Fundless Sponsors: What They Can Bring to Middle Market Transactions

No Firm Commitment

By Phil Curatilo and Beth Haas

November 19, 2007

A tightening credit market and ever–increasing deal competition is driving private equity firms to secure investment opportunities from alternative sources. In this environment, fundless sponsors have emerged as another option for middle–market, committed capital funds.

Fundless sponsors (aka independent sponsors) are groups with access to investment opportunities but without committed pools of capital. They have existed for decades under various names, working in concert with small institutions and wealthy families to identify, screen and evaluate investment opportunities. Today, fundless sponsors are increasingly appreciated for their ability to add value to an investment that goes beyond deal sourcing.

These independent sponsors generally share the same fundamental strategy: Seek out good deals and find partners to help fund them. Here are some primary fundless sponsor groups:

Operational experts: Experienced executives can offer sponsors extensive management expertise. Post–closing, their operating knowledge can take pressure off the primary sponsor and help accelerate investment success. This group is especially well–suited for transactions in which the existing CEO, or other key members of the management team, may be transitioning out of the business.

Industry experts: Individuals or groups with deep knowledge of a particular industry sector can be great partners for funds with a more generalist approach. When sourcing deals, their professional network provides an entry into companies that may not be “for sale,” and their experience can be invaluable post–close.

Other private equity groups: These include established PE groups that may be between funds or that have opted for a pledge–fund structure where backers choose to invest on a deal–by–deal basis. These groups often have a proven track record that gains credibility with private company owners, investment bankers and funding sponsors.

Buy–side intermediaries: This category refers to individuals or small intermediary groups with years of experience in sourcing proprietary deals. Instead of merely settling for a success fee, they are finding alternative ways to monetize their skills in sourcing both the initial investment as well as subsequent add–ons through equity participation in deals ultimately backed by a private equity group.

Fundless sponsors are often highly connected and armed with years of industry–specific experience and can oftentimes reduce the amount of time needed for post–closing maintenance. They also typically maintain relationships with active intermediaries who might be off the radar screen of the typical sponsor and may therefore find companies that private equity firms have overlooked or that were not broadly marketed

When working with fundless sponsors, bear in mind several key considerations. First, understand the capabilities of the fundless sponsor in question. Next, examine the equity stake and fees that the fundless sponsor seeks. Often, experienced operators request a closing fee, an equity stake in the company and potentially a share in ongoing management fees. The best fundless sponsor should be able to provide strategic counsel beyond the transaction closing that will cause your equity and theirs to appreciate in value.

Other fundless sponsors, such as buy–side intermediaries, may offer private equity firms more leeway in terms of fees and ownership, perhaps even prearranging fee structures associated with sourcing future add–on acquisitions.

In addition, the stage at which a deal is brought to the private equity firm by the fundless sponsor will also impact compensation. A signed letter of intent, or LOI, at an attractive purchase price is much preferred to an introduction to a competitive auction process where the heavy lifting is yet to be done.

Finally, understand the extent to which the fundless sponsor will reach into its own pocket to help fund the deal. Generally, a serious fundless sponsor will invest a small amount of its own capital to establish credibility with both the company and the private equity firm.

In a fluctuating economic environment, dealflow remains the name of the game. By understanding the types of fundless sponsors and how they contribute to the deal environment, private equity firms and investment banks can benefit from a little extra help.

Phil Curatilo is principal and Beth Haas is vice president at Key Principal Partners LLC.

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