Introduction:

In today’s ever-changing business landscape, independent sponsors play a vital role in the mergers and acquisitions (M&A) market. As the industry faces a slowdown due to various economic factors, it is crucial for independent sponsors to understand the impact and develop strategies to thrive in challenging environments. 

In an exclusive interview with Chase Stuart, New York Office Managing Partner at Ice Miller LLP, we delve into the effects of the M&A slowdown on independent sponsor deals and explore actionable insights to navigate these challenges successfully.

The Impact of the M&A Slowdown on the Independent Sponsor Deal Community:

Stuart explains that while the M&A slowdown has undoubtedly affected independent sponsors, they have been relatively less impacted compared to traditional sponsors. The slowdown has disproportionately affected larger deals, leaving the sub-$10 million EBITDA market, where independent sponsors often operate, less impacted.

While barriers to becoming an independent sponsor have risen due to challenges in securing capital and fewer high-quality assets available for purchase, there remains a consistent interest from individuals eager to make their mark. Independent sponsors’ agility and willingness to be more aggressive in closing deals gives them an advantage over certain traditional sponsors. Stuart notes that independent sponsors, especially those not currently managing a portfolio of companies, have a stronger incentive to close deals promptly to establish a track record and secure future opportunities. Despite the challenging M&A landscape, Ice Miller has seen a continued appetite for getting deals done from the independent sponsor community.

Availability of Capital for Independent Sponsor Deals:

The availability of capital is always a crucial concern for independent sponsors. Stuart highlights the challenges in securing financing, with traditional banks and private credit funds becoming more conservative and selective in their lending practices. While debt has become more expensive, equity capital is still relatively accessible for good deals.

Stuart advises independent sponsors to focus on building robust networks on the equity side, leveraging relationships with SBIC funds, mezzanine/equity funds, and flexible equity investors. However, he notes that the underwriting standards for lenders have tightened, making it essential to align deal terms with what capital providers are willing to accept.

Changes in Deal Terms and Economics:

As the market dynamics shift, independent sponsors must navigate changes in deal terms and economics. Stuart emphasizes that the pricing of deals has changed, and debt financing has become more expensive. Consequently, independent sponsors may need to inject more equity or negotiate lower purchase prices to compensate.

While it’s certainly harder to get a deal closed in this market, the ability to secure favorable terms and economics is really about the deal. “As capital providers have more leverage in negotiations, they are able to exert more pressure on economics.  However, I represented an independent sponsor recently who had a number of capital providers put in bids, and the independent sponsor was able to achieve what I would call the ‘strong economic profile’ an independent sponsor likes to see.”

Key Strategies for Independent Sponsor Success:

Stuart advises independent sponsors to really understand their profile. “As an independent sponsor, you’re going to be talking to a network of bankers, accountants, sellers, entrepreneurs, owners, and lenders. Know who you are, who you want to be, and market yourself accordingly. Sketch out how you want the next five years to look and then drive your efforts toward getting to that result.” 

Here are several key strategies Stuart suggests independent sponsors to use to navigate the current market landscape successfully:

1. Find a Good Deal: The first and most crucial step is to find a high-quality deal. Independent sponsors should focus on identifying proprietary deals or opportunities where sellers are either motivated to partner with specific individuals due to their operating experience or are reluctant to sell to a traditional PE sponsor.
   
2. Get the First Deal Closed: For new independent sponsors, the primary goal should be to close the first deal, even if the economics may not be optimal. Establishing a track record is essential for getting future deals and attracting capital.
   
3. Hire the Right Advisors: Independent sponsors should be mindful of hiring experienced and reliable advisors, including legal, accounting, and industry-specific experts. A strong advisory team can help navigate potential pitfalls, provide creditability to the independent sponsor, and ensure a smooth deal process.
   
4. Consider Long-Term Implications: Independent sponsors should carefully evaluate the concessions they make during deal negotiations and considering the long-term implications. They need to ensure the credit agreement and other deal documents align with their post-closing vision and provide a reasonable framework for ongoing operations.

Conclusion:

Amidst the M&A market slowdown, independent sponsors should demonstrate adaptability and foresight. With a clear understanding of market nuances, access to the right capital sources, and the strategies highlighted, they will remain well-positioned to continue to identify opportunities, foster innovation, and drive impactful transactions that help shape this industry’s future.

Tell us what you think on LinkedIn or Instagram! @opusconnect.

By Lou Sokolovskiy, Opus Connect
August 2023