Why 49ers stars' investment firm didn't pan out in the end

Feb 13, 2011 @ 12:01 am

By Bloomberg News

Harris Barton, a former right tackle with the San Francisco 49ers, remembers the time that Reggie White of the Philadelphia Eagles flattened him.

It was Sept. 24, 1989, and for two downs, Mr. Barton had fended off Mr. White's “rip and club” move of throwing opponents off balance and knocking them to the turf.

On third down, Mr. White knocked Mr. Barton on his butt and hit quarterback Joe Montana so hard that he fumbled the ball. Mr. Montana went on to throw four touchdown passes in the fourth quarter to beat the Eagles, 38-28, en route to the team's fourth Super Bowl championship.

After some initial success, Mr. Barton also took some lumps in the investing game. HRJ Capital LLC, an investment firm he co-founded with another former 49er, Hall of Fame defensive back Ronnie Lott, collapsed in 2009 amid complaints by investors who say they were misled about the extent of its woes.

The rise and fall of HRJ, which for a time also had Mr. Montana as a partner, is a story of how former football champions traded on their star power only to be undone by a rookie mistake in the way that they financed their investments.

“It worked for nine years, but mistakes were made,” Mr. Barton, 46, said as he sipped coffee at an Italian restaurant in Palo Alto, Calif. After HRJ's demise, he said, he was embarrassed every time he walked into a place like this in Silicon Valley.

“I felt like everyone was looking at me and saying, "There he is, the dumb athlete who couldn't manage his firm,'” Mr. Barton said.

GRIDIRON GLORY

Mr. Barton, an All-Pro who won Super Bowls in 1988, 1989 and 1994 with one of football's most dominant dynasties, set up the fund-of-funds firm in 1999.

Woodside, Calif.-based HRJ, which Mr. Montana joined as a partner from 2003 to 2005, invested in venture capital firms, hedge funds and private-equity funds. Its clientele included elite athletes, pension funds, foundations and endowments.

Wrapped in the glory of their triumphs on the gridiron, the ex-49ers easily won entree to the most prestigious names in finance — from VC firm Kleiner Perkins Caufield & Byers and hedge fund Tudor Investment Corp. to buyout company Blackstone Group LP.

George Roberts, co-founder of KKR & Co. LP, became a mentor and golf partner of Mr. Barton's. Ken Griffin, chief executive of Citadel LLC, invited Mr. Lott to make a speech to his hedge fund's greenhorn traders on what it takes to excel as a rookie.

At its peak in May 2008, HRJ managed $2.4 billion from offices on three continents for sports stars such as Indianapolis Colts quarterback Peyton Manning and San Francisco Giants home run king Barry Bonds, according to a roster of the firm's clients.

The Houston Firefighters' Relief and Retirement Fund, Cornell University's Office of University Investments and other institutions also took advantage of HRJ's access to elite money managers.

The firm threw parties to celebrate its success: In 2007, it flew many of its three dozen employees to London to schmooze with European clients at a luxury skybox at Wembley Stadium while the Miami Dolphins played the New York Giants on the field below in the first regular-season National Football League game outside North America.

The good times came to an end two years later because of the way that HRJ financed its investments.

Most funds of funds raise money from investors and then commit capital to private-equity managers. HRJ took a different approach: It made commitments to money managers prior to raising cash from new clients.

INVESTORS OUTRAGED

When those managers called for capital, HRJ paid primarily with debt issued by Silicon Valley Bank, a unit of SVB Financial Group, which had $15.7 billion in assets as of Sept. 30. For five years, HRJ paid down its debt with money from new investors in its funds.

When credit dried up even for the highest-quality borrowers in 2008, HRJ was sitting on more than $338 million in unfunded pledges and was unable to raise cash to cover its bets. HRJ spiraled toward insolvency until its assets were acquired in 2009 by Capital Dynamics AG, a Swiss private-equity fund-of-funds firm.

“If more funds had used this method, it would have brought the fund-of-funds industry to its knees,” said Austin Long, co-founder of private-equity consulting firm Alignment Capital Group LLC.

Investors were outraged on discovering that HRJ had quietly transferred its overcommitment from an affiliate controlled by Mr. Barton and Mr. Lott to the funds of funds themselves, said Deirdre Nectow, head of business development at Cambridge Associates LLC, a consulting firm that represented clients with more than $339 million invested in HRJ.

The move made HRJ's limited partners responsible for the debt to SVB and the capital calls issued by buyout firms. Ms. Nectow said that the shift violated the limited-partnership agreements HRJ had signed with its clients, which established that the funds would remain debt-free.

Cambridge learned about the transfer only after pressing Jeffrey Bloom, the firm's general counsel and chief compliance officer, for more details about the state of HRJ's funds during the financial crisis. Cambridge then demanded an accounting of the move.

“We were dismayed by the actions they took,” Ms. Nectow said.

Mr. Bloom and Mr. Barton declined to comment about the transfers. Mr. Lott declined to comment for this story.

HRJ's financial maneuvers also triggered litigation from three senior executives: Lane Auten, a former investment banker with Banco Santander SA, who headed HRJ's marketing and fundraising efforts from 2003 to 2008, and Duran Curis and Darren Wong, both of whom managed HRJ's funds of funds and brought in new clients.

In a lawsuit filed in Santa Clara County (Calif.) Superior Court, the trio accused Mr. Barton, Mr. Lott, Capital Dynamics and SVB of stiffing them on more than $17 million in compensation.

The former executives said that HRJ owes them portions of the management fees paid by clients in the firm's funds. When HRJ started running out of cash in 2008, the plaintiffs said, the founders and SVB agreed to cut off those payments to them and instead use the fees to secure debt owed by HRJ and its affiliates to the bank, including $8 million in personal loans it made to Mr. Barton and Mr. Lott.

“These guys promised us, "You will be paid this money for all the work you do for 10 years,' but they overextended themselves and they broke that promise,” said Mr. Auten, a managing partner at Impact Capital Partners, an investment consulting firm.

All of the defendants, who have denied the allegations in court filings, declined to comment.

Mr. Barton said that he was hurt by HRJ's failure. He lost his equity in the firm from its sale, and his personal finances came under strain.

Mr. Barton made a lineman's wage in the National Football League, averaging about $620,000 a year.

In 2004, he bought and renovated a mansion in Palo Alto that is now worth about $6 million. Mr. Barton said that he was worried about losing his house as HRJ unraveled.

Mr. Barton, a Georgia native, has a Southerner's gift for storytelling. With his easygoing nature and 12 handicap on the golf course, he made a lot of friends among venture capitalists.

In December, he and Mr. Lott held a gala in San Francisco's City Hall to benefit Champion Charities, which they founded to raise money for brain cancer research.

Both of Mr. Barton's parents died from the disease. At 6-foot-4, he stood head and shoulders above the 400 partygoers, autographing footballs and greeting friends such as mergers-and-acquisitions adviser Frank Quattrone.

“Harris was passionate about creating a compelling investment firm, and Ronnie had this magical aura around him,” said Andy Rachleff, a founding general partner of Benchmark Capital, a venture firm. “They understood what their currency was and they weren't embarrassed about using it.”

From the moment that the two athletes started their firm as Champion Ventures during the dot-com boom, they were confident that they could exploit their celebrity, Mr. Barton said. After Mr. Montana joined the firm, the principals changed its name to HRJ, using the first letters of their names.

MASTER OF ACCESS

Mr. Montana, a three-time Super Bowl Most Valuable Player, was known as Joe Cool for his eye-of-the-storm calm and precise passing.

The hard-hitting Mr. Lott earned renown as one of the toughest defenders ever to play the game. After his pinky finger was smashed in an on-field collision in 1985, he had part of it amputated rather than miss games the next season.

Venture capitalists held the 49ers stars in as much awe as rank-and-file fans, Mr. Auten said. When Mr. Barton and Mr. Lott launched their $40 million VC fund of funds in 1999, it was invited to invest in Sequoia Capital, Benchmark and Kleiner, which were turning away other investors routinely.

Mr. Barton and Mr. Lott were equally successful in parlaying their friendships with hedge fund and private-equity managers into investments in their funds.

In 2002, the buyout boom picked up where the dot-com bust left off. HRJ joined a wave of funds of funds that offered smaller foundation and pension managers a chance to spread their bets across a number of exclusive private-equity funds.

In 2007 alone, 173 private-equity funds of funds raised $57 billion in capital globally, up from the $4.3 billion deployed by 27 in 1997, according to research firm Preqin Ltd.

“Without funds of funds, we couldn't get the access we needed to do this kind of investing,” said Lisa Eslinger, chief investment officer at the $400 million Iowa State University Foundation, which placed $8 million in an HRJ fund that bought distressed assets.

In keeping with the industry norm, HRJ charged 1% on managed assets and 5% of profits on top of fees collected by the underlying funds themselves.

Mr. Barton said that he savored being a player in the global investment game. He hit the links at the exclusive Nanea Golf Club on the Big Island of Hawaii with Mr. Roberts and talked shop over Italian dinners with Marc Lasry, chief executive of Avenue Capital Group, a hedge fund.

Mr. Barton said that he loved visiting technology startups in Silicon Valley with Mr. Lott.

“It was like football in August: You're in the locker room and Bill Walsh said we're going to win the Super Bowl,” Mr. Barton said, referring to the 49ers Hall of Fame head coach, who died in 2007. “There's no rush like that, except when you walk into a company with six guys and one's from Poland, and another is from Israel, and they're going to make a hit company, have an [initial public offering].”

Mr. Barton easily could have wound up with the New England Patriots or New York Jets, both of which almost picked him in the 1987 draft. Instead, the 49ers selected him in the first round as they were reaching full bloom under the cerebral Mr. Walsh.

The 280-pound tackle rapidly learned that at the pro level, he would need more than size and strength to prevail in the head-to-head wrangling on the line of scrimmage; Mr. Barton would need knowledge. He spent long hours dissecting the tendencies of his opponents.

“He was obsessed with watching film,” said Brent Jones, a tight end who played alongside Mr. Barton. “Harris was always a key player on our offensive line.”

Mr. Barton noticed on film that the late Reggie White liked charging inside the tackle and used an uppercut move — the rip — to knock the linemen backward before clubbing them down. So Mr. Barton placed more weight on his left foot to withstand Mr. White's attack.

Even as Mr. Barton collected Super Bowl rings, he was drawn to the other front-page story unfolding in the Bay Area: the computer revolution. He said that he pinched 49ers letterhead and wrote to Cisco Systems Inc. Chief Executive John Chambers and Yahoo Inc. co-founder Jerry Yang to express his admiration for their companies and his desire to learn more about them.

The gambit got Mr. Barton meetings with the executives, and he later became friends with John Mumford, founder of Crosspoint Venture Partners, and other venture capitalists. Mr. Barton said that he also cold-called KKR's Mr. Roberts in 1994 to introduce himself and became a protege of the dealmaker.

Mr. Roberts and Mr. Mumford declined to comment.

In a pre-season game in August 1998, Mr. Barton's NFL career came to an abrupt end when a Miami Dolphins defender fell on his ankle and broke his fibula. Mr. Barton, then 34, said he went into a state of withdrawal as he faced life without football.

A few weeks later, he had lunch with Mr. Lott, who had reluctantly left the game in 1995 after his own body gave out, at the Peninsula Creamery diner in Palo Alto.

Mr. Barton told his former teammate that he didn't know what to do with his life. Mr. Lott suggested that they could help athletes invest with venture capitalists.

FOOTBALL PIZZA PARTIES

“Let's call these guys; they're all friends of yours,” Mr. Lott told Mr. Barton. “Let's go meet Mumford.”

Mr. Mumford told the two athletes that to secure allocations in top VC funds they needed more than capital; they would have to be active investors who contributed something of value to startups. So Mr. Barton and Mr. Lott told John Doerr, senior partner at Kleiner, and other venture capitalists that they would be happy to visit their portfolio companies and tell motivational football stories, throw Monday Night Football pizza parties for employees and help recruit talent.

After the duo received spots in VC funds, they contacted their friends in pro sports and offered them a chance to cash in on the then-raging dot-com market. Their fund-of-funds firm was born.

Mr. Barton and Mr. Lott set up shop in a ranch-style office in Woodside, a wealthy hamlet near Stanford University.

Mr. Barton, an effusive personality, couldn't sit still, and wandered the office slapping backs and asking how the funds were performing. Mr. Lott was an intense, taciturn presence who spoke in sports analogies.

Mr. Lott liked to say that every team member at HRJ ate from the same soup bowl. To drive the point home one year, he gave silver spoons from Tiffany & Co. to every employee.

By 2003, Mr. Barton and Mr. Lott had raised $309 million for three VC funds of funds. When VC fundraising plunged after the tech bust in 2000, Mr. Barton said, Mr. Roberts advised him to shift into leveraged-buyout funds.

They were gearing up as the U.S. recession of 2001 left scores of companies weakened and spurred interest rates to fall. HRJ committed $278 million to 35 buyout funds via HRJ Growth Capital I and II from 2002 to 2006, according to fund documents.

And Mr. Lott led a push into hedge funds with the HRJ Legends Multi-Strategy funds, a $330 million investment pool.

Mr. Montana, who invested in property, joined HRJ in 2003 and led the development of a real estate fund of funds. HRJ invested $308 million in real estate assets managed by Fortress Investment Group LLC, Lone Star Funds and other firms.

In 2005, he quit as a partner.

Mr. Montana, 54, who promoted Skechers sneakers last year, declined to comment.

In 2006, HRJ's first global buyout fund returned 23%, compared with a 13.6% gain for the S&P 500.

By 2007, HRJ had $1.7 billion in invested capital and 40 employees in offices in Silicon Valley, New York, Chicago, Zurich and Shanghai. That year, Mr. Barton and Mr. Lott launched their largest fund yet: the $550 million HRJ Global Buy-Out III.

The fortunes of HRJ were about to shatter, thanks to the pre-commitment model it had adopted in 2003.

Mr. Barton said that HRJ used debt to lock down more investments with elite money managers. The move also helped the firm raise funds by showing potential investors where it was placing its bets.

“We knew what funds they were investing in and that was valuable,” Ms. Eslinger said.

Mr. Bloom, the lawyer who was then the firm's chief financial officer, helped the founders set up an affiliate in 2003 to hold the debt owed to SVB. Called Eleven Rings, the limited-liability company took its name from the total of Super Bowl rings won by Mr. Barton, Mr. Lott and Mr. Montana.

Whenever HRJ made commitments to invest in buyout and VC funds, Eleven Rings drew on its SVB credit line to pay capital calls issued by those funds. In this way, Mr. Barton, Mr. Lott and Eleven Rings — not HRJ's clients — bore the lending risk.

When the subprime mortgage collapse started rattling markets in late 2007, Mr. Barton said, Mr. Mumford warned him and Mr. Lott to pull back on making commitments to buyout firms. It was too late.

By April 2008, Global Buy-Out III had closed $420 million in pledges to 25 buyout firms, according to HRJ records. When those firms started issuing capital calls to Eleven Rings to make payments under threat of default, the affiliate burned through its SVB credit line.

HRJ's fate hung on whether it could bring in investors amid the worst financial crisis in decades.

After Eleven Rings transferred its debt obligations to HRJ's funds, Suomi Mutual Life Assurance Co., an investor in the Global Buy-Out III Asia Fund, expressed its pique.

“HRJ Capital, Eleven Rings and SVB, in an attempt to address the disastrous overcommitment problem that they created, have taken actions to improperly shift the problem and the SVB loan onto the limited partners of the HRJ Asia Fund,” Jussi Snellman, the Finnish insurer's lawyer, wrote to an HRJ attorney on Feb. 9, 2009. An SVB spokeswoman declined to comment.

On the night of Dec. 15, 2008, Mr. Barton, Mr. Lott and Mr. Bloom gathered in a conference room at SVB's Palo Alto office. Mr. Barton said that the mood was somber as Greg Becker, SVB's president, presented them with a document that the bank was about to submit to the Securities and Exchange Commission.

It stated that HRJ was unable to repay almost $69 million in loans and that SVB was assuming control of its funds and management fees. There was virtually no chance that investors would give HRJ money to manage once the news hit.

“This is a funeral; you're going to kill these guys,” HRJ lawyer Frank Currie told Mr. Becker, according to Mr. Barton. The 8K went public at midnight, and HRJ was done.

Four months later, SVB found a buyer for HRJ, preventing its limited partners from being wiped out in a possible bankruptcy.

In April 2009, Thomas Kubr, chief executive of Capital Dynamics, agreed to pay $29 million to retire HRJ's $57 million debt to SVB. Capital Dynamics also assumed the $8 million in personal loans to Mr. Barton and Mr. Lott.

The deal ended HRJ's overcommitment crisis, and none of HRJ's limited partners chose to sue the firm. And HRJ's VC IV fund, which invested with the Accel Partners fund backing Facebook Inc., was worth 1.2 times its invested capital as of last Sept. 30.

Mr. Barton accepts responsibility for the fall of HRJ, a beating he said that ached far more than the blows he suffered on the football field.

“At the end of the day, my name was on the door, so I'll take the hit,” he said. After spending a year with Capital Dynamics, he opened H. Barton Asset Management, which will invest alongside VC firms in tech startups.

“I want to be back in the game,” Mr. Barton said. “I think I can make a go of it again.”

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