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Broken-deal and other fees: How PE, families work with independent sponsors

  • Independent sponsor fees vary across managers
  • Firms say fees depend on independent sponsor’s skill set
  • Family offices usually won’t pay broken-deal fees

When family offices and private equity firms work with independent sponsors, one question that arises is who pays broken-deal fees.

The answer seems to be — not family offices, according to a panel discussion at Buyouts Insider’s Family Office Connect conference in New York on May 21.

While FOs are not likely to pay dead-deal fees, PE firms are, said David Acharya, partner at AGI Partners.

“If you go to a family office, there’s virtually zero chance of them covering dead-deal costs. If you go to a pure-play private equity fund, it’s the other way around: They’re more than happy to cover dead-deal costs,” Acharya said.

There are contributing factors, of course. Equity and mezzanine shops generally will agree to pay broken-deal costs, depending on how much they like the deal and how interested they are in maintaining a relationship with the independent sponsor, Acharya said.

“It comes down to which capital partner you go to. … If broken-deal costs keep you up at night, going to a pure-play private equity fund is probably your best choice,” he said.

Broken-deal costs were part of a broader discussion about terms like fees that independent sponsors charge investors on deals.

Independent sponsors generally are managers that invest without traditional, commingled, blind-pool funds. Such managers work in a variety of ways, including sourcing deals and then reaching out to investors for funding.

These sponsors vary in what they charge investors. In some cases they may charge a traditional management fee of 2 percent and performance fee of 20 percent of profits. In other cases fees are lower, or fees are only for ongoing monitoring of the investments and deal-related charges.

A continuous, active role in a portfolio company warrants an annual management fee, said Noah Kroloff, managing director at independent sponsor Black Granite Capital.

The firm structures carried interest in various ways, including tiered carry, Kroloff said. Tiered carried interest ramps up depending on performance.

“We try to customize … depending on which group we’re talking to … to be flexible and find something that works with capital partners we’re working with,” Kroloff said.

Firms that fund deals with independent sponsors tend to view fees as dependent on the level of the sponsor’s expertise and participation in the portfolio company.

Bob Levine, managing partner at L2 Capital Partners, which works with independent sponsors on deals, said a sponsor who proposes a deal with L2 will be sharing fees.

“Bringing a deal is worth something. Beyond that, it’s a blank slate as to what it’s worth and how fees are shared,” he said. Other factors include the sponsor’s skillsets and whether they bring industry expertise relevant to the specific deal, the strength of the firm’s relationship with the sponsor and whether the deal was truly proprietary or one that was orchestrated by a banker.

Brad Batten, a partner with Zwick Partners, agreed that fee sharing depends on the sponsor’s involvement in the deal, pre- and post-close. “The more value-add you bring pre- and post-close, the more willing we are to pay fees,” Batten said.

Action Item: Read more about the conference here: https://bit.ly/2JTcQyF