Why the Independent Sponsor is Emerging as an Attractive Option for Sellers, Individual Investors and Even Private Equity Funds

Business owners contemplating an eventual exit are more likely familiar with their traditional options regarding a prospective merger or sale: a sale to a partner, family member, employees, a strategic buyer, or a private equity buyout. However, they may be less familiar with a type of buyer that often presents a very compelling option: an independent sponsor.

Independent sponsors, formerly called fundless sponsors, are experienced dealmakers who often possess deep industry knowledge in finance, operations and management within their acquisition sector targets. Unlike private equity firms, these investors source, structure, and manage transactions without first assembling a pool of capital. In short, they target a specific company, create an operations and management structure to optimize its performance and then locate investors to purchase it. They earn their compensation by taking a percentage of closing costs (typically two to five percent), a management fee for ongoing operational engagement in the acquired business, and/or via carried interest in the project, earning a share of the partners’ return on investment. They sometimes invest a small portion of the purchase price or roll their fee into the transaction. This emerging trend has gained traction as a viable alternative to traditional private equity models, offering unique advantages for both buyers and sellers as well as investors.

Independent sponsors operate by leveraging their industry expertise, extensive networks, and deal sourcing capabilities to identify attractive opportunities. As noted, independent sponsors don’t fundraise and then figure out where to deploy capital; instead, they focus on tailored financing solutions on a deal-by-deal basis. Such investment latitude is particularly appealing in the lower middle market, where deal sizes can be smaller and the investor community is often more diverse. Investors in independent sponsors are generally the same parties that invest in traditional private equity funds (family offices, high net worth individuals, university endowments, etc.). More often today, even private equity firms invest in deals controlled by independent sponsors, saving PE firms time focused on executing smaller yet viable transactions. Further, individual investors often favor the independent sponsor model because it avoids management fees associated with uncommitted capital, enables investors to know and approve exactly where their money will be invested, and they are not locked into a binding commitment of several years, as most PE investment necessitates.

In a 2022 independent sponsor survey published by law firm McGuireWoods, 75 percent of independent sponsor deals occurred in the lower middle market. Further, approximately two-thirds of all the transactions surveyed had a purchase price less than six times the target company’s EBITDA (earnings before interest, taxes, depreciation, and amortization). More than 80 percent had a purchase price less than seven times EBITDA and 90 percent had a purchase price less than eight times EBITDA.

Independent sponsors have recently been active buyers across competitive sectors such as healthcare, business services and technology. Yet they are also active in less favored areas such as manufacturing. Their success can be credited to a targeted approach, deep market knowledge and a hands-on operational focus, all of which enable swift deal execution with motivated sellers and far less red tape on the way to closing. Conversely, selling to a traditional private equity fund frequently involves a lengthier and more complex process, typically requiring a seller to navigate multiple layers of decision-making within the fund structure over many months. The streamlined, more direct, efficient, and usually less costly transaction process in a sale to an independent sponsor explains their increasing prevalence, especially within the lower middle market.

For business owners contemplating a near-term sale, there are several notable benefits to selling to an independent sponsor:

• Personalized attention from a senior professional investor
• Agility in navigating the transaction process
• The buyer’s vested interest in the success of the specific acquired business; it’s not just another company within a large fund
• Better alignment of business interests and values between the buyer and the existing management team
• Post-sale peace of mind for the seller regarding business continuity

Independent sponsors are adroit; they can offer more creative deal structures as well as customize financing solutions to meet the unique needs of a business inclusive of seller financing, earn-outs, or other flexible arrangements that may be more challenging to negotiate with traditional private equity funds.

In the ever-evolving M&A landscape, the growing prevalence of independent sponsors reflects a shift towards more flexible and personalized deal structures, which can be especially appealing to lower middle market companies. The tailored approach, sector expertise, and a less arduous closing process that characterize the independent sponsor model make it a compelling alternative for sellers that is likely to continue to gain momentum and permeate many business verticals in the years ahead.

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