Cherry Tree Companies, LLC, made a remarkably good decision in 1991, when it invested $3 million in a start-up launched by Steve Shank and gave him a tiny chunk of office space to work in. Cherry Tree also showed remarkable patience. Most of the payoff didn’t come until 15 years later.

Today, Capella Education Company (Nasdaq: CPLA) is one of Minnesota’s highest-profile corporations. It went public in November 2006. On January 8 this year, it had a market capitalization of $936 million.

Minnetonka-based Cherry Tree benefited mightily. The firm’s fourth venture fund closed its books in 2007 as its most successful, thanks largely to its stake in Capella. The fund distributed $140.5 million to investors. They put up $16.2 million.

What’s more, Capella was just the beginning of a rare hat trick that Cherry Tree pulled off over a 13-month stretch of 2006–2007. Three of its portfolio companies slipped through that narrow window of opportunity in this decade’s lackluster market for initial public offerings: Capella, based in Minneapolis, Dolan Media (NYSE: DM), also in Minneapolis, and Titan Machinery (Nasdaq: TITN), in Fargo.

That’s a strong piece of the action for Cherry Tree. Consider that only 15 Minnesota companies had gone public in the six years before Capella did.

In each case, Cherry Tree and its investors put about $3 million into the company and cofounded it with management. Tony Christianson, Cherry Tree’s chairman, and Gordon Stofer, CEO, won’t disclose their firm’s internal rates of return on the investments. Still, they make it clear that all three have been big winners for Cherry Tree. Capella and Dolan, just two of 15 companies in Cherry Tree IV’s portfolio, accounted for 80 percent of the $140.5 million distributed by that fund.

But the hat trick isn’t “the real story” about Cherry Tree, Christianson says. What sustained the firm and made the investment strategy work, he says, was the 50/50 partnership that he and Stofer have preserved since they founded their company in 1980. That, and a still-morphing business model. What began as a venture capital firm has become a diversified operation that includes investment banking and investment management, and now plans to take shorter routes to public markets with shell-company and special-acquisition transactions.

A Partnership Forged

To their partnership, Stofer and Christianson bring similar styles and backgrounds, but complementary skills. Stofer, 61, directs operations. Christianson, 56, is the strategist.

“Tony Christianson is a guy who sees around three or four corners,” Steve Shank says.

Stofer, meanwhile, “has an extremely savvy sense of the market for growth companies,” according to Dan Carr, who heads the Minneapolis-based entrepreneurial networking group the Collaborative. Stofer has been a frequent panelist at the group’s high-powered finance events.

Both Christianson and Stofer hold degrees from the Harvard Business School. Both have won “Director of the Year” awards from the National Association of Corporate Directors; combined, they’ve served on more than 70 corporate boards. Both are from the Midwest—Christianson from Elbow Lake in rural Minnesota, and Stofer from Rocky River in the Cleveland suburbs.

The venture firm Northwest Growth Fund (now Norwest Equity Partners) is what brought them together in the Twin Cities in the 1970s.

Stofer was a Cornell University undergraduate. He and his wife had lived in Maine and had moved to Boston when they saw Time magazine’s iconic “The Good Life in Minnesota” cover story, now framed at Cherry Tree’s office. “Minnesota seemed to be a Boston business climate with a Maine geography,” Stofer says. They decided to move west. Stofer first worked at Honeywell, then landed a job at Northwest Growth.

Christianson had earned his undergraduate degree at St. John’s University in Collegeville. At Harvard, the venture business intrigued him. He discovered that Northwest Growth’s Bob Zicarelli was a national leader in the industry.

“I was lucky enough to get a job offer from Zicarelli and I took it,” he says, even though it paid only one fourth what he’d been offered by Boston Consulting out East. “I walked in and there was Mr. Gordon Stofer.”

They both prospered at Northwest, but the entrepreneurial bug bit them. They wanted to be their own bosses and left to found Christianson Stofer Financial, which they soon renamed, opting for the more lively Cherry Tree.

“You can either think of George Washington, or you can think of cherry picking deals,” says Stofer. He and Christianson did the latter.

Patience for a Long Gestation

Cherry Tree has financed and advised more than 150 emerging companies since then, including 22 that eventually went public. Christianson and Stofer credit a pair of long-time mentors for much of their success: Charley Oswald, architect of the growth at Twin Cities–based National Computer Systems, and Mike Winton, a Minneapolis venture capitalist and philanthropist who died last April.

The partners’ first transaction was an acquisition of Card Catalog Company, a local business that supplied libraries with catalog cards. But in 1982, Christianson and Stofer formed their first venture fund, which raised $9.8 million from five Twin Cities families. Then they began tapping into pools of institutional capital, which grew rapidly during the 1980s. Their second fund, launched in 1983 with $29.5 million, was primarily for health care investments. One success was Share Development Corporation, a pioneering local HMO that eventually merged with UnitedHealth Group, another early Cherry Tree investment.

The firm’s third ($31.5 million in 1987) and fourth ($16.2 million in 1991) venture funds focused mostly on education. Capella was part of that category, though its founder was not.

Shank had been CEO at Tonka Corporation, which was purchased by Hasbro in 1991. He went from running a large public company in the toy industry to launching a largely self-funded start-up in another: online education for adult learners. Cherry Tree provided Capella’s original financing and had a significant minority stake. Early Capella board members were Shank, Christianson, and longtime Cherry Tree associate John Bergstrom.

Bear in mind that Capella began pushing the idea of an online university several years before Netscape’s IPO and the take-off of the dot-com era. Cherry Tree stuck with the company through its long gestation period.

By the time Capella went public in November 2006, it had raised $80 million through private financings. It filed to go public in 2005, but given tough market conditions, it didn’t pull the trigger on its IPO until 18 months later, and then raised about $75 million. (Capella also made a secondary offering in 2007.)

Cherry Tree distributed its shares of Capella, though its hedge fund and principals still own stock. For Stofer and Christianson, Capella’s success (24,000 students, 1,300 employees, 1,555 faculty, and 12-month revenues of $261 million as of last September 30) validates their early faith in online education.

Shank, who had no experience as an entrepreneur when he launched Capella, credits Cherry Tree for strategic consulting and for patience. Christianson’s involvement was “absolutely essential to our development,” he says.

Platform Investing

Cherry Tree’s first two funds focused almost entirely on Minnesota companies. Its third and fourth swung more to “platform investing,” Christianson says.

That suited the partners’ investment style. Both Stofer and Christianson emphasize “very limited use of leverage” and a focus on long-term partnerships with single companies in their overall strategy to finance growth companies. They like to identify and bond with an entrepreneurial CEO, then grow with his original platform company. Christianson cites Cherry Tree’s work with Dolan Media founder Jim Dolan as a classic example.

The relationship dates to 1992. Dolan was working for the Jordan Group in New York City, which did financings and deals for media companies. “Tony began to call me to talk about media business models—who’s good and who’s not,” Dolan says.

Eventually, they formed a joint venture, Dolan/CTV Acquisition Company, to do a media deal. They looked at a community newspaper chain in Texas and a newsletter company in California. After four months, they signed a term sheet to buy Finance and Commerce, a business newspaper in Minneapolis, and by 1993, Dolan had moved here.

Finance and Commerce became the base for an acquisition spree. Cherry Tree was involved in the first few deals. Dolan, Christianson, and Bergstrom went onto the board of what was now Dolan Media. All told, the company did 69 deals—mostly legal and business publications—before going public in August 2007. Some deals didn’t come easily, however. A proposed acquisition of the Baltimore Daily Record hit a snag in 1994. Credit was tight, but Christianson dreamed up a financing mechanism that saved the deal.

“His brainstorming helped us come up with a deal structure,” Dolan says. “His connections helped us come up with an investor in New York. Tony has never dictated what he wants us to do. He always says, ‘Do what’s good for the business.’”

Cherry Tree is the only outside investor that has ever controlled his company, Dolan says. Initially, it had an 80 percent stake in Dolan Media. By 1996, its stake had fallen to 58 percent, and when Dolan went public, Cherry Tree’s ownership was down to 8 percent.

Dolan Media stock fell sharply last fall, but by then, only Cherry Tree’s principals and hedge fund were investors. Dolan Media expected revenues of about $190 million for 2008. It now prints 61 niche publications in 21 markets from coast to coast, and has moved into a number of related businesses.

Out of the Venture Business

As Cherry Tree worked through its four venture funds, it found them taking longer. It closed its first fund after eight years, the second and third after 12 years. The fourth went for 16 years, an unusually long life for a venture fund.

Christianson and Stofer say that the fourth fund’s investors, aware that they had two big potential winners in Capella and Dolan, urged Cherry Tree to hold off the closing until the fund could profit from those two IPOs.

But already in the early 1990s, Christianson and Stofer sensed the need for diversification. Fundraising had become more difficult; they had raised less for their fourth venture fund than for each of the previous two. And they were weary of the failures that venture capitalists inevitably must deal with. “We tended not to like shutting down companies,” Christianson says.

“We tried a number of ideas that did not work out” when it came to diversifying, Stofer recalls. One was an education-only private equity fund. The timing, he says, was too early.

Investment banking beckoned because it could generate more immediate, project-based returns than the bounties that took years to harvest from venture investments. In 1996, Christianson, Stofer, and the head of one of their portfolio companies formed an investment banking partnership. Five years later, in 2001, Christianson and Stofer sold the business to their cofounder and another principal.

It wasn’t that they wanted out, they say. It was just an opportune moment to make a deal. The buyers, Dave Henderson and Kevin Green, renamed their operation Triple Tree, and Christianson and Stofer soon got back into investment banking at Cherry Tree, stressing transactions in the education, information technology, and retail industries.

Something similar happened more recently. Cherry Tree diversified again in 2006, buying locally based Crosswater, LLC, a multiclient family office. Crosswater’s principals—former Piper Jaffray executives Brenda Sallstrom, Ryan Steensland, and Jim Sand—joined Cherry Tree, which had more than $500 million of assets under advisement from 21 high–net worth family clients.

Then as 2008 ended, the Crosswater principals negotiated to buy Stofer and Christianson out, signing a deal on December 31. It was an amicable transaction, and Stofer says they got an attractive price relative to what they’d paid. Cherry Tree might do a similar business again some day, but selling made sense now.

Is the Next IPO Cherry Tree’s?

Cherry Tree’s partners “have survived by reinventing themselves,” says Rick Brimacomb, a past president of the Minnesota Venture Capital Association who runs a financial advisory firm in Minneapolis. They intend to do it again this year.

They have the wind at their backs in the form of a third hot IPO, Titan Machinery, which went public in December 2007. Titan has become a leading consolidator of farm equipment dealerships. Of the 67 companies that went public in the United States during the 12 months ending November 28, it was the best performing, according to Renaissance Capital’s ipohome.com site.

Titan’s roots go back to an equipment dealership near Elbow Lake that Christianson’s grandfather opened in 1926. His father kept up the store for years, and Tony Christianson’s brother, Peter, remembers working there from the age of 12.

Now Peter is Titan Machinery’s president and CFO. A series of M&A deals began in 2003, when Tony Christianson suggested that his family’s dealership firm and two others in the region could merge. The idea was to gain efficiencies of scale.

The merged business, Titan, had 10 stores. Cherry Tree was a minority investor, while Peter Christianson and Titan’s CEO, Dave Meyer, together were majority stockholders. Peter credits his brother with turning Titan into a consolidator and helping to finance what became a rapid-fire succession of deals. Titan quickly added 40 more stores through 20 Midwest acquisitions.

“Cherry Tree brought vision to our company,” Peter Christianson says. Titan, now with 52 stores, expected revenue of as much as $635 million for the year ending January 31, nine times its revenue of $67 million in 2003. Like Capella, Titan made a secondary offering of stock last year. Cherry Tree’s principals and investors still held 6.7 percent of Titan stock as of November 28, a stake the market valued at $11.7 million at the time.

Cherry Tree’s recent performance helped persuade Lazard Capital Markets to sign on as the lead underwriter for an initial public offering that Cherry Tree itself proposes to make. Manhattan-based Lazard will underwrite the IPO of Cherry Tree Acquisition Corporation, which is a “special purpose acquisition company” or SPAC.

SPACs are sometimes called “blank-check companies.” Investors in such entities, which are essentially empty shells when they go public, leave it up to their principals to pick out a promising private company, then buy it or merge with it using the proceeds of the IPO. The acquired company is instantly transformed into a public company with a listed stock.

Christianson and Stofer propose to raise $80 million from investors for their SPAC. Then, if the deal follows the pattern of other recent SPACs nationally, Cherry Tree Acquisition would use that investor money plus the added equity from the IPO to buy a growth company with a value of roughly two and a half times the proceeds of the public offering.

Cherry Tree filed in November 2007 to take its SPAC public, but the hostile market for IPOs still had them waiting to move ahead as of early January. Stofer says they hope to make the offering in 2009. If it happens, it will allow Cherry Tree to raise a large amount of money quickly from the public market, and gain continuing liquidity from the market. In contrast, the firm waited years for payoffs from its venture funds. Ultimately, the SPAC’s acquisition could lead to another significant public company in Cherry Tree’s portfolio of growth investments.

Another deal Stofer says his firm anticipates doing in 2009: acquiring an already-public shell company and using it to buy a privately held firm, a transaction known as a reverse IPO.

One thing Cherry Tree isn’t doing now is raising venture funds. Will Stofer and Christianson raise a fifth fund? They have no plans to, Christianson says, “but we never say never.”

Cherry Tree’s Hat Trick

Cherry Tree doesn’t disclose its return on these investments, but two of the three recent IPOs from the firm’s portfolio, Capella and Dolan, accounted for 80 percent of the $140.5 million that was distributed to investors in the Cherry Tree IV venture fund, an eight-fold return on their investment.

* Share price and market share are as of market close on January 8, 2009.