Independent Sponsor Update: Key Takeaways from Q2

Levenfeld Pearlstein’s Independent Sponsor team provides comprehensive legal services to independent sponsors and their capital providers, delivering tailored, strategic legal solutions to drive successful outcomes. Our multi-disciplinary team has extensive experience in structuring, negotiating and executing all aspects of independent sponsor transactions and beyond. We collaboratively work across multiple practice areas to ensure that our sponsor clients have access to well-rounded, high-caliber legal advice at every stage of their transactions and throughout their portfolio.
 
The second quarter was another busy one for us: In addition to deal work and portfolio company matters, our team attended conferences and continued to meet with various capital providers, independent sponsors, placement agents, and service providers to keep on top of current trends and developments in the market. The following is a summary of our key takeaways and insights from the past quarter.

KEY AMENDMENTS TO QSBS UNDER OBBBA

We continue to see increasing use of corporate structures to take advantage of the Qualified Small Business Stock (“QSBS”) gain exclusion under Section 1202 of the Internal Revenue Code.

A common structure is to form a C-corporation buyer entity (either a corporation or an LLC that files a “check the box” election to be taxed as a corporation), which is considered the issuer of the QSBS stock. The buyer entity acquires the equity or assets of the target. The buyer entity is owned by a holding company taxed as a partnership (LLC or limited partnership). The holding company is owned by the sponsor, capital provider, rollover seller(s), management incentive plan participants, etc.

Effective for stock issued after July 4, 2025 (the date of enactment), the One Big Beautiful Bill Act (“OBBBA”) introduces three pivotal changes to QSBS rules:

1. Tiered-Gain Exclusion: The previous “five-year cliff” for 100% gain exclusion is replaced with a more flexible, tiered system for QSBS acquired after the enactment date. This allows for partial tax benefits at earlier holding periods:
   • 50% exclusion for QSBS held for at least three years but less than four years.
   • 75% exclusion for QSBS held for at least four years but less than five years.
   • 100% exclusion for QSBS held for at least five years.
   • Note that a 28% capital gains rate, not the 20% rate (plus NIIT of 3.8%) would apply to the portion of gain that is not excluded pursuant to this provision. For a three-year QSBS holding period, the effective capital gains tax rate would equal ~15% because of this higher rate applied to the non-excluded gain portion.
   • This tiered approach provides an opportunity for founders and investors who desire to hold QSBS on a shorter time horizon, offering substantial tax savings even with earlier liquidity events.
     
2. Increased Per-Issuer Gain Exclusion Cap: The per-issuer gain exclusion cap is raised from $10 million to $15 million. This increased cap will also be adjusted for inflation starting in 2027. It is crucial to note that investments made in QSBS prior to the enactment date will still only benefit from the current per-issuer cap of $10 million, even if sold after the new legislation takes effect.
3. Enhanced Aggregate Gross Assets Threshold: The corporate-level aggregate gross asset threshold for qualifying as a small business is increased from $50 million to $75 million. This threshold will also be adjusted for inflation beginning in 2027.

Key QSBS Changes Under OBBBA (Prior Law vs. New Provisions)

Parameter	Prior Law (Stock acquired before July 4, 2025)	OBBBA Provisions (Stock acquired after July 4, 2025)
Holding Period for Exclusion	More than five years for 100% exclusion; 50% or 75% for earlier acquisitions	Tiered: three years (50%), four years (75%), five+ years (100%)
Per-Issuer Gain Exclusion Cap	Greater of $10 million or 10x basis (basis is generally the equity investment amount)	Greater of $15 million, adjusted for inflation from 2027, or 10x basis (basis is generally the equity investment amount)
Aggregate Gross Assets Threshold	$50 million	$75 million, adjusted for inflation from 2027
Effective Date	N/A (Applies to stock acquired on or before OBBBA enactment	Stock issued / acquired and tax years beginning on or after OBBBA enactment date

Key Implications for Independent Sponsors.

The higher $75 million asset threshold offers additional headroom for sponsors to pursue larger platforms or additional add-on acquisitions. Additionally, the tiered holding period may provide for more flexibility for sponsors pursuing roll-ups or multiple add-ons, since, under the prior requirements, each new capital contribution restarted the five-year holding period for that contribution.

As this is an area of tax law with considerable nuance, it is very important to analyze planning for QSBS viability on the front end with tax advisors and have alignment with capital providers.

DEAL FLOW AND M&A OUTLOOK

• The quarter began with tariff announcements and public market sell-offs, which quickly reversed after most new tariffs were paused.
• Uncertainty has been the biggest challenge — especially for businesses impacted by tariffs. Those companies will need to show flexibility in their supply chain and an ability to pass through price increases. Labor and supply chain stability have become major diligence focus areas.
• New tariffs have created uncertainty in sectors with exposure to imported components (e.g., manufacturing, electronics, auto parts). Sponsors are increasingly factoring in potential margin compression or supplier diversification costs.
• Cost of capital has repriced buyer return expectations downward, creating valuation gaps, but sponsors are bridging the gap with earnouts, equity rollover, and contingent consideration.
• We see independent sponsor deals becoming more competitive due to capital markets stabilizing and dry powder seeking yield. Sponsors with sector specialization or proven operating partners continue to stand out.
• Certain resilient niches — including service-based businesses, light manufacturing, and domestic supply chains — are seeing good deal flow.
• Despite some of these headwinds and uncertainty, we saw deal flow rebound in the second quarter. We have onboarded several new and established independent sponsors who currently have outstanding IOIs and LOIs for new platform acquisitions. We are also seeing more “off-market” and proprietary deals as intermediated auctions cooled slightly.

GROWTH OF DEAL-BY-DEAL MODEL

The independent sponsor model continues to evolve and become increasingly institutionalized. There are several reasons for this:

• There continues to be a dearth of exits of portfolio companies owned by private equity funds, as evidenced by the rise of continuation funds. Additionally, the fundraising environment for new funds continues to face headwinds. For LPs looking to allocate capital to lower middle market opportunities, independent sponsor-led transactions have become a great (and increasingly preferred) alternative to traditional private equity funds.
• Independent sponsors are still sourcing off-market opportunities and driving value creation in ways traditional funds can’t always match.
• There is an ever-growing ecosystem of investors that are specifically focused on independent sponsors, including funds created specifically to invest in independent sponsor deals. Notable funds include: Align Collaborate, Ocean Avenue Capital Partners, and GEM (which closed an over $450M fund for its inaugural independent sponsors fund).
• Investors have gotten comfortable with the deal-by-deal model, and it can be a more efficient way for capital to be put to work because investors can identify the opportunities that match their investment objectives and partner up with the right sponsor.
• It aligns well with the realities of lower middle market M&A landscape. When the right pieces come together for a particular deal, there can be great alignment among capital, the sponsor, the seller and the management team — which can drive tremendous value for everyone involved.
• Talent keeps migrating. Seasoned M&A professionals and operators continue to lean into the model.

KEY CONSIDERATIONS WHEN NEGOTIATING WITH CAPITAL PROVIDERS

• Make sure you have a signed NDA with a non-circumvention clause before sharing deal information with the capital provider.
• Capital providers are going to first underwrite the deal and quality of the underlying company before looking at the quality and background of the sponsor. There needs to be a good angle to the deal that is going to drive value creation. For example: Is it proprietary, is the sponsor bringing in a seasoned operator, etc.
• Sponsors should focus on the investment opportunity and be transparent with the capital provider throughout the process and holding period.
• Focus on finding the right capital partner that is a fit for the deal. Have they invested in independent sponsor transactions? How many? Get references and learn their track record.
• Focus on capital providers that understand and align with your vision for growing the business rather than looking for the best economics. It is important to develop trust and work with someone looking to be a long-term partner. There will be inevitable bumps in the road; sponsors and capital providers need to be prepared for that.
• There are several different types of capital providers and ways to put together the capital stack. It is important to find the right match based on the sponsor and deal.
• It is critical at the term sheet stage to get all of the terms in writing. You don’t want there to be surprises when getting to the definitive documentation. Watch out for capital providers that attempt to sideline your governance rights and economics.

SOME ADVICE FOR NEW INDEPENDENT SPONSORS

• Have a good angle and start with one to three sectors you know well — depth beats breadth.
• Build relationships early: capital, advisors, lenders, sellers.
• Get good legal and financial advice early. Structural mistakes can be expensive to fix later. Work with law firms, accounting firms, and other service providers that understand and regularly work with independent sponsors.
• Develop repeatable processes for diligence, marketing, and reporting. Professionalism builds trust.
• Pick the right partners, including who is the best fit culturally and can help with value creation, and who understands the independent sponsor model.
• Avoid competitive processes.
• Independent sponsors typically win deals because the seller wants to sell to, and partner with, that sponsor vs. a seller looking for the highest price. The best sponsors win deals by building great relationships with potential sellers.
• Focus on value creation from the beginning. The closing of the transaction is just the starting point. Work with management on developing the plan, so they have a sense of ownership in the process and buy-into the plan.
• Avoid getting too aggressive on the capital structure with too much leverage. Consider over-equitizing if pursuing add-ons and grow into leverage. If pursuing add-ons, it is important to work with capital providers that can provide follow-on capital.

RECAP OF INDEPENDENT SPONSOR SERIES AND M&A OUTLOOK SERIES

• As part of our recurring “Independent Sponsor Series” interviews I sat down with Ryan Sullivan of North Park Group and Paul Moffatt at Encore One:
  • Independent Sponsor Series: A Conversation with Ryan Sullivan on North Park Group’s Unique Background and Long-Term Strategy (Part One). In this part, we covered the following questions:
    • Can you share the story behind North Park Group’s founding and what motivated you to focus on acquiring and operating U.S.-based manufacturing and distribution businesses?
    • Your firm operates under a long-term hold model, aiming to retain companies for over 10 years. What led to this decision, and how does it benefit both North Park Group and the companies you acquire? 
    • It’s a very interesting and compelling structure that that you have. Can you talk about it from the investor’s perspective?
    • North Park Group emphasizes working closely with businesses to develop and execute strategic growth plans. Can you elaborate on your investment philosophy and the specific industries or deal types you target?
    • Congratulations on the recent acquisition of Arcadia GlassHouse, marking your fifth platform investment in the manufacturing and distribution sectors. What key factors contributed to this success, and how did you identify Arcadia GlassHouse as a compelling opportunity?
    • In what ways does your firm provide value to portfolio companies beyond capital, particularly given your operational focus? 
    • One of your core tenets is to retain employees post-transaction, preferring not to make management or employee changes. How do you structure partnerships with operating partners and management teams to ensure alignment and success?
    • What differentiates North Park Group from other financial sponsors in the lower middle market? 
  • Independent Sponsor Series: Ryan Sullivan of North Park Group Discusses the M&A Outlook and Offers Advice to Business Owners and Independent Sponsors (Part Two). In this part, we covered the following questions:
    • How do you see the M&A market evolving over the next 12-24 months, particularly in the manufacturing and distribution sectors? What macroeconomic factors or trends are most likely to influence deal activity in your focus areas?
    • What advice would you give to business owners considering selling their business to an independent sponsor? 
    • For most of your sellers, is it a clean break? Or do you have some of them roll and continue with the business?
    • How can business owners best prepare for an acquisition process? 
    • What advice would you give to someone considering the independent sponsor model, especially those interested in a long-term hold strategy? 
    • Are there any common mistakes you see new independent sponsors make?
    • What were the biggest challenges you faced when starting out, and how did you overcome them? 
  • Independent Sponsor Series — Capital Provider Spotlight: A Conversation with Paul Moffatt of Encore One (Part One). In this part, we covered the following questions:
    • Can you provide an overview of Encore One and its investment policy?
    • What role do independent sponsor transactions play in your overall investment strategy?
    • How does your approach differ from other capital providers investing in independent sponsor deals?
    • What are your investment criteria for deal selection?
    • When it comes to structure, economics, and control of independent sponsor deals, how do you facilitate an alignment of interest between your family office and the independent sponsor?
    • How do you typically approach economics with independent sponsors?
    • Are you firm or flexible on deal terms depending on the sponsor and opportunity?
    • How do you view and negotiate protective covenants and rights with independent sponsors?
  • Independent Sponsor Series — Capital Provider Spotlight: A Conversation with Paul Moffatt of Encore One (Part Two). In this part, we covered the following questions:
    • What is the ideal independent sponsor partner?
    • What makes an independent sponsor stand out in your selection process?
    • What would make you pass on an independent sponsor deal?
    • What is the current environment for independent sponsor transactions?
    • Have you seen shifts in deal structures, pricing, or capital availability?
    • Are you seeing increased competition among capital providers for independent sponsor-led deals?
    • What advice do you have for independent sponsors seeking family office capital?
    • How do you expect the independent sponsor model to evolve over the next five years?
• Additionally, as part of our recurring “M&A Insight Series” I sat down with David Kakareka at Balmoral Advisors and Michael Norton at Houlihan Capital:
  • M&A Insights Series — Valuation Expectations and Industry Trends: A Conversation with Dave Kakareka of Balmoral Advisors (Part 1) | LP. In this part, we covered the following questions:
    • How would you describe the current state of the middle market?
    • Are there any industries showing outsized growth or resilience?
    • Are you seeing any shifts in how buyers and sellers approach valuation expectations?
    • How is capital availability and financing conditions?
    • Are you seeing more creative financing solutions like seller notes or minority equity investments?
    • What trends are you seeing with private equity activity in the middle market?
    • Are independent sponsors playing a more significant role?
    • Can you talk about sector-specific trends?
  • M&A Insights Series — Tariff Impacts, Deal Processes, and Advice for Buyers and Sellers: A Conversation with Dave Kakareka of Balmoral Advisors (Part 2) | LP. In this part, we covered the following questions:
    • How competitive are the deal processes and buyer behaviors for middle market sale processes?
    • How are strategic and private equity teams approaching deals differently?
    • What are the biggest challenges facing the middle market?
    • How are tariffs or trade restrictions impacting deal valuations?
    • What advice would you give buyers and sellers over the next 12-18 months?
  • Valuation Trends, Buyer-Seller Dynamics, and Advice for Sell-Side Businesses: A Conversation with Michael Norton of Houlihan Capital (Part 1) | LP. In this part, we covered the following questions:
    • How would you describe the current state of the lower middle market?
    • What are some key trends you’re seeing in the market?
    • Are there any hot sectors or industries right now?
    • Are there any kinds of deals that are becoming more prevalent?
    • Where are valuations trending? What factors may be driving multiples?
  • Valuation Trends, Buyer-Seller Dynamics, and Advice for Sell-Side Businesses: A Conversation with Michael Norton of Houlihan Capital (Part 2) | LP. In this part, we covered the following questions:
    • How are deals being financed, and what is the capital availability?
    • How have buyer-seller dynamics changed in the past few years?
    • To expand on that, the independent sponsor segment has matured to a point where it’s its own asset class now. Often, lower middle market deals have an independent sponsor rather than a larger fund because of the maturation of the capital side and the nimbleness of their platforms. Years ago, investment banks were a little leery of showing deals to someone who didn’t have committed capital behind them, and I don’t think we see that as much anymore with established independent sponsors who have a track record of execution. What are your thoughts?
    • What do you see when it comes to seller motivations? Are you seeing sellers who want to partner with private equity or an independent sponsor or want to retire and not be involved with the company post-closing?
    • Are you seeing gaps in valuation?
    • What best practices can you share with potential sellers?
    • What is the market outlook?
    • What are some lessons learned for sellers?

If you would like to know more about any of the topics above or are facing questions about your transaction, please reach out to Robert E. Connolly or another member of the LP Independent Sponsor team.