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Pharos Capital's flush, but not immune to 'bunker mentality'
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Even with $600 million under management and at least $100 million available for new investments, Pharos Capital Group isn't about to go on a shopping spree in this Bear market.

Pharos Partner Jim Phillips (at left) told VNC during a Thursday interview that his company "is not immune to the psychology, the 'bunker mentality', at this point in time."

However, he said, Pharos' slight "contrarian streak" means the company continues to move cautiously forward, even while some other firms may be "afraid to stick their heads up out of the foxhole, at this time."

Heightened vigilance is a given in today's shifting environment. Phillips noted that the recent collapse has not yet revealed a clear picture of the "new world" of finance. Instead, he said, it will take six to 18 months before investors, governments and other stakeholders know what has actually happened to the Old World. "Most of the ripple effects, I think, have yet to be determined," he said.

Meanwhile, Phillips said Pharos' deal-flow pipeline looks about like it did a year ago, except that now "the pricing is coming to us" – becoming more favorable for Pharos-as-buyer.

Ticking-off obvious impediments to business-as-usual, Phillips first noted that business owners are finding the window for initial public offerings tightly closed – "we've never seen the market as closed" as it is, now, he said.

The 41-year-old former Goldman Sachs executive earned his own stripes in New York City in the years leading-up to the Dot.com bust of 2000, which he described as "an indoctrination I don't wish on any future generation."

In addition to the IPO barrier, Phillips said debt for leveraged buyouts and other purposes is now difficult, if not impossible to secure on workable terms. Meanwhile, many deep-pocketed individual investors are simply glued to the sidelines.

Phillips said Pharos continues to look for undercapitalized companies that are breakeven or better, run by "real" management teams and needing $10 million or more for organic growth or acquisitions. Pharos' online profile indicates the company prefers to invest $5-$20 million, in stages.

Keeping an eagle's eye on Pharos' portfolio companies has taken on even greater priority, said Phillips, partly because some of those companies will now have a tougher time sustaining growth contingent upon financing for mergers or acquisitions.

Phillips said debt resources are "dissolving before our eyes." With lenders' perceptions of risk amplified, borrowers' ability to secure loans at higher multiples of earnings, cashflow or other metrics is inevitably weaker.

"We're not a big user of leverage," Phillips noted, "but, it's important in the capital structure," partly because "debt is almost always cheaper money than equity." He added that if, for example, a portfolio healthcare company can't buy an imaging machine, then "you see fundamentals affected" and that deficiency "flows right through the structure" of the enterprise.

These and other pressures will almost certainly lengthen portfolio-asset holding times significantly, delaying realizations of returns and leading many private-equity and venture-capital firms to increase contingency reserve funds, "because you just don't know how long this is going to last." In line with that, while Pharos has deployed to portfolio companies about two-thirds of its $600 million under management, the remaining $200 million has been allocated about evenly for reserves and new investments.

Increased pressure on CEOs and C-level sales and marketing executives is another inevitable consequence of limited access to the capital base, Phillips said. Particularly in the current environment, "it's easy to find yourself 'not aligned' with management," because of demands for returns on investments. In some cases, he said, management might have been hoping to stay atop the operation, generate dividends and eventually "cash-flow their way into retirement," whereas the private-equity fund managers and their limited partners seek a "realization" of greater magnitude.

The result is increased pressure for sales and organic growth. Phillips said sales and marketing personnel "are our most difficult hires at every company...," because a good salesman "is as important an asset as you can have in your company."

In fact, he said, a company's capital requirements are dramatically influenced by "the life-cycle of purchasing" and the company's investment in salespeople, who can take a long time to establish traction, while being paid more compensation than their CEOs. Committing to hire a sales executive, Phillips said, can be likened to "an entirely separate portfolio investment," so critical is the sales function.

Phillips said Pharos has direct communications with portfolio-company salespersons, when needed. However, he said, when sales performance becomes an issue, "the heat" ideally comes from the CEO, with Pharos getting "deep dive" information during regular quarterly board meetings.

More direct intervention is necessary, he said, when, for example, a CEO has difficulty addressing performance issues with someone they've worked alongside through thick and thin, particularly in smaller companies. When needed, Pharos may require more frequent reports or may call salesmen directly.

Pharos also makes clear its readiness to help close sales, create networking opportunities and solicit referrals, to further the company's success.

In fact, Phillips said he believes Pharos is "pretty management-friendly" and deeply committed to supporting entrepreneurs, whom he said he and his colleagues admire for making "leaps of faith" in launching companies.

Phillips also stressed, as have others at the top of PE and venture-capital firms, that they, too, face entrepreneurial pressure: They must not only confront common business risks; but, must also satisfy limited partners' demands for returns that are equal to or greater than those originally anticipated. In addition, he continued, investors sometimes insist a fund maintain "geographic diversity" in its portfolio, a mandate that can translate into limiting the number of "backyard" investments, even though Pharos execs "would prefer to be able to drive to any of our investments."

Often, too, Pharos must meet investors' expectations that, in addition to managing funds, Pharos will also help them find co-investors and spot opportunities for direct investment, apart from investment via Pharos.

Pharos has nearly 30 companies in its portfolio. The company has nine employees in Nashville, five based in Dallas and three who shift continually between the two cities.

Looking ahead, Pharos continues to build its talent pool. Phillips said Pharos is now searching for "one or two" recent undergraduates to train. He explained that Pharos does not consider it essential to hire MBAs, "because I'm not sure that we feel that the talent differential or the price differential is there."

Pharos calls two cities home, partly because Pharos Co-Founder Kneeland Youngblood is both a native Texan and a former surgeon who, with his co-founders, recognized Nashville's prominence as a center of healthcare entrepreneurism. In 1997, when Youngblood and Co-Founders Michael Devlin and Bob Crants began pursuing their vision for what eventually became Pharos Capital Group LLC, both Dallas and Nashville were deemed underserved with regard to both venture capital and private equity. Today, Pharos' holdings in the Nashville region include such familiar local names as Iasis, Gordian, Psychiatric Solutions and Windsor Health, among others.

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Tags: Bob Crants, education, Goldman Sachs, Jim Phillips, Kneeland Youngblood, Michael Devlin, Pharos Capital Group, private equity, recruitment, venture capital

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