Family Offices and Independent Sponsors: Could they be a perfect match?

The independent sponsor community continues to grow and thrive – the universal acceptance of the asset class and its importance to the private equity ecosystem has resulted in capital sources available to fund independent sponsor deals broadening. Private equity and debt funds (IS funds), whose sole purpose is to fund Independent Sponsor deals, are starting to become more common. These IS funds are challenging the niche that family offices previously enjoyed and changing the competitive landscape.  

Despite this, family offices are still an important and favored source of capital for many independent sponsors, especially those who have a demonstrated track record, have closed multiple investments, and bring industry and/or operational differentiation. For these independent sponsors, having a capital provider that allows them to maintain control over the transaction and the value creation plan is of primary importance. Compared to IS funds, family offices tend to bring capital and strategic oversight through board positions and limited day to day involvement. They recognize the role of the independent sponsor for sourcing the deal and developing the business thesis based on their deep experience in building and growing businesses.  

A leaner model, better economics 

Unlike IS Funds, the majority of family offices are not interested in developing the infrastructure needed to support a direct investing model. This requires hiring investment teams supported by operating partners, significant investment and commitment, and limits their ability to pivot expeditiously if their situations or circumstances change. Independent sponsors help address this.  

Historically, for the independent sponsor, the economics of working with a family office tended to be more favorable than traditional private equity where there are two layers of carried interest to satisfy: the general partner and the limited partner. In the independent sponsor/family office relationship, the family office is the limited partner. IS funds have to contend with two layers of economics. In a successful exit, there is more than enough to satisfy all stakeholders. However, transactions where the outcomes are marginal or average at best, family offices have the edge and are more attractive.  

The practical barriers to getting deals done 

While a match between independent sponsors and family offices seems to be made in heaven, why are we still not seeing more deals relative to the growth in the independent sponsor community?  This is because the same obstacles in finding the right family office partner still exist for independent sponsors: 

• Connecting and networking with family offices. Family offices tend to keep a low profile. Independent sponsor need to leverage relationships and referral networks for introductions to family offices.  
• Trust and chemistry between the parties. Building trusted relationships takes time. In the context of a deal setting, time is a luxury and independent sponsors are working under tight timelines during their exclusivity period leading to misalignment of transaction deadlines.   
• Family office commitment. Often, family offices are initially intrigued by a deal, however, as they work through the diligence period and understand more about the risks involved, they may have second thoughts. It is not uncommon for the family office to leave the independent sponsor at the “altar.” 
• Capital allotment. Many independent sponsor deals involve “buy and build” strategies which, by their nature, require additional follow-on equity subsequent to the initial investment. Family offices may not want to risk additional exposure to a single investment and, therefore, are reluctant to commit; or they will offer a “soft” commitment.  
  
  

The family office perspective 

From the family office perspective, many of the independent sponsor considerations apply. But family offices also raise the following challenges:   

• Identifying the right independent sponsor for them. Exponential growth in the independent sponsor community coupled with a lack of data to measure an independent sponsor’s track record is hard to come by. For a family office with limited resources, it is hard to determine where to begin in assessing which independent sponsor is the right fit.  
• Letting go. Trusting the Independent Sponsor to go out and do their job can be difficult for many family offices. Even with the independent sponsor leading the charge, the family office is often asking how the relationship is set up to address any significant complexities or complications. 
      

The Next Phase: More Competition, More Differentiation

Despite ongoing challenges and obstacles, for many independent sponsors, family offices are still the equity provider of choice. However, as the independent sponsor ecosystem continues to mature and grow, we expect more dedicated capital providers to enter the market, thereby creating more competition and supply, which could lead to better deal terms for the independent sponsor. As a result, family offices, in order to maintain their edge, may need to find more creative and differentiated ways to add value to independent sponsors.