The Acquisition Financing Conundrum for Independent Sponsors

Posted on: February 23rd, 2022


Independent sponsors are an increasing force in the middle market buyout world. Their market ascent has driven higher volume of M&A activity and more creative forms of acquisition financing. The independent sponsor label refers to non-private equity sponsors and includes a wide variety of business people including business owners, family offices, and high net worth individuals. Their competitive advantage is their entrepreneurial expertise in business building, the ability to implement a growth plan and ensure business development scaling.

Most independent sponsors are extraordinarily successful business people who are investing their own capital in an acquisition. Despite their prior success, independent sponsors often face an uphill climb when it comes to acquisition financing. It would seem that the finance part of the equation would be easy for them, but middle market acquisition financing providers often struggle to meet independent sponsor needs. Many acquisition financing providers such as banks, mezzanine funds and debt funds are more focused on private equity deals and lack the flexibility to widen their credit parameters to accommodate the needs of independent sponsors. They take comfort in the implicit credit enhancement value that equity funds can offer.

Tendency of Acquisition Financing Lenders

The tendency of acquisition financing lenders to overvalue private equity support results in their propensity to undervalue independent sponsors. Lenders often excessively discount the amount of an equity rollover, or to assume future support is not available due to the smaller check writing capacity of the independent sponsor. This leads many acquisition financing providers to impose more stringent structural standards on independent sponsor deals such as lower loan-to-value rations and lower funded debt to EBITDA multiples. This has the effect of creating more of an equity gap in the transaction, which certain lenders such as private debt funds, are all too happy to fill through equity co-invests.

Fortunately, there are a growing number of lenders who specialize in this asset class and see less risk and more credit strength in independent sponsor deals. This new breed of acquisition financing provider includes bank middle market lending groups and non-equity focused mezzanine funds. They are stepping forward to embrace independent sponsors with honest terms and reliable service. They are not looking for excessive equity positions but want to directly lend and nurture the long-term growth of independently sponsored companies.