McGuireWoods recently hosted its third annual Independent Sponsor Conference in Dallas, drawing more than 800 independent sponsors and capital providers from more than 40 U.S. states and three countries. At the conference, McGuireWoods lawyers joined independent sponsors and capital providers to share insights on industry trends and best practices for structuring and executing transactions.
Here are some of the key takeaways from this year’s conference.
“Truths” about independent sponsor economics are consistent.
For the third year, McGuireWoods’ panel on independent sponsor economics detailed what fees actual capital providers are paying through independent sponsor-led deals. Many of the caveats remain the same (attractiveness of the investment, “skin in the game” from the independent sponsor, and going-forward roles and responsibilities), with the closing fee, management fee and carry structure tending to gather around consistent ranges. We continue to see growing support for the advice succinctly provided by one panelist: “Don’t chase money; chase relationships.”
Independent sponsors and capital partners are implementing new “hybrid” structures combining the benefits of committed private equity structures and deal-by-deal structures.
As the independent sponsor model continues to mature, some of the more experienced independent sponsors and capital partners are finding ways to implement structures that provide the independent sponsor with a level of “committed capital” while offering the capital partner significant co-investment opportunities, more consistent transaction flow and an agreed-upon sponsor-economics package. Illustrating the reality that committed private equity structures and deal-by-deal structures each have their own advantages, these hybrid structures are an evolving and important theme in today’s environment.
Shared-control structures can take on myriad forms and vary among capital providers and independent sponsors.
What is perhaps most important in situations with shared control is that the parties engage in candid discussions early in the process to gain a full understanding of expectations. That understanding will foster the relationship needed if the parties later face unanticipated challenges in the business. Also, shared financing arrangements with multiple capital providers are becoming more commonplace and necessary, adding a layer of complexity to structuring rights among the various stakeholders.
Family offices recognize the emergence of the independent sponsor model as a lasting, viable investment structure.
These capital sources realize that independent sponsors source deals to which the capital sources would not otherwise have access, allowing investors with limited internal resources to leverage the deal flow provided by independent sponsors to expand the capital sources’ own internal capabilities. This structure provides opportunities for diversification, especially for family offices that have historically invested in the industry in which the family generated its wealth. After closing, independent sponsors can be a valuable extension of the capital providers’ management capabilities, and the partnership between an independent sponsor and a family office can provide significant strategic value to a company. To capture these benefits, these capital providers are altering their investment theses and getting creative with economics to properly align interests.
When navigating a deal from letter of intent to closing, relationships are paramount.
Independent sponsors play a unique role in facilitating a partnership among the target company management, rollover sellers, new equity investors and lenders. Term sheets set out non-binding rules of the road, but successful independent sponsors spend months (even years) cultivating deep relationships with the target company and also with capital providers. When timing or due diligence hiccups occur, these relationships can be key to holding the deal together.
The most highly sought-after capital providers are firstly great partners.
Independent sponsors highlighted being trustworthy and reliable first, as specific roles and responsibilities of the capital providers can range from being relatively uninvolved to very involved in structuring, diligence, deal negotiations and day-to-day management of the investment. The most seasoned independent sponsors tend to value great partners over a few extra points of carry.
Lower-middle-market deals dominate, but size doesn’t matter.
Some independent sponsors are long-time and well-capitalized investors with sophisticated investing strategies and proprietary origination channels focused on deals requiring equity checks exceeding $100 million, while others are pursuing the model with companies at or under $1 million of EBITDA. The majority of independent sponsor-led deals have enterprise values between $20 million and $75 million.
The universe of independent sponsors continues to expand.
While many investors look for independent sponsors in the form of proven private equity professionals who have departed such firms, independent sponsors have varied backgrounds including operations expertise, investment banking, consulting and more. Regardless of background, great independent sponsors create value through the hard work of finding compelling deals, making them investable, and running the investment from origination, through diligence, closing and all the way to the ultimate exit.
McGuireWoods continues its leading role in supporting the independent sponsor community. If you are an independent sponsor or family office, please join one of our peer networking groups around the country. If you are an investor interested in getting to know independent sponsors, we want to know you. Thank you to all of those who attended ISC 2019, making it another huge success!