Private Eye: Independent-sponsor market comes into focus with pair of recent surveys

About half of independent sponsors have no plans to raise a committed fund some day — a surprise given the widely held view that sponsors would prefer to avoid the hassle of raising money for each deal if they could.

These and other facts about the rapidly growing and evolving independent-sponsor market have emerged from a recent pair of surveys.

That 51 percent of independent sponsors say they have no plans to raise a committed fund comes from the Guide to Independent Sponsors, based on a survey of 175 independent sponsors conducted this summer by Buyouts Insider, publisher of Buyouts magazine.

Its other main findings are less of a surprise. Asked about their investment strategy (respondents could pick more than one), 89 percent said they pursue buyouts, 69 percent growth equity, 42 percent consolidations and 19 percent distressed debt/turnarounds. Just 14 percent said they invest in venture capital deals.

The world they occupy is very much the lower-middle market in North America, according to the survey. More than nine in 10 (93 percent) said they target companies with enterprise values of up to $50 million. More than half say they pursue targets with enterprise values of $51 million to $100 million, while just 1 percent said they seek larger companies with enterprise values of more than $1 billion.

The most popular industries targeted include business services (70 percent), manufacturing (63 percent), distribution (51 percent), healthcare services (49 percent) and consumer products (48 percent). Among less popular industries are software/SaaS/cloud businesses (36 percent), education (30 percent) and retail (19 percent).

A remarkable level of detail on the independent-sponsor market can also be found in the Citrin Cooperman 2018 Independent Sponsor Report, released Oct. 23.

Based on a survey of more than 200 independent sponsors, the report discusses the economic terms of independent-sponsors transaction; those terms help explain why so many are happy operating on a deal-by-deal basis. To be sure, deal economics are not standard and vary by deal according to such factors as the attractiveness of the transaction and how involved the independent sponsor plans to be in managing the company.

That said, most survey respondents (57 percent) said they charge a closing fee that’s a percentage of transaction value. “Sixty percent always roll at least part of their closing fee into equity,” the report said. “Younger firms are more likely than older firms to roll their closing fee in full into equity.”

Just under half of respondents (48 percent) said they charge portfolio companies a management fee that is a percentage of EBITDA — 4 percent or more is common — with both a floor and a cap, while another 13 percent said they charge a percentage of EBITDA with no floor and no cap. In actual dollars most respondents take in annual management fees of between $100,000 and $500,000, according to the report.

Tiered carried interests tied to performance are the rule among independent sponsors, although their structures vary widely.

More than a third (38 percent) say they can earn carried interest of 20 to 24.9 percent while more than one in 10 (11 percent) said they can earn carried interest of 25 percent or more. Most have a hurdle rate of return that has to be achieved before carry kicks in, and 8 to 9.9 percent is a typical hurdle. One respondent reported that they get 10 percent carried interest on generating a 3x return, 15 percent carry on a 5x return and 20 percent on a 10x return.

Other notable findings from the Citrin Cooperman study:

• The most popular equity contribution on closing a deal for independent sponsors is 2 to 5 percent (27 percent), followed by 6 to 10 percent (21 percent), more than 20 percent (18 percent) and less than 2 percent (18 percent).
• Just over a quarter (26 percent) of independent sponsors say they cover broken deal costs, while 16 percent say that the equity funding source covers them. In many cases the costs are shared.
• Family offices are the top capital providers on independent-sponsor deals, followed by mezzanine funds that co-invest, wealthy investors and private equity funds. Younger firms tend to rely more heavily on family offices for financing than older firms, the study found.
• More than four in 10 (41 percent) respondents said that during a typical year they consider and review more than 100 opportunities. Three-quarters pointed to boutique investment banks or business brokers as a deal source.

And why did respondents in the Citrin Cooperman study decide to become independent sponsors? Just one in five (20 percent) said they did so as a precursor to raising a committed fund (respondents could pick more than one answer). The most popular response, at 58 percent, was “flexibility the model provides.” That was followed by a “desire to sponsor deals” (51 percent); “wanted better economics” (25 percent); and “opportunity to participate” (21 percent).

Given the potential by so many firms to earn more than 20 percent carried interest, don’t expect any slowdown in the formation of independent sponsors in the months ahead.

Action Item: Download a copy of Citrin Cooperman study: https://bit.ly/2QAo5Ax