Independent/fundless sponsor and Family Office surge

Little Sheep's picture
Little Sheep - Certified Professional
Rank: Gorilla | banana points 605

What is the wise WSO community's thoughts on the rise of independent/fundless sponsors as well as uptick in Family Offices? Will this play out long term and fair well against a downturn vs traditional funds?

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Comments (16)

Dec 28, 2018

Little Sheep, pure crickets, that's where I come in. Any of these useful?

  • Independent Sponsor advice I want to become an independent/fundless sponsor for a dental rollup. I'm currently on the ... LPs/Family offices to do this after I get LOIs on the offices? Thanks, WSO, this is a great community! ... a collection of offices, integrate them into a platform to then flip. Any advice on making connections with ...
  • FT Advice: PE at Family Office or IBD interviews?? Instead I worked for a v. large family office, in the PE division. The summer has been great and I have ... sponsors we have relationships with. There is also a significant amount of time spent managing the money we ... have directed in sponsor funds. Finally, I suspect I would be more in training mode for the first year, ...
  • The Truth About GE's Financial Management Program (FMP) roles which can give a relatively decent chance of moving to Wall Street are those in BD (business ... contribution to the central FMP office. International Rotations in the Financial Management Program You should ... Effectively a Back Office Role Most work is extremely mind-numbing and boring, and could be done by any high ...
  • Week 3 of IBD Internship: The Pitch were family, all comforts taken and the formalities of the office forgotten. Both members of the ... at my desk rather than wear them into the office every day. Kevin sent out an email to the entire ... I received an email on which I was CCd from the intern sponsor addressed to a managing director, vice ...
  • Week 2 of IBD Internship: Hitting the Desk offices and cubicles are. One can walk in a complete circle around the floor, each with sections of ... cubicles and offices belonging to senior bankers on the far side. Stepping into open territory felt like ... intern-issue messenger bag touting freshlings. Before long, Jeb, one of our intern sponsors, was on the scene ...
  • SunTrust Robinson Humphrey (STRH): An Extensive Review Associate, that probably goes down to 55 hours a week. This is actual office time- you obviously have to be ... comparison to other large investment banks. While STRH does have a significant NYC and SF office, it is ... start families or they are originally from the Southeast. It's the culture of the South to move at ...
  • Evercore Private Capital Advisory group foundations, and family offices seeking to utilize the secondary private equity market. Jamoldo- Hedge Fund ... advice and execution services to leading private equity sponsors and institutional investors on a variety ... of strategic transactions across the private capital spectrum including: sponsor driven private ...
  • More suggestions...

You're welcome.

Most Helpful
Jan 7, 2019
Little Sheep:

What is the wise WSO community's thoughts on the rise of independent/fundless sponsors as well as uptick in Family Offices? Will this play out long term and fair well against a downturn vs traditional funds?

Two different discussions here, but I think they both stem from a common theme. They're both really interesting and I'm glad someone brought it up - not all of us here on WSO work in midtown and follow the recruiting timeline and wear patagonia vests and deal sleds, some of us are just out in the lower middle market in a secondary/tertiary metro trying to put good deals together.

The common theme is that there is a lot of capital trying to make its way into private companies of all shapes and sizes, and there are a lot of avenues to get there. One need only to take a look at that dry powder chart that Pitchbook puts out seemingly every two weeks to see that 1) there's a lot of growth in capital directed toward private markets, and 2) it's not getting spent fast enough. As that capital builds and builds, it creates pressure - either it finds creative ways to go to work, or it just eats away at return, through higher prices, poor decision-making, or acceptance of being paid less for the same work. I think all of the above are happening. Both of your questions stem from the "creative ways to go to work" branch.

I don't know as if there is an actual uptick in family offices. I do think there's an uptick in family offices trying to get involved in more direct investing. Instead of pooling capital a few times (maybe a family houses its funds at an asset manager, which invests in a variety of asset classes and relies on a fund-of-funds to access private equity funds, who then make the direct investment), they go "fuck it, it can't be that hard, let's stop paying all the fees to the middlemen and we'll just do it ourselves" and they hire someone from the rapidly expanding pool of moderately experienced deal professionals to do some deals.

The truth is, making good investments over a long period of time is hard, and it's always going to be hard. Can some family offices skip over the long chain and hire good people to do deals? Sure they can. But not all of them will, and there's going to be some really crappy deals made by some total morons, and some family offices will get spooked, and we'll swing back away some from this rush to direct investing. I don't know if it will be back towards traditional fund-based private equity, but there will always need to be some pooling that allows capability-low capital-rich sources to partner with capability-high capital-low groups to find and make good deals.

Some of that need to pool capital is absolutely related to the rise of independent & fundless sponsors. I'll also toss in search funds, since I think of them as a special species of independent sponsors. These are all ways for capital to get around traditional committed funds - not that committed funds are bad, but they can drive some perverse incentives and not every capital source can get comfortable with the lockup period. It wasn't that long ago that bankers wouldn't even let fundless sponsors get to management presentations because they were perceived as a waste of time - now, it's such a more widespread model that service providers (your risk / legal / accounting diligence support) are building out practices specifically to support those groups. I don't know if anyone here pays attention to or goes to ACG meetings, but you can take a quick run through ACG event schedules in any secondary market, and almost all of them are going to have something about independent sponsors this year.

I think that's a model that's here to stay. I don't think it will replace traditional private equity, but at least in the lower middle market, I think there will be a handful of fundless sponsors covering every metro in the country. In the 90s, there weren't that many people with private equity experience; but you don't have to train for 20 years to build the toolkit and relationships to do it yourself, so the number of people who can successfully put deals together and sell the idea to a funding source has grown pretty substantially. It seems like a lot of them are going and getting experience and then breaking off and going home or to somewhere they want to live and setting up a small shop.

I think search funds are a special case, and I'd love for someone here who has run a search fund to comment. I'm biased on them, because I've met a bunch of searchers, and I think the entire search fund subindustry is built on the egos of newly-minted MBAs who think they can do anything. I understand that many searches have turned out successfully, and that's great; I've also met plenty where I shake my head and wish that their parents hadn't been quite so supportive. Funding searches might be a different story, since that's turned out to be kind of like a VC approach - you shotgun money across a wide range of searchers, and you let 'em sink or swim and hopefully there's a couple of home runs in there. There's a few firms that have raised funds to do exactly this, and I think they've turned out pretty well (although I can't say I have any insight into exact terms).

I know it's a long answer, but I think it's an interesting topic. Traditional private equity is but one way for capital to reach private companies, and just as lending models built complexity over time, I think we are seeing the same thing in equity investing.

    • 12
Jan 8, 2019

Layne, +1 SB

Thank you very much for your in depth response. What are your thoughts on working for an independent sponsor at the analyst level?

Jan 10, 2019
Jv55:

Layne, +1 SB

Thank you very much for your in depth response. What are your thoughts on working for an independent sponsor at the analyst level?

Don't.

Jan 10, 2019
Whiskey5:
Jv55:

Layne, +1 SB

Thank you very much for your in depth response. What are your thoughts on working for an independent sponsor at the analyst level?

Don't.

Hard to disagree with this. On the one hand, if you went to work for someone who had partner-level skills but left their old firm for some reason that didn't have to do with their capability ceiling, AND they were interested in having you work on deal elements with increasingly greater complexity and value, AND they were a skilled teacher/mentor, AND they had line of sight to enough capital to not be a hindrance for deals, AND they had a very sound thesis on which they were hoping to execute, THEN working for an IS as an analyst could be a very, very valuable skill development experience.

If you're missing any single one of those, then the experience a) sucks and b) won't set you up for much career optionality. It's tough enough to thread that needle that it's only worth it in rare, rare circumstances.

    • 2
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Jan 11, 2019
Layne Staley:
Whiskey5:
Jv55:

Layne, +1 SB

Thank you very much for your in depth response. What are your thoughts on working for an independent sponsor at the analyst level?

Don't.

Hard to disagree with this. On the one hand, if you went to work for someone who had partner-level skills but left their old firm for some reason that didn't have to do with their capability ceiling, AND they were interested in having you work on deal elements with increasingly greater complexity and value, AND they were a skilled teacher/mentor, AND they had line of sight to enough capital to not be a hindrance for deals, AND they had a very sound thesis on which they were hoping to execute, THEN working for an IS as an analyst could be a very, very valuable skill development experience.

If you're missing any single one of those, then the experience a) sucks and b) won't set you up for much career optionality. It's tough enough to thread that needle that it's only worth it in rare, rare circumstances.

Really appreciate the responses here. I am trying to diligence this IS as much as possible. Waiting to here back what past analysts have said about their experience with the firm. I have a final round with the owner coming up. He seems to have a tremendous background serving as a CEO for two separate companies and longtime CFO for a F500. The people I have talked to that are currently at the company have made it seem like I would be working the entire deal process especially since the CEO is not a "deal" guy and personally loves working with the portco's more.

Jan 11, 2019
Jv55:

...I would be working the entire deal process especially since the CEO is not a "deal" guy and personally loves working with the portco's more.

This is a giant red flag to me.

Look, being an investor is hard. Someone in their 40's or so with a decade-ish of experience should be able to:

  1. Use their existing relationships with intermediaries and business owners to source opportunities
  2. Use their existing relationships with funding sources to raise deal capital
  3. Come up with their own key diligence questions to evaluate opportunities that isn't a 13-page cover-everything list that a lawyer gave them
  4. Construct a transaction structure that reflects an understanding of capital structure and different ways of deploying debt and equity
  5. Build their own models and investment committee / fundraising materials
  6. Read, edit, and negotiate the PSA and associated transaction docs
  7. Follow a project management timeline that leads to a closed deal with appropriate funding
  8. Be a value-add board member

Here's the important part: if they can't do any single one of these things, then they will not be able to teach you. Their attitude for finding analyst help should be "I know how to do all of these things, and with help, I'll be able to offload some of the simpler, time-consuming things so I can make better use of my limited time," not "I need someone to do the things I'm not good at."

If this person's strength is as a CEO or an operator, that's great - but what he needs is a partner who has investor skills, not an analyst.

    • 4
Jan 11, 2019
Layne Staley:
Jv55:

...I would be working the entire deal process especially since the CEO is not a "deal" guy and personally loves working with the portco's more.

This is a giant red flag to me.

Look, being an investor is hard. Someone in their 40's or so with a decade-ish of experience should be able to:

  1. Use their existing relationships with intermediaries and business owners to source opportunities
  2. Use their existing relationships with funding sources to raise deal capital
  3. Come up with their own key diligence questions to evaluate opportunities that isn't a 13-page cover-everything list that a lawyer gave them
  4. Construct a transaction structure that reflects an understanding of capital structure and different ways of deploying debt and equity
  5. Build their own models and investment committee / fundraising materials
  6. Read, edit, and negotiate the PSA and associated transaction docs
  7. Follow a project management timeline that leads to a closed deal with appropriate funding
  8. Be a value-add board member

Here's the important part: if they can't do any single one of these things, then they will not be able to teach you. Their attitude for finding analyst help should be "I know how to do all of these things, and with help, I'll be able to offload some of the simpler, time-consuming things so I can make better use of my limited time," not "I need someone to do the things I'm not good at."

If this person's strength is as a CEO or an operator, that's great - but what he needs is a partner who has investor skills, not an analyst.

oh my god someone need to sticky this. probably most valuable post of 2019 -- calling it.

    • 2
Jan 11, 2019

The gentlemen is 60 is and is well known in his industry (what I am told). I think this is what allows the firm to source proprietary deals and secure funding by being an industry expert. The company is looking to do 8-12 deals in 2019 (mainly tuck-ins). I didn't mean to discredit him by not calling him a "deal" guy that is just the message his wife relayed to me lol. I would hope he is able to do all those things but his passion lies in being an operator. However, I really appreciate you bringing up all these points because you are absolutely right. This should be about being a learning experience. I am going to write all these points down and use them to drive my questions during the interview.

Jan 11, 2019

moved comment

Jan 11, 2019

The gentlemen is 60 is and is well known in his industry (what I am told). I think this is what allows the firm to source proprietary deals and secure funding by being an industry expert. The company is looking to do 8-12 deals in 2019 (mainly tuck-ins). I didn't mean to discredit him by not calling him a "deal" guy that is just the message his wife relayed to me lol. I would hope he is able to do all those things but his passion lies in being an operator. However, I really appreciate you bringing up all these points because you are absolutely right. This should be about being a learning experience. I am going to write all these points down and use them to drive my questions during the interview.

Jan 11, 2019
Layne Staley:

The common theme is that there is a lot of capital trying to make its way into private companies of all shapes and sizes, and there are a lot of avenues to get there. One need only to take a look at that dry powder chart that Pitchbook puts out seemingly every two weeks to see that 1) there's a lot of growth in capital directed toward private markets, and 2) it's not getting spent fast enough. As that capital builds and builds, it creates pressure - either it finds creative ways to go to work, or it just eats away at return, through higher prices, poor decision-making, or acceptance of being paid less for the same work. I think all of the above are happening. Both of your questions stem from the "creative ways to go to work" branch.

To me the problem in this space (middle market PE and lower middle market PE) has always been that the "product market fit" just isn't there. Companies that fit the fund investment criteria (stable cash flows, great management teams, defensible market positions) don't need PE money. Companies that do need PE money don't fit the investment criteria.

    • 2
Jan 11, 2019
labanker:

To me the problem in this space (middle market PE and lower middle market PE) has always been that the "product market fit" just isn't there. Companies that fit the fund investment criteria (stable cash flows, great management teams, defensible market positions) don't need PE money. Companies that do need PE money don't fit the investment criteria.

I think this is true for the traditional private equity model where they read a bunch of CIMs and take in a bunch of management presentations and are more or less generalists who believe they can "get smart" on an industry quickly. For the riskiness of lower middle market deals that are hairy enough to be cheap enough to actually buy, they can't "get smart" enough to construct a vision that earns them a return.

A lot of the capable LMM independent sponsors I meet are very, very specific to an industry niche - like they know exactly how to open and run a certain size and theme and price point of restaurant concept in the Southeast. I think that knowledge allows them to expand the "risk" section of the investment criteria to be able to actually invest in companies that would benefit from PE money.

    • 2
Jan 10, 2019

Regarding the fundless sponsor model, I think it provides PE shops (especially smaller LMM funds) the opportunity to be more prudent and patient with their investment decisions. There isn't a timeline to put capital to work which can help take away the temptation to pull the trigger on buyouts during times of extremely high valuations. You would hope that because of this, their portfolio companies would have been acquired at cheaper valuations and would be more likely to weather the storm of a downturn.

However, having capital locked up for ~7 years can obviously help funds stay afloat during a downturn until things turn back around. I know a principal at a fundless sponsor (LMM) and they have only purchased 2 companies in the past 14 months (they're usually at 5-6 per year) due to high valuations. They're obviously not happy about the lack of deals, but they are content knowing they're not overextending themselves, which has been a factor contributing to the longevity of the firm.

    • 1
Jan 11, 2019

Very interesting topic and I have seen tremendous growth in both areas in recent years. I think both will continue to exist, but as @Layne Staley pointed out, it is really a function of capital overhang. Right now capital is abundant and even some traditional private equity funds have made the decision to support fundless sponsors who have deals under LOI as another avenue to spend their funds/ever-growing pile of dry powder. I think the fundless model will continue for the foreseeable future, but there will likely be a shakeout in the fundless market during more challenging economic times. No one knows when that will be, but the fundless model as it currently exists only works so efficiently during boom times. As stated previously, the market acceptance of fundless sponsors coming to management presentations and being taken seriously when they submit IOIs/LOIs is only going to continue as long as bankers and sellers believe the funding is there. Much different story when they start to question if the fundless sponsor actually has the money lined up.

The problem is threefold - first I think the "dual carry" concept is going to bite some LPs and institutional investors in a slower growth/downside case. P/E is likely going to see return compression overall given the current price and growth environment, but many GPs and LPs still think we are in an environment where 2x+ ROICs and 20%+ IRRs will continue to be the norm. Carry usually has return hurdles associated with it, but for funds that are investing in fundless deals, there is usually carry associated with both the fundless sponsor and the GP/institutional investor. Paying dual carry is much more palatable for LPs when the firms are buying strong companies at good prices during a market upswing and making 2x/3x/4x returns. Paying top-of-market multiples when the economic/growth picture isn't quite as rosy, the quality of inventory for sale is degrading, with two layers of carry is a recipe for LP disappointment. This will take a longer time to correct, because the funds will need to see some realizations and LPs will need to reevaluate if they want to support these types of deals in the future. The second issue is that I would argue many of the institutional investors that jumped into the fundless game have not spent much time thinking about a "downside case" beyond a return standpoint. The problem with fundless deals is that unlike a traditional fund, if a fundless sponsor investment goes poorly, the fundless sponsor often has less incentive than a traditional fund to manage through and try to resuscitate its bad investment. Without long-term LP relationships at risk, pooled carry and a committed fund for management fees, the fundless sponsor has little "hook" to continue working a deal if he realizes there is likely no carry at play for him, and is far better suited trying to find another platform especially if lenders have turned off the management fee. Some fundless sponsors also have little/no personal investment in the deal beyond rolling deal fees. For institutional investors that have 10, 20, 30+ fundless sponsor deals in their portfolio, it could be a rude awakening if/when they realize they have to play sponsor and manage the deals themselves to try to preserve their capital. Some traditional funds are well suited to do this, but many of the funds that are investing in these deals are not. Lastly, we have been in an environment of record LBO volumes for several years. If/when the market slows down, I think fundless sponsors are at greater risk of being "crowded out" by traditional sponsors in auctioned deals. Good fundless sponsors will still find ways to land proprietary deals at attractive prices, but I think it will be more challenging for fundless sponsors to be taken seriously in widely auctioned deals when we are not in a period of such "abundance".

All that said, there are a number of well-trained, successful independent sponsors who will continue to do very well and attract capital for their deals. While there is definitely a difference in quality of managers at the traditional P/E level, the difference is even starker in the fundless sponsor realm. I personally would invest in fundless sponsor deals with the right team, structure, target, etc. but I think the number of fundless sponsors in the industry is going to decline and the lower quality ones will be exposed.

Regarding family offices, they have many similarities with fundless sponsors and often support these types of deals. The major difference is that family offices often created their wealth by successfully owning and operating businesses versus being a "deal guy". For this reason, they are well suited to support both fundless sponsor deals and make direct investments. However, I think the challenge for this model is finding professionals who are good at sourcing and finding the right targets. While some sellers/management teams might like the prospect of never having to go through another sale process and being owned by a family for a long period of time, many managers are realizing the power of private equity to generate significant personal wealth through management option pools and flipping the company every 3-5 years. Family offices are going to have to get creative with phantom equity and other economic incentives to continue to be an attractive alternative to traditional P/E. I know several execs who are on their second or third private equity rodeo. However, as long as family offices can find the right talent to source quality opportunities, properly incentivize their deal teams and portfolio company managers, and find the right portfolio companies to invest in, this model is likely to continue.

    • 4
Jan 14, 2019