by: Kay Francoeur
At ECA, we primarily work with private equity. More than 85% of our clients are investor owned or backed, and we’re experienced in placing great candidates for PE firms, for portfolio operations leaders, and with portfolio companies.
Part 1 and Part 2 of our series on PE basics covered the fundamentals of what PE firms are and why the size of these funds really matters, and Part 3 explored the differences among fund types and the typical investment strategies they follow. In our last installment of this series, we explore the emergence of so-called “fundless” or “independent” sponsor models, which are increasingly in vogue, especially in the lower-middle market (LMM) sector that ECA knows well.
Traditional Fund vs. Fundless (aka “Independent”) Sponsor
There is one key difference that fundless models offer: in contrast to traditional private equity firms, where general partners raise funds from limited partner investors, fundless (or “independent sponsor”) models operate with no committed capital.
Traditional PE fund models ask investors to commit to a blind pool. Often, they have little to no influence over the investments they make and are committed to a relatively long time horizon (a typical investment period is 3-10 years, though timelines vary and could be as long as 7-10 years). With the independent sponsor model, the typical order of operations is reversed: the investment team sources deals and outlines operational improvements first and then will bring potential deals to their partners, who will review each potential acquisition and invest on an individual basis.
Who are the independent sponsors behind these emerging fundless models? Independent sponsors are usually experienced operators, coming from three main areas: PE professionals who’ve transitioned from conventional committed capital model to a deal-by-deal model; investment bankers who want access to equity ownership and have a more hands-on role with companies they help fund; and industry experts and entrepreneurs with deep experience in a specific field who can add valuable insights to acquired companies.
Just a few years ago, fundless models were almost unknown, or at least operating more under the radar – but now, these models are increasingly popular, occupying a competitive position in LMM PE.
Some LPs believe they have more control over investment decisions in this model, as the deal-by-deal nature of these funds offers greater flexibility and more opportunity to offer their opinions on each transaction. Some investors are also attracted to these models because there are no fees on uncommitted capital, in contrast to annual management fees traditional funds charge, and also might have fewer restrictions on time horizons so investors are likely not committed to nearly a decade of illiquidity. Another potential advantage is the expertise that independent sponsors bring – they are often seasoned PE pros who bring their deep operational and industry-specific expertise front and center in fundless models.
But there are also some disadvantages to this model. One drawback is that fundless models can suffer from a lack of efficiency – since there is a need to raise capital from scratch each time an attractive deal is on the table, this can create bottlenecks in the front end of the process. Investors who are attracted to flexibility a deal-by-deal structure offers would do well to keep this caveat in mind.
There are two basic fundless models:
- The search fund
- The fundless sponsor
In a search fund, typically one or more principals target two to four industries for about two years, with the intent to purchase just one company and run its daily operations after the transaction. Search funds occupy a unique niche within broader PE in that they focus on an individual company rather than multiple companies. Traditional PE is rarely involved in the day-to-day operations whereas search funds get far more involved in the weeds of the company’s functioning. Similar to other types of PE funds, search funds will hold investments for lengthy periods before selling, typically 4-6 years. Search funds primarily operate in the lower middle market.
Fundless sponsors work more similarly to conventional private equity firms. They have a professional management team that doesn’t intend to take over the day-to-day operations of an acquisition. Fundless sponsors are also usually adding to an existing portfolio of companies.
We hope this has been a helpful overview of some of the main facets of the field of PE. Please check out our other articles and videos digging into specific levers PE firms use (what is “value creation,” really?) and details on in-demand roles at the PE firms and portcos we work with here at ECA. In our podcast Not So Private Equity, you can also hear directly from partners and founders of PE firms themselves on the nuances of their investment strategies, why size matters, and the key factors that they consider in making a good deal.
Kay Francoeur is a Project Manager at ECA Partners. She can be reached at [email protected]
