a
privileged position in evaluating new information technology opportunitie=
s.
"The company is really at the forefront of web development," Africk says.
"We thought they would be a great way of evaluating opportunities in this
market." Africk declines to comment, however, on whether Apollo has
considered raising a dedicated venture capital fund.
Assessing the Risks of a New Frontier
In spite of the rush of buyout G.P.s looking into the realm of venture
capital, at least a few sources have questioned whether LBO shops possess
the skill sets to compete against venture capital veterans. Doug Karp, a
managing director at E.M. Warburg, Pincus & Co. says the management teams=
of
venture-backed companies, because they tend to be less seasoned, require
more handholding by the investor, and also that venture capital deals
typically require multiple rounds of financing, unlike most leveraged
buyouts. "It is a tough decision to know on which deals to keep going and
which to stop funding," Karp says. "It is a nail biter when you are the o=
nly
one that is left that is willing to continue to contribute capital."
Banking On Over-Night Successes?
The recent profits plucked from venture-backed IPOs also must be seen as =
the
exception to the rule in the venture capital industry, Karp and other
sources say. "The typical venture deal must be done in five-plus years an=
d
in {the dot.com era} it seems to have become five-plus days," Karp says.
Once the current market hype over Internet companies begins to subside, h=
e
says venture capital once again will be seen as a long-term building proc=
ess
rather than a get- rich-quick investment. Even those G.P.s who have dippe=
d
their toes in venture-capital- related deals say now, in the midst of the
hype, is a time to exercise caution. "As with most things, the grass is
always greener, and it is a good time to be careful, as well as a good ti=
me
to be innovative," Berkshire's Lubin says. "It is easy to look out there =
and
see the huge market valuations that these Internet companies are running =
at
and not have it appear a little perilous."
NOTE: About six months ago, Roger McNamee, founding partner of Integral
Capital Partners formed the first-ever technology-exclusive buyout firm,
Silver Lake Partners. At that time, Mr.McNamee said that the market timin=
g
was right for a leveraged buyout fund that focused exclusively on technol=
ogy
companies. The firm planned on raising about $800 million for a first-tim=
e
fund, but was expected to close on over a billion dollars because of
investor demand.
Full story at
www.redherring.com/insider/1999/0226/vc-buyoutfund.html
Tushar J. Mehta
email: [email protected]
voicemail: (206) 405-2335