Heizer a pioneer in field of venture capital

December 13, 2004

BY MICHAEL KRAUSS

Ned Heizer Jr.'s father didn't want him to go to Yale Law School. It was the McCarthy era, and Heizer's father feared there were too many communists at Yale.

Young Ned enrolled anyway, and sure enough, he met card-carrying communists at Yale. But his studies there set him on a course to become one of Chicago's most esteemed practitioners of free market economics.

More than half a century after graduating from Yale, Heizer, 75, was honored last week by the Illinois Venture Capital Association for his pioneering efforts in venture capital in Illinois. He was presented with the association's Stanley C. Golder Medal.

Perhaps one of the purest forms of free enterprise capitalism, venture capitalists raise money from investors, identify fledgling companies run by entrepreneurs, and make investments in those companies. Returns can be high but so is the risk.

It's a business Heizer helped invent for the entire nation.

"Ned Heizer is an innovator, an absolutely brilliant guy, and the father of venture capital, not only in Chicago but nationwide," said David Coolidge, vice chairman of William Blair & Co. and a junior executive when Heizer began his career. "He invested in some amazing companies over the years."

From 1962 to 1968 Heizer created the venture capital arm of Allstate Insurance Co., establishing Allstate as an investment industry innovator.

"Allstate got intrigued with the idea there were great opportunities in things that weren't investment-grade securities," Heizer said. "We invested in start-ups and turnarounds, things that were considered crazy by most people at the time.

"You had great upside. The program wasn't supposed to be high risk. It was high return. We wouldn't go into anything unless we thought it would be successful. We had very few failures. Nine out of 10 of our deals turned out pretty well.

"We invested for cash-flow growth. That was a winning formula for years. Our program at Allstate did very well. At the end of 1968, we managed 4 percent of Allstate's assets but delivered 50 percent of the profits."

'Prudent man'

In 1969 Heizer formed Heizer Corp. with the aim of continuing to invest in young companies and gain high returns. With the help of John McDermott, of McDermott, Will & Emery, and investment banks White Weld, Hayden Stone and William Blair, Heizer turned to the capital markets to raise $80 million to $100 million.

Thanks to Heizer's track record at Allstate, within weeks, the partners were subscribed to the tune of $131 million. Then a legal opinion came out that nearly sunk the firm.

Private equity was in its infancy, and the offering became controversial.

Capman and Cutler, then as now a leading Chicago law firm, advised that an investment in Heizer Corp. would violate the "prudent man rule," a standard regulation that requires trustees and portfolio managers to make financial decisions in the manner of a prudent man with intelligence and discretion.

McDermott said that lawyerly decision almost sunk Heizer, because "any fiduciary who made an investment in Heizer Corp. could be personally responsible for losses." Harris Bank pulled out of the financing because of the opinion.

Since Heizer already had 35 other sophisticated investors signed on, McDermott Will & Emory and Sidley & Austin took a chance that the "prudent man rule" was being followed, and the initial fund raising went ahead.

Interesting solution

"William McCormick Blair had an interesting solution to the prudent man problem," McDermott said. "He told the Art Institute of Chicago he would give them $1 million, but only on the condition it was invested in Heizer Corp. That solved that problem."

With funds raised, Heizer said he proceeded on a 16-year run that generated compound annual returns of 26 percent.

In the process, he backed companies like Amdahl, Computer Consoles, Federal Express, Fotomat, IDC Corp., Intel, Material Science Corp., Spectra Physics and Vacation Resorts.

Heizer admits missing out on a couple of major winners because he didn't like their valuations.

Ross Perot's computer company EDS set an investment threshold at a hefty 50-times earnings. "We didn't invest," Heizer said. "Ross Perot liked to tell everyone how stupid Heizer Corp. was. I turned down Apple, too, because they wanted too high a price. That's part of the business. You can't get them all."

According to McDermott, Heizer Corp. was the largest independent venture capital firm in the United States in the 1970s. Today McDermott estimates the private equity business has grown to $80 billion, meaning that Heizer Corp. operated with one-tenth of 1 percent of what's sloshing around today.

Heizer prepared himself early for a career as a venture capitalist. While at Yale he was tapped to teach economics to undergraduates. With labor troubles in the steel industry, he conducted a ground-breaking financial analysis of U.S. Steel Corp. Based on Heizer's assessment, the company was in poor condition. His work brought him to the attention of Leonard Spacek, the legendary head of Arthur Andersen who recruited Heizer out of law school in 1954.

After two years with Andersen, Heizer joined Kidder Peabody for two years to learn the investments business. From there, it was on to a four-year stint as a management consultant at Booz Allen and Hamilton, where Allstate was his client. He joined Allstate in 1962, and became assistant treasurer of the company.

Continues as individual

Because of changes in the tax laws, Heizer Corp. was liquidated in 1985. Individually, Heizer continued to make venture investments, and he founded the Heizer Center for Entrepreneurial Studies at Northwestern University's Kellogg School of Management. He also funded the creation of the Heizer Award with the Academy of Management, which recognizes top academic scholarship in the entrepreneurship arena.

"He inspired me to do work on entrepreneurship," says Kellogg professor Morton Kamien, head of the Heizer Center for Entrepreneurial Studies. "A whole generation of people got into the venture capital business because of Ned Heizer."

At the IVCA awards ceremony, Heizer couldn't resist telling a story that compared Chicago's culture with that of California. When he announced to friends in Lake Forest he was leaving Allstate to start Heizer Corp., his neighbors expressed grave concern. Confided one close neighbor: "If it doesn't work out, you can always come live with us."

In contrast, Heizer described a kitchen discussion at a West Coast dinner party where the wife of the controller of Memorex sought Heizer's advice about her husband. "I don't know what's wrong with him," Heizer reported the woman saying. "He's the only man on the whole West Coast who doesn't want to start his own company."

Said McDermott, "We've come a long way from the days of the pioneers. Ned Heizer is one of the great pioneers of this industry."

Michael Krauss is a Chicago-based tech writer and consultant.

 

 ©2004 Marion Consulting Partners