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The Ultimate Investment Club for Entrepreneurs

At CMS, a highly successful but little-known financial services firm, entrepreneurs help each other find the best places to invest.
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Mark Solomon is telling a story.

It is a night several years ago, he is saying, and he is driving for hours through an unrelenting rainstorm to visit a prospective client for CMS, the Philadelphia financial services company that he founded in the late 1960s. In the car with Solomon are his deputies: Paul Silberberg, CMS's president, and Bill Landman, CMS's chief investment officer. For a firm that represents the likes of Bernie Marcus, the founder of Home Depot, this prospective client, a man worth hundreds of millions of dollars, would be a nice fit. He would also be an amazingly nice catch.

And yet, there is a problem. The CMS team, soaked from the short walk from the car to this entrepreneur's house, makes a lengthy presentation in the living room. "We look for three things in a client," says Silberberg. "One is a very successful entrepreneur who has built the business. Number two is geographic location--our clients are all within a three-hour plane ride of Philly because we would like to get back for dinner after visiting them, even if it's a late dinner. Third, and probably the most important, is shared values. We look for people whom we like, who are honest, and who are philanthropic. We look for people who really care about more than just creating wealth for themselves and their families, who are trying to use that wealth to help repair the world in some way. And we don't care how--inner city work, save the whales, hug the trees, we just don't care."

This entrepreneur, however, was not the saving, hugging, or repairing kind. As Solomon recalls, he said, "'I've read all your material, and it seems you're extremely philanthropic. You need to know I'm not.' And he was proud of this."

Solomon decided to give it his best shot. "I was going to take a chance on converting him," he says, and he began to regale this man with personal stories about the joys and virtues of philanthropy. Then he launched into a brief tutorial on the Rule of 72. "He didn't know what it was, so I said, if you take the rate of interest you earn and divide it into 72, it tells you how long it takes for you to double your money." Assuming this entrepreneur could earn a steady rate of 6%, Solomon offered some quick back-of-the-envelope calculations, showing that the man would probably be highly placed in the Forbes 400 by the time he was 70. "Do you know how big the hole has to be to bury you and that amount of money?" Solomon asked. "What in God's name are you going to do with it? This guy just looked at me like I was talking in Chinese."

Solomon decided to stand up and announce that he just didn't see how this was going to work for either CMS or the entrepreneur. The CMS execs filed out, piled back in the car, and drove for four hours in the rain, doing their best to keep the car from hydroplaning on the Xooded roads home to Philadelphia.

Even to most entrepreneurs, CMS is a largely unfamiliar name, a firm few know about and even fewer have joined. CMS doesn't exactly seek anonymity, but its obscurity results from the firm's aversion to the media (this is its first real profile) as well as its focus on only the most select (and successful) entrepreneurs. Technically speaking, CMS views itself as an "alternative investment boutique" or "an entrepreneurs' buyers cooperative." Its offices in Philadelphia, where all 100 employees work, comprise two rambling floors of a low-rise brick building on an aggressively unpretentious block. The firm currently has several hundred active clients to whom it offers advice on life insurance, estate planning, and asset allocation. More important, CMS invites those same clients to invest in various funds, generally ranging in size from $30 million to $150 million, that the firm creates at a rate of about four or five per year. Since its inception, the firm and its clients have invested more than $3 billion in real estate and private equity. Every client who invests is an entrepreneur--no corporate executives, entertainers, or idle rich. Every client has been referred by existing clients or someone within CMS's vast network of contacts. And every client has been screened in the same manner as the wealthy-but-ungenerous man Solomon and company visited that night in the driving rain.

Let me explain who our clients are," says Mark Solomon, the founder of CMS. "They tend to be older people who have had a value-realizing event. And the return of their money is more important to them than the return on their money."

All of which suggests some obvious questions: Why doesn't CMS--itself an entrepreneurial, profit-maximizing concern--just sign up every wealthy investor it can find? And why does it focus so much on the criterion of philanthropy? And above all, what can an everyday entrepreneur, someone on the ground floor of building a business, learn from these people in the penthouse? As it turns out, quite a lot. But first, consider the question of why this peculiar firm limits its membership to entrepreneurs. CMS is fundamentally a network of men and women who help themselves, and each other, by helping the firm. In other words, CMS makes money for its clients, and for itself, because it uses its clients' expertise to scout out good investments. When weighing a potential investment, for instance, CMS's in-house analysts may crunch the numbers on a prospective buy and then ask one or two of its entrepreneur/clients with expertise in that area to get on a plane, look things over, and report back. As Bill Landman, the CMS investment chief, puts it: "There's virtually no business we consider buying where we can't call up two or three clients so they can offer insights about the opportunity."

Of course, the firm's clients are not only very wealthy but very busy. Don't they mind getting pulled into such time-consuming investing projects? "Not at all," says Bernie Marcus, the retired founder of Home Depot. "So many of the financial people today sit in front of their computers and they only know the numbers. But here, these partners at CMS go to people who have been in the kind of businesses they're considering. You can't buy that kind of information. And all these clients share freely with them because they know that. These guys are smart enough to listen to the people who have become successful. This is how they perpetuate their success."

These are not venture capitalists looking to seed start-ups. CMS invests in more mature companies that are up and running and looking to grow, and the firm always looks for a measure of control in the businesses it pursues.

Two recent deals typify the process. Three years ago, CMS teamed up with KRG Capital, a Denver private-equity firm, in purchasing two Pennsylvania-based companies: TransCore Holdings and UTI Medical Devices. TransCore is a leading provider of automated toll-collection systems like the ones used by EZPass. "It's a fascinating business, a great management team," Landman concluded after a period of due diligence. What really charmed him, however, was TransCore's strategic position in a field that promised terrific growth--as well as the belief that the fledgling company would benefit from his firm's involvement. CMS quickly matched TransCore with a new accounting firm and a new law firm that could handle the intricate state and government contracts the company depends upon. "We went on the company board," Landman says. "We're very involved with the company day to day."

Landman is similarly optimistic about UTI, which engineers, manufactures, and assembles precision medical equipment. He explains that KRG was in the process of buying and integrating several small medical-device companies when some CMS clients told him about UTI. Seeing a nice fit, he brought the idea to KRG. Landman believes that the resulting deal (the new integrated device firm that has kept the UTI name) has enormous potential, and as usual CMS and its clients have been tapped for expertise, advice, and guidance. This has meant visiting UTI's production facilities at various locations around the country and helping the company reconfigure its executive ranks. Landman, for instance, has helped recruit and interview CEO and CFO candidates.

One of the first investments that I made with them went bad," says Donald Crawford, a broadcast entrepreneur who owns a chain of 28 radio stations. "And on their own initiative they made good on any losses we sustained."

The origins of CMS go back to the mid-1960s, when Mark Solomon was selling sophisticated high-end life insurance policies to doctors and entrepreneurs in the Philadelphia area. Solomon discovered that he didn't like doing business with doctors, but that he loved doing business with entrepreneurs. By the time he formed CMS (originally Capital Management Systems) in the late 1960s and brought Paul Silberberg onboard a few years later, the firm had honed its expertise in peddling insurance and financial- and estate-planning advice. "The entrepreneur part of CMS, like most things in life, was an accident," Solomon says. "Over time you gravitate toward where you feel most comfortable." As Silberberg explains, it might be easier and less time-consuming to represent nonentrepreneurs--people who don't ask so many questions about potential investments. But it would be more difficult on the back end, especially since CMS's funds are illiquid and often put investors' money out of reach for as long as 10 years. "In private investments you need time to work things out," says Silberberg, "and less sophisticated clients don't give you time. We have yet to buy a business that hasn't run into a problem. It's just a question of how big and when. And our clients give us time to fix those things."

Or at least they do now. In the early 1980s, when CMS first started investing alongside its clients in real estate and individual businesses, the learning curve was steep. While some early residential real estate deals turned out well, a commercial office building endeavor blew up. Then came a disastrous investment in a Chuck E. Cheese pizza franchise in which CMS lost its clients' money along with its own. A wipeout. The loss undercut CMS's most fundamental covenant with its clients--that it would never endanger principal. In some ways, however, the debacle proved a turning point for the firm. The partners decided that CMS would immediately come clean to clients about just how bad things had gone and transfer to those same clients the firm's own shares in a profitable buyout fund.

If building trust is the first step to building a profitable business, CMS made a mint by screwing up and then owning up. None of the clients were happy, of course; some still grumble about Chuck E. Cheese even now, almost 20 years later. Yet CMS has a client base of realists who understand that things can go wrong. "One of the first investments that I made with them went bad," recalls client Donald Crawford, a broadcast entrepreneur who owns a chain of 28 radio stations around the country. "They had the mantra of protecting clients' capital at all costs. And on their own initiative they made good on any losses we sustained. It just showed me that these were men of their word and it was a safe bet being with them for the long haul."

It is a widely held truism that entrepreneurs tend to be far better at creating personal wealth than managing it. Solomon and Silberberg don't go so far as to say that entrepreneurs are bad investors, but CMS has long understood that people busy building a business have such enormous time constraints--and such a single-minded focus on their work--that they're prone to stumble. "We knew from the beginning that there was a real need for diversification and that our clients weren't doing it," says Silberberg. "They didn't know how to do it. They were just like we were--they had the attention span of a gnat. We also knew they weren't going to do the homework. They were making huge bets that were ridiculous. We saw that we had the opportunity to create a real service. We were at least going to make more studious bets. And we were going to take some of those eggs and put them in other baskets." The good thing, adds Silberberg, is that his clients have always understood their limitations. "The difference between the entrepreneur and the doctor is that the doctor doesn't know anything about investments but thinks he does," he says. "The entrepreneur doesn't know anything about investments and recognizes it. Doctors are wonderful people. They're just not good business people."

The years have taught Silberberg several lessons that he likes to share with his clients: "Number one would be that people are everything," he says. "Both the beginning and the more sophisticated entrepreneur get carried away with the sex appeal of the transaction--they have to look at the people behind it." His second point is that many investors look at how much money they can make--and gloss over the risks: "We look closely at how much we can lose." His third key lesson goes to the heart of the entrepreneur's dilemma: If you want to create wealth, Silberberg says, most do it by concentration, just as his clients have done as they built their businesses. At some point, though, there's too much risk in that strategy, and that's when it becomes imperative to protect wealth by diversifying. This is not, Silberberg emphasizes, simply a matter of splitting money between stocks and bonds. "The beginning entrepreneur cannot get access to some of the really good asset classes," he says, referring to the kind of exclusive private equity deals his firm favors. But Silberberg says every entrepreneur can diversify by vintage, by geography (especially with real estate), and by choosing between different operating partners.

It has taken Silberberg and company more than a decade to smooth out their approach to investing and create a successful system; in the meantime, the firm has found it useful to move away from piecemeal investments in small businesses like fast-food franchises. CMS now makes all investments from pooled funds, to which clients contribute, so as to socialize the returns. As Solomon puts it: "We're able to take the grand-slam home runs and doubles and strikeouts and come up with a good average." While CMS's focus on up-and-running companies and real estate minimized the damage from the bursting of the technology bubble, the firm has nevertheless struggled to find big winners over the past few years. For one thing, as the stock and bond markets have grown tougher, the number of investors pouring into the marketplace for alternative investments in private equity and real estate has grown, leading to increased competition and higher prices. At the moment, CMS has scaled back the size of its funds to correspond with what it sees as a scaled-back opportunity to buy good companies--and good real estate projects--at good prices.

"What we're trying to do is generate a 500-basis-point advantage over the public markets," says Silberberg. CMS has easily beaten this goal over the past two decades, racking up a 20% return in its multifamily housing funds (while public multifamily REITs earned on average about 11%) and a 20% return in private equity (while the S&P 500 returned about 15%). Irvin Naylor, a Pennsylvania entrepreneur who made his fortune from a box company and who now owns several East Coast ski resorts, has about 10% of his net worth invested with CMS. "My rate of return, cumulatively for 20 years, is 24.5% annually," he says. But Silberberg says he always tells new clients that "yesterday is yesterday." He adds that if people like Warren Buffett and Jeremy Siegel are correct in predicting more modest returns of, say, 7% over the next few years, then CMS would be shooting for a 12% return in private equity. Says Silberberg: "That would make us and our clients very happy."

The person entrusted with this task at CMS is Bill Landman, the chief investment officer. In the 1970s and early 1980s, before he came to the firm, Landman worked as a sports agent, and his demeanor--casual, friendly, confident, yet completely opaque--hints at a bearing that must have served him well in contract negotiations. During the spring and summer season he worked with baseball stars such as Tony Pe - a, Ken Griffey, and Tim Raines; during the off-season he spent time cutting real estate deals. His interest in private equity deals came later. "I'm the ultimate generalist," Landman says. At CMS, however, where equity investments run the gamut from buyout funds to CD packagers to tube-sock manufacturers, and where the real estate investments range from garden apartments in Birmingham to rental complexes in Seattle, that's not a bad thing. Versatility, and knowing a little about a lot, is a plus--especially since the firm has a big Rolodex of people who know a lot about a little.

Here's how it works: In a roundtable investment meeting with a dozen managers of the firm's real estate funds, Landman's associates give updates on their property investments around the country. Landman fires back general questions about hurricane damage, job loss, market saturation, and competition. But when the topic turns to potential investments in various markets in the South, he insists some members of the group contact their clients with special expertise in the region. "Let's get them on this as quickly as possible," he says. Later, in a meeting convened to discuss a huge equity fund investment in assisted-living facilities and geriatric daycare, Landman asks various deputies to contact specific clients so the firm can get a better sense of what CMS might be able to add to the daycare business. A thumbs-up from these clients, or a strategy for making the facilities spit back a better return, would mean the difference between going forward or tabling the project.

Such an approach drives home the point that CMS's value proposition is not merely something the firm offers its clients; it's something its clients offer one another. As Bernie Marcus points out, CMS's trump card is its clientele. The firm knows that its clients are as smart, and usually smarter, than anyone in the CMS office.

Still, if CMS's decision to limit clients to entrepreneurs essentially translates into a mercenary decision to add value to the firm, CMS's second peculiarity--the decision to make philanthropy a driving force--is arguably more complicated. One explanation goes like this: CMS's two top executives, Silberberg and Solomon, long involved with philanthropic activities themselves, have an authentic desire to sow their ideas with employees (who are urged to volunteer with community projects), fellow partners (who are forced to dedicate to charity 10% of their gross income share), and like-minded, deep-pocketed entrepreneurs (who are invited to attend conventions on charitable giving). While true, all this merely helps explain why CMS does good, not why CMS has done well.

As Silberberg notes, philanthropy has served CMS as an "indicator" of a client the firm would like to work with. And while it may be counterintuitive, there seems little question that CMS's success is due in part to its decision to limit clients and give money away. In Philadelphia, a relatively conservative business community where family connections can be more useful in reaching the upper echelons than raw talent, the firm's emphasis on exclusivity and philanthropy have set it apart. Thus CMS partners sometimes make reference to entrepreneurs who end up on their "LTS list" instead of their client list. "LTS," says Silberberg, "means life's too short."

Bernie Tenenbaum, a private-equity investor who used to run the entrepreneurial studies program at the Wharton School of Business and knows CMS well, explains that by doing good deeds, the firm built value for its clients: "They were able to break into a club, servicing a very narrow niche, by demonstrating both charitable leadership and personal commitment," he explains. Tenenbaum likewise remarks that philanthropy has had great utility for both CMS and the client base it serves. The first-order impact of a successful entrepreneur is wealth creation, he says; the second is philanthropy--the desire to have an impact on society. "I think what the CMS guys have done is tap into that desire for their clients to make a difference," he explains, "to create a legacy that outlasts themselves." Many of the CMS clients contacted for this story agree. Harold Toppel, for instance, who founded and later sold the Pueblo International chain of super stores, tapped the firm's philanthropic expertise when he and his wife decided to set up an after-school mentoring program. They didn't know how to go about it until CMS sent an adviser to Toppel's home in Florida. "Without CMS's help," Toppel says, "we wouldn't be where we are with that program."

Through the years, some observers have questioned Silberberg and Solomon's philanthropic motives but have been at a loss to show they fall short of practicing what they preach. Indeed, whether their motivations are heartfelt or strategic--or both--the CMS partners have demonstrated a steadfast involvement with community and religious charities. Says one client: "I believe they're sincere, I believe they're genuine. But if they're not, who cares? They're doing great things. And if they're not sincere, they sure have been doing this a long, long time. They're acting like a charitable company every single day."

Seated at a circular oak table in a conference room at CMS, Mark Solomon is telling another story. Five years ago, he is explaining, an old friend called to say, "Mark, I've got a client who is a real estate developer and needs a new source of equity. You've got to meet with him." So Solomon asked his friend what the developer did and heard something distinctly unappealing in response. The friend said, "He buys underperforming hotels."

To Solomon, this was exactly the kind of risky investment CMS avoids. "I said, 'Let me explain who our clients are," Solomon recalls. "They tend to be older people who have had a value-realizing event, and the return of their money is more important to them than the return on the money. So I don't think buying underperforming hotels is going to resonate with our client base."

Solomon's friend told him to shut up and try listening for a change. So Solomon listened to a few details of the hotel business Jim Procaccianti was running out of Rhode Island. Then Solomon, his interest piqued, went to meet Procaccianti--or Proc, as everyone at CMS now calls him. It seemed to Solomon, and to some CMS clients, that the way the Procaccianti Group functioned--buying a foundering hotel and using its own integrated construction, design, and management divisions to relaunch it--had potential. And so CMS went ahead and dedicated a small portion of a multifamily housing fund to a hotel that Procaccianti wanted to buy. CMS rules dictate that the firm must put its own money in a fund along with its clients' money; they also dictate that any joint venture partner (Procaccianti in this case) must invest his or her own money as well. So in this hotel test project, they'd all succeed or fail together--CMS, its clients, and Procaccianti.

As it turned out, there was nothing but upside. CMS backed the Procaccianti Group in the $6 million purchase of a Ramada Inn in East Hartford, Conn. The hotel was doing $3.5 million annually in gross income and was earning $138,000 in net operating income--"basically, no income at all," says Solomon. The development team put $6 million into revamping the place--new skin, new elevators, new management, new everything. At the end of the first year, the gross stayed the same but the net went up to $750,000. The management team then changed the hotel from a Ramada to a Sheraton, and in the second year, the gross rose to $7.1 million and the net to $2.2 million. At that point, says Solomon, "we could see that this strategy worked, and we did six more hotels with different funds."

More recently, Procaccianti came up with an opportunity to buy a large number of hotels and turn them around, and CMS took two clients on a fact-finding mission. "The fact-finding team was very encouraging," says Solomon, "so we went back out [to our clients] and raised $125 million." So far, CMS has committed about $43 million of the new fund.

CMS, says Bernie Marcus, has always known that while successful entrepreneurs are not like everyone else, they are very much like each other. Solomon, Silberberg, and Landman, says Marcus, "are entrepreneurs themselves, so they understand us. They understand what entrepreneurs want and need. These are all self-made men, and all self-made men go through certain kinds of struggles. The CMS group is kind of like a family of entrepreneurs."

It's no accident that when scrutinizing CMS for the entrepreneurial lessons its clients can teach, it turns out that the firm itself is just as instructive. Bernie Tenenbaum, the former entrepreneurial studies exec, explains that the CMS partners had the imagination early on to see that they could lead in a marketplace of entrepreneurs when no one saw the opportunity. "They were in effect looking for themselves in the mirror," says Tenenbaum. "They said, 'We can't be the only ones.' Then they had the persistence to keep at it. Woody Allen says that 80% of success in life is just showing up. Well, they stayed focused on their niche, and they didn't deviate. It's a classic lesson for other entrepreneurs. They said: 'Who am I and what am I good at doing?' And once they knew, they stuck to it."

This is Jon Gertner's first piece for Inc.




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