Rescuing Tech's Orphans

Call it salvage capital. More private equity is flowing into struggling companies

In 2003, Terry Garnett and David Helfrich quit their jobs at established venture-capital firms to try their hands at building their own outfit. But they weren't looking to do traditional VC investments. Instead, they wanted to focus on what they saw as a growing opportunity: private equity buyouts of small tech companies. These deals, which range from $20 million to $100 million, fall into a little-served gap. The companies involved are neither the freshly minted startups that venture capitalists seek nor the established outfits that buyout specialists chase. "We felt we found a new niche that hasn't been addressed," says Garnett. "We said, 'Gosh, maybe there's a market for these small, orphan businesses."'

No question, the opportunity is tantalizing. From 1997 through 2000, 6,832 companies raised a first round of venture capital, according to researcher VentureOne. A few bubble-era survivors still have potential but are idling under inept owners, stagnating inside big companies, or struggling with too little capital. "Because tech is maturing for the first time, the accumulated nonsense lying around that needs to be fixed is enormous," says Roger McNamee, a partner at Silver Lake Partners, which does large-cap tech buyouts. The opportunity: salvage capital. By fixing up these neglected outfits, Garnett & Helfrich Capital and other buyout firms plan to give these tech companies a new lease on life.

A few firms already do these deals. One of the oldest is Gores Technology Group LLC, a Los Angeles firm founded in 1987. Another is Golden Gate Capital in San Francisco, founded in 2000 by former Bain Capital LLC partners.

Several salvage deals already have paid off. One is VeriFone Holdings Inc., a maker of credit-card readers. Once profitable and independent, VeriFone began losing money after it was acquired by Hewlett-Packard Co. (HPQ ) in 1997. Gores Technology bought VeriFone from HP in 2001 for an undisclosed sum. Now VeriFone is profitable and plans to raise $230 million in its initial public offering. There were 98 buyouts of tech companies last year, for a total of $5.8 billion, according to Thomson Financial Venture Economics.

Still, G&H's debut deal illustrates how treacherous it can be to combine the volatility of tech startups with the swashbuckling ways of private equity buyouts. In the next few weeks, the firm is scheduled to close on the $35 million purchase of a 50% stake in San Jose (Calif.) computer terminal maker Wyse Technology Inc. Yet the deal almost didn't happen. G&H was days away from signing a contract with Wyse a year ago when its potential co-investor, buyout shop Texas Pacific Group (TPG), backed out. At the time, Garnett wasn't sure his firm, which hadn't yet closed on its $250 million fund, could survive the blow. Only by pulling out of the Wyce deal, completing the fundraising, and then soothing Wyse's owners were Garnett and his partner able to complete their initial transaction.

The really hard work lies ahead. Wyse briefly held the spotlight in the mid-1990s when its stripped-down computers, or "thin clients," were promoted as replacements for the PC, but the company's growth has stalled in recent years. Now G&H is betting it can push Wyse's revenues from $175 million last year to $1 billion in 2009. The idea is to promote thin clients in developing countries where PCs may be too expensive for many buyers, and to increase revenue from its Rapport software, which manages Wyse's terminals as well as devices like cell phones. "My job is to get this company growing very, very quickly," says John Kish, Wyse's CEO.

Garnett and Helfrich first spotted the opportunities in small tech buyouts when they were VCs at Venrock Associates and ComVentures, respectively. In 2002, Venrock had co-funded a $14 million buyout of security software maker PGP Corp. from McAfee Inc. (MFE ). Sales rose quickly at the newly independent PGP, and within six months it was bringing in more cash than it was spending.

In July, 2003, the duo quit their jobs, formed G&H, and hit the road to raise their first fund. In the process, they met James G. Coulter, co-founder of Texas Pacific. Intrigued by the pair's approach, Coulter said that if G&H found any attractive deals before it finished raising its fund, TPG would consider loaning the new firm the necessary capital and co-investing. G&H quickly set its sights on Wyse. After an October meeting with Coulter, Garnett thought G&H and TPG had a deal to split a 50% stake in Wyse.

Yet the deal never really fit at TPG, a common problem for small tech buyouts. Wyse was too small to produce significant returns for the firm's $4 billion U.S. buyout fund, and it was too big for the $400 million venture-capital fund. In January, 2004, after Garnett and Helfrich hammered out a six-page document detailing the deal's terms, Coulter called to say TPG wasn't interested. "We weren't laughing," says Helfrich.

G&H had to tell its investors, which include Harvard and Stanford universities, the deal had hit a roadblock. Still, G&H closed its fund without losing any investors. That summer, the pair reignited talks with Wyse.

Despite the snafu, G&H's investors think the firm has loads of potential. "What has gone on in the venture industry in the last decade has created an opportunity now on the buyout side," says Catherine Crockett, a general partner at Grove Street Advisors LLC. Whatever the risks, the time seems to be right for salvage capital.

By Justin Hibbard in San Mateo, Calif.

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