Competition for private equity transactions from independent sponsors is on the rise. As this emerging asset class of investors grows in size and power, it is gaining momentum in the market and searching for larger deals.

Who are independent sponsors? They are typically M&A professionals who have left a private equity or investment banking firm to pursue deals on their own, without a formal fund behind them. Instead, they raise capital on a deal-by-deal basis. Independent sponsors may include family offices and executives with deep industry expertise looking for equity ownership in a business. They typically like to be more involved in a business than do traditional private equity investors.

Many independent sponsors believe that their approach to investing gives them greater flexibility to pursue deals and allows them to have a greater alignment of interest with their limited partner investors. What’s more, an abundance of capital in the market has made it easier for independent sponsors to attract financing partners and raise money one deal at a time.

Lenders, in particular, should be attuned to the growing influence and deal acumen of independent sponsors. In the past, lenders shied away from independent sponsors because they did not have a long track record of closing deals. But independent sponsors are proving to be quite resourceful, carving out a significant slice of deal flow for themselves and establishing a model of success that involves a keen understanding of the industries in which they operate.

Independent sponsors are adept at gaining the trust of target companies, spending months and months with the management team to learn about the business and forging deep relationships. It’s no surprise, then, that independent sponsor-backed deals are becoming more prevalent in middle-market transactions with values of $10 million to $75 million. And many of these sponsors are starting to move further upstream. For lenders, this means more deals that will require the use of debt.

A significant advantage for independent sponsors competing for deals is their natural appeal to business owners. Rightly or wrongly, many business owners still hold an outdated opinion of private equity as corporate raiders intent on maximizing returns through financial engineering. By contrast, they see independent sponsors as real people they can personally connect with—not always the case with a PE firm, they believe.

PE firms, for their part, are beholden to investors who demand to see a return on their investments within a set timeframe. Private equity firms have about three to five years to put investments to work, a handful of years to grow their portfolio businesses, and a fixed period to exit those deals so they can raise their next fund.

Independent sponsors, however, operate under a different model. They can provide longer-term capital and without limitations on how long they can hold onto their investment. They are not bound by certain structures to exit an investment quickly. That is a very attractive selling point for, say, a family-run middle-market business looking for capital.

Another advantage independent sponsors have is that family-run enterprises are eager to partner with family offices because they share commonalities in their approach to business. For instance, having an investor that truly understands how a family-run business operates can go a long way to contributing to the future success of the business.

The bottom line is that independent sponsors represent an increasingly important source of capital for private companies in the market. From a lender’s perspective, independent sponsors represent an emerging opportunity that they should seriously evaluate.

Insight

Independent sponsors are an exciting new asset class in the M&A market. Lenders are advised to take these groups seriously, as many are setting their sights on larger deals that will require more debt.