Behind the demise of a former high flyer in private equity

CHS Capital LLC, once one of the four leading private equity firms in Chicago, is calling it quits after it failed to raise money for a new fund.

Founded in 1988 as Code Hennessy & Simmons LLC, the firm raised its biggest fund in 2005. But the lack of investor interest in contributing to a sixth fund over the past year led partners to splinter into new firms.

The generalist approach of CHS, with its midsize funds and investments in an array of industries, has fallen out of favor with pension funds, endowments and foundations that are gravitating to smaller niche funds. CHS' mediocre returns, pulled down by a slew of investments just before the 2008 financial crisis, also hurt the firm.

“The challenges are around performance and story,” said Randall Winters, who leads Chicago-based ELK Capital Advisors LLC and provides advisory and fundraising services to investment managers. “If you are unable to raise your next fund, you are unable to survive as a firm.”

CHS tried to reorient its funds last year to focus on smaller acquisitions costing from $75 million to $300 million. But its $1 billion target for the new fund and continuing multisector focus were a non-starter with investors.

CHS managing partner Brian Simmons and partner Daniel Hennessy, who co-founded CHS in 1988 with Andy Code, decline to comment, citing federal restrictions related to fundraising for their new firms. Mr. Code, who left CHS last year to join Chicago investment firm Promus Equity Partners LLC, said he has an agreement with his former partners not to discuss CHS.

Messrs. Code, Hennessy and Simmons, who worked on buyouts in Citicorp's Chicago office, formed the firm with a big assist from Mr. Simmons' father, onetime Allegheny Ludlum Corp. Chairman and CEO Richard Simmons, who invested $3 million of his own money and persuaded Allegheny to invest $25 million.

Over its lifetime, CHS invested in some 400 companies and, like other private equity firms, sought to profit through sales and initial public offerings. While CHS partners were at the top of their game when they attracted $1.3 billion in 2005 for a fifth fund, it was a third larger than any they had ever managed and required them to deploy capital just as asset prices were peaking. In 2006 and 2007, CHS made 22 investments and sold just two companies, along with one initial public offering, according to its news releases.

When a firm significantly raises the size of its funds, that can be a concern for investors, said Steve Kaplan, a University of Chicago professor who studies the industry. Either the firm has to do more deals and increase its staff or it has to make bigger acquisitions for which its approach might not be suited, he said.

Recent returns for CHS suggest its strategy stumbled. The fifth fund had returned 8.5% as of the end of 2012, compared with 13% or better for rivals that also raised money in 2005 and ranked among the top fourth. The prior CHS fund, with $1 billion raised in 1999, has had a 12.6% return vs. 17.8% for top funds.

While assets under management at private equity firms more than tripled over the past decade, to $3.273 trillion worldwide last year, according to Preqin Ltd., the number of firms has jumped, too, boosting the pressure to stand out. “If you have a bad fund, then your investors may give you one mulligan, but they tend not to give you two,” Mr. Kaplan said. “It's not sticky money.”

Chicago's largest private equity firm, Madison Dearborn Partners LLC, also raised a big, $6.5 billion fund in 2006 just before prices plummeted, but its size has allowed it to wait out the downturn. GTCR LLC, the second-biggest firm, concentrates on a handful of industries. Willis Stein & Partners LP, another one-time major Chicago company, began folding operations last year after a decade in which it hadn't raised new money.

CHS likely wasn't helped by the departure of partners because that can raise questions for investors about who's managing their money. In addition to Mr. Code, Steven Brown left for Promus and Richard Lobo joined Nova Capital Management Ltd. in Chicago.

Mr. Code said his decision was driven by a desire to segue to smaller, microcap deals at Promus, where his private equity arm invests mainly on behalf of 15 wealthy families, including his own. “There's very few of the bigger funds being raised today,” Mr. Code said. “People want specialty.”

The CHS name will live on as 15 investment professionals, including six partners, work on winding down the firm's investments even as they start new firms.

Mr. Simmons is teaming with partners David Hawkins and Marcus George to form ShoreHill Capital LLC, seeking at least $350 million for small industrial and distribution transactions, according to industry sources. Partner Thomas Formolo has formed New Harbor Capital LLC to raise $150 million for investments in health care, education and business service companies. And Mr. Hennessy has plans for a non-traditional private equity firm that lets public shareholders join investments, the sources say.