A brief overview of the world of independent sponsors

An independent sponsor is someone who raises equity capital on a deal-by-deal basis. Unlike a private equity investor, they typically do not have a committed pool of capital to use for purchasing a business. Unlike a self-funded search operator, they often do not have plans to actively operate the business after acquisition and instead will leave a management team in place.

What’s the advantage of the independent sponsor model?

Most people operate as independent sponsors while they build a track record necessary to raise a fund. In a private equity fund, the deal decision making is typically delegated to the general partners. In other words, the investors into a fund may not have a say on which deals the fund invests in and likely will have a locked-in time horizon of 10 years. This means the investors need to really trust and believe in the investing prowess of the fund managers. Typically, the best way to gauge the abilities of a fund manager is to look at their past performance in other deals.

With the independent sponsor model, green investors can build a track record of well performing deals before raising committed capital in a fund model. Additionally, the independent sponsor model helps entrepreneurial investors save on fees and have a more flexible mandate. Because there is no pool of funds under management with a strict mandate, there are fewer back-office burdens and less costs associated with accounting, and compliance.

What are the responsibilities of an independent sponsor?

Independent sponsors are always responsible for sourcing and structuring deals. They are often involved in the operation and management of the investment after the acquisition as well.

What sizes of businesses are bought by independent sponsors?

Due to the fees involved, independent sponsors target larger deals than those sought after by self-funded search entrepreneurs. The common range for an independent sponsor starts at $1M of EBITDA (typically a $3M+ acquisition) and goes up to $10M+ of EBITDA. In Citrin Cooperman’s 2023 Independent Sponsor Report, 56% of independent sponsors bought a business with less than $5M of EBITDA and 36% of independent sponsors bought a business with $10M to $15M of EBITDA, with the remaining buying a business with more than $15M of EBITDA. 

In short, most independent sponsor deals are between $10M and $50M of enterprise value.

What are the economics of a deal via an independent sponsor?

Typically there are three elements of compensation for an independent sponsor: the acquisition fee, the management fee, and carried interest (or performance fees). 

The acquisition fee is paid upon closing of the deal. It serves to offset the hard and soft costs the sponsor bore when sourcing and structuring the deal, such as finders’ fees, admin costs, legal costs, and insurance costs. This fee can range from 2 to 5% of the deal size. Often times the sponsor will roll the fee into equity into a deal.

The management fee is paid for sponsors who take a management role in the investment. For businesses that have existing management teams in place, the fee may be smaller as it mainly relates to board meetings, strategic guidance, and reporting. For businesses that will require closer to full-time work from the independent sponsor, the fee may be quite significant. While the structure of the fee can vary, McGuideWoods’ 2022 Independent Sponsor Deal Survey found that over 75% of independent sponsors structure the fee based on EBITDA. The most common approach is a fee ranging from 3 to 7% of EBITDA with a floor and cap.

Carried interest is the form of compensation for the independent sponsor that is tied to the performance of the acquisition. Most sponsors earn at least 15% of carried interest and a max of around 25% of carried interest. Given that carried interest represents a share of the financial return of a deal, many investors will require a hurdle, or a minimum return profile, before a sponsor becomes eligible for their carried interest. The hurdle is often around 8%.

Who are the investors into deals brought by independent sponsors?

The typical investors for independent sponsors are quite varied. The most common ones include family offices, mezzanine funds that co-invest, high-net-worth (HNW) individuals and SBIC funds.

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.