Journal of EDM Finance - Fall 2011 Issue

Passage of the Dodd-Frank Act, and its provisions requiring the registration of advisers to private funds, including advisers to private equity funds, has had a profound impact on the regulation of our industry. Regulatory developments outside of Dodd-Frank have also affected the regulatory environment for advisers to private equity funds, including new “Pay-to-Play” rules and amendments to the Form ADV Part 2 for registered advisers.

One of the major changes impacting the private equity industry as a result of the Dodd- Frank Act, is the elimination of the “private advisor” registration exemption, on which many private equity advisers relied.

New registration rules will require private equity advisers with more than $100 million in assets under management to register with the SEC by July 19 2011.

Advisers with between $25 million and $100 million in assets under management will be prohibited from registering with the SEC and will instead be required to register with their home states. If the adviser’s home state does not have an examination program, or if the adviser is, because of its business, required to register with 15 states or more, advisers may register with the SEC.

Advisers with less than $150 million in assets under management are exempted from registration if they advise solely private funds, defined as funds relying on the 3(c)(1) and 3(c)(7) exemptions of the Investment Company Act of 1940. This exemption will not be available to advisers that manage products other than private funds such as separately managed accounts.

Advisers to solely venture capital funds will also be exempted from registration. The SEC issued a definition of the term “venture capital fund” which will in fact preclude the vast majority of private equity firms from exempting themselves under this definition.

Advisers to family offices have received more than an exemption in that they have been exempted from the definition of the term “investment adviser.” This will have the affect of exempting them not only from the registration provisions, but from all of the other provisions, of the Investment Advisers Act of 1940.
The SEC has proposed a very narrow definition for family offices as having no clients other than “family clients,” be wholly owned and controlled by family members, and not holding itself out to the public as an investment adviser.

Advisers that will be required to register will need to:

• Develop a compliance program, including developing and implementing policies and procedures reasonably designed to prevent violations of the securities laws, conduct an annual review of those policies and procedures, and designate a Chief Compliance Officer;

• Establish, maintain and enforce a Written Code of Ethics, which must apply to the adviser’s personnel and must include provisions on standards of business conduct, compliance with the federal securities laws, reporting of personal securities transactions, and reporting violations of the Code;

• Maintain books and records, including substantial records relevant to the adviser’s business;

• Follow specific rules when entering into advisory contracts;

• Adopt and Implement a Written Proxy Voting Policy; and

• Disclose information about their advisory business, advisory personnel, fee arrangements, industry affiliations and control persons.

Additionally, advisers will have a fiduciary duty with respect to their relationships with clients and will be subject to examination by the SEC.

As a result of some of the Dodd-Frank provisions, certain advisers to private equity funds, both registered and unregistered, will be required to provide information to regulators to enable them to conduct their systemic risk monitoring activities.

Notwithstanding passage of the Dodd-Frank Act, other regulatory developments over the past year have also affected the regulation of the private equity industry in the US:
Changes to the Form ADV Part 2 – New SEC rules require registered investment advisers to provide more detailed disclosure about their activities and to provide this disclosure in a “plain English” format.These enhanced disclosures will now be available publicly on the SEC’s Web site.

Adoption of Pay-to-Play Rules – The SEC recently adopted rules which will impose limitations on certain campaign contributions and restrict the use of third-party placement agents in soliciting government plans .

Advisers to private equity funds will need to address a number of significant aspects of their business, including their compliance infrastructure, and whether the firm has the framework necessary to respond to growing demands from regulators and investors.

In the next several issues we will spotlight NAIC Board members to invite our readers to learn more about the NAIC leadership. In this edition, we’re pleased to introduce two of those new members, Rebecca Connolly, a partner with Fairview Capital Partners, and Carlos Signoret, founder and principal of Hispania Capital Partners.

Rebecca Connolly first learned of the NAIC seven years ago, as a new hire to Fairview Capital Partners.The Connecticut-based private equity shop was the first fund of funds in the country to focus specifically on the emerging domestic markets. Connolly currently serves as a partner. Previously, she served as a general partner at Everest Ventures and as private equity attorney for Testa, Hurwitz & Thibeault LLP. An alumna of The College of Holy Cross she also holds a J.D. from Boston Law School.

Over the years, Connolly’s interactions with NAIC members have complemented her day to day work with emerging managers. The cooperative spirit is one aspect she enjoys most about working with NAIC members.

“I think it’s one of the few associations in the country where there’s true collaboration,” Connolly says.

Connolly points not only to the attitude of the membership as proof, but also the organization’s structural progress. She considers NAIC’s recent combination with the Marathon Club to be a step in the right direction because consolidation of the two groups eliminates what she sees as a lot of confusion in the marketplace about the two organizations. The recent re-instatement of 501(c)(3) status to NAIC’s Entrepreneurial Growth and Investment Institute (EGII) , should also make it easier for the newly combined entities to raise money for educational programs targeting women and minority entrepreneurs. It’s something of a perfect storm for Connolly, who has clear intentions about her contribution to the NAIC.

In the year ahead, Connolly is especially interested in increasing membership and raising capital for the NAIC. She believes her existing relationships with fund managers and partners of Fairview Capital should allow her to help get the word out to firms that are currently unaware that NAIC even exists.

Increasing access to capital is another key concern of Connolly’s. For years, limited access to capital has served as a roadblock for investment managers who focus on the emerging domestic market and the women- and minority-owned businesses in which they invest. Connolly sees her new-found position on the NAIC board as a larger platform from which to spread the shared mission of the NAIC and Fairview. She believes that, once adequately informed, smart capital will take advantage of all the unrealized opportunity in the emerging domestic market at large.

“One of our jobs, as a fund of funds, is to aggregate capital on [emerging managers’] behalf,” Connolly says, adding that it also is her responsibility to make a financial case for why EDM investment is smart investment. “[Investing] in funds with a focus on the developing urban markets and [in] entrepreneurs that are developing companies focused on this market is actually a really good investment, regardless of anybody’s gender or race.”

Carlos L. Signoret and his partners at Hispania Capital Partners have been members of NAIC since 2003. The young firm was closing on its first fund at that time, and the partners viewed joining the organization as a good way to continue expanding their network. Hispania has raised $216 million in committed institutional financing across two funds since then, and has completed 17 platform and add-on acquisition transactions in the U.S. and Puerto Rico.

Over the years, the partners’ relationships with other NAIC members have deepened and strengthened, as has their commitment to helping the organization shatter the barriers limiting opportunities for people of color and women in the investments industry. So when the opportunity to join the NAIC board arose, Signoret was enthusiastic about accepting the challenge.

“As a board member of NAIC, I will be able to help advance the organization’s primary focus of expanding access to capital to minority-focused and managed investment companies,” he says. “These investment companies are still in their development phase, relative to the rest of the industry, and require special support to help the managers build their investment teams and track record.”
Signoret has more than 20 years of leveraged finance and private equity transaction experience. He is especially skilled at leveraged finance with senior mezzanine and high-yield debt structures for middle market and large corporations. Before stepping out to launch Hispania, he was a principal at CM Equity Partners LP, where he completed seven transactions in four platform acquisitions employing more than $200 million in equity and debt capital. During an earlier stint at Chase Manhattan Bank, Signoret worked leveraged acquisitions and financing transactions with some of the leading buyout firms in North America. While at Chase, he also was responsible for closing and monitoring private equity transactions in later-stage equity investments. He holds a master’s in applied economics and corporate finance from the University of Michigan, and a bachelor’s in finance from the University of Puerto Rico.

“Diversity of the manager’s background is important because it provides a complementary vision that is useful when analyzing new investment trends and opportunities,” he says. “This is especially the case with the U.S. Hispanic market, which reflects positive demographic and purchasing power trends in the longterm “

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.

Relationships Matter

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

Section 342 of the Wall Street Reform Act aims to transform the complexion of the financial services industry.

The global financial crisis has loomed large in the minds of the American public and of elected officials responsible for the public good.
Determined to prevent such a massive meltdown in the future, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act, last July. Dodd- Frank seeks to create a regulatory environment attuned to correcting the entrenched, systemic causes of the crisis, but it also contains a provision to right other shortcomings within the industry as well. Introduced by Rep.
Maxine Waters (D-CA), Section 342 of Dodd- Frank calls for an Office of Minority and Women Inclusion (OMWI) to be established at the various federal regulatory agencies, including the Treasury, the Federal Deposit Insurance Corporation (FDIC), the 12 regional Federal Reserve banks (FRB), the Securities and Exchange Commission (SEC), and the new Consumer Financial Protection Bureau. These OMWIs will address the scarcity of people of color and women in senior management within the financial services industry. The legislation also extends to all contractors–financial institutions, investment banking firms, mortgage banking firms, asset management firms, brokers, dealers, financial services entities, underwriters, accountants, investment consultants, and providers of legal services– doing business with these agencies, which is estimated to be worth billions of dollars each year.

A 2010 Government Accountability Office (GAO) report on the financial services industry, Trends in Management Level Diversity and Diversity Initiatives, indicates “that overall diversity at the management level in the financial services industry did not change from 1993 through 2008, and diversity in senior positions remains limited.” This dearth of diversity is no secret.Rather, it has been part of an entrenched and persistent culture of homogeneity in the financial services industry.

In a speech delivered in September 2010, SEC Commissioner Luis A. Aguilar cited findings from the GAO report reflecting data collected by the Equal Employment Opportunity Commission (EEOC) showing that “in 2008, white males held 64 percent of senior positions, African Americans held 2.8 percent, Hispanics 3 percent, and Asians 3.5 percent.” The reasons to remedy the situation these stark figures portray are several-fold, according to Aguilar, and one reason is of particular importance. “The financial services industry serves as an important pipeline into corporate boardrooms across this country.Improving the diversity statistics in the industry will significantly expand the pool of candidates for board seats.”

Almost on cue, those who question the value of diversity, or the wisdom of promoting it through regulation, have already begun the naysayers’ chorus. In her July 8, 2010 response to Article 342 in Real Clear Markets, Diana Furchtgott-Roth, former chief economist at the Department of Labor and current senior fellow at the Manhattan Institute, said, “Race and gender ratios, if not quotas, must be observed by private financial institutions that do business with the government. In a major power grab, the new law inserts race and gender quotas into America’s financial industry. … This has had no coverage by the news media and has large implications.” Furchtgott-Roth’s provocative narrative is being repeated throughout the blogosphere and is gaining traction.Opponents of the larger legislation have even introduced a bill to repeal it in the form of H.R. 87 [112th].

As this debate continues, it is incumbent upon financial services firms that are owned by people of color and women to be prepared for the opportunity the establishment of OMWI offices represents. Defenders of the law rightly point out that existing provisions, although well intentioned, have not resulted in full inclusion of women and people of color, and that Wall Street is still predominantly white and male. In an opinion piece in The National Law Journal of October 4, 2010, Pamela Bethel, formerly an attorney with the SEC and who testified before Congress when Dodd-Frank was being debated, writes: “In October 2008, Congress passed the Emergency Economic Stabilization Act, which contains a provision requiring the treasury secretary to develop and implement standards and procedures to ensure, to the maximum extent practicable, the inclusion of women- and minority-owned businesses in TARP. But in practice, this admirable goal was not met. Of 52 contracts awarded by Treasury under TARP, minority-owned firms got only three. That is why Congress passed Section 342.”

The question of who deserves inclusion is simply answered by accepting that women and people of color are not exempted from the responsibility of taxpayer obligations such as TARP, so implying that they should have no expectation of participating in business contracts related to TARP and other mainstream financial opportunities goes against the American ethos with regard to inclusion and representation. And to harp on the fear that unqualified women and people of color will be hired to the exclusion of white males is to accept that all white males working in the crisis-stricken financial services industry are intrinsically more qualified than any female or minority candidates; a debatable assertion at best, and statistically un-provable. Such hysteria is countered by factual precedent. “During the savings and loan crisis of the 1980s and 1990s, the Resolution Trust Corporation (RTC), which was cleaning up the mess, took a major step toward inclusion of minorities,” Bethel writes. “The RTC hired many private law firms to assist the government in its work. Those law firms were not allowed to staff the projects in their normal fashion. They were required, on each assignment, to enter into a joint venture with a minority-owned law firm. The results were that the work was performed successfully and cost-effectively and that a whole new cadre of minority-owned law firms emerged and gained respect and financial success.” As the question of why diversity matters continues to be asked, it’s as though precedent has not borne out its value. “What we have learned as a culture is that we do best when we open up the door of opportunity, when the contract and work force look like America,” said Bethel during a recent interview with EDM Journal, adding that contrary to what the law’s detractors are saying, the provision doesn’t demand numbers or quotas. “That is unconstitutional.”

Diversified leadership has been shown to make a positive difference in outcomes, and Section 342 of the Dodd-Frank Act seems poised to open more opportunities for well-qualified women and minorities to enter senior and leadership positions in the financial industry.As entities affected by the legislation are called to account for their diversity efforts, the FDIC and the FRB announced the establishment of OMWI offices on January 18. Women and minority owned funds firms that could benefit from healthier levels of inclusion in the industry would be well served to gear up to secure a share of the business and/or contracts that fall under OMWI’s purview. The Web sites of participating agencies are useful resources for announcements about seminars and other available opportunities. Firms might also look to team up with others to respond to RFPs on projects that require a broader skill set than any one firm may possess. “These are the ways for those who have not been in the Federal arena to move closer to the front of the line,” Bethel says. EDM

NAIC and the Toigo Foundation are teaming up to accelerate the entry of people of color and women into the private equity industry.

The Toigo Foundation is an organization many firms and business associations have known for years as a partner to industry and the source of some of the nation’s brightest young minority men and women now working in all sectors of the industry.

Today, the program proudly represents nearly 1,000 alumni who are pursuing careers with top financial services firms, serving as leaders with key institutional investors and launching their entrepreneurial businesses as our newest generation of emerging managers.

The National Association of Investment Companies (NAIC) has had a longstanding relationship as one of Toigo’s strongest supporters. Last fall, with NAIC’s recognition of Toigo at its 40th Anniversary Gala and the foundation’s launch of the Toigo Institute, designed to reach an even broader base of minority finance professionals, NAIC President Samuel J. Boyd Jr. Began exploring the positive impact of building a more formal collaboration between the organizations. “We want a structured engagement with Toigo,” Boyd said.

For minority financial professionals just starting their careers, bridging the gap from business school to the private equity sector can be daunting. Boyd believed a more strategic NAIC/Toigo Institute partnership could create an important resource that supports the ongoing education of Toigo Alumni and an opportunity to host collaborative events that bring major finance industry players together (institutional investors, private equity firms, plan sponsors) in relaxed symposia settings. The goal of the industry events would be to foster interaction, nurture relationships and discuss strategies for increasing access and inclusion in the sector — core objectives of both organizations.

“Each organization has been a tremendous resource for the other,” Boyd added. Future programs developed as a result of the NAIC/Toigo collaboration can serve as the bridge from graduate school to Wall Street, the Silicon Valley, the Chicago Financial District and all points in between.

Investing in Diversity

In the last two decades, the Toigo Fellowship has fostered the aspirations of young people of color looking to serve their communities as leaders within finance. A recent Bloomberg Businessweek analysis showed that even though minority enrollment in full-time MBA programs has increased on some campuses, there is plenty of room for improvement on campuses across the country. Increasing minority representation at graduate business schools is the Toigo Foundation’s first point of engagement. With the Toigo MBA Fellowship, the Foundation plays a key role in the recruitment and diversity initiatives of many Wall Street firms. Today, Toigo Fellows can be found in the conference rooms of financial powerhouses like The Carlyle Group, Credit Suisse, JP Morgan, UBS and dozens of others.

Toigo Fellows are often called upon by the NAIC to participate in plenary sessions and panel discussions at the annual conference. “The NAIC has continued to extend its generosity by allowing Toigo fellows to participate in the annual conference,” says Nancy Sims, president and CEO of the Toigo Foundation.

NAIC also has drawn upon the talents of Toigo Fellows as writers and researchers for various NAIC-sponsored publications.Several NAIC member firms are active in the mentoring programs provided to Toigo fellows.Expanding the partnership between the NAIC and Toigo seems, as Boyd says, “A natural fit.”

In 2009, Toigo set its sights on the inner circle of private equity by creating a post-graduate fellowship program which provides MBA graduates with entrée into the sector, a virtual classroom and networking events.In a three-part rotation, each Toigo Private Equity MBA Graduate Fellow has the opportunity to spend six months at a leading private equity firm, three months with an institutional investor and, finally, three months at a portfolio company.

“The rotational structure of the post-graduate Fellowship provides an unparalleled experience for a young professional to gain a 360 view of the investment process within the PE sector,” Sims says. “The Toigo Private Equity MBA Graduate Fellowship provides a one-year stipend plus a tuition-relief bonus. In addition to The Carlyle Group, NAIC member firms Vista Equity Partners and Palladium Equity Partners have committed to participating in the program.

Nurturing Entrepreneurial Talent

While the Toigo Foundation is largely known for its student-focused programs, the formation of the Toigo Institute for Leadership Excellence Advancement and Diversity announced in 2010 ensures the nonprofits efforts reach and influence a broader base of minority leaders.

One of the first Toigo Institute initiatives is aimed at building a support program for emerging entrepreneurs. The Toigo Bridge to Business program enables the foundation to provide start-up capital to selected entrepreneurs who have presented a comprehensive business plan outlining their product, targeted line of business, growth potential and the risk factors involved. The selected entrepreneurs will also gain access to Toigo’s knowledge brokers and a diversified set of industry mentors. In the initial year (2011), funding will be available to Toigo Alumni entrepreneurs, with ongoing education and networking programs benefitting a broader base of minority and women entrepreneurs.

“As an offering of the Toigo Institute, Bridge to Business addresses Toigo’s continued investment in our talent and their entrepreneurial aspirations. It furthers our agenda to support the creation of future emerging managers for our industry. Providing financial and intellectual capital as well as coaching and counsel is more important than ever,” Sims says.

The innovative program will draw on the expertise of practitioners, academics and investors to ensure an objective and effective process for evaluating and selecting “Toigo Entrepreneurs.” We hope to engage several participants in the program over the next two to three years.

The NAIC/Toigo alliance will provide education and resources to Toigo Bridge to Business applicants and other minorities poised to launch new ventures.“Taking part in the learning and networking experiences Toigo entrepreneurs will have, directly aligns with NAIC’s goal to be an active participant in the promotion of new women and minority-owned businesses” Boyd adds.

Coming Together

While there is no formalized arrangement or contractual agreement between the two organizations, the synergies are clear and strong enthusiasm shared. “With several overlapping constituencies and complementary missions, together we can introduce high value-add programs and activities to our mutual member base,” Boyd noted.

This spring, the Toigo Institute and NAIC cohosted their inaugural joint venture: a symposium titled “Pension Funds Investment into Private Equity — Lessons Learned, Best Practices and Models of Innovation.” The symposium featured Professor Josh Lerner of the Harvard Business School. Lerner led an interactive discussion with a distinguished panel of institutional investors and examined how pension funds can drive innovation in entrepreneurship through investments.

“By leveraging our relationship, we hope to strengthen our efforts in touching the industry with education, networking and exchange on topics of relevance to our private equity investment community” Boyd says. EDM

With five years of experience under its belt and more than $600 million under management, Clearlake Capital Group brings ambition and a deep respect for relationships to the NAIC member mix.

Clearlake Capital Group was founded in 2006, but the firm’s genesis was in an idea that goes back nearly 15 years. Before forming its own firm, the Clearlake’s leadership team had watched for several years as other private equity firms grew in assets under management by focusing on bigger companies.The Clearlake founders identified opportunities for smaller-end, middle-market, turnaround and specialsituation private equity, and established the firm to serve what it saw as a neglected market segment.

“At highly successful firms over the past 10 to 15 years, private equity has evolved to outsized returns with large [generic] mega-cap outcomes,” says Behdad Eghbali, one of Clearlake’s founding partners. “[We focus on] smaller, more complex transactions. This segment of the market is wholly underserved. A lot of private equity firms have the capability to make deals and source deals. We have operational expertise to grow and help businesses.”

With a target transaction size of $15 million to $75 million, and a history of operational relationships with management to restore, transform and grow companies, Clearlake is positioned to deliver on its vision.

Two of the firm’s three founding partners, Steve Chang, and Jose Feliciano, originally met while working at Goldman Sachs in the 1990s. They reunited several years later, when they both worked at Tennenbaum Capital. The two later met Eghbali during his stint with a private equity firm, Texas Pacific Group (TPG).

“Several [Clearlake] team members are from TPG and Tennenbaum,” Eghbali says, noting that their long history of working together makes for “a cohesive investment team..”

Such deep relationships at the team level, coupled with sector and product capabilities and relationships, form the basis of Clearlake’s working dynamic.Among them, Clearlake’s partners have committed more than $3 billion across more than 50 investments.“[We] did transactions with TPG and had good professional and personal relations with Behdad at TPG,” Feliciano says. “We felt comfortable in that relationship dealing with the ups and downs [over time]. It felt great to set up our own firm.”

Now five years into operation, Clearlake has more than $600 million under management in private equity and credit investing. During this period, the firm has become acquainted with the National Association of Investment Companies (NAIC) and its members, and it joined last year.

“Relationships evolved and there was commonality with many members’ missions,” Feliciano says. “ [NAIC] is an important voice for smaller and emerging private equity companies.”

He emphasizes that it is increasingly important to bring capital and attention to segments and communities that largely remain underserved, a function that NAIC can perform.

“Clearlake’s astounding success is exciting to watch,” says Samuel Boyd, NAIC president and CEO. “They’ve put the right pieces together: a talented and experienced team, a sound investment strategy and results that would make any institutional investor very happy. We’re ecstatic about having them as a member of NAIC.Our broad network of like-minded firms and institutional investors wrapped around our programming will serve Clearlake well”.

Eghbali sees NAIC membership as an important way to generate deal flow through interaction with other general and limited partners and to bring attention to smaller groups the Clearlake partners may not see otherwise.

“When we set up the firm [five] years ago, we were not aiming to be the largest, but rather a world class investment firm within a specialized investment niche,” Feliciano says. “We raised our first fund in 2006 (less than $200 million), and our second fund in 2009 (more than $400 million) with great early results.We would like to raise a third fund and believe investors will reward [strong] performance.”

Clearlake does not make any hard projections, but is confident of its approach. “We want to build the business in a responsible, methodical manner, with larger funds [targeting] business situations that fall through the cracks while maintaining our initial strategy focus on smaller and mid sized companies,” Eghbali adds.EDM

The SBA’s revamped SBIC program has some emerging managers pursuing it as a means to augment fundraising

When capital began to become more and more scarce in 2008 and 2009, Francisco DeJesus, a partner with Dallas-based 21st Century Group LLC, knew it was time for a strategy change. Business was far from “usual,” with the capital markets drying up and the national economy rocked hard by recession.

“At the lower to middle range of the market, debt capital completely disappeared,” recalls DeJesus, who defines that “range” as including companies whose sales vary from $5 million to $10 million. Those opportunities are the meat and potatoes for leveraged buyout firms like 21st Century, which participate in the form of debt security in such transactions.

“We also control the equity,” DeJesus says. “That’s one way that we take advantage of the yields while giving sellers confidence in our ability to put together complete transactions.” But even the most comprehensive approach to the small and midsized market wasn’t taking hold in 2009. With the markets in a decidedly uncooperative state, 21st Century began investigating new funding options. During that exploratory stage, DeJesus and his team pinpointed the SBA’s Small Business Investment Company (SBIC) program as a good potential alliance for the firm.

Breaking it Down

Since 1959, SBICs have supplied equity capital, long-term loans and management assistance to qualifying small businesses. The program’s goal is to improve and stimulate the national economy in general and the small business segment, namely by stoking and supplementing the flow of private equity capital and longterm loan funds. The SBIC’s mission is accomplished through the following means:

• Licensing top fund managers with exceptional deal flow;

• Seeking participation from major private investors;

• Managing risk to taxpayers through standardized risk management procedures;

• Communicating understandable program ground rules;

• Offering funds time to develop results, given the cyclical nature of venture investing; and

• Focusing on profit maximization.

In addition to investing capital, SBICs provide hands-on involvement in their portfolio companies, including board participation, corporate governance, strategic planning and marketing, recruitment, financial support, capital raising and company exit support. Since its inception, the SBIC program has put more than $56 billion into 100,000 small firms.

Currently finishing up its SBIC application process, 21st Century may soon get a share of that capital, plus the support that comes along with it. DeJesus says the firm kicked off the application process by attending a preliminary meeting with the SBA, and then talking to its investors about the potential market opportunity.“We walked through the process with the SBA to make sure we understood the program and how to apply for it,” he says.

DeJesus’ next step was to fill out a Management Assessment Questionnaire (MAQ). The MAQ consists of SBA Form 2181, together with the Exhibits in SBA Form 2183 (both are available on the SBA website).“The MAQ is very similar to what you would get from a pension fund, with some extra questions in it that are specific to the U.S. government and the SBIC program,” he says.

The firm was then invited to attend an SBIC management presentation, where 21st Century’s participation strategy was laid out for the approval committee to either approve or deny. “There’s no in-between, they just make a decision,” DeJesus says.After getting a thumbs-up, 21st Century moved onto the second step, which the SBA calls the “formal licensing phase.”

The SBIC formal license application consists of the same SBA Form 2181 used in the MAQ (to be updated by the applicant as needed), together with the exhibits found in SBA Form 2182. Exhibits include (but aren’t limited to) a legal proceedings questionnaire; business experience and education of principals; declaration of significant investors; and an organizational chart.

So far, DeJesus says the application process has been seamless, and hasn’t presented any significant challenges or surprises.“From our point of view, everything has gone exactly as planned,” he says.“We submitted what we needed to submit, the SBA answered us like they said they would, and we moved onto the next step. It was pretty simple.”

If and when 21st Century’s final stamp of approval comes from the SBA, DeJesus says the firm’s SBIC business will serve as a “drop down” to its existing private equity activities. “We’re not looking to turn our company into an SBIC; we’re just taking a portion of the capital,” he says. “On the strategic side, we see an opportunity to provide both debt and equity to middle market companies, and we think that the SBIC program will help us achieve that goal.”

Warming Up

The fact that emerging managers like 21st Century are warming up to the idea of the SBIC program comes as no surprise to Lawrence Manson Jr., chairman and CEO at NexGen Capital Advisors, a Chicagobased firm with offices in Washington, D.C., and Seattle. In existence since 2008, NexGen helps banks (among other institutional investors) ferret out interesting, high-quality, investment opportunities. It just so happens that SBICs are a CRA-eligible investment.Banks that have assets greater than $277 million have a CRA investment requirement that generally represents more than 1percent of total assets.

As part of its mission, NexGen has developed a proprietary, pre-packaged fund-of-fund of SBICs and also helps SBIC sponsors develop financial institution marketing strategies. “We’re in the market, raising a $100 million fund and, in turn, have agreed to invest that capital in as many as eight SBICs,” says Manson, who sees the SBA program as a great way to augment Private Equity firms fundraising.

“Sponsors really need to think about the SBIC platform as an alternative to, or augment for, their current fundraising activities,” Manson says.He sees licensing as the top challenge for private equity firms looking to become SBICs. He adds that having a strong track record that’s aligned with a thoughtful business plan can go a long way in helping applicants secure a license.

The process can take anywhere from four to six months or longer to complete, says Manson, noting that the SBA considers those applications with the greatest likelihood of success first. “It’s not necessarily first come, first serve. If the SBA believes that you can raise capital, or if you already have capital committed, it will improve the likelihood and speed at which you get through the licensing process.”

Citing Goldman Sachs’ need to access leverage from the federal government, Manson says the SBIC program is a natural choice for emerging managers looking to gain an edge in a competitive capital-raising environment. “The money essentially comes from the same place. The SBIC doesn’t have to drive 100 percent of your firm’s strategy, but it can definitely be a valuable component of it.” EDM

When the Journal of EDM Finance was established in the Spring of 2005, it was intended to be the voice of the private equity industry for the Emerging Domestic Market; to put into print in a periodical format what NAIC had been doing for nearly forty years. For certain, it has achieved that and more. Now, six and half years and 13 issues later, the EDM Journal continues to inform its readers in a unique, yet familiar way. Stories that cover insights from institutional investors, private equity firm’s investment prowess and fund raising forecasts have been the mainstay in the EDM Journal. In so doing, the EDM Journal continues to be a clarion call for the understanding of America’s underserved market, the Emerging Domestic Market. This issue’s coverage is in keeping with that tradition and serves as a very good example of the heightened interest in the EDM by institutional investors and the U.S. Federal Government. NAIC’s collaborative strength is also showcased in the Fall 2011 issue.The feature story on the Association of Asian American Investment Managers is an illustrative piece on how AAAIM has captured the attention of the financial world by harnessing the energy of the investment community to positively address the need for more Asian investment managers-a critically underserved market. (See pg. 16) The NeuroFocus story is an exciting read that strikes at the heart of innovation and venture interests. (See pg. 21) NeuroFocus’ groundbreaking discoveries and approach to marketing represents the latest in advanced marketing- an uncanny yet brilliant approach to understanding customer psyche. The cover story, my interview with the California State Controller, John Chiang, is a mustread as it delves into how his decisions have positively affected the lives of Californians.

This is indeed a very exciting time. As NAIC combines forces with The Marathon Club, it is important to note that now with an expanded board of directors, members and staff, NAIC has more expertise and added resources to build its platform and to more assertively address the needs and opportunities of NAIC members and the emerging domestic private equity market. (See pg. 26) So continue to expect more from NAIC and its Journal of EDM Finance. We accept the challenge and very much look forward to continuing to lead the charge of providing a broad platform to support EDM fund managers and a periodical medium to tell content-rich private equity stories.

Thank you for supporting the only periodical entirely devoted to covering private equity in the Emerging Domestic Market, the Journal of EDM Finance.

All the Best,
Samuel J. Boyd Jr.
President & CEO

As a publisher who has spent decades producing magazines like the Journal of EDM Finance, I am excited about the almost limitless potential of a device invented by NeuroFocus Inc. that will allow the company to take its pioneering work on using the science of the brain for market research out of the lab and into real-life settings.

NeuroFocus, which is wholly owned by the Nielsen, unveiled Mynd, “the first dry, wireless headset designed to capture brainwave activity across the full brain today” in March. Mynd tracks electrical impulses from the brain, using neuroscience, to interpret them and to test responses to brands, products, stores, advertising, websites or videos. (See pg. )

“Whenever you experience a product second by second, your brain is parsing that experience,” says Dr. A.K. Pradeep, the chief executive officer and founder of NeuroFocus. “If we have access to how our brain reacts second by second to that product experience, we are able to isolate what works and what doesn’t work.”

While our story and others have emphasized Mynd’s use in marketing products, our interest was piqued by the developer’s suggestion that it could be used to shape content. “Content” is what goes into magazines like this, websites like those we create and various other media.

Interest in “neuromarketing” peaked after a 2004 study at Baylor College of Medicine validated its use in testing brand associations with Coke versus Pepsi.

More and more, NeuroFocus plans to use this science to create products, not just to study existing products. Such wisdom, Dr. Pradeep says, “could enable product designers or content designers to avoid standard pitfalls.”

This is promising news for print media that live under constant predictions of our demise. Cyberspace is increasingly competitive too. My company, Cox Matthews & Associates Inc., produces content in both worlds. It would be a radical breakthrough if media could rely on science, rather than increasingly outmoded notions, to tell us which headline, which color or which picture will sell more copies or attract page views.

If Mynd gives us answers, then attracting investors for new media ventures and advertisers to keep them going would become easier. Investors, in turn, would reap a healthy return.

With Mynd headsets on real people using media in real time, Dr. Pradeep says, “You could dramatically transform the landscape of market research as it pertains to enjoying and viewing things at home.”
NeuroFocus also has applied neuroscience to learn what motivates the brains of various demographics — mothers, women in general, men and baby boomers to buy. For the media, such data could assure that we reach target audiences by providing irresistible content. With its wires and sensors, Mynd may look like a headdress Medusa might wear, but it appears to have a bright future.

Elsewhere in this issue, we are pleased to report on several developments that should benefit NAIC members over the long haul: the combining of the National Association of Investment Companies with The Marathon Club, (See pg. 26), the growth of an NAIC partner, the Association of Asian American Investment Managers., (See pg.16) and expanding opportunities at the Small Business Investment Company program at the U.S. Small Business Administration’s (See pg. 0).

All of these are encouraging signs for the EDM community, and we take pride in keeping you up to date on these issues.

Regards,

William E. Cox Publisher