The Pros and Cons of Selling Your Business to Independent Sponsors

How independent sponsors are changing business sales

The rise of independent sponsors or “fundless sponsors” is one Sellers must pay attention to as the market continues to become more competitive for quality assets compared to prior years. An independent sponsor is generally an individual or group that does not have a committed investment fund (different from private equity firms); however, they have close-knit relationships with potential Limited Partners to provide capital once an asset is found. Independent sponsors can range from search funds (looking for one business to run day-to-day operations) or operate as a firm that acquires multiple businesses (Example: CMG Companies located in Houston, Texas). Additionally, independent sponsors can partner with both family offices and private equity firms (both of which maintain committed capital) to support their equity commitments to potential transactions.

Independent sponsors usually have a background as a C-Suite Executive in an industry or have worked in private equity or investment banking. By leveraging their industry experience and established relationships, independent sponsors are well-positioned to identify target companies where they can drive value creation. This expertise not only benefits investors but can also lead to positive outcomes for all stakeholders, including the employees of the company.

As a Seller, there are a couple of advantages to partnering with an independent sponsor:

• Experience: Generally, an independent sponsor will have previous experience in an industry, allowing for potentially greater growth in the company as the sponsor leverages relationships to attract both customers and quality terms with vendors.
• Flexibility in Deal Structure: An independent sponsor is able to structure deals that combine rollover equity, equity, and financing, similar to funds with committed capital. Additionally, an independent sponsor can include seller notes, earnouts, and other alternative arrangements leading to independent sponsors generally being more flexible than traditional private equity funds.
• Incentive Alignment: An independent sponsor may ask for the Seller to stay involved in the business. With that said, an independent sponsor is usually involved in the operations of the business they acquire as compared to other acquirers who will take a board seat and be involved in operations at a high level. The reason for this is that the independent sponsor is usually required to spend a certain amount of time with the company but also wants to work alongside sellers for future growth planning.

There are also a couple of items to consider when considering partnering with an independent sponsor:

• Funding Concerns: As referenced above, independent sponsors do not have a committed fund. Due to needing to secure capital, the process of closing can be delayed based on the number of funding sources and amount of capital needed. Additionally, there is always a risk that an independent sponsor does not receive funding from prospective equity sources leading to the failing of a transaction after a considerable amount of time and money spent on the process.
• Timing of Closing: Due to the independent sponsor not maintaining committed capital, the objective of a seller is to complete diligence and close timely. An independent sponsor may not be able to close as quickly as Private Equity as the funding of costs come out of the Independent Sponsors own pockets and there may be incentive to preserve personal capital. This is different from private equity in that private equity uses committed capital at the start of a process and pays for diligence throughout the process, leading to a deal being closed.
• Timing of Exit: If a Seller is looking to retire or exit the business altogether following a transaction, an independent sponsor may not be right for you. Similar to private equity, an independent sponsor may ask or require a Seller to roll equity into the newly formed entity and work alongside the buyer to help transform the Company for future growth.

Comparing independent sponsors and private equity firms

While taking into account the above, Sellers must also realize that there are advantages to partnering with private equity firms that are separate from the pros and cons related to the independent sponsors. Private equity firms are funded and while this leads to a stronger potential for closing a transaction, there is less flexibility available for private equity firms as they are focused on the greatest returns for their limited partners. Additionally, there is potential a Seller is going to be an add-on for a private equity firm meaning they will be integrated into a larger company and creating synergies that can benefit Sellers if they maintain equity in the business.

If you are to negotiate with independent sponsors, you should be aware of the items that impact negotiations including the following:

• Understand the Sponsor’s Incentives: Independent sponsors usually retain 5 – 20% of equity and also receive a carried interest (similar to that of General Partners (GPs) in Private Equity Funds) that will be received after achieving certain return hurdles. This is important to be aware of as the sponsor may focus more on performance-based incentives rather than upfront capital rewards (such as large management fees) as an independent sponsor generally puts more capital into the business.
• Discuss Indemnities and Risk Allocation: As Reps and Warranties Insurance becomes more prevalent to transactions, the Seller should negotiate regarding who will bear the cost of insurance and any other negotiated indemnities such as an environmental escrow. Sponsors do not want to incur significant fees during diligence due to limited funding and may have flexibility in this area.
• Build Trust and Set Realistic Expectations: Sellers should aim to build a relationship with the independent sponsor as this will assist with formulating a path for growth, facilitate smoother negotiations, and ultimately help set reasonable value expectations. An independent sponsor will avoid any risky or overly complex deals and creating trust will help ease any uncertainty from the buyer.

Conclusion

The bottom line is that Sellers can benefit from the increase in number of independent sponsors as this can broaden the pool of prospective buyers and ultimately result in greater likelihood of a successful transaction. The certainty of closing is highest with private equity firms and strategics but can increase to the same likelihood for independent sponsors that have closed multiple transactions and have a group of investors who are supportive and have helped them fund more than one transaction. As dry powder continues to be deployed and quality assets continue to be purchased, the valuations can only increase and flexibility for Sellers will increase.

Keiter’s Transaction Advisory Services, team is highly experienced and provides thoughtful advice for Sellers considering a transaction, including important steps to take before executing a Letter of Intent (LOI). Contact your Keiter Opportunity Advisor or Email | Call: 804.747.0000