The VC on the Corner

Think the most you can expect from a bank is a line of credit? You might be missing out on the emergence of banks' private-equity arms.

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Capital

Banks -- and not just big banks -- have started to eye growth companies as targets for private-equity investments

When you think about everything a good bank could offer you, are you focused on a credit line? If you are, it may be time to refocus your priorities.

That's because a growing number of banks -- large and small -- are setting up venture arms to invest in private-equity deals with entrepreneurial companies. At a time when volatility in the stock market, reduced venture-capital investment, and a range of other economic concerns have put some constraints on capital raising, banks' increased involvement as investors is one trend that is moving in the right direction for business owners.

"There are so many banks doing these kinds of deals now that they've quickly become a standard source of financing to pursue," says Gordon Tunstall, a financing intermediary whose firm, Tunstall Consulting Inc., is based in Tampa. When Tunstall recently raised $20 million for a software company that needed the funds to convert to an application- service-provider model that would substantially broaden its customer base, several banks were among the equity investors. "I'd have to say that they're interested in the same kind of deals that any other professional private-equity investor would consider: companies with at least a 20% to 30% growth rate, good profit potential, and a clear exit strategy, which might mean an IPO or a sale to a strategic partner," Tunstall says.

Although the trend developed relatively quickly, it seemed for a while as though it might be confined to the nation's largest banks, with Chase, Bank of America, and First Union emerging as big players. "Throughout much of the late 1990s, large banks were successful in finding legal ways around the regulatory restrictions that had limited their abilities to underwrite securities and make equity investments," explains Jerome Walker, a partner and banking regulatory expert at Salans, Hertzfeld, Heilbronn, Christy & Viener, a law firm in New York City. "They were looking for ways to move beyond the small, community-based investments that the government had been encouraging them to make for decades."

The logic behind the appeal of equity was irresistible. "The return that a bank can earn on a good private-equity investment is a lot more than the spread between the interest it pays for deposits and the interest it earns on loans," comments Sarah Miller, general counsel for the American Bankers Association Securities Association, based in Washington, D.C. "This is why we're no longer just seeing the top-tier banks getting involved in what we call 'merchant banking' activities. Even the smaller banks are interested, and many have started getting their feet wet."

A friendlier regulatory environment has also helped clear the path. Although legal restrictions still exist -- largely to preserve the financial soundness of banks as they take on new risks -- many types of investment opportunities are now possible, among them joint ventures or investing in common-stock deals, leveraged buyouts, and mezzanine (or interim) financing.

"As of now, what we've seen is two common forces driving banks into these deals," reports Jay Hachigian, a partner in the Waltham, Mass., office of Gunderson, Dettmer, Stough, Villeneuve, Franklin & Hachigian, a law firm that represents venture-capital funds and emerging growth companies. "It might be that a bank already has a lending relationship with a company, so now this becomes a way of broadening that relationship to include an investment component. But we've also seen cases where banks decide that the way to start their dealings with a young company is through an equity investment. And their thinking may be, as this company grows and becomes more mature -- and therefore more able to sustain debt -- the bank will also become a lender."

What's the bottom-line impact of all this for the owners of entrepreneurial ventures? More financing sources mean, at least in theory, better prospects for raising growth capital. But with a developing trend like this one, you'll need to be creative in figuring out how to tap into the market.

Certainly, if you have a relationship with a lending institution, it's worth investigating whether that bank maintains a private-equity arm to invest in customers or other growth companies. But don't be surprised if it's tough to get an answer to that question. Tunstall laughs as he notes, "I regularly bring deals to First Union Capital Partners. But if I went to the local branch of First Union and asked someone there about private-equity financing opportunities, it's a pretty good bet that he or she wouldn't know what I was talking about."

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