Irvine-based Lotus Innovations LLC is a hybrid private equity firm that focuses on emerging technology companies and provides back-office operations and staffers to its entrepreneurs, both rarities in the sector.
“I’ve never seen anything like it,” said Marc Hayden, chief executive of gen-E, a Lotus Innovations portfolio company that provides software-as-a-service products that monitor large organizations’ entire IT networks.
Lotus “isn’t a venture capital fund, but it’s open to risk and invests in early-stage companies that need capital or operational expertise,” Hayden said.
He said that he can “essentially outsource all the noncore competencies” of his company to Lotus because it has the specialists—in administration, law, marketing and media relations, and information technology operations—and offices that entrepreneurs need to run the daily operations of a company.
“It’s more efficient,” he said. “I don’t have to develop policies and procedures,” think about healthcare benefits, or consider hiring controllers.
Lotus has people who can immediately fit into a smaller company because they understand the culture and the challenges that face a growing business, Hayden said.
Another benefit, he said, is that “those back-office operations disappear” from a Lotus portfolio company when it’s sold. Those staffers remain with Lotus to work with new portfolio companies.
Active Investor
Lotus opened its doors in 2013 when it raised its inaugural $10 million fund, Lotus Fund I. The fund invests in smaller companies with less than $30 million in annual revenue that develop software or services for other companies, said Christian Mack, Lotus’ managing director.
“We also prefer to invest only in the early stages of a company,” Mack said.
Those are big differences from conventional private equity firms, which usually prefer to acquire and develop privately owned middle-market companies that earn more than $30 million in annual revenue, provide a proven product or service, and have established customers.
Owners of middle-market companies typically decide to sell their businesses prior to retirement or because they no longer have an interest in running them. Private equity firms usually work with business owners to further develop and improve the companies’ operations prior to a sale to larger corporations or before pursuing initial public offerings.
Lotus Innovations’ Fund I was meant to be a five-year commitment, but it closed after one year. The fund acquired three companies in less than six months, and investors got a 33% internal rate of return within its first two years..
The fund is closed to investors and further acquisitions, though Lotus is raising $30 million for Fund II. Investors would commit to a five-year period and allow Lotus to acquire and develop under-valued enterprise technology companies, according to its prospectus.
Mack said he helped create Lotus after he sold his Irvine-based enterprise software company, gen-E—the progenitor of Hayden’s company—in 2012 to private equity firm Solis Capital Partners in Newport Beach for an undisclosed amount.
Gen-E the following year changed its name to Resolve Systems. The company optimizes the performance of communications networks.
Lessons Learned
Resolve grew under Solis’ guidance, then spun out a division that adopted the name gen-E, which is a portfolio company in Lotus Fund I.
Mack said the experience with Solis taught him a lot about investments, private equity, entrepreneurs and developing a company.
“We really saw an opportunity to help smaller and midsized companies.”
Such companies were starving for capital after the recession, he said, because most banks weren’t lending to small-business owners and most private equity firms preferred to work with older companies with established products and customers.
He said he knew from experience that access to working capital, experienced leaders and efficient back-office operations were key elements of business growth.
Yet Mack and his two partners, Linda Ritchie and Mark Prynn, wanted to be more than a source of funding to smaller companies, according to Securities and Exchange Commission documents. They wanted Lotus to be an active investor.
“I like working with entrepreneurs,” Mack said, understanding their challenges and helping them find solutions.
Loads Lightened
Mack said he knew as an entrepreneur that one person at a small company usually performs multiple roles. The company founder, for example, is also usually the chief executive, chief financial officer, vice president of marketing, and chief technology officer, all at the same time.
That means entrepreneurs typically can’t devote most of their time working to their strengths, such as developing products or services, he said, and therefore their companies can’t grow as quickly or efficiently as companies with dedicated sales, marketing, legal and administrative staff.
Venture capital funds can usually provide funding and guidance for an expansion, Mack said, but the entrepreneurs still have to hire back-office staff and develop company policies.
So he decided to relieve entrepreneurs of such duties by providing those components—expansion capital, operational leadership, back-office staff, and office space—when they joined Lotus.
He said the cost for the startup is about the same as hiring full-time staff, though the support relieves executives of what can be time-intensive duties.
A small company could grow very quickly with the proper back-office operations, Mack said.
In the Nest
Entrepreneurs, however, are expected to work in Lotus’ Irvine office once a month.
“We like to see them” and discuss their work, Mack said.
Hayden, gen-E’s chief executive, travels from Florida to Irvine monthly and said there’s a benefit to working in the Lotus office because it “basically has an experienced board of advisers” who can discuss ideas and solutions for his company.
He declined to provide annual sales for gen-E but said annual revenue has increased 230% since Lotus acquired it.
He said he believes that Lotus’ investment strategy will spark the next generation of private equity and venture capital investors.
Mack said there are currently too many private equity and later-stage venture capital investors pursuing the few companies that have $30 million in annual revenues, the magic number for most traditional investors.
“There’s just a little too much money available at that level,” he said.
“Right now, we see more deals than we can finance. There is not a lot of competition to finance companies that have less than $30 million in revenue.”
