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					  INVESTING
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                                                                                          AS FEATURED IN      ...
S
The Big Straddle
Not quite a venture firm, not really an LBO shop, Summit Partners
has staked out profitable territory in the middle                                                                                by Kelly Holman


    Summit Partners’ investment in E-TEK Dynamics Inc., a fiber-op-        from TA Associates, one of the few other firms to work the line be-
tics component and subsystems maker, had all the hallmarks of the          tween venture capital and LBOs as Summit does. At TA, the two had
Boston-based private equity firm’s investment style.                       focused more than 50% of their time on technology and healthcare
    At the time, in July 1997, the San Jose, Calif., company’s founders,   deals—mainly growth capital buyouts. (Before TA, the two had also
Theresa Pan and her husband, J.J. Pan, were looking for liquidity.         worked together at First Chicago Investment Corp. in the late ’70s.)
Summit was only too happy to oblige them, acquiring a 60% stake in             “The basic premise was to find profitable, high-growth companies,
the company for $108 million.                                              and technology was one of the best places to do that, ” Woodsum says.
    The bet proved incredibly savvy. Three years later, in June 2000,      Shortly after Summit’s launch, Gregory Avis, a former corporate finance
JDS Uniphase Corp. shelled out $18.4 billion in stock for E-TEK and        analyst at Cleveland’s McDonald & Co., joined the firm.
Summit reaped more than $4 billion, one of the most                                                Summit raised $160 million in its first fund, in-
successful realizations in private equity history.                                             cluding $100 million from a Shearson/American Ex-
    For two decades, Summit has fashioned a niche for                                          press Inc.-led U.S. investor group in late 1984 and
itself providing equity to business owners who seek                                            the balance from a consortium of French banks and
liquidity, growth capital or both. In an industry where                                        tech companies in early 1985.
most large firms focus exclusively on early or midstage                                            “We had about 15 entrepreneurs that had agreed
venture capital, on the one hand, or leveraged transac-                                        to invest with us,” Woodsum says. “That really
tions on the other, Summit is one of the few big shops                                         helped distinguish us from our competitors.”
that specializes in unleveraged, late-stage growth cap-                                            While Summit does invest in LBOs, from the out-
ital investments in profitable companies, straddling the                                       set its defining characteristic has been its emphasis
line between venture investing and LBOs.                                                       on growth plays.
    Relying on an unusually intensive cold-calling sys-                                            “They’re very good at finding companies early on
tem to develop leads and relationships, it has invested                                        with young management teams and developing the
in more than 255 companies over 20 years and ex-                                               teams into professional managers,” says Earnest
ited more than 195, chalking up annual internal rates                                          Jacquet, co-chief executive of Parthenon Capital
of return averaging 30% on its private equity funds.                                           LLC, a Boston middle-market investment firm, and a
    From its founding in 1984 by Stephen Woodsum and E. Roe Stamps         former general partner at Summit.
IV, two veterans of Boston’s TA Associates, Summit has raised more             Summit typically contributes $10 million to $250 million of equity
than $5.5 billion in six private equity funds and three subordinated       for noncontrolling stakes in companies that are already in the black.
debt vehicles and has grown into a global asset management firm with           “They typically put up a significant amount of dough but don’t re-
110 employees and offices in Boston, Palo Alto, Calif., and London.        ally rely on a lot of leverage to get their deals done,” says Joseph Attar,
    And, in a crucial test, it successfully navigated a management suc-    a senior vice president at AmSouth Capital Corp., a New York-based
cession from its founders to the next generation of dealmakers in 2001.    middle-market lender.
    “Summit is a very well-regarded firm both on the venture side and          At the beginning, the emphasis was heavily on technology compa-
the buyout side,” says David Chapin, a partner at Ropes & Gray LLP in      nies. “They could take significant market share and grow very quickly
Boston, whose firm does not advise Summit. “They’re savvy invest-          in a relatively short period of time,” Woodsum explains. “We rode
ment professionals who seem to find good situations to invest their        those horses for a long time.”
money in.”                                                                     The payoffs could be handsome. In its first deal in 1984, for in-
    Stamps and Woodsum borrowed much of Summit’s business model            stance, Summit teamed with TA to back an experienced entrepreneur,



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Robert Cook, who needed growth capital for his Vienna, Va.-based those in the typical VC’s portfolio, Summit executives say.
VM Software, a software developer that had $600,000 in revenue                  “Our business relies much more heavily on us being right eight or
from sales into IBM Corp.’s mainframe market. Summit and TA in- nine times out of 10 and losing money no more than one or two out of
vested $153,000 for a joint minority stake. A year later, Summit and TA that,” managing partner Bruce Evans says.
took the company public, realizing $696,595.                                    Its calls have been more right than wrong. Though the 30% over-
    There is still a heavy commitment to software, communications all average IRR for its funds reflects the outsized, 100%-plus IRR on
technology and services, semiconductors and information services. its fourth, 1995 fund—boosted by the E-TEK windfall—that was not a
“They’ve got people who are not only on the leading edge of technol- fluke.
ogy, but the bleeding edge,” Am-                                                                                     “They’ve tended to outper-
South’s Attar says.                                                                                              form both relevant benchmarks in
    Summit managing partner                                                                                      the venture capital and buyout
Walter Kortschak, who heads the                                                                                  class of funds,” says Mike Kelly, a
Palo Alto office, has helped hatch                                                                               managing director at Hamilton
a long list of California tech                                                                                   Lane, a Philadelphia private eq-
deals—including one in McAfee                                                                                    uity asset management company
Inc., the Santa Clara, Calif.-based                                                                              that is a limited partner in several
antivirus software maker that be-                                                                                Summit funds. “Their perform-
came a household name for com-                                                                                   ance is driven by a large number
puter users. Summit invested $5                                                                                  of successful investments in every
million in 1991 to provide liquidity                                                                             fund, both on a multiple of dollars
for John McAfee, who was run-                                                                                    invested and IRR basis.”
ning the business with four em-                                                                                      Indeed, Summit’s track record
ployees. After McAfee went pub-                                                                                  was strong enough that investors
lic in 1993, Summit harvested a                                                                                  agreed to a 25% carried interest
total of $120 million, Kortschak                                                                                 on its current fund, the $2.1 bil-
says.                                                                                                            lion 2001 vintage Summit Ven-
    But Summit’s portfolio in-                                                                                   tures VI LP. Few other firms have
cludes other companies in busi-                                                                                  been able to get more than 20% of
ness and financial services,                                                                                     the profits on their funds.
healthcare and life sciences, in-                                                                                    The record is not unblem-
dustrial products and consumer                                                                                   ished, though. The $180 million
products.                                                                                                        Summit Accelerator Fund LP
    Reflecting that mix of sectors,                                                                              Summit raised in 1999 to fund
the firm maintains two deal                                                                                      early-stage but profitable compa-
teams—one for growth capital and                                                                                 nies, with $2 million to $10 mil-
one for classic leveraged deals—                                                                                 lion in equity per deal, still has a
though the lines are somewhat                                                                                    negative return. “Our fund in-
fluid and each side draws on in-                                                                                 vested in the teeth of the down
dustry expertise from the other.                                                                                 years in the bubble, 1999 to 2001,”
    (As an adjunct to both sides of        clockwise from top left: Roberts, Mannion, Kortschak and Trustey      Evans says. “If you were investing
the business, Summit also raised                                                                                 in technology when the Internet
three mezzanine funds, including the latest, a $465 million vehicle bubble collapsed, you couldn’t help but see some degradation in your
that closed in March. It will invest up to $70 million per deal, exclu- portfolio.”
sively in Summit deals.)                                                        Likewise, Summit Ventures V LP, a $1.1 billion 1998 vintage fund,
    While Summit is sometimes considered a venture firm because of had a negative 2.6% IRR as of Dec. 31, 2003, according to public pen-
its unleveraged equity investments in growth companies and its will- sion fund disclosures. But Evans says that has turned positive with
ingness to take minority stakes, its investments are less risky than realizations this year, and he is optimistic that fund ultimately will



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prove to do better than just break even. “We certainly think we’ll be             “Eventually, I think we’ll get to the point where it will make sense
in the top half and probably the top quartile,” he says.                      to consider a larger fund that is focused on the [leveraged] buyout
    One of the keys to the firm’s success historically has been its heavy     world,” Evans says.
investment in unearthing leads and building relationships. Every ven-             That would be new turf where the firm will face stiff competition
ture and buyout firm cultivates executives and entrepreneurs, of              from bigger, more-established LBO players.
course, but Summit devotes extraordinary resources to the effort:                 One banker who works with financial sponsors questions how well
Some 30 associates in three offices devote most of their time to cold-        Summit will be able to compete in large auctions of nontechnology
calling companies to set up meetings with Summit.                             companies given the firm’s strong expertise in technology.
    “We call entrepreneurs and build relationships in advance of their            “I think it’s going to be tough for them [to make the transition into
desire to raise capital,” Evans says. “When it comes time to raise cap-       auctions],” he says, citing Summit’s reputation for tech and growth
ital, they think of us. We find many of our opportunities that way.”          capital deals. “If you’re doing an auction process, why are you going
    Summit has fine-tuned the technique over the years, according to          to show it to them?”
Hamilton Lane’s Kelly. “A lot of groups have tried to copy that ap-
proach, but very few have been successful in executing it,” he says.              The firm has managed other transitions, however. In 2001, for in-
Few other private equity shops have invested in the personnel and             stance, it took two crucial steps to lay the foundation for the future.
organized their business like Summit, he says.                                    That was the year the firm set up shop in London in a bid to tap a
    The coming years, however, could test this approach. Like many            market ripe with growth capital opportunities.
sponsors that have grown from midsized to large firms, Summit faces               The Mayfair office now has six investment professionals. So far, it
the challenges of investing larger and larger pools. Cultivating pro-         has executed only two deals in Europe, but one has already been a
prietary opportunities is likely to become harder as the firm has more        home run. Summit sold its Berlin-based wireless digital content port-
money to put out.                                                             folio company Jamba! AG to VeriSign Inc. in May for $273 million,
    It already participates in some auctions.                                 realizing a gross return of 3.8 times its $40 million all-equity invest-
    “Since we have more resources and capabilities, we’ve been able to        ment nine months earlier in September 2003.
successfully enter larger markets that are controlled by intermedi-               Jamba! hit Summit’s growth targets much earlier than the firm ex-
aries,” as Evans puts it.                                                     pected, says general partner Scott Collins, achieving four years of
    But there are pitfalls, he concedes. In 1998, Summit teamed with          growth in nine months.
TA Associates to invest $50 million for a 50% stake in Private Business           The investment was the payoff from a contact Summit had culti-
Inc., a Brentwood, Tenn.-based maker of software for community                vated in Germany, who introduced Summit to Jamba’s founders—a
banks, in a competitive process. The company was highly profitable,           sign, perhaps, that its networking tactics as well as its investment
generating $23 million to $25 million in Ebitda on about $50 million          style can be transplanted across the Atlantic.
of revenue. But the firms paid top dollar and borrowed 4 times Ebitda             But the management succession at the beginning of that year may
for the deal. “The amount of competition that existed for this business       have been the biggest test. After more than a year of talks, in January
was such that the price was full,” Evans says.                                2001 Woodsum, Stamps and Avis turned over the reins to Evans, Ko-
    But a new management team could not expand the business as                rtschak, Martin Mannion, Thomas Roberts and Joseph Trustey, most
successfully as the founders, and the debt began to bite when the             of whom have been with the firm since the 1980s.
economy slowed and bank consolidation accelerated. Ultimately, Sum-               “If you hearken back to our roots, it really was always our plan to
mit lost 90% of its $24 million investment, says Evans.                       build a firm that could live a long, long time,” Woodsum says. “Roe and
    “The lesson you have to learn is you have to be honest with your-         I have been in the industry a long time and seen a lot of firms that
self about the situation you are facing and make judgments about how          couldn’t make that transition.”
things are rather than the way you want them to be,” he says.                     Kelly at Hamilton Lane concurs: “They are one of the few organ-
    Still, by the nature of things, Summit is likely to be forced into big-   izations that have dealt with the issue of transition and haven’t skipped
ger deals that are more likely to be auctioned and leveraged.                 a beat.” I




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