Private equity firms are still raising captive funds. In fact, the amount of dry powder sitting in funds waiting to be allocated has hit record highs. There’s no question that traditional funds are a highly successful and sought-after investment model. However, as the industry continues to mature, more and more alternative types of investment models have emerged, competing with traditional buyers for the chance at closing great deals.
Fundless sponsors or independent sponsors are one such group that have become more prevalent in recent years. However, even with their proliferation, investment bankers still rarely view them as viable buyers. Today, more investment bankers are letting independent sponsors into their processes, but many still feel that working with independent sponsors is a risky proposition.
Where’s the money?
Investment banks want certainty of close, which isn’t always an easy task for an independent sponsor that must go find funding to complete a deal.
“Certainty of closing is an important consideration and, in several instances, has actually been more important than price. Assuming that there was a good, disciplined process, the owners will have at least a few final offers in a fairly narrow range of values. As a result, other factors – like certainty of closing, relationship with the buyer and plans for post-closing – make the difference between the winner and second place,” says Ramsey Goodrich, a managing partner with investment bank Carter Morse & Goodrich. “Because they don’t have a dedicated fund, independent sponsors, by definition, have a higher risk of closing, which makes it a bit scary for sellers. The fear is that there will be a second round of negotiations and two levels of due diligence, two levels of fees, and two levels of management oversight and the deal falls apart. All else being equal, it is hard for sellers to get over this risk.”
Independent sponsors are used to running up against this issue. That’s why firms like The Grantchester Group and Rotunda Capital, although independent sponsors, have arrangements with investors that have captive capital so that they can move quickly with a commitment if they find a deal that they want to execute on.
“Bankers want to know that you have capital. They can’t risk getting to LOI and not getting to close. That’s why my model is to have strong established capital partners that have the capital to close alongside of Grantchester. However, if our capital partners don’t want in, we risk not getting the deal done. That is a challenge,” says Liz Griggs, CEO and Managing Partner of Grantchester Group.
Taylor Grant, a managing partner with Fox Three Partners, an independent sponsor founded in 2014, adds, “Certainty of close comes up often in conversations. Most brokers like to understand where the money is coming from. We don’t have to prove ourselves quite as much as we used too, but it’s still a conversation.”
However, despite the perceived risk of not getting to the finish line, there are many positives to working with independent sponsors that the investment banking community is starting to realize, leading to independent sponsors being included more frequently in competitive sell side processes. “Generally speaking, we have tended to avoid independent sponsors, but over the last few years, there has been a real maturation in the marketplace where more and more sophisticated investors are going ‘fundless’, especially operating executives or those spinning out of a PE fund,” says Goodrich. “We have started to open up our processes to those independent sponsors that have a proven track record of successful closings and that have real expertise in an industry niche.”
Indeed, according to the 2018 Independent Sponsor Report published by the accounting firm CitrinCooperman, more and more private equity professionals are becoming fundless sponsors. The firm surveyed more than 200 independent sponsors and 65 percent of respondents came from private equity firms. Almost 60 percent of independent sponsors came to be because they wanted more flexibility.
Independent sponsors make bankers look good
While traditional private equity firms certainly come with their own set of unique benefits, many independent sponsors also have unique attributes, such as deep operational experience and the ability to make longer-term commitments to companies.
“Having operational experience, we focus a great deal on how to increase the value of companies and we take a longer-term perspective than most private equity. If a banker is not talking with us, they might be missing what their client wants,” says Grant. “If a seller is turning the keys over and completely exiting, they might care less about working with us. But those sellers who care about a true partnership and legacy, and a go-forward plan generally want to hear from us.”
In addition to having flexibility on structure and hold-period, many independent sponsors have in-depth vertical industry knowledge. Additionally, they are known to be passionate about getting a deal done. “Some independents are also more creative or passionate about getting a deal done. We have seen a few instances of when a PE fund has passed on an opportunity on a direct basis, but they have been a successful financial backer of an independent sponsor in the same deal because of what that independent sponsor team brings to the table, which can be everything, but the capital. We love to see independent sponsors who have real operating experience – former CEOs especially,” says Goodrich.
Disregarding independent sponsors puts investment banks at a real disadvantage.. “If you are a banker, you get paid to close deals. Independent sponsors many times bring differentiators. They offer something different from the norm. Independent sponsors, like Grantchester Group often have more industry knowledge or operating experience. Having an independent sponsor in the mix allows the banker to show their clients the breadth and depth of their relationships, and many times helps them win the deal, providing their clients with more good options, a tremendous positive for the banker,” says Griggs.