Northcreek fills credit void

February 24, 2011 11:33 AM, Feb. 24, 2011

A partnership started by Cincinnati banking veterans has started to make investments in small businesses from its $63 million debut fund, helping fill the gap for companies struggling to access credit.

Northcreek Mezzanine, which received its Small Business Investment Co. license in April 2010, is focused on investing in established Midwestern businesses with revenues in excess of $5 million. Northcreek will consider investments nationally, but its location means a good portion of its funding will be in the Midwest.The group now includes co-founders and managing partners K. Rodger Davis and Barry A. Peterson and partner Steven M. Touvelle. This year, it named a fourth partner, Mary Sue Emerson.

So far, Northcreek has closed two deals, one of which was local - iNet interactive in West Chester, which publishes niche technology publications. A third investment, also local, is close to closing, and Northcreek is studying "several" other local opportunities, Peterson said.
Lenders such as Northcreek Mezzanine help fill a void at a time when credit is still tight for small business. As banks move toward fully secured credit lines and away from credit exposure, they may choose not to fully renew - or perhaps even terminate - existing credit lines with some businesses. That's where "mezzanine lenders" such as Northcreek step in.

"Our favorite thing to do is sit down with small business owners and try to solve their problems," said Davis, who has 25 years of banking experience. "I can't think of an industry that we haven't seen a loan in, and we've made loans in most (industries)" during their banking careers.

"It's what we enjoy doing," Peterson said. "We could have done this at a bank. We wanted to be entrepreneurs."

Northcreek, which is licensed to operate as a debenture fund through the Small Business Investment Companies program, is able to access $2 from the U.S. government for every $1 it raises through private investors. Northcreek has so far raised $21 million in its debut fund from its limited partners, and accessed another $42 million from the government.

It hasn't been easy. Davis and Peterson, who have known each other 18 years, began raising money in June 2008 for the first fund. They initially had success, but that fall came the near-collapse of the country's financial markets. Between Sept. 14 and Oct. 3 alone, Lehman Brothers filed for bankruptcy; Merrill Lynch was sold to Bank of America; American International Group was saved by the Federal Reserve; and the $700 billion Troubled Asset Relief Program was created.

In that environment, sources of funding temporarily dried up for Northcreek, and in December 2008, Davis and Peterson shut down trying to raise money and worked as consultants until June 2009.

Their Northcreek Mezzanine Fund I debuted at $45 million in April 2010, when Touvelle joined the group; since then it's added $18 million. Davis said the fund may raise a bit more capital, but $70 million is about the maximum.

Under SBIC regulations, a maximum of 10 percent of an SBIC's total capital can be invested in a single small company. And 25 percent of an SBIC's investments must be directed to entities whose net worth is less than $6 million. SBICs are required to invest in small businesses in either debt or equity, or a combination of the two.

Peterson said Northcreek plans to invest in at least 20 businesses with its first fund, and that hopefully a third of those investments are in local companies.

Davis said this type of financing is "absolutely vital" to keeping small businesses going.

Without access to credit, they would have to sell, cut jobs or cut expenses, he said.

Until the recent financial panic, successful small businesses often took financing of their capital structures for granted. In addition to loans from banks, these business owners could access funding through brokerage accounts, personal savings or the savings of family and friends, and home equity, said Adrian Breen, regional president for the Greater Cincinnati and Kentucky region at First Financial Bank. Downtown-based First Financial is an investor in Northcreek.

The Great Recession and subsequent losses in brokerage accounts and home values have put maintaining that capital structure under stress, Breen said.

Simultaneously, banks have moved to reduce credit exposure and make more loans that are fully secured. The result: A lack of credit for many small businesses that have survived the recession.

In the short term, a lack of credit can hurt businesses that are sitting on excess inventory, or that have a high number of accounts receivable. In the longer term, a lack of credit hurts businesses that might be looking to buy equipment, expand their buildings or make acquisitions.

Banks still want to lend to small businesses, Breen said, but they may not be able to fully meet every business' credit needs. The resulting gap is where Northcreek steps in. Mezzanine lending carries a higher interest rate - between 10 and 14 percent - but less than what a venture capital firm would charge - up to 30 percent.

"Their role is critical not only to expansion and growth, but also to stabilize companies," Breen said of Northcreek. "Typical resources have been depleted, and most companies have found that a lot of money went to sustaining operations."

Breen said Davis and his partners have established themselves in the community as good bankers.

"A group like Northcreek will have a unique competitive advantage," he said. "They are business guys who run their own business, and they're bankers. So they understand both sides."

Peterson said Northcreek typically looks at a three- to five-year investment time frame. Once its fund closes, Northcreek has five years to invest the money, and five years to realize its investment. When the current fund is two-thirds invested, Northcreek can start raising money for a new fund.

There will be plenty of demand, Breen said.

"That prolonged economic downtown makes the role of an SBIC like Northcreek critical."

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