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Private Equity Firms Fueling the Growth of Electronic Trading

Private equity firms are rushing to invest in electronic trading companies and financial technology companies that provide services to hedge funds.

It's good to be in the financial technology industry these days — especially if your company is getting calls from private equity firms looking to invest in one of the economy's hottest growth sectors.

Dan Dykens, CEO of Boston-based Norbury Financial, says he's been getting cold calls from venture capital firms interested in investing in his research management solution. The former hedge fund manager built Norbury Links, software designed to manage E-mails, research notes and filings. Dykens currently is selling the technology to hedge funds and traditional mutual funds, as well as funds of funds and even private equity firms. "We haven't taken any private equity to date," Dykens says, but he's considering it.

Over the past few years, private equity firms have invested billions of dollars in the financial technology sector, particularly in electronic trading, and the pace of deals has picked up recently. In January, Automated Trading Desk (ATD), a high-tech market maker in U.S. equities that is expanding into equity options, announced a $60 million investment from Technology Crossover Ventures (TCV). On April 2, FX Solutions, an electronic market maker in the retail foreign exchange market that white labels an automated execution platform, reported that it received more than $100 million from Francisco Partners. Also in April, Getco, a privately held automated market maker in Chicago, reportedly raised $300 million from General Atlantic (GA), a former investor in Archipelago and NYMEX. And Sequoia Capital, a technology-focused venture capital firm with a 30-year history of investing in Apple, Cisco, Yahoo and Google, recently made an investment in an automated market maker (specifics have not been disclosed).

Today, "There is so much innovation and change taking place across the capital markets," observes Scott Carter, a partner at Sequoia Capital. In the past, however, "Even if you had the idea that you could apply technology to the capital markets, it was dominated by human beings in pits," he notes.

Clearly, the convergence of technology and finance is attracting the new wave of private equity money. "You have a massive trend toward electronic trading, you have significant regulatory change with Reg NMS being implemented, and you have increasing market structure trends and a focus on globalization," says Bob Trudeau, general partner at Palo Alto, Calif.-based TCV. "All of these market structure trends create some market opportunity."

Trudeau explains that one of the most important factors in most of TCV's investments is the management team. "The first motive is to back a great management team," he says, adding that he got to know the management team at ATD over the past three years before TCV invested in the market maker. "To watch these guys execute successfully over the last few years made it exciting to partner with them," Trudeau remarks.

ATD CEO Steve Swanson says the private equity firm has opened doors through relationships with the broker-dealer community and the buy side. "The fact that TCV has made an investment in us legitimized who we are," he says.

But selling a stake in one's company doesn't come without strings attached. Private equity firms typically sit on the board or control management of the companies in which they invest, and they often bring in new management. "We help out with recruiting, advice, strategy, [and] product and customer introductions," relates Bob Greene, managing partner at Contour Ventures, an early stage venture capital firm in New York that recently invested in YellowJacket Software, a peer-to-peer communications network for energy traders in the OTC derivatives market (see "Yellow Jacket Software Captures Market Data from Instant Messaging Converations").

Greene notes that one of the advantages of being located in New York is that the VC firm sees a lot of deal flow. "We're right here in New York City," he says. "It's Wall Street guys selling to Wall Street guys."

In fact, private equity firms are targeting both the financial technology companies and the financial services companies themselves. In May, for example, TCV and Spectrum bought a majority interest in RJ O'Brien, the world's largest futures and commodities merchant. Though the size of the investment was not disclosed, according to one source familiar with the deal, each private equity firm put up $200 million.

While it's hard to believe given the frenzy of recent deals, Stephen Bruel, an analyst with TowerGroup's securities and capital markets practice, says financial technology historically has been an under-invested sector for most private equity firms. But, he notes, as a high-growth area, electronic trading is helping to change that. "Among the macro trends across the securities landscape, [private equity firms] are going to be looking for the electronic trading platforms," Bruel says. "The companies in that sector are going to be most coveted."

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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