News
New Kids on the Block
In today’s extremely competitive M&A landscape, investors need every edge they can get to find deals. That often means embracing a buyer class that was previously
overlooked. Independent sponsors are becoming increasingly popular and accepted by investors — and they bring several advantages to the table.
Show Me Something New
“Investors like independent sponsors because they can source proprietary deals that they may not otherwise see,” says Reed Smith Partner Chris Sheaffer, who also serves as global vice-chair of the private equity group. “Just because you’re a private equity fund doesn’t mean you’re seeing every transaction that comes to market.”
The lower middle-market in particular is so brimming with family-owned and privately-held businesses that it makes it impossible for a PE firm to source all deals by themselves. This where independent sponsors are beneficial in bringing more potential targets to the table. According to Sheaffer, most independent sponsors have been doing business for a long time. They have industry contacts and are able to source proprietary deals “that a more traditional private equity fund may not be able to get a look at.”
Independent sponsors are known for finding deals outside of auction processes. However, most don’t have the capital to fund deals by themselves and this is where they look to partner with PE firms.
“We are seeing more and more traditional private equity sponsors being open to funding independent sponsors.”
“We don’t source deals through traditional auction processes,” says Agility Equity Partners Partner Justin Bertram. “Our sourcing is more proprietary and it’s more relationship based. That’s why we go through independent sponsors. For us, they are feet on the street. They are business development people. They are the ones who build relationships with management teams as well as sellers and companies. They are negotiating deals directly with them.” The firm tracks around 1,500 independent sponsors in the U.S., according to Bertram. Agility was known as Tail End Capital Partners up to recently.
Independent sponsors can be categorized into three buckets:
- People who spun out from other PE firms and are looking to get their feet wet, establish a track record by doing a deal or two on their own, then go raise a fund
- Folks who act as intermediaries or deal brokers; they find a deal, bring it to a PE firm, then look to get a fee
- Traditionalists who have stayed independent all along and are planning to remain so
Hands-on Experience
Independent sponsors also bring operational expertise to the table says VSS Capital Partners Principal Michael Gebhardt, whose firm will look at few dozen independent sponsor opportunities a year. “We see a lot of times independent sponsors who are partnered up with former senior executives and have a detailed plan for value creation. We have come across situations where we’re like, ‘Wow, this is a really good team. We’d be excited to back them and for them to go execute,’” he says.
Direct Access, Lower Fees
Independent sponsors do not have the restriction of needing to build out a diversified portfolio of assets, says Asante Managing Director Brandon Lay. “In this particular environment, their ability to be nimble and opportunistic is an advantage,” he says. Investing in independent sponsor deals allows for direct access to a particular asset, whereas investing in a private equity fund means investing in a vehicle where many assets aren’t identified at the initial time of the investment. “Independent sponsors provide direct exposure, and this is particularly attractive for deal-oriented investors, particularly family offices,” Lay says.
One independent sponsor told Mergers & Acquisitions that he likes the flexibility and autonomy of being independent instead of being forced to do deals just to that asset. If it’s their first deal and they want to do more independent sponsor deals, if they want to go on to raise a fund, that first deal has to go right. We love that alignment of incentives.”
Discounted fees are another advantage to working with independent sponsors, as investors are not paying to support an entire firm, according to John McCormick, a partner at placement agent Monument Group. According to a recent McGuireWoods survey, a five percent management fee based on trailing 12-month Ebitda has become the most common free structure in lower middle market independent sponsor deals, though this can vary deal by deal. “Ultimately, it’s about having control,” McCormick says.
“It’s the ability to say, ‘I like that deal,’ or ‘I don’t like that deal. I can pick and choo deploy capital. He only does the deals that he really wants to do. For the most part, everything is done by his timeline.
For High Vista Strategies Managing Director Whit Matthews, he likes independent sponsors’ deal-by-deal approach before they start fundraising.
“If you go into a single deal with an independent sponsor, that’s often the only deal that they’re focused on,” he says. “They’re spending the vast majority of their time managing se, and I can negotiate some of the economics. There’s no lag time. I’m not paying you in advance to go find a deal. You’re bringing the deal to me.’ So, there’s no J-curve. All of that plays into the return profile.”
Sheaffer adds, “We are seeing more and more traditional private equity sponsors being open to funding independent sponsors, which has not always been the case given the “fee on fee” structure that it creates.” “If you go into a single deal with an independent sponsor, that’s often the only deal that they’re focused on. If they want to go on to raise a fund, that first deal has to go right.” Independent Sponsors Are Growing Many see the ecosystem of independent sponsors just getting started. “It’s growing at a rapid clip in terms of the number of groups that are out there,” says Matthews. “We’re tracking over 500 different independent sponsors today. The number of folks that kind of call themselves independent sponsors is always evolving and changing. It’s an ecosystem that we’re constantly monitoring and tracking.”
A lot of the growth is driven by people leaving larger firms and going out on their own, according to Matthews. “Not everybody that’s a successful private equity investor at the principal or junior partner level is going to move all the way up the food chain of those organizations,” he says. “This may naturally push some folks into the independent sponsor ecosystem. They want to bet on themselves and do their own thing.” Adds Sheaffer, “I think that independent sponsors will continue to compete for the lower middle-market transactions and be a good source of deal flow.”