Private Equity Dealmakers Are Shunning Big Firms to Go It Alone

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Independent sponsors don’t charge the usual 2% management fee that traditional private equity firms levy on assets under management in a fund. Instead, they typically take a transaction fee equaling 1% to 2% of the target company’s value, as well as an annual monitoring fee of 3% to 5% of adjusted earnings before interest, taxes, depreciation and amortization. Carried interest, or the portion of profits they take, levels up after hitting certain performance hurdles. 

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There are an estimated 1,400 active independent sponsors, about double the number in 2019, according to law firm McGuireWoods, which hosts an industry-leading conference that connects those firms with capital providers. That event had roughly 1,600 attendees last year, a sixfold increase from 2017.

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“The independent sponsor universe only continues to grow in a healthy fashion because of the availability of capital to back them,” said Jon Finger, a McGuireWoods partner.

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Many independent sponsors are investing in deals that generate $2 million to $10 million of adjusted earnings, according to a report from advisory firm Citrin Cooperman. Independent sponsors accounted for 27% of transactions that closed last year on Axial, a deal network for the lower middle market.

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Such deals have grown larger in the past 18 months, with enterprise values for some ranging from $500 million to $1 billion, said Matt Swain, global co-head of equity capital solutions at Houlihan Lokey Inc. He estimated that his firm has advised on 50 deals over the past three years.

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“The independent-sponsor market is becoming much more institutional, much more complex,” Swain said.

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But in some ways it’s just about going back to basics: Find a founder-run business that has room to grow, pull together a small syndicate of equity and debt investors, and buy it at lower valuation and with less leverage than what’s typically used in larger deals. A growing number of baby boomers who founded businesses are looking to retire, and the smallest end of the private equity industry provides ready buyers. 

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“Everybody is looking for alpha,” said Sylvie Gadant, managing partner of transaction advisory services at Citrin Cooperman. “They’re looking for other avenues to get a return on their capital.”

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Freedom and Flexibility

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Increasingly, dealmakers are leaving bigger firms, and they like the freedom and flexibility of investing without a fund, according to John Koeppel, team leader of the private equity and independent-sponsor practices at law firm Lippes Mathias. Successful independent sponsors are also often former private equity operators or people with deep expertise and contacts in a particular industry, he said. 

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Lee’s BellTower backs younger and ambitious people with “extensive domain expertise,” he said. “They partner well for the long term with business owners who like their focus and energy.”

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The model also allows independent sponsors to focus on the health of the company instead of making decisions to benefit a fund.

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“The money is being invested in creating value and not bureaucratic overhead, excessive fee leakage, and diluted carry to people not impacting the outcome,” Lee said.

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David Acharya started Acharya Capital Partners in 2020 after working at other independent sponsors. So far he has done two deals and exited one with the sale of event-marketing firm Impact XM, which generated a return on capital of more than 21 times for his investors.

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Acharya said he has noticed a recent increase of new entrants to his corner of the private equity industry, which he attributes in part to a lack of other opportunities for advancement at bigger firms. 

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“A lot of these professionals — including the fact that they haven’t gotten a carry check in a long time because of the challenges in the exit market — they’re saying, ‘Instead of doing this, let’s just go off on our own and become independent sponsors,’” Acharya said.