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Your new bankers: hedge funds

These complex firms will start backing small companies.

By Phaedra Hise, FSB Magazine

(FSB Magazine) -- Growing companies could be tapping into a new source of capital in 2007: Hedge funds are getting into the private-equity business. And although some are investing in large venture capital or similar institutional funds, other managers are hitting the VC breakfast circuit in search of direct investments.

Hedge fund Managers have always had the freedom to invest 10 percent of their fund, known as a "side pocket," in illiquid assets. Traditionally they've chosen real estate or big energy companies. But lately they've been looking at more creative outlets, including small growth businesses.

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"This is money directly going to companies," says Russell Tencer, managing partner at the Parker Boston Group (parkerboston.com), a consulting firm that has played matchmaker for half a dozen such deals in the past year. "We found that around half our contacts in the hedge fund world were willing to consider making a private-equity investment."

This summer Parker Boston brokered a $1.5 million investment for a software company and $600,000 in seed capital for a startup jewelry manufacturer in New York City called Classic Gems.

Typically, Tencer says, hedge fund managers are looking for established companies with $1 million to $5 million in annual operating cash flow, though some are willing to make early-stage investments.

So far, hedge fund managers behave less like venture capitalists and more like giant angels, including sometimes passing on board seats. "They're usually not as active as the VCs," Tencer says. "That's what everybody thinks is so great about it."

Please send feedback or column ideas to fsb_mail@timeinc.com.

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