Diamond State Ventures Seeds New Fund with $75M in Capital

Entrepreneurs seeking capital for expansion or acquisitions have a fairly new source of venture capital available to tap when they feel the time is right.

Diamond State Ventures II, the bigger sister to the previously successful Diamond State Ventures fund, launched in late 2007 and was recently licensed by the U.S. Small Business Administration as a Small Business Investment Co.

SBICs may qualify for long-term government-backed loans and it allows DSV II to invest in companies around Arkansas’ somewhat restrictive usury law.

DSV II, based in Little Rock, is capitalized at $75 million and could invest as much as $90 million, said Joe Hays, president and managing partner of the fund.

“We expect to have it fully invested in the next five years or so,” he said.

Hays couldn’t give a percentage breakdown, but said a significant number of investors in DSV II are from Northwest Arkansas and that the fund is actively looking at companies based in this corner of the state. Tim McFarland, an entrepreneur, consultant and former banker, is working with DSV II and essentially serves as the fund’s Northwest Arkansas representative.

DSV II has closed two deals so far and has a “half dozen” that are in the works, with “two or three” looking like they may close by the end of 2008, Hays said.

Larry Carter, a partner in both funds, said DSV II will be similar to the first fund, in that it will focus on three buckets: expansion stage, early stage and change-of-control transactions. Though Carter and Hays said they likely will be very demanding of early stage investments, having learned some pitfalls through the first fund.

DSV was capitalized at about $45 million. Almost 50 percent of it went to expansions, about 25 percent were early stage investments and about 25 percent were change-of-control (acquisition or succession) transactions, Carter said.

DSV invested in companies like Mountain Valley Spring Water of Hot Springs, Clear Mountain Natural Spring Water of Little Rock, the former DMD Industries Inc. of Springdale and TrestleTree Inc. of Fayetteville.

In all, the first fund invested in 24 portfolio companies, 13 of which were in Arkansas. But of the ones that were based out-of-state, many had key relationships, like facilities or customers, within Arkansas, Hays said.

The fund invested about $21 million in Arkansas companies and attracted investment of about that same amount through other funds based in other states, he said. 

The two have a good working relationship with several out-of-state funds, which is important because venture capital funds will frequently pool their resources to invest in companies.

“Because we do have the ability to rely on our co-investor network, we’re real comfortable of doing change-of-control transactions up to $30 million and expansion financing of $10 million-plus,” Carter said.

Most of the transactions will involve at least one co-investor, he said, and the average transaction size will be in the $8 million to $10 million range.

As for the cruddy economy?

“As the senior credit market has moved away, it’s opened a door for us,” Carter said. “That allows more demand for junior capital, which is the role we fill.

“Today’s market has more opportunity if you’re sitting in our seat than it did a year ago. Our deal flow is higher than it was six months ago.”