Financial Sponsors Group

A Hub for Private Equity Powerhouses and Strategic Investment Advisory

Author: Manu Lakshmanan
Manu Lakshmanan
Manu Lakshmanan
Management Consulting | Strategy & Operations

Prior to accepting a position as the Director of Operations Strategy at DJO Global, Manu was a management consultant with McKinsey & Company in Houston. He served clients, including presenting directly to C-level executives, in digital, strategy, M&A, and operations projects.

Manu holds a PHD in Biomedical Engineering from Duke University and a BA in Physics from Cornell University.

Reviewed By: Patrick Curtis
Patrick Curtis
Patrick Curtis
Private Equity | Investment Banking

Prior to becoming our CEO & Founder at Wall Street Oasis, Patrick spent three years as a Private Equity Associate for Tailwind Capital in New York and two years as an Investment Banking Analyst at Rothschild.

Patrick has an MBA in Entrepreneurial Management from The Wharton School and a BA in Economics from Williams College.

Last Updated:August 8, 2023

“Financial Sponsors” refers to private equity and buy-side firms concerned with investments and leveraged buyouts.

Financial sponsors group (FSG) is an investment banking division that deals directly with private equity, hedge fund, sovereign fund, and pension fund transactions. In addition, they advise on capital issuances and portfolio management. 

Financial sponsors are considered an industry group within investment banking that raises capital from buy-side parties, invests and advises them, and earns a commission or split profits with the party. 

Common deal types for the financial sponsor group include debt refinancing and portfolio company exits. Debt refinancing usually uses leverage to complete a purchase, typically known as leveraged buyouts. 

On the other hand, portfolio company exits involve a PE firm building a stake in a target company before finding an ideal exit strategy. Usual exit strategies include initial public offerings, secondary buyouts, and strategic sales.

Key Takeaways

  • Financial Sponsors Group (FSG) deals with private equity and buy-side firms, advising on investments and capital issuances.
  • FSG is different from Financial Institutions Group (FIG), serving buy-side parties and earning profits from investments.
  • FSG analysts are recruited from undergrad and MBA levels, with appealing buy-side exit opportunities.
  • FSG plays a role in M&A deals, utilizing strategies like "carve out" and bolt-on acquisitions.
  • Current trends include sustainable investments and the impact of Special Purpose Acquisition Companies (SPACs) on the financial sponssponsors'scape.

The Financial Sponsors Group vs. the Financial Institutions Group

FSG and FIG sound similar, but their operations are different. 

FIG clients include commercial banks, insurance companies, specialty finance firms, brokerage companies, etc. These clients differ from PE firms, often considered “alternative asset managers.”

The financial sponsor's group raises capital from enterprise clients, such as funds, government and sovereign entities, or wealthy individuals. As their name suggests, financial institutions focus on serving a mix of enterprise and regular investors. 

The business model of the two groups also differs fundamentally. The financial sponsor's group does not earn a commission from facilitating and advising deals but makes a direct profit or loss based on their investments in companies and assets.

Financial sponsors gain exposure to various industries and deal types because private equity firms and significant funds typically venture into all industries with different kinds of companies.

Working in the Financial Sponsors Group

Recruiting in investment banking for FSG analysts is similar to any other group, as firms look for candidates with strong financial knowledge, GPA, previous working experience, and more.

Lateral hires are rare for FSG because fewer people voluntarily leave buy-side firms to join an investment bank. Instead, firms emphasize recruiting straight from undergrad and MBA levels for the analyst and associate roles. 

The specific work of FSG varies from firm to firm and makes FSG a riskier choice than standard coverage groups in terms of the difficulty and rigor of their work. However, most FSGs fall into two general categories: relationship-based and execution-based.

Whereas industry coverage groups focus on a specific sector and require a deeper understanding of their respective industry trends, FSG covers a wide range of industries and analyzes multiple industries that a portfolio mainly contains. 

Like other coverage groups, FSG analysts must stay up to industry and macroeconomic trends for the buy-side and determine average multiples, leverage ratios, and other deal terms. 

Typical tasks for junior bankers in FSG include building models, the data room, scribing the CIM, and maintaining communication with clients. 

In valuation and financial modeling, FSG work is similar to other coverage groups, requiring the standard skillset and multiples such as EBITDA and PE ratios.

Buy-side investor presentations generally provide comprehensive information and analysis on their target and performance. You can find many of these documents on the SEC or a firm's website. 

The exit opportunities in the financial sponsors' group are incredibly appealing. Since the work deals directly with PE firms, hedge funds, and such, investment bankers typically look to buy-side exits after a few years of work.

Role of Financial Sponsors Group in Mergers and Acquisitions (M&A)

M&A deals in the financial sponsors' sector are primarily influenced by economic conditions (interest rates) and deployable capital. Therefore, PE Firms require sufficient equity and adequate interest terms to finance their endeavors in M&A.

There are two main types of M&A deals within the PE investment lifecycle following a portfolio exit, classified by AIBC

1. Acquisition backed by a financial sponsor

When a financial sponsor makes acquisition decisions, their reasoning usually differs from other strategic acquirers.

While strategic M&A is focused on synergies in product development, market share, and more, financial sponsors consider asset quality, turnaround/potential, and ways for sponsor contribution.

Due to the nature of the deals (quality over synergy), financial sponsor acquisitions typically have a lower valuation than those strategic acquisitions. Nevertheless, the valuation could also link to credit and capital.

Deals in a time of robust credit markets and large sums of dry powder (deployable capital) may also lead to compelling valuations for M&A deals within financial sponsors.

As financial sponsor M&A gets increasing attention and mounting competition for assets in today's world, many buy-side firms are opting for unique ways to acquire.

KKR, for example, pursued a "carve out" strategy in its acquisition deal with Campbell Soup in 2019, as it purchased the company's international operating units and imploys adjustments. 

Methods such as the "carve out" acquisition may resolve corporation management faults and mismatches in overall strategy by unlocking the actual value of a particular segment of a larger target company. 

2. Bolt-on Acquisition by a financial sponsor

Like the concept of "bolt-on" suggests, companies utilize this deal to synergize and supplement their current market share and product base, similar to a strategic acquisition. 

Creative strategies have also been springing from bolt-on acquisitions, such as the buy-and-build strategy. Methods involve a PE firm purchasing suitable platform companies and acquiring additional add-ons. 

As companies provide more and more synergies to the initial platform company, they typically see cost reduction and revenue increase. As a result, such a strategy has become increasingly popular over the last decade.

Multiple arbitrages are another method for bolt-on acquisitions to unlock additional value. This strategy suggests that smaller companies usually trade at lower multiples and allows for a reduction in the weighted average cost of purchase. 

With meticulous analysis, PE firms can find these smaller companies through proprietary sourcing methods. These smaller companies could be concealing issues in the transparency of liquidity that are noticeable in larger entities.

3. Portfolio exit

Portfolio exits are one of the essential components of the PE deal lifecycle, and PE firms result in different approaches to exiting based on economic factors. 

An initial public offering or a dividend recapitalization is among the financial sponsor's most common exit methods. PE firms also look for strategic buyers for the exit, which typically leads to a higher valuation.

Investment bank FSGs are typically present in every stage of the PE deal lifecycle, playing a role in advising and finding the optimal target for acquiring and selling.

Example of a Financial Sponsor Group Deal: Case Study

Having discussed the deal types and cycles within the financial sponsors' group, we can examine one of the significant deals in the last decade.

In 2018, Clearlake Capital utilized the "carve out" strategy in acquiring Provation, a software provider of intelligent procedure documentation and coding solutions in clinics, from Wolters Kluwer, an information services company based in the Netherlands.

In this 180 million dollar acquisition, Clearlake kept David Del Toro as the CEO of the target company and brought in operational advisors from Clearlake to the management level. This deal was advised by TripleTree and facilitated by Wells Fargo and Varagon. 

The board members in Clearlake expressed that Provation aligns with the firm's product roadmap and its potential to achieve organic growth. This is also attributed to Clearlake's extensive software and "carve out" deal experience.

With thorough analysis, Clearlake believed that factors including improved clinical productivity, increased profitability, more accurate reimbursement, and enhanced quality of patient care would drive more and more medical facilities to adopt Provation's offerings. 

This deal was an enormous success for Clearlake, as it sold Provation to Fortive in just three years for 1.4 billion dollars. Fortive shares jumped immediately after its acquisition as it sought to finance the deal with short-term debt and equity. 

At the time of the deal in 2021, Provation served more than 5,000 hospitals and clinical centers with about 110 million dollars in revenue that year. 

With the help of a financial sponsor, Provation became one of the best healthcare software providers, with safe, efficient, and scalable procedures to support public and private health entities.

Current Trends in the Financial Sponsors Landscape

In recent years, global investment has driven a rising debt burden that leaves financial sponsors largely susceptible to competitive lending between credit funds. Moreover, the lending scenario pushes buy-side firms to be more risk-taking in their endeavors. 

A significant concern is that there are low to no debt covenants in private funds, which could lead to a dangerous level of leverage, particularly in private funds.

Investment banking typically possesses regulation in lending, whereas private funds can be way less constrained. In addition, company restructuring resulting in litigation has also increased. 

Financial sponsors have also been pressured to participate in sustainable lending practices and investments. 

ESG practices are now favored or required by limited partners more than ever before and are considered a key metric for evaluating buy-side portfolio performance. 

Investments and impact funds are now mainly being incorporated by financial managers to align financial returns with social or environmental impact, which has worked in favor of many firms.

Statistics found that ESG funds suffered less from the COVID-19 outbreak in market volatility and saw an increasing demand due to supply chain issues.

Financial Sponsors Group And Special Purpose Acquisition Companies

The rise of SPACs (Special Purpose Acquisition Companies) has led to massive momentum in the financial sponsors' world. In addition, SPACs provide a great investment opportunity in times of market turmoil.

SPACs are shell companies with a great management team and acquisition strategy, constructed to raise capital via an IPO or merge with an existing company.

When dealing with SPACs, financial sponsors can significantly reduce the timing for a target IPO and negotiate a premium price when selling to a SPAC due to the nature of its deal window.

Many prominent SPAC sponsor profiles include PE investment funds, those that hope to become direct sponsors to profit directly from the IPO, and the company's lifecycle after an acquisition. 

Financial sponsors receive founder shares, which are exchanged for listing common shares at a ratio of one-fourth of the IPO proceeds. In addition, sponsors also gain from SPAC's stock price rise after the IPO.

Once public, the SPAC will make decisions on acquisition targets, followed by communication to its shareholders and PR. Shareholders will see an increase in value depending on the public's reaction. 

When the deal is officially closed, depending on the success of the SPAC, the SPAC should gain more publicity and lead to more pushes in the share price of the entity itself. 

Although experiencing growing attention, some investors have huge doubts surrounding SPACs. For example, Ivana Naumosky raises suspicions in the HBR article, claiming that the SPAC bubble will soon experience a burst. 

Points have been raised that there is less legitimacy and transparency in the rise of SPAC companies, and they are essentially a form of reverse mergers that saw their period of boom and bust. 

A financial sponsor group is an ever-changing group due to its close correlation with the buy-side and economic trends. Therefore, banks must constantly adapt and assess shifting trends to stay competitive in this particular coverage group.

Researched and authored by Kevin Wang LinkedIn

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