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How do you raise $250 million in private equity when your firm has only invested $87.5 million—or $6 million a year—in its first 15 years? “That was probably the toughest issue to overcome,” said Rick Elfman, ’83, senior managing director at Sterling Capital Partners. “We started out in the 1980s with friends and family putting in $50,000 or $100,00 per deal. As our track record built up, we developed a huge list of individual investors and had people putting in $1 million per deal.”
Elfman shared his experience May 16 in private equity as an incognito guest of Neubauer Family Professor of Entrepreneurship and Finance Steve Kaplan’s course “Entrepreneurial Finance and Private Equity.” In the class, students posed as limited partners and were asked to decide if they would have invested in Sterling Capital Partners five years ago. About 30 minutes into the exercise, a student finally asked the most important question – the one posed above. “That is the first thing a limited partner would have questioned,” Kaplan said.
Because of these financial restraints, Sterling Capital Partners was forced to pass on bigger deals, Elfman told students after finally identifying himself. “We had to prove we could raise money and do larger deals,” he said. “There was a period in time where we just couldn’t do deals because we had no personal liquidity. Investors would say, ‘Do you think it’s a good deal? How much money are you putting into the deal? And how long do you think the money will be out?’”
Potential limited partners were so skeptical when Sterling marketed the fund in 2002 that one asked for a list of 300 investors and actually called 85 of them to see if Sterling Partners had hidden any bad deals in its track record, Elfman said. Despite facing one of the toughest markets in history after 9/11, the firm raised $300 million by mid-2003, he said. Now closing its third fund, Sterling Partners recently attracted $1 billion in investors and is now the fifth biggest private equity fund in the Chicago area, Elfman said.
In developing its own best business practices, Sterling Capital determined it would add value to its services by hiring its own human resources staff in the late 1990s, Elfman said. “Very few private equity firms have their own HR, even today,” he said. “What could be more important than hiring the right people? You might hire a headhunter to find people, but we thought it was important to have somebody on our payroll who has aligned interests and is helping coordinate and assess talent.”
The exercise, which Kaplan designed before Sterling Capital became so successful, tested students’ ability to evaluate a private equity firm both quantitatively and qualitatively, he said. “The qualitative analysis is on the strategy, the team, and the terms,” Kaplan said. “Can they generate value? Can they generate good returns? Are the terms reasonable and fair to the investors? The quantitative part is how you evaluate their previous track record. It’s not trivial. There are a number of tricks and complications.”
—Phil Rockrohr