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On The Grow

Fund that finances emerging ventures could mean high rewards.

If you crave more entrepreneurial exposure, consider investing in a portfolio run by professional venture capitalists who specialize in funding promising young businesses.

The traditional route for doing this is limited partnerships, but those can be quirky and illiquid. Equus II is a publicly traded closed-end fund that serves the same purpose.

Closed-end funds are like open-end funds, except they have a fixed number of shares that trade on a stock exchange (the AMEX, in Equus' case); you buy and sell shares through a broker. The fund's share price fluctuates in relation to its net asset value, which is the per-share value of the underlying portfolio. Depending on demand, shares can trade at a premium or a discount--that is, for more or less than net asset value.

Equus feeds capital to carefully selected young companies and nurtures them until they go public. The fund's managers structure financing to encourage bottom-line results, and an Equus executive normally sits in on the companies' boards.

Equus isn't a true venture capital fund because it doesn't gamble on start-ups. It limits its scope to companies that have revenues, putting it more in the business-development camp.

Last year, for example, Equus financed a project to roll seven small home-repair businesses into one operation, then took the enterprise public. Its total investment was $3.1 million. Even after selling some of the stock, the fund's remaining stake in the company--which has since acquired 13 additional businesses--is worth more than $34 million.

Other successes since the fund's 1992 inception include Allied Waste Industries Inc., one of its biggest holdings, which has grown from a tiny company with three garbage trucks to one of
the nation's largest waste-disposal concerns. Equus' remaining position in retailer Garden Ridge--part of it has been sold at a $7.3 million gain--is worth $4.2 million today compared with its $700,000 cost. And the fund's stake in NCI Building Systems is worth more than 20 times its original cost.

Such windfalls have produced exceptional returns. On a net-asset-value basis, the fund gained more than 20 percent in 1995 and nearly 30 percent last year. Over its life, it has posted an impressive 21.1 percent annualized return.

Equus requires a long-term investment horizon. The values of its holdings typically mark time for several years before the companies go public, if they even make it that far. For the same reason, Equus' net asset value doesn't mimic the stock market's movements closely, so don't expect the fund to ride any rallies, although its gains can dry up quickly when bearish conditions stifle initial public offering (IPO) activity.

Some investors might also be turned off by the fund's generous incentive structure, which follows the standard for business-development companies: Besides a 2 percent management fee, the fund gets 20 percent of all realized capital gains, less any unrealized losses, on a cumulative basis, although a new structure is being voted on.

Nonetheless, there's a lot of value incubating in this fund. Not only are most of its holdings valued at cost for net-asset-value purposes, but the fund's own shares recently traded at a huge 31 percent discount. The markdown has shrunk since 1992 and will narrow further if continued success draws more investors to discover the fund. A shrinking discount multiplies a firm's gains, and anyone buying Equus now would still be one of the early birds.

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This article was originally published in the May 1997 print edition of Entrepreneur with the headline: On The Grow.

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