With an all-time record set last year for the highest value of merger and acquisition transactions in the United States at $1.97 trillion,* there were plenty of M&A participants who took advantage of this deal flow momentum—including independent sponsors. They are carving out a meaningful piece of the M&A pie for themselves and quickly adapting to a model of success that often involves keen industry insight, key details on the target and practical resolutions to challenges.
We at Katten—through deals we’ve done and market data we’ve gathered—have noticed some interesting behavior, a few possible trends, and several ways that participants in independent sponsor transactions are getting ahead. Highlighted below are some of our observations of the current independent sponsor transaction landscape and some trends to watch.
- Independent sponsor-backed deals are becoming increasingly prevalent in lower middle-market transactions with values of $10 million to $75 million. Independent sponsor transactions reached what would seem to be peak levels in 2015 when compared to independent sponsor activity in recent years. Katten itself was involved in more independent sponsor transactions in 2015 than in any other single year.
- More institutional investors are comfortable with the independent sponsor model. Although the M&A environment in 2015 remained extremely competitive and sky-high valuations priced many institutional investors out of bids for higher middle-market companies, independent sponsors continued to find value in the lower middle market and source transactions at lower multiples than those in the higher middle market. As a result, we saw a wider cross-section of institutional investors team up with independent sponsors in 2015. Beyond traditional private equity firms, mezzanine funds have shown an increasing appetite to finance acquisitions sourced by independent sponsors. In addition, as family offices have begun to implement direct investment strategies, they have increasingly relied on independent sponsors to source transactions, identify management teams and carry out post-closing strategies. Opportunities to find transaction partners seem as ripe as ever for operations-focused independent sponsors with successful track records.
- Trends in independent sponsor economics were more discernable in 2015. Our market data survey shows that, in 2015, the maximum promote interest opportunity for independent sponsors was typically 20 percent of the fully diluted equity capital of the target. In a reversal from our market data survey in 2014, promote interests were almost always entirely subject to performance hurdles based on EBITDA, equity sponsor IRR or equity sponsor multiple of invested capital. Only in a small number of transactions did we see any portion of promote interests granted to independent sponsors vest without achieving performance hurdles.
- Independent sponsors are being asked to invest more at closing. More often than in years past, independent sponsors were required to invest 100 percent of closing fees paid in 2015. Perhaps not coincidentally, independent sponsors are receiving larger portions of post-closing management fees from the target relative to the equity sponsor.