The Independent Sponsor Model: The 101 Guide (2022)

The independent sponsor model is not new, but its popularity has really risen in the last five years. Still, for many the basics of the model remain a mystery. This article seeks to demystify the core components. We spoke to a number of independent sponsors and their advisors to lay out some of the core structures and challenges.

What is An Independent Sponsor?

For context, an independent sponsor [editor’s note: the older and more pejorative term was “fundless sponsor”] is a person or firm that acquires companies and raises funds for the deals on a deal-by-deal basis instead of a pool of committed capital. Unlike a search fund, where an individual seeks a single company to buy and then lead, an independent sponsor does multiple deals.

Behind the Trend

When people talk about the reasons behind the rise of independent sponsors, there are several reasons people usually reference for the rise in the independent sponsor model: 1) the desire by investors to avoid management fees on uncommitted capital; 2) the desire by investors to have investment discretion on each deal and custom fees/economics on each deal; 3) the desire by dealmakers to avoid the setup and management headaches of committed capital funds; 4) the desire to break out of restrictive time horizons set by 10-year fund vehicles. The rise of the model is also tied to an increasing number of business operators moving into the buyout game, enabled by new efficiencies around finding and deploying capital.

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Fee Structures

Independent sponsors make money in three main ways, but there is a huge amount of variation when it comes to the details.

  1. Transaction Fees: When a deal closes, the independent sponsor often collects a fee from the capital providers coming into the deal. This is frequently 1% to 3% of the enterprise value (EV) of the acquired company, but sometimes this is done as a flat fee or a percentage of invested capital rather than EV. Furthermore, sometimes this fee is required, by the capital partners, to be rolled in as equity into the investment vehicle (the acquiring entity).
  2. Management Fees: It is common for independent sponsors to receive ongoing management fees for overseeing the acquired company. This typically ranges from 3% to 6% of EBITDA, but variations include flat fees or even salary/bonus structures. These fees are negotiated with the capital providers and depend on how actively involved in the business the independent sponsor will be. There can also be annual floors and caps to these fees.
  3. Equity Promote (Carry): This last component can range from single-digit percentages up to 50%. “Tiered structures are also common,” said Drew Brantley of Georgia-based Frisch Capital Partners. Frisch is a 22-year old firm which helps independent sponsors raise money from debt and equity partners. As Brantley explained, with a tiered structure, the upside to the independent sponsor increases as hurdles are met, for example the initial return of capital or reaching 8%-10% IRR. Jon Finger, partner at law firm McGuire Woods, which has an entire practice dedicated to independent sponsors and advised on over 50 independent sponsor deals in the last two years, sees similar structures. “A lot of independent sponsors favor the simplicity of non-hurdle-based carry, after return of capital, but many of our deals utilize a tiered structure,” Finger said. However, in a recent McGuire Woods survey of 225 independent sponsor transactions, 34% of those deals had a 20% to 30% carry structure without any performance hurdles.

All three fee components are widely negotiated and often depend on the experience level of the independent sponsor, the capital partner involved, and the attractiveness of the deal.

Brantley noted, “There is no such thing as ‘market’ for fee structures. When capital providers are thinking about these three levers, they are asking themselves, ‘Are we going to be able to get the returns we need, and how can we cut the sponsor in on the economics?’ How good is the deal, what is the track record of this sponsor, and what value is the sponsor bringing to the table on this specific deal?”

Where Does the Capital Come From?

Independent sponsors turn to a wide range of capital sources, including committed capital PE funds, wealthy individuals, family offices, fund of fund investors, insurance companies, endowments, lenders, and hybrid equity/debt investors.

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There are no hard and fast rules as to how much of their own capital an independent sponsor is expected to put up. It depends on the resources of the sponsor. Massachusetts-based Carwik Capital is a recently formed independent sponsor started by two former operators of chemical and metal manufacturing companies, Mike Slowik and Michael Carpenter. They are planning to put their own capital to work, complemented mostly by debt rather than equity partners.

Private equity firms have long been interested in investing with independent sponsors because of the prospect of getting into an under-the-radar, and thus less competitive, deal. A more recent trend has been the rise of interest from family offices to work with independent sponsors, and vice versa. With deep pockets and flexible time horizons, family offices can be a great fit. However, family offices are not without complications. They can be slow to make decisions. Furthermore, when the family office is run by a professional manager, rather than the original wealth generator, the independent sponsor can find themselves needing to cut or even split their fees, because the manager needs to layer their own compensation economics on top.

Raising capital is tricky. Brantley said, “Many independent sponsors underestimate the capital raise side of this business, and often confuse interest in seeing your deal with certainty of close.” It takes a lot of effort to involve many potential partners, but as Brantley notes, “If you only show it to 1 or 2 people who are ‘interested’ and they walk away, your deal can fall apart. Most people have a war story where a deal fell apart because the capital fell through.”

Jon Finger added, “Just because you have a deal under LOI at what you think is a good price, that does not mean it is fundable. Of deals that reach an exclusive LOI, in our experience recently, two-thirds to three-quarters are actually getting closed, which is indicative of the market we’re in and how aggressive capital is being deployed.”

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“Of deals that reach an exclusive LOI, in our experience recently, two-thirds to three-quarters are actually getting closed”

Firms like Frisch have emerged to help sponsors position and market their deal to capital partners, gather competitive proposals from equity and debt investors, and assist with structural terms. There are also specialty events, such as the annual Independent Sponsor conference run by McGuire Woods, and both Axial and McGuire Woods run smaller more regional events.

Who Is Becoming an Independent Sponsor?

While former PE investors and investment bankers can successfully become independent sponsors, ex-operators have a distinct advantage. “When you are an operating executive who knows a space, that’s extremely valuable,” said Finger. “Domain expertise makes your leverage in negotiations with both the seller and capital providers much stronger.”

Michael Carpenter of Carwik also noted, “Operational experience really helps with due diligence, as well as convincing a bank to work with you. And it is a requirement for SBA loans.” However, Finger noted that experience with M&A and financing transactions is also really important, especially when it comes to gaining the confidence of capital partners.

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The other consideration is whether you start an independent sponsor firm as a solo founder or with a team. When Slowik decided to form Carwik, he looked to bring on a trusted, complementary partner. “I thought about doing this individually,” he said, “but felt that doing it with a peer would be invaluable. Together, we could give each other emotional support and work together building our portfolio companies. It would be more fun and we would have more success.”

Big Challenges

Every time we talk to a new private equity team, whether they have a committed fund or are funding on a deal-by-deal basis, we hear a common refrain: the hardest part of this game is deal flow. Many overestimate the strength and reach of their personal networks, and underestimate the amount of work it takes to expand their reach and coverage (hint: Axial can help). For buyers who intend to stay disciplined, this is particularly relevant in today’s competitive environment. You have to look at more deals simply because you’ll get outbid on many interesting ones.

Another tricky part of being an independent sponsor is managing the time frames around closing a deal. Brantley noted, “Time frames and deal terms become hurdles, and you need to plan ahead. Strategics and committed funds can move very fast, but unless you have 100% of your capital lined up prior to LOI, you will need additional time to get to close. We always recommend at least a 90-day exclusivity period, with an automatic extension. We also caution independent sponsors against getting too specific, especially around deadlines, in the LOI, because capital partners might have their own due diligence questions.”

There is another challenge related to the other two: the negative bias bankers have against independent sponsors. Let’s be honest — this bias is not totally without cause. Bankers obsess over certainty of close. Independent sponsors often require longer time frames for diligence and negotiation and there is always risk that their capital falls through. However, the reality is that both strategics and committed funds stall during due diligence or pull out of deals all the time. With the rise of highly credible independent sponsors, both in terms of capital connections and deal proficiency, as well as exceptional operational backgrounds, this negative bias among advisors and brokers has softened. We expect that to continue improving.

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FAQs

What is the independent sponsor model? ›

The Independent Sponsor Model represents the evolution of the traditional private equity model, whereby talented private equity sponsors aim to identify, acquire, grow and exit a business for a profit, while avoiding some of the traditional private equity pitfalls and barriers to entry.

How do independent sponsors get paid? ›

The fee paid to the independent sponsor upon completion of a transaction generally ranges between 2% and 5% of the purchase price. Capital partners often expect a significant amount of the transaction fee to be reinvested into the deal.

How does an independent sponsor work? ›

“Independent sponsor” is an expansive and evolving category that may be understood to cover any transaction in which a sponsor first sources, diligences, and negotiates the recapitalization or buyout of an acquisition target and then subsequently seeks financing partners to close the transaction.

How much equity do independent sponsors get? ›

Carried interest

Above 8%, the independent sponsors will receive 100% of the proceeds until their total share of the proceeds equals 10%. After that, any additional profit will be split 90% for LPs-10% for the independent sponsor.

What is the difference between a sponsor and investor? ›

A sponsor is the person or team that champions all aspects of a commercial real estate project on behalf of the equity investors. The sponsor is often referred to as the General Partner (GP), whereas the rest of the investors are Limited Partners (LPs).

Who is a sponsor of a private equity fund? ›

Typically, the manager or general partner of a private equity or venture capital investment fund. The sponsor is typically run by one or more private equity or venture capital investment professionals who are responsible for: Forming the investment fund (typically a limited partnership or a limited liability company).

What is a sponsor fund? ›

Sponsored Fund means any Fund for which Adviser acts as the investment adviser, investment manager or in a similar capacity (other than a Fund for which Adviser acts solely as a sub-adviser or portfolio consultant or in a similar capacity).

What is a promote structure? ›

A waterfall and promote structure, also known as a waterfall model, is a method for distributing the profits from a real estate investment in an uneven way.

What is a sponsor in a loan? ›

Sponsor loan. A sponsor loan allows a parent or other creditworthy person to borrow on behalf of a student and take full responsibility for the loan.

What is a Fundless sponsor? ›

A fundless sponsor is a group or individual seeking to identify acquisition candidates and negotiate acquisitions without having the equity financing required to complete the transaction upfront (hence, they are 'fundless').

What is sponsor equity? ›

Sponsor Equity means the Capital Stock of Holdings purchased by Sponsor on or prior to the Closing Date in an aggregate Cash amount equal to not less than 26% of the Purchase Price (as defined in the Stock Purchase Agreement).

What is private equity model? ›

Private equity, in a nutshell, is the investment of equity capital in private companies. In a typical private equity deal, an investor buys a stake in a private company with the hope of ultimately realising an increase in the value of that stake.

Who are the sponsors in mutual funds? ›

The Fund Sponsor

SEBI regulations say that a fund sponsor is any person or any entity that can set up a Mutual Fund to earn money by fund management. This fund management is done through an associate company which manages the investment of the fund. A sponsor can be seen as the promoter of the associate company.

What is a hurdle rate in finance? ›

A hurdle rate is the minimum rate of return required on a project or investment. Hurdle rates give companies insight into whether they should pursue a specific project. Riskier projects generally have a higher hurdle rate, while those with lower rates come with lower risk.

What does a search fund do? ›

A search fund is an investment vehicle formed by individuals who deploy privately raised capital to search for, acquire, and actively lead privately held companies for the medium term.

What do sponsors get in return? ›

By sponsoring events, companies enjoy a set of perks that typically include the following: Increased brand exposure through the event itself, event advertising, and media coverage. In-event speaking opportunities that help boost their brand equity. Direct contact with an audience full of relatively warm leads.

What is the role of a project sponsor? ›

A project sponsor is a senior management role that provides resources, support, and leadership to the project team and generally “owns” the project. This person also serves as a link between the project manager and other decision-making groups.

How is equity sponsor calculated? ›

We'll first calculate the approximate sponsor equity contribution using the formula below: Sponsor Equity Contribution = Common Equity Value @ Exit / (1 + Minimum Deal IRR) ^ LBO Holding Period.

How much does a GP invest in a fund? ›

Large GP commitments.

LPs typically expect GPs to contribute 1-5% of the fund's total size using their own money. If the GPs are raising a large fund, they may not have that kind of cash to pay their commitment up front.

What is private equity model? ›

Private equity, in a nutshell, is the investment of equity capital in private companies. In a typical private equity deal, an investor buys a stake in a private company with the hope of ultimately realising an increase in the value of that stake.

Who are the sponsors in mutual funds? ›

The Fund Sponsor

SEBI regulations say that a fund sponsor is any person or any entity that can set up a Mutual Fund to earn money by fund management. This fund management is done through an associate company which manages the investment of the fund. A sponsor can be seen as the promoter of the associate company.

What is a financial sponsor in M&A? ›

A financial sponsor is a private-equity investment firm, particularly a private equity firm that engages in leveraged buyout transactions.

What is a sponsor in a loan? ›

Sponsor loan. A sponsor loan allows a parent or other creditworthy person to borrow on behalf of a student and take full responsibility for the loan.

What are the three types of private equity funds? ›

There are three key types of private equity strategies: venture capital, growth equity, and buyouts.

What is the difference between equity and private equity? ›

To go back to first principles, equity is a stake of a company's value. Public equity is a share in a company that is publicly traded on a stock exchange. Private equity is a stake in any company that is not publicly traded.

What is private equity in simple terms? ›

Private equity describes investment partnerships that buy and manage companies before selling them. Private equity firms operate these investment funds on behalf of institutional and accredited investors.

What do sponsors get in return? ›

By sponsoring events, companies enjoy a set of perks that typically include the following: Increased brand exposure through the event itself, event advertising, and media coverage. In-event speaking opportunities that help boost their brand equity. Direct contact with an audience full of relatively warm leads.

What is a difference between sponsor and trust? ›

It falls upon the Trustee to do this job. Let us understand the role of trustee in a mutual fund by understand their rights and obligations. There is a difference between sponsor and trustee in mutual fund. The sponsor is the capital provider while the trustee is the internal regulator of the fund.

How do financial sponsors make money? ›

Essentially, FSG is an “industry group” for firms that raise capital from outside investors or the government/retirement system, invest in companies and assets, and split the profits with those outside investors.

How is equity sponsor calculated? ›

We'll first calculate the approximate sponsor equity contribution using the formula below: Sponsor Equity Contribution = Common Equity Value @ Exit / (1 + Minimum Deal IRR) ^ LBO Holding Period.

How do I become a financial sponsor? ›

To become a financial sponsor, you must file an I-864, or an Affidavit of Support. In this affidavit, you promise to support the non-citizen once the non-citizen enters the U.S. To be a financial sponsor, you must: Be a U.S. citizen or lawful permanent resident.

What are sponsor clients? ›

Sponsor Client means any (i) investment fund, partnership (including the Sponsor(s)), limited liability company, SPV, corporation or similar investment vehicle, (ii) client or the assets or investments for the account of any client, and/or (iii) separate account, for which, in each case, the general partner(s) of any ...

What is sponsor support? ›

A sponsor is an alcoholic who has made some progress in the recovery program shares that experience on a continuous, individual basis with another alcoholic who is attempting to attain or maintain sobriety through A.A.

Who is sponsor and applicant? ›

4- Sponsor and Applicant: who is who

When talking about sponsorship application, the “sponsor” is the Canadian citizen or permanent resident that wants to bring their spouse or common-law partner into Canada. And the “Applicant” is the one that is applying to come to Canada and live here as a permanent resident.

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