FARGO, N.D. -- When First Bank System decided in 1986 to sell some of its small-town banks in the Dakotas and Minnesota, Donald Mengedoth knew almost immediately he was interested.
Negotiating the deal to buy 21 of them took a year, but it wasn't that difficult. For Mr. Mengedoth, the North Dakota manager for First Bank, the catch was lining up $55 million to purchase the $640 million-asset operation.
What resulted was a complex financing scheme, notable for one unique component: venture capital.
Perceived as Risky Move
Despite Mr. Mengedoth's confidence, the markets thought the deal risky.
After selling stock and high-interest notes to everyone from the presidents of the individual banks to big insurance companies, the group was still $14.4 million short. Investment bank Piper Jaffray Inc. suggested venture capital.
Mr. Mengedoth was not excited about the prospects. "We went, 'Ach, those guys are sharks,'" he recalls.
Turning to venture capital was a last resort. "We really weren't in a selection mode," says Mark Anderson, the company's chief financial officer and part of the rounding team. "We just needed the money."
Seven years later, Mr. Mengedoth is the chief executive of Fargo-based Community First Bankshares, a fast-growing holding company that has expanded to $1.4 billion in assets and 39 banks in five states.
The nine venture capital firms that invested in the original deal are satisfied and almost out. The company has gone public. And Mr. Mengedoth declares his risky walk on the wild side of financing a success.
"They are not the piranhas we thought," he says. "There were some ups and some downs. But the catch is worth the chase."
What Community First did was rare. Though no formal records are kept on the number of banks and thrifts funded by venture capital, the number is thought to be tiny.
Charles River Ventures, which kicked $1.8 million into the Community First start-up, invested in some thrifts in the early 1990s.
But those days are, for the most part, history. Today's higher bank and thrift prices have made it tough to get the payoffs that venture capitalists demand.
"The values have gotten very high, and that makes them less attractive to venture capital companies," says Bob Henderson, chairman of Boston-based Greylock Management Co., which, along with Charles River, was the biggest venture capital investor in the bank.
For Community First, the biggest drawback to venture finance may be evident right now. As they sell off their holdings, the venture capitalists have deflated the company's share price.
"I see no reason why it shouldn't be. trading at 10 times earnings," said Steve Schroll, banking analyst at Piper Jaffray. "The venture capital sales are holding the price down."
Community First has been selling at about nine times earnings.
24% Rate of Return Sought
But pressure on its stock value is the final price Community First must pay for using venture capital. The hardest part was meeting the investors' initial demands.
"Their hurdle was to see a 25% annual rate of return on their investment," Mr. Mengedoth recalls.
As negotiations progressed, Mr. Mengedoth was amazed at the due diligence shown by the venture capital firms. Several contacted business associates that Mr. Mengedoth had not seen in 30 years, investigating his background.
While the soon-to-be banking company and its investors were comfortable with each other, the Federal Reserve Bank was not.
They were leery of the venture capitalists, and would not approve the deal without "the right mix" of investors and investments, Mr. Mengedoth recalls. "They wanted as permanent a debt as possible." Regulators Get into Act During the ensuing months, the Fed and company officials haggled over limits on the venture capitalists. None could individually own more than the amount Mr. Mengedoth had committed, and they had to agree not to invest in any other bank holding company while owning Community First stock.
"Those firms were put through a lot of regulatory hassles that they weren't accustomed to," Mr. Mengedoth says.
Finally, in November 1987, CommUnity First was rounded, complete with a venture capitalist, Charles River president John Neises on the board. (He recently resigned his seat.)
Today, as Community First continues a buying spree of small-town midwestern banks, the company has turned to more traditional avenues, including stock and subordinated debt offerings.
30% Rise Predicted
Analysts, including Mr. Schroll, believe that the economics of the company's aggressive expansion will be reflected in the stock price after all the venture capitalists have sold their stakes. He predicts a 30% rise over the next year.
Looking back, Mr. Mengedoth says that venture capitalists aren't bad to work with as long as you can meet their expectations.
"The last thing a venture capitalist wants to do is come in and run a bank," he says. "T. hey are very passive investors."
Mr. Engen is a freelance writer based in Minneapolis.