As a deal by deal investor, raising capital is essential to your survival.  There are a myriad of capital raising approaches independent sponsors may use to get deals launched. But what strategies work best for what situations, and how do successful independent sponsors implement those strategies for best results?

That is exactly what Erik Ginsberg of Slate Capital and Logan Walters of Forge Equity discussed in a recent ISF Digital Lunch & Learn, moderated by Richard Consul, CFA of Bankers Edge Advisory

 

Getting Started - Building a Stable of Investors
Erik kicked it off by mentioning that your first conversations when you start looking at the independent sponsor model should be with fundraising sources – you can’t do anything without those. “You can’t have enough capital sources.” 75-80% of conversations will be “no’s” he said for reasons outside of your control. You want to form a stable of providers – some of those will turn into repeat investors.

Logan added, you should also start conversations with institutional investors as early as possible – those take longer to cultivate. Your worst encounters are the ones who leave you hanging and won’t tell you “No.” Those often end up being a time suck – because family offices aren’t pressed by the need to deploy capital like a fund, they can often have long drawn-out “Maybes”. Institutional investors though are quick with a “No.” They likely however will wait until you’ve developed a track record to invest with you.

Tip: "Ask every capital provider who else they would recommend you talk to for a deal they might not be interested in."

Logan also suggested after every conversation you have, ask that capital provider who else they’d recommend you talk to. This is a great way to expand your network, and as Erik noted, a good way to see if that capital provider liked what they heard from you (if they don’t offer a recommendation, that  tells you something!)

Richard advised investing in a CRM is important for deal by deal investors  to better track the data on the investors you speak to and include metrics on  check sizes the investors are willing to write and be able to send mass emails to save you time.

Get a Partner
Richard asked  Erik and Logan to weigh in on the benefits of  having a partner as an independent sponsor or  if it’s better to go solo. Both Erik and Logan agreed that it’s much more beneficial to have a partner. It puts capital providers at ease – putting to bed the question of what happens to the deal if you “Get hit by a bus.” It’s also good to have a sounding board for ideas and issues, and they’ll come in with their own set of skills to add to the business. Erik noted that even the best independent sponsor can have a bad day and get emotional over a deal, so having a partner can counter-balance that.

Deal Structure - Continuity of Interest is Key in a Deal
Erik started this part of the conversation by stating that whether it’s a rollover, seller note or earn out, you want the founder/management of the selling company to have skin in the game. 30% ownership is a good target number for management – although it can range from 10-49%. If it’s not via a rollover it can be done with a seller note or earn-out to show they are invested in the future of the business.

Logan observed that banks right now are being more aggressive – they are hungry which may allow you to get cheaper debt. Erik added that market conditions will be fluid – a couple of years ago banks all but disappeared – you had to go to more non-bank lenders then.

"A big benefit of SBICs is that they often show much more patience to work through issues in a deal."

Erik added that SBICs offer pros and cons – they are more about debt – on average, they prefer an 80-20 debt to equity ratio. A big benefit, is that investors, like SBICs, who offer more of a debt and equity balance will often show much more patience in deals and give more leeway for independent sponsors to take the time they need to make a deal work and work through issues.

What Happens When the Dog Catches the Car?
Richard kicked it off by noting that independent sponsor deal sizes are getting bigger – so how do you navigate it  when you’re “The dog that catches the car?” Erik said he used a third party for his largest deal that didn’t work out and ultimately used his own relationships and, for the first time, a PE firm to get the deal to the finish line. But that meant giving up control of the deal.

But the size of the deal shouldn’t deter you. Logan and Erik both noted it’s often easier to get funding for a larger deal. You just have to stay true to your process and approach – regardless of deal size and economic climate – whether it’s a boom or recession. You never know when a great deal will present itself.

If you do try and work with a PE firm on those larger deals, there are ways to do so successfully. Either you have a proven track record that gives them confidence in you, or you can get commitment letters from other capital providers to tie into the LOI.

Picking Service Providers
Richard asked: “What If the capital provider says they want to choose certain service providers for the deal?” Erik and Logan had different answers for this one. Logan felt that if the independent sponsor was firm on choosing, then they’d need to pay a larger share of the fee. Erik turned that around and stressed that if the capital provider was firm, then he’d ask them to pick up those costs.

Rates Versus Flexibility
Richard posed the question – “Do rates matter more than flexibility from your capital provider?” Both Erik and Logan agreed that flexibility matters more. You want to be aligned in what you want to accomplish – will your cash flow be affected by your investment plans at a higher rate? Maybe. But going with non-bank lenders who may cost a point or more may be more beneficial as they offer more flexibility for you to make your preferred investments.

Capital Providers are your partners - find one who fits the deal and can write additional checks for add-ons if they are needed.

Logan added that you want a capital provider who will help you through unforeseen circumstances. Erik relayed the story of one who stayed with him through a deal adversely affected by Covid. They could have forced him out, but they had patience and as a result the deal ultimately wound up becoming very successful. But a bank may not have had that kind of patience.

Richard also asked the question about how to pitch capital from your current provider for add-ons. Erik responded by stressing that you really need to have the right fit upfront if you know you’re going to do add-ons and it should be discussed early. Find a partner who is willing to underwrite additional spend and build it into the model. Everyone has to understand that it’s part of the deal.

Author: Stephanie McAlaine, Executive Director, Independent Sponsor Forum