Today’s Independent Sponsor: Hungry and Hyper-Focused

For most deal professionals, Q4 has been high pressure. Firms are starving for quality deals as valuations continue to rise. In a Thanksgiving day article, Bloomberg’s Tara Lachapelle reported “private-equity firms are sitting on $1.32 trillion of dry powder, and about $481 billion of that is slated for buyouts, according to Preqin’s third-quarter report.”

The independent sponsor — quite possibly the hungriest type of deal professional — has a unique set of circumstances affecting the way they source, value, and execute on deals this quarter given their lack of a committed fund. We polled a subset of Axial’s 100+ independent sponsor members to find out exactly what’s on their plate.

According to a September 2015 report by Rotunda Capital, “the harder fundraising environment, coupled with investment restraints and increased reporting requirements, has led more investment professionals to complete deals on a deal-by-deal basis as independent sponsors.” Since independent sponsors traditionally do not invest out of funds and the market is extremely competitive, strong relationships with capital partners are especially important. Fifty percent of the independent sponsors we polled said that the most important factor in their success closing a deal was ready access to capital in the form of equity.

Alternatively, not a single independent sponsor cited their success stemming from strong debt relationships, likely because the debt landscape is easier to navigate this quarter given the availability of cash. Similarly, very few independent sponsors cited success due to strong intermediary relationships, leading us to believe that fewer independent firms are electing into auction processes and competitive deals.

Independent sponsors, like most deal professionals in Q4, are hyper-focused on deal sourcing. Looking forward to 2016, independent sponsors on average are looking to close two deals. In discussing their deal funnels, 50% of independent sponsors said they’ll need to source the same amount of deals as a traditional private equity firm in 2016. Another 20% said they’ll aim to source even more deals than firms with committed funds. For independent sponsors with a lean team or limited resources, this means they’ll be working overtime to get creative in their sourcing strategies and gain the coverage they need over the lower to middle market.

Of the 70% of independent sponsors who aimed to source at the same or higher rate of a traditional firm, 100% said they had some level of industry expertise that guides their investment theses. John Fruehwirth of Rotunda Capital has cited preference towards those who “can move quickly to target industry verticals where their experience and background permit them to source proprietary deals.” Independent firms with a healthy deal appetite and laser focus on industries that require extensive knowledge (such as software, leisure facilities, or building products) see dividends in deals sourced through their proprietary relationships.

Thirty-three percent of those we polled who have closed deals in the last one to two years credited strong referrals as part of their success. With an ever-present emphasis on driving company performance, those who have worked with independent sponsors often appreciate their tenacity and persistence.

Given the current market, the question is: Can traditional firms stomach another quarter of fewer deals closing? Or will we see an even greater shift to the independent sponsor model?