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  • Todd Dauphinais | The Key to Setting Your Firm Apart
    POSTED 6.1.21 M&A Masters Podcast

    On this week’s episode of the M&A Masters Podcast, we sit down with Todd Dauphinais, Founding Principal and Managing Partner of Clavis Capital Partners in Dallas. Clavis Capital Partners realized that there was a better model and approach to private equity, and set out to create an investment firm focused on operations, the longer term, and on deploying capital in the most flexible and effective manner possible – the independent sponsor model. 

    We chat with Todd about what inspired him to build Clavis, and where the name Clavis even came from, as well as:

    • The successful effects of the independent sponsor model
    • The importance of strategy for growing businesses 
    • Building a company culture that sets you apart
    • How the rapid advancement of technology can be used for market benefit
    • Rep and warranty policies 
    • And more 

    Listen now…

    MENTIONED IN THIS EPISODE:

    TRANSCRIPT:

    Patrick Stroth: Hello there, I’m Patrick Stroth, President of Rubicon M&A Insurance Services. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today I’m joined by Todd Dauphinais, Founding Principal and Managing Partner of Clavis Capital Partners. Based in Dallas, Clavis Capital Partners recognized that there was a better model and approach to private equity, and set out to build a different kind of investment firm. One that was more focused on the operations, on the longer term, and on deploying capital in the most flexible and effective manner possible. And that model would be the independent sponsor model. So, Todd, it’s going to be great to talk to you about this. I’m very excited. Thanks for joining me today.

    Todd Dauphinais: Yeah, thanks, Patrick. I really appreciate it. Thanks for having me on today.

    Patrick: Yeah, before we get into Clavis Capital Partners, let’s give our audience a little bit of context for you. How did you get to this point in your career?

    Todd: Oh, it’s a great question. Thanks for asking that, Patrick. So I started Clavis, eight years ago, I was 43 years old at the time. Up until that point, in my career, I’d spent most of my career in operations, I had been the CEO of a midsize manufacturing firm for a number of years, I had done the kind of the big corporate thing I’d worked for Schneider Electric, which is a European based industrial company. I ran a number of their business units in their M&A team for a while. And I started out my career at Deloitte Consulting, doing strategy and operations consulting. And you know, as I look back, all of that experience, that operations and strategy and even the consulting experience really, is beneficial to what I do today. 

    And when I started Clavis, eight years ago, I like most things, you know, I was looking for, I wanted to take my operational experience and apply it to more more of an investing type model I talked to, and frankly, when I was interviewing with a number of PE firms, and I was looking for that firm that had more than operational background, and then operational bent that that had that was similar to my background. And I really, I couldn’t find it, I mean, I kept running into the same type of person over and over again. And in groups that were really, the backgrounds were much more financial services, financial engineering, investment banking backgrounds. And so you know, I remember the time actually, I was I was at the office of a good friend of mine, and was bemoaning the fact that I couldn’t quite find the job that I was looking for. 

    And he’s the one that finally kind of said, well, then go create it yourself. And so I guess the short story is, I couldn’t find the job that I was looking for. So I had to, I had to invent it. Unfortunately, it didn’t pay well at the time. But, you know, I really had a vision at the time to start a group that was staffed by and lead by operational and strategic people, and really had a vision at that time to create this, and it takes a lot longer than you ever think it will. But, you know, fast forward now our team is all operating and strategic professionals. And you know, we’ve been successful thus far. So I guess it worked out. But in the early days, you never know if that’s if that’s gonna work or not.

    Patrick: Yeah, I was. That is what happens when you get to be our age, and you blink, and all of a sudden five years goes by so you slog it through and blink, and you know, it all be behind you. So that’ll be great. Yeah, that brings it Yeah. And that brings us to Clavis Capital. And obviously, you didn’t name name, the organization Dauphinais Capital, because yeah, you’re more creativity than us insurance, folks and the lawyers out there. So give us a story. Because that’s nice insight into the culture of the firm. You know, how did you come up with the name Clavis Capital?

    Todd: Yeah, no it is a it is a good. It’s a funny story. Um, so the story is that we had rented a house in Sun Valley, Idaho many years ago, my wife was seven and a half months pregnant, and I had a two and a half year old. And on a Sunday night, I took my family out to dinner and came back to the house and this was before Airbnb, and before any of that. I’d rented it from a friend of mine who had a rental service and, and as I get back on Sunday night, I realize I’ve locked myself out of the house. It is, it is locked up tight as a drum and I tried to find a way in the house, I can’t get in the house, and it’s later it’s getting late on Sunday. 

    And I was standing on the back porch, and I’m kind of looking down and just really ticked off at myself for doing this because I couldn’t blame anyone, I couldn’t blame my two and a half year old. And as I’m looking down, I happen to glance over in a flowerbed and in the flowerbed it, I picked up a glint of a metallic object in there. And so I reached down and lo and behold, there’s a key, it’s the, it’s the backup key, and it had been there for a long time. And so and it got us in the house. And and that key is always been significant to me. And there’s a lot you could, you know, there’s all kinds of different things, you could you could read into that, but I kept that key. 

    And so when I started my firm, I wanted to, I wanted to do something that that that involve that key. Well, clavis is Latin for key. Yeah. And, you know, everything key was not only generic, but all of the URLs were taken. And so I had to go to Latin to find, to find an available URL and something like that, that sort of sounded neat. And so that’s that really is the the story behind the name. And it, it really like you mentioned, it, it, it’s part of our culture, and it’s in culture is a big thing for us both in our firm, my firm and, and the companies we invest in, we pay a lot of attention to culture. And so that’s a, that’s a cool little story that we can tell to people, it has some meaning and it obviously, is very meaningful to us.

    Patrick: Yeah, I think that’s fantastic. And there’s a key is iconic for a lot of different different areas, and so forth. And you talk about culture, and there are a lot of people that they pay lip service to culture, but it is a real strength is something you got to focus on, particularly for the type of organization you are, because let’s face it, in the investment world, right now, you’ve got over 4000 private equity firms out there, and more coming every time. Add to that family offices. And then, you know, there are 1000s, I don’t know, it’s very fragmented the sector, but you’ve got independent sponsorship sponsors out there, too. 

    And you have to distinguish yourself from all the others out there. And and culture is a great way because it comes from the heart, you can’t fake it. And so, you know, you and I talked earlier, you mentioned that you made, you know, your website is as you recognize as a better model out there, but you intentionally went the independent sponsor route, and you’ve not outgrown into a fund. So let’s talk about that as a model, what it does for you what it enables you to do for your investments, and how that’s been successful.

    Todd: Yeah, in your right to bring up there, there’s a lot of there’s a lot of competition in this market. And it’s, it is really difficult to, certainly to differentiate yourself or to get that message out. And, and to get people to understand that the and there’s no barrier to entry to being an independent sponsor. That’s the thing that’s most frustrating to me in a lot of ways is there’s there’s no you know, anybody can hang their shingle up and, and just call themselves that, that term. And so I even struggle with a little bit of the what to call ourselves, we don’t call ourselves generally, PE, because we’re not a fund, nor do I have any interest whatsoever in raising a fund. And there’s some specific reasons for that. But what I do for a living, what really gets me jazzed in what gets me out of bed in the morning is not deploying capital, per se, it’s building businesses. 

    That’s where the operational background comes in. What me and the other members of my team are really good at and really, really like, is building businesses. And so the second you raise institutional fund, you are now in the asset deployment business. And your job now is to get that that those dollars out the door, the people who do that for a living, they’re great people, and they they have a lot of fun doing what they’re doing. But they spend their day differently than how I spend my day. I spend my day really working on with our leadership teams and our portfolio companies developing long term strategy, developing, you know, the the plans and the operational plans to really grow those businesses. 

    And so we spend a lot more of our time doing those operational and strategic things. If I have a fun, that’s not what I get to do on a day to day basis. I’m managing LPs. I’m raising money on deploying that capital and it causes you to do some things that you might not want to do. There are pros and cons to both models, no doubt but what gets me really excited is being able to spend dedicated time on our portfolio companies and working with the leadership teams, and sort of being that that right hand person to the CEO of our portfolio companies. So I get, I get the best job really, in my opinion, I have the best job in the world and get to be sort of Kwazii CEO and strategy guy. But without the day to day headaches that I used to have when I was running my own my own company.

    Patrick: You summarize that really well, where you say, look, the day you open up a fund, you become, you know, you move away from what you love doing, which is being company builder, and you go from company builder, to financial engineer, nothing wrong, but there are some people that love the engineering, there are other people that really love rolling up their sleeves. And, and doing that, I would think that would appeal to owners and founders looking at, you know, they’re at an inflection point, they want to move to the next level. And, you know, they want somebody who’s going to actually be with them side by side, and, and work with them. And I think under this model, there’s no dilution of your attention.

    Todd: Yeah, that’s right. And it does, it appeals to the person who is really looking for a partner, not just looking to sell their business to the highest bidder. And there are both types out there, and they’re there, they’re fine. But we are very selective in the types of things that we get involved in for a number of reasons. Number one, we can’t do a whole lot of deals, at the same time, we can only concentrate on so many deals. And that’s really how I want it. I mean, that allows me to get deeply involved in my team to get deeply involved in each individual deal. We also can’t afford to get any one of them wrong. In a fund structure, you know, you may invest in 10, 15 companies in a fund and you know that two or three or four of them are just not gonna go well, they’re gonna go bad, I can’t afford that I every single deal that we get involved in is its own deal. 

    And, and so I can’t afford to get it wrong. So we spend a lot of time really evaluating our opportunities. And that’s where you mentioned earlier culture, that’s where culture comes into this. And it’s not just lip service, because the you can tell a lot about how successful and investments going to be based on the company culture that the leadership of that company has built. And if you go into a place and they’ve got really great culture, you can feel it, it’s it’s not something that’s easy to see, necessarily, but you can feel it, those investments will do nine times out of 10 or 10 times out of 10, those those investments are going to do just fine because they’ve been built right from the ground up. Because the the leadership have focused on building that culture.

    Patrick: I’m curious when you talk about culture now. I mean, it’s one of those you can see it or you can feel it immediately. It doesn’t have to be translated, I mean. Is it that easy? Did you are you able to tune to recognize that real quick? 

    Todd: Yeah, we’ve gotten better at it. But yeah, you you can tell, you can tell. And there’s a couple things that are that are a little bit telltale, when you when you go to even before you go visit, you can usually get some sense of the culture. It’s amazing, you know, just what you can tell by going out to the internet and seeing, you know, how does the website present and what’s you know, what, what is that? Does that talk about culture? You know, we’ve we’ve seen, we’ve, we’ve gotten really intrigued with some companies where there were YouTube videos that the CEO had put out there that talked about culture, you know, if you can, a lot of times even before going out there, you can tell a little bit. 

    Then definitely when you go out on site, and you meet with the leadership team, and you meet with the management, how they talk, how they talk about their company, you can always tell what’s the level of pride in the company, both how they talk, how does the how does the business present. If you walk around the plant, in our case, we do a lot of manufacturing stuff and the plants really clean and people are wearing the logo and stuff that tells you a lot about the pride of the people that the people have in the firm and the culture that they have. If you go there and nobody talks about the employees and it’s a dark and you know really, really

    Patrick: Gritty.

    Todd: Gritty place. Usually that kind of tells you a little bit as well. So it’s more art than science. But if you’ve got a little bit of a trained eye to it and you’re looking if you’re looking for it you can you can see.

    Patrick: Yeah, why now and we know not to focus on numbers or anything but you’re usually going from majority interest and then you prefer having the the owner founder remain with you or are how many others deals happen where the owner just wants an exit?

    Todd: You know, in in every case that we’ve actually done the deal, the owner has stayed with the business. But having said that, because of our operational background, it doesn’t scare us to have situations where an owner might be looking for an for an exit, not only a financial exit, but but you know, he’s looking to retire or to step back or whatever. I tell owners all the time, I’d rather know what your intentions are, I can work around those. And we’ve had a situation we’ve had two situations in our portfolio where the owner wanted to stick around for a transition period a year or two. 

    And they wanted to retire. And, and we were fine with that. And, and we, in both cases, honored that that wish and worked with the owner to find the right leader for that business after the owner stepped away. And we’re not scared of that at all. But in most cases, we’re looking for somebody who’s looking for a partner. And if if they’re looking for a partner, then they’re usually not looking to just sell 100% and go sit on the beach, because that’s, that’s, that that doesn’t work with our model very well.

    Patrick: Gotcha. And, and your focus is on the industrial sector, which before I started this podcast, being quite admittedly, based in Silicon Valley, our view of manufacturing is pretty much limited to the tech sector sector, where you’ve got clean rooms and all these spotless, little germ free environments and everything. And, you know, you’re in that nice, gritty, you know, sector there where the where the real work happens. And I’m surprised to see how, you know, manufacturing and industrials are actually thriving right now. So, you know, you gotta share with me, why did you pick that sector? Is it just your background? Or, you know, other reasons? 

    Todd: Yeah, it’s it’s, a lot of it came from my background to start with, it’s something that I know a little bit about having having run manufacturing businesses before. So I, you know, I was trained in LEAN manufacturing, and six sigma, all of those fancy words that came out of the 80s, 90s and 2000s. But really, our focus is in industrial and manufacturing, not as much because we know something about it. But we really believe in that sector. And in particular, the Renaissance that we believe is, is kind of happening in this country in manufacturing, some people call it manufacturing 4.0, or whatever you want to call it. But we have a specific thesis about what is going on in manufacturing. And what we’re seeing in the reshoring of manufacturing back to the US the kind of undoing of what happened over the last 30 years, when manufacturing, when supply chains got very disaggregated and and placed globally. 

    And that worked for a long time. What we’re seeing now is the market has evolved such that speed to market, rapid prototyping, mass customization, all of these things that are now trends in the market. And it really starts with the consumer, the consumer has gotten really used to having something delivered custom made instantaneously to their door, you can’t do that if you’re manufacturing everything in China. So we and then throw on top of that the world has just gotten a lot more complex and complicated. And you throw in, you know, trade wars and things like that. China, Asia in particular has gotten a lot less interesting and a lot less advantageous. It’s a lot that China has gotten more costly over the last decade or two. And so we’re seeing a lot of people come back reshoring but the manufacturing that is coming back is looks a lot different than the manufacturing they left. 

    And this is where it looks a lot more like your Silicon Valley and your tech oriented businesses then it certainly did in the you know, industrial age when you were talking big plants and and a lot of people there’s a lot of technology now involved in producing goods and prototyping goods and speed the market. There’s a lot more high tech stuff that is is is being invested in and put into ground here in the United States. And so even though, you know, our orientation is manufacturing and industrial, that doesn’t mean that we don’t pay a lot of attention to the technology and the the very rapid advancement of technology that’s occurring in our space. And, and that’s really where we like to invest. We’re looking to invest in more tech enabled manufacturing, and you’re seeing that across the board, it’s it’s really an exciting place to be right now.

    Patrick: Now with and with your, your targets, your investments, you’re usually the first institutional capital coming.

    Todd: Yep.

    Patrick: Okay. So a unique aspects to what you’re doing as an independent sponsor, you had mentioned, you can’t get these these deals wrong, you don’t have that margin for error as you’re going forward. And in mergers and acquisitions, there are a couple things that happen, you touched on with culture is, you know, you cannot remove the human element. This isn’t, you know, Company A and Company B, you know, coming together. This is one group of people agreeing to partner with another group of people. And so, you know, you’ve got that human element. And a lot of times what happens, and I imagine this happens every time in your case is that you have, you’re on one side of the table and you’re an experienced buyer, and your counterparty, the seller is inexperienced. 

    It’s not that they’re naive, they just don’t do this all the time. As they go through the process, you know, particularly when you’re going through diligence, which you’ve got to be thorough, because you can’t afford to miss. They’re not used to that. And then following that process, okay, they come through the diligence, then you sit down, you’re, you know, bringing out the purchase and sale agreement. And then there’s this indemnification clause, and what the seller hears who’s not experienced when when their lawyers reading the indemnification clause, they hear buyer saying to them, okay, I know we just went through this invasive diligence process, but just in case we the buyer missed anything. And that miss leaves us suffering financially, we’re gonna hold you to pay us for any losses we have. It’s just, you know, if we couldn’t find something, we don’t want to be out of pocket with a lemon. So, you know, that’s just part of the business is standard procedure will have an escrow and you’re all set, probably nothing’s there. 

    So don’t worry about it. And for seller that’s not used to hearing that they their response is. Wait a minute, I told you everything. You can’t hold me responsible for something I didn’t know about. Experienced buyers as well, yeah, but I’m making a bet of 10s of millions of dollars, that your memory is perfect. This, this happens in all the deals, it’s just part of the process. And right there, you’ve taken a collaborative situation, and all sudden, there’s this potential for distrust to come in stress, fear of the unknown. And, you know, it’s a real challenging thing, and sometimes derails deals. And the tragedy is that that whole process can can be avoided. And the way that happens is now the insurance industry in the last several years came through with an insurance policy, it’s called reps and warranties, it essentially takes the reps that the seller outlined, that the buyer vetted with due diligence, and the insurance industry simply says like, buyer, if if there’s a breach of at least a financial loss, come to us don’t go to the seller come to us. 

    Buyer has certainty of collection, they avoid the very, you know, tentious part of probably having to clawback money from the seller. And so they’re taking care of. Seller gets a clean exit. A policy attachment point is lower than most escrows. So they don’t have as much money held back in escrow. So they have more cash at closing. Better yet, they get peace of mind. Because if there is a loss, you know, they don’t have to pay it, they’re not going to lose any of their money. And so it just seems to smooth the process over. And the beautiful thing for us is in concept, this was great. But in practice, it wasn’t very useful because rep and warranty was reserved for deals at $100 million transaction value and up. They had very strict eligibility standards. You had to have audited financials, a battery of third party diligence reports and everything. And so it just wasn’t feasible for the smaller deals. 

    Competition has come into the insurance market since the pandemic. And now eligibility for rep and warranty has now fallen to deals as low as 10 to $12 million. And you don’t need audited financials now to qualify. And so that’s the purpose of our conversation with a lot of people out there is to make them aware that this thing that used to not be available is now available for the lower middle market where I really believe it makes a huge impact. Because if you can save somebody a million bucks or 2 million that’s that’s huge. You know, but don’t take my word for it, you know, Todd good, bad or indifferent. What experience have you had with rep and warranty?

    Todd: Yeah, now you it’s a great point, Patrick. The biggest thing for me is it removes a potentially contentious item out of the process at a critical time in the in the process. And you described it well that you know, you get through a due diligence process and now you got this. This this additional thing and to a to a seller who doesn’t do this for living, you know, that feels very bad faith. Yeah, bad faith or whatever. And so the rep and warranty product, kind of smooths that over quite a bit. And, and so we have utilized rep and warranty insurance in pretty much every deal that we’ve done for the last two, maybe three years, I believe. 

    And it does, it does smooth that over. The statistics I’ve seen is it’s that that part of the insurance market has really exploded because it’s for exactly the reason it’s, it’s good for all, you know, both parties involved in the process. And as an M&A professional, I want as little friction in the processes as I can get. And that’s that’s, that’s great. It’s gonna be interesting to me to see, I’ve seen a lot of statistics about the the implementation of rep and warranty policies. I haven’t seen a lot of statistics around the claims against those policies, and how often those policies or those claims get, get paid out. 

    Luckily, we haven’t had any any issues with with with any of our policies and you know, knock on wood, hopefully that is that that remains, that remains the case, that’s not something I want to be an expert in. So it’s a great product, it’s something that just makes the deal process work a lot better on our part. And, you know, I think it’s, it’s something that has been a real boon, actually, to the to the to the insurance carriers who develop this, and it’s become a lot more competitive. In the early days, there were two carriers that were that were that were that had 90% of the market. Now, you got a lot of other options there, which is good for competition.

    Patrick: Yeah, I think it helps because the more carriers are out there, there’s just more variety, where a couple carriers will will specifically target an industry or transaction size, and treat it more favorably, they’re just more familiar, they’re more comfortable with it. And then I would say on the claims side, so far, we haven’t heard anything industry wide reports are coming on, you know what the impact of COVID has been on rep and warranty policies. By and large, though, less than, you know, 10% of the policies out there, maybe 15 to 20% of the policies incur a breach reported, hasn’t been paid, but they just notify the carrier that actually paying this is very small as a very profitable line of coverage. 

    Even with consultation, we only they will see that because the demand is getting bigger, I would just say for 2021, we could probably see insurance carriers, maybe raising their retentions a little and maybe bringing the pricing up just by a little like a point or two, just because the demand is so high. Not because of losses. Which is a nice signal that is going to be sustainable. So we’re very, very happy with that. And now we’re able to do not only platform deals, but add ons. And so I think that’s just the more out there that we can be available, the better the better for everybody. Todd with, you know, where we are right now with, hopefully we’re at the beginning of the end of the pandemic. Now, as we move forward, and people are beginning to move out and get out and do site visits and everything like that. What trends do you see for the rest of the year into 2022? Either industrial, Clavis Capital? What do you see out there?

    Todd: Yeah, the market is is extremely competitive, and I think will remain so. There’s so much capital that’s out there, chasing deals, you know, in a lot of ways, COVID took a lot of what would otherwise be transactable companies off the market for whatever, you know, people were busy dealing with, with COVID related things, certainly industries that were heavily impacted. But it didn’t change the amount of capital chasing those deals. And so we’re seeing all kinds of just perverse behavior in the market, we’re seeing people that have come that traditionally would be more upper middle to large cap buyers come in to come down into the middle market, and even in the lower middle market space, it’s gotten a lot more competitive. 

    And I don’t see that changing. I really don’t the I think that’s going to be with us for a long period of time. The debt markets still remain very, very liquid. And so I you know, I and I don’t see a big correction to that coming anytime soon. So it’s gonna, it’s going to remain very difficult. It’s going to remain a seller’s market. And, you know, I think that’s going to be with us for quite some time. I think the industrial space will continue to be a good space to be in, but I think, you know, a lot of spaces are going to be good spaces to be in.

    Patrick: Yeah, don’t see any shrinkage in the industrial sector, particularly with logistics. So many people don’t realize how to get a good, you know, product from point A to point Point B. And as you said, that’s evolving as we speak now. And there’s plenty of room out there for that kind of stuff.

    Todd: Yeah, absolutely.

    Patrick: Do you think, one of the things I wanted to ask you. Do you think because of COVID, there are a number of companies that may have been out on the market and they they, you know, pull their pulled their chips off the table, they pulled their horns in, and then weathered the storm. And they may want to wait to get 12 months of performance post pandemic, on the books to kind of show where they are to improve their status before they go back out?

    Todd: Yeah, absolutely. We’re, what we’re seeing, and also hearing anecdotally in the market is that the second and third quarter of this year, you know, we talked to a lot of financial advisors and investment bankers and people that represent sellers. And what they’re telling us is towards the end of q2, and into q3 this year, there’s going to be a lot that comes on the market, because you’re going to have gotten that q1 and q2, really q2 of 2020, off the off the trailing 12. And I think that that will continue into q3, and q4 and even into 2022. And so I think you’re gonna see a lot of that, as people have recovered, that you’re gonna just see. 

    And you know, if you think about it, if you have a, a business owner, that’s call it, that’s in their, in their late 50s, early 60s, they’ve now been through three major financial disruptions in their, in their career between, you know, this, and 2008. And even even going back to bite off. At some point people go, you know, what, I don’t want to go through another one of those major disruptions and so and you’ve got baby boomers that are retiring, and the transfer of wealth, the generational wealth transfer, a lot of those in family owned companies is going to happen. It’s just going to the next, I think through the remainder of my career, honestly, is going to remain a heightened amount of activity, both on the on the supply of deals and on the demand for deals out there.

    Patrick: Man I hope you’re right. I really hope you’re right. Todd Dauhpinais with Clavis Capital, really appreciate having you here today. How can our audience members find you?

    Todd: Yeah, um, so a couple different ways. Our website is, is claviscp.com. So www.claviscp c l a v i s. C as in Charlie P is in partners.com. And then on there is all of our contact information, my phone number, my cell number is on there and email address. So that’s probably the easiest way to get us. And we would love to hear from anybody out there that certainly that that is looking to transact. But even somebody that’s looking for, you know, some advice and counsel on what to do we take those phone calls as well.

    Patrick: I think I think that’s a great value to people out there is, you know, there may not be a deal happening right tomorrow. But, you know, having those initial conversations goes a long way. So I really do appreciate you offering that out to the community. Todd Dauphinais, thank you very much. Really appreciate you. We’re going to talk again soon.

    Todd: That sounds good. Thanks, Patrick. Appreciate it.

  • Jon Finger | The Benefits of Building Relationships with Independent Sponsors
    POSTED 5.18.21 M&A Masters Podcast

    Our guest for this week’s episode of M&A Masters is Jon Finger. Jon is a Partner at McGuireWoods LLC in Dallas, and his practice focuses on private equity and corporate transactions. He and his partners were the first in the area of independent sponsors to create a private equity practice dedicated to independent sponsors. Jon and his partners also created “Deal-by-Deal”, a podcast that focuses on the independent sponsor community of the M&A market.

    Jon says, of this independent sponsor relationship, “Many of these sellers are selling their baby – this has been, and will be, their legacy. Finding independent sponsors who are really appreciative of that is a big part of what we look for in our network for the clients that we want to be working with.”

    We discuss the importance of building a network and prioritizing the independent sponsor relationships, as well as:

    • The difference between independent sponsors and other buyers
    • Perceptions of private equity
    • Finding creative ways and best practices to partner with independent sponsors
    • The ideal client of the independent sponsor community
    • Hybrid models of independent sponsors and private equity funds
    • And more

    Listen now

    MENTIONED IN THIS EPISODE:

    TRANSCRIPT:

    Patrick Stroth: Hello there, I’m Patrick Stroth, President of Rubicon M&A Insurance Services. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today, I’m joined by Jon Finger, Partner and McGuireWoods. McGuireWoods is a full service law firm with over 1000 attorneys and 24 offices throughout the US and beyond. Jon’s practice focuses on private equity and corporate transactional matters from McGuireWoods, Dallas office. It is in the area of independent sponsors, where Jon and his partners were the first to create an M&A practice and ecosystem dedicated solely for this segment of private equity. So it’s a real great pleasure to have a true pioneer in a new class of business for private equity. Jon, thanks for joining me today.

    Jon Finger: Thank you, Patrick. Pleasure to be here.

    Patrick: Now, before we get into the practice of with independent sponsors, which literally did not exist until you guys came along, let’s start with you. Tell us how you got to this point in your career. 

    Jon: Sure. Really appreciate appreciate you giving me the opportunity to join you today. So I’ve been I’ve been practicing for about about 20 years. And about halfway through my career, which had predominantly been representing lower middle market, committed private equity fund clients, we saw a lot of activity within that independent sponsor community. And at that time, it was still evolving. The models obviously been around for some time, but it was really, I think, evolving into what has become today. And it just happened to be around the same time that myself and a few of my partners were changing law firms. And around that time, what we dedicated ourselves to was building our network. And so we had this network of capital partners, family offices, private equity mez funds, etc. 

    And as we built that network, what we found was, there was an incredible intersection with the independent sponsor community. And so as we were building the network, and our practice was evolving, what we like to think was our secret sauce was our ability to introduce investment opportunities to our network of capital partners. And so we were going to trade shows, we were calling on companies, we were doing all these different things. And we saw a lot of great success out of that. The reality is, it’s very time consuming. And so ultimately, what the a bit of a lightbulb moment was, the independent sponsor in our network can be doing a lot of that spadework if you will, for us. So as we started to see, okay, if we spent more time harvesting our independent sponsor relationships, and really finding opportunities that they had, that we could then introduce to our capital partner network, it really made what we were doing much more efficient. 

    And so we weren’t having to necessarily go out there, find those investment opportunities, we were leveraging the independent sponsor community. And so what really led to where we are today, I hearken back to that where it was a situation that we were at the intersection of capital partner, and deal opportunity. And so it really allowed us to differentiate ourselves with our network. And we we continue to do it today, with I think, really good results. And that that was probably the biggest pillar of what led to where I am in my practice today, where a lot of my work is, is with independent sponsors.

    Patrick: And let’s get a little bit more detail with the independent sponsors. How are they different from private equity or other other investors or acquirers out there?

    Jon: Sure. So lots of different ways, no doubt. I think the first thing I tell you is, of course, you know, every independent sponsor is different. That’s the beauty of it. That’s the fun of it. But as a general matter, right, independent sponsors don’t have a committed fund that stands behind them that they’re able to draw down capital for each deal. So you know, the independent sponsor, let’s say they’re putting in 500 grand sometimes seven figures. The reality is, most videos we work on me independent sponsor is putting that level of capital. And there’s another, you know, $10-20 million in equity capital and obviously lender coming in. 

    So the biggest difference right is they don’t have that committed fund behind them. What that also means is, it allows the independent sponsor to really identify the capital partner that makes the most sense for each opportunity and each situation. And so, you know, use the word the scope bespoke if you want. Luckily, I got the right on the second try there, but so it allows them to bring more of a bespoke nature to each opportunity that gives them that flexibility and differentiates them from a traditional private equity fund. Another I think area that I would want to really highlight with the independent sponsor is it’s a segment of private equity. But there is a perception out there with some sellers, that it’s, you know, big, bad private equity, right? And what does this mean for my business, and so a lot of our independent sponsors, really had the ability to play off that, and, and just, you know, many of them are entrepreneurs, many of them sold their business, and now they’re looking to acquire a business. 

    And just that ability, I think, that they demonstrate to relate to those sellers is another way that they’ve been able, I think, to differentiate themselves from more institutional, private equity. And, and it’s, it’s really something where I think the independent sponsor has also capitalized on these market dynamics, if you will, where you have the sellers, and you know, it’s it’s definitely a robust M&A environment, as you know, but there are a lot of other things that it allows the independent sponsor to come to the capital partner, and also have a situation where you can really be creative with the economics that the independent sponsor is, is receiving on each different deal. And so, you know, maybe it’s not a two and 20 structure, right. And so there are a lot of those different optionality, if you will, that the independent sponsor brings brings to the table, I’m sure we’ll, we’ll talk more about some of those things. But I think high level, those are probably some of the bigger differentiators.

    Patrick: Well, I the perception out there. And this is why it’s so important, I’m so happy to have you here in the lower middle market with with sellers that need to know about all these different options out there on alternatives is where to go. Unfortunately, a lot of organizations, they, the owners, and founders who aren’t in M&A every day, if they don’t know any better, they default to, you know, a strategic, which may not have their best interests at heart, they may default to an institution, or you know, they may be fearful of private equity, and just shut the door on that completely. And that’s, that’s not at their advantage. And so it’s very important to understand that there are these great options out there. 

    And you know, quite frankly, until I learned more about your practice, I had a notion about independent sponsors where they were the sole source of capital, and so they only targeted smaller deals, they didn’t have the, you know, the reserves. No, they tap on that, and then they can leverage that to their interest, which is also I think their interest is is aligned with with the sellers. Explain how you guys develop this practice, just from the ground up. I mean, it because, and we’ll get into this a little bit more, but I mean, this is a pretty fragmented sector.

    Jon: That’s the beauty of the sector. From my perspective, it is it is an endless ocean of opportunities for us to develop relationships, and add value to be independent sponsors. I think, as I look back on how the practice developed, you know, again, the reality is this model has been out there for a long time, back when it was, you know, a guy or gal with a deal who just, you know, was raising capital from his neighbors. And then it was called fundless sponsor, right, which I’ve really tried to push hard to get away from that one, because, you know, it does have a bit of a pejorative nature, but the reality is, it’s not true. I mean, these independent sponsors, yeah, they don’t have a $300 million fund behind them, but they’re writing meaningful checks on these deals. 

    So, you know, I think that evolution of, you know, bringing helping bring credibility to the market was something that really helped us develop the practice, but I think a few things I would point out kind of getting back to what I was talking about before. What we have the ability to do is, is really eliminate a lot of the friction in the system where, you know, independent sponsors may have the need to hire a placement agent sometimes right? For a given situation. And there may be instances where, look, what we’re trying to do is connect our capital partner relationships with our independent sponsor relationships. To be abundantly clear. We’re lawyers, we’re not bankers, we can’t get paid introductions, introductory fees, placement fees, so that friction’s gone, right, we’re just trying to put the right groups together to get deals done. 

    And so that was a really, I think, powerful message and continues to be. But of course, one of the things that independent sponsors always struggle with is dead deal risk, right? That’s part of the equation that they don’t have the ability to just have $100,000 dead deal expense and just draw down from a fund to pay it. And so, for us, it was being selective around developing relationships, that we really wanted to have 5, 10, 20 years down the road, and be creative with ways that we could truly partner with those independent sponsors. And so whether it’s discounting fees or finding other creative solutions, where it’s not okay, just write me a check. That ability, I think, to be shoulder to shoulder with the independent sponsor was was really powerful. What we did with our network was, as we found different opportunities to connect our networks, we created essentially YPO for independent sponsors, which are regional chapters of independent sponsors that get together, share best practices, and and ultimately find opportunities to connect people with deals. 

    Those chapters led to us developing our independent sponsor conference a few years ago, which in 2019, we had over 800, solely independent sponsors, and capital partners. And it was a great opportunity to get everyone together. And it was all people who wanted to be there because of who was there. Right. And, and that obviously had great benefit to us, not from a charging registration fees, but from a developing our network and our client base. And so that has really, I think, allowed us to take a leadership position in the independent sponsor community, and develop that practice, where I do think we’re regarded as the preeminent firm with independent sponsor transactions, either on the capital partner side, the independent sponsor side, and really just knowing what’s market, right. And that’s a critical component to all of these deals. We’re in the middle of our latest deal survey. 

    So we’re leveraging both our expertise, but now we’re taking that opportunity to get input from our network of what’s market on all different sorts of components of the deal. And so that’ll be coming out down the road. And then I think the last thing I would tell you about really being a true partner to the independent sponsor is, in the next few months, we’re going to be launching independentsponsorforum.com, which is our, I think, what we’re trying to do is find that next way to develop a true platform for the independent sponsors and the capital partners, that has a lot of great content, and really allows us to demonstrate, again, that leadership position within the community. And so that’s kind of, you know, starting from day one to where we are today, I think some of the, the hallmarks along the way that have really allowed us to grow the practice.

    Patrick: One of the things I really appreciate what you’re saying I’m I’m a marketing guy at heart, I really enjoy messaging and the importance of communication. But, you know, you built the practice, largely not on just the relationships, but just the trust that you’re going to execute. You’re not getting paid just to be around and do introductions, but you’re literally your interests are aligned with the independent sponsor, and you want the best for them and it’s a small community, so clearly you are doing something right, because all you have is your reputation and you deliver. And execution I think is is important, particularly for a lot of firms out there, where they may have a lot of resources, have a lot of other things to offer and make a lot of noise, but at the end of the day it’s execution. 

    And this is a class of private equity that cannot afford as you said, you know, misfires And so that I think is critically important that you’re coming in and you’re delivering that. And then just through that great reputation now, the community is expanding, and you’re not sitting back. McGuireWoods is finding more ways to add value through information and best practices so that more deals happen faster, smoother, cheaper, happier, and and that aligns a lot of specialty firms. And so it’s such a pleasure to have a firm like yours to highlight on that. Now, one thing I will say is I’m very proud of our platform here at M&A, M&A Masters Podcast. But we’re not the only podcast out there that is talking about mergers and acquisitions and everything. Jon will talk about your your show, because that’s actually how I found you, 

    Jon: Sure. No fantastic. So one of the I think ways that we’ve been trying to transition and continue to grow a lot of what we’re doing. A couple of my partners, Greg Hawver and Rebecca Brophy really are spearheading deal by deal. And so it’s a podcast that’s focused on the M&A environment, but in particular, the independent sponsor community. And so we’re really trying to, I think, highlight, a lot of best practices within the independent sponsor community, also highlight different independent sponsors and capital partners. But to your point, particularly with what’s been happening in the pandemic, having that ability to find different ways to connect with your network, they’ve done an incredible job. And it’s, it’s, it’s definitely something we’re super proud of.

    Patrick: Yeah, I consider the silver lining of the pandemic, the evolution of, you know, the the Zoom, and the podcast and the communication, because there are messages out there. And it’s just, you know, finding the right channel where there’s an area of interest. And I will tell you, there are over 1 million podcasts out there. And there wouldn’t be that many if there weren’t such a diverse amount of interest out there in need for information. And something that’s, you know, quite frankly, quite, quite easy to deliver. Jon, let’s talk about, you know, give me a kind of a profile of your ideal client with the independent sponsor. I know very similar to there are other things out there. If you’ve seen one independent sponsor, you’ve seen one independent sponsor. Is is there, you know, for others that are listening out there, give us an idea, what’s the ideal profile of a client from McGuireWoods with this practice?

    Jon: Sure. So to your point, is, is definitely spot on. So within the independent sponsor community, there’s no question that there’s no one size fits all for what the what the ideal client for us is, in the sense that a lot of our clients in the independent sponsor world spun out of blue chip, private equity firms, they have that pedigree of doing deals, and now they’re doing deals as independent sponsors, they have been, and I think, will continue to be a great client base for us. At the same time, a lot of our independent sponsor clients are entrepreneurs who founded and sold a business. And now they want to go out and do it again, maybe they’re looking at bigger deals, maybe they sold their business to private equity, and started to understand that model better. And frankly, a lot of our independent sponsor clients who’ve been wonderful, are true CEO level talent, that, you know, maybe they made a lot of money for private equity. 

    And they have a Rolodex within a market or within a segment to say, I want to go out and do a roll up in this space. And that allows them with that domain expertise to really be a powerful and successful independent sponsor, and a great client for us. I think, when I look at some of the, I think, common characteristics, I would look at the independent sponsor who really wants a different value proposition who isn’t just looking for a lawyer that can draft a document for them and, you know, get them to closing. We’re looking for the client that really wants us to be their partner. And so whether it’s to the point about helping them find capital, helping them find, build out that executive team, helping them find the right provider, I mean, frankly, for services they need in conjunction with a deal. 

    We’re doing a lot with our CPA network, as you know, and I’m sure we’ll probably get into later, the prevalence of rep and warranty insurance on basically all deal sizes is huge right now. And so, where they say okay, who are the right firms to talk to, to go out to get a policy, our ability to say, okay, we’ve seen Patrick in action on X number of deals, and he’s really the value add guy around what’s important in this policy? What’s your history? What’s the claims history with this insurance? So I guess what I would say is that ability for us to really help develop the ecosystem and find independent sponsors that value, that benefit that we can provide is always huge for us. 

    But building those long term relationships, right, it’s we want that client, that’s not just coming to us for one meal, that over the next 20 years, we’re going to do 3, 4, 10 deals with them, and develop that trust. And that relationship, that’s probably the most important thing. And then ultimately, right, just doing the right thing, just finding people who they’re going to treat people, well, in particular, these sellers, many of these sellers, right. They’re selling their baby, right? I mean, this has been, and will be their legacy. And I think finding independent sponsors that are really appreciative of that is a big part of what we look for in our network. For the clients that we want to be working with.

    Patrick: Well, there’s a couple of things you brought up there that we’re definitely going to segue into. And, one of them is, first of all, you cannot remove the human element with these transactions. You know, most people out on the street, they think M&A, they think Amazon buying Whole Foods. Company by company. This is people working with people. And you know, within that you got humans that are fallible, and there’s fear, there’s greed, there’s all these other emotions that come into these, you know, life changing in some cases, transactions. I mean, they’re they’re very, very big deals for people. And you cannot dismiss that. And so you’ve got that element where you met with reps and warranties insurance, the amount of risk, these deals do not happen in a vacuum, there is tremendous financial risk that can be out there for the seller, who is personally financially liable to their eventual buyers. 

    And when a business owner is not used to M&A, it comes a realization that it is they can’t hide behind their corporate veil, it is their personal assets, their wealth, their retirement, literally their house could be at risk. And that realization comes to them a lot of times after they’ve gone through due diligence, they’ve been trying to work with the other counterparty and work together. And all of a sudden, boom, I’m responsible for you with my wealth for something I may not have known about. And in the typical response for a real, savvy, educated, experienced buyer is, well wait a minute, I’m making, you know, 10s of millions of dollars bet that your memory is perfect. And I’m afraid I just can’t do that. And so you’ve got that conflict where you’ve got a buyer that doesn’t want to get stuck, you know, with a lemon, and the seller doesn’t want to be kept on the hook indefinitely, particularly for things they don’t know about. So you’ve got that natural tension that can devolve to being adversarial is really a danger out there. 

    And what’s been great is the insurance industry came in with an insurance policy that transfers that risk away from the deal parties over to the insurance company. And the benefit to a buyer is, hey, if you have a financial loss as a result of the breach of the reps, you have certainty of collection, and you’re not going to have to clawed back and have ill will toward your target company who is probably now partner of yours, okay, for the seller. The policy can replace 90% of an escrow. So less money from the purchase price is being set aside and goes right to the the seller’s pocket. So they get more cash at closing, even better to get the peace of mind that they’re going to keep more money because there’s not going to be the risk of a clawback and as you know, is a product that has stood the test of time and is being used, you know, quite a bit now throughout the M&A community. 

    The news that I want to share out this is that this product was reserved solely for deals that were $100 million transaction value and up, you had to have thorough diligence, you had to have, you know, audited financials, you know, do extensive third party diligence of which was very, very expensive, so it wasn’t a fit for the sub 100 million dollar deals. That’s changed, thanks to technology, thanks to competition, eligibility standards for rep and warranty insurance have never been simpler. The cost has never been lower. And the claims it’s been sustainable where the claims have not overwhelmed the industry so we can see these lower rates continuing for a very long time. And there may have been players in the M&A space that maybe thought about rep and warranty a year or two ago, and had a not so good experience. That’s not the case now. And the more people understand about that, the better. But again, you don’t have to take my word for it. Jon, good, bad or indifferent. share with me your experience with rep and warranty.

    Jon: Sure. Excellent. Give you you know, I won’t choose your word I’ll tell you mine, right. It’s been it’s been phenomenal. And I think what I would say you hit on it, but I think my biggest takeaway that what, what I appreciate, and frankly, what my clients appreciate, is, if you’re doing a $20 million enterprise value deal, you can get rep and warranty insurance. And frankly, I’m doing one right now, that’s about 14 million. Right. And so, I think that that’s definitely something that my clients have not really understood as well as they should have. It’s not just the 50, 75, $100 million deal, you can really get a policy on a $20 million deal. That, you know, frankly, a lot of the time, as you alluded to the sellers rolling over, right, maybe they’re the CEO, whatever they are, and the idea that there’s going to be some sort of friction, right, or post closing dispute is just, it’s heart wrenching. It’s difficult in whatever word you want to choose. And having that ability to, for lack of a better phrase offload the risk, right. 

    But it’s, it’s to me, it’s less about offloading the risk. It’s offloading the friction, right? It’s, it’s having that ability to say, okay, let’s really focus on what’s best for the business going forward, let’s focus on growing the business. And if we ran into a issue with a customer, let’s not be focused on was there a breach of a rep, let’s focus on how do we make that relationship better. And so our experience with rep and warranty it with, if I look at my deals, it’s it’s probably two thirds of my deals, it’s probably maybe more, maybe less. But you know, two thirds of my deals have rep and warranty insurance. And it’s a great product. It’s it really has developed and mature, where it’s an incredible tool for all the reasons you stated, but I just can’t I can’t overstate the impact of having the ability post closing, not to have that immediate dispute, particularly when, as we all know, that first year that integration period, that can be the most difficult, challenging, time consuming. And frankly, it can it can really have a determination about how things and how relationships evolve. And again, just taking that out of the equation, to a, to a full extent, or a partial extent, is extremely helpful. 

    Patrick: Yeah, what’s real tragic, and, you know, these disagreements are all avoidable. Yeah, you know, insurance is not the magic bullet is gonna cure all ills, but just having that there lowers the temperature in the room. And then, you know, as we go on with life, I mean, there’s so much concern in M&A now about, you know, communication and culture and those types of areas that we didn’t think about 10-15 years ago. And so anything we can do to enhance the relationships, I think, is a definite net positive. Now, john, as we’re talking today, you know, we’re getting through the first half of 2021, we’re, you know, fingers crossed, we can see the end of the pandemic out there. I mean, it’s, it’s possible now, more so than before, you know, and in this, you know, circumstance, you know, what do you think, what trends do you see either for independent sponsors, specifically, or for M&A in general, for the balance of 2021? What trends do you see?

    Jon: Sure, I think that maybe I’ll think a bit of the easier one is this is a very robust M&A environment. And I don’t think anything on the horizon for the next nine months, leads me to believe that’s going to change anytime soon. There’s just so much in the way of tailwinds going on with the economy going on with the reopening trade, etc. So I think generally M&A, it would be very surprising if we didn’t have a very strong year. On the independent sponsor side. I think you’re going to continue to see a few things. One, the the attractiveness of the deal by deal model in the independent sponsor framework, I truly believe will continue to grow over the next however many months and years. And so much of that comes back to, there’s so much dry powder out there, people are desperately trying to find different opportunities to get capital to work. 

    There is undoubtedly on the capital partner side, an interest in diversifying their private equity dollar investments, right. And so maybe they’re not going into the next Apollo or BlackRock or whatever it is, and finding an opportunity to be have more discretion over where their money is going. You know, and maybe it’s understanding the be independent sponsor oftentimes brings more proprietary deals brings more attractive deals, but at the end of the day, brings deals with the capital partner can say, yeah, I want to put my money behind this one. And that’s a different construct than just putting money into a private equity fund. So I really do think you’re going to continue to see that demand side from the capital partners. And then the independent sponsor, there’s a lot of reasons of course, why the model is so attractive. And it’s going to continue to be so and I think you’re going to continue to see increased supply of independent sponsors out there. 

    And so those factors together, I think, will generate a lot more independent sponsor transaction activity. Another trend I tell you that we really see and have seen is a bit of a increased focus on what I would call hybrid structures. So there’s definitely some good things about the committed private equity fund model, there are some good things about the independent sponsor model. And a lot of our capital partner relationships and clients are looking for as well as independent sponsor relationships. And clients are looking for opportunities to bring the best of both to their structure. And so there are a lot of different hybrid structures that we’ve been working on, that both sides of the equation are very interested in. And I think that’s going to continue as we project forward. 

    The last thing I’d probably put out there around the independent sponsor community is I have seen as the proliferation of independent sponsors continues, I have seen a greater focus with our independent sponsor community on being a bit of a more of a domain expert, and focusing more of their attention on I’m not just looking for a deal in manufacturing, business services, consumer healthcare, technology, you know, I’m going to be a SaaS guy, or I’m going to be looking at opportunities where I can bring my manufacturing expertise to bear and so I do think that the generalist independent sponsor will always have value. But I also feel like we’re going to continue this see this trend of independent sponsors being more focused on certain industries, where it ultimately just I think, allows them to bring greater value to their capital partner relationships.

    Patrick: Well, I think the idea, first of all, that continuing innovation and iteration of the structures is is really encouraging because it’s not just one way or the other, let’s find a third way. And that seems to be prevalent. And I think that naturally, as you have more buyers coming into a space, you know, as with anything else, you’re going to have to differentiate yourself. And and I think that only as more value. More competition is always is always a real good thing. So great, great insights there. And we got to keep an eye out for that. Jon, how can our audience members find you and McGuireWoods, not only you know, for the McGuireWoods Dallas, but also for the upcoming conference that you’re going to be having? I believe it’s in October. And if you can restate again, the podcast.

    Jon: Sure. So the podcast is Deal by Deal. Those will be coming out on a very regular basis. Our conference will be late October, in Dallas at the Ritz Carlton again, we have some really neat improvements going on this year. For more information. Pretty simple, independentsponsorconference.com. And then also keep your eye out for independentsponsorforum.com. We’ll be rolling that out in the next couple months as well.

    Patrick: Jonathan Finger of McGuireWoods. It’s been an absolute pleasure. Thanks again for joining us today.

    Jon: You betcha. Thanks, Patrick. I appreciate you.

  • The Rise of the Independent Sponsors
    POSTED 4.27.21 M&A

    You have PE firms… you have Strategic Buyers… you have VCs…

    You have Independent Sponsors.

    These are individuals looking for a deal. They have money and experience, and they’re looking to buy a company.

    They differ from other M&A players in key ways.

    A PE firm reaches out to investors, builds up a nest egg and then, with that pool of money, buys a series of companies… They might buy at $20M, put $10M into the company and then sell for $150M to $200M – a nice return for the fund and the investors.

    They’re buying to build a portfolio for the benefit of their investors.

    But Independent Sponsors often don’t worry as much about portfolios or building a fund…

    In fact, they used to be called Fund-less Sponsors.

    A common perception in the M&A world is that anyone without a fund behind them doesn’t have the money to do deals.

    But Independent Sponsors do, although they are often not the sole source of capital…

    They find a target, put it through their vetting process, and then they go to PE firms or other sources of money as potential investors.

    The Independent Sponsor’s point is that a PE firm has cash it needs to put to work – why not with me? The Independent Sponsor has done the legwork and found a viable target.

    Typically, PE firms and other investors struggle to find good deals in today’s environment. They cold call owners/founders, go through their referral network, or work with investment banks to find targets. It’s not a terribly efficient system.

    Simply put: Independent Sponsors find deals but might need capital. PE firms and other investors have capital and are looking for deals.

    So it’s a win-win.

    Jon Finger, a partner with McGuireWoods whose practice focuses on private equity and corporate transactional matters, is a big believer in Independent Sponsors. As he puts it, we learned that going to trade shows, calling on companies, and the like is very time consuming. The lightbulb moment for us was that the Independent Sponsor in our network can be doing a lot of that spadework if you will, for us and our network. So if we spent more time nurturing our Independent Sponsor relationships, and really finding opportunities that they had, which we could then introduce to our capital partner network, it really made what we were doing much more efficient.”

    The match made in heaven with Independent Sponsors is made even more powerful when you consider the potential advantages Independent Sponsors may have with target companies.

    • Independent Sponsors can have more flexibility to take their time in harvesting opportunities and closing deals.
    • This extra time, says Finger, “allows the Independent Sponsor to really identify the capital partner that makes the most sense for each opportunity and each situation.”
    • An Independent Sponsor may be able to effect a more personal approach that target companies find appealing. The Independent Sponsor is often a former CEO in the industry. There is a rapport… relationship building… a spirit of collaboration.
    • Independent Sponsors may have a variety of structures that other investors may not have access to by virtue of requisite investment criteria or regulations that constrain how they are able to invest.

    Who Are Independent Sponsors?

    Independent Sponsors are so diverse… coming from many different backgrounds and points of view.

    Often, they are former CEOs or top executives. They know the industry they are investing in. They have contacts… they know the landscape. That makes them ideal “judges of characters” for what targets to invest in.

    Finger works extensively with Independent Sponsors. He explains what makes them so effective:

    “A lot of our clients in the Independent Sponsor world spun out of blue chip, private equity firms. They have that pedigree of doing deals, and now they’re doing deals as Independent Sponsors.

     “[Many] are entrepreneurs who founded and sold a business. And now they want to go out and do it again. And frankly, a lot of our Independent Sponsor clients are true CEO level talent, that may have made a lot of money for investors in the past. And they have a Rolodex within a market or within a segment to say, I want to go out and do a roll up in this space. And that allows them, with that domain expertise, to really be a powerful and successful Independent Sponsor.”

    The Drawbacks to Being an Independent Sponsor

    Independent Sponsors face a serious issue. They cannot afford to have a deal go south. If they spend $100,000 on due diligence and other expenses, they are out that money if there is no sale… because negotiations fell apart, for example.

    A PE firm with a $150M fund can more easily pursue deals that don’t pan out. They can bat .700 or .800. But an Independent Sponsor must bat 1.000.

    There is a way Independent Sponsors can mitigate that risk.

    Representations and Warranty (R&W) insurance can actually reduce the friction in the negotiations of Reps. This specialized type of insurance covers any financial loss from a breach in Reps. That gives peace of mind to the Buyer. And the policy can replace 90% of an escrow. So less money from the purchase price is being set aside and goes right to the Seller’s pocket. Good to get more cash at closing, even better to get the peace of mind

    Another benefit is that the post-closing integration process is more successful because there is no mistrust and animosity in the leadership of the acquired company. They feel they were treated fairly in the deal, and they have cash on hand.

    Both parties can move forward together, which is key to a successful and profitable acquisition.

    R&W coverage helps close deals and integrate the companies.

    These days it’s more widely available than ever, even for sub-$20M deals.

    And thanks to competition, eligibility standards for R&W insurance have never been simpler. The cost has never been lower. And the claims have not overwhelmed the industry, so we can see these lower rates continuing for a very long time.

    As a broker specializing in Representations & Warranty insurance, I’d be glad to discuss the benefits of coverage for your specific deal. Please contact me, Patrick Stroth, at pstroth@rubiconins.com.