Privately Speaking: Summit Partners

With its unusual deal sourcing model and its willingness to back entrepreneurs throughout the cycle, US-based growth investor Summit Partners continues to plough a profitable furrow in a crowded segment, writes Christopher Witkowsky

In the winter of 2009, Ron Clarke, the ebullient chairman and chief executive of FleetCor, a global provider of fuel cards and workforce payment products to businesses, believed he had found an amazing investment opportunity.

He had been eyeing an acquisition that would help grow FleetCor’s business, and in the crippled financial environment following the collapse of Lehman Brothers, he felt the time was right to move in and take over the business, which was called Corporate Lodging Consultants (CLC).

The acquisition was perfectly in line with the investment strategy being executed by Clarke, who had been backed by Boston-based Summit Partners since 2002. Summit and Clarke believed FleetCor could be expanded well beyond its local trucking fleet markets into different geographies and related,lines of business. CLC, which provided workforce travel savings and solutions, fitted the profile.

But there was a problem: with markets in a tailspin, banks weren’t lending and investment firms, including some of Clarke’s backers, were afraid to do deals. Clarke’s instinct was good, but he couldn’t convince anyone to back him.

Sometimes you have to make the hard trade, and you have to say, 'ok, I believe I'm right in doing this and I'm doing it even though it's a scary time. Sometimes when things are profoundly uncertain, you have the greatest ability to make a sound and profitable investment.

Bruce Evans

Until he approached Summit. The strategy with FleetCor had always been growth through acquisitions. In Clarke, Summit had found a partner with a natural ability to find solid add-ons, according to Bruce Evans, one of several managing directors who head the firm.

After some intense internal debate, Summit decided to back Clarke. It took him on a road show to line up co-investors for the deal, and ultimately, led a group that financed the $100 million acquisition of CLC.

The investment would bear fruit spectacularly: the additional growth it provided eventually helped the company go public and trade at 22 times Summit’s original investment. To date, Summit’s gain on FleetCor is in excess of $1 billion.

“Sometimes you have to make the hard trade, and you have to say, ‘ok, I believe I’m right in doing this and I’m doing it even though it’s a scary time. Sometimes when things are profoundly uncertain, you have the greatest ability to make a sound and profitable investment,” Evans says. “When you believe in a person and you believe in a company and you believe in their ability to make something work, you have what you need as an investor.”.

The FleetCor story perfectly illustrates Summit’s philosophy, and explains why many of its LPs have stuck by it for more than two decades. It invests in profitable, growing businesses run by management teams it knows well and trusts. And having been around since 1984, it invests regardless of cycle – because it’s been through the peaks and troughs.

“When people see things in terms of cycles, they don’t get too high or too low. We feel comfortable these guys have been around the block and see things other groups might not who haven’t been through down cycles,” says Tom Gladden, partner at Adams Street, a long-time investor in Summit funds. “The people in management positions at Summit have seen downturns; they know how to manage companies and they know what portfolios go through.”

Performance is solid: according to one LP who has seen a recent Summit investor presentation, the firm is producing around a 30 percent net IRR on its growth funds since inception. The firm’s positioning also seems to strike a particular chord with LPs these days, many of whom are looking to ramp up their exposure to the mid-market, while steering clear of firms who rely heavily on leverage.

However, this brings its own challenges: how can a growth investor like Summit differentiate itself from the competition, as more money pours into this previously quite segment of the market?

Tested by the market

It’s no exaggeration to say that the recent private equity fundraising environment has, for many managers, been nightmarish. But amidst all this fundraising carnage, there have been a few exceptions: firms whose performance has been consistently strong, and whose existing LPs are happy to re-invest into new funds. Summit is on that list.

With its strong historic track record, the firm has moved through various recent marketing efforts with relative ease (though Summit executives will tell you the fundraisings were challenging).

In July, Summit closed its debut credit fund on $520 million, which lends to companies with no prior connection to the firm (this strict separation is in place to differentiate the new credit vehicle from the firm’s subordinated debt funds, which it has raised since 1994 to provide credit into its own deals).

Last year, the firm had one of the quickest fundraises in the market, collecting $2.7 billion for its eighth growth equity fund in about nine months; shortly before, it had closed its third venture capital fund on $520 million.

The firm has consistently managed to attract new investors into its funds, allowing it to expand beyond its roots as a late-stage venture investor. In the 1990s, Summit shifted its focus into growth investing in mid-market companies, and then in the early 2000s expanded into Europe, where it collected €1 billion for its European debut vehicle. It now offers three products lines to LPs: growth equity, venture capital and credit-related vehicles.

The firm’s evolution also included a management shift, whereby the original founders handed over the reins to the

When people see things in terms of cycles, they don't get too high or too low.

Tom Gladden

new generation of Summit’s leaders. E. Roe Stamps, Stephen Woodsum and Gregory Avis, who co-founded the firm in 1984, all stepped back in 2001 after Summit closed its $2 billion sixth fund.

Summit’s new leaders had already enjoyed long careers with the firm. Marty Mannion joined in 1985 from IBM, where he was a systems engineer; Evans joined a year later from the same company, where he’d worked as a marketing representative; Tom Roberts, who runs the firm’s growing credit strategy, came on board in 1989 from Booz Allen Hamilton; Walter Kortschak (who’s now senior consultant to Summit) joined in 1989 from Crosspoint Venture Partners; and Joe Trustey signed up in 1992 after having worked as a consultant with Bain & Company.

Others who rose to the top ranks were Peter Chung, who joined Summit in 1994 from Goldman Sachs and runs the firm’s Palo Alto office, and Scott Collins, who joined in 1996 after working as a strategy consultant at McKinsey & Company and now runs Summit’s Europe arm. The most recent addition to the senior ranks was Harrison Miller, who first joined Summit in 1988 – but then left for business school and senior roles at Lightspan and before rejoining the firm in 2003.

In recent conversations with Private Equity International, four of the MDs talked about different areas of Summit’s business. But all four had a consistent line on the key to Summit’s success: its experience; its commitment to finding profitable, growing businesses with strong management teams; and, critically, the firm’s direct sourcing model.

Hard-working associates

Summit’s “associate model” is a system of directly sourcing potential investments and, according to firm executives, is a major reason Summit has been successful for as long as it has. It’s the key to the firm’s philosophy of finding strong and growing businesses, run by quality managers.

It works like this: Summit’s associates spend hours cold-calling potential leads and mining the firm’s extensive database, built up over its 28-year history and containing thousands of businesses in which the firm has some interest. Associates are expected to work industry conferences and spend time in conversations that will often lead nowhere – all in service of the database. So a Summit investment may be the result of several years’ of tracking and building a relationship with a company’s management. Many of the firm’s best deals have emerged this way, it says.

In today's world we view sector expertise and domain knowledge as a sine qua non for growth investing.

Peter Chung

The model developed from a desire to find profitable growth companies that had not raised capital before, and were not necessarily looking to do so in the future. “That was the beginning of our associate model 28 years ago. While the world has changed dramatically since 1984, the primary role of our associates remains idea generation and the development of relationships which ideally lead to proprietary investment opportunities,” according to managing director Chung. “That emphasis has been part of the DNA of the firm since our founding.”

Summit organises its research roughly by industry groups; since the beginning, its core focus has been technology (broadly defined to include software, applied technologies and communication technology and services), healthcare, and growth products and services, which generally includes business and financial services and consumer-facing businesses.

“In today’s world we view sector expertise and domain knowledge as a sine qua non for growth investing,” Chung says. “We’re calling on thousands of companies a year, and we often have proprietary and unique insight into what’s going on in their industry sector. Many CEOs with whom we interact value our perspectives on their business and are keen to maintain that dialogue regardless of financial needs.”

Summit’s associates (and its more senior investors) are expected to generate ideas “the old fashioned way”, Chung says. “There’s no substitute for spending time on the phone or in person with companies, getting to know that business, and giving them the opportunity to get to know us.”

The hope is that if it puts in the hours to develop a relationship with a particular CEO, that executive will look to Summit first when the time comes to seek investment. This doesn’t preclude working with investment bankers on opportunities – but even in competitive situations, Summit believes its system gives it an advantage over other bidders as it has already built a relationship with the entrepreneur.

I didn’t want any money!

A good example of this approach comes from France. Summit successfully imported its direct sourcing model to Europe after opening its London office in 2001. The firm populates the office with investment professionals that speak the languages of the various countries in the region, which allows them to develop relationships with local entrepreneurs.

An associate on the Europe team started to develop a relationship with an entrepreneur named Jacques-Antoine Granjon, another of Summit’s colourful portfolio company CEOs. Granjon is the founder of French company, one of the country’s first e-commerce sites, which organises sales events for its more than 11 million members.

Summit invested an undisclosed amount in in 2007, buying a 20 percent stake, and beating out local investment firms. Granjon tells PEI that prior to Summit’s investment in 2007, he was not interested in bringing in outside capital. Some of his partners convinced him to meet with potential investors, but Granjon was not impressed. “I saw a few other private equity firms and I didn’t like the way they were acting … I didn’t need them. I needed to make my company grow and [I was] spending too much time [meeting with potential investors],” he says.

With Summit, however, Granjon says he was impressed with the firm’s track record and the quality of the relationship he developed with its team. Summit’s associate had an “intelligent” initial conversation with Granjon, which led to more meetings. This gave Summit the opportunity to explain its “deep credentials in the Internet space”, according to Collins.

So when the company decided to bring in an investment partner, Summit was top of the list – which probably came

When you have investors like that in your company, it gives you a higher level of confidence in what you are doing.

Jacques-Antoine Granjon

as something of a surprise to European firms courting the business. “Conventional wisdom would say: there’s no way an American firm would be able to directly source an investment in France. And we were able to do that; [we were] able to beat French-based growth equity investors who probably felt that they somehow had the inside edge,” Collins says.

While Granjon didn’t need the money, he says Summit was able to help him expand geographically both in Europe and the US, as well as help him better arrange the operational side of his business. “They helped me in putting an organisation in place, upgrade our financial reporting and recruit a CFO, which we needed. When you have investors like that in your company, it gives you a higher level of confidence in what you are doing,” he says.

Future challenges

This sourcing model helps to set Summit apart from its competition, which sure is fierce and growing. Many firms, including some that have traditionally targeted larger buyouts, have increased their focus on the mid-market, which seems to have become the strategy du jour for many LPs in the wake of the financial crisis. One example is mega-firm TPG, which is raising its second growth equity fund, targeting $2 billion. The firm’s debut growth fund is a relatively good performer and marketing for the second vehicle has been robust, sources have said in past interviews. That certainly poses a challenge to long-time operators in the space like Summit, who have previously enjoyed a somewhat less crowded market.

The big question is whether Summit can continue to find the kind of proprietary deals on which it has traditionally thrived. In the current challenging climate, competition for solid, growing companies is likely to be hotter than ever.

But with its extensive database, and its associates working tirelessly to build relationships with promising entrepreneurs, Summit would seem to have a better chance than most of retainining its pre-eminence. And if its recent run of fundraising success is any indication, LPs are certainly fully on board with the Summit way of viewing the world.

Box: Well in credit

Summit Partners has raised “subordinated debt funds” since 1994. Capital from these vehicles – raised mostly, but not entirely, from limited partners who also commit to the firm’s growth equity funds – is used to finance Summit’s own deals.

The firm saw an opportunity a few years ago to move more into the credit space, providing capital only to companies with whom the firm’s equity funds did not work. So Summit imported a team from Guggenheim Partners and started to refine its strategy.

In July, the firm closed its debut credit fund on $520 million, well above its $200 million target. This included commitments from new investors, who were looking for a different strategy from the firm’s equity products.

The credit fund invests using the same philosophy as any of the firm’s other vehicles, using the direct sourcing system to find quality companies – sometimes with bad balance sheets – and build relationships with management over time.

“For the right company, not big enough to do a syndicated loan deal or a high yield bond offering, but which has credit needs, historically, we didn’t have something for them unless they were raising equity with mezzanine debt,” according to Tom Roberts, a managing director at Summit who, along with Todd Hearle and Jamie Freeland, leads the credit strategy. “Now we have a fund where we can address those needs directly, and the demand for that type of credit is really fantastic these days.”

For the right company, not big enough to do a syndicated loan deal or a high yield bond offering, but which has credit needs, historically, we didn't have something for them unless they were raising equity with mezzanine debt.

Tom Roberts

Demand is high because small banks and other lenders that once served smaller, mid-market companies with earnings before interest, taxation, depreciation and amortisation of between $20 million and $50 million have slowed their lending activities, Roberts says.

“Those banks have been under such capital pressure for the last three or four years; they will make loans to companies that are $10 million, $20 million, $30 million in EBITDA, but not very often and not very aggressively,” Roberts says. “We’re hoping to fill that need.”

Summit made its first deal from the credit fund last year, investing an undisclosed amount in a Nashville, Tennessee-based company called Covenant Surgical. Covenant develops and acquires surgical centers for a variety of outpatient procedures, like colonoscopies.

Inevitably, Summit became aware of Covenant through its direct sourcing system. A firm associate was at a healthcare trade show and discovered Covenant, which had only recently launched and was beginning to develop its relationships with target acquisitions.

Through this meeting, Summit started to track Covenant almost since its founding. The company raised some equity, took out a credit line from a local bank and started to grow through acquisitions.

After a few years, Covenant identified a deal that would grow its business by 50 percent, but couldn’t get financing from its local bank. “They didn’t want to raise equity because they thought that would be too expensive. They wanted to stretch to get this deal done, get it integrated, show a little better story and then go raise equity,” Roberts says.

Summit liked the company and understood its plan, so decided to invest. Covenant closed on the acquisition, and then another one in its pipeline, which allowed the company to refinance its senior debt. Having used all its senior and second lien debt, the company is now actively looking to raise equity and further expand.

“We understood their needs, the deal fit perfectly for us, it was space and a firm we knew very well, we had great contacts from doing our due diligence and it turned into our first deal,” Roberts says.

While this deal was proprietary, Roberts says, “I don’t know if the majority of our deals will be that way. But it’ll be the plurality, and it very well might be the majority. A big part of our deals have come and will come from exactly that: just tracking a company with a good set of managers and being there with one product or the other depending on their needs.”