Posted on May 04, 2015

Beedie deal with Bond Capital highlights rise of merchant banking

Beedie Development Group’s (BDG) decision to allow Bond Capital to manage an $85 million private equity fund will make Bond one of Canada’s largest merchant banks.

The decision also highlights growth in merchant banking, which is the sector of finance that often involves extremely wealthy individuals, families or small groups of people who lend to entrepreneurs or buy small equity stakes in their ventures.

Bond already manages hundreds of millions of dollars in five separate funds financed by wealthy individuals, although founder Davis Vaitkunas declined to reveal his funds’ value.

Merchant banks predate the 1500s in Italy and are sometimes described as being the original modern banks, although the merchant bank tradition is less established in North America.

Entrepreneurs first seek financing from conventional banks or credit unions, which charge about 4% interest on loans.

Once the business owners have tapped out those sources, they seek less conventional financing.

“When their bank glass overflows, they look to my glass,” Vaitkunas said.

Competing Metro Vancouver merchant banks include Walter Berukoff’s Red Lion Management, Callidus Capital (TSX:CBL) and the Belzberg family’s Second City Capital.

Patriarch Joe Segal and his family operate the Kingswood Venture Capital Corp. (KVCC) division within their Kingswood Capital Corp.

“We have dozens of private investments currently,” said Gary Segal, KVCC’s chief executive officer.

Some past KVCC investments included single-digit-percentage equity stakes in companies such as Avigilon Corp. (TSX:AVO) and Urthe-Cast Corp. (TSX:UR) before they went public.

Not all wealthy individuals buy small stakes in ventures, because many prefer to have a majority stake that gives them control.

Fiore Financial Corp. CEO Frank Giustra, for instance, told Business in Vancouver that buying small stakes in companies is “not what I do.”

BDG, which is primarily a real estate developer, has been in the merchant banking business for several years, managing its fund internally, through its Beedie Capital division, and investing in ventures such as YYoga and Nettwerk Music Group.

“Relative to the overall size of BDG, I don’t see [merchant banking] becoming a significant driver for the overall business yet,” BDG president Ryan Beedie told BIV.

“[Merchant banking] will become more important as the years go on, and it’s an area of growth for sure.”

Beedie, who has small investments in Bond’s other five funds, said he will share the final decision on investments in BDG’s own fund, which Bond will manage, with Vaitkunas and other Bond staff.

Beedie’s aim is high: he wants to see annual returns in the “low- to mid-teen” percent range.

“I’m not interested in doing low-risk deals that won’t generate much,” he said.

BDG’s $85 million fund includes some money committed but not yet placed, and Beedie intends to add new money to the fund.

Vaitkunas said many of the investments could be made to D-grade recipients and carry an 18% interest rate.

“A-grade risk would be through a bank. B-grade would be fully secured with equipment. C-grade is if there is cash-flow but no assets, and D-grade is an equity risk where there is no cash flow or assets,” Vaitkunas said.

Loan recipients opt to pay the high interest rate because they see it as being preferable to selling equity, which Vaitkunas said they believe will yield an even higher future return.

Most debt for those ventures is from a bank, so when the small amount of high-interest debt is added, the blended interest rate could be close to 5.5%.

The sweet spot for Beedie's fund is when companies are cash flow positive and have a market capitalization of between $8 million and $300 million.

He said his ideal investment is in the $3 million to $7 million range.

Preferable sectors include technology, manufacturing, transportation and distribution.

He is unlikely to invest in mining, commodities or energy.

“Beedie and Bond Capital both have good reputations in this space, so, big picture, it’s a good move on Beedie’s part to do this,” said Thane Stenner, who manages portfolios for ultra-high-net-worth individuals and is a director of wealth management at StennerZohny Investment Partners, which is part of Richardson GMP.

He added that many super-rich people he knows are in Tiger 21, which is a peer-to-peer learning network for high-net-worth investors, and they invest in both mezzanine or convertible debt, which are investments riskier than A-grade bank debt.

“The main reason they do this is that they can get higher yields with commensurate higher risk,” Stenner said, adding that he believes Beedie’s estimated annual return is realistic.

“Everyone is looking for higher yields nowadays, so that’s why the asset class and sector is growing nicely.”•

gkorstrom@biv.com