Wall St. and Business Wednesdays: Three Years Later...

As reported in this week's issue of Barron's, according to the National Association of Investment Companies, minority-focused investment firms now handle around $4 billion in assets, up from $2.4 billion three years ago, when Barron's analyzed the sector in an article appearing in its June 5, 2000 issue.

Barron's wrote this week of the $4 billion :"That may seem minor-league compared with the $226 billion of assets managed by mainstream venture-capital firms. Still, industry players are hoping the Kauffman report, as well as a more hospitable economy, will provide the spark."

The "Kauffman report" referred to is one that many of you have learned about through BlackElectorate.com via links in our Economics/Wall St. news section.

Today, for the record, and for those of you who missed it, we include the very informative press release (with an embedded link to the entire report) put out by the Kauffman foundation announcing their report, followed by the article on the subject of minority entrepreneurship and venture capital from three years ago in Barron's.

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Kansas City, MO.- The Kauffman Foundation today released a pioneering report, MINORITIES AND VENTURE CAPITAL: A New Wave in American Business, the first profile of venture capital funds that make significant equity investments in minority business enterprises (MBEs). The report, based on a study by Dr. Timothy Bates of Wayne State University and Dr. William Bradford of the University of Washington, finds investments in MBEs resulted in healthy returns equal to, if not slightly higher than, traditional investments by mainstream venture capitalists.

Recent studies, including the Kauffman Foundation's The Entrepreneur Next Door, reveal that minorities, especially African-Americans, are 50 percent more likely than any other demographic group to engage in business start-up activities.

"Access to capital is one of the biggest hurdles for any entrepreneur - and even more so for minority entrepreneurs," said Carl J. Schramm, president and chief executive officer of the Kauffman Foundation of Kansas City, the nation's largest supporter of entrepreneurship and the sponsor of the study. "We hope this report helps to lower those capital barriers."

The report, which is an analysis of venture capital funds operated by members of the National Association of Investment Companies (NAIC) - a group of investment companies that share an interest in financing MBEs - is the first to explore the approaches to financing MBEs and calculate the rates of return of minority-oriented VC funds.

"We set out to find out if minority-oriented venture capital investing was solid," said study co-author Dr. Timothy Bates, distinguished professor at Wayne State University. "We found strong, preliminary evidence of a robust minority venture capital industry."

Key Findings

Minority enterprise venture capital investing is quite profitable. The average investment per firm was $562,000; the average gross yield per firm was $1,623,900, generating an average net return of $1,061,500.
Minority-oriented venture capital funds did not concentrate in high tech. Unlike the broader industry, which invested heavily in high-tech ventures, a more diverse portfolio kept funds focused on MBEs from their colleagues' steep slump.
Public pension funds are the leading source of VC funds for minority businesses. However, these funders favor older, more established funds; therefore commercial banks and insurance companies as well as minor funding sources (under $5 million) such as government funds, foundations and individuals, play a key role in financing MBEs.

In the early 1990s, only several million dollars in venture capital had been invested in MBEs. According to Bates and Bradford, the minority VC sector now has well over $1 billion in capital under management, with $2 billion within reach. The authors found that minority-oriented venture capital funds grew enormously during the 1990s. The 24 funds that responded to the detailed questionnaire had raised $1.3 billion through year-end 2000. In 1998 alone, five of the surveyed minority-oriented VC funds had raised over $700 million in capital from institutional sources.

Return on investment

Taken together, 117 investments tracked by Bates and Bradford from the 24 MBE-targeted venture capital funds surpassed a 20 percent rate of return. During that same time period, according to industry analysts, the S&P 500 Index had a 17 percent return. Furthermore, Venture Economics (VE) and the National Venture Capital Association derive a Private Equity Performance index. VE tracks the performance of over 1,400 US venture capital and buyout funds on a quarterly basis. As of early 2001, the ten-year trailing average annual return for the Private Equity Performance Index was 20.2 percent.

"This report dispels the most insidious myth about investing in minority-owned businesses," said Amy Domini, founder and CEO of Domini Social Investments LLC, creator of the Domini Index. "It signals to investors, analysts and scholars, that if you overlooked this niche, fearing low returns, it's time to take a second look."

The study used three approaches to measure profits: gross and net cash flows, internal rates of return (IRRs) and cash flow present values. IRRs are perhaps the most widely used measure of venture capital investment performance. An IRR is the discount rate at which the investment's cash flow returns equal the cost of the investment. It does not express the length of the investment's life, its size, or its gains and losses evenly.

Returns were not dominated by a few highly profitable deals. IRRs for the MBE-oriented funds ranged from minus -32 percent to +79 percent, with a median of 19.5 percent and a mean of 23.9 percent. Unlike many other surveys, rather than leave the IRR calculations to survey participants, which previously had resulted in spotty data, Bradford's team calculated the IRRs.

In a regression analysis, higher IRRs were associated with large dollar size of investments (over $1 million), active involvement of VC partners in the portfolio companies and funds that were diversified. Lower IRRs were associated with smaller investments, receiving SBA funding, and specialized investing that emphasized communications firms.

The authors concluded that larger investments earn higher yields and that communications focused funds (with 40 percent or more invested in communications) had lower IRRs than balanced funds. Investments by funds that are highly active in their firms had higher IRRs. The authors also found the nearly universal role of syndication among minority-oriented venture capitalists moderated risk while building value.

Where do minority-oriented funds get their money?

Of the 24 responding NAIC member venture capital funds that are MBE oriented, capital was raised from six major and four secondary sources. The six major sources include: commercial banks and insurance companies (14), miscellaneous, including families, foundations, endowments and individuals (11), corporations (10), intermediaries known as funds of funds (7), public pension funds (6) and corporate pension funds (6).

While public pension funds were the largest source of capital, corporations provided the fewest dollars. Of these major sources of capital, only banks and insurance companies, say Bates and Bradford, have been accessible to newcomers. Minor sources ($5 million or less) have therefore played a key role in the industry's development. These include government, corporations, foundations and endowments, and individuals.

Overall, the funds tapped a median of three types of financial capital resources. Judging from the survey responses, a minority VC fund seeking to raise over $20 million from one funding source would be best off, concluded Bates and Bradford, approaching public pension funds, banks and insurance firms, funds of funds and corporate pension funds.

"At first, profit-oriented sources equated minority-oriented funds with social investing and shied away," noted co-author Dr. William Bradford, endowed professor at the University of Washington, "but as word spreads that these are lucrative investments, this should change."

Where and how do minority-oriented venture capital funds invest?

Minority-oriented venture capitalists don't emphasize high tech. Twenty of the 24 funds surveyed that invested in communications firms were primarily in broadcast, not broadband. Sixteen invested in services (excluding medical), 15 in non-electronics, non computer-related fields. While 13 invested in wholesale and retail trade operations, 12 invested in manufacturing related to electronics and computers.

Because the niche had little exposure to the Internet bubble, the authors predict it will sustain profitability even as mainstream venture capital firms and funds generate losses.

"Picking 'broadcast over broadband' gave minority venture capitalists a healthier return than the industry as a whole," noted Rhonda Holman, a Kauffman Foundation vice president. "No one would be surprised to hear that a minority-oriented VC's last three investments were in broadcasting, especially radio stations, high tech electronics manufacturing and restaurant chains."

Minority entrepreneurs Frank Washington and Amador Bustos both ran such firms. Washington, a 20-year telecom veteran, raised $4 million in venture capital for Systems Integrators Inc (Sii), which he restructured to help debug newspapers for Y2K. In 2000, Sii's sale returned $18 million to equity investors. Today Washington chairs MediaZing, an electronic multimedia advertising firm in Sacramento, CA.

In 1992, Michoacan Mexico native and University of California/Berkeley grad Amador Bustos launched Z-Spanish Radio Network. He turned it into the largest Hispanic-owned satellite radio network in the U.S., with 32 owned and operated stations and 42 affiliates. Bustos credits Syndicated Communications, a Maryland-based venture partners' group, for his success. "It's capital one can't get anywhere else--dreams and start up business plans aren't bankable," Bustos observes. In 2002, he merged his $475 million firm with Entravision, Communications Corp, which has a market cap of $1.5 billion.


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The Ewing Marion Kauffman Foundation of Kansas City works with partners to advance entrepreneurship in America and improve the education of children and youth. The Kauffman Foundation was established in the mid-1960s by the late entrepreneur and philanthropist Ewing Marion Kauffman. Information about the Kauffman Foundation is available at www.kauffman.org.

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June 5, 2000

Venture capitalists focused on non-mainstream deals are making headway, slowly

BY CHRISTOPHER WILLIAMS

Barron's

In 1992, when Laurence C. Morse tried to raise money to invest in minority-linked businesses, he came up with about half of the $200 million he wanted -- and it took him two years to obtain that, an eternity in the venture capital world. Morse, who is co-managing partner of Fairview Capital Partners in Farmington, Connecticut, also fell short in 1995, trying to raise $175 million for a second fund, but this time by only $50 million. But in the spring of 1998, he hit his target for a third, single-client, fund: $50 million. Says Morse, who runs a "fund of funds' that invests in other funds making minority affiliated investments: "It's never been easy raising money in this sector, but it has gotten a little easier."

That could be both the rallying cry and lament of those who work in the small and little-publicized corner of the venture-capital world focused on promising companies owned, run or otherwise linked to minority groups and women. While minuscule compared with the total private-equity capital market, this sector is enjoying a growth spurt.

Minority-focused investment firms control $2.4 billion in assets, up from a bit over $500 million a decade ago, according to an estimate by Fairview. "More capital has come into [this area] over the last five years than in the previous 20 years," says Morse. "But it's still a trickle."

However, the trickle is slowly turning into a steady stream as more minority investment pros, savvier about deal-making and finance than their counterparts of a decade ago, enter the fray. And these venture capitalists are investing in a broader spectrum of companies, from start-ups to mature middle-market and large companies in all industries, Morse observes. Some have done well, backing such corporations as BET Holdings, a leading African-American media firm; Netnoir, a major Web portal aimed at the black community, and Z-Spanish Media, a rapidly expanding Hispanic radio network that's being acquired by Entravision Communications.

Minority venture-capital funds have drawn growing interest from big-time mainstream players, such as Chase Manhattan , Allen & Co. and Citigroup , which has joined with Earl G. Graves, publisher of Black Enterprise magazine, to launch an $86 million fund to invest in mid-size minority firms.

"It's a hot area," declares Luke Sweetser, of the North Texas Opportunity fund in Dallas. He's trying to raise $35-$40 million from pension funds and companies such as Texas Instruments to invest in minority businesses in the Houston area. "We saw it was a neglected market segment with lots of potential," Sweetser declares.

One thing is certain: There's plenty of cash out there. Last year, U.S. venture capitalists invested a record $48.3 billion in various companies, up 151.6% from the previous year's figure, according to the Arlington, VA-based National Venture Capital Association. And funds established to make such investments attracted a record $46.55 billion in 1999, 66.9% above 1998's total.

The recent meltdown in the Internet and tech stocks seems to have had little effect, at least so far. Venture capitalists pumped $22.7 billion into start-ups in the first quarter, easily eclipsing the $6.2 billion recorded a year earlier.

But while the mainstream white players are sloshing around in a sea of capital, minority entrepreneurs and venture capitalists looking to invest in their ideas operate in more of a puddle. Of the $90 billion of institutional equity capital estimated to be invested now in U.S. firms, less than $2 billion is targeted toward minority-focused start-ups, says Courtland Cox, director of the U.S. Commerce Department's Minority Business Development Agency. Only 1% of the funds in the venture-capital community are controlled by minority-owned firms.

The players interviewed by Barron's maintain that racism figures little in this, at least directly. "The reality is that our profession is made up predominantly of Caucasian males," says Sweetser. "Our deal flow comes from our peers." In other words, there are too few minority members in the general venture-capital community to steer money toward firms run by women or Hispanics, African Americans or other minority groups.

Alberto Peisach, a Florida venture capitalist trying to raise up to $50 million for Latin American and U.S. Hispanic companies, is painfully aware of that. Peisach, president of Vision Asset Management in Miami, says he's making little headway in expanding his base of investors beyond wealthy individuals to institutions and insurance companies. "Unless you're referred, they don't listen to you," he laments.


Yet there appears to be no dearth of promising opportunities. Minority-owned companies are growing at more than double the rate of all firms in the U.S., Cox maintains, and an estimated two million such firms are generating sales in excess of $200 million.

"The deal flow is humongous," says Peisach, who adds that he has invested in eight Internet companies over the past three months, all boasting positive cash flow.

One of the major mainstream entrants, Quetzal/Chase Capital Partners of New York City, closed on a $170 million fund on March 31 to invest in communications companies throughout the nation run by women and minorities.

Managing members Reginald Hollinger and Lauren Tyler say they aren't having problems finding potentially lucrative situations. "We've been very pleased with the quality and volume of deals that have been presented to the fund," says Tyler. The fund, with an investment of $7.5 million, led a third-round financing for Urban Box Office, a New York company creating an online network targeting the global urban minority market. It's also put $30 million into Blue/Chip Broadcasting, an African-American radio outfit in Cincinnati, and $4 million into Hookt.com, a New York hip-hop music and lifestyle Internet portal.

One problem for minority venture-capital funds is that most haven't been around long enough to establish the lengthy track records that institutional investors like to see. But many individual minority venture capitalists contend that their returns compare favorably with those of successful general venture-capital and private equity funds: 20%-40% a year.

In January, Peisach plunked down $3.6 million for a 50% stake in Latin American Access, a World Wide Web incubator aimed at the Hispanic markets. Currently, he estimates, the firm, which has alliances with IBM and Hewlett-Packard , has a value of $40 million. He's looking to raise $10 million to expand the venture, which could go public at year-end.

Few minority capitalists have done bigger deals than TSG Capital Group. At $700 million in assets and with backers such as Fairview, Chase Capital Partners and the Mellon Foundation, the Stamford, Connecticut-based private-equity group is the largest player in the minority sector. And its managing partner, Cleveland A. Christophe, says it has always met its financing goals.

Unlike some of its rivals, TSG targets outfits that serve minority markets, but aren't necessarily owned by minorities. TSG acquires a controlling interest and assumes a very active role in its investments, which typically reach $100 million in equity capital.

One of Christophe's bets was on Envirotest, the once publicly traded leader in centralized vehicle-emissions testing. In 1990, TSG (at the time called Equico), invested $2 million to help buy the emissions-testing operations of United Technologies for $56 million.

Christophe helped take Envirotest public at $16 in 1993, turned it around after it had stumbled and sunk below $2 in 1997 and then engineered its buyout for $600 million in 1998 at $17.25 a share. Equico, which controlled 2.3 million shares at the time of the buyout, realized a gain of $44 million on its $2 million stake, the venture capitalist notes happily.

No one makes money on every deal, of course. About a quarter of the 25 operations in which TSG has invested over the past 16 years have been losers. But, Christophe says, his firm's compounded return over that period exceeds 40%.

One of the companies in which he invested, Urban Brands -- a 300-store apparel chain focused on plus-size women -- may be an IPO candidate. And TSG has high hopes for Z-Spanish, which is being bought by Entravision for $475 million. He says TSG's initial $2 million investment in Z-Spanish, made in 1996, has grown to $90 million.

"We believe [the minority-linked business] sector will always deliver superior returns," says Herbert Wilkins Sr., head of Silver Spring, Maryland-based Syncom Management, one of the oldest and largest companies in this investment area, with $165 million in assets. One advantage investors in this area have, he says, is selectivity. "We've got the pick of the crop. All the money is running after dot.coms. This sector is going begging."

Somewhat ironically, with mainstream giants such as Bank of America and Chase sniffing around, competition promises to heat up for the best deals. "We see it as good business," says Edward Powers, of Bank of America's community development venture-fund portfolio, which over the past year has made commitments to provide more than $100 million to 11 regional and national private equity funds focused on businesses run by women or minorities.

Still, for many mainstream investors, the tremendous gains generated by Internet-related funds in recent years blunted interest in just about anything else. Morse ran into this problem when he was raising money for his second fund, "in an environment when the best [technology] funds were generating absolutely extraordinary returns of 90%-150%. There's not a reason [for those investors] to look for new niches."

Udayan Gupta, founder of biztrail.com, an online minority-venture-capital resource and author of the coming book Done Deals: Venture Capitalists Tell Their Story , notes that Internet investments are exactly what institutional investors are still looking for. He thinks a lot of small minority venture-capital firms don't have the skills to jump on trends in information technology or, if they do, take too long to make decisions.

New York entrepreneur Robert Bolder was a victim of such deliberation. The 45-year-old African American sought angel financing for his software-development company, Codepower.com. He approached many minority investment firms, but a hard commitment was slow in coming. Frustrated, Bolder accepted $850,000 in seed financing from Institutional Equities, a mainstream firm based in Dallas. "We needed to find a venture-capital firm that could help us in real time," he says. Bolder's site should begin operating this month and could go public in November.

Minority venture capitalists aren't missing the Internet boat entirely, of course. Syncom is invested in several such operations, although they're just a small part of its holdings. And there are minority funds with an Internet and high-tech focus, such as New Vista Capital, a $50 million firm in Palo Alto.

Of course, if the Internet stocks don't regain a lot of the ground they've lost in the past few months, more venture capitalists may be looking elsewhere anyway for promising deals.

Reprinted by permission. Copyright 2000 by Dow Jones & Co. Inc. All rights reserved.

Wednesday, July 30, 2003

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