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Buzz Article:
Sources of Capital - Hedge Funds
by Kenneth H. Marks, Larry E. Robbins, Gonzalo Fernandez, John P. Funkhouser and D. L. Sonny Williams, 6/2/2010
Introduction
HEDGE FUNDS
The investment universe tends to be divided into three broad categories: stocks, bonds, and alternative investments. Alternative investments include real estate, commodities, private equity, and hedge funds. The SEC describes hedge funds as private unregistered investment pools that traditionally have been limited to sophisticated, wealthy investors; they are not mutual funds.[3]
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These funds employ various investment strategies and techniques seeking higher-than-market returns, and in some cases investing in emerging growth and middle-market companies. The line of distinction between the hedge funds and private equity funds has blurred as hedge fund managers seek to boost returns, diversify risk, and attract more capitalS0 by making[2] investments in areas traditionally targeted by private equity.
As a source of financing, hedge funds make debt and equity investments using some traditional financing structures (i.e., participating in preferred stock rounds with venture investors) and some recently popular ones. One of the more recent investment approaches adopted by hedge funds to invest in middle-market companies has been tranche B or second lien financing. This junior debt sits below the senior lender in claim priority against some or all of the assets of a company. Table 5.15 illustrates how second lien financing compares to private equity mezzanine financing. Distressed debt funds, specialized high-yield funds, a few commercial banks, and some commercial finance companies also accelerated junior debt lending as credit in the early part of the decade became plentiful. During the five years leading up to the 2008 credit crisis, second lien deals drove the effective cost for high-yield debt down and forced many mezzanine lenders to sit on the sidelines. As the credit markets began to freeze in 2008, second lien financing declined significantly and the pendulum swung in favor of mezzanine deals as borrowers sought more stable (and available) debt financing.
Hedge funds have also been active with investments into publicly traded companies seeking private placements using PIPES (see Glossary). This type of investment has allure for both hedge funds (because they have at least the potential for liquidity and ease of valuation of assets) and private equity funds (frequently used with smaller public companies of the type often appealing to private equity funds-i.e., the ability to invest in illiquid and potentially undervalued companies).[3]
Given the market meltdown at the end of 2008, we are unsure of the future of hedge funds in early stage or middle-market deals. In addition, it is not clear how the tradingshort-term temperament typical of hedge funds will play out in private equity over the long term, as patience and some operating experience are likely required in times of turbulence, change, and growth of privately held companies.
Read more about the Sources of Capital in the Encyclopedia of Private Equity and Venture Capital
[1] Securities and Exchange Commission, "Invest Wisely: An Introduction to Mutual Funds."
[2] Harris Smith, "Crossing the line: The growing convergence of private equity and hedge funds," Grant Thornton white paper, 2006.
[3] Ibid.
The above material is excerpted from:
The Handbook of Financing Growth: Strategies and Capital Structure by Kenneth H. Marks, Larry E. Robbins, Gonzalo Fernandez, John P. Funkhouser and D. L. "Sonny" Williams.
To order the Entire Second Edition of, The Handbook of Financing Growth: Strategies, Capital Structure, and M&A Transactions, 2nd Edition
This material is used by permission of John Wiley & Sons, Inc.
Kenneth H. Marks, CM&AA,* is the founder and a managing partner of High Rock Partners, Inc., providing strategic consulting, investment banking, and interim leadership services to emerging growth and middle-market companies. As CEO he founded a high-growth electronics company and, led and sold a technology business to a Forrune 500 buyer. As adviser, he has worked with managers and board members ro develop and implement growth, financing, turnaround, and exit srrategies in over two dozen companies. Marks' past positions include president of JPS Communications, Inc., a fast-growth technology subsidiary of the Raytheon Compnny, and president/CEO of an electronics manufacturer that he founded and grew to $22 million.
Mr. Marks created and teaches an MBA elective titled "Financing Early Stage and Middle-Markct Companies" at North Carolina State University; and created and teaches "Managing Emerging Growth Companies," an MBA elective, at the Hult International Business School in Boston (formerly the Arthur D. Littlc School of Management) in connection with Boston College's Carroll School of Management. He is the author of the publication Strategic Planning for Emerging Growth Companies: A Guide for Management (Wyndham Publishing, 1999).
Mr. Marks was a member of the Young Presidents Organization (YPO); the founding YPO Sponsor of the Young Entrepreneurs Organization (then YE0 and now EO) in the Research Triangle Park. North Carolina Chapter; a member of the Association for Corporate Growth: and a member of the board of directors of the North Carolina Technology Association. Marks obtained his MBA from the Kenan-Flagler Business School at the University of North Carolina in Chapel Hill.
Larry E. Robbins is a founding partner of Wyrick Robbins Yares & Ponton LLP, a premier law firm locared in the Research Triangle Park arca of North Carolina. He is a frequent lecturer on the topics of venture crlpital and corporate finance and serves on the boards of directors of entrepreneurial support organizations, technology trade associations, and charitable and arts organizations. Mr. Robbins receivcd his BA, MRA, and JD from the University of North Carolina at Chapel Hill. He was also a Morehead Scholar at UNC.
Gonzalo Fernández is a retired vice president and controller of ITTs telecom business in Raleigh, North Carolina. Subsequently he spent 15 years working as a finance executive for emerging growth companies and as an accounting and business consultant to other companies. He is a past president of the Raleigh Chapter of the Institute of Management Accountants. He received his BA in accounting from Havana University, Cuba. He wrote the book Estados Financieros (Financial Statements) (Mexico: UTEHA, third edition, 1977).
John P. Funkhouser has been a partner with two venture capital funds, and operated as chief executive officer of four companies in a variety of industries from retail to high technology. In his venture capital capacity, he was a corporate director of more than a dozen companies and headed two venture-backed companies. The most recent company he led from a start-up concept to a public company is a medical diagnostics and devices business. Mr. Funkhouser worked in commercial banking with Chemical Bank of New York, in investment banking with Wheat First Securities, and in venture capital with Hillcrest Group. He has an undergraduate degree from Princeton University and an MBA from the University of Virginia, Darden Graduate School of Business Administration.
D. L. "Sonny" Williams is a managing partner at High Rock Partners. As CEO, for over 25 years he led three global manufacturing/technology companies through major transitions; and as an adviser, he has worked with companies in numerous industries to create value and implement change. Mr. Williams has over 30 years successful operating experience in engineering, manufacturing, sales/marketing, and senior executive roles. His career is highlighted by having led the turnaround of three global manufacturing/technology enterprises ($50 million to $330 million in revenues in nine countries) over a 20-year span in CEO/president/director roles, serving the automotive, consumer, industrial, aircraft, and medical component markets. Mr. Williams' leadership accomplishments include successfully achieving dramatic lean enterprise-based cost restructures, low-cost country expansions/sourcing, and accelerated organic growth through strategic value proposition repositioning; complemented by leading eight acquisition/ merger/joint venture-related negotiation/lintegrations. Mr. Williams' value-creating experiences were magnified by successfully repositioning two of the corporate companies for investment-attractive management buyouts.
Mr. Williams received his BSEE from Kettering University and his Executive MBA from the Kenan Flagler Business School at the University of North Carolina, Chapel Hill. He is president of the Association for Corporate Growth (Raleigh-Durham chapter) and a member of the National Association of Corporate Directors.
John Wiley & Sons
Founded in 1807, John Wiley & Sons is the oldest independent publishing cormpany in the United Stares. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding.
The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation, and financial instrument analysis, as well as much more.
For a list of available titles, visit their Web site at http://www.WileyFinance.com/.
* The Certified Merger & Acquisition Advisor (CM&AA) credential is granted by Loyola University Chicago and the Alliance of Merger & Acquisition Advisors.
Comments
On Wednesday, June 2, marshall sterman wrote...
...as a "primer" for students interested in sorting out the various entities in professionally managed investment funds the authors have gotten it right- until their last "opinion" paragraph which, unfortunately, put them in the "amateur" category.