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VIEWPOINTTHE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
PRIVATE EQUITY
Stryker Rich:
MDP’s Sage
Decision Led
to Happy Exit
VENTURE CAPITAL
Why IBM Was
Drawn to
Cleversafe
Q &A
Selecting the
Best Performing
PE & VC Funds
PE&VCKey
toStrong
PensionFund
Returns
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
RealityVersus Myth
For the past three IVCA Viewpoints, we have sought to dispel the common myths that give private
investing in private companies --private equity investments in mature businesses in particular --
a bad rap. But the misrepresentations persist, and not just because of election-year antics of
uninformed critics.
As you may recall, we have explored through real situations the topics of“Private Equity, Public
Good,”the true beneficiaries of private investing in“I am a Private Equity Investor,”and the collaboration
between PE/VC firms and their portfolio companies in “Partnering for Growth,” our last Viewpoint.
This edition of Viewpoint strives to help people grasp the nuanced processes and methodologies
behind investing in private companies. We explain through case studies how PE and VC firms go
about the business of choosing a startup or established company to invest in, helping advise them, and
assisting in actualizing their future --whether as an independent company or as a unit of another
company or investment firm.
We also offer a rich dialogue with two Illinois pension funds and an investment consulting and
asset management firm that manages or advises on trillions of dollars of holdings to illuminate how
the net returns from PE and VC investments outperform their general portfolio or benchmarks.
Here are the takeaways --and we hope you will pass them along to the skeptics, cynics and
nonbelievers.
Growth is the key component and objective of both PE and VC firms. Improving the operations of
their portfolio companies or investments is uppermost--so their investors will benefit as well as
the other essential stakeholders: employees, customers, suppliers, and the communities in which
their employees work and live. For that latter evidence, peruse the case study of Madison Dearborn
Partners’ investment in Sage Products, a mainstay corporate citizen in McHenry County.
Some More Realities
Job creation is almost always an outcome.Yes, some jobs are lost early on but as the strategy
and operational changes take hold, new skill sets are required and overall employment increases.
Operational improvements are the key to success.They take a liking to an investment prospect
for the chance to make needed operational advances. Yes, they want to buoy an investment, but
they desire that the investment remain stable in the market --for their own reputations’ sake, if
nothing else.
Value creation is the mission.
Let’s relate these stories and facts --and celebrate the Art+Science of Investing in Private
Companies.
Facts Are Facts
executivedirector’scomments
Maura O’Hara
IVCAExecutive Director
IVCA VIEWPOINT | 2016 1
Adams Street Partners’ Terry Gould, who heads the global
PE firm’s venture and growth equity investments, admits he
often uses a familiar four-letter profanity when he hears
someone disparage private investing. “We’re not trying to cut
jobs; we’re trying to create things,” he asserts.
IVCA Viewpoint has devoted the past three reports to
illuminating what private investing in private companies
nurtures and achieves.Their titles say it best: “Private Equity,
Public Good,”“I Am a Private Equity Investor” and “Partnering
for Growth.” Still, the defamation persists too frequently.
This report strives to show, not just tell, how PE and VC
firms make a real difference for the private companies they
invest in. Through case studies, filled with rich detail that
help relate how the investors and the private companies they
invest in grow and prosper while adding--not slashing jobs
--and,yes,how the investors also benefit while strengthening
their companies.
What’s a counterpart? Think how British restaurateur and
TV personality Gordon Ramsay saves struggling restaurants
on ”Kitchen Nightmares“ and horrid lodgings in “Hotel Hell.”
It’s All About Growth
Of course, VC and PE firms differ. VC firms finance startups
and entrepreneurs in hopes that over a number of years,
usually 5 to 10, the startups will blossom and, eventually, lure
a buyer or go public. PE firms typically invest in relatively
mature companies,aiming to grow them and later exit--again
for seven years on average--at a profit.
Still, growth constitutes PE and VC firms’ overriding
mission.They each play a vital role--VC in the entrepreneurial
ecosystem and PE in building effective and efficient companies
through an engrained platform for change. For PE, especially.
What critics fail to grasp is that in today’s global
investment landscape,other countries are directly competing
with the U.S. As a result, over the last two decades, the U.S.
share of venture capital investment worldwide shrank to 54
percent from 90 percent.1
It’s A Global Battle For Investment Funds
“This innovation arms race is a virtuous competition where the
byproducts are new technologies that improve the way we live,
new jobs and economic opportunities,greater productivity and
greater economic growth,”Scott Kupor,managing partner at
VC firm Andreessen Horowitz, told the Senate Committee on
Small Business and Entrepreneurship in July.
As for PE firms,they are laser-focused on creating value
through actions that will improve operations and spur growth.
They conduct rigorous analysis, put the right management
team in place,and identify and monitor the critical metrics
for driving value. Even public companies acknowledge they
can learn powerful lessons from how PE firms employ real
and sustainable operating and productivity improvements
at their portfolio companies. And during a window of 3-10
years, usually.
What’s especially worrisome is this reality: The move
to impose more regulations on private investing is reshaping
the investment landscape, locally and globally. Disruption
ensues. And as profit margins tighten, private investment
firms must center even more on operational superiority to
achieve their investment objectives.
The following case studies make clear that for private
investments to succeed, PE and VC firms and their portfolio
companies concentrate on how to improve their companies
so,yes, they can exit at a profit to willing buyers or investors.
It’s time to stop demonizing the private investment
community.
Too often, PE firms are labeled as “job killers,” disparaged as “vultures” that strip
their portfolio companies’ assets or borrow heavily against them. A New York
Times series on PE in mid-summer perpetuated that notion.As for VCs, detractors
blame them for hyping their startups in search of billion-dollar-plus valuations
for their“unicorn”investments. Regulators are tightening their scrutiny.
–PE & VC–perpetually misunderstood
Investing in Private Companies
1
nvca.org
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
2
ivcachairman’scomments
Bob Fealy
IVCA Chairman
Founding Managing Director,
Limerick Investments
Bob Fealy
IVCA Chairman
Founding Managing Director,
Limerick Investments
ivcachairman’scomments
What We Do, How We Do It
When I was incoming IVCA chairman, I expected that my 18-month term would be an “active” time.
It certainly has been. Being that active voice on behalf of our members has been essential at a time
when the state’s financial strife persists and when a sustained misconception continues to be held
by some about the investment objectives of private equity and venture capital firms.
This explains our association’s vigor in advocating for our industry to legislators, government
officials and the public at large. It also explains why this Viewpoint focuses on dispelling the myths
around PE investments by telling specific stories that illuminate the art + science of private investing
in private companies. In short, PE is about growth and adding value, not “greed” and slashing jobs,
as the rhetoric might suggest.
As I began my chairmanship,I listed four principal areas of focus,and I want to give you a progress
report on each of them because it underscores what IVCA firms and their members have achieved
toward our vital objectives:
Engage. In supporting an entrepreneurial spirit in Illinois,we continue to meet with state legislators
and government officials in Springfield and elsewhere in an effort to promote a better understanding
about private company investments in the state.We made our voice heard on a number of fronts,
and it played a critical part in the Illinois Treasurer’s new $222 million Illinois Growth & Innovation
Fund,which will support Illinois-based VC and PE firms over the next sixyears.Our opposition to a bill
that would disadvantage Illinois public pension funds led its co-sponsor to establish a task force,
that includes IVCA representation, to consider the bill’s ramifications; no action was taken on it in
the recent session. Thanks to our IVCA Political Action Committee, we raised a record $105,000
to support our legislative activities. Many thanks go out to Lee Mitchell, Chair of the IVCA Political
Action Committee, and Campaign Co-chairs Darren Snyder of Prairie Capital and Jim Tenbroek of
Growth Catalyst Partners for their exceptional efforts.
Enlarge.We have worked to grow our membership, particularly among large family investment
offices in Chicago and Illinois, many of which have direct investment strategies in addition to
investing in PE and VC funds. They can benefit from our programming and from networking
professionally and socially at our events. Existing IVCA members will gain from better understanding
the strategies these groups employ in making their investment decisions.
Expand. The association has been involved actively in increasing diversity in our industry,especially
among African Americans and Hispanic Americans, and Executive Director Maura O’Hara continues
to drive this essential effort.
Educate. IVCA sponsored educational programs and luncheons in the past year on topics ranging
from private equity valuation and mitigating reputational risk, to negotiating roll-over equity and clos-
ing a growth financing round.Thanks to our members and member firms for assisting in developing and
conducting these sessions and for sponsoring them.
It’s been a pleasure to serve this association and to work with our two exceptional leaders,
Maura O’Hara and Association Coordinator Kathy Pyne. We also thank Neil, Gerber & Eisenberg LLP
for providing our office space.The IVCA will continue to constructively and thoughtfully advocate for
our membership--and to build an understanding of the vital role private equity and venture capital
play in improving our Illinois business environment and growing our economy.
IVCA VIEWPOINT | 2016 3
An Illinois Venture Capital Association study of the 10-year
performances of the four Illinois public pension funds found
that they realized annualized returns from their private equity
portfolio of 11.6 percent, net of fees, compared to 6.9 percent
from their overall portfolio return.
Over five years, three of the pension funds’ private equity
holdings outperformed the overall portfolio return by a range
of 110 to 720 basis points. The other fund posted a 10-basis
point improvement.The pension funds’ assets ranged from
$15.8 billion to $46.2 billion and averaged nearly $29 billion.
PE is an important component within the public pension
funds’portfolios.It provides diversification of returns besides
often outperforming the public market’s returns, net of fees.
Nationally,Preqin,the alternative assets industry’s leading
data source, also found in a study that on a net return basis,
after fees and carry, PE has been the best-performing asset
class for pension funds over three and 10 years ended Dec.
31, 2012. Over a five-year time horizon, PE has been beaten
only by fixed income and,significantly,this was during a period
of generally falling interest rates, a phenomenon unlikely to
be repeated in the near future, Preqin noted.
CalPERS, manager of the nation’s largest public pension
fund, recorded a similar result over a 20-year period. It
realized a 12.3 percent annualized return, net of fees, from
its PE holdings over a 1995-2015 period vs. 8.2 percent
from its public equity portfolio.
Investors have noted the performance. Preqin said that
94 percent of pension funds and other investors it spoke to
felt that the performance of their PE portfolios had met or
exceeded expectations. The other six percent felt returns
had fallen short of their expectations in the past 12 months.
What accounts for these superior long-term net
returns from PE & VC? To find out, IVCA conferred with the
chief investment officers of the Illinois Municipal Retirement
Fund and Teachers’ Retirement System of the State of Illinois
as well as an associate partner, private equity, at Aon Hewitt
Investment Consulting that advises on or manages $35
billion in PE & VC assets on behalf of institutional clients.
PARTICIPATING WERE:
R. Stanley Rupnik-----------------------------------
of the state’s Teachers’Retirement System,with its $46 billion
in assets at year-end Fiscal 2015 on June 30,2015,and whose
private equity staff of four serves 400,595 members.
Dhvani Shah----------------------------------------
of the 77-year-old Illinois Municipal Retirement Fund, with
its $34.7 billion in assets as ofJune 30,2016,and whose four-
member private market team serves nearly 3,000 employers.
Shari Young Lewis ----------------------------------
ofAon Hewitt,which advises hundreds of clients on building
tailored private equity investment portfolios.
Private equity
is an important
component
within the public
pension funds’
portfolios.
It provides
diversification
of returns
besides often
outperforming
the public
market’s returns,
net of fees.
Private Equity is Essential
to Public Pension Funds
PRIVATE EQUITY PORTFOLIO ANNUALIZED
RETURNS (10-YEAR) NET OF FEES
11.6%
For public pension funds, including
Illinois’ four major pension funds, private
equity continues to deliver superior net
returns compared to all other asset
classes over the longer terms. It helps
explain why the appetite for the asset
class has risen in recent years.
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
4
In a Q&A format, the three investment professionals
weigh in on a number of specific issues pertaining to
their PE and VC investments.
What percentage ofyourassets doyou invest in PE/
VC,and talk a bit about the history for such investing.
TRS: We have a 14 percent target, which amounts to a
little more than $6 billion of our ($46 million) asset base.
Typically,we target $1-1.6 billion of new investments in a given
year. Our initial PE and VC investments date back to the mid-
1980s with a more formal institutionalization of the program
in the early 2000s.
IMRF: Nine percent is our alternative investments target,
which includes PE and VC, hedge funds and the like. Three
components comprise PE/VC: fund of funds, two evergreen
separate funds and our direct PE/VC portfolio. We began
making these investments in 1986, but I started our direct
PE and VC portfolio in 2012 and it now includes 14 firms with
$753 million in commitments from 28 mandates.
AON HEWITT: In the last 10 years on average, we invested
$2.5 billion a year.We focus on funds that are raising $100
million or more. Since our clients are making large commit-
ments to funds (typically $15 million to $100 million per fund),
we tend to invest in mid-size to larger funds. There are a lot
of incredible $25-150 million micro VC opportunities and we
would love for our clients to invest in them, but their check
sizes are too big.
What is your general investment philosophy
regarding PE and VC?
TRS: PE/VC are expected to generate long-term returns in
excess of publicly traded equities.That is best accomplished
by investing in underlying businesses in growing markets with
defensible strategies led by the best management teams.
IMRF: When it comes to PE/VC standalone evaluations,
a return of 2x investment at 20 percent is the rule of thumb.
If it’s a debt-like strategy, it might be in the low teens, and
if it’s a buyout value creation situation, we want more. It all
depends on what strategy we’re applying to each individual
situation. Right now, we’re looking at funds with a broader
rather than specialty or niche approach.
AONHEWITT:We build diversified portfolios for our clients
across strategies,geographies,and industries.We recommend
they invest relatively equally each year to take into consider-
ation vintage year risk. Our goal is to build downside protection
as well maximize their upside potential. As a consultant, we
function as“matchmakers,”seeking to find great opportunities
that fit each client as well as cover different risk tolerances.
We also manage discretionary assets.
What doyou lookforin the PE/VC firm and manager?
TRS: We emphasize working with partners based on a
consistent balance between risk and return.Top performers
serially repeat. Having an award-winning Emerging Manager
program is a valuable tool to learn about new managers.
As with many large plans, the key challenge is finding and
sourcing opportunities that aren’t widely shopped. In the
current environment, we focus particularly on general
partners with a demonstrable track record of successful exits.
IMRF: We make qualitative and quantitative assessments
to determine management skills, attractive of investment
strategy and fit with our portfolio. As for qualitative, which
comes from interviews,we assess managers’skills,expertise,
strategy--there’s no substitute for evaluating their team.
On the quantitative side, we consider a lot of data points;
we look at track records along multiple dimensions and
unrealized investments.And some managers can be perfect
but don’t fit with our portfolio. A due-diligence visit can
make a difference; I didn’t move forward with an investment
after one, concluding that “only time will tell” whether it will
be a solid investment.
AON HEWITT: We focus on six areas in our due diligence
plus an independent area. The independent area is
operational due diligence. If the first six are great but the
firm is not operationally adequate, then we don’t invest. The
other six are:
Business: Who owns the firm and how is it allocated
among the team,composition and retention of LPs,how many
products they have, back office, etc.
Team: Mix of skill sets, turnover/new hires, depth of team
resources, network, skin in the game, etc.
Performance: Consistency, realizations, returns, write-
offs, length of track record, etc.
Investment process: Market opportunity, competitive
advantage, ability to create value, deal sourcing, valuation
discipline, etc.
Risk management: Investment committee process for
new and follow-on investments,monitoring,ability to work out
challenged companies,etc.
Terms and conditions: management fee, distribution
waterfall, preferred return, key person, LP approvals, etc.
Q
Q
“PE/VC are expected to generate long-term
returns in excess of publicly traded equities.
That is best accomplished by investing in
underlying businesses in growing markets
with defensible strategies led by the best
management teams.”
Q
IVCA VIEWPOINT | 2016 5
”...private equity
investments
outperformed
the overall
portfolio...”
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
6
PE/VC is a
long-term
commitment
and we
underwrite
new
investments
accordingly.
What is your general time frame for holding a
PE/VC investment?
TRS: PE/VC is a long-term commitment and we underwrite
new investments accordingly.We model 12-13 years for funds
and 5 years for co-investments.In certain instances,we will
use secondary markets to rebalance the portfolio tactically.
IMRF: We underwrite investments to hold to maturity;
we’re not going to be selling in the secondary markets
because you leave things on the table. Generally, 7-10 years
and it varies by strategy.
AONHEWITT: It’s a long-term asset class, and we do a lot
of client education to explain that they are investing for at
least 10-12 years so it is hard to be tactical. We are always
evaluating new funds for clients since we may consider not
re-committing to a managerwho is not performing as expected.
We underwrite a manager’s subsequent fund as a new
investment.With that said we are cognizant of managing the
number of manager relationships each of our clients have.
How do you identify new and prospective
PE/VC firms to do business with?
TRF: Many managers seek us out, and we’re happy to
meet with them. The key challenge is finding and sourcing
opportunities that aren’t widely shopped. So the staff tries
to maintain a proactive stance within the industry and
manager universe, leveraging resources of our consulting
partner Torrey Cove Capital Partners --a nondiscretionary
specialist advisor that focuses exclusively on PE/VC and
real assets --and continually mining separate account
relationships as a sourcing mechanism for new relationships.
IMRF: We have an open door policy and conduct a lot of
manager meetings in person, on conference calls or over
video. We need to always know what’s out there.
AONHEWITT: We’re constantly proactive. We have an
open door policy and are always reaching out. We’re always
asking LPs what they’re looking at and sharing bad or good
diligence. Some have reached out via LinkedIn. We get
attention from papers we’ve published. Placement agents
also send people our way. We also keep in touch and, if we
Q
Q
didn’t get in someone’s first fund, perhaps we can be in the
second. In the current investment environment, you can’t
rest on your laurels.
If you couldn’t invest in PE/VC, what would
be the impact on your pension holders?
TRS: The System would miss the plan’s highest net-of-
fees returning asset class, historically. The plan’s asset
allocation model and expected return would look dramatically
different without the risk return profile provided by private
equity investments.
IMRF: Every cent we earn more on that dollar, the
employer rate goes down. Payroll for our employers equals
$7 billion; if you reduce economic costs, and employer
contribution base by 1 basis point, it equals $700,000 in
savings per year. The role of private equity is important in
generating the assumed rate of return and the more it can
generate, it helps reduce the contribution rate.
What are the key differences in evaluating a PE and
a VC investment candidate?
IMRF: With a PE candidate, you can ask questions for
6-8 hours. With a VC prospect, you need to have a lot more
knowledge walking in about how VC and a venture company
work, and you don’t need eight hours. Cash flow and
quantitative analysis --and even qualitative --looks different
for a venture fund.
AONHEWITT: Buyout, distressed debt, turnaround,
secondaries, energy funds, and venture capital funds all
operate differently due to their different investment strategies.
Therefore, during our diligence we focus on different areas
depending on the strategy. Venture capital firms generally
tend to be small (with some exceptions). They mitigate risks
through deal structure and milestone based investing,
whereas preferred equity, use of leverage, and investment
timing differ significantly with other PE strategies.
Consistency in returns is valued in buyouts, but we could
expect a few home runs to drive the entire return of a
venture fund. An early stage venture capital investor often
wants to be physically near its companies to spend time
with founders, whereas proximity to portfolio companies is
less important for other strategies.Although we are always
evaluating a fund’s unrealized portfolio, with buyout and
growth we have more financial metrics to determine how
value has been created.With venture capital this assessment
is more qualitative.
What characteristics are vital in hiring a new
member of your team?
IMRF: Strong skills in due diligence,analysis,underwriting
and monitoring.Investing in PE/VC is not just finding the next
Q
Q
Q
”We make qualitative and quantitative
asessments to determine management
skills, attractive of investment strategy and
fit with our portfolio. As for qualitative,
which comes from interviews, we assess
managers’ skills, expertise, strategy–there’s
no substitute for evaluating their team.“
IVCA VIEWPOINT | 2016 7IVCA VIEWPOINT | 2016 7
The role of
private equity
is important
in generating
the assumed
rate of return.
great manager and giving money; that’s just a deal and you
must live with that deal for the next 10 years.Also important:
Does the candidate understand financial statements and what
issues can come up? Can that person glean valuable insights?
How do you monitor and keep up with your PE and
VC investments?
TRS: Our scale lets us sit on many advisory boards
where additional insights can be gained. Our partner Torrey
Cove Capital delivers an independent quarterly review for
all fund investments and co-investments. Staff also
prepares updates from advisory board meetings, periodic
on-sites in manager offices and formal annual reviews of
all co-investments.
What about investing in Illinois companies?
IMRF: We like it when a portfolio company is based in
Illinois, especially Chicago. It’s more convenient and is easier
to think about. Over 40 percent of our portfolio represents
holdings based in Illinois. Of course, under Illinois Code, if
everything is equal between an Illinois-based opportunity and
an outsider, the tip-off goes to the homegrown company.
So,what ifyou read bad news––massive job layoffs,
etc.––about a prospective investment for a client’s
portfolio?
AONHEWITT:Our clients are sensitive to headline risk
and so we consider this potential as we are conducting
diligence. Some of these headlines could cause us to stop
diligence immediately. However, most of the time it is just
noise and not meaningful.
What has changed over the past 5–10years or even
morerecentlyasitappliestoyourprivateinvestment
portfolio, approach, etc.?
TRS: PE/VC is a much more mature asset class now.
Deal processes are more efficient and the ability to source
on a proprietary basis isn’t as easy as the past for buyout
firms. During the financial crisis, PE/VC developed
considerable skill in debt-for-control transactions; that
market has become quite saturated with capital. The last
downturn also increased the pool of capital for secondary
funds. As a result, discounts to fair market value have
compressed and secondary funds offer limited partners
such as TRS an exciting portfolio-management tool.
Q
Q
Q
Q
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
8
While each venture capital fund’s investment strategy varies,
one common factor is clear: The fund assumes significant risk
with each individualinvestment.Acompanymayhave little orno
revenue, a nascent business plan and a founder or founders
without extensive management experience. Still, venture
capitalists finance early-stage companies they believe can
have favorable futures and strong potential to build value.
That was the situation in 2011 when Adams Street
Partners first invested in Naurex Inc., then a three-year-old
clinical-stage company developing a promising compound
to treat severe depression.At the time,the startup was in a
clinical trial with its lead compound.The company had grown
out of earlier research by its founder,Joseph R. Moskal, Ph.D.,
and colleagues at Northwestern University’s Falk Center
for Molecular Therapeutics.
For its part, Chicago-based Adams Street Partners has
focused since 1972 on private market investment management
and manages over $27 billion of assets.Terry Gould,a partner
for 23 years, heads its Venture/Growth Equity Investments
and specializes in healthcare investing.
Adams Street was the lead investor in an $18 million
Series A financing in May 2011 for Naurex.The company used
the funds primarily for a Phase II trial of its lead compound.
Just over four years later, Allergan purchased Naurex for
$560 million in cash, plus additional future considerations.
Gould first learned of Naurex from an acquaintance in
the industry, and upon a review of the Naurex board, he
realized he knew two of the directors. He had lunch with one
and concluded that it might be worth learning more about
the opportunity at Naurex. Gould then asked Bill Gantz, the
Adams Street
was the lead
investor in an
$18 million
Series A
financing in
May 2011
for Naurex.
Funding
NaurexNaurex’ compounds target depression,
a medical condition often requiring
treatment that affects nearly 7 percent
of U.S. adults and costs an estimated
$83 billion a year.
IVCA VIEWPOINT | 2016 9
former president of Baxter International and a veteran of
several venture-backed success stories, to meet with the
Naurex team.
That Initial Meeting
After a two-hour meeting in the Naurex office in Evanston,Ill.,
the two men felt that the company had interesting data
regarding its lead compound and a potential, large market
opportunity.Gould decided to pursue his diligence further and
learn more about the trial data and the management team.
After a number of months,he started to put together the
$18 million Series A financing.
Offering Counsel
In addition to the investment capital provided byAdams Street
Partners, Gould provided counsel to Naurex on a number of
issues--from personnel and clinical trial design to spending
plans, compensation and other possible sources for capital.
Gould and Gantz became directors, with Gantz serving
as board chairman.They attended board meetings and spoke
regularly to Naurex officials. In addition, Gantz dedicated one
day a week to work with the company after the initial financing
round, in which Gantz was also an investor through his firm
PathoCapital.
Financing Round II
Naurex’Phase II trial results put the company in a position to
raise additionalcapital.In December2012,Naurexcompleted
a $38 million Series B financing that was led by new investor
Baxter Ventures, which Baxter International had established
in 2011 to invest up to $200 million in promising companies.
Adams Street Partners participated in the Series B financing
and played a major role in lining up up additional investment
partners for the Series B round.
Naurex used the Series B proceeds to fund several
key programs that included conducting a Phase IIb trial of
its compound, and further developing second- and third-
generation programs for other central nervous system
disorders. Norbert G. Riedel, Baxter’s chief science and
innovation officer, joined the board in conjunction with
Baxter’s investment.
LookingAhead
Naurex management continually considered possible scenarios
for its future, including going public or entering into an
acquisition or strategic partnership.This is common practice
with promising startups, especially in the pharmaceutical
industrywhere Big Pharma often looks fordrugs orcompounds
that could help fill their new product pipeline needs.
”The Naurex investment fits the profile
that investment firms such as Adams
Street Partners seek in a startup. We’re
not buying established businesses.
We’re trying to create things, to build
companies.”
As Naurex’ clinical trials continued, and as results
showed promise,the company needed additional financing.
Its lead compound to treat depression was going to be
entering its final testing phase in 2015.If all went as planned,
Naurex hoped to release the product commercially in 2019.
Company management and board members began
preparing for a third round of financing at the time as well.
In addition, in January 2014, board member Riedel was
named the company’s president and CEO, succeeding
interim CEO Derek Small, who continued as a director.
In December 2014, Naurex raised $80 million in the
Series C funding. Five new investors joined this funding
round along with Adams Street Partners and a number of
previous investors.
Naurex management then began a dialogue with
investment banks and pharmaceutical companies to
consider the path forward.
AllerganAcquisition
On July 26, 2015, Dublin-based Allergan, a leading global
pharmaceutical company, bought Naurex in an all-cash
transaction.
“We were quite pleased with the transaction,” says
Gould.“It met the firm’s objectives in terms of the
multiple of invested capital returned.”
Gould adds that the Naurex investment fits the profile
that investment firms such as Adams Street Partners seek
in a startup.“We’re not buying established businesses.
We’re trying to create things, to build companies.”
Gould is hopeful that the Naurex project may be the
beginning of future success in the biotech/pharma space in
the Chicago area. A number of former Naurex employees
are now leadingAptinyx,a spinout ofthe Naurex technology
platform. Gould and Adams Street Partners provided
seed capital to Aptinyx and then helped the company raise
$65 million in Series A financing in early 2016 to advance
therapies for neurological disorders.
“Perhaps Aptinyx will build on the success of Naurex
and become another notable success in the Chicago
biotech marketplace,” Gould says.
1010
The quick answer: Yes. At least if you adopt the blueprint
of Chicago venture investor-turned-entrepreneur Eddie
Lou. His own for-profit startup, Shiftgig, is growing rapidly
--raising over $35 million in venture capital funding and
doubling its markets by year-end --as the digital market-
place that connects people to work shifts via a smartphone
expands.
In 2004, he co-founded OneGoal, a nonprofit that today
guides students in low-income communities in five major
metro areas to enroll and succeed in college.Lou,who arrived
in Chicago in 2001 to work at OCA Ventures, an early-stage
VC firm, got OneGoal started as an after-school program in
Dunbar High School. Its headquarters,
for all practical purposes, was at the
co-founders’ apartments in Lincoln Park.
Over the first five years, he and his
co-founders and others evolved the
after-school program into an in-school,
three-year model used today.The Lincoln
Park apartments are gone, but OneGoal
continues to thrive!
In brief, OneGoal identifies students,
called Fellows, who have potential and
commitment to college but, without
academic, family and peer support, would
have very limited college prospects. It
starts as a for-credit class during Fellows’
junior and senior years in high school.
During their freshman year at 22 colleges
and universities that are OneGoal
partners, the students receive intensive
coaching delivered remotely.
From an initial 32 Chicago Fellows
served in 2007, the program will serve
an estimated 9,300 Fellows in Chicago,
Houston, Massachusetts, Metro-Atlanta,
and New York by the end of the 2016-17
school year. In the midst of its next five-
year strategic planning process, OneGoal has its sights set
on dramatically increasing that number in the next five years.
Ten years ago,OneGoal was one staff member,three schools
with 32 Fellows and a $180,000 operating budget (half of
which was raised from just eight of Lou’s friends).Today, the
full-time staff numbers over 100, with more than 180 schools
and an operating budget exceeding $10 million.
So what VC “steps to success” can help start and sustain
a nonprofit? Here are Lou’s VC learnings:
Lesson I: Operate the nonprofit like a business.
The only difference from a for-profit enterprise is that the
management team doesn’t have financial equity in the
business,but they possess social equity.A legitimate business
plan is essential to scale and grow. Many of the same rules
of a for-profit apply to a nonprofit. The business plan
provides a high-level view of the organization, combining
basic marketing, strategic, operational/management and
financial tactics. It also includes the nonprofit’s mission,
values, strengths and assets.
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
10
Applying VC
Art+Science
to Nonprofit
Work
Venture capitalists and private equity investors
are savvy at helping startups and established
companies flourish. But could they apply
their knowledge and know-how to starting
and developing a successful nonprofit?
OneGoal will serve an
estimated 9,300 Fellows
in Chicago, Houston,
Massachusetts, Metro-
Atlanta, and New York
by the end of the 2016-
17 school year.
Applying VC
Art+Science
to Nonprofit
Work
IVCA VIEWPOINT | 2016 11IVCA VIEWPOINT | 2016 11
Lesson II: Build in a scalable fashion.
Many nonprofits develop a high-touch operation that
usually isn’t all that scalable and costs too much.That’s why
we don’t offer scholarships or one-on-one counseling for
Fellows. Every aspect of our model reflects how to build
the business in a scalable fashion.
Lesson III: Insist on building toward strong metrics.
Nonprofits often forget about measuring their progress in
fulfilling their mission.They track their performance such as
dollars raised, membership growth, people served and
overhead expenses,but they don’t measure the real progress
in achieving what matters. As with a for-profit operation,
OneGoal sets targets and scrutinizes its metrics monthly,
focusing on Fellows’ performance over the three-year
program.It examines attendance rates,grade point averages,
test scores, as well as the number of Fellows we help and
the schools that partner with us. We amass a lot of data.
OneGoal knows that after joining the program, students
increase their GPA and school attendance and improve
their SAT/ACT test scores. It also knows that at Chicago
high schools, 16 percent of freshmen go on to get a college
diploma; 82 percent of OneGoal high school graduates enroll
in college and 78 percent are on track to earn their degree.
Lesson IV: Build a great management team and staff.
Just as at a high-growth, for-profit organization, talent is
critical for a nonprofit. From past experience, Lou has found
that many volunteers quit after two months. This is where it
pays to focus on a scalable organization, where volunteers
can be coached and trained to succeed. As for staff, he
recommends taking time to really think hard about what
talent is needed. Look for people with passion, purpose,
pride and brainpower.
Lou says it pays to follow “your gut” in making personnel
choices, which he did in selecting OneGoal’s executive
director in 2007. After reviewing dozens of resumes and
talking to more than a handful of finalists, he tapped Jeff
Nelson, a Teach for America star who was an elementary
classroom teacher at an inner-city Chicago school (and
now OneGoal’s CEO).“Jeff (who is 34) had passion and vision;
he had all the potential of being a great entrepreneur such
as resourcefulness, leadership and sales,” says Lou.“Jeff
soaked up knowledge like a sponge; he was exceptionally
coachable.”
Here’s a recent problem OneGoal fixed: When some
Fellows who got into college didn’t go, it was discovered
their parents hadn’t filled out required tax forms.As a result,
their children couldn’t qualify for scholarships and financial
aid.OneGoal now partners with a nonprofit that offers free
tax help to low-income people.Parents also now sign an
agreement that if their Fellow gets into college,they must
complete the necessary paperwork for them to get assistance.
LessonV: Insist on active board participation.
Few, if any, decisions for a nonprofit are more important
than whom to choose to help lead it, and that applies to
directors. Legally speaking, they are accountable for
overseeing the organization’s purpose. What’s essential?
They should care deeply about the nonprofit’s purpose;
understand principles of good business practices; be
strategic thinkers; grasp that their role is governance, not
management; have integrity; and be willing to give of their
time and money.
OneGoal’s national board of seven nonmanagement
directors comprises Lou, a founder of an investment bank,
the chairman of a private equity firm, a Facebook executive,
a former executive of Teach For America, a lawyer-
philanthropist, and retired NBA star Earvin “Magic”Johnson,
whose Magic Johnson Enterprises is rooted in service.
OneGoal directors are expected to attend 3 of 4 board
meetings, get involved in a committee and give at least
$25,000 annually. One of its directors donated $1 million.
LessonVI: Leverage technology
Since using metrics and compiling data is critical for a
nonprofit to succeed, it’s increasingly vital to leverage
technology in a number of ways. OneGoal uses a customized
platform that delivers up-to-date information to teachers
and staff and reports that track each Fellow’s progress.
Technology helps OneGoal to differentiate instruction, to
assist Fellows in finding their top match colleges, to send
Fellows text messages to nudge action over the summer,
and to track their progress in college.
OneGoal knows
that after joining
the program,
students increase
their GPA and
school attendance
and improve
their SAT/ACT
test scores.It also
knows that at
Chicago high
schools, 16
percent of
freshmen go on
to get a college
diploma; 82
percent of
OneGoal high
school graduates
enroll in college
and 78 percent
are on track to
earn their degree.
82percent
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
12
Private equity investors identify portfolio prospects in a
plethora of ways. But a casual comment at a charity dinner
hosted by Rita Canning, wife of Madison Dearborn Partners’
Chairman John A. Canning, Jr., sparked the firm’s interest
in Sage Products LLC. At the event in June 2012, Sage
Chairman Vincent Foglia mentioned to the Cannings that
Sage’s four co-founders were mulling a possible sale of
the Cary, Ill., maker and provider of infection control and
preventive care products.
Six months later, on Dec. 12, MDP acquired Sage for
$1.06 billion. Last February, 38 months later, Sage and MDP
announced a sale to medical device maker Stryker Corp.
for $2.78 billion. Sage’s 2015 sales had risen to $430 million.
The acquisition closed on April 1. MDP itself generated
$1.5 billion on behalf of its investors, a gross return of 4.2x
invested capital and an internal rate of return of roughly
60 percent.
A Front Row Seat
What happened between that serendipitous June dinner
conversation and February 2016, as recalled by the principal
players, offers a front row seat into how an established
and experienced PE firm offers guidance, resources and
money (of course) to a portfolio company to help it grow,
prosper and exit its control.
When considering acquiring Sage,“the first order ofbus-
iness was recognizing,‘let’s not kill the golden goose,’” recalls
MDP’s Lead director Timothy Sullivan, a co-founder and
managing director of the Health Care team. Over more than
four decades, Sage: established a veteran and experienced
management team; built a track record of creating new
markets within hospitals; possessed a well-defined pipeline
of new products that typically launched a new franchise
every 3—4 years; focused on both internal R&D for new
products and acquiring early–stage products; and sourced
ideas from clinicians.
Talks and visits to Sage also illuminated to MDP, Sullivan
says, the vast pride and retention rates of Sage employees,
all of whom knewVince and Scott (CEO D.Scott Brown); Sage’s
new “tremendous” warehouse; and that the company “knew
sausage making” in consistently introducing new products.
The MDP Health Care team--assisted by three of its
advisory Round Table members, including former Baxter
International CEO Harry Kraemer, former Gambro CEO
Thomas Glanzmann, and former NorthShore University
Health System President Jeff Hillebrand --believed it could
create value at Sage through additional new product
innovation, domestic growth and international expansion.
Talks ensued and MDP, competing with a Sage rival for the
acquisition, prevailed with its overall price and package.
Consequently, before year-end 2012, MDP with Sage’s
management team and MDP limited partner co-investors
acquired a 67 percent stake in Sage.
Initially,Sage’s founders hadn’t expected a PE firm to buy
it.“We were dealing with some misconceptions of PE,” says
CEO Brown. “So we did our due diligence.” They talked to
several people, including Kraemer, about PE firms’ practices,
wanting to ensure that Sage --a prominent charitable and
civic-minded McHenry County employer --wouldn’t have to
diminish such local support,among other issues.
What they heard alleviated their misconceptions. About
MDP, “they’re great believers that by giving back to the
community where you live and work and bringing jobs and
hiring local suppliers,you build a strong,healthy community,”
Brown says.
The Partnership
Lead director Sullivan and MDP Health Care team colleagues
Nick Alexos and Jason Shideler spent a great deal of time in
regular communication with Sage and CEO Brown. They
would touch base weekly to every 10 days, particularly as
Madison Dearborn Partners’
SageDecision
At a charity
dinner, a casual
comment sparked
Madison Dearborn
Partners’ interest
in Sage Products.
IVCA VIEWPOINT | 2016 13
they worked with Sage management and managers on
strategy review and on certain initiatives, such as an
international sales summit MDP helped develop. They also
held several meetings at Sage on the issue of sales force
expansion and the 11-member board delved deeply into
that and other matters.
Says Brown about Shideler, in particular: “I could call
Jason and tell him,‘I’m thinking about this and what do you
think.’ He would say,‘Let us run the numbers and we’ll get
right back to you.’”
Growth, of course, is an essential goal for investors in
private companies, and MDP has an arm that specifically
helps portfolio companies look at growth investments. That
experienced group helped Sage look in particular at growing
international sales,the number of its own new products and
the number of new commercial products it could acquire.
On the international sales front, MDP figured it could
help Sage open up distribution channels abroad, especially
in Europe, to grow sales. Historically, less than 10 percent
of sales came from outside the U.S., although sales had
increased in the few years before MDP’s investment. Sage
established a European headquarters and relocated its
international director to Switzerland.
MDP Health Care team advisors Glanzmann and Kraemer
helped Sage’s sales team understand that the approach to
doing business in Europe differed from the U.S. Suppliers
there deal much more heavily with large national health
services.The two advisors helped Sage hold an international
summit with industry veterans.
Subsequently,Sage increased its focus on adapting to and
building its European markets by hiring a number of sales
reps or country managers and new product-development
executives as well as product-development and marketing
teams. It put minimum purchase requirements and volume
incentives in place to drive growth, and it set up an
international advisory board. As a result, international sales
climbed above expectations.
Awakening Opportunities
MDP also helped Sage in the human resources area after the
retirement of its HR director. MDP encouraged hiring a strong
HR VP who would report directly to Brown. The department
became more robust through centralized hiring --which
freed up sales managers --and more intimately involved in
successfully expanding the sales force while preserving the
company’s culture.
Culture shift and sales force disengagement could easily
have occurred since Sage expanded its sales territories and,
as the broader sales team grew, shrank the average number
of hospital beds (a common metric used by medical product
providers’ sales teams) each sales person commanded. Sage
and its HR team focused on communicating that change
clearly and transparently. The upshot: The typical sales rep
made more or the same total compensation than in the
previous year despite shrinking their respective territory.
MDP also convinced Sage, which always had created its
products,to consider acquiring new products.Jason Shideler
worked closely with a Sage product-development manager
to look at smaller opportunities of commercial products
ready to sell.One such acquisition identified was in the patient
mobility space that helps nurses lift heavy patients onto a
(continues on page 16)
MDP itself
generated $1.5
billion on behalf
of its investors,
a gross return
of 4.2x invested
capital and an
internal rate of
return of roughly
60 percent.
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
14
Idea+Execution=
$1.3 BILLION
Why IBM pursued Cleversafe
When a venture capital fund invests in a new company, its
investment horizon spans years so it sets one primary
mission: growth.
That was New Enterprise Associates’ objective when
the global venture capital firm led the then-fledgling data-
storage company Cleversafe’s small Series B financing round
in August 2006. Ten years later, NEA was the lead investor
in Cleversafe’s $55 million Series D financing round.
“We’re about growth,”says Peter Barris,NEA’s managing
general partner,who joined the Cleversafe board of directors
after the Series D round.“Building critical mass is important,
especially to differentiate yourself and build competitive
moats around a company.”
The firm’s journey with Cleversafe until its sale in early
October 2015 to IBM for over $1.3 billion serves as a case
study of how a private investor selects a promising company
for its funding and continues to invest until its exit years
later. For the most part, all VCs follow some iteration of
NEA’s selection process and investment strategy and the
various types of assistance it provided during its union.
Chris Gladwin’s“Better Idea”
For NEA,the motivation to go with Cleversafe --whose founder,
serial entrepreneur Chris Gladwin (with an engineering degree
from MIT) had a better idea for how to store mountains of
data --encompassed these principal factors:
Founder:“We had a familiarity with Chris through one of
his earlier companies, MusicNow, so in determining which
is most important --the horse or the jockey --we didn’t have
to choose. We had a great entrepreneur (the jockey) who
we knew was brilliant, had the ability to assemble a strong
team and possessed a unique technology concept in a
data-storage field (the horse) that was exploding and that
played to his background.”
Leadership: “We were Cleversafe’s largest shareholder
but we didn’t have a controlling interest and didn’t look for one.
We bet on a board of reasonable people making reasonable
judgments and getting everyone on the same page. As a
director, I viewed my role as making sure the board members
were all rowing in the right direction.”
“Big Idea”: “Ours was a bet on technology. Chris had a
theory that storage was where it was happening but that
NEA has invested
nearly $400 million in
Chicago companies
in the last decade,
the most of any
metropolitan area
outside of Silicon
Valley. It considers
Chicago notable for its
central U.S. location
and business model
innovations.
$400M
IVCA VIEWPOINT | 2016 15
typical storage systems that relied on a centralized file
directory weren’t going to be sufficient and would be a
bottleneck. His theory that object-based (think pictures
and videos) data storage software and appliances offered a
better solution proved valid,thanks to his distinct information
dispersal algorithm and Tier 1 storage system to slice up
data. It actually got better as the size of the system grew.
The more you stored, the more the system got faster, more
reliable and more cost effective, while others’ systems got
slower, less efficient and less reliable the bigger they got.”
Intellectual Property: “Cleversafe had a differentiating
technology and protected technology. At the time we sold
it to IBM, we could count 350-plus issued patents. By one
measure, it ranked in the top 10 global companies with the
most potent patent portfolio, along with IBM,Apple, Samsung
and the like.”
Talent Pool: “Chris was convinced that Chicago had
advantages (as Cleversafe’s home) and that he could find the
talent he needed to continue and scale the business in
Chicago or he could attract it to the city. Chicago has lots of
talent and a huge supply source from Midwestern universities.
He felt he didn’t have the challenge startups have in Silicon
Valley where there’s little loyalty and very high human capital
costs.” NEA has invested nearly $400 million in Chicago
companies in the last decade, the most of any metropolitan
area outside of Silicon Valley. It considers Chicago notable
for its central U.S. location and business model innovations,
citing Groupon.
For NEA, a bit of risk existed, of course. While it was a
diversified, multi-sector investor with two-thirds of its
investments in technology, it didn’t have a lot of experience
in the data storage field. But it had studied the storage
space and knew in general how it was evolving. NEA partners
also believed that Cleversafe’s data security feature was
a huge advantage to drive sales because companies didn’t
have to invest in a separate security system.
Barris and others at NEA,Cleversafe Chairman Chris Galvin
and the other Board members helped guide the company
by offering the counsel and key introductions.
A“Lord of the Rings”Turning Point
For the board,a key turning point came at a meeting in 2008
when Gladwin showed directors a “Lord of the Rings” movie
on an iPhone receiving the content from Cleversafe servers.
Still, NEA and investors had a particular challenge:
Cleversafe perhaps had introduced its technology too early.
While Cleversafe servers could store terabytes of data at
lower cost,not a lot of customers cared then about petabytes.
One petabyte is roughly 1,000 terabytes or one million
gigabytes and can hold about 500 billion pages of standard
printed text. Today, hundreds of companies care about
petabytes. It took Cleversafe five years before it signed its
first client.
Now IBM Cloud Object Storage, Cleversafe was founded in Chicago in 2004
by S. Christopher (Chris) Gladwin, who had developed distinct data-storage
software that stockpiles petabytes of pictures, videos and other objects
in both in-house and cloud-based servers. It was sold to IBM for more than
$1.3 billion in cash.
Among the world’s largest and most active venture capital firms, New
Enterprise Associates is a diversified investor, but with most of its investments
in technology and health care. Founded in 1977, NEA has invested nearly
$400 million in Chicago companies in the last decade, including Cleversafe
for which it was lead investor in its Series B and Series D financing rounds.
Peter Barris
NEA’S MANAGING GENERAL PARTNER
Chris Gladwin
FOUNDER, CLEVERSAFE
Early investors saw
returns of 35-100x
their initial investment.
For Gladwin, the impact
of IBM’s acquisition
of Cleversafe had an
especially joyous effect.
“We created fantastic
jobs for over 250
people.“
35-100x
RETURNS
250JOBS
CREATED MORE
THAN 80 NEW
MILLIONAIRES
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
16
MDP Sage Article Continued from Page 13Cleversafe Article Continued from Page 15
For Cleversafe,the critical milestone came with the signing
of Shutterfly as a customer in late summer 2011.At the time,
the 12-year-old Internet-based social expression and personal
publishing platform needed a leading-edge tech advance for
scaling data.It also wanted to find a storage provider that could
help it realize cost savings of over 60 percent for storage.
A Shutterfly Moment
The contract with Shutterfly proved the spark for other
lighthouse deals. Signing up were enterprises such as KDDI,
the Tokyo telecommunications giant, and Sky Television, the
pan-European broadcaster.
Barris and other board members assisted Gladwin and
the company with its go-to-market strategy in seeking to
identify and foster customers to compete, especially against
its biggest rival EMC (now Dell EMC). Reflecting the expected
sales surge, Cleversafe and its investors used much of the
proceeds from the August 2013 Series D financing round to
boost the company’s sales operation.
About growth, Barris explains that investing firms often
encourage entrepreneurs to grow faster and spend faster
than they’re comfortable with. With Cleversafe, though,
NEA was “very sensitive to expense growth because it was
pretty capital intensive to develop and patent its technology
and because early sales were slower than desired. We had
to make sure we weren’t out of sync with those issues.”
With each round of financing, what board members
offer management differs.“In the earlier stages, it may be
credibility or access to expertise. Later, you want to offer
real experience that might help in identifying companies
that might acquire the firm,” Barris says.
In 2015, talks with IBM heated up and on Oct. 5, it
announced it was acquiring Cleversafe --which had tech-
nology and client relationships valued at $364 million and $23
million, respectively --for undisclosed terms.The transaction
closed a month later.(In February 2016,an SEC filing by IBM
revealed that it had paid over $1.3 billion in cash for the
company, including $1 billion in goodwill.) Before it was
acquired, Cleversafe was valued at slightly over $200
million based on its 2013 financing, according to estimates
by research firm Pitchbook.
It was a good fit.The strategic acquisition strengthened
IBM’s leadership positions in storage and hybrid cloud and
helped its clients drive their digital transformation. Early
investors saw returns of 35-100x their initial investment.For
Gladwin, the impact had an especially joyous effect.“We
created fantastic jobs for over 250 people.When I look at our
employees and investors,we returned over $1 million to more
than 80 people, many of whom we hired out of college.”
gurney through a novel method using inflating blowers. Sage
was able to successfully negotiate and consummate that
transaction in January of 2015.
Sage’s Brown articulates why MDP’s assistance proved
so helpful: “I learned in a short period of time how to think
about our business differently with MDP’s counsel,” he says.
“We were a company owned by the same founders for 41
years, and MDP asked all the questions we never asked
ourselves. Simple things like ‘Have you ever thought about
doing this or that?’ They were engaged every step of the way
and so committed to success.”
The Exit Scenario
Sullivan notes that, typically, MDP invests in a portfolio
company for around five years. In the health-related sector,
the average hold has been seven years. In Sage’s case, he
says, the company had always maintained an open door
in terms of talking with possible suitors--and in the latter
part of 2015, the company received strong interest from a
couple of prospective strategic acquirers. At the time, the
health-related market and public companies’ stocks were
trading at historic highs.
MDP’s view about Sage was to have a very quick and
private process by keeping the matter to a very small group
of internal managers and potential strategic buyers who had
indicated a strong interest in Sage.“And if they offered the
right value,OK,great,and if not,the company’s done well and
will continue to execute on their strategic plan,”says Sullivan.
The process identified Stryker, one of the world’s leading
medical technology companies, as the as the next Sage
steward. Based in Kalamazoo,Mich.,Stryker has a strong
culture and values similar to Sage’s as well as a decentralized
organization that would let Sage continue to do what it did
best. Additionally, while Sage sales abroad had risen to $20
million in 2015,the company and MDP wanted to increase that
growth.Stryker’s strong international sales force was viewed
as a positive for Sage.
The transaction was struck.As for MDP,at its exit,it set up
the Sage Legacy Fund with a $1 million contribution from MDP
to assure charitable contributions would continue to McHenry
and other local organizations.
IVCA VIEWPOINT | 2016 17
ivcaevents
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
18
ivca educationalevents
IVCA/NVCAAnnual Luncheon
April 13: Attendees acquired a rich behind-the-scenes story
of Chicago’s Cleversafe related to the 10-year rise of the
object-based storage software and appliances company
through its acquisition to IBM in October 2015.
Cleversafe founder Chris Gladwin, initial investor Jim
Dugan of OCA Ventures and growth investors Peter Barris
of New Enterprise Associates and Chris Galvin of Harrison
Street Capital related milestone events for the company.
Thoma Bravo’s Lee Mitchell was moderator for the event,
sponsored by Baker Tilly and Ropes & Gray LLP.
In addition, NVCA President and CEO Bobby Franklin
delivered “A View from the Hill” in which he discussed his
impression of Washington legislative activity as it affects
venture capital and private equity issues.
IVCA Educational Events – Highlights
April 26: “How to Use Communication Planning to Mitigate
Franchise Risk,” sponsored by IVCA service provider member
Edelman, explored how VC and PE firms can anticipate and
mitigate reputational risk for themselves and for portfolio
companies. Jeff Zilka, general manager of Financial
Communications and InvestorRelations at Edelman,moderated
a panel that included a general counsel, Mark Tresnowski of
Madison Dearborn Partners; two investing partners,Bob Fealy
of Limerick Investments and Kim Vender Moffat of Sterling
Partners; and a crisis authority, Andy Liuzzi of Edelman.
Attendees gained an awareness of the importance of
assessing reputational risk in due diligence and of completing
a crisis assessment at the time of investment and ensuring
that portfolio companies develop crisis mitigation and
response plans. They also took away a high-level checklist
for a due-diligence and crisis plan.The panelists’ consensus:
Thoughtful preparation for a possible future crisis proves
very helpful.
May 4: “Navigating the Dynamic Regulatory Landscape
of Private Equity Valuation,” sponsored by KPMG, captured
the attention of attendees as KPMG audit partner Sean
McKee and a panel moderated by KPMG Managing Director
Brian Bouchard delved heavily into the issue.
McKee delivered an update on the AICPA Fair Value
Task Force, which he co-chairs, that is producing a more
user-friendly guide to measuring fair value with examples
to use to consider real situations faced by valuation
specialists and auditors.
The panelists exploring the perspectives of the SEC
and both limited and general partners about recent
valuation developments included Quintin Kevin, partner
and chief financial officer of Adams Street Partners; Nabil
Sabki, regulatory attorney at Latham & Watkins LLP; Senior
Vice President Adam Freda of 50 South Capital Advisors;
and John Kneen, partner, chief financial officer and chief
communications officer at Beecken Petty O’Keefe & Co.
September 13: Private equity was in the spotlight at the
luncheon for “Structuring and Negotiating Rollover Equity.”
Saul Rudo, national head of Katten Muchin Rosenman LLP’s
Tax Planning practice, assisted by Steve Jarmel, founder of
Periscope Equity, provided attendees with a deeper grasp
of how to best structure rollover equity to minimize tax
issues. Katten Muchin Rosenman sponsored the event.
Rudo discussed key questions that must be addressed
when deciding rollover equity. He also talked about possible
structures for such a transaction, including LLC, C Corp
with LLC Holdco and S corporation.
September 27: “Closing a Growth Financing Round”was
the topic for a lively IVCA luncheon forum. It featured
entrepreneurs who shared their experience and insights into
the “growth round” of financing, which goes beyond the initial
investments and took their companies to the next level of
growth. Michael Gray, Partner at Neal Gerber & Eisenberg
LLP, the event’s sponsor, served as moderator of the panel
that included:
Talia Mashiach, founder and CEO of EVED, a spend
management platform purpose-built to manage the event
category. EVED is on its third round of financing.
Aashish Dalal, CEO of PARKWHIZ, an online platform for
reserving parking in real time. On its fourth financing round,
it raised $37 million.
Justyn Howard, founder and CEO of SPROUT SOCIAL, a
provider of a suite of scalable software products that
drives customer and business engagement. It is in its fifth
financing round.
Jason Weingarten, co-founder and CEO ofYELLO,which
provides web and recruitment software plus services
associated with the software. It is on its fifth financing round
and has raised $61 million.
Four major
programs on
PE and VC
issues
drew lively
discussions
in 2016.
IVCA VIEWPOINT | 2016 19
ivca awards dinner
Five hundred guests attended the December 7 event, which
honored individual award honorees, two Portfolio Company
of the Year recipients and the first Legislative Appreciation
Award recipient.
Honored were:
Warren E.Holtsberg, co-head of Portfolio Management
at MVC Capital, who received the Richard J. Daley Award
for his outstanding civic contributions.
LeeM.Mitchell,managing partner at Thoma Bravo LLC and
former IVCA chairman,who received the IVCA Fellows Award.
PeterJ.Barris,managing general partner at New
Enterprise Associates, who received the Stanley C. Golder
Award, which recognizes outstanding success in private
company investing.
Paylocity, the leading independent provider of online
payroll and human resources services for thousands of
clients with 25—1,000 employees, as the venture-backed
company recipient. IVCA member Adams Street Partners
invested $10 million in the company in 2008 when it employed
192 people. In 2015, Paylocity employed 1,320, including 635
in Illinois.
Sterigenics International,a provider of contract
sterilization services,as the private-equity portfolio company
winner. IVCA member GTCR and two of its former executives
acquired the company in March 2011 and sold a majority stake
in it to Warburg Pincus in May 2015. In 2015, it employed
over 1,700 employees worldwide, including 182 in Illinois.
Portfolio
Company of
the Year
recipients were
VC-backed
Paylocity and
PE-backed
Sterigenics.
Honorees (left to right): Presenter Bob Fealy and Daley Award honoree Warren Holtsberg; presenter Jim TenBroek and Fellows Award honoree Lee M. Mitchell;
Golder Award honoree Peter Barris with presenter Bon French; PE Portfolio Company of the Year Sterigenics’ CEO Michael Mulhern with presenter Sean Cunningham;
and VC Portfolio Company of the Year Paylocity CEO Steve Beauchamp with presenter Jeffrey Diehl.
Andersen Tax, LLC
Baker Tilly Virchow
Krause, LLP
CBRE Group
Citizens Bank
Deloitte LLP
DLA Piper, LLP (US)
Edelman
EmPower HR
EY
Freeborn & Peters
Greenberg Traurig, LLP
Heizer Center,
Northwestern University,
Kellogg School of
Management
Horwood, Marcus &
Berk Chtd.
Houlihan Lokey
Jenner & Block LLP
Jones Day
JP Morgan
Katten Muchin
Rosenman LLP
Kelley, Drye &
Warren LLP
Kirkland & Ellis LLP
KPMG LLP
Kutchins, Robbins &
Diamond, Ltd.
Latham & Watkins LLP
Water Street
Healthcare Partners
Waveland Investments
Wind Point Partners
Winona Capital
Management
WP Global Partners
Wynnchurch Capital, Ltd.
Zebra Ventures
50 South Capital Advisors, LLC
7wire Ventures
Adams Street Partners, LLC
Agman
Anderson Pacific Corporation
Arbor Investments
ARCH Venture Partners
Baird Capital
Beecken Petty O’Keefe & Co.
BlueCross BlueShield
Venture Partners
CapX Partners
Chicago Teachers’
Pension Fund
Chrysalis Ventures
CME Ventures
Cressey & Company, L.P.
Duchossois Capital
Management
Dundee Venture Capital
The Edgewater Funds
Financial Investments
Corporation
First Analysis
Frontenac Company
GE Ventures
Golder Investment
Management, LLC
Growth Catalyst Partners
GTCR LLC
Harrison Street Capital
Healthbox Global Partners
H.I.G. Capital
High Street Capital
Hyde Park Angels
Hyde Park Venture Partners
Illinois Municipal
Retirement Fund
Illinois State Board of
Investment
IllinoisVENTURES, LLC
Jump Capital
KDWC Ventures
LaSalle Capital
Limerick Investments, LLC
Linden Capital Partners
Madison Dearborn Partners
MATH Venture Partners
Mesirow Financial Private
Equity
Mid Oaks Investments LLC
MK Capital
Moderne Ventures
Monroe Capital
Motorola Solutions
Venture Capital
MVC Capital
New Enterprise Associates
NIN Ventures
OCA Venture Partners
Origin Ventures
ParkerGale Capital
Patriot Capital
PPM America Capital
Partners
Prairie Capital
Pritzker Group Private
Capital
Pritzker Group Venture
Capital
Prospect Partners
RCP Advisors
River Cities Capital Funds
Romar Partners
RoundTable Healthcare
Partners
Sandbox Industries
Shore Capital Partners
State Universities
Retirement System
Sterling Partners
Svoboda Capital Partners
Teachers’ Retirement
System of Illinois
Thoma Bravo, LLC
Tribune Company
Valor Equity Partners
Victory Park Capital
Vistria Group
Investor
Members
Academic
and Service
Provider
Members
ivca membership
50 South Capital Advisors, LLC
Adams Street Partners, LLC
ARCH Venture Partners
Baird Capital
Beecken Petty
O’Keefe & Company
Founding
Members
Baker Tilly Virchow
Krause, LLP
Edelman
EY
Greenberg Traurig, LLP
Kirkland & Ellis, LLP
Kutchins, Robbins &
Diamond, Ltd.
Neal, Gerber &
Eisenberg LLP
Ropes & Gray LLP
Silicon Valley Bank
Provide outstanding
support for IVCA in the
form of services and/
or the highest levels of
event sponsorship
Sponsoring
Members
Duchossois Capital
Management
The Edgewater Funds
EY
First Analysis
Frontenac Company
Mesirow Financial
Private Equity
Mid Oaks
Investments LLC
MK Capital
Motorola Solutions
Venture Capital
OCA Venture Partners
Prairie Capital
Pritzker Group Venture
Capital
Silicon Valley Bank
Sterling Partners
Svoboda Capital Partners
Thoma Bravo, LLC
Wind Point Partners
Locke Lord LLP
Lockton Companies
Martin Partners
Mayer Brown LLP
McDermott Will &
Emery LLP
Neal, Gerber &
Eisenberg LLP
PEF Services LLC
Perkins Coie LLP
Plante Moran, PLLC
Polsinelli PC
PricewaterhouseCoopers
The PrivateBank
Ropes & Gray LLP
RSM US LLP
Sidley Austin
Silicon Valley Bank
Simon Compliance
Square 1 Bank,
a division of Pacific
Western Bank
Stern Cassello & Associates
Thompson Flanagan & Co.
University of Chicago Booth
School of Business
University of Illinois
University Technology
Park at IIT
Vedder Price P.C.
William Blair
Winston & Strawn LLP
Wintrust Commercial Bank
THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
Adams Street Partners, LLC
DLA Piper, LLP (US)
Duchossois Capital
Management
Frontenac Company
GTCR LLC
Katten Muchin
Rosenman LLP
KPMG LLP
Latham & Watkins LLP
Limerick Investments, LLC
Madison Dearborn
Partners
McDermott Will &
Emery LLP
OCA Ventures
Origin Ventures
Plante Moran, PLLC
Pritzker Group
Private Capital
Pritzker Group
Venture Capital
RCP Advisors
RSM US LLP
Shore Capital Partners
Square 1 Bank,
a division of Pacific
Western Bank
Sterling Partners
Thoma Bravo, LLC
Winston & Strawn LLP
Wintrust Commercial Bank
Have sponsored
at least one event
during the year
Supporting
Members
Robert Fealy
Chairman: 2015-2016 Vice Chairman: 2014 Secretary: 2012-2013
Limerick Investments, LLC
Maura O’Hara
Maura has been Executive Director of IVCA since 2003.
She oversees all aspects of the Association and represents
IVCA in the community.
Lee M.Mitchell
IVCA–PAC Chairman: 2015-2016
Chairman: 2013-2014 Vice Chairman: 2011-2013 Secretary: 2010-2011
Thoma Bravo, LLC
JeffreyPiper
Treasurer: 2015-2016
Svoboda Capital Partners
JamesTenBroek
IVCA–PAC Co-Chairman: 2013-2016 IVCA–PAC Chairman: 2012-2013
Chairman: 2010-2012 Vice Chairman: 2009-2010 Secretary: 2008-2009
Growth Catalyst Partners
WalterFlorence
Vice Chairman: 2015-2016 Secretary: 2014
Frontenac Company
AnthonyPalcheck
Secretary: 2015-2016
Zebra Ventures
2016 officers
KathyPyne
Kathy is the IVCA’s Association Coordinator and is
responsible for events, member communications and
database management. Kathy joined IVCA in 2005.
staff
ivca governance
Illustration:RoyScott,cover,page8;MichaelAustin,pages5,7&11Design:AvilaCreativeInc.
About IVCA IVCA advocates for Midwest Venture Capital and Private Equity funds who invest private dollars into
private companies on behalf of Institutional Investors including: pension funds, endowments, foundations, and
insurance companies. IVCA membership includes investors at all stages of private companies from the largest
private equity firms in the Midwest to some of the smallest early stage venture investors. IVCA advocacy includes
Illinois government affairs,educational programming,sharing of best practices,media outreach,and collaboration
with entrepreneurs and the groups that represent entrepreneurs.

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2016 IVCA Viewpoint - The Art+Science of Investing in Private Companies

  • 1. VIEWPOINTTHE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES PRIVATE EQUITY Stryker Rich: MDP’s Sage Decision Led to Happy Exit VENTURE CAPITAL Why IBM Was Drawn to Cleversafe Q &A Selecting the Best Performing PE & VC Funds PE&VCKey toStrong PensionFund Returns
  • 2. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES RealityVersus Myth For the past three IVCA Viewpoints, we have sought to dispel the common myths that give private investing in private companies --private equity investments in mature businesses in particular -- a bad rap. But the misrepresentations persist, and not just because of election-year antics of uninformed critics. As you may recall, we have explored through real situations the topics of“Private Equity, Public Good,”the true beneficiaries of private investing in“I am a Private Equity Investor,”and the collaboration between PE/VC firms and their portfolio companies in “Partnering for Growth,” our last Viewpoint. This edition of Viewpoint strives to help people grasp the nuanced processes and methodologies behind investing in private companies. We explain through case studies how PE and VC firms go about the business of choosing a startup or established company to invest in, helping advise them, and assisting in actualizing their future --whether as an independent company or as a unit of another company or investment firm. We also offer a rich dialogue with two Illinois pension funds and an investment consulting and asset management firm that manages or advises on trillions of dollars of holdings to illuminate how the net returns from PE and VC investments outperform their general portfolio or benchmarks. Here are the takeaways --and we hope you will pass them along to the skeptics, cynics and nonbelievers. Growth is the key component and objective of both PE and VC firms. Improving the operations of their portfolio companies or investments is uppermost--so their investors will benefit as well as the other essential stakeholders: employees, customers, suppliers, and the communities in which their employees work and live. For that latter evidence, peruse the case study of Madison Dearborn Partners’ investment in Sage Products, a mainstay corporate citizen in McHenry County. Some More Realities Job creation is almost always an outcome.Yes, some jobs are lost early on but as the strategy and operational changes take hold, new skill sets are required and overall employment increases. Operational improvements are the key to success.They take a liking to an investment prospect for the chance to make needed operational advances. Yes, they want to buoy an investment, but they desire that the investment remain stable in the market --for their own reputations’ sake, if nothing else. Value creation is the mission. Let’s relate these stories and facts --and celebrate the Art+Science of Investing in Private Companies. Facts Are Facts executivedirector’scomments Maura O’Hara IVCAExecutive Director
  • 3. IVCA VIEWPOINT | 2016 1 Adams Street Partners’ Terry Gould, who heads the global PE firm’s venture and growth equity investments, admits he often uses a familiar four-letter profanity when he hears someone disparage private investing. “We’re not trying to cut jobs; we’re trying to create things,” he asserts. IVCA Viewpoint has devoted the past three reports to illuminating what private investing in private companies nurtures and achieves.Their titles say it best: “Private Equity, Public Good,”“I Am a Private Equity Investor” and “Partnering for Growth.” Still, the defamation persists too frequently. This report strives to show, not just tell, how PE and VC firms make a real difference for the private companies they invest in. Through case studies, filled with rich detail that help relate how the investors and the private companies they invest in grow and prosper while adding--not slashing jobs --and,yes,how the investors also benefit while strengthening their companies. What’s a counterpart? Think how British restaurateur and TV personality Gordon Ramsay saves struggling restaurants on ”Kitchen Nightmares“ and horrid lodgings in “Hotel Hell.” It’s All About Growth Of course, VC and PE firms differ. VC firms finance startups and entrepreneurs in hopes that over a number of years, usually 5 to 10, the startups will blossom and, eventually, lure a buyer or go public. PE firms typically invest in relatively mature companies,aiming to grow them and later exit--again for seven years on average--at a profit. Still, growth constitutes PE and VC firms’ overriding mission.They each play a vital role--VC in the entrepreneurial ecosystem and PE in building effective and efficient companies through an engrained platform for change. For PE, especially. What critics fail to grasp is that in today’s global investment landscape,other countries are directly competing with the U.S. As a result, over the last two decades, the U.S. share of venture capital investment worldwide shrank to 54 percent from 90 percent.1 It’s A Global Battle For Investment Funds “This innovation arms race is a virtuous competition where the byproducts are new technologies that improve the way we live, new jobs and economic opportunities,greater productivity and greater economic growth,”Scott Kupor,managing partner at VC firm Andreessen Horowitz, told the Senate Committee on Small Business and Entrepreneurship in July. As for PE firms,they are laser-focused on creating value through actions that will improve operations and spur growth. They conduct rigorous analysis, put the right management team in place,and identify and monitor the critical metrics for driving value. Even public companies acknowledge they can learn powerful lessons from how PE firms employ real and sustainable operating and productivity improvements at their portfolio companies. And during a window of 3-10 years, usually. What’s especially worrisome is this reality: The move to impose more regulations on private investing is reshaping the investment landscape, locally and globally. Disruption ensues. And as profit margins tighten, private investment firms must center even more on operational superiority to achieve their investment objectives. The following case studies make clear that for private investments to succeed, PE and VC firms and their portfolio companies concentrate on how to improve their companies so,yes, they can exit at a profit to willing buyers or investors. It’s time to stop demonizing the private investment community. Too often, PE firms are labeled as “job killers,” disparaged as “vultures” that strip their portfolio companies’ assets or borrow heavily against them. A New York Times series on PE in mid-summer perpetuated that notion.As for VCs, detractors blame them for hyping their startups in search of billion-dollar-plus valuations for their“unicorn”investments. Regulators are tightening their scrutiny. –PE & VC–perpetually misunderstood Investing in Private Companies 1 nvca.org
  • 4. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES 2 ivcachairman’scomments Bob Fealy IVCA Chairman Founding Managing Director, Limerick Investments Bob Fealy IVCA Chairman Founding Managing Director, Limerick Investments ivcachairman’scomments What We Do, How We Do It When I was incoming IVCA chairman, I expected that my 18-month term would be an “active” time. It certainly has been. Being that active voice on behalf of our members has been essential at a time when the state’s financial strife persists and when a sustained misconception continues to be held by some about the investment objectives of private equity and venture capital firms. This explains our association’s vigor in advocating for our industry to legislators, government officials and the public at large. It also explains why this Viewpoint focuses on dispelling the myths around PE investments by telling specific stories that illuminate the art + science of private investing in private companies. In short, PE is about growth and adding value, not “greed” and slashing jobs, as the rhetoric might suggest. As I began my chairmanship,I listed four principal areas of focus,and I want to give you a progress report on each of them because it underscores what IVCA firms and their members have achieved toward our vital objectives: Engage. In supporting an entrepreneurial spirit in Illinois,we continue to meet with state legislators and government officials in Springfield and elsewhere in an effort to promote a better understanding about private company investments in the state.We made our voice heard on a number of fronts, and it played a critical part in the Illinois Treasurer’s new $222 million Illinois Growth & Innovation Fund,which will support Illinois-based VC and PE firms over the next sixyears.Our opposition to a bill that would disadvantage Illinois public pension funds led its co-sponsor to establish a task force, that includes IVCA representation, to consider the bill’s ramifications; no action was taken on it in the recent session. Thanks to our IVCA Political Action Committee, we raised a record $105,000 to support our legislative activities. Many thanks go out to Lee Mitchell, Chair of the IVCA Political Action Committee, and Campaign Co-chairs Darren Snyder of Prairie Capital and Jim Tenbroek of Growth Catalyst Partners for their exceptional efforts. Enlarge.We have worked to grow our membership, particularly among large family investment offices in Chicago and Illinois, many of which have direct investment strategies in addition to investing in PE and VC funds. They can benefit from our programming and from networking professionally and socially at our events. Existing IVCA members will gain from better understanding the strategies these groups employ in making their investment decisions. Expand. The association has been involved actively in increasing diversity in our industry,especially among African Americans and Hispanic Americans, and Executive Director Maura O’Hara continues to drive this essential effort. Educate. IVCA sponsored educational programs and luncheons in the past year on topics ranging from private equity valuation and mitigating reputational risk, to negotiating roll-over equity and clos- ing a growth financing round.Thanks to our members and member firms for assisting in developing and conducting these sessions and for sponsoring them. It’s been a pleasure to serve this association and to work with our two exceptional leaders, Maura O’Hara and Association Coordinator Kathy Pyne. We also thank Neil, Gerber & Eisenberg LLP for providing our office space.The IVCA will continue to constructively and thoughtfully advocate for our membership--and to build an understanding of the vital role private equity and venture capital play in improving our Illinois business environment and growing our economy.
  • 5. IVCA VIEWPOINT | 2016 3 An Illinois Venture Capital Association study of the 10-year performances of the four Illinois public pension funds found that they realized annualized returns from their private equity portfolio of 11.6 percent, net of fees, compared to 6.9 percent from their overall portfolio return. Over five years, three of the pension funds’ private equity holdings outperformed the overall portfolio return by a range of 110 to 720 basis points. The other fund posted a 10-basis point improvement.The pension funds’ assets ranged from $15.8 billion to $46.2 billion and averaged nearly $29 billion. PE is an important component within the public pension funds’portfolios.It provides diversification of returns besides often outperforming the public market’s returns, net of fees. Nationally,Preqin,the alternative assets industry’s leading data source, also found in a study that on a net return basis, after fees and carry, PE has been the best-performing asset class for pension funds over three and 10 years ended Dec. 31, 2012. Over a five-year time horizon, PE has been beaten only by fixed income and,significantly,this was during a period of generally falling interest rates, a phenomenon unlikely to be repeated in the near future, Preqin noted. CalPERS, manager of the nation’s largest public pension fund, recorded a similar result over a 20-year period. It realized a 12.3 percent annualized return, net of fees, from its PE holdings over a 1995-2015 period vs. 8.2 percent from its public equity portfolio. Investors have noted the performance. Preqin said that 94 percent of pension funds and other investors it spoke to felt that the performance of their PE portfolios had met or exceeded expectations. The other six percent felt returns had fallen short of their expectations in the past 12 months. What accounts for these superior long-term net returns from PE & VC? To find out, IVCA conferred with the chief investment officers of the Illinois Municipal Retirement Fund and Teachers’ Retirement System of the State of Illinois as well as an associate partner, private equity, at Aon Hewitt Investment Consulting that advises on or manages $35 billion in PE & VC assets on behalf of institutional clients. PARTICIPATING WERE: R. Stanley Rupnik----------------------------------- of the state’s Teachers’Retirement System,with its $46 billion in assets at year-end Fiscal 2015 on June 30,2015,and whose private equity staff of four serves 400,595 members. Dhvani Shah---------------------------------------- of the 77-year-old Illinois Municipal Retirement Fund, with its $34.7 billion in assets as ofJune 30,2016,and whose four- member private market team serves nearly 3,000 employers. Shari Young Lewis ---------------------------------- ofAon Hewitt,which advises hundreds of clients on building tailored private equity investment portfolios. Private equity is an important component within the public pension funds’ portfolios. It provides diversification of returns besides often outperforming the public market’s returns, net of fees. Private Equity is Essential to Public Pension Funds PRIVATE EQUITY PORTFOLIO ANNUALIZED RETURNS (10-YEAR) NET OF FEES 11.6% For public pension funds, including Illinois’ four major pension funds, private equity continues to deliver superior net returns compared to all other asset classes over the longer terms. It helps explain why the appetite for the asset class has risen in recent years.
  • 6. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES 4 In a Q&A format, the three investment professionals weigh in on a number of specific issues pertaining to their PE and VC investments. What percentage ofyourassets doyou invest in PE/ VC,and talk a bit about the history for such investing. TRS: We have a 14 percent target, which amounts to a little more than $6 billion of our ($46 million) asset base. Typically,we target $1-1.6 billion of new investments in a given year. Our initial PE and VC investments date back to the mid- 1980s with a more formal institutionalization of the program in the early 2000s. IMRF: Nine percent is our alternative investments target, which includes PE and VC, hedge funds and the like. Three components comprise PE/VC: fund of funds, two evergreen separate funds and our direct PE/VC portfolio. We began making these investments in 1986, but I started our direct PE and VC portfolio in 2012 and it now includes 14 firms with $753 million in commitments from 28 mandates. AON HEWITT: In the last 10 years on average, we invested $2.5 billion a year.We focus on funds that are raising $100 million or more. Since our clients are making large commit- ments to funds (typically $15 million to $100 million per fund), we tend to invest in mid-size to larger funds. There are a lot of incredible $25-150 million micro VC opportunities and we would love for our clients to invest in them, but their check sizes are too big. What is your general investment philosophy regarding PE and VC? TRS: PE/VC are expected to generate long-term returns in excess of publicly traded equities.That is best accomplished by investing in underlying businesses in growing markets with defensible strategies led by the best management teams. IMRF: When it comes to PE/VC standalone evaluations, a return of 2x investment at 20 percent is the rule of thumb. If it’s a debt-like strategy, it might be in the low teens, and if it’s a buyout value creation situation, we want more. It all depends on what strategy we’re applying to each individual situation. Right now, we’re looking at funds with a broader rather than specialty or niche approach. AONHEWITT:We build diversified portfolios for our clients across strategies,geographies,and industries.We recommend they invest relatively equally each year to take into consider- ation vintage year risk. Our goal is to build downside protection as well maximize their upside potential. As a consultant, we function as“matchmakers,”seeking to find great opportunities that fit each client as well as cover different risk tolerances. We also manage discretionary assets. What doyou lookforin the PE/VC firm and manager? TRS: We emphasize working with partners based on a consistent balance between risk and return.Top performers serially repeat. Having an award-winning Emerging Manager program is a valuable tool to learn about new managers. As with many large plans, the key challenge is finding and sourcing opportunities that aren’t widely shopped. In the current environment, we focus particularly on general partners with a demonstrable track record of successful exits. IMRF: We make qualitative and quantitative assessments to determine management skills, attractive of investment strategy and fit with our portfolio. As for qualitative, which comes from interviews,we assess managers’skills,expertise, strategy--there’s no substitute for evaluating their team. On the quantitative side, we consider a lot of data points; we look at track records along multiple dimensions and unrealized investments.And some managers can be perfect but don’t fit with our portfolio. A due-diligence visit can make a difference; I didn’t move forward with an investment after one, concluding that “only time will tell” whether it will be a solid investment. AON HEWITT: We focus on six areas in our due diligence plus an independent area. The independent area is operational due diligence. If the first six are great but the firm is not operationally adequate, then we don’t invest. The other six are: Business: Who owns the firm and how is it allocated among the team,composition and retention of LPs,how many products they have, back office, etc. Team: Mix of skill sets, turnover/new hires, depth of team resources, network, skin in the game, etc. Performance: Consistency, realizations, returns, write- offs, length of track record, etc. Investment process: Market opportunity, competitive advantage, ability to create value, deal sourcing, valuation discipline, etc. Risk management: Investment committee process for new and follow-on investments,monitoring,ability to work out challenged companies,etc. Terms and conditions: management fee, distribution waterfall, preferred return, key person, LP approvals, etc. Q Q “PE/VC are expected to generate long-term returns in excess of publicly traded equities. That is best accomplished by investing in underlying businesses in growing markets with defensible strategies led by the best management teams.” Q
  • 7. IVCA VIEWPOINT | 2016 5 ”...private equity investments outperformed the overall portfolio...”
  • 8. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES 6 PE/VC is a long-term commitment and we underwrite new investments accordingly. What is your general time frame for holding a PE/VC investment? TRS: PE/VC is a long-term commitment and we underwrite new investments accordingly.We model 12-13 years for funds and 5 years for co-investments.In certain instances,we will use secondary markets to rebalance the portfolio tactically. IMRF: We underwrite investments to hold to maturity; we’re not going to be selling in the secondary markets because you leave things on the table. Generally, 7-10 years and it varies by strategy. AONHEWITT: It’s a long-term asset class, and we do a lot of client education to explain that they are investing for at least 10-12 years so it is hard to be tactical. We are always evaluating new funds for clients since we may consider not re-committing to a managerwho is not performing as expected. We underwrite a manager’s subsequent fund as a new investment.With that said we are cognizant of managing the number of manager relationships each of our clients have. How do you identify new and prospective PE/VC firms to do business with? TRF: Many managers seek us out, and we’re happy to meet with them. The key challenge is finding and sourcing opportunities that aren’t widely shopped. So the staff tries to maintain a proactive stance within the industry and manager universe, leveraging resources of our consulting partner Torrey Cove Capital Partners --a nondiscretionary specialist advisor that focuses exclusively on PE/VC and real assets --and continually mining separate account relationships as a sourcing mechanism for new relationships. IMRF: We have an open door policy and conduct a lot of manager meetings in person, on conference calls or over video. We need to always know what’s out there. AONHEWITT: We’re constantly proactive. We have an open door policy and are always reaching out. We’re always asking LPs what they’re looking at and sharing bad or good diligence. Some have reached out via LinkedIn. We get attention from papers we’ve published. Placement agents also send people our way. We also keep in touch and, if we Q Q didn’t get in someone’s first fund, perhaps we can be in the second. In the current investment environment, you can’t rest on your laurels. If you couldn’t invest in PE/VC, what would be the impact on your pension holders? TRS: The System would miss the plan’s highest net-of- fees returning asset class, historically. The plan’s asset allocation model and expected return would look dramatically different without the risk return profile provided by private equity investments. IMRF: Every cent we earn more on that dollar, the employer rate goes down. Payroll for our employers equals $7 billion; if you reduce economic costs, and employer contribution base by 1 basis point, it equals $700,000 in savings per year. The role of private equity is important in generating the assumed rate of return and the more it can generate, it helps reduce the contribution rate. What are the key differences in evaluating a PE and a VC investment candidate? IMRF: With a PE candidate, you can ask questions for 6-8 hours. With a VC prospect, you need to have a lot more knowledge walking in about how VC and a venture company work, and you don’t need eight hours. Cash flow and quantitative analysis --and even qualitative --looks different for a venture fund. AONHEWITT: Buyout, distressed debt, turnaround, secondaries, energy funds, and venture capital funds all operate differently due to their different investment strategies. Therefore, during our diligence we focus on different areas depending on the strategy. Venture capital firms generally tend to be small (with some exceptions). They mitigate risks through deal structure and milestone based investing, whereas preferred equity, use of leverage, and investment timing differ significantly with other PE strategies. Consistency in returns is valued in buyouts, but we could expect a few home runs to drive the entire return of a venture fund. An early stage venture capital investor often wants to be physically near its companies to spend time with founders, whereas proximity to portfolio companies is less important for other strategies.Although we are always evaluating a fund’s unrealized portfolio, with buyout and growth we have more financial metrics to determine how value has been created.With venture capital this assessment is more qualitative. What characteristics are vital in hiring a new member of your team? IMRF: Strong skills in due diligence,analysis,underwriting and monitoring.Investing in PE/VC is not just finding the next Q Q Q ”We make qualitative and quantitative asessments to determine management skills, attractive of investment strategy and fit with our portfolio. As for qualitative, which comes from interviews, we assess managers’ skills, expertise, strategy–there’s no substitute for evaluating their team.“
  • 9. IVCA VIEWPOINT | 2016 7IVCA VIEWPOINT | 2016 7 The role of private equity is important in generating the assumed rate of return. great manager and giving money; that’s just a deal and you must live with that deal for the next 10 years.Also important: Does the candidate understand financial statements and what issues can come up? Can that person glean valuable insights? How do you monitor and keep up with your PE and VC investments? TRS: Our scale lets us sit on many advisory boards where additional insights can be gained. Our partner Torrey Cove Capital delivers an independent quarterly review for all fund investments and co-investments. Staff also prepares updates from advisory board meetings, periodic on-sites in manager offices and formal annual reviews of all co-investments. What about investing in Illinois companies? IMRF: We like it when a portfolio company is based in Illinois, especially Chicago. It’s more convenient and is easier to think about. Over 40 percent of our portfolio represents holdings based in Illinois. Of course, under Illinois Code, if everything is equal between an Illinois-based opportunity and an outsider, the tip-off goes to the homegrown company. So,what ifyou read bad news––massive job layoffs, etc.––about a prospective investment for a client’s portfolio? AONHEWITT:Our clients are sensitive to headline risk and so we consider this potential as we are conducting diligence. Some of these headlines could cause us to stop diligence immediately. However, most of the time it is just noise and not meaningful. What has changed over the past 5–10years or even morerecentlyasitappliestoyourprivateinvestment portfolio, approach, etc.? TRS: PE/VC is a much more mature asset class now. Deal processes are more efficient and the ability to source on a proprietary basis isn’t as easy as the past for buyout firms. During the financial crisis, PE/VC developed considerable skill in debt-for-control transactions; that market has become quite saturated with capital. The last downturn also increased the pool of capital for secondary funds. As a result, discounts to fair market value have compressed and secondary funds offer limited partners such as TRS an exciting portfolio-management tool. Q Q Q Q
  • 10. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES 8 While each venture capital fund’s investment strategy varies, one common factor is clear: The fund assumes significant risk with each individualinvestment.Acompanymayhave little orno revenue, a nascent business plan and a founder or founders without extensive management experience. Still, venture capitalists finance early-stage companies they believe can have favorable futures and strong potential to build value. That was the situation in 2011 when Adams Street Partners first invested in Naurex Inc., then a three-year-old clinical-stage company developing a promising compound to treat severe depression.At the time,the startup was in a clinical trial with its lead compound.The company had grown out of earlier research by its founder,Joseph R. Moskal, Ph.D., and colleagues at Northwestern University’s Falk Center for Molecular Therapeutics. For its part, Chicago-based Adams Street Partners has focused since 1972 on private market investment management and manages over $27 billion of assets.Terry Gould,a partner for 23 years, heads its Venture/Growth Equity Investments and specializes in healthcare investing. Adams Street was the lead investor in an $18 million Series A financing in May 2011 for Naurex.The company used the funds primarily for a Phase II trial of its lead compound. Just over four years later, Allergan purchased Naurex for $560 million in cash, plus additional future considerations. Gould first learned of Naurex from an acquaintance in the industry, and upon a review of the Naurex board, he realized he knew two of the directors. He had lunch with one and concluded that it might be worth learning more about the opportunity at Naurex. Gould then asked Bill Gantz, the Adams Street was the lead investor in an $18 million Series A financing in May 2011 for Naurex. Funding NaurexNaurex’ compounds target depression, a medical condition often requiring treatment that affects nearly 7 percent of U.S. adults and costs an estimated $83 billion a year.
  • 11. IVCA VIEWPOINT | 2016 9 former president of Baxter International and a veteran of several venture-backed success stories, to meet with the Naurex team. That Initial Meeting After a two-hour meeting in the Naurex office in Evanston,Ill., the two men felt that the company had interesting data regarding its lead compound and a potential, large market opportunity.Gould decided to pursue his diligence further and learn more about the trial data and the management team. After a number of months,he started to put together the $18 million Series A financing. Offering Counsel In addition to the investment capital provided byAdams Street Partners, Gould provided counsel to Naurex on a number of issues--from personnel and clinical trial design to spending plans, compensation and other possible sources for capital. Gould and Gantz became directors, with Gantz serving as board chairman.They attended board meetings and spoke regularly to Naurex officials. In addition, Gantz dedicated one day a week to work with the company after the initial financing round, in which Gantz was also an investor through his firm PathoCapital. Financing Round II Naurex’Phase II trial results put the company in a position to raise additionalcapital.In December2012,Naurexcompleted a $38 million Series B financing that was led by new investor Baxter Ventures, which Baxter International had established in 2011 to invest up to $200 million in promising companies. Adams Street Partners participated in the Series B financing and played a major role in lining up up additional investment partners for the Series B round. Naurex used the Series B proceeds to fund several key programs that included conducting a Phase IIb trial of its compound, and further developing second- and third- generation programs for other central nervous system disorders. Norbert G. Riedel, Baxter’s chief science and innovation officer, joined the board in conjunction with Baxter’s investment. LookingAhead Naurex management continually considered possible scenarios for its future, including going public or entering into an acquisition or strategic partnership.This is common practice with promising startups, especially in the pharmaceutical industrywhere Big Pharma often looks fordrugs orcompounds that could help fill their new product pipeline needs. ”The Naurex investment fits the profile that investment firms such as Adams Street Partners seek in a startup. We’re not buying established businesses. We’re trying to create things, to build companies.” As Naurex’ clinical trials continued, and as results showed promise,the company needed additional financing. Its lead compound to treat depression was going to be entering its final testing phase in 2015.If all went as planned, Naurex hoped to release the product commercially in 2019. Company management and board members began preparing for a third round of financing at the time as well. In addition, in January 2014, board member Riedel was named the company’s president and CEO, succeeding interim CEO Derek Small, who continued as a director. In December 2014, Naurex raised $80 million in the Series C funding. Five new investors joined this funding round along with Adams Street Partners and a number of previous investors. Naurex management then began a dialogue with investment banks and pharmaceutical companies to consider the path forward. AllerganAcquisition On July 26, 2015, Dublin-based Allergan, a leading global pharmaceutical company, bought Naurex in an all-cash transaction. “We were quite pleased with the transaction,” says Gould.“It met the firm’s objectives in terms of the multiple of invested capital returned.” Gould adds that the Naurex investment fits the profile that investment firms such as Adams Street Partners seek in a startup.“We’re not buying established businesses. We’re trying to create things, to build companies.” Gould is hopeful that the Naurex project may be the beginning of future success in the biotech/pharma space in the Chicago area. A number of former Naurex employees are now leadingAptinyx,a spinout ofthe Naurex technology platform. Gould and Adams Street Partners provided seed capital to Aptinyx and then helped the company raise $65 million in Series A financing in early 2016 to advance therapies for neurological disorders. “Perhaps Aptinyx will build on the success of Naurex and become another notable success in the Chicago biotech marketplace,” Gould says.
  • 12. 1010 The quick answer: Yes. At least if you adopt the blueprint of Chicago venture investor-turned-entrepreneur Eddie Lou. His own for-profit startup, Shiftgig, is growing rapidly --raising over $35 million in venture capital funding and doubling its markets by year-end --as the digital market- place that connects people to work shifts via a smartphone expands. In 2004, he co-founded OneGoal, a nonprofit that today guides students in low-income communities in five major metro areas to enroll and succeed in college.Lou,who arrived in Chicago in 2001 to work at OCA Ventures, an early-stage VC firm, got OneGoal started as an after-school program in Dunbar High School. Its headquarters, for all practical purposes, was at the co-founders’ apartments in Lincoln Park. Over the first five years, he and his co-founders and others evolved the after-school program into an in-school, three-year model used today.The Lincoln Park apartments are gone, but OneGoal continues to thrive! In brief, OneGoal identifies students, called Fellows, who have potential and commitment to college but, without academic, family and peer support, would have very limited college prospects. It starts as a for-credit class during Fellows’ junior and senior years in high school. During their freshman year at 22 colleges and universities that are OneGoal partners, the students receive intensive coaching delivered remotely. From an initial 32 Chicago Fellows served in 2007, the program will serve an estimated 9,300 Fellows in Chicago, Houston, Massachusetts, Metro-Atlanta, and New York by the end of the 2016-17 school year. In the midst of its next five- year strategic planning process, OneGoal has its sights set on dramatically increasing that number in the next five years. Ten years ago,OneGoal was one staff member,three schools with 32 Fellows and a $180,000 operating budget (half of which was raised from just eight of Lou’s friends).Today, the full-time staff numbers over 100, with more than 180 schools and an operating budget exceeding $10 million. So what VC “steps to success” can help start and sustain a nonprofit? Here are Lou’s VC learnings: Lesson I: Operate the nonprofit like a business. The only difference from a for-profit enterprise is that the management team doesn’t have financial equity in the business,but they possess social equity.A legitimate business plan is essential to scale and grow. Many of the same rules of a for-profit apply to a nonprofit. The business plan provides a high-level view of the organization, combining basic marketing, strategic, operational/management and financial tactics. It also includes the nonprofit’s mission, values, strengths and assets. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES 10 Applying VC Art+Science to Nonprofit Work Venture capitalists and private equity investors are savvy at helping startups and established companies flourish. But could they apply their knowledge and know-how to starting and developing a successful nonprofit? OneGoal will serve an estimated 9,300 Fellows in Chicago, Houston, Massachusetts, Metro- Atlanta, and New York by the end of the 2016- 17 school year. Applying VC Art+Science to Nonprofit Work
  • 13. IVCA VIEWPOINT | 2016 11IVCA VIEWPOINT | 2016 11 Lesson II: Build in a scalable fashion. Many nonprofits develop a high-touch operation that usually isn’t all that scalable and costs too much.That’s why we don’t offer scholarships or one-on-one counseling for Fellows. Every aspect of our model reflects how to build the business in a scalable fashion. Lesson III: Insist on building toward strong metrics. Nonprofits often forget about measuring their progress in fulfilling their mission.They track their performance such as dollars raised, membership growth, people served and overhead expenses,but they don’t measure the real progress in achieving what matters. As with a for-profit operation, OneGoal sets targets and scrutinizes its metrics monthly, focusing on Fellows’ performance over the three-year program.It examines attendance rates,grade point averages, test scores, as well as the number of Fellows we help and the schools that partner with us. We amass a lot of data. OneGoal knows that after joining the program, students increase their GPA and school attendance and improve their SAT/ACT test scores. It also knows that at Chicago high schools, 16 percent of freshmen go on to get a college diploma; 82 percent of OneGoal high school graduates enroll in college and 78 percent are on track to earn their degree. Lesson IV: Build a great management team and staff. Just as at a high-growth, for-profit organization, talent is critical for a nonprofit. From past experience, Lou has found that many volunteers quit after two months. This is where it pays to focus on a scalable organization, where volunteers can be coached and trained to succeed. As for staff, he recommends taking time to really think hard about what talent is needed. Look for people with passion, purpose, pride and brainpower. Lou says it pays to follow “your gut” in making personnel choices, which he did in selecting OneGoal’s executive director in 2007. After reviewing dozens of resumes and talking to more than a handful of finalists, he tapped Jeff Nelson, a Teach for America star who was an elementary classroom teacher at an inner-city Chicago school (and now OneGoal’s CEO).“Jeff (who is 34) had passion and vision; he had all the potential of being a great entrepreneur such as resourcefulness, leadership and sales,” says Lou.“Jeff soaked up knowledge like a sponge; he was exceptionally coachable.” Here’s a recent problem OneGoal fixed: When some Fellows who got into college didn’t go, it was discovered their parents hadn’t filled out required tax forms.As a result, their children couldn’t qualify for scholarships and financial aid.OneGoal now partners with a nonprofit that offers free tax help to low-income people.Parents also now sign an agreement that if their Fellow gets into college,they must complete the necessary paperwork for them to get assistance. LessonV: Insist on active board participation. Few, if any, decisions for a nonprofit are more important than whom to choose to help lead it, and that applies to directors. Legally speaking, they are accountable for overseeing the organization’s purpose. What’s essential? They should care deeply about the nonprofit’s purpose; understand principles of good business practices; be strategic thinkers; grasp that their role is governance, not management; have integrity; and be willing to give of their time and money. OneGoal’s national board of seven nonmanagement directors comprises Lou, a founder of an investment bank, the chairman of a private equity firm, a Facebook executive, a former executive of Teach For America, a lawyer- philanthropist, and retired NBA star Earvin “Magic”Johnson, whose Magic Johnson Enterprises is rooted in service. OneGoal directors are expected to attend 3 of 4 board meetings, get involved in a committee and give at least $25,000 annually. One of its directors donated $1 million. LessonVI: Leverage technology Since using metrics and compiling data is critical for a nonprofit to succeed, it’s increasingly vital to leverage technology in a number of ways. OneGoal uses a customized platform that delivers up-to-date information to teachers and staff and reports that track each Fellow’s progress. Technology helps OneGoal to differentiate instruction, to assist Fellows in finding their top match colleges, to send Fellows text messages to nudge action over the summer, and to track their progress in college. OneGoal knows that after joining the program, students increase their GPA and school attendance and improve their SAT/ACT test scores.It also knows that at Chicago high schools, 16 percent of freshmen go on to get a college diploma; 82 percent of OneGoal high school graduates enroll in college and 78 percent are on track to earn their degree. 82percent
  • 14. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES 12 Private equity investors identify portfolio prospects in a plethora of ways. But a casual comment at a charity dinner hosted by Rita Canning, wife of Madison Dearborn Partners’ Chairman John A. Canning, Jr., sparked the firm’s interest in Sage Products LLC. At the event in June 2012, Sage Chairman Vincent Foglia mentioned to the Cannings that Sage’s four co-founders were mulling a possible sale of the Cary, Ill., maker and provider of infection control and preventive care products. Six months later, on Dec. 12, MDP acquired Sage for $1.06 billion. Last February, 38 months later, Sage and MDP announced a sale to medical device maker Stryker Corp. for $2.78 billion. Sage’s 2015 sales had risen to $430 million. The acquisition closed on April 1. MDP itself generated $1.5 billion on behalf of its investors, a gross return of 4.2x invested capital and an internal rate of return of roughly 60 percent. A Front Row Seat What happened between that serendipitous June dinner conversation and February 2016, as recalled by the principal players, offers a front row seat into how an established and experienced PE firm offers guidance, resources and money (of course) to a portfolio company to help it grow, prosper and exit its control. When considering acquiring Sage,“the first order ofbus- iness was recognizing,‘let’s not kill the golden goose,’” recalls MDP’s Lead director Timothy Sullivan, a co-founder and managing director of the Health Care team. Over more than four decades, Sage: established a veteran and experienced management team; built a track record of creating new markets within hospitals; possessed a well-defined pipeline of new products that typically launched a new franchise every 3—4 years; focused on both internal R&D for new products and acquiring early–stage products; and sourced ideas from clinicians. Talks and visits to Sage also illuminated to MDP, Sullivan says, the vast pride and retention rates of Sage employees, all of whom knewVince and Scott (CEO D.Scott Brown); Sage’s new “tremendous” warehouse; and that the company “knew sausage making” in consistently introducing new products. The MDP Health Care team--assisted by three of its advisory Round Table members, including former Baxter International CEO Harry Kraemer, former Gambro CEO Thomas Glanzmann, and former NorthShore University Health System President Jeff Hillebrand --believed it could create value at Sage through additional new product innovation, domestic growth and international expansion. Talks ensued and MDP, competing with a Sage rival for the acquisition, prevailed with its overall price and package. Consequently, before year-end 2012, MDP with Sage’s management team and MDP limited partner co-investors acquired a 67 percent stake in Sage. Initially,Sage’s founders hadn’t expected a PE firm to buy it.“We were dealing with some misconceptions of PE,” says CEO Brown. “So we did our due diligence.” They talked to several people, including Kraemer, about PE firms’ practices, wanting to ensure that Sage --a prominent charitable and civic-minded McHenry County employer --wouldn’t have to diminish such local support,among other issues. What they heard alleviated their misconceptions. About MDP, “they’re great believers that by giving back to the community where you live and work and bringing jobs and hiring local suppliers,you build a strong,healthy community,” Brown says. The Partnership Lead director Sullivan and MDP Health Care team colleagues Nick Alexos and Jason Shideler spent a great deal of time in regular communication with Sage and CEO Brown. They would touch base weekly to every 10 days, particularly as Madison Dearborn Partners’ SageDecision At a charity dinner, a casual comment sparked Madison Dearborn Partners’ interest in Sage Products.
  • 15. IVCA VIEWPOINT | 2016 13 they worked with Sage management and managers on strategy review and on certain initiatives, such as an international sales summit MDP helped develop. They also held several meetings at Sage on the issue of sales force expansion and the 11-member board delved deeply into that and other matters. Says Brown about Shideler, in particular: “I could call Jason and tell him,‘I’m thinking about this and what do you think.’ He would say,‘Let us run the numbers and we’ll get right back to you.’” Growth, of course, is an essential goal for investors in private companies, and MDP has an arm that specifically helps portfolio companies look at growth investments. That experienced group helped Sage look in particular at growing international sales,the number of its own new products and the number of new commercial products it could acquire. On the international sales front, MDP figured it could help Sage open up distribution channels abroad, especially in Europe, to grow sales. Historically, less than 10 percent of sales came from outside the U.S., although sales had increased in the few years before MDP’s investment. Sage established a European headquarters and relocated its international director to Switzerland. MDP Health Care team advisors Glanzmann and Kraemer helped Sage’s sales team understand that the approach to doing business in Europe differed from the U.S. Suppliers there deal much more heavily with large national health services.The two advisors helped Sage hold an international summit with industry veterans. Subsequently,Sage increased its focus on adapting to and building its European markets by hiring a number of sales reps or country managers and new product-development executives as well as product-development and marketing teams. It put minimum purchase requirements and volume incentives in place to drive growth, and it set up an international advisory board. As a result, international sales climbed above expectations. Awakening Opportunities MDP also helped Sage in the human resources area after the retirement of its HR director. MDP encouraged hiring a strong HR VP who would report directly to Brown. The department became more robust through centralized hiring --which freed up sales managers --and more intimately involved in successfully expanding the sales force while preserving the company’s culture. Culture shift and sales force disengagement could easily have occurred since Sage expanded its sales territories and, as the broader sales team grew, shrank the average number of hospital beds (a common metric used by medical product providers’ sales teams) each sales person commanded. Sage and its HR team focused on communicating that change clearly and transparently. The upshot: The typical sales rep made more or the same total compensation than in the previous year despite shrinking their respective territory. MDP also convinced Sage, which always had created its products,to consider acquiring new products.Jason Shideler worked closely with a Sage product-development manager to look at smaller opportunities of commercial products ready to sell.One such acquisition identified was in the patient mobility space that helps nurses lift heavy patients onto a (continues on page 16) MDP itself generated $1.5 billion on behalf of its investors, a gross return of 4.2x invested capital and an internal rate of return of roughly 60 percent.
  • 16. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES 14 Idea+Execution= $1.3 BILLION Why IBM pursued Cleversafe When a venture capital fund invests in a new company, its investment horizon spans years so it sets one primary mission: growth. That was New Enterprise Associates’ objective when the global venture capital firm led the then-fledgling data- storage company Cleversafe’s small Series B financing round in August 2006. Ten years later, NEA was the lead investor in Cleversafe’s $55 million Series D financing round. “We’re about growth,”says Peter Barris,NEA’s managing general partner,who joined the Cleversafe board of directors after the Series D round.“Building critical mass is important, especially to differentiate yourself and build competitive moats around a company.” The firm’s journey with Cleversafe until its sale in early October 2015 to IBM for over $1.3 billion serves as a case study of how a private investor selects a promising company for its funding and continues to invest until its exit years later. For the most part, all VCs follow some iteration of NEA’s selection process and investment strategy and the various types of assistance it provided during its union. Chris Gladwin’s“Better Idea” For NEA,the motivation to go with Cleversafe --whose founder, serial entrepreneur Chris Gladwin (with an engineering degree from MIT) had a better idea for how to store mountains of data --encompassed these principal factors: Founder:“We had a familiarity with Chris through one of his earlier companies, MusicNow, so in determining which is most important --the horse or the jockey --we didn’t have to choose. We had a great entrepreneur (the jockey) who we knew was brilliant, had the ability to assemble a strong team and possessed a unique technology concept in a data-storage field (the horse) that was exploding and that played to his background.” Leadership: “We were Cleversafe’s largest shareholder but we didn’t have a controlling interest and didn’t look for one. We bet on a board of reasonable people making reasonable judgments and getting everyone on the same page. As a director, I viewed my role as making sure the board members were all rowing in the right direction.” “Big Idea”: “Ours was a bet on technology. Chris had a theory that storage was where it was happening but that NEA has invested nearly $400 million in Chicago companies in the last decade, the most of any metropolitan area outside of Silicon Valley. It considers Chicago notable for its central U.S. location and business model innovations. $400M
  • 17. IVCA VIEWPOINT | 2016 15 typical storage systems that relied on a centralized file directory weren’t going to be sufficient and would be a bottleneck. His theory that object-based (think pictures and videos) data storage software and appliances offered a better solution proved valid,thanks to his distinct information dispersal algorithm and Tier 1 storage system to slice up data. It actually got better as the size of the system grew. The more you stored, the more the system got faster, more reliable and more cost effective, while others’ systems got slower, less efficient and less reliable the bigger they got.” Intellectual Property: “Cleversafe had a differentiating technology and protected technology. At the time we sold it to IBM, we could count 350-plus issued patents. By one measure, it ranked in the top 10 global companies with the most potent patent portfolio, along with IBM,Apple, Samsung and the like.” Talent Pool: “Chris was convinced that Chicago had advantages (as Cleversafe’s home) and that he could find the talent he needed to continue and scale the business in Chicago or he could attract it to the city. Chicago has lots of talent and a huge supply source from Midwestern universities. He felt he didn’t have the challenge startups have in Silicon Valley where there’s little loyalty and very high human capital costs.” NEA has invested nearly $400 million in Chicago companies in the last decade, the most of any metropolitan area outside of Silicon Valley. It considers Chicago notable for its central U.S. location and business model innovations, citing Groupon. For NEA, a bit of risk existed, of course. While it was a diversified, multi-sector investor with two-thirds of its investments in technology, it didn’t have a lot of experience in the data storage field. But it had studied the storage space and knew in general how it was evolving. NEA partners also believed that Cleversafe’s data security feature was a huge advantage to drive sales because companies didn’t have to invest in a separate security system. Barris and others at NEA,Cleversafe Chairman Chris Galvin and the other Board members helped guide the company by offering the counsel and key introductions. A“Lord of the Rings”Turning Point For the board,a key turning point came at a meeting in 2008 when Gladwin showed directors a “Lord of the Rings” movie on an iPhone receiving the content from Cleversafe servers. Still, NEA and investors had a particular challenge: Cleversafe perhaps had introduced its technology too early. While Cleversafe servers could store terabytes of data at lower cost,not a lot of customers cared then about petabytes. One petabyte is roughly 1,000 terabytes or one million gigabytes and can hold about 500 billion pages of standard printed text. Today, hundreds of companies care about petabytes. It took Cleversafe five years before it signed its first client. Now IBM Cloud Object Storage, Cleversafe was founded in Chicago in 2004 by S. Christopher (Chris) Gladwin, who had developed distinct data-storage software that stockpiles petabytes of pictures, videos and other objects in both in-house and cloud-based servers. It was sold to IBM for more than $1.3 billion in cash. Among the world’s largest and most active venture capital firms, New Enterprise Associates is a diversified investor, but with most of its investments in technology and health care. Founded in 1977, NEA has invested nearly $400 million in Chicago companies in the last decade, including Cleversafe for which it was lead investor in its Series B and Series D financing rounds. Peter Barris NEA’S MANAGING GENERAL PARTNER Chris Gladwin FOUNDER, CLEVERSAFE Early investors saw returns of 35-100x their initial investment. For Gladwin, the impact of IBM’s acquisition of Cleversafe had an especially joyous effect. “We created fantastic jobs for over 250 people.“ 35-100x RETURNS 250JOBS CREATED MORE THAN 80 NEW MILLIONAIRES
  • 18. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES 16 MDP Sage Article Continued from Page 13Cleversafe Article Continued from Page 15 For Cleversafe,the critical milestone came with the signing of Shutterfly as a customer in late summer 2011.At the time, the 12-year-old Internet-based social expression and personal publishing platform needed a leading-edge tech advance for scaling data.It also wanted to find a storage provider that could help it realize cost savings of over 60 percent for storage. A Shutterfly Moment The contract with Shutterfly proved the spark for other lighthouse deals. Signing up were enterprises such as KDDI, the Tokyo telecommunications giant, and Sky Television, the pan-European broadcaster. Barris and other board members assisted Gladwin and the company with its go-to-market strategy in seeking to identify and foster customers to compete, especially against its biggest rival EMC (now Dell EMC). Reflecting the expected sales surge, Cleversafe and its investors used much of the proceeds from the August 2013 Series D financing round to boost the company’s sales operation. About growth, Barris explains that investing firms often encourage entrepreneurs to grow faster and spend faster than they’re comfortable with. With Cleversafe, though, NEA was “very sensitive to expense growth because it was pretty capital intensive to develop and patent its technology and because early sales were slower than desired. We had to make sure we weren’t out of sync with those issues.” With each round of financing, what board members offer management differs.“In the earlier stages, it may be credibility or access to expertise. Later, you want to offer real experience that might help in identifying companies that might acquire the firm,” Barris says. In 2015, talks with IBM heated up and on Oct. 5, it announced it was acquiring Cleversafe --which had tech- nology and client relationships valued at $364 million and $23 million, respectively --for undisclosed terms.The transaction closed a month later.(In February 2016,an SEC filing by IBM revealed that it had paid over $1.3 billion in cash for the company, including $1 billion in goodwill.) Before it was acquired, Cleversafe was valued at slightly over $200 million based on its 2013 financing, according to estimates by research firm Pitchbook. It was a good fit.The strategic acquisition strengthened IBM’s leadership positions in storage and hybrid cloud and helped its clients drive their digital transformation. Early investors saw returns of 35-100x their initial investment.For Gladwin, the impact had an especially joyous effect.“We created fantastic jobs for over 250 people.When I look at our employees and investors,we returned over $1 million to more than 80 people, many of whom we hired out of college.” gurney through a novel method using inflating blowers. Sage was able to successfully negotiate and consummate that transaction in January of 2015. Sage’s Brown articulates why MDP’s assistance proved so helpful: “I learned in a short period of time how to think about our business differently with MDP’s counsel,” he says. “We were a company owned by the same founders for 41 years, and MDP asked all the questions we never asked ourselves. Simple things like ‘Have you ever thought about doing this or that?’ They were engaged every step of the way and so committed to success.” The Exit Scenario Sullivan notes that, typically, MDP invests in a portfolio company for around five years. In the health-related sector, the average hold has been seven years. In Sage’s case, he says, the company had always maintained an open door in terms of talking with possible suitors--and in the latter part of 2015, the company received strong interest from a couple of prospective strategic acquirers. At the time, the health-related market and public companies’ stocks were trading at historic highs. MDP’s view about Sage was to have a very quick and private process by keeping the matter to a very small group of internal managers and potential strategic buyers who had indicated a strong interest in Sage.“And if they offered the right value,OK,great,and if not,the company’s done well and will continue to execute on their strategic plan,”says Sullivan. The process identified Stryker, one of the world’s leading medical technology companies, as the as the next Sage steward. Based in Kalamazoo,Mich.,Stryker has a strong culture and values similar to Sage’s as well as a decentralized organization that would let Sage continue to do what it did best. Additionally, while Sage sales abroad had risen to $20 million in 2015,the company and MDP wanted to increase that growth.Stryker’s strong international sales force was viewed as a positive for Sage. The transaction was struck.As for MDP,at its exit,it set up the Sage Legacy Fund with a $1 million contribution from MDP to assure charitable contributions would continue to McHenry and other local organizations.
  • 19. IVCA VIEWPOINT | 2016 17 ivcaevents
  • 20. THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES 18 ivca educationalevents IVCA/NVCAAnnual Luncheon April 13: Attendees acquired a rich behind-the-scenes story of Chicago’s Cleversafe related to the 10-year rise of the object-based storage software and appliances company through its acquisition to IBM in October 2015. Cleversafe founder Chris Gladwin, initial investor Jim Dugan of OCA Ventures and growth investors Peter Barris of New Enterprise Associates and Chris Galvin of Harrison Street Capital related milestone events for the company. Thoma Bravo’s Lee Mitchell was moderator for the event, sponsored by Baker Tilly and Ropes & Gray LLP. In addition, NVCA President and CEO Bobby Franklin delivered “A View from the Hill” in which he discussed his impression of Washington legislative activity as it affects venture capital and private equity issues. IVCA Educational Events – Highlights April 26: “How to Use Communication Planning to Mitigate Franchise Risk,” sponsored by IVCA service provider member Edelman, explored how VC and PE firms can anticipate and mitigate reputational risk for themselves and for portfolio companies. Jeff Zilka, general manager of Financial Communications and InvestorRelations at Edelman,moderated a panel that included a general counsel, Mark Tresnowski of Madison Dearborn Partners; two investing partners,Bob Fealy of Limerick Investments and Kim Vender Moffat of Sterling Partners; and a crisis authority, Andy Liuzzi of Edelman. Attendees gained an awareness of the importance of assessing reputational risk in due diligence and of completing a crisis assessment at the time of investment and ensuring that portfolio companies develop crisis mitigation and response plans. They also took away a high-level checklist for a due-diligence and crisis plan.The panelists’ consensus: Thoughtful preparation for a possible future crisis proves very helpful. May 4: “Navigating the Dynamic Regulatory Landscape of Private Equity Valuation,” sponsored by KPMG, captured the attention of attendees as KPMG audit partner Sean McKee and a panel moderated by KPMG Managing Director Brian Bouchard delved heavily into the issue. McKee delivered an update on the AICPA Fair Value Task Force, which he co-chairs, that is producing a more user-friendly guide to measuring fair value with examples to use to consider real situations faced by valuation specialists and auditors. The panelists exploring the perspectives of the SEC and both limited and general partners about recent valuation developments included Quintin Kevin, partner and chief financial officer of Adams Street Partners; Nabil Sabki, regulatory attorney at Latham & Watkins LLP; Senior Vice President Adam Freda of 50 South Capital Advisors; and John Kneen, partner, chief financial officer and chief communications officer at Beecken Petty O’Keefe & Co. September 13: Private equity was in the spotlight at the luncheon for “Structuring and Negotiating Rollover Equity.” Saul Rudo, national head of Katten Muchin Rosenman LLP’s Tax Planning practice, assisted by Steve Jarmel, founder of Periscope Equity, provided attendees with a deeper grasp of how to best structure rollover equity to minimize tax issues. Katten Muchin Rosenman sponsored the event. Rudo discussed key questions that must be addressed when deciding rollover equity. He also talked about possible structures for such a transaction, including LLC, C Corp with LLC Holdco and S corporation. September 27: “Closing a Growth Financing Round”was the topic for a lively IVCA luncheon forum. It featured entrepreneurs who shared their experience and insights into the “growth round” of financing, which goes beyond the initial investments and took their companies to the next level of growth. Michael Gray, Partner at Neal Gerber & Eisenberg LLP, the event’s sponsor, served as moderator of the panel that included: Talia Mashiach, founder and CEO of EVED, a spend management platform purpose-built to manage the event category. EVED is on its third round of financing. Aashish Dalal, CEO of PARKWHIZ, an online platform for reserving parking in real time. On its fourth financing round, it raised $37 million. Justyn Howard, founder and CEO of SPROUT SOCIAL, a provider of a suite of scalable software products that drives customer and business engagement. It is in its fifth financing round. Jason Weingarten, co-founder and CEO ofYELLO,which provides web and recruitment software plus services associated with the software. It is on its fifth financing round and has raised $61 million. Four major programs on PE and VC issues drew lively discussions in 2016.
  • 21. IVCA VIEWPOINT | 2016 19 ivca awards dinner Five hundred guests attended the December 7 event, which honored individual award honorees, two Portfolio Company of the Year recipients and the first Legislative Appreciation Award recipient. Honored were: Warren E.Holtsberg, co-head of Portfolio Management at MVC Capital, who received the Richard J. Daley Award for his outstanding civic contributions. LeeM.Mitchell,managing partner at Thoma Bravo LLC and former IVCA chairman,who received the IVCA Fellows Award. PeterJ.Barris,managing general partner at New Enterprise Associates, who received the Stanley C. Golder Award, which recognizes outstanding success in private company investing. Paylocity, the leading independent provider of online payroll and human resources services for thousands of clients with 25—1,000 employees, as the venture-backed company recipient. IVCA member Adams Street Partners invested $10 million in the company in 2008 when it employed 192 people. In 2015, Paylocity employed 1,320, including 635 in Illinois. Sterigenics International,a provider of contract sterilization services,as the private-equity portfolio company winner. IVCA member GTCR and two of its former executives acquired the company in March 2011 and sold a majority stake in it to Warburg Pincus in May 2015. In 2015, it employed over 1,700 employees worldwide, including 182 in Illinois. Portfolio Company of the Year recipients were VC-backed Paylocity and PE-backed Sterigenics. Honorees (left to right): Presenter Bob Fealy and Daley Award honoree Warren Holtsberg; presenter Jim TenBroek and Fellows Award honoree Lee M. Mitchell; Golder Award honoree Peter Barris with presenter Bon French; PE Portfolio Company of the Year Sterigenics’ CEO Michael Mulhern with presenter Sean Cunningham; and VC Portfolio Company of the Year Paylocity CEO Steve Beauchamp with presenter Jeffrey Diehl.
  • 22. Andersen Tax, LLC Baker Tilly Virchow Krause, LLP CBRE Group Citizens Bank Deloitte LLP DLA Piper, LLP (US) Edelman EmPower HR EY Freeborn & Peters Greenberg Traurig, LLP Heizer Center, Northwestern University, Kellogg School of Management Horwood, Marcus & Berk Chtd. Houlihan Lokey Jenner & Block LLP Jones Day JP Morgan Katten Muchin Rosenman LLP Kelley, Drye & Warren LLP Kirkland & Ellis LLP KPMG LLP Kutchins, Robbins & Diamond, Ltd. Latham & Watkins LLP Water Street Healthcare Partners Waveland Investments Wind Point Partners Winona Capital Management WP Global Partners Wynnchurch Capital, Ltd. Zebra Ventures 50 South Capital Advisors, LLC 7wire Ventures Adams Street Partners, LLC Agman Anderson Pacific Corporation Arbor Investments ARCH Venture Partners Baird Capital Beecken Petty O’Keefe & Co. BlueCross BlueShield Venture Partners CapX Partners Chicago Teachers’ Pension Fund Chrysalis Ventures CME Ventures Cressey & Company, L.P. Duchossois Capital Management Dundee Venture Capital The Edgewater Funds Financial Investments Corporation First Analysis Frontenac Company GE Ventures Golder Investment Management, LLC Growth Catalyst Partners GTCR LLC Harrison Street Capital Healthbox Global Partners H.I.G. Capital High Street Capital Hyde Park Angels Hyde Park Venture Partners Illinois Municipal Retirement Fund Illinois State Board of Investment IllinoisVENTURES, LLC Jump Capital KDWC Ventures LaSalle Capital Limerick Investments, LLC Linden Capital Partners Madison Dearborn Partners MATH Venture Partners Mesirow Financial Private Equity Mid Oaks Investments LLC MK Capital Moderne Ventures Monroe Capital Motorola Solutions Venture Capital MVC Capital New Enterprise Associates NIN Ventures OCA Venture Partners Origin Ventures ParkerGale Capital Patriot Capital PPM America Capital Partners Prairie Capital Pritzker Group Private Capital Pritzker Group Venture Capital Prospect Partners RCP Advisors River Cities Capital Funds Romar Partners RoundTable Healthcare Partners Sandbox Industries Shore Capital Partners State Universities Retirement System Sterling Partners Svoboda Capital Partners Teachers’ Retirement System of Illinois Thoma Bravo, LLC Tribune Company Valor Equity Partners Victory Park Capital Vistria Group Investor Members Academic and Service Provider Members ivca membership 50 South Capital Advisors, LLC Adams Street Partners, LLC ARCH Venture Partners Baird Capital Beecken Petty O’Keefe & Company Founding Members Baker Tilly Virchow Krause, LLP Edelman EY Greenberg Traurig, LLP Kirkland & Ellis, LLP Kutchins, Robbins & Diamond, Ltd. Neal, Gerber & Eisenberg LLP Ropes & Gray LLP Silicon Valley Bank Provide outstanding support for IVCA in the form of services and/ or the highest levels of event sponsorship Sponsoring Members Duchossois Capital Management The Edgewater Funds EY First Analysis Frontenac Company Mesirow Financial Private Equity Mid Oaks Investments LLC MK Capital Motorola Solutions Venture Capital OCA Venture Partners Prairie Capital Pritzker Group Venture Capital Silicon Valley Bank Sterling Partners Svoboda Capital Partners Thoma Bravo, LLC Wind Point Partners Locke Lord LLP Lockton Companies Martin Partners Mayer Brown LLP McDermott Will & Emery LLP Neal, Gerber & Eisenberg LLP PEF Services LLC Perkins Coie LLP Plante Moran, PLLC Polsinelli PC PricewaterhouseCoopers The PrivateBank Ropes & Gray LLP RSM US LLP Sidley Austin Silicon Valley Bank Simon Compliance Square 1 Bank, a division of Pacific Western Bank Stern Cassello & Associates Thompson Flanagan & Co. University of Chicago Booth School of Business University of Illinois University Technology Park at IIT Vedder Price P.C. William Blair Winston & Strawn LLP Wintrust Commercial Bank THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES
  • 23. Adams Street Partners, LLC DLA Piper, LLP (US) Duchossois Capital Management Frontenac Company GTCR LLC Katten Muchin Rosenman LLP KPMG LLP Latham & Watkins LLP Limerick Investments, LLC Madison Dearborn Partners McDermott Will & Emery LLP OCA Ventures Origin Ventures Plante Moran, PLLC Pritzker Group Private Capital Pritzker Group Venture Capital RCP Advisors RSM US LLP Shore Capital Partners Square 1 Bank, a division of Pacific Western Bank Sterling Partners Thoma Bravo, LLC Winston & Strawn LLP Wintrust Commercial Bank Have sponsored at least one event during the year Supporting Members Robert Fealy Chairman: 2015-2016 Vice Chairman: 2014 Secretary: 2012-2013 Limerick Investments, LLC Maura O’Hara Maura has been Executive Director of IVCA since 2003. She oversees all aspects of the Association and represents IVCA in the community. Lee M.Mitchell IVCA–PAC Chairman: 2015-2016 Chairman: 2013-2014 Vice Chairman: 2011-2013 Secretary: 2010-2011 Thoma Bravo, LLC JeffreyPiper Treasurer: 2015-2016 Svoboda Capital Partners JamesTenBroek IVCA–PAC Co-Chairman: 2013-2016 IVCA–PAC Chairman: 2012-2013 Chairman: 2010-2012 Vice Chairman: 2009-2010 Secretary: 2008-2009 Growth Catalyst Partners WalterFlorence Vice Chairman: 2015-2016 Secretary: 2014 Frontenac Company AnthonyPalcheck Secretary: 2015-2016 Zebra Ventures 2016 officers KathyPyne Kathy is the IVCA’s Association Coordinator and is responsible for events, member communications and database management. Kathy joined IVCA in 2005. staff ivca governance Illustration:RoyScott,cover,page8;MichaelAustin,pages5,7&11Design:AvilaCreativeInc.
  • 24. About IVCA IVCA advocates for Midwest Venture Capital and Private Equity funds who invest private dollars into private companies on behalf of Institutional Investors including: pension funds, endowments, foundations, and insurance companies. IVCA membership includes investors at all stages of private companies from the largest private equity firms in the Midwest to some of the smallest early stage venture investors. IVCA advocacy includes Illinois government affairs,educational programming,sharing of best practices,media outreach,and collaboration with entrepreneurs and the groups that represent entrepreneurs.