As secondaries get creative, an independent sponsor completes a revamp

Private equity secondaries are becoming increasingly creative as more money than ever flows into the market and LPs and GPs view such processes as a routine part of their programs.

Case in point: Argonne Capital Group, an independent sponsor that has operated on a deal-by-deal basis, just completed a liquidity process for six portfolio companies.

Restructurings for independent sponsors, as opposed to those with blind-pool funds, are rare. But the independent-sponsor market is growing, and as the primary side of the market grows, the secondary market will likely expand as well.

Atlanta-based Argonne, formed in 2003, bundled the six companies into one fund called Argonne Capital Partners I. Deutsche Bank spinout Glendower Capital led an investor group including GCM Grosvenor, Hamilton Lane and Strategic Partners in an about $530 million investment into the deal.

The group bought out investors in some of the companies, refinanced debt on five of the companies and provided growth capital for others, Argonne said in a May 21 statement. Investors in each deal had optionality to sell out of their interests in the companies or re-invest their proceeds into the new vehicle, according to Holcombe Green, head of Lazard’s secondaries advisory group, which advised Argonne on the deal.

Argonne will continue to manage the companies in Argonne Capital Partners I, the statement said.

Argonne was formed by Michael Klump, president and CEO, who previously was vice chairman of Equity Investment Group. It has completed 22 acquisitions since inception.

The six companies involved in the deal are Sunshine Restaurant Partners, the sole master licensee for IHOP in the U.S.; ACG Texas and Peak Restaurant Partners, two IHOP franchisees in Texas and seven western states, which were combined to become the largest IHOP franchisee; On the Border, a Tex-Mex casual-dining brand in the U.S.; Krystal, a quick-service hamburger chain in the Southeast; and National Fitness Partners, a national franchisee of Planet Fitness.

The new fund acquired all the equity of the IHOP assets from existing Argonne partnerships and partial equity interests in On the Border, Krystal and National Fitness Partners, the statement said.

Long vs short

The transaction changes the timing dynamic for the companies. Original investors in the six companies were family offices and high-net-worth individuals — investors with long-term hold horizons.

The new investors have the timing constraints of their traditional PE funds (usually a 10-year fund life with one or two one-year extensions), which will put more pressure on Argonne to find exits for the investments.

“We were very selective in picking our partners for this secondary vehicle [to] make sure they were like-minded [and] ultimately going to place the health and well-being of the companies above funding or timing constraints,” said Bill Weimar, managing director with Argonne.

But “these are institutional equity investors; they will have more timing parameters than the existing investors,” Weimar said. “We’re a bit excited about the sense of urgency that’ll create for us as a firm to deliver on the key initiatives we have for each company in pretty quick fashion.”

Still, Argonne does not plan to change the way it operates the companies: “We like playing the long game. We’re not making short-term decisions.”

Firms that operate on a deal-by-deal basis like Argonne generally tap a group of select investors to put up capital for each transaction. Independent sponsors can spend years investing deal by deal, building a portfolio and track record that they may eventually use to launch a blind-pool fund. This type of transaction is a way to provide the sponsor with an exit for their investments and deliver liquidity to original investors, according to a person with knowledge of the deal.

It also enables the independent sponsor to stay in control of the asset and not sell to an external buyer like a private equity firm. A PE buyer would either take over the asset completely or buy an interest that would dilute the independent sponsor’s control.

“If the independent sponsor really believes in the value of the company and thinks they can drive value for the next five or six years, there’s no reason they should sell to a PE sponsor,” Green said.

“The incoming PE sponsor could have a very different vision for the company.”

The deal gives Argonne the chance to build relationships with institutional-level investors, which could help if it decides to launch a blind-pool fund, Weimar said.

The firm also has support from its existing investors and can continue to operate on a deal-by-deal basis, he said.

Not a trend

Several sources said they don’t see a trend forming around independent sponsors accessing the secondary market. Argonne’s deal is unusual but may be simply a creative one-off process unique to the GP, sources said.

“It’s probably more about the motivations of the underlying investors, what’s happening in the underlying assets and what’s happening with the GP itself,” said a secondary buyer. “How successful are they right now? Where are their funding sources and what is the state of those relationships, and where are they moving from or to?”

Others, however, do see deal flow heating up in this niche corner of PE. “Secondary buyers are finding unique ways to deploy capital,” the person with knowledge of Argonne’s deal said.

Capital flows to independent sponsors who are also first-time managers hit an estimated $32 billion last year, up from $29.6 billion in 2016, according to Palico. Last year’s tally was out of a total of $69 billion raised for first-time managers, Palico said.

This increase is due in part to the challenge of raising a traditional first-time fund, David Lanchner, spokesman with Palico, told Buyouts in a recent interview. Fundless sponsors can be a way to give a new, promising GP a test-run before actually committing to a blind pool, he said.

Action Item: Check out Argonne’s Form ADV here: https://bit.ly/2J5sFSK