Pacesetter Capital Group
Its History and Leadership Role in underserved Markets and
Pioneering Role in Developing Emerging Fund Managers
and Dedication to Creating Larger Minority Businesses
By
Don Lawhorne
President and CEO
Pacesetter Capital Group
October 2007
ABOUT PACESETTER CAPITAL GROUP (PCG)
THE BIRTH OF PACESETTER CAPITAL GROUP
The nearly 40 years of history here at Pacesetter began in 1970 with one fund, MESBIC Ventures, Inc. (MVI), the nation’s oldest surviving Minority Enterprise Small Business Investment Company (MESBIC). The MESBIC program was an extension of the Small Business Administration’s (SBA) Small Business Investment Company (SBIC) program which was established in 1958. The MESBIC program was designed to attract private capital to leverage capital from the SBA to finance mostly so called minority-owned small businesses (MBEs).
The initial license was granted to UCC Ventures and was funded with $150,000 provided by University Computer Company (UCC), a Dallas based entrepreneurial firm founded by Sam Wyly. At the time, MESBICs were eligible to leverage their private capital up to four times. That meant that in 1970 UCC Ventures’ initial $150,000 was eligible for up to $600,000 in SBA funds, thereby creating a $750,000 pool of capital for investing into MBEs. By 1972, it became apparent that this endeavor might work even better as a “community fund” owned by a consortium of corporations and banks interested in helping MBEs. With a ground swell of corporate support fostered by the founding president, Walter Durham, UCC Ventures was spun off and renamed MESBIC Financial Corporation of Dallas. Walter raised nearly $5 million of new private capital over the next decade or so from over 50 corporations and banks.
THE TRANSITION FROM SOCIAL INVESTING TO ECONOMIC INVESTING
I got involved in 1980 after having met Walter Durham through a graduate school classmate. At the time, I was a college administrator and faculty member at Brookhaven College in the Dallas area. I had hired Walter Durham to teach a small business course on Tuesday mornings. Over the next year or so, Walter began promoting the idea that my academic credentials, corporate and military experience, college teaching, and personal interest in diversity could be a great fit for MESBIC’s needs. Initially, I could not see a fit, since I had no direct work experience in finance, accounting, or small business. I did have two significant data points on the importance of diversity. While in graduate school, I wrote my thesis on the relationship between leadership styles and discrimination charges filed with the EEOC.
Secondly, I had several years of large company experience in the middle 70s that included a tour in human resources. While there, I wrote an “Affirmative Action Plan” which led to the company receiving a commendable rating from the EEOC and earned me a promotion. What appealed most to me about MESBIC was the idea of working with entrepreneurial firms and their owners. Hence, I took a semester leave of absence from Brookhaven College to confirm the fit. It worked and I spent the next two years working directly with a variety of small businesses.
Except for my first few months of analyzing the portfolio companies and getting a handle on the regulatory requirements for a MESBIC, I spent most of my time working major assignments directly with portfolio companies. My favorite assignment lasted about six months and involved a local electronic component distributor with three best-of-the-breed, fast growth semi-conductor lines at the time. As I got near the end of this assignment, the company was at breakeven and I had lined up a strategic alliance with a very large regional distributor who was very eager to help grow the top line for this struggling Hispanic-owned entity. Little did I know at the time, my work there would lead to my own chance at the helm of an entrepreneurial enterprise. About a year later, the Chairman of that regional distributor called me and asked if I would be interested in taking on the President and CEO positions of a small, well established passive component distributor with three locations here in the Southwest.
By this time, I had a little over two years at the MESBIC and really enjoyed working with the entrepreneurs, and particularly problem companies. I had made enough forward progress in each assignment to believe that I could run a small business. Equally important, when I joined the MESBIC, the plan was for me to have a shot at the CEO position within two to three years. However, my own assessment was that the founding CEO had the best MESBIC job in America and that he would likely remain CEO much longer than I was willing to wait. So with my newly established confidence, I leaped. It was a blind leap of faith, into yet another incredible small business experience.
THE ROAD TO BECOMING A RECOVERING ENTREPRENEUR
Within 18 months, I had doubled the annual revenues of this small firm and orchestrated a management buyout during what some would say were the early stages of outsourcing by many OEMs (Original Equipment Manufacturers) needing large amounts of electronic parts and assemblies. I felt great and so did my Board. The bad news was the next 18 months. The other side of outsourcing locally soon brought the first wave of electronic parts from mostly global companies, particularly Asian suppliers into the US market. I saw two vectors emerge that shortened and stalled what had been this industry’s growth cycle that had historically lasted an average of five years during the previous two decades. Suddenly the cycle was shortened to less than two years, an indicator of what would eventually impact most industries in the decade ahead.
Vector one came at or near month 30 of my MBO (Management Buyout) when the five-year cycle experienced a rapid contraction. Vector two saw interest rates spiral to 18% which subsequently led to a major decline in the availability of growth capital, especially for many early stage companies seeking to fuel their new products and services. These forces accelerated the demand for cheaper components and related parts which led to my gross profit margins plummeting from a high of nearly 40% to the low 20s. Plus, a couple of my most promising growth customers fell delinquent, and one filed bankruptcy. I was soon in a major workout of my own company.
Bottom line, I liquidated my company outside of bankruptcy with an unusual amount of support and flexibility from my senior lender. While winding down operations, I started a small contract manufacturing firm in the back of the failed business. This new firm grew enough that I eventually sold it and paid off the short fall on the bank loans of the failed distribution company that had my personal guarantee. Tired and tattered, having experienced the downside of losing my entire net worth and equity funds from several friends, I knew I had to start over and use the good and bad entrepreneurial experience to my advantage going forward.
Coincidentally, the founding president of MESBIC announced his plans to leave as I was positioning my manufacturing company for sale. I applied for the MESBIC CEO position and was honored to get it. At the time, my skill set was near perfect for the job. I had previous experience at the MESBIC and now over three years as an entrepreneur, plus my corporate, military, and academic experience. I dubbed myself “a recovering entrepreneur, former college teacher and administrator, turned small business venture capitalist.”
THE RECOVERING ENTREPRENEUR BECOMES VENTURE CAPITALIST
When I became CEO in 1985, we had $5 million under management which meant that the MESBIC had grown from $150,000 in 1970 to $5 million 15 years later. Of that $5 million, $3 million was in Certificates of Deposits (CDs) earning 18%, and the remaining $2 million was invested in about 15 MBEs. The MESBIC had lost nearly 50% of everything it had invested since 1970. So did all the other MESBICs. It had been a rugged road with no meaningful economic success during the first 15 years for this specialized industry. By 1985, these pioneering efforts reinforced the notion that underserved markets and minority businesses were more social, minor, diminutive, and not the ideal place for ROI capital.
Like most MESBICs in the middle of the 1980s, our portfolio was like a farm camp with many promising players. We were providing these small business owners an opportunity to refine their entrepreneurial skills. In reality, our money was the tuition money allowing entrepreneurs to master Job One: Generating positive cash flow from operations ASAP! This skill set is essential to becoming an effective entrepreneur and vital for raising capital. Without economics, the social expectation would remain enabled and take decades to undo.
As the new CEO, I had these objectives:
It was these priorities that helped get us off the social paradigm and move forward to the promise land of competitive returns as a basis for managing substantial funds in order to do larger deals. With this agenda, I set a goal in 1985 to have $10 million in assets by 1990. In 1990, we hit $12 million. In 1990, I set a goal to have $100 million by 2000. In 2000, we came in over $120 million.
In 2000, I created what I called Vision 2010. I wanted MESBIC, now renamed Pacesetter Capital Group (PCG) to have $1 billion under management with a best of the breed, diverse fund management team. By 2005, we managed six funds, three SBICs and three private equity funds with assets of nearly $250 million. The impact of the triple hit of 9/11, the market meltdown, and Katrina, had a dramatic impact on our growth plans as many of our businesses encountered severe contractions.
We have consistently had the most diverse fund management team in the industry. Between 1993 and 2005, we recruited and helped develop over 12 emerging managers and several entrepreneurs through our operating partner model. Today, many of these talented individuals have become senior fund managers with mostly new Funds.
I was blessed to have Tom Gerron as my CFO until his retirement in 2003. When it comes to company building and fund management, a great CFO is a must and Tom played a vital role in our success formula. What prepared us for doing larger deals were the major upgrades to our Deal Team beginning in the early 1990s. This quantum leap in talent began with our first seasoned deal professional “Deal King,” Divakar Kamath, hired in 1993. Divakar gave us a national reach for deal flow and extreme competence in sophisticated transactions. Linda Roach (1996) became “Lady Pacesetter,” a brilliant relationship manager and was a master at high yield transactions.
Linda is now “Lady Oakcrest” at Oakcrest Capital, a new private equity Fund launched by J.C. Watts, former Oklahoma Congressman and star athlete at Oklahoma University. Richard Venegar (1999) was hired to work with our under-performing deals and served us well. He is now the CEO at Milestone Growth Fund. Steve Martinez (1997), now a General Partner at Aurora Resurgence was a remarkable hire with best of breed academic credentials and super high yield debt deal making skills.
Guillermo Borda (2001), now with Bank of America, Private Equity, built a great risk management system during his four years at PCG while advancing our knowledge of best practices in documentation and relationship management with major corporations and banks. Rahul Vaid (2001) is the master deal maker who built our thriving technology practice. Our bench strength went ever deeper with several bright and highly talented portfolio managers and analysts hired over the past decade.
PCG’S NEARLY FOUR DECADES OF EXPERIENCE IN UNDERSERVED MARKETs
As I look back over PCG’s nearly 40 years of history and standing as the oldest family of funds dedicated to providing growth capital for wealth creation through company building in emerging markets, I see three distinct periods, 1970-1985, 1986-2000, and the new millennium, 2000 and beyond. I named each:
1970-1985: The Era of the Pioneers.I see several unique characteristics to this period. First, it starts on the cusp of the passage of the Nation’s highest impact civil rights legislation. This law allowed for major breakthroughs in education, employment, job advancement with major corporations and public entities. It is a period where integration accelerated allowing promising talent to move away from historically segregated communities, which already had many successful community-based minority-owned businesses.
Corporate America began placing more and more men and women in fast track upward mobility programs. This led to middle and senior managers in finance, operations and engineering, the areas where the language of profits and cash flow are best learned. Plus, the early 1970s saw the creation of the MESBIC program, the first wide scale attempt to increase the supply of growth capital to MBEs. Equally important, the National Association of Investment Companies (NAIC) was launched as the sole advocate for the MESBIC industry. Its mission, then and now, remains to increase the availability of growth capital and to attract more diversity among private equity fund management teams. NAIC remains an unstoppable force in improving access to capital and diversity among private equity firms and fund managers.
During this time there were a few good outcomes and some unintended bad outcomes. The latter included far too much social investing by inexperienced fund managers with equally inexperienced entrepreneurs. This led to dismal ROIs for nearly all of the specialized SBICs. While nearly 200 specialized SBICs were created in this era, by 1985 there were only seven or eight, including Pacesetter’s SBIC, with more than $5 million under management. And, there would soon be less than 30 surviving specialized SBICs, mostly owned by Asian Americans doing Asian American deals in that community.
Without solid economics, the message remained minority means social, small, diminutive, mostly inner city based businesses, too much dependency on so called set aside procurement programs, and a hotbed for political and legal posturing about race. Except for uncertain levels of SBA leverage funds and a few large banks seeking CRA (Community Reinvestment Act) credit, sorely needed private capital was at risk of becoming ever less available.
The good outcomes during this era were manifold. First, these pioneering funds and their emerging managers did help bring some of the more promising entrepreneurs and their firms to the forefront in their markets. This visibility helped create more business development opportunities and an increasing awareness within the financial community that this market wasn't going away. In 1985, there were less than 10 MBEs with annual revenues above $5 million in Texas. Pacesetter had invested in most of them. These same companies spawned even more entrepreneurial talent for the next era.
Plus, the specialized funds that survived produced the first generation of emerging fund managers experienced in under-served markets and managing private equity funds for competitive returns. These seasoned fund managers became known as the Deans of the private equity market dedicated to this niche. Deans and their funds became the primary training grounds for many of today's highly talented emerging fund managers. The major gap at the close of this era was far too little capital compared to the available talent and investment opportunities.
These pioneering funds included Pacesetter Capital Group (PCG), Opportunity Capital Partners (OCP), Fulcrum Capital Partners (FCP), Syndicated Communications (SYNCOM), Capital Dimensions Company (CDC), EquiCo Capital, Broadcast Capital, and Minority Equity Capital Company.
1986-2000: The Parting of the Green Sea.Here too we find several unique trends. Many of the talented managers who had risen into senior corporate positions had excellent incentive packages when Corporate America began what was called at the time “right sizing.” These highly experienced executives often took “buy outs” and went on to establish their own businesses. This group of seasoned executives had three unique advantages over the crop of entrepreneurs already on the playing field. These former corporate managers had 1) excellent academic training, 2) exceptional leader/managerial experiences, and 3) great relationship capital. 1985-2000 included numerous mergers, an abundance of IPOs (Initial Public Offerings), mostly technology, and a rapid rise in private equity.
Again, the NAIC was the primary source for increasing the availability of growth capital to underserved markets and diversity among fund managers. In the early 1990s, the rapid rise in private equity had virtually no money going to underserved markets and emerging Fund managers. The NAIC had been seeking to address this trend for most of the late 80s and accelerated its focus in the early 90s. Thanks to the NAIC’s great leadership under JoAnn Price, by 2000 over $2 billion in assets were placed in Funds, mostly serving underserved markets and/or managed by diverse fund management teams.
These trends provided many channels for these corporate players to apply their professional management skills across a broad range of industries. This cross-fertilization further broadened the “networking” reach for corporate players turned entrepreneurs. By the mid-1990s, there was plenty of talent, increasing opportunities, better access to money, and relationships to make things happen. The serial entrepreneur was born, especially in technology. Build, sell, and do it again, and again!
The downside was within what I saw as an imperceptible growth disruption that hit many of the entrepreneurs of the 80s and early 90s. These seasoned men and women were highly experienced in the “old economy industries” which were increasingly becoming vulnerable to technology and global “outsourcing and off-shoring.” Also, this era saw a quantum leap in fast growth companies owned and lead by mostly Asian-Indians and Asian-Americans. This group was deep in technology and even deeper in global outreach for manufacturing and technology service companies. Many of the African-American and the Hispanic owned companies formed in the 70s, 80s, and 90s remained in the old economy and at risk of not being “globally competitive.” Equally important, some were stuck in their own outdated paradigm for company building.
2000 & Beyond: The New Millennium the Emerging Fund Manager Meets the Flat World and the Rise of the Serial Entrepreneur.This is the era of addressing diversity in private equity fund management and teams for company building as the flat world supplier diversity programs began to unintentionally impede success.
This era comes after the lessons learned from the nanosecond 90s, the horrific consequences of irrational exuberance, and the unintended consequence of suppler diversity programs. Let me begin by saying the obvious, this era is merely underway and has yet to prove its ultimate market impact. My points here are based upon my investment experience and industry knowledge during the past 25 years.
The New Millennium began with an abundance of “ready now” talented entrepreneurs and company builders, emerging fund managers, and an increased level of capital aimed at emerging fund managers and to a lesser degree, underserved markets, than in any other period in the history of private equity. In mid-2007, it was estimated that the number is well over $3 billion, a quantum leap from the early 1990s where the amount of growth capital was negligible from pension funds or in the 1970s and 1980s when there was no access to pension funds.
Let’s look at the split on the $3 billion. Roughly one-third of the dollars went to buyout funds led by emerging managers who were well trained within most of the larger Investment Bank firms. These teams were doing and continue to do traditional buyouts in traditional markets. Another third went to Equity Funds with emerging fund managers doing non-control investing in traditional markets. The remaining third of the $3 billion went to fund managers with emerging managers doing non-control investing, mostly with MBEs and/or small businesses addressing underserved markets. Each of these groups are doing what they were trained to do, invest capital for competitive returns. This is a good thing by any standard, “know what you are good at and do it exceedingly well.”
All of this has been very good for the emerging fund managers, their CPO, and the markets they serve. Please note that the final third went to where Pacesetter began nearly 40 years ago, non-control investing by mostly emerging managers in mostly underserved markets with underserved entrepreneurs, so called MBEs. Starting with my first year as CEO until today, Pacesetter has had the development emerging managers as it centerpiece.
I’d be remiss if I didn’t recognize the major role the “Fund of Funds” has played in the development of each of these three distinctly different kinds of capital providers. For us, Fairview Capital Partners, Bank of America, Progress Investment Management, and Wells Fargo remain our biggest supporters.
LESSONS LEARNED
Let me point out a few indelible lessons learned by PCG and many other fund managers during the past 20 years, including horrific consequences of irrational exuberance. Lesson One is never under estimate the rapidity of change, up and down, and its impact on your business model and related processes. All through the 90s faster, smaller, and cheaper became the mantra of the times and remains an expectation by customers in virtually all markets.
The good news was by the mid-90s, innovation and disruptive technologies had provided a host of new, new things for consumers and businesses alike! We went from bricks and mortar to clicks and eyeballs. The bad news was many well established traditional bricks and mortar businesses and many “old school” fund managers, including us, were wooed into a vortex of change that none of us would have guessed would decimate shareholder value for so many businesses, large and small. Remember, the branded and established companies such as Time Warner, Lucent Technology and rising stars like Global Crossing, WorldCom, and Enron?
What goes up does indeed come down and the so called meltdown came down with a vengeance in the new millennium. This unrelenting downward trend too had “rapid change” and the attendant havoc on valuations and exit strategies. We still have a few companies from that era with “no way out.” As the line from a hit song by Kenny Rogers puts it “…you’ve got to know when to hold ‘em and know when to fold ‘em.” Make that Lesson Two! A fund manager has to “know when to hold ‘em and when to fold ‘em.” Many of us missed the obvious by believing there was no end in sight for the upside, not to unlike the captain of the Titanic who believed his ship was invincible.
Lesson Three, being good, even very good in the past is rarely adequate for the future. In fact, the single biggest barrier to excellence is being good. In the new millennium, excellence is the minimum standard for fund management success. Lesson Four, details determine destiny. In deal making and company building, details undergird excellence. Lesson Five, perhaps the most important lesson, providing growth capital to privately held companies requires great selection on the front end. Essentially, we invest in M&Ms, management and markets. While both are equally important, great management is the key!
While too early to call, the new millennium offers a tremendous array of opportunities for entrepreneurs with excellent products and services and capital providers. Stay tuned!