State Investment Council member Leonard Lee Rawson still has many reservations about the SIC’s private equity program, but he said relations with program adviser and manager Sun Mountain Capital are improving.
“The dialogue is getting better,” Rawson told the Journal.
That’s a major advance from last March, when Rawson asked the council to consider firing Sun Mountain because of concerns over potential political influence in some investment decisions.
Sun Mountain presented an update on the program’s performance at the SIC’s last monthly meeting in Santa Fe in late June.
After that meeting, Rawson said he and Sun Mountain Managing Director Brian Birk are working on building trust.
“The nature of private equity is tough to evaluate, so you have to have complete confidence in your manager,” Rawson said. “That’s what Brian and I are trying to get through, for us to have confidence in each other.”
To do that, the SIC and Sun Mountain agreed in April to take steps to reinforce transparency and accountability in investment decisions, including a commitment by Sun Mountain to present quarterly updates on program performance, rather than the previous twice-per-year reports.
Improvement in returns
In its latest update, Sun Mountain reported a significant improvement in making money from council investments in local venture funds and startup companies.
Under the program, which started in 1993, the council can commit up to 9 percent of the state’s Severance Tax Permanent Fund in venture capital activity in New Mexico, including contributions to venture funds that invest in New Mexico companies, and direct investments in local startups.
Sun Mountain was hired in 2006 to advise the council on its investments in private venture funds, which, in turn, invest that money in local startup companies.
Sun Mountain also manages a $90 million fund of state money to make direct investments in private companies.
As of first-quarter 2012, the state had $269 million invested in local venture funds, as well as direct investments in startups. The state still had $84.5 million available for new investments before breaching the statutory limit of 9 percent of the Severance Tax Permanent Fund.
Looking at the full 19-year life of the program, the overall value of council investments since 1993 was down by 3.2 percent as of first-quarter 2012, according to Sun Mountain.
That, however, represents an immense improvement compared with the performance of SIC investments prior to 2004, before the council had a professional manager and adviser for the program, Birk said.
In fact, if investments from 2004-2011 are isolated from the 1993-2004 period, then the value of state investments has increased by an average of about 1.5 percent per year, according to Sun Mountain, representing multimillion-dollar gains for the state.
In addition, returns would be a lot higher if not for the recession, which caused more than half a dozen venture-backed companies to crash and burn.
Birk said poor returns prior to 2004 are because the State Investment Council voted directly on investments in venture funds and startup firms, and the state’s commitments were aimed more at promoting jobs and economic development than investment returns. Consequently, for the 1993-2004 period, investment performance was a negative 18.2 percent, and concern rose about pay-to-play influence in investment decisions.
New central goal
But since 2004, the council and its investment advisers have made making money the central goal of the program, with jobs and economic development a secondary objective, Birk said.
“Prior to 2004, the program was not managed correctly, and to this day we’re still digging ourselves out of the hole the program was in,” Birk said.
In fact, the 1.5 percent rate of return from 2004-2011 is actually 7 percentage points higher than returns from council investments in national and international venture capital funds. Those transactions are managed separately, with California firm LP Capital Advisers providing advice since 2011.
In addition, the SIC’s investment portfolio now includes much healthier companies than before the recession, which pushed some big startups into bankruptcy, such as Eclipse Aviation Corp., Birk said. The council had invested about $19 million in Eclipse.
“A lot of the weaker companies have been weeded out with the recession,” Birk said. “Those that have survived are much healthier, and we’re seeing a number of them emerging from the pack to be leaders in their industries.”
Of the 38 companies that the council still has money in, two made the New Mexico Flying 40 list this year: Aspen Avionics Inc. and Vibrant Corp.
Still, Rawson and SIC member Mike Martin, who supported Rawson’s motion last March to consider firing Sun Mountain, said they will watch closely for positive returns in future Sun Mountain reports.
“Theoretically, I think private equity investments are a good thing,” said Martin, who is also president of Western Bank in Lordsburg. “But the execution needs to be significantly improved. I’m not sure all the funds we’ve invested in are doing the job, or getting the results, that New Mexico citizens would expect.”
Rawson said the program has substantially under-performed over the years, and it could still take a long time to achieve significant payback. That’s because returns only come when companies either go public or are sold off, and the national market for initial public offerings, and for mergers and acquisitions, is still depressed.
“I’m very guarded about the program,” Rawson said. “Venture capital investments are generally aimed at chasing returns, particularly those ‘home runs’ (or high-paying exits). It takes many years, and often companies go belly up before they produce returns.”
But both Martin and Rawson are cautiously optimistic that the April agreements on transparency and accountability will strengthen relations with, and confidence in, Sun Mountain Capital.
The council’s Private Equity Investment Advisory Committee, which Martin chairs, has chosen the council’s national program adviser, LP Capital, to provide third-party oversight of Sun Mountain’s investment decisions, said SIC spokesman Charles Wollmann. Sun Mountain has also committed to providing monthly reports on new capital commitments to venture funds and companies.
Venture capitalists hope the agreements with Sun Mountain mean more stability for investors.
“We need a stable and predictable policy environment for investments,” said Trevor Loy, managing partner for Flywheel Ventures. “That’s currently missing as a result of all the political bickering.”