Independent sponsors were once seen as a second-tier option to raising a traditional fund. But now, investors like Cambridge Associates are seeing these individual investors — or at most three people — doing deals outside the typical fund construct become an increasingly active segment of the lower-middle market.
“The maturing of the private equity industry has created this talent to produce these deals in a more entrepreneurial way, which can be an exciting and compelling opportunity,” said Cambridge’s co-head of North American private equity research Keirsten Lawton.
As opposed to angel investors, which tend to focus on startup ventures, independent sponsors assume control of established businesses. Lawton explained to Institutional Investor over video these sponsors have begun to fill a growing niche as the private equity industry expands. As institutional capital chases after the same larger companies and megafunds, two clicks down many smaller businesses with $1 million to $5 million in EBITDA are still sold without the use of investment banks or other sophisticated intermediaries.
In addition, emerging private equity managers are having a tough time raising a debut fund out of the gate. And yet these professionals need to establish a track record.
“Private equity still presents significant opportunities to generate outsized returns, but it’s harder, and the returns are concentrated, and it’s an expanding maturing market,” Lawton said.
Meanwhile, a new generation of private equity professionals are doing deals one by one to build a track record. So, succeeding as an independent sponsor is a good intermediary step towards raising that first fund.
“You get 1-3 people who are betting on themselves to buy a company. They don’t have a fund; they’re doing deals on a deal-by-deal basis,” she said, adding that many of these sponsors find their deals through building connections or by taking advantage of some sector expertise.
Other allocators are also seeing this as a growing trend, with some beginning to selectively back independent sponsor transactions. “This is definitely a trend we’re seeing more and more of,” said Alex Band, chief investment officer for Partners Capital, explaining that the investment firm is making a few selective investments in this space alongside a broader focus on spinouts and emerging managers.
Band told II that the model is increasingly shedding an older perception that deal-by-deal sponsors were simply managers who had been unable to raise a traditional fund or lacked a sufficient track record.
“If you look back five, ten years ago, those doing this deal-by-deal were thought to be taking this approach because they couldn’t raise a fund and didn’t have a track record," Band said. "So, you potentially felt that you were sacrificing access to talent. I think you could argue that’s less of a case today.”
Band explained Partners Capital is now increasingly seeing individuals and teams take the independent sponsor route “as a fast way to start their businesses and to get some investments on the board before fundraising.”
