Meet the 2006 IVCA Award Honorees: Q&A With Sam Mencoff, Paul Finnegan

Meet the 2006 IVCA Award Honorees: Q&A With Sam Mencoff, Paul Finnegan

November 20, 2006

CHICAGO - “ Sam Mencoff and Paul Finnegan of Madison Dearborn Partners sat down with the Illinois Venture Capital Association to discuss the evolution of private equity in Chicago and their firm's investment mentality.

Illinois Venture Capital Association: You are each pioneers when it comes to private equity in Chicago. Please provide us with an overview of how the industry has evolved over the last 25 years.
Sam Mencoff:
You can trace it back to a handful of original investors. Starting in the late 1960s in Chicago, the Heizer Corporation was a powerful and early force in the industry. Of course, we are most familiar with First Chicago, which was encouraged by the Small Business Investment Act of 1958 and began its private equity operation in the late 1950s.

First Chicago was one of the pioneering, bank-affiliated private equity investors in the nation. The firm came into prominence under the leadership of Stan Golder, who built First Chicago's venture capital operation into a real force throughout the 1970s and into the early 1980s.

Following Golder's departure to form Golder Thoma, John Canning assumed the leadership of First Chicago Venture Capital. Golder Thoma has since spawned several other private equity firms including Thoma Cressey Equity Partners, GTCR Golder Rauner and Waud Capital.

Over the years, out of First Chicago you have seen the formation of other firms like Marquette Venture Partners, Wind Point, Linden, Water Street Capital and Golder Thoma.

Another foundation investor in the early years after the 1958 legislation was Continental Illinois. Other firms have formed out of Continental Illinois (notably Willis Stein and CIVC). First Chicago has gone on through several mergers to become JP Morgan and has once again pursued a very aggressive private equity program.

Frontencac has been engaged in private equity investing in Chicago since the early 1970s and is one of the pioneers of the business.

Paul Finnegan: First Chicago generated national spinoffs as well. A number of people went to T.A. from First Chicago and Summit was subsequently founded by a number of those same people. First Chicago was also an early financial backer of KKR.

In addition to its own vibrant private equity industry, the City of Chicago has indeed had a national impact on the business.

IVCA: Let's turn to the genesis of Madison Dearborn.
SM: Madison Dearborn was founded in late 1992 and began investing in 1993. The firm was led by the principals that comprised First Chicago Venture Capital. First Chicago was a terrific place for us. We generated positive results for them and they were very supportive of our efforts.

At that time, though, it began to appear that the regulatory framework enabling bank affiliates to invest in private equity was coming under scrutiny, which could have potentially resulted in a curtailment of First Chicago's private equity operations.

We concluded - “ and First Chicago agreed - “ that the best strategy to continue to operate the private equity business was to do so outside of First Chicago. With their full support, we spun out of First Chicago in late 1992 and took the entire staff with us (all the investment professionals and all the support staff).

In effect, we simply put a new name on the door: Madison Dearborn Partners.

First Chicago was very supportive of that move and was one of the largest investors in our first $500 million fund. I believe that First Chicago committed approximately $110 million to our first fund. They gave us a terrific sendoff. We continued to manage the portfolio we built for First Chicago on a contractual basis.

IVCA: Let's fast forward to more recent times. Please Talk about Madison Dearborn's most recent fundraising efforts and how the firm is positioned heading into 2007.
We just completed raising our fifth fund, which is a $6.5 billion fund. As part of that effort, it's nice to see the large number of limited partners who have been with us for all of our funds.

In our fifth fund, we spent a fair amount of time raising capital internationally. We now have a blend of international capital along with our traditional providers of U.S.-based endowments and pension funds. We have grown from the fund of $550 million to $925 million, $2.2 billion, $4 billion and our most recent $6.5 billion fund.

In our fifth fund, we are seeking to replicate the strategy we pursued successfully in our fourth fund, which was to create a diversified portfolio of growth- and later-stage buyouts across our five industry specializations (basic industries, communications, consumer, financial services and healthcare).

We're now up to 25 full-time principals and 12 associates. The associate program is relatively new. We hire young and talented individuals who have previously worked at an investment bank. They join Madison Dearborn and work with us for two years before heading off to business school. In essence, the program is a two-year interview for both sides.

After graduation, we hope to attract back those associates who have been particularly impressive. Four of our current six vice presidents are alumni of this program. The program has become and will remain an integral part of our recruitment plan.

IVCA: There's a lot of capital in the marketplace, and because of your firm's past success, you're able to raise a sizeable fund. What are some of the challenges of so much money out there with valuations and regulatory attention?
Cycles are a part of our business. We've been investing through cycles for decades now. It does feel to us at this point that we're at or near a high point in this cycle from the perspective of acquisition and leverage multiples. That suggests to us that this is a good time to be cautious.

On the other hand, when you have markets that are as vibrant as these markets have been, it gives you some wonderful opportunities for achieving liquidity for your investors.

In 2005, we generated almost $2 billion of liquidity from our portfolio. In 2004, we generated about $950 million. In 2006, we are so far at about $1.3 billion. We're continuing to use these robust financing markets to aggressively pursue liquidity. Even in toppy markets, though, there will be some attractive new investment opportunities.

We are always sifting through the tons of quarry rock to find a few diamonds. Our investment pace over the last few years has been in excess of $1 billion per year. We have invested anywhere between $1 billion and $1.3 billion the last few years on an annual basis.

IVCA: Finally, please tell us about the benefits of working with the same partners for so many years.
We still have eight of our original 14 founders with the firm. We have never lost anyone to a competitor. Our average tenure is 12 years and we have a number of people who have worked together for more than 20 years.

To try to understand Madison Dearborn is to understand our culture. We have one office. Every Monday at our group meeting, all 25 partners plus the 12 associates sit around the same large table and discuss our deal activity, our portfolio and liquidity.

That's a very important part of who we are. Our culture has helped sustain us through the good and challenging times. Looking forward, the firm is in a transition from our founding stage (with a small group of individuals) to a larger institution (managing billions of dollars of capital).

The challenge Sam and I face is to effect this transition while at the same time ensuring we retain the entrepreneurial spirit that has been so important to our success. Mentoring and advancing our younger people will be a critical part of this process.