Major institutional investors and wealthy individuals, spooked by volatility on Wall Street and seeking to diversify, are diverting a record amount of money into Los Angeles-area private investment funds.
So far this year, local leveraged buyout firms have raised at least $3 billion, and local venture capital funds have raised at least another $1 billion. The new wave of capital is in addition to pre-existing mountains of cash that local funds have had at the ready to invest.
“Five or six years ago nobody would have believed these numbers,” said Arthur Levine, managing director of Beverly Hills-based Levine Leichtman Capital Partners LP, which earlier this month held a “preliminary closing” for a $310 million fund that will be used for late-stage venture capital investment. (A preliminary closing, which occurs shortly before a fund stops accepting additional investments, is the point at which the fund begins making investments.)
“I think there are a lot of people who are looking at the stock market and deciding that it can’t get any better, so they are switching their money from public to private investments,” Levine added.
These funds are essentially in the business of accumulating cash and then placing investments – often in privately held companies. Once a company’s value has been enhanced – whether through consolidation, restructuring or any number of strategies – the fund will typically divest it, distributing the proceeds to investors or using them to make further acquisitions.
West L.A.-based buyout firm Leonard Green & Partners has raised the largest pot of cash locally, according to several local fund managers. In the first week of September, the firm will hit the preliminary close on its latest fund, at which point it will have about $1.2 billion, Leonard Green officials said. That amount will likely go even higher by the final close, which is slated for some time in the third quarter, the company said.
Leonard Green’s most recent fund-raising effort dwarfs the prior $311 million fund that closed in 1996.
The company specializes in buying up, merging and then reselling companies, many of them local, at a profit.
“We like the Southern California market a lot,” said Peter Nolan, a partner at Leonard Green. “We would like to dominate the local opportunities. We will be net buyers of companies for the next few years.”
Nolan said the firm this year will make equity investments of around $175 million to leverage transactions worth just under $1 billion.
Nolan said that Leonard Green, which in the past has focused heavily on the retail sector, is looking to increase its presence in the auto repair and financial-services industries. The firm just recently signed a letter of intent to buy an East Coast financial-services company for about $250 million, Nolan said, declining to name the company.
Freeman Spogli & Co., based in West Los Angeles, is also sitting on a large pile of cash. The firm closed a $915 million fund in March, the largest in its history and almost equal to the roughly $1 billion the firm had previously raised in its entire 14-year history.
The firm’s most recent prior fund, closed in 1993, totaled $580 million.
The cash bonanza pouring into Freeman Spogli is good news for local companies because much of the money raised will be spent on the West Coast, said founding partner Brad Freeman.
“We invest everywhere, but we have more relationships on the West Coast so I suppose we have a disproportionately large number of deals out here,” he said.
Freeman Spogli’s more recent acquisitions have been in the medical devices and publishing sectors. Just last week, Advance Auto Parts, a Roanoke, Va.-based company 86 percent owned by Freeman Spogli, agreed to buy the Parts America chain from Sears, Roebuck & Co. for $175 million.
Freeman said the surge in money flowing into L.A.-area investment funds is coming primarily from institutional investors such as pension plans and insurance companies.
“A number of pension funds are getting allocations to this investment class,” he said. “These plans have pools of $40 billion or $50 billion, so even a 4 or 5 percent commitment can be a very large amount of money.”
There is some concern that the glut of available capital might intensify competition between the LBO and venture capital firms. That, in turn, could lead to higher prices and slimmer profit margins down the road.
“You have lots of money chasing a few good deals,” said Lloyd Greif, president of downtown investment bank Greif & Co. “To that extent you have a lot of funds trying to outbid each other.”
In many ways, private funds compete with Wall Street. When the equity markets are soaring, privately held companies are more likely to seek capital there, through initial public offerings. Likewise, public companies are more likely to use their high-priced stock to buy up private companies.
But when Wall Street slumps, private companies are more likely to turn to private investment funds for capital infusions or acquisitions.
“I don’t want to badmouth the stock market, but when stocks are down we are excited,” said Nolan. “We’re long on cash, so when stock prices go down, there are opportunities for us.”
While both Leonard Green and Freeman Spogli have closed funds with well over $2 billion so this year, the amount of money controlled by local investment funds is estimated to be much larger.
Aurora Capital Partners, one of the largest LBO funds based in Los Angeles, would not release any information regarding its fund-raising efforts or investment strategy. Industry sources, however, said that firm has between $500 million and $750 million available to invest.
Apollo Advisors, the LBO fund based in New York but with a major L.A. presence, closed a $3 billion fund in April.
A similar surge in funding is coming into local venture capital firms.
Levine Leichtman Capital Partners set out to raise $300 million in its most recent fund, the second in the company’s history. As of Aug. 1, it had already exceeded that amount, hitting $310 million. That figure is expected to grow a bit more before the final close in the next few months.
Levine said a large portion of the money raised will be invested in Southern California companies.
“I just think that Los Angeles is a very diverse economy and that there are a lot of companies that are looking for money,” he said.
Reprinted with the permission of the Los Angeles Business Journal. August 24, 1998