Rivalry developing in Chicago private equity

For two decades, Madison Dearborn Partners LLC has been unrivaled as the top private equity firm in Chicago. Now two competitors, GTCR LLC and BDT Capital LLC, are gaining ground and could snatch the lead.

GTCR is expected to close this month on a new $3.75 billion fund, according to people familiar with its fundraising. BDT, the investment firm led by former Goldman Sachs Group Inc. banker Byron Trott, may try to raise as much as $5 billion next year, one source says. Madison Dearborn's most recent fund—raised in 2009—was $4.1 billion.

Madison Dearborn's partners, including Chairman John Canning Jr., co-CEOs Paul Finnegan and Samuel Mencoff, are expected to decide at the firm's annual meeting this month whether to take a stab at another fund next year.

Tending the biggest fund in the Midwest has given Madison Dearborn both bragging rights and an inside track when it comes to buyouts because companies are eager to have it make an offer. If a private equity firm competes against fewer rivals or just looks at more deals, it likely will pay less for a business, which can translate into better returns. Madison Dearborn may cede that regional edge if its fund size slips relative to BDT or GTCR. The three firms decline to comment.

“Whether you can raise money and how successfully you can do it is very strongly related to performance,” says University of Chicago professor Steve Kaplan, who specializes in the industry.

Returns for three of GTCR's past four funds since 2000 ranked among the top quarter of all funds as of the end of March. By comparison, just one of Madison Dearborn's past three funds ranked in the top quarter for the same period, according to PitchBook Data Inc., a research firm based in Seattle.

Madison Dearborn's latest fund was smaller than its previous one, a $6.5 billion fund raised in 2006. Generally, a firm doesn't want to reduce its fund size, but many large firms did so during the financial crisis, says Adley Bowden, PitchBook's director of research. In any case, Madison Dearborn returns have been “pretty strong,” he says.

While the three firms do deals all over the U.S., local ties may smooth the way for local deals — and that can lead to outsize profits. When Madison Dearborn bought a majority stake in Chicago-based Trans-Union LLC from Chicago's Pritzker family in 2010, it more than doubled its money on a sale two years later.

In the wake of the financial crisis, competition for investor dollars intensified because cash-strapped pension funds couldn't afford to lock up as much money for the longer investment periods required by private equity firms. More recently, investor interest in private equity has returned as rising stock prices have pushed up investable assets.

So far this year, U.S. private equity firms are on track to raise more money than they did last year, with a few big firms, such as Silver Lake Partners, amassing megafunds of more than $5 billion and pushing up the average fund size. Still, middle-market firms raising $1 billion to $5 billion, similar to Chicago's contingent, are doing about the same as in the past.

GTCR, led by partners Philip Canfield, Dave Donnini and Collin Roche, expects to raise $500 million more for its latest fund than it did for its previous one, $3.25 billion raised in 2011.

The Ohio Police and Fire Pension Fund committed $50 million to GTCR's new fund in August. It says in a statement that GTCR's latest fund was “an attractive investment opportunity” because “since its founding in 1980, GTCR is one of the oldest and most successful private equity firms in the U.S.”

BDT declines to provide returns for its first fund, which raised $2 billion in 2009. It's too young to have a meaningful track record, but there's “tons of interest around BDT,” says Mr. Bowden, noting Mr. Trott's reputation as Warren Buffett's favorite investment banker.

“I am a huge fan of Byron's, and I think the firm he has built is truly world-class,” says Eric Lefkofsky, an investor with BDT who leads Chicago-based Groupon Inc. and venture-capital firm Lightbank LLC.

Mr. Trott champions a variation on the private equity model with plans to own businesses for up to 12 years, longer than the industry average of four to seven years. BDT also offers complementary merger-and-acquisition advisory services.

Despite its competitors' recent success, Madison Dearborn can continue to claim that it has attracted more investment dollars since inception, $18 billion versus GTCR's $16 billion, including the latest fund. BDT has racked up $3 billion so far, including a $1 billion “annex” fund tacked onto its first fund. For the first time, there's pressure for Madison Dearborn to hang onto their title as Chicago's biggest private equity firm.