What Differentiates Successful Independent Sponsors in a Crowded Market?
As independent sponsors have taken on a greater role in the M&A market, competition for deals has grown more intense, requiring greater sophistication and the right team to ensure success.
In a recent Expert Webcast conversation, “Structuring and Executing a Deal with Independent Sponsors,” Robert Connolly joined fellow panelists Sylvie Gadant of Citrin Cooperman, Stenning Schueppert of Evolution Strategy Partners, Joe Solari of ZRG Partners, and Patrick Stroth of Liberty Company Insurance Brokers to discuss why the volume of independent sponsor deals is growing, how the most successful independent sponsors differentiate themselves, the best way to manage risk, and the “anatomy” of an independent sponsor deal in today’s market. The panel was moderated by Alex Kasdan of Expert Webcast.
Insights of relevance to both founders selling their companies and independent sponsors include:
The factors propelling the growth of independent sponsors. A recent Axial report found that independent sponsors accounted for 27% of closed deals on the Axial platform, the highest share of any buyer type over the last 12 months — compared to 20% for private equity funds. As additional capital has supported deal-by-deal investing in the lower middle market, more independent sponsors have seized the opportunities. Whereas in past years financial engineering was the main driver of value, operational expertise now plays a larger role. Independent sponsors with the right kind of operational experience, management capabilities, and the ability to assemble a strong team have benefited from meaningful tailwinds.
What drives success as an independent sponsor. The independent sponsor world has grown dramatically, which brings both more opportunity and some new challenges. One of the factors that originally created the independent sponsor opportunity was a void left by lower middle-market PE firms moving up market. As awareness grew about the opportunity this shift created, the market became more crowded, making differentiation a key component of success. Independent sponsors who leverage operational experience, specialize in a particular niche, and find a way to create economic alignment between the sponsor, capital provider, rolling sellers and other key stakeholders will realize the most success. Increasingly, independent sponsors are also teaming up as co-sponsors — pairing emerging sponsors with established ones, or combining complementary industry and financing expertise — to solve for certainty of close, exclusivity, and the learning curve inherent in first deals.
The role of human capital in driving success. Talent plays a key role throughout the deal process. From bringing in the right operators who can pressure-test the thesis, to marshalling the expertise of an operator with industry experience who can talk shop to pulling in the team members who can credibly attract capital from investors, assembling the right team is crucial. A strong team understands that it has to deliver on the promises it makes in order to get the deal done. Teams that properly set up the financial foundation and the financial reporting structure of the business before the deal closes will be best positioned to drive the business forward from day one.
How up-front risk transfer through M&A insurance helps independent sponsors win deals. The independent sponsor model has succeeded because it has increased the simplicity of deals, making it easier to get them done, and because it has been effective at mitigating risk through robust diligence, the use of sophisticated legal advisors, and making effective use of representations and warranties (R&W) insurance. This insurance product transfers financial risk away from the deal parties to an insurance company, facilitates smoother negotiations, and actually delivers on paying out if there is a loss.
The anatomy of an independent sponsor deal in today’s market. The process typically begins with an indication of interest (IOI), which evolves into a letter of intent (LOI), though in the lower middle market, sponsors often move directly to the LOI. At this point, the sponsor is going down two parallel paths: First, the sponsor engages in the pre-diligence and financial due diligence process. Once the sponsor is comfortable moving forward, legal due diligence and documentation begins, as with any other M&A deal. On the second track, the sponsor begins the process of speaking with capital providers and lenders to set up the financing, making disciplined use of non-disclosure and non-circumvention agreements to protect the sponsor’s position in the deal.
Before the LOI is signed, the most successful sponsors line up potential capital providers, and they resist exclusivity milestones (such as a 30-day capital identification deadline) that shorten runway and shift leverage away from the sponsor. Once a capital provider has been selected, the sponsor negotiates the term sheet that will set forth the economics and governance throughout the deal. Locking these terms down at the term sheet stage is critical, as leverage shifts to the capital provider once the parties move to definitive documents.
Then comes the closing and the post closing, when the sponsor’s hard work to transform the business and create new value truly begins.
To watch the full conversation, click here. Questions about taking the plunge as an independent sponsor? Reach out to Robert Connolly or another member of LP’s Independent Sponsor team, or explore LP’s Independent Sponsor Series interviews for deeper conversations with sponsors and capital providers across the market.