What is an independent sponsor and why does it exist?
An independent sponsor is an individual or group which lacks committed capital in order to fund a transaction to acquire a company. Colbeck Capital Management points out that most Independent Sponsors come from 2 distinct backgrounds: (1) former private equity employees or (2) operators with deep experience in an industry. Both types of Independent Sponsors can be successful as each brings a unique skill set. The most successful Independent Sponsors are those that have good financial acumen and excel at business operations in order to be successful at raising capital and manage a growing enterprise.
The Independent Sponsor model has become more prominent since the financial crisis given the expansion of private debt funds, the concentration of funds raised and merging of investment strategies at larger PE funds, and diminishing willingness of PE funds to navigate particularly complex situations. Provided that PE funds are not as focused on servicing smaller opportunities and steer clear of complex situations, there is a market opening for independent sponsors to actively participate in buy-out opportunities such as roll-ups, divestures, carve-outs, and nontraditional businesses where the execution difficulty pre-crisis was too high.
Independent Sponsor Financing Options
According to Colbeck Capital Management, independent sponsor financing options typically fall into 3 distinct categories: (1) strategic debt solutions, (2) PE solutions, and (3) seller financings.
Strategic Debt Solutions
A strategic debt solution is usually provided by a private debt lender where the independent sponsor would find a debt solution which often carries an elevated capital cost in exchange for providing the independent sponsor more control, less equity dilution, and access to management fee/salaried income while running the acquired company.
A PE solution is financing from a traditional private equity fund. PE funds typically view an independent sponsor as an extension of their origination team. Compensation to the independent sponsor usually comes in the form of equity upside once certain return hurdles have been met. PE solutions typically provide independent sponsor less control, less equity, and reduced management fee income while the PE fund is invested in the respective company. While this financing category is not as lucrative as the strategic debt option, it does offer the advantage of better alignment of interests, access to capital where the purchase price is beyond a strategic debt solution, and traditional PE support via sourcing additional potential M&A opportunities.
Seller financing is deferred purchase price consideration, typically structured as a subordinated non-interest-bearing note that is paid out on a refinancing, business sale, or as structured payments over time. If available, seller financing may be ideal for an independent sponsor as the cost is the most economical, it reduces the upfront cash consideration needed to obtain a platform, and it provides a mechanism to ensure the seller accommodates a smooth transition from the former owner to the independent sponsor.
For most transactions, the preferred solution will likely be a combination of strategic debt and seller financing. Seller financing is very common as this form of financing yields advantages to both the independent sponsor and financing partners as rolling consideration provides an economic incentive for the seller to ensure a smooth transaction while leaving an enterprise value cushion. Better skilled independent sponsors typically look to maximize the seller financing component of a transaction in order to minimize strategic debt and limit the need for 3rd party financing. In transactions where the independent sponsor does not have significant seller financing available or is unable or unwilling to pay an elevated price, the most likely outcome for financing would be to find a PE fund solution.
Colbeck Capital Management
Colbeck has specialized in independent sponsor finance for the past 10+ years. Its founders and investment team have focused on independent or unsponsored direct lending transactions for over the past 25+ years. Unsponsored transactions are in many ways similar to independent sponsor transactions. These deals require both the buyer and the strategic debt provider to be entrepreneurial, flexible, and creative.
According to Colbeck Capital Management, independent sponsors are often short on capital but long on experience. Colbeck has a long history of backing such independent sponsors and building successful business outcomes.
Independent sponsors benefit from strategic debt solutions provided by Colbeck because they receive significant economic advantages over traditional PE such as: (1) less equity dilution, (2) more business control, and (3) the ability to own a business. Colbeck compliments these economic advantages with: (1) heavy engagement pre-closing to bridge buyer and seller needs, (2) the ability to fund additional capital for add-on acquisitions, (3) an extensive network to source new M&A opportunities, (4) the ‘halo’ provided by Colbeck’s institutional sponsorship, and (5) access to Colbeck’s relationships to assist with C-suite recruiting needs.
The most successful transactions for independent sponsors occur when they engage primary capital providers early in the process to ensure that the deal is executable from the perspective of an appropriate purchase price, proper structure, and investable legal structure. While some independent sponsors (and PE funds) prefer to wait until later in the process to engage a capital provider, Colbeck’s experience has been that this delay often yields subpar outcomes as independent sponsors (and PE funds) agree to terms and conditions which do not conform to strategic debt standards.
The independent sponsor universe is an exciting niche for strong operators that want to acquire an existing business. These sponsors have become more prevalent since the financial crisis as PE investment strategies have become more concentrated, leaving smaller and/or more complex transactions underserved by the traditional capital markets. Independent sponsors usually finance transactions via a combination of strategic debt, PE funding, and/or seller financing. Colbeck Capital Management focuses on providing strategic debt solutions to experienced business managers who are short on capital but long on experience. These transactions can be a win-win – independent sponsors receive outsized economics and control while Colbeck aligns with an excellent operating partner.
About the Author
Mr. Hokayem joined Colbeck Capital Management in 2013. Prior to joining Colbeck, he was a Director at PNC Capital Markets. While at PNC, he worked in numerous capacities as a corporate banker and portfolio manager across the corporate bank. Mr. Hokayem has also held positions in risk management, contract finance, asset-based lending, and specialty finance verticals. He has spent most of his career focused on private middle-market companies. Additionally, Mr. Hokayem has lectured at New York University’s Stern School of Business, taught at Wall Street Training, and spoken at multiple investment conferences. Mr. Hokayem holds a Master’s in Business Administration from New York University’s Stern School of Business where he graduated with the highest distinction. Mr. Hokayem holds the rank of Eagle Scout and is actively involved with mentorship programs across New York City.