Go funded or fundless?
McGuireWoods LLP hosted its annual event this week in Dallas, TX, bringing together capital allocators and a wide variety of independent sponsors, with attendance at all time high. Below are key takeaways, highlighting a thriving independent sponsor community and the growing relevance of the model in a shifting allocation landscape.
💸 Fundless: the fundless model is increasingly relevant in lower middle market private equity. The trend is toward deal-by-deal investments, where each transaction is analyzed and funded individually rather than through a committed closed-end fund structure. This approach allows for greater flexibility across business cycles and often leads to better stakeholder alignment.
🤝 Aligned: independent sponsors typically commit more of their own resources upfront to bring vetted deals to allocators and ensure successful deal execution instead of relying on recurring management fees. They are primarily motivated by the equity upside embedded in each deal. In the deal-by-deal model, there is more reputational and brand equity at stake. Allocators and sponsors also actively collaborate on due diligence, forming deeper relationships and trust over time.
🎯 Specialized: while generalist sponsors still abound, most capital allocators are looking for focused sponsors that bring deep industry knowledge and strategic insight. There will be more specialized pools of capital in the lower middle market as investors demand unique and differentiated approach to increase alpha capture.
👩✈️ Operator-Led: historically, many lower middle market funds were led by professionals with a financial background. Increasingly, fundless sponsors are being founded or run by former operators. They also tend to leverage industry experts and partners to accelerate the value creation process at their companies. Operators bring a hands-on understanding of how businesses operate, which is vital for smaller companies that often need more than just financial engineering to grow and achieve operating efficiencies.
🌟 Value Creating: independent sponsors tend to find unique deal situations at a discount relative to larger peers, with incremental value created over time through operational improvements. These lower middle market deployments will combine both organic and inorganic (M&A) growth strategies to scale revenue and EBITDA from a low base. This helps support a more robust multiple expansion than is typically realized in larger deals, while delivering strong risk-adjusted returns.
