As published by...

6/21/2006

CHICAGO — Jim Tyree of Mesirow Financial sat down with the Illinois Venture Capital Association to discuss his passion for private equity as well as the health of the industry today.

Illinois Venture Capital Association: Please describe Mesirow Financial's various private equity practices and how the firm allocates its commitments.
Jim Tyree: Our private equity business has really evolved over the years. It started 25 years ago as a direct investment vehicle. We are now completing fundraising for our ninth direct investment fund. Nearly 10 years ago, we started a fund-of-funds business and now have three partnership funds we manage.

Overall, our total committed capital is about $1.5 billion with approximately $1 billion allocated toward the fund-of-funds. Our client base is virtually all institutional investors including public funds, corporate/ERISA pension funds, Taft-Hartley funds, foundations and endowments and even some offshore investors. Our client base has grown through the strong endorsement of many of the top asset consulting firms in the U.S. and abroad.

Within the fund-of-funds, about one-third of our commitments go toward venture capital funds, about 40 percent of our commitments are to domestic buyout funds and the remaining commitments are split between special situation funds (mezzanine, industry-specific funds or distressed equity funds and Western European-focused buyout funds).

We have purposely raised moderately sized fund-of-funds to allow us to be highly selective. We may only commit to a dozen or so premier funds per year overall of those subasset classes.

On the direct investment side, we really focus on both direct deal origination as well as co-investments with our managers through our fund-of-funds. The latter has been particularly interesting over the last few years as we have seen significant high-quality incremental deal flow coming from our fund-of-funds.

I think the general partners of the funds within our fund-of-funds understand the capabilities we can bring to bear as co-investors in a deal. At the core, we are direct investment practitioners.

IVCA: On the direct venture side, what would be the typical range of an investment throughout the life of a company?
JT: On the venture side, we are quite diverse. We are doing some early stage deals. One interesting opportunity we are looking at today is a start-up aircraft manufacturer. That is pretty exciting. We have worked in start-up software as well as a very early stage telecommunications company.

We are also well positioned to lead a later round of financing in venture-backed companies that we have been closely monitoring within the underlying portfolios of our fund-of-funds. Within that portfolio strategy, we're really happy and our returns have been exceptional.

IVCA: Your fund-of-fund investments are international in scope. Being based in Chicago, please describe your relationship with local private equity and venture firms.
JT: We firmly believe that the differential between the top quartile performers in private equity is important. In some vintage years, it is measured in 1,500 or 2,000 basis points. Information today shows an average of some 1,400 basis points dispersion in returns between the median and the upper quartile cutoff dating back to 1980. Now that's alpha!

It is critically important from our perspective as a fund investor to access the best funds across the world. That really comes from previous track records. We very rarely invest in new funds. Our goal is to find the best of class across the board. That frankly comes from proven track records and then a stability of that track record.

To the extent that we find those folks in Chicago, we are happy to invest in them. To the extent where their history hasn't put them in the top quartiles, it is very difficult for us to invest in those funds.

IVCA: Please talk about your investment managers. How many people do you have on staff investing in private equity?
JT: Overall, we have about 15.

IVCA: Are they categorized by specialists? For instance, do you have people who focus just on venture investments?
JT: We have about five on the direct side and roughly 10 on the fund side. Those skills are interchangeable and they work together quite well. We believe the direct team helps the partnership team in their investment process. I know through co-investment opportunities that we have seen the partnership team benefit from the direct investment business. We are careful to keep the investment decisions independent.

IVCA: This is all in addition to your background in private equity, correct?
JT: Yes. Private equity was the first business I started at Mesirow Financial. Private equity is still my first love, and if you know me, you'll see the private equity group is on this floor with me and has been with me for more than 20 years.

IVCA: While you are obviously managing the whole business, you can't micromanage too closely to know what's going on in that department, right?
JT: I stay close. I stay very close to what we are doing as I do with all our businesses. We have great people that constitute the partnership and direct investment teams. Marc Sacks and Paul Rice are the people who manage our fund-of-funds business on a daily basis while Tom Galuhn leads our direct investment efforts.

The four of us make up our Private Equity Investment Committee. While my colleagues are directing and building the private equity business on a day-to-day basis, I am very interested in what they do just as I'm interested in all six of our business units. This is one business I know a lot about.

IVCA: Having been in the business for more than 25 years, please talk about your perception of the health of the private equity industry.
JT: Frankly, I think the private equity industry today is as healthy as ever. It is probably getting a little too healthy because there are tremendous pools of capital out there. I think capital is allocated a lot better because experienced partners are getting money. Of course, when there is so much money already in the business and more is on its way, there is pressure on returns.

That is not necessarily bad because the competing returns of fixed income and equities are also under pressure. A low interest rate environment allows transactions to happen that create competitive rates of returns. While I classify private equity as having a very bright future, it's one that's more limited than what we have seen in the past in terms of size of returns.

IVCA: On the direct venture side, are you seeing the return of irrational valuations for technology start-ups?
JT: Our folks bring me transactions that are valued at significant multiples of future expected revenues. I see that on the direct venture side immensely. It bothers me. Not too many people who want to start a business worry about getting cashed out. You just bring it in with a big valuation and that puts more pressure on you as an entrepreneur.

I read something recently that talked about how entrepreneurs today are more in tune with starting a business without capital. I think that is the wisest thing I have ever heard. The article was shunning raising big money with big valuations and advised start-ups to go it on their own and use internal funds to scrape by.

I think that is going to create better businesses. Though it is probably the opposite side of what I like to hear as a private equity guy, I think it's a positive sign.

At the same time, I think the sophisticated entrepreneur – especially the serial entrepreneur – seeks out those premier venture funds that have a measurable track record of building successful companies in lieu of getting the highest possible valuation going in. I'm encouraged by that kind of discipline and I think that bodes well for the future.

IVCA: In addition to the IVCA, you are involved with a number of local business and economic development organizations including the Executives' Club of Chicago and the Chicagoland Chamber of Commerce. How do you leverage these organizations to grow your firm?
JT: I know firsthand what a great job the IVCA has done for the private equity business here in Illinois. It has been a pleasure working with them in a number of different areas. It gives a voice to the community that is critically important and I encourage us to continue to fight for the IVCA.

I really believe that in business you can't compartmentalize your life. My life is comprised of four categories: friends and family, my business, health-care and education. None of those is separate.

For example, I married my CFO. She knows my business inside and out. I sit on the board of a research foundation and am on two hospital boards as well as an advisory board for a third hospital. I serve on three university boards and I am chairman of City Colleges of Chicago. Of course, I am involved with the Executives' Club of Chicago and the Chicagoland Chamber of Commerce. All of these roles are interrelated.

In many ways, they are all related to private equity. Private equity is an area that gives Mesirow Financial a great entree into utilizing our capital skills in helping many parts of the economy. It has been a core of what we do.

© 2006 IVCA. Reprinted with permission.