Mill Road Trumpets Micro-Cap LBOs

A source knowledgeable about the firm said Fund II will likely close later this year. Triago is a placement agent for part of the firm’s fundraising efforts.

Greenwich, Connecticut-based Mill Road was founded in 2004 by Thomas Lynch, a former executive at The Blackstone Group and Lazard Capital Partners.

Fund II, which has been in the market for more than a year, held an initial close of $126 million in mid-2012. Overall, the firm has invested in more than 40 companies, mostly in industries such as consumer products and retail, restaurants and business services.

Mill Road’s strategy, according to Scott Scharfman, a managing director, “looks back to the early days of private equity, when nearly all buyouts involved publicly traded companies.”

But unlike the hostile LBOs of yesteryear, Mill Road always acts in partnership with the companies it hopes to take private. Mill Road’s take-privates, said Scharfman, are “always friendly. … We might tell a founder, ‘If you’re interested, we also take companies private.”

So far, the firm’s strategy has paid off.  The firm’s debut fund, Mill Road Capital LP, a 2007-vintage fund that raised $247 million, was returning a gross IRR of 23.5 percent, and a gross return multiple 1.8x as of Dec. 31, 2012, according to an investor in Fund II. Investors in that fund include the Kentucky Retirement Systems and the Indiana Public Retirement System. That fund invested in such well-known companies as Rubio’s, a popular Mexican fast-food chain in Southern California, and Destination Maternity, a retailer of maternity wear. 

Ultimately, the firm is very selective about the companies it helps take private—just 10 percent of the companies the firm initially buys stock in. “If we don’t do a transaction,” said Scharfman, “it’s almost always because the stock price has gone up.”

But that, too, is part of the strategy, he said. The firm’s stock positions—mostly in micro-cap companies that have been “completely overlooked by institutional investors”—have provided a steady stream of capital gains, said Scharfman. “We use those gains to help cover management fees, and investors enjoy that.”

Another aspect of Mill Road is that the firm’s portfolios change dramatically over an investment cycle. Initially, almost all of the fund’s investments are in toe-hold stock positions, but after a few years, those stock positions will be sold off, and the fund’s remaining investments will consist mainly of the companies it has taken private. Fund I, for instance, which is now entering the end of its investment cycle, is currently around 90 percent invested in the companies it has taken private, according to Scharfman.

And when it comes to exits, nearly all of Mill Road’s portfolio companies are sold to strategic or financial investors. Almost none of the companies Mill Road has taken private have sought to go public again, Scharfman said.