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Eager to boost the value of their investments, venture capitalists lavish their portfolio companies with a broad array of services.
P.B. Gray, CFO Magazine
May 8, 2006
Cincinnati is a long way from Nanjing, China — 7,300 miles and a world apart from the reassuring conventions of business, American style. That was a big worry for Jonathan C. Dill, CFO of Ampac Packaging. Dill visited China in 2002 as part of a team seeking to open a factory that would substantially reduce manufacturing costs for his company, which had been making shopping bags and other packaging in Ohio since the 1960s. Once in China, though, the sheer size of the country and its cultural differences seemed overwhelming to him.
That's why, he now says, he was so grateful for the advice he got from the executives at Asimco Technologies Ltd. The auto-parts company had been a business pioneer in China since an American launched it there in 1993. Asimco's executives reassured Dill that he'd made the right decision in choosing a factory site in Nanjing, a port city with lower labor costs than other fast-growing cities in China. Asimco also helped Dill make sense of perplexing tax regulations and introduced him to key vendors in China. "This was our first offshore venture, and they were a great sounding board," says Dill. "They helped educate us on the basics of doing business in China."
So why should an auto-parts maker share its wisdom with a packaging company? Not from goodwill alone. The two share an investor, Key Principal Partners, or KPP, a middle-market private-equity and venture-capital firm based in Cleveland. Partners at KPP, the private-equity arm of Key Bank, introduced the executives of the two firms and encouraged them to share strategically important information.
Fostering such relationships among portfolio companies is a high priority at the firm these days. "We want to distinguish ourselves as guys who bring a lot more than just money to the table," says Timothy Fay, a managing partner at KPP. "We invest in passionate, headstrong entrepreneurs, and we want to offer them not only capital, but also our expertise and our network of business veterans all over the world."
KPP isn't the only firm lavishing its portfolio companies with love these days. Once satisfied to play a limited role in their companies — mostly as money machines — many venture capitalists and other investment firms now are providing them with a variety of services and benefits. Among other things, they are trying to forge relationships among portfolio companies so all may benefit from a broader network of contacts with customers, suppliers, vendors, government officials, and Wall Street. Venture capitalists and private-equity firms also are helping portfolio companies recruit talented executives and negotiate strategic alliances. They even help pinch pennies — by negotiating cut-rate group deals with outsourcing companies or other vendors on behalf of portfolio companies.
Return to Keiretsu
KPP's policy suggests a return to keiretsu. A practice much in vogue in the 1980s, keiretsu refers to the network of interlocking relationships among powerful companies in Japan. Kleiner Perkins Caufield & Byers, a Silicon Valley venture-capital firm, was one of the first to put in place a uniquely American version of keiretsu. It created a network within its portfolio linking hundreds of companies and thousands of executives. The term fell out of favor during the deep Japanese recession in the 1990s, but the concept has grown increasingly popular among U.S. venture-capital firms. "Whether you call it a network or whatever, it is something that entrepreneurs crave," Ray Lane, general partner with Kleiner Perkins, said at a recent roundtable.
Lane's comments reflect the new economics underlying the venture capital business. Investment in new companies is a fraction of what it was at its peak in 2000: $22.3 billion in 2005, down from $94.7 billion in 2000, according to VentureOne, a market-research unit of Dow Jones & Co. in New York. Venture capital firms and private-equity firms are competing for deals against a big herd of other well-heeled investors these days, including hedge funds. That's driving up valuations and making deals more costly. VCs also are finding it harder to cash out of their investments. The IPO market is still relatively weak and corporate buyers have been slow to purchase. As a result, companies are lingering longer in portfolios. In an effort to boost the value of their investments, VCs are getting more involved in helping their portfolio companies control costs, build profitability, and find new markets — even if that means going global at a very early stage.
Networks Beyond Networks
At Summit Partners in Boston, VC and private-equity experience is a critical component of the bargain it strikes with rapidly growing private companies. Founded in 1984, the firm has raised more than $9 billion in capital and invested in more than 275 companies, of which more than 100 have completed public offerings. These days, Summit spends a lot of time working with CEOs to build the management teams and the boards of its portfolio companies, says Bruce R. Evans, a managing partner at Summit. "When I started in this business in 1986, it was a big deal for a venture capitalist to have 10 years of experience," Evans notes. "Now, there are investors like me with 20 years' experience and, as a result, our networks are deeper and we have a bigger, more experienced pool of management talent from which to draw."
In 1999, for instance, Summit had invested in Unica Corp., a small, Waltham, Massachusetts-based company that created direct-marketing software. Eager to build a strong board of directors, Unica turned to Summit for help and successfully recruited James Perakis, a respected software-industry veteran. A former chairman and CEO of Hyperion Software, a Summit portfolio company based in Santa Clara, California, Perakis joined Unica's board in 2000.
For five years, Perakis, Evans, and other directors helped guide growth and put in place the necessary financial discipline. In August 2005, Unica went public, scoring a big payday for its founders — and for Summit Partners. Its market capitalization today is about $250 million. Summit had invested a total of $6.5 million in Unica; its stake today is valued at four to five times its initial investment. By helping the company recruit experienced and respected people for management and its board, "Summit helped us run like a public company from an early start, which helped build investor confidence as we prepared for an IPO," says Unica co-founder and CEO Yuchun Lee.
Like Summit, KPP plays the role of matchmaker for its portfolio companies, many of which don't know how to recruit executives with specific expertise in managing growth. "We find that entrepreneurs may have extraordinary technical expertise and great marketing and sales skills, but they are at a turning point when they come to us," says KPP's Fay. "They're on the verge of breaking into the big time, but there's a Swiss-cheese quality to the rest of the management team." Often, he adds, the critical missing component is the CFO.
"For a lot of company founders, the CFO is the weak spot in a company," says James C. Johnston, CEO of Johnston Co., in Lexington, Massachusetts. "For the VCs, the CFO is a critical link to the business, a scorekeeper of sorts who tracks the company's progress against the plan." Johnston speaks from experience; young, entrepreneurial companies regularly hire him as a temporary CFO. Johnston says a number of VCs are taking a more active role in bringing in strong CFOs to assist CEOs — and keep them on track. "Founders, by nature, tend to be optimistic and expansive," he says, "and some of them have a tendency to lose track of previous commitments to the board. VCs want a CFO in place who provides the essential discipline according to the plan."
Over time, KPP has built a network of CFOs who are comfortable instilling financial discipline in a fast-paced, freewheeling, entrepreneurial environment. Some of those CFOs have worked in six or more of the firm's portfolio companies and have experience in creating financial order out of chaos. "We airlift them into the situation, if necessary," says Fay. "We want to ensure financial integrity, which enhances the value of the company — for us and for the entrepreneur."
In November 2004, KPP bought Honsador Lumber in Hawaii for an undisclosed sum. Jim Pappas, a former accountant and Honsador's brilliant, hard-driving owner, had, over a decade and a half, built the business into the largest building-products supplier in the islands. Revenues topped $150 million in 2005, a double-digit increase over 2004. The problem: "The CEO was running it out of his head," recalls Fay. "The finance department was a haphazard operation, completely lacking in the proper systems."
KPP recruited Drew Neathery, "the perfect disciplinarian," says Fay. Neathery had worked at another one of the firm's portfolio companies and was a trusted envoy for KPP. At Honsador, Neathery, in conjunction with one of KPP's information-technology professionals, Chelsea Stoner, installed the necessary financial-reporting systems that enabled executives to manage the company's growth more adeptly. He created an assortment of so-called dashboard metrics that gave other managers a clear view of the top-selling products and their profit margins on a day-to-day basis.
Tighter control is paying off for KPP. Fay expects Honsador to experience a fourth year of material double-digit growth in 2006. Profit margins have widened, he says. More significantly, says Fay, Honsador's EBITDA grew 20 percent from 2004 to 2005.
P.B. Gray is a freelance business writer based in suburban Boston.