After recently attending IGlobal’s Independent Sponsor New York Conference and McGuire Woods Dallas Independent Sponsor Conference, it is clear that the independent sponsor community continues to grow and thrive. While it is difficult to estimate the total number of independent sponsors, we would expect there may be as many as 500; and they come in all shapes and sizes.

New independent sponsors continue to enter the market, including more and more private equity professionals who are realizing the only way to obtain an equitable share in the economics of their deals, and to be properly recognized and rewarded for their efforts, is to set up shop. The independent sponsor model, which has its share of risks, has relatively low barriers to entry and favorable economics if done right.

While some believe the independent sponsor market is maturing, we believe it is still in a growth phase. Considering it a mature industry is getting ahead of ourselves. While some independent sponsors have been at it for 10-15 years, they are the minority. Most firms have emerged within the past five years. Today, many have multiple portfolio companies, and many are adopting "buy and build” strategies in highly fragmented industries, resulting in platforms earning tens of millions of EBITDA.

We are also beginning to see numerous exits with the majority of our independent sponsor clients advising us they are exceeding expectations with outsized returns - allowing both capital providers to meet their return thresholds and independent sponsors to share in the upside. Private equity firms and other investor groups continue to embrace the model as evidenced by the number of people attending independent sponsor conferences and by firms that have adopted specific independent sponsor-targeted funds and programs. This validates the model for those sitting on the sidelines and thinking about launching an independent sponsor firm and tells us how far independent sponsors have come. 

A major discussion topic is whether or not to raise a fund. For many, it's the natural evolution of the model, while other "die-hard" independent sponsors say they plan to continue in their current state. Earlier this year, McGuire Woods launched its first Emerging Managers Conference, a two-day speed dating event designed to match independent sponsors with LPs. It's a telling story of the demand from both sides to engage and learn more. 

For many, the independent sponsor model is a steppingstone towards raising a fund. Private equity professionals entering the fray tend to be at the level below partner, or new partners in a fund who have established a track record as part of the broader fund. On their own, they haven’t yet established the credibility to raise a fund. Using the independent sponsor model allows them to establish an independent track record and position themselves for a traditional PE or SBIC fund. Several placement agents emphasize the importance of this step and are working with independent sponsors to introduce them to LPs for co-invest opportunities that enable the parties to get to know each other. In fact, there are several groups that have capital allocated to a “rising” group of independent sponsors wishing to go the fund route.

Independent sponsors that have been around for some time – veterans of the industry – continue to stay true to the model. They enjoy the flexibility and independence the model provides. Moreover, the economics can be better, reporting requirements are typically less onerous, and the stress levels are lower than those associated with deploying a fund. Successful independent sponsors have established investor relationships and typically have a core group of capital providers they can turn to. The number of SBIC funds, primarily with debt strategies and limited equity, have grown significantly. They are a natural partner for independent sponsors active in the lower middle market. But as independent sponsors move upmarket, SBICs are no longer a good financing source due to their net income caps and other restrictions. As an alternative, there are more than a fair share of private debt funds that are happy to support their deals.

The equity side can be more challenging – equity investors, particularly control investors, have their own return thresholds and want the lion share of the economics. Also, independent sponsors have to disclose their business thesis, value creation strategies, and seller relationships with private equity funds, thereby running the risk they may be circumvented or find their influence marginalized. While these “bad actors” exist, they are not typical of the broader private equity universe. Having a traditional fund structure does allow sponsors to move quickly and gives them more flexibility in competitive processes or in chasing larger deals.

While the banker-run sell-side environment has opened up to independent sponsors, they appear to still be at a disadvantage compared to funded groups. A positive with investing from a fund is the fact that sellers know from the outset who they are dealing with. Independent sponsors may spend months building a relationship with, and garnering trust from, sellers only to later bring in their capital providers once they have exclusivity and have performed the bulk of the due diligence. The odds are the equity provider will either control the deal post-closing or have considerable influence. If the chemistry between the capital provider and seller is not there, it erodes the trust that has been built up by the independent sponsor over an extended period. Sellers may be more inclined to walk away or go in a direction where they know what they are dealing with.

In assessing the pros and cons of an independent sponsor model versus traditional fund structure, there is no clear winner or right or wrong answer. Each sponsor, in setting their long-term goals based on their unique situation, will come up with what is best for them. The good news about the independent sponsor model is that you can start down a path and pivot at any point. The only deadlines are those set by the independent sponsors themselves.

Contact

Claudine Cohen, Managing Principal, Value360 practice

646.625.5717