Starting a “cashless fund” has its challenges. One of the main problems is that a cashless fund starts with . . . no cash. The independent sponsors need to search for acquisitions, which in and of itself is a full time job and often requires travel. Depending on when the investors become involved, the founders may be required to pay attorneys to draft and negotiate a term sheet and a purchase agreement and undertake certain due diligence. They may also need to pay accountants and other service providers to provide advice and provide other due diligence. The cost of travel and payment to service providers can be a significant drain on a fund that starts without investors. The problem is compounded when the first, second, or third deal falls apart after the independent sponsors have spent significant time (and money) chasing after the acquisitions.
One solution is to seek out alternative fee structures with service providers. Service providers that provide success and failure fees, flat fees that are staged to coincide with the stages of the due diligence and acquisition process, or combinations of the foregoing, can keep service providers motivated through an independent sponsor’s successes and failures.
Compensation for Independent Sponsors
A promoter working with numerous investors has significant leverage in dictating the investment terms. An independent sponsor negotiating with a single investor, however, has less control over the investment terms.
Typically, however, an independent sponsor receives the following three categories of compensation:
- Acquisition Fee. The independent sponsor receives a fee at closing simply for getting the transaction over the finish line.
- Management/consulting fee. Depending on the role that the independent sponsor plays in the ongoing operations of the target, the independent sponsor may receive an annual management fee or consulting fee.
- Carried interest. Upon the sale of the acquired company, the independent sponsor will receive a portion of the sale price.