An independent sponsor is an individual or small organization that identifies a target, whether it is a company or real estate, and then seeks a handful of investors, often a single investor, to provide the equity for the acquisition. Some people describe the independent sponsor structure as one that circumvents the use of a private equity fund: entities that typically invest in a private equity fund, such as family funds, large investors or pension funds, will skip the private equity fund and invest directly in a project that a private equity fund would otherwise acquire and operate. Instead, the “independent sponsor” operates the business or property, receives various fees and equity in the project, and reports (and distributes profits) back to the investor. In these cases, the independent sponsor is also called a “cashless fund” because the sponsor provides all the functionality of a private equity fund but seeks out acquisition opportunities first and then finds the cash second.
The independent sponsor structure, however, is not always an end-run around private equity funds. Often, private equity funds invest with independent sponsors for reasons stated below. The structure of the deal may be significantly different when a private equity fund is involved. Click here to learn more about the challenges new independent sponsors face.
Why Do Investors Like The Independent Sponsor Structure?
Investors like the independent sponsor structure versus the private equity structure for four reasons:
1) Complete Control Over Investment Decisions
Investors in a private equity fund have no control over what investments the private equity fund makes. After the investor chooses the fund, it relinquishes all control over investment decisions. Typically, private equity funds tell investors about the general characteristics of investments the fund will make: industry or asset classes that will be considered, a range of revenues or other metrics of potential investments, etc. With the independent sponsor structure, the investors know exactly where the money will go because the acquisition target will have been identified prior to the investment. In some cases, the independent sponsor will have an executed purchase agreement to share with the investor so that the investor has a greater understanding of the potential investment.
2) Greater Control Over The Investment Terms
In general, investing in a private equity fund often means accepting the terms proposed by the fund, unless the investor is investing a plurality or majority of the fund’s investment. With an independent sponsor project, there is often a single investor, which results in negotiated investment terms.
3) Greater Control Over The Project
An investor in a private equity fund has no say in the operations of the acquired business or property. An independent sponsor investor, however, can elect to exert no control or significant control over the project.
4) Access To More Deals
Private equity funds, flush with cash, are chasing a limited number of opportunities, making for a challenging environment. One solution some PE funds have found is to invest in smaller deals, where there is less competition. Investing in smaller deals, however, can be labor intensive, which is why private equity funds sometimes prefer to invest in those deals with an independent sponsor.
Why Do Independent Sponsors Like The Structure?
Independent Sponsors like the structure for a number of reasons stated below, but the short version is that life is a lot easier when raising money from a single investor as opposed to a handful or even dozens of investors.
1) Less Hassle
Raising money from third parties, whether through a traditional private placement or a newer “crowdfunding” method takes a significant amount of work. Face it, it’s a hassle to round up even a handful of investors. Dealing with a single investor takes much less energy and time. Identifying a single investor and negotiating a single term sheet is much more efficient than pitching dozens of potential investors, negotiating side letters with the larger investors and getting everyone to hand over their checks and wire funds. The fewer investors, however, the more negotiating leverage those investors have.
2) Easier Securities Law Structure
Raising capital from multiple investors requires compliance with state and federal securities laws. The typical method is to rely on a Rule 506 exemption. An investment by a single investor in an independent sponsor’s project will be a securities transaction, as well. As a result, the independent sponsor will have to comply with both state and federal securities laws, just as it would if there were numerous investors. Depending on which states the independent sponsor and the investors are located and how the deal is structured, however, may eliminate the need to make state and federal securities filings or, at the very least, reduce the number of state securities laws filings.