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Hercules Capital: Switching To External Management ?

The BDC Reporter is taking a break from its regularly scheduled slog through IQ 2017 earnings releases to briefly review a shocking new development out of Palo Alto. The most successful technology BDC – Hercules Capital or HTGC – is asking its shareholders to switch from being  internally managed to externally managed.

BIG PLANS

The new Investment Advisor would be Hamilton Advisers, LLC. That’s an entity formed and owned by Manuel Henriquez, HTGC’s Chairman, Chief Executive Officer, President, co-founder and chief bottle washer.

The press release announcing this unexpected development, just hours after we reported briefly on 5 new senior hires at the BDC, would change the economics of the BDC.

A number of reasons are given in the press release for the proposed change in management status from internal to external. The BDC Reporter had a quick look at the arguments offered up for the “externalization”, summed up here in a quote from the CEO:

“We are seeking to pursue externalization for strategic reasons. While internal management has served our shareholders well in the past, we believe that the changing competitive environment makes externalization important. It will enable us to offer a greater variety of solutions to financial sponsors to the benefit of Hercules.”

Of course, much more color is offered up in the press release- including the expectation that “Hercules’ distribution rate or investment performance [will not]  be adversely impacted by externalization.”

OUR VIEW

The BDC Reporter promises News, Views and Analysis. We’ve communicated the News, and we’ll wait to see the Special Proxy and have some mulling time before we offer up any Analysis. However our initial View – which we imagine most of our readers will be quietly sharing – is that Mr Henriquez has been watching all the fortunes being made at asset management groups around the country, including those which own public and private BDCs, and has decided to grasp at the brass ring.  We refer anyone unclear at what we’re talking about to consider the huge income being received by the small number of individuals who own some of the larger BDC External Managers (Prospect Capital – PSEC – is a notable example) and the value that accrues to whoever has an Investment Advisory contract with a BDC. Thanks to the near absence of any checks or balance from “independent” Board members; a “do whatever seems right” by many shareholders” and a loose rein approach by the SEC and stock exchange regulators, External Managers can make a fortune. Given that HTGC already has mounds of equity capital raised and an infrastructure ready to go, this is essentially a cash-less Management Buy-Out by Mr Henriquez, and the opportunity to oversee his own privately-owned asset management firm.

MARKET VIEW

Shareholders have not been enthusiastic about the proposed change. At time of writing, the stock price has dropped by 12%. The first reaction of HTGC shareholders is that Mr Henriquez’s fortune may be made at their expense and over $120mn of market capitalization has been wiped out in a few minutes. All the BDC’s stock gains in 2017 are currently wiped out.

MORE TO COME

This will be a contentious issue till a shareholder vote (no date yet) occurs.