Despite the obstacles, emerging managers with some mileage under their belts are breaking through the barriers and winning bigger, mainstream deals.
Growth and progress are good in any line of business, but what happens when companies outgrow their “new” or “emerging” status and want to play in the big leagues? Can they shed their labels and join the heavy hitters, or are they shut out by those who conclude that because they were once emerging, they should forever be considered too small to attract mega-deals?
Many veteran minority- and women-owned private equity firms face this dilemma.
“When we go out to raise funds, we get people telling us that we really don’t ‘fit’ because we’re an emerging, minority firm that’s really not ‘emerging,’” says Terry Jones, managing partner with Syncom Venture Partners in Silver Spring, Md. “It gets a little crazy.”
Jones, who dislikes labels like “emerging” and “minority,” says his firm’s 34-year history, five funds and broad investment selections should be enough to propel it out of any stereotyped category and into the mainstream.Unfortunately, that doesn’t always happen. Pension funds, for example, often dictate that in order for them to invest directly into private equity investment firms, each firm must have at least $500 million to $1 billion of assets under management. Firms outside those parameters are often consigned to the “fund of funds” option. This can be extremely beneficial to younger firms, and indeed these fund-of-funds have played an important role in Syncom’s past and present services, Jones says. However, the challenge of this market development is that general partners are often limited in their ability to expand their direct relationships with the pension funds themselves.
In addition, the consolidation of capital from several pension funds into a single fund-of-funds can inadvertently limit the amount of capital that an “emerging” fund can raise.
For example, instead of being able to access, say, $15 million to $20 million from three or four pension investors (potentially $60 million to $80 million), the firm may be able to get only a single $15 million to $20 million investment from the fund-of-funds in which the pension funds have invested.
Another issue is staying power. Given the realities of venture-capital investing, it is inevitable that managers of multiple, previously successful funds are likely one day to have a “non-winner.” The question is, if and when that happens, will our seasoned fund managers be out of business, or, will they be able to stay intact, as our mainstream counterparts have done with one or two underperforming funds?
The challenge is how to make institutional investment capital flow more readily to minority managers, particularly those who invest in minority entrepreneurs.
By 2050, ethnic minorities are projected to make up more than half of the nation’s population. However, by 2050, the majority of the retired population will be non-Hispanic whites. In our market-driven economy, the private sector will create most of the jobs needed to absorb the millions of younger, increasingly minority workers coming into the workforce over the next several decades. The Kauffman Foundation sponsored, Minority in VC Studies by Bates and Bradford have shown that minority-owned and managed companies are the most effective at hiring and developing minority workers. As such, it is imperative that private equity firms who invest in minority companies are sustained and enhanced. “The real opportunity here is for pension funds to refine their Emerging Manager programs to hyper-focus on investing in private equity funds that in turn invest in minority-owned and managed companies. Doing so will have a significant and positive impact on the broader US economy,” says Jones.
Richard Venegar, president and CEO of Milestone Growth Fund in Minneapolis, has 25 years’ of experience with four successful funds, a couple of SBICs and a few private equity fund buyouts. His track record is stellar, by any measure. Some of the deals he’s done have involved mainstream private equity firms. Still, he says breaking through the barriers and getting in on the bigger deals isn’t always easy.
The fact that the current capital markets are challenging across the board doesn’t make things any simpler for firms like Milestone, which has completed deals in the $1 million to $50 million range. Venegar credits strong industry relationships and the firm’s eye for solid deals with helping it gain the confidence of mainstream, private equity firms.
“You really have to have relationships with these organizations before you can do business with them,”
Venegar says. “People want to invest in people whom they like, so it’s up to the individual, private, emerging manager to get his or her head out of the sand, do some outreach and interface with the general market.”
While the larger deals remain elusive for the industry, Venegar says those in the $100 million to $300 million range are within reach, because some larger firms — whether they are venture- or buyout-focused — now are willing to “let smaller companies get a piece of the action.”
Still, Veneger compares where the financial industry is today to where major league baseball was before 1947, when Jackie Robinson broke the color barrier.
Referring to pioneering African American sluggers like Robinson, Roy Campanella and Hank Aaron, Veneger said, “What would baseball look like if it weren’t for those players? The financial industry could be much better if everyone was playing. Unfortunately, smaller and particularly minority- and womenowned private equity firms are often nonparticipants in the mainstream private equity market”.
“If America is going to be great, we’ve all got to be involved in the game. Women and minorities need to be included,” Venegar says.
Expanding Our Universe
Patricia Miller Zollar, managing director at New York-based asset management firm Neuberger Investment Management, which runs a fund of funds for emerging managers, sees significant opportunity ahead for those who stay the course and focus on “graduating” to the next investment level.
“We invest in emerging managers, many of which start out in the ‘emerging’ space, but then graduate to Neuberger’s core fund,” Zollar says.
While the number of emerging firms ready to “graduate” remains low, she points to the critical number of managers who raised their first rounds in the 2004-2007 timeframe as a good potential group that could make a move into the bigger leagues soon.
“As we get further into 2011, we’ll see a point where these firms will be graduating out of the emerging category,” Zollar says, adding that as smaller firms currently focused on non-traditional markets make their way up the ladder, they’ll discover that each new step presents new challenges.
“A firm that’s in its third or fourth fund with managers who have 10 years of experience might suddenly find itself being compared to organizations with 10 funds and 30 years of private equity experience,” she explains. “At each new level, the competition gets stiffer and stiffer.”
In contrast, an emerging firm that dedicates itself to the space and performs well can usually excel without having too many obstacles in its way. “The non-emerging manager space is a completely different universe. That’s not to say it’s impossible to tackle, but it is definitely challenging.”
To overcome those obstacles, Zollar echoes advice offered by Jones and Venegar: maintain a solid track record with a stable of experienced managers who aren’t afraid to delve into broader investment opportunities.
“The emerging managers who have broken through the barriers are the ones that have built teams, invested successfully, honed their strategies and returned capital to their investors. When those stars align and when emerging managers are given a shot, they not only outperform other firms in their category, but also the entire universe.” EDM