Key Points:
- Raising capital is one of the most consistent challenges for an independent sponsor (fundless sponsor).
- Sponsors rely on building a deep network of industry talent and capital providers to broker successful deals.
- New independent sponsor investing sites like CapitalPad offer a convenient source of capital to close a funding gap. (funding details below)
From my perch working in finance and writing about entrepreneurship and private business investing, I’ve seen a trend gradually emerging in the private equity universe.
We’ve seen pronounced growth in the independent sponsor segment of private equity. It’s an evolving landscape that’s enticing more and more private equity associates to test the waters, especially after they’ve gained some experience and developed a robust personal network.
Not a ton has been written about how to become an independent sponsor. It feels like a relatively young marketplace that’s still developing and evolving.
But the independent sponsor business model has a lot to offer. Sponsors gain tremendous flexibility and control over the terms and time horizons of the deals they broker. And it gives institutional investors, family offices, and high net worth individuals an alternative way to invest in private small businesses without relying on expensive private equity funds.
The Challenge of Independent Sponsor Financing
Independent sponsors (aka fundless sponsors) are a lot like traditional private equity funds without the funds. That is, they don’t have a pre-existing pool of committed capital to deploy when acquiring businesses.
Instead, the independent sponsor business model begins with the sponsor sourcing a deal. They identify an acquisition target, then leverage their network and industry connections to find an operator for the business.
Independent sponsors usually do this work on their own time and pay for expenses out of their own pocket. They aren’t supported by a fund and are often entirely self-funded during the search for acquisition targets.
That setup also means they don’t have investors lined up in advance. It’s only after they source a deal, conduct due diligence, negotiate terms, and line up operational management that they can approach investors with the opportunity.
There’s a lot riding on the fundraising stage of the deal, because the sponsor has already footed the bill for all the costs leading up to this point. Pre-deal expenses include legal fees, accounting and audit fees, travel, marketing/promotion, rent, insurance, and all the other costs of doing business.
Unfortunately, a lack of funds is a common point of failure for independent sponsors. Sponsors can struggle to raise enough capital to close a deal even after having a letter of intent (LOI) accepted. That’s especially true for less established sponsors whose network of potential investment capital partners may be more limited.
Failing to close a deal is painful and costly. It leaves the sponsor with no way to recoup the sunk costs of the upfront expenses and time they’ve already put into it.
That’s why having a strategy for raising capital as an independent sponsor is critically important. You need to have a plan—and a backup plan—before you invest the time and money putting together your deal.
How Independent Sponsors Raise Capital
Independent sponsors have historically raised capital through their own personal networks. Many independent sponsors have a background in private equity, hedge funds, investment banking, or some other financial profession. So many already have some connections to well-capitalized institutions, family offices, or high net worth individuals who could be sources of capital.
Once an independent sponsor has an accepted LOI, they can pitch the opportunity to invest in the deal to capital providers. It’s wise to have your prospective investors in mind as you negotiate the terms of the acquisition, making sure the deal affords them attractive terms.
It’s worth underscoring the importance of building and maintaining a network that includes potential capital providers. Independent sponsor financing depends on their ability to raise money for each deal without a pre-committed capital. Many sponsors have an anchor investor in mind from the start of the process, but investors won’t sign on for sure until they know the exact terms of the deal.
It’s not uncommon for a single investor to take the entire allocation to an independent sponsor deal. In other cases, the sponsor may need to raise smaller amounts from a variety of sources, including friends and family, other investors in their personal networks, or institutions looking to invest in private businesses.
New options for independent sponsor financing are emerging
The independent sponsor market has generally been quite fragmented, but that’s now changing with centralized funding platforms.
CapitalPad helps independent sponsors raise investment capital in two ways:
- CapitalPad helps provide capital to independent sponsors raising for a deal.
- CapitalPad helps investors get access to independent sponsor deals.
The platform hosts a group of accredited investors looking for opportunities. CapitalPad wraps them all into one special purpose vehicle (SPV), so sponsors can deal directly with the manager of its fund instead of interfacing with multiple small investors. And you receive one check instead of managing multiple wires and bank verifications.
It’s a simplified way to find investors, and can come in particularly handy if you find yourself with a funding gap you need to fill in order to close your deal. Simply post your deal on CapitalPad and the amount you want to raise. Doing so gives you instant access to dozens of eager investors.
For any allocation CapitalPad can’t fill up itself, it offers to introduce sponsors to much larger funds that want to allocate to independent sponsor deals. CapitalPad offers this at no charge to sponsors, only asking that its platform’s investors get priority for the allocation.
This makes CapitalPad a great, low-hassle way to fill up your allocation.
Conclusion
The independent sponsor marketplace hasn’t become as efficient as traditional private equity just yet. The structure of every deal is a little different, and there aren’t really standardized terms across all sponsors and opportunities. Meaning there’s a lot of variation in the terms and structures from one independent sponsor deal to the next.
But the independent sponsor success stories I’ve observed have a few important elements in common. The sponsors are experienced and well connected. The economics of the deals are favorable all around: for the seller, the sponsor, and the equity investors.
The biggest challenge is almost always raising enough capital.
But even this is getting easier. The independent sponsor ecosystem continues to mature, with tools like CapitalPad helping to deliver greater efficiency and investor access to this evolving marketplace.
