As the Internet seeps into every corner of the private equity market, key players in the New Economy have had to find new ways to absorb the financial success of the ever-increasing number of dotcoms. And as they say, if you can’t beat them, join them.
That’s exactly what a number of buyout firms like Kohlberg Kravis Roberts & Co., Hicks, Muse, Tate & Furst and Francisco Partners have done, each forming strategic partnerships with venture firms to extend their investments into the realm of VC.
One of the most recent examples of such alliances took place in March, when J.W. Childs Associates LP linked up with Boston-based Internet Venture Works (IVW), an Internet accelerator formed in December.
Meanwhile, executives from buyout giant KKR and Internet-focused Accel Partners in February partnered to create Accel-KKR Internet Co., which will invest in companies seeking to combine their online and offline strategies to create more rapid growth and value (VCJ, April, page 5). Both firms believe hybrid enterprises such as theirs are the wave of the future.
In another deal, publicly traded venture firm CMGI Inc., along with Hicks Muse and Pacific Century Cyberworks Ltd. in March formed @Ventures Global Partners, a $1.5 billion venture capital partnership targeting Internet companies in Asia, Europe and the Americas.
With a slight variation on the new Accel-KKR enterprise, IVW and J.W. Childs, which specialize in buyouts and growth equity investments in middle-market growth companies, are also positioning themselves for the future. Most market observers say this partnership, focusing on turning bricks-and-mortar into click-and-mortar enterprises, is clearly a win-win scenario for both firms and their portfolio companies.
Francisco Partners, a new private equity firm that makes information technology investments, formed a strategic partnership with early-stage technology investors Sequoia Capital Partners. Sequioa will likely invest in Francisco Partners’ debut fund and will assist with the due diligence process for Francisco’s deals.
Glenn Hopkins, managing director at J.W. Childs, a buyout firm with $1.5 billion under management, said the firm evaluated various options, including hiring consulting firms or selling a minority stake of an online subsidiary to venture capitalists to unleash the potential e-commerce opportunities in their portfolio companies. Then they crossed paths with IVW, a new Internet accelerator with a similar idea in mind.
“The idea is to put together an organization that combines the best of all possible worlds,” Hopkins said. “IVW brings together a group of proven, highly competent Internet entrepreneurs and executives who can go in and marry their Internet expertise with the sector expertise of our portfolio company management teams in order to generate the best possible e-commerce business out of that combination.”
Hopkins would not disclose the value of the deal, but said J.W. Childs has a minority stake in IVW. IVW has since partnered with search engine Lycos Inc. According to a statement from Lycos, the agreement provides the potential for online distribution of portfolio companies’ products and services across the Lycos network of Web sites, giving the new start-ups rapid access to nearly half of all U.S. Web users.
You Scratch My Back . . .
Probably one of the most compelling elements of such a partnership is that all parties have much to gain. Buyout firms are scampering to get Internet credits in their portfolios and there are myriad Internet companies in need of funding that can be provided by an established private equity firm.
“They take their bricks-and-mortar financial expertise and management expertise, and we take our Internet dotcom management and financial expertise,” said Rob Frasca, chief executive officer of IVW. “We pull the two together and there is a big treasure chest of unlocked value. And for us, that jumpstarts our business, and for them it unlocks serious value from an already existing portfolio.”
Quality Stores, a $1.3 billion retailer of specialty agricultural supplies, is the first of J.W. Childs’ portfolio companies to be readied for the e-commerce market. The company expects to go live in June. IVW calls its process of acceleration – transforming bricks-and-mortar (BAM) companies into clicks-and-mortar companies – the “dotBAM” model.
VC/LBO Partnerships Old News
While those who are involved in crossover partnerships like the J.W. Childs/IVW venture are excited to begin conquering the new world of investments and trump them up as the wave of the future, others consider the partnerships between buyout firms and venture capitalists as nothing new.
“We’ve been saying for years that venture and the buyout areas tend to blur . . . it’s not a new thing,” said Edgar Soule, managing director at gatekeeper Abbott Capital Management LLC. “There are some buyout firms that see the appeal of venture capital and are starting to dip their toes in that, and there’s some venture funds that have been doing leader stakes. People adjust to the market.”
The core of this partnering trend does not lie in the decision to ally, but rather in the needs that are ushering in these alliances. For many firms these days, venture capital does not mean industries such as health care, life sciences and communications, but just one industry – the Internet. And this industry is forcing the need for certain skills in management and infrastructure that buyout firms simply do not have. Therefore partnerships with venture capital firms and Internet companies become a viable, not to mention lucrative, option.
“The Internet is a somewhat new and different world,” said Hopkins. “And for a lot of guys who have had long and hugely successful careers in their industries, it requires a whole new set of skills, tools, business metric and the like that they are struggling to get comfortable with.”
IVW sees itself as extending its contribution beyond developing a business plan. “Up until now the only kind of opportunity for a bricks-and-mortar company to build a dotBAM was to talk to a venture capitalist,” Frasca says. “What the venture capitalist is going to do is hire in a CEO and help write the business plan and go away. We provide the infrastructure, the technology, we have an engineering team. We really roll up our sleeves to accelerate these companies to market. And we provide the functionality of a VC and an incubator along with the buyout expertise.”
In addition to the technological guidance that a VC firm or Internet company can provide, buyout firms may also find they have an inside view into future e-businesses and can then utilize this information in developing a strategy – turning a strong player into an industry leader using e-commerce tools.
The buyout firm is not the only party that benefits from this partnership. For an Internet company, having a private equity firm behind it or not can be the difference between success and failure. According to Matt Miller, chief operations officer of IVW, bricks-and-mortar companies have the brand name, distribution, product and customers – many of the things that the current e-tailers are missing.
Dotcoms can make considerable reductions in their spending by acquiring a brand name and customers, rather than starting from scratch. “You [look at] some of these [pure-play dotcoms] and they’re spending $30 million quarter-to-quarter trying to build a brand. All they have is, quite frankly, a Web site, and you can’t do that forever,” Frasca says.
The Road Less Traveled
So while firms like Childs and KKR are already taking advantage of the New Economy, it is likely that many others will follow suit.
“Our LPs, who are all well aware from our annual meeting of our efforts with IVW, are very supportive of the fact that what we’re doing here is launching an effort to allow each of our portfolio companies to maximize the value of their Internet opportunity,” Hopkins says.
And if Frasca and Miller have their finger on the pulse of the New Economy, then the firms that choose not to take advantage of this trend may have a rocky road ahead of them. “Talk to the analysts out there – and we have – and they echo what we’re saying,” Frasca says. “And that is that the bricks-and-mortar companies have to wake up. Some of them are going to get burned if they don’t come in. That window is only open for a very short period.”