Insights

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.