On Oct. 2-3, McGuireWoods hosted its second annual Independent Sponsor Conference in Dallas, attended by more than 600 independent sponsors and capital providers from more than 35 U.S. states and Canada. At the conference — the largest of its kind after doubling in size from the prior year — McGuireWoods’ private equity team, alongside McGuireWoods’ credit and tax specialists, joined independent sponsors and capital providers to share insights on industry trends and best practices for structuring and executing transactions. Below are some of the top takeaways. We look forward to seeing you next October for our 3rd Annual Independent Sponsor Conference in Dallas!
Many factors are driving the explosive growth of independent sponsors.There continues to be a migration of investment professionals from the traditional blind pool committed fund model to the independent sponsor model, a shift caused by pressures from both limited partners (such as the insatiable desire for direct investments, negotiating lower fees and pushing for more investment discretion) and general partners (misalignment of fund economics in the typical committed fund context, more investment flexibility and surplus of available capital). Additionally, as more traditional private equity funds and junior capital providers are looking to back independent sponsors, it is less a matter of competition for deals but more a collaborative effort to work together to source great opportunities and deploy capital toward attractive assets at valuations that are not hyper-inflated.
There is no single set market formula for independent sponsor economics. A host of factors come into play, including the size, type and price of the deal, the experience and background of the independent sponsor and the organizational makeup of the capital provider. There are some capital providers that view independent sponsors only in the context of a specific deal and may be willing to pay better economics to get a deal they really like. There are other capital providers who view independent sponsors as potential future committed fund prospects that they can seed. And while these groups may not pay the highest economics on a particular deal, they are often willing to consistently follow and eventually seed independent sponsors that they really like. Independent sponsors should consider both their short-term and long-term objectives for their businesses when making decisions on which capital providers may be the right fit for them.
Even good independent sponsors struggle. Competition for deals is everywhere and capital is flooding the market looking for deals. This challenges even the best independent sponsors. Leverage the power of the independent sponsor community and — particularly for new independent sponsors — take advantage of the close-knit network of independent sponsors for insights on common issues such as capital partner reputations, managing the seller as an independent sponsor and structuring economics. Whether pairing up with another independent sponsor or just learning from others’ experiences, community members often are willing to help other independent sponsors — another distinction from most traditional private equity. It can be lonely as an independent sponsor, and this is one way to help mitigate this concern.
Patience is a virtue. For most new independent sponsors, completing that first deal takes longer than expected. Stay focused and wait for the right opportunity without becoming frustrated or getting involved in the wrong transaction. As one panelist described, being an independent sponsor is the ultimate “get rich slow” model. Discipline increases the chances of success.
Differentiation is key for independent sponsors. With this model continuing to expand in popularity, independent sponsors need to keep in mind ways in which to differentiate themselves. Industry experience can be tremendously valuable to investors. Being able to offer strong and relevant operational experiences and perspectives on a deal is a value-add.
Tips on working with an independent sponsor. Be flexible on economics and don’t expect a rigid “market” construction of fees. Capital providers should focus on an independent sponsor’s experience and value-add. Independent Sponsors need to look for the right partner, not just a source of capital. And capital providers should work to nurture relationships early in the process with each party demonstrating mutual respect. The Management Services Agreement is the king, so be sure to clearly define expectations on roles, performance and compensation. Starting with the due diligence process and continuing throughout the deal, transparency is key. A lack of transparency can cause either the independent sponsor or the capital partner to walk away.
Great independent sponsors simplify complex situations and demonstrate their value. It’s critically important to forge strong relationships with sellers. The most successful independent sponsors invest time in upfront legwork, and find value in hidden corners of the market and identifying valuable partners. In addition to deal flow and expertise, independent sponsors often play a crucial role in business development and operational support, allowing funds to focus on the lower middle market instead of supporting larger professional staffs often necessitated in middle market funds.
These key takeaways were also published in a Nov. 6 column by The Texas Lawbook.