How this trio built Philly’s largest private-equity outfit: with cash from Pa., bets on firms like Five Below

Twenty years ago, as many investors were betting big on the dot.com stock bubble, three Philadelphia financial pros walked away from big jobs at national companies and launched a firm they pointed in a different direction.

That firm, LLR, is now the largest private-equity investor based in Philadelphia, with 68 professionals (and hiring more). LLR has raised $3.5 billion and bought into more than 100 companies, 29 in Pennsylvania, for clients that include Pennsylvania’s taxpayer-funded public pension systems.

LLR has grown through financial crises and bull markets, raising larger sums every couple of years to back “lower-middle market” firms in financial technology, health care, cybersecurity, and other businesses.

At least one firm that LLR backed in its early stages, the Philadelphia-based Five Below retail chain, has become a hot public company with 800 stores. But most aren’t well-known.

LLR has grown, not by cutting bigger deals, like the national Apollo Global or Carlyle private-equity groups, but by hiring more investment pros so it can buy into more companies with sales below $100 million that have big prospects for improvement.

It’s a lucrative business: LLR has collected around $600 million in client fees and shared profits, including $145 million (through 2018) from one client, PSERS, the taxpayer-funded Public School Employees’ Retirement System. Its managers say LLR tends to outperform their other private-equity managers, more often than not. Private equity, in the aggregate, sometimes outperforms, and sometimes trails, U.S. stocks. PSERS doesn’t publish yearly returns for private-equity funds.

In 1999, LLR’s founders were stepping into the unknown. Howard Ross left his job as head of the Philadelphia office of the accounting giant Arthur Andersen. Seth Lehr quit as boss at Legg Mason’s investment banking business. Ira Lubert had, a little earlier, left as top lieutenant and likely successor to the man he called his “second father,” Warren “Pete” Musser, of Safeguard Scientifics That firm was betting on local dot.com meteors like Internet Capital Group and VerticalNet that later crashed.

Lubert told me at the time that he didn’t understand how he could expect to make money from internet start-ups, led by young visionaries, which lacked products or sales, let alone profits. First, he went back to his old specialty -- buying hotels and other business real estate -- with real estate whiz Dean Adler.

But Lubert also had a vision: He would raise piles of money for a group of private investment funds run, not by old-fashioned generalists like Musser but by specialists like Adler. “There’s lots of money, chasing too few quality deals,” Lubert told me at the time. Expertise was worth more than capital.

Ross’ financial insight and Lehr’s deal-making made them ideal partners, Lubert figured.

From the beginning, Lubert targeted public funds. In LLR’s early years he invested more than $250,000 in campaign contributions to Pennsylvania and Philadelphia candidates, according to state and city records. Top state recipients included then-State Treasurer Barbara Hafer, who in 2003 told me, regarding Lubert and other donors, “Not only do they give me money, I hope they vote for me," while adding that she’d fire them if they didn’t produce pension profits. Lubert also gave to then-State Sen. Vince Fumo (D., Phila.), a state employees’ pension (SERS) trustee, and Rob McCord, a Hafer successor who wanted to be governor.

Hafer, Fumo, and McCord each were sentenced for crimes related at least in part to payments from campaign contributors. Lubert wasn’t accused of wrongdoing, and LLR was retained as new public officials filled board posts vacated by criminal convictions. Lubert’s contributions ended by 2008.

Already by 1999, “we had done a few other funds with Ira," including a real estate fund that prospered, and a biotech fund that did poorly, recalled Charles J. Spiller, PSERS’s private-investments chief, in an interview last year.

“We were impressed by Seth and Howard," and their status as Pennsylvania-based investors, Spiller added. PSERS bought a quarter of LLR’s initial $250 million fund. "It was quite successful,” eventually more than doubling the state’s money. PSERS has invested in the next four LLR funds as well, as has SERS.

Besides LLR, other firms where Lubert is a partner include Lubert-Adler (real estate), LEM Capital (apartments), LBC Credit Partners (distressed debt), Patriot Financial Partners (banks), and Quaker Partners, among others, which also invest Pennsylvania pension assets.

Among LLR’s first investments was Crothall Services Group, a hospital housekeeping and supply contractor based in Wayne.

Bobby Kutteh, then a Crothall director, said chairman Graham Crothall wanted to expand. But “with just our line of credit at Mellon Bank, we were nervous about making payroll," Kutteh recalls. “So we brought in LLR as an investor. Seth and Howard took seats on the board, and they created some discipline for us.” They didn’t interfere with day-to-day management. But “they were a great sounding board in terms of people-related decisions, geographic markets that might be appropriate to pursue, information and strategy."Plus the cash.

"We were a $100 million [yearly sales] company with 5,000 people, and the result is today we are a $4 billion company with 48,000 people,” says Kutteh, now chief executive at Crothall successor Compass One Healthcare, part of a U.K. conglomerate.

LLR is one of a handful of area firms -- another is NewSpring Capital, of Radnor -- that has been around long enough and grown large enough that managers in Philadelphia can make a career building businesses they back without having to move away.

“I think the world of those guys,” said Jim Flynn, a West Point graduate and GE veteran, who has headed three LLR-backed companies -- Paoli-based Maxwell Systems (construction software) from 2002 to its 2014 sale; Horsham-based Sicom Systems (fast-food software), from 2014 to its 2018 sale; and now Edmunds GovTech, a Northfield, N.J., government-software maker.

Unlike other private-equity operators, “they are very good at understanding the difference between investing and operating," Flynn said. It’s as if LLR had learned the lessons second lieutenants learn about leadership on the battlefield, he added.

In the Great Recession that started in 2008, sales were “really brutal,” but Ross and his LLR tech group encouraged Flynn to upgrade Maxwell software, “counter to conventional wisdom, which was to hunker down and save every nickel. Their thesis was, and I agreed with it: roads were still wearing out, plumbing had to be repaired, people still needed places to live and shop." Patience paid off: As the United States recovered, “we took off, and it led to our acquisition by our largest competitor.”

To Flynn, LLR is “a growth equity firm,” not one of the cost-cutting, debt-building private-equity giants that make the industry a target of populist politicians. “That’s why I like this work,” Flynn concluded. “It’s financially rewarding, but -- it sounds funny -- that’s not the driving force. It’s very personally satisfying to see people grow and spread their wings and be proud of what they are doing.”