Deal-by-deal: Why 'fundless' PE players are on the rise

At the beginning of June, James Gamett, a former Stepstone Group head, launched Sweetwater Capital Partners to invest in secondaries and direct investments on a deal-by-deal basis. In doing so, he joined an increasingly populous band of independent, or “fundless”, sponsors sourcing deals – often in the lower mid-market – and corralling investors on an opportunistic basis.

Independent sponsors and other professionals who find investment opportunities and raise capital on a deal-by-deal basis have been around for decades, but their number has increased in recent years. Although there’s no official tally, sources recently put their number in the US at between 500 and 1,000.

“We have more than 650 independent sponsors in our database,” says Christopher Sheeren, a partner with Huron Capital Partners, a Detroit-based lower mid-market private equity firm. “Four years ago, we had about 200.”

There are several reasons why this model is appealing to capital providers and private equity professionals alike.

With heightened competition for deals, both general partners and limited partners looking to invest directly are welcoming the opportunity to access incremental proprietary dealflow delivered by independent sponsors. Greater scrutiny of private equity funds from their LPs and regulators is also prompting private equity professionals to take the less conventional ‘fundless’ route.

There are three broad types of independent sponsors. The vast majority comprises experienced private equity professionals still several years from becoming partners at a large firm who have decided to jump ship. They have access to proprietary deals and capital providers and don’t yet want to go through the hassle of raising a first-time fund – although being an independent sponsor is often a precursor to doing so. The rest are either operational experts, who often parachute in as chief executives of the target company, or intermediaries, such as investment bankers.

“We work with a variety of different independent sponsors, from industry experts to financial experts,” says Brett Holcomb, vice-president of Chicago-based Prospect Partners, a lower mid-market firm working with independent sponsors. “It’s a fairly broad definition.”

Typical capital providers include GPs such as Prospect, Huron and Detroit-based Peninsula Capital Partners, as well as LPs like family offices and high net worth individuals who want to invest directly and welcome the access to exclusive investment opportunities.

“It’s difficult to find good quality assets to buy in the lower mid-market,” says Sylvie Gadant, a partner at advisory firm Citrin Cooperman and the head of its transaction advisory services practice. “Independent sponsors are providing private equity firms and family offices dealflow and these deals are less shopped.”

Being an independent sponsor can be lucrative for those professionals as the economics resemble those found in more traditional transactions and there are fewer parties with which to split the fees. There’s usually a closing fee, also called a success fee; a management fee, which is fixed or can be a percentage of EBIDTA and is shared with the capital providers; and a piece of equity tied to returns that’s akin to the carry (and should be the largest of the three pots).

LPs also benefit from working with independent sponsors, whether they invest directly with them or via a lower mid-market fund.

“Independent sponsors can help drive greater returns,” says Holcomb, whose firm counts Goldman Sachs, JPMorgan Asset Management, University of Notre Dame and Commonfund Capital among its LPs. “I’d like to believe our LPs appreciate some of the benefits our partnerships with independent sponsors bring to the table.”