Second chances

Two decades after it laid the foundations for the private equity secondary market, Paul Capital continues to innovate.

This year has been one of milestones for Paul Capital Partners. In February it became the first secondaries firm to open an office in Latin America. In May, the firm closed its ninth and largest ever secondaries fund, raising a total of $1.65 billion ? in excess of both its $1.25 billion initial target and its $1.5 billion hard cap. The fund is over eight times the size of Paul Capital's first institutional fund, which closed on $202 million in 1995.

Paul Capital has come a long way. For four years before that first fund, the firm only raised capital for deals a one-off basis. In those days, private equity secondaries activity was more a series of transactions than a formal marketplace, says Paul Capital partner David de Weese. Paul Capital, along with other early movers like Coller Capital and Landmark Partners, in large part institutionalized the sector.

Phil Paul founded his eponymous firm in 1991. During the 1980s he had been chairman and CEO of the Hillman Company, the investment vehicle of Pittsburgh steel-and-coke billionaire Henry Hillman. When Hillman decided to reallocate his assets to endow a medical foundation, Paul offered to buy out Hillman's interests in 42 venture capital and leveraged buyout funds for $85 million, and Paul Capital was born. Five investors supported the transaction: the pension trusts of DuPont, AT&T and Hughes Aircraft, as well as BancBoston and the Howard Hughes Medical Institute.

?They were institutional investors who had all had allocations to private equity, but who had not really done a secondary transaction,? de Weese recalls. ?It was one of the first large secondary transactions. There wasn't even a name for the market at that point.?

Henry Hillman had been among the earliest investors in private equity and venture capital in the US. Hillman's capital was nearly three-fourths of Kleiner Perkins Caufield & Byers' first, $8 million fund in 1972, de Weese says.

Hillman was also an early backer of Kolhberg Kravis Roberts. The relationships and reputation Paul Capital enjoyed because of its connections to Hillman were a boon to the new firm in the years following the transaction. Even in its earliest days, when the firm had a staff of two, it was able to access blue chip institutional investors. In fact, when Paul Capital did decide to raise a blind pool of capital in 1995, it was because its investor base had grown large and Paul Capital's backers found themselves writing too many small checks, de Weese says. Now, the firm's secondaries platform alone has between 200 and 250 limited partners, and invests in every industry except real estate oil and gas. Paul Capital has offices in New York, San Francisco, London, Paris, Toronto, São Paulo and Hong Kong, and more than 60 employees. The firm's business has also expanded to include two additional lines of investment: healthcare royalty and revenue interests and private equity fund of funds.

Paul Capital Partners

Year founded: PARTNERS:
Fund of funds:
Total number of employees:
88 David York and Phil Paul
Assets under management: David de Weese, Simon Guenzl, Dan Mulderry, Guy Rico,
$4 billion Bryon Sheets, Elaine Small, Brian Sullivan
Offices: Healthcare:
San Francisco, New York, London, Paris, Toronto, Walter Flamenbaum Lionel Levanthal, John Leone,
São Paulo, Hong Kong Ken Macleod, Jean-Pierre Naegli
Paul Capital Partners I-IV 1991-1995 $92 million Individual transactions
Paul Capital Partners V 1995 $202 million Secondary investments
Paul Capital Partners 1997 $48 million Acquisition of an interest in Merrill Lynch Capital
Appreciation Ltd. Partnership II Cayman Ltd.
Paul Capital Partners VI 1998 $273 million Secondary investments
Paul Capital Partners VII 2001 $808 million Secondary investments
Paul Capital Partners VIII 2004 $960 million Secondary investments
Paul Capital Partners IX 2008 $1.65 billion Secondary investments
Paul Royalty Fund 2000 $294 million Healthcare royalties and revenue interests
Paul Royalty Fund II 2003 $657 million Healthcare royalties and revenue interests
Top Tier II 2002 $478 million Fund of venture capital funds
Top Tier III 2005 $620 million Fund of venture capital funds

Keeping it all together
Keeping tabs on the firm's thousands of assets is also quite a task, simply due to the nature of the industry. A typical buyout fund might make three investments in a year, and might have a team of a dozen examining each of these investments for six months before committing capital to a deal. But for Paul Capital, which looks at some 3,000 portfolio companies a year and closes on funds that hold maybe 500 of those, a long due diligence period might be two days.

?We're never going to know ? hopefully ? as much as the general partner who made the investment in the first place,? de Weese says. ?Our job is to sanity check the information they give us. We're buying the fund after they've been in the investment three to five years; we can look and see what the GPs have actually done.?

Of course while one portfolio company's failure might sink a primary fund, it will rarely irreparably damage one of Paul Capital's secondaries or fund of funds. The flip side is that ?you never own enough of Google to make a fortune,? de Weese says.

Paul Capital monitors the funds down to the company level. The investment team follows the whole portfolio's performance, and the accountants receive quarterly reporting from the funds. But as the firm's most recent secondaries fund alone holds positions in more than 200 funds, and around 2,000 companies in those funds, Monitoring all of them would be impossible. To manage the burden, Paul Capital tends to focus on the more substantial investments.

?It's managing a combination of keeping your eye on the overall performance of the fund holdings in our portfolio as well as keeping your eye on the performance of the performance of the key larger companies within those funds,? says Jensen. ?Of course that necessarily leaves the monitoring of the smaller individual company positions out of our day-to-day focus.?

The firm uses two sets of IT systems to manage all this data, Jensen explains. The first is a due diligence system of sophisticated Excel spreadsheet models that the firm has enhanced and expanded over time. The second a tracking system: Sungard's Investran. Paul Capital uses the system to track its own funds, including everything from information about investors to accounting records, as well as track the value of all transactions that have occurred within the underlying investments in any of its funds, down to the company level.

The firm also uses Intralinks to manage communications with its LPs. Intralinks is secure web portal where Paul Capital posts correspondence to its investors, including quarterly reporting, capital calls and distribution notices. The firm has also expanded its use of Intralinks to share information with prospective investors as well.

The implementation of FAS 157 has naturally made Paul Capital's life more difficult, Jensen says. The firm now has to spend a great deal of time evaluating the methodologies used by the fund managers in its portfolios to ensure they are compliant.

?Our documentation and support process for valuation has significantly increased with the implementation of FAS 157,? Jensen says. ?So we have had to dedicate significantly more resources to the documentation in the valuation process and to validating valuation approaches used by the GPs of our fund holdings.?

The firm has to do more planning up front to manage the process more efficiently throughout the year, and has had to streamline its accounting processes. The firm has occasionally tapped in outside contractors with expertise in the area as well.

Given the firm's far flung offices and diverse strategies, maintaining the dynamic of a tight-knit partnership requires special attention, says chief financial officer Phil Jensen. The bulk of the buyout team is based in New York, while the venture team is in San Francisco. Most of Paul Capital's back office support is housed in San Francisco as well. Investor services, the division of the firm that furnishes LPs with information and data, resides in San Francisco, while investor relations is in New York. Each coast has IT operations, although the head of IT is located in New York. Then there are the offices in Paris, São Paulo, Toronto, and Hong Kong, which are all primarily dedicated to secondaries.

But despite the geographic spread, de Weese stresses that there is only one secondaries investment committee. No office makes decisions in isolation; the partners get together by conference call or video conference at least once a week to discuss all the transactions in the pipeline. A lot of those transactions turn out to be multi-office deals: the seller of the assets might be based in New York, but maybe a few of the funds in the portfolio are in Silicon Valley, and maybe some of the assets in those funds are in Europe. Working around time zones can be a bit unwieldy, but on the whole communication is constant, de Weese says.

There is a fair amount of synergy between the platforms as well. If someone from the secondaries program is looking to make an investment in a group of assets that includes a life sciences company, he can reach out to someone in the healthcare royalties group. The fund of funds team can reach out to the secondaries team for help finding or evaluating general partners. Sometimes the fund of funds team will invest alongside the secondaries team. In last year's spinout of Scale Venture Partners from Bank of America, the secondaries team spoke for $75 million of the portfolio and the fund of funds program acquired $25 million.

Growing and growing
The secondary market continues to evolve at a rapid clip, as more investors begin to use it as a portfolio management tool. Capital raised for secondary transactions reached $15 billion in 2007, more than double the $6.4 billion raised in 2004. The market is being shaped by the arrival of dedicated intermediaries and increasing competition. The emerging markets are also beginning to bear fruit.

Turmoil in financial marketplaces around the world will likely yield some interesting buying opportunities, Jensen says. And at press time, the firm was planning to launch two new products in the coming months. ?Our teams will be very busy in the next year or so,? Jensen says.