Things to Know About Independent Sponsor Deals as an Investor

Independent sponsor transactions are a growing segment in the private equity landscape, offering unique opportunities and structures for investors. Based on the 2022 Independent Sponsor Deal Survey by McGuireWoods, here are key insights and trends:

1. Transaction Sizes and Market Focus

• Lower Middle Market Dominance: Over 75% of deals targeted companies with enterprise values between $10 million and $75 million, aligning with the lucrative lower middle market.

• Equity Checks: Similarly, 75% of transactions involved equity commitments ranging from $5 million to $50 million, excluding debt financing and seller rollover equity.

2. Deal Pricing

• Attractive Multiples: Two-thirds of transactions were priced below 6x EBITDA, with more than 90% priced below 8x EBITDA. Independent sponsors often leverage operational expertise and relationships to secure favorable terms.

3. Independent Sponsor Economics

• Closing Fees: These ranged between 1% and 2.49% of enterprise value in nearly 80% of deals. Fees tend to decrease as transaction sizes increase.

• Reinvestments: Around 60% of independent sponsors rolled over more than half of their closing fees into equity, showing confidence in their deals.

4. Management Fees

• Common Practice: 60% of deals reported management fees of 5% of the target's trailing 12-month EBITDA (TTM EBITDA). Floors ($100k–$399k) and caps ($500k–$999k) were common.

5. Carried Interest (Promote)

• Models: The "variable-with-hurdles" model was used in 61% of transactions, often tied to MOIC (70%) or a combination of MOIC and IRR (17%).

• Hurdles and Payouts: Most deals included two to three hurdles, with carry percentages rising progressively. The first hurdle typically ranged between 1.0–2.0 MOIC, with carry percentages of 10%–15%.

6. Broken-Deal Costs

• Risk Sharing: In control buyouts, 61% of transactions had equity providers covering all broken-deal costs. However, smaller deals often required independent sponsors to bear a share of these costs.

Why This Matters for Investors

• Lower Risk Entry: Investors gain access to the high-growth lower middle market, often at favorable valuations.

• Aligned Interests: Independent sponsors frequently reinvest their closing fees, aligning their financial outcomes with those of equity partners.

• Structured Returns: With predefined management fees and carried interest hurdles, these deals offer clarity on potential returns.

Final Thoughts

Independent sponsor deals represent a distinct asset class within private equity. Their unique structures and market focus provide diverse opportunities for investors, especially those interested in the lower middle market. As this segment evolves, staying informed about industry norms and terms is essential for maximizing investment success.