Small Fund vs. Rollup

What do all of you guys think would have a higher chance of success for someone with a few years of M&A investment banking and a few years of PE experience and a serious entrepreneurial itch? For some quick background, I have some family friends and contacts who are very interested in pooling together some private capital and doing some deals. One particular family recently had their business recapped by a sponsor at a $1B+ valuation.

  1. Raising $20mm, finding a platform and attempting an industry rollup where I would be an investor (albeit a small one) and also be entitled to a big chunk of the management incentive option pool
    Pros: would be able to focus all time and energy into growing 1 single business. Could work to quickly learn the ins and outs of a particular industry and start gaining deep knowledge in that niche
    Cons: concentrated bet on a single business. All eggs in one basket, no diversification, etc.

  2. Raising a slightly higher amount (call it $20 - $30mm) and doing 2 or 3 deals in a more traditional GP/LP setup with 20% carry
    Pros: diversification
    Cons: would need to spread time and energy across multiple companies. Likely would take longer to deploy the capital. Likely significantly more upfront legal work to take this route

Interested to hear people's take on this and hear some different viewpoints.

Comments (9)

Most Helpful
Oct 4, 2019 - 12:11pm

What about option C? Do neither. Instead try an independent sponsor model and raise capital deal-by-deal. This will give you flexibility to try and take down multiple deals if the opportunity is there while focusing on the roll-up first. It will also let you build a track record to make raising a larger fund later a bit easier if that's the route you decide to go. Doesn't really make sense to go the fund route without some kind of track record.

I don't know if it'd be smart to try and weigh in on what of these options are "easier". None of them will be easy, but you've got the background to have developed the some of the skills needed to do any of them.

Oct 4, 2019 - 1:06pm

I am familiar with the independent sponsor model but not as familiar with how the economics work. Does each deal have different management and carry structures? I guess another benefit of that would be that any potential bad deals would be siloed and wouldn't impact the carry/performance of the others

Oct 7, 2019 - 12:44pm

Generally speaking, the economics are fairly similar to that of a regular fund, with the potential of higher carry (or mgmt fees, although unlikely from my experience) to compensate for the "free" sourcing. In your case, the advantage of the independent sponsor is that you'd be able to look at a much wider range of deals, both in terms of strategy (ie. roll-up, traditional LBO, et) but also size. Obviously, this flexibility comes at a cost as you'll have no revenues until you close a deal.

Oct 7, 2019 - 3:01pm

Let me preface this by saying that the independent sponsor model is still relatively new and although I have a keen interest in the model, I am not an expert so it's not because I haven't seen something that it's not possible or already done. You see structures where carry is higher than 20% (I have seen up to 40%) and/or carry is structured into several tranches with different hurdle rates. In cases where the sponsor will take an operational role, the sponsor will often receive sweet equity in addition to options. Also seen cases where some LPs did pay management fees pre-deals in exchange for better deal terms (ie. ROFO, liquidity preference, etc).

The one tricky thing with the model is how / when do investors have to commit once you find at deal and the situation does leave you in a bit of a catch 22. Business owners will rightly want to see a pretty high level of certainty that you have the funds required to complete the acquisition before they'll spend time and money allowing you to do proper diligence and investors don't want to commit until a lot of the diligence has been done. On the other hand, you want to make sure that investors take the risk of dead deal costs so investors will often commit in 2 phases: first they'll commit to the dead deal costs and give you a commitment letter that's a bit fuzzy of the conditions for funding so you can get the seller to allow you to do DD and second, for the full dealonce DD is completed for a final bid.

Oct 4, 2019 - 12:15pm

Option 2 will not work with your skill set. The companies will be too small and you'll lack tactical knowledge necessary. Lack of middle management makes trad PE guys worthless when dealing with sub $15M - $20M rev CO's.

  • 1
Oct 4, 2019 - 1:25pm

You said 3 deals?

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