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VC firm raises $116M for second fund after knocking first one out of park

September 29, 2008

Thanks to hefty 35 percent gross returns on its $60 million first fund, locally based Centerfield Capital Partners LP has raised nearly twice as much for its second.

This month, the venture capital firm closed on $116 million from a variety of investors. As before, Centerfield's 50 limited partners include major Hoosier institutions. But this time, numerous big banks, insurance companies and pension funds from outside state lines were also investors.

"What differentiated us, first of all, is our returns are quite strong," said Centerfield founding partner Tom Hiatt, commenting on the fund's ability to broaden its base of investors.

Centerfield began raising the money 2-1/2 years ago. It plans to use it to invest in Midwestern manufacturing, distribution, health care and business services companies. It favors established firms with $10 million to $50 million in annual revenue that lead niche industries. Of the 25 companies in Centerfield's portfolio, six are based in Indiana.

Indiana's largest public pension funds contributed nearly one-fifth of Centerfield's new $116 million. The performance of the first fund is a validation of the decision by the public pensions six years ago to diversify into private equity. When the Indiana State Teachers' Retirement Fund invested $1 million in Centerfield in July 2002, it was the first time an Indiana public pension had ever backed a local venture capital firm. Until six years before that, Indiana's pensions had been restricted by law from investing in anything riskier than bonds.

Molly Deuberry, TRF's director of communications, said the teachers' pension has seen a 35-percent gross return on its $1 million investment.

That return, unconfirmed by Centerfield, could still increase or decrease. Hiatt said Centerfield has exited only half the firms its first fund invested in. Hiatt's partner, Centerfield co-founder Scott Lutzke, would say only that the venture firms' gross returns are "north of 25 percent."

Centerfield's returns on its first fund would definitely put it in the top quartile nationally for venture firms that raised their money in the same year, said Adam Wade, spokesman for Dow Jones Venture One, which tracks the venture industry.

Any way you slice it, Centerfield's first fund earned enough profit to persuade the pensions to up their ante.

In 2006, TRF and the Indiana Public Employees Retirement Fund formed the $155 million Indiana Investment Fund, which is managed by global investment bank Credit Suisse. Curt Rossman, manager of Credit Suisse's Indiana office, said the Indiana Investment Fund contributed $20 million to Centerfield's new fund: $12 million from TRF and $8 million from PERF. And he said TRF invested an additional $3 million on its own.

"We just continue to be impressed with a team that has 75 years of combined experience, due to their ability to source, guide and close investments," Rossman said.

Centerfield's portfolio

The term venture capital conjures images of risky bets on Internet ventures or new drugs. But Centerfield has made its gains by investing in manufacturers with a long track record.

Westfield-based Standard Locknut LLC, for example, is a 60-year-old industrial machining company with 185 employees that makes specialized bearings used in heavy construction, mining and power transmission. Centerfield wouldn't disclose the specifics of any of its individual investments.

Standard Locknut CEO Ollie Martins said that under Centerfield's tutelage his company expanded its strategy from a focus on just one major customer to serving the whole bearing industry. It has also launched a private line of specialty locknuts, washers and adapters. Standard Locknut has cut production times and added statistical process control software to its machinery to guarantee quality.

As a result, Martins said, the company can now tout its products' superiority to low-grade competing products from China that require waiting months between order and delivery. Now that it's battling for market share based on excellence, not cost, Martins said, Standard Locknut has successfully increased its prices with no pushback from its customers.

"The beauty is [Centerfield executives] leave us alone and do not dictate every little detail," he said.

Centerfield's bet on Wabash-based Thermafiber Inc. is similar. Founded in 1934, Thermafiber has 150 employees. It uses the byproducts of steel production to make high-grade insulation that's used primarily in commercial buildings.

Thermafiber CEO Steve Edris said his company's insulation is in some of the world's most famous buildings, including Las Vegas casinos, the Sears Tower, Kuala Lumpur's Petronas Twin Towers, and Taipei 101, the world's tallest building.

The company is modernizing, thanks to new equipment. And, with Centerfield's help, Edris said, his company is considering acquisitions.

"They take ideas from management," Edris said. "We had one [previous] private equity group who put themselves in all the chief spots. That didn't pan out too well."

To be sure, not all of Centerfield's investments pan out. Hiatt has repeatedly bet on Indianapolis-based Powerway Inc., which makes quality assurance software for the auto industry. Centerfield's predecessor, Middlewest Ventures LP, invested more than $3 million in Powerway in the 1990s. Centerfield invested another $1.2 million in Powerway in late 2001. The company once hoped to stage an initial public offering in 2003, but those plans fell apart when it lost contracts with Detroit automakers.

Hiatt said he prefers to let Powerway speak for itself about its current prospects but added that the company's products had recently been endorsed by the European Association of Auto Suppliers.

Ditching the 'training wheels'

To increase the size of its first fund, Centerfield partnered with the U.S. Small Business Administration's Small Business Investment Company program. Centerfield actually raised just $20 million for its previous fund and leveraged the SBIC's two-for-one match to increase the total to $60 million.

Centerfield did not continue its affiliation with the SBIC for its new $116 million fund. That's not unusual, said John Taylor, who leads research for the Arlington, Va.-based National Venture Capital Association. New venture funds often affiliate with the SBIC to get its "good housekeeping seal of approval," Taylor said. But once they've proven themselves, they take off the "training wheels."

"To me, it's a very, very good sign that they're able to raise money from smart institutional investors without the need for the SBIC," Taylor said. "If you have a top quartile legacy, the rule of thumb is you have a much easier time raising money. And it's almost impossible for someone not in top quartile to raise anything at all."

Given Wall Street's recent woes, it's fair to wonder whether any of Centerfield's investors will have trouble delivering the cash they've promised when the company makes its capital calls. Hiatt said he'd never seen that happen in more than 20 years in the business. Taylor agreed. He said default terms for venture investors are typically onerous. Rather than renege on their promise to invest, most limited partners in venture capital companies simply sell their stake to other investors.

A more pressing concern, Taylor said, will be the state of the economy going forward. Slowdown or recession will decrease demand for the goods and services Centerfield's portfolio companies produce.

And in a buyer's market, it can be hard to sell companies for the type of gains venture capital investors expect. That'll make it difficult for Centerfield to reproduce the 35-percent return that wowed investors in the first fund.

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