Private equity dealmakers are shunning big firms to go it alone

Pitching an institutional investor on a single private equity deal rather than a diversified fund was long deemed the sign of a buyout newcomer or a struggling rainmaker.

But now firms that take the single-deal approach — known in the industry as independent sponsors — are surging in popularity.

It's a way for employees at big private equity and advisory firms to strike out on their own, rather than wait for the current crop of senior partners to make room at the top for the next generation. For investors who've chafed at the slow pace of returns from buyout funds, it offers the hope of quicker paydays.

Even experienced financiers see investing on a deal-by-deal basis as a more promising path, including former Carlyle Group Inc. Chief Executive Officer Kewsong Lee, who founded BellTower Partners in 2023. BellTower has invested in three companies as an independent sponsor and exited two investments since its debut. 

"I like to think of it as a return to first principles," Lee, 60, said in an interview. "It's attracting sharp, proven, driven deal professionals who identify compelling investment opportunities without a committed fund." 

Even KKR & Co. co-founder Henry Kravis said a young investor should buy a small company and grow it through acquisitions, rather than starting a fund.

"The world needs another private equity fund like a hole in the head," Kravis told students during an event at Columbia Business School earlier this year.

Independent sponsor Altaline Capital Management was launched last year by mid-career veterans of TA Associates, H.I.G. Capital and KKR, spurred by a slowdown in deals and fewer opportunities for career advancement, according to Rafael Telahun, a managing director. 

"For folks who are in a hurry, those moments serve as a bit of a push," he said. In turn, the "pulls" were the volume of deals to be done in the lower middle market and the growing number of investors willing to finance those transactions, he said. 

Altaline has three active investments and exited one deal that Telahun completed before the firm's debut, which gave him confidence that the independent-sponsor model could work, he said. 

IVEST Consumer Partners had one recent success with Care Bears, the beloved 1980s children's brand that inspired TV shows and plush toys. The independent sponsor, which acquired Care Bears from the Weiss family in 2023 alongside traditional private equity firm Cloverlay, agreed last month to sell the asset to Authentic Brands Group.

During its ownership, IVEST relied on its intellectual property expertise to quadruple Care Bears' royalty income in three years, according to IVEST co-founding partner Aston Loch. 

"Independent sponsors are the next iteration of private equity," Loch said in an interview. 

The model is attractive because the fixed fees are lower and incentive fees are weighted toward the back end of the deal, after a firm has had a successful sale, according to Jeff Ennis, a founding partner of Ocean Avenue Capital Partners. His shop, with more than $1.9 billion of assets, raises funds that invest solely in independent-sponsor deals. 

Independent sponsors don't charge the usual 2% management fee that traditional private equity firms levy on assets under management in a fund. Instead, they typically take a transaction fee equaling 1% to 2% of the target company's value, as well as an annual monitoring fee of 3% to 5% of adjusted earnings before interest, taxes, depreciation and amortization. Carried interest, or the portion of profits they take, levels up after hitting certain performance hurdles. 

There are an estimated 1,400 active independent sponsors, about double the number in 2019, according to law firm McGuireWoods, which hosts an industry-leading conference that connects those firms with capital providers. That event had roughly 1,600 attendees last year, a sixfold increase from 2017.

"The independent sponsor universe only continues to grow in a healthy fashion because of the availability of capital to back them," said Jon Finger, a McGuireWoods partner.

Many independent sponsors are investing in deals that generate $2 million to $10 million of adjusted earnings, according to a report from advisory firm Citrin Cooperman. Independent sponsors accounted for 27% of transactions that closed last year on Axial, a deal network for the lower middle market.

Such deals have grown larger in the past 18 months, with enterprise values for some ranging from $500 million to $1 billion, said Matt Swain, global co-head of equity capital solutions at Houlihan Lokey Inc. He estimated that his firm has advised on 50 deals over the past three years.

"The independent-sponsor market is becoming much more institutional, much more complex," Swain said.

But in some ways it's just about going back to basics: Find a founder-run business that has room to grow, pull together a small syndicate of equity and debt investors, and buy it at lower valuation and with less leverage than what's typically used in larger deals. A growing number of baby boomers who founded businesses are looking to retire, and the smallest end of the private equity industry provides ready buyers. 

"Everybody is looking for alpha," said Sylvie Gadant, managing partner of transaction advisory services at Citrin Cooperman. "They're looking for other avenues to get a return on their capital."

Freedom and flexibility

Increasingly, dealmakers are leaving bigger firms, and they like the freedom and flexibility of investing without a fund, according to John Koeppel, team leader of the private equity and independent-sponsor practices at law firm Lippes Mathias. Successful independent sponsors are also often former private equity operators or people with deep expertise and contacts in a particular industry, he said. 

Lee's BellTower backs younger and ambitious people with "extensive domain expertise," he said. "They partner well for the long term with business owners who like their focus and energy."

The model also allows independent sponsors to focus on the health of the company instead of making decisions to benefit a fund.

"The money is being invested in creating value and not bureaucratic overhead, excessive fee leakage, and diluted carry to people not impacting the outcome," Lee said.

David Acharya started Acharya Capital Partners in 2020 after working at other independent sponsors. So far he has done two deals and exited one with the sale of event-marketing firm Impact XM, which generated a return on capital of more than 21 times for his investors.

Acharya said he has noticed a recent increase of new entrants to his corner of the private equity industry, which he attributes in part to a lack of other opportunities for advancement at bigger firms. 

"A lot of these professionals — including the fact that they haven't gotten a carry check in a long time because of the challenges in the exit market — they're saying, 'Instead of doing this, let's just go off on our own and become independent sponsors,'" Acharya said.

Steven McGrath, managing partner of Level Capital Partners, accidentally found his way into the independent world a decade ago after his previous firm backed away from private equity. He already had a letter of intent to acquire an anesthesia-management company and decided to seek investors on his own, McGrath said in an interview. He has since completed five deals and has one-full time investor employee, as well as operating partners who help on each deal.

Both McGrath and Acharya said they had considered raising a dedicated investment fund, which would mean moving away from the deal-by-deal model, but neither were in a hurry to do so because they liked the flexibility of being an independent sponsor.

The valuations tend to be lower than traditional private equity deals, with more than half having multiples of four to six times earnings, Citrin Cooperman said in its report. That compares with a median of more than 11 times for buyouts last year, according to a separate report from McKinsey & Co.

Proponents of the independent-sponsor model say it generates better returns with a loss rate that's similar to U.S. buyouts.

A University of North Carolina study commissioned by the Small Business Investor Alliance and its Independent Sponsor Forum found that such deals had a median gross internal rate of return that was about 5 percentage points higher than the industry benchmark. The mean total value to paid-capital, a measure of performance, was 2.86 times for independent sponsors compared with 2.13 times for the industry.

"While investment returns are likely to have a greater range of outcomes when compared to the universe of committed funds, it is too large a market to ignore given the high caliber of investors and operating executives focused on single deal opportunities," said Gabrielle Zadra, head of private market research at consulting firm Cliffwater.

The deals do come with certain risks that aren't present in the pooled-fund model. For one, would-be acquirers don't line up the financing until after they have a handshake agreement to purchase a company. That means that the sponsor could struggle to secure financing, causing the deal to fall apart.

The very nature of the transactions — founder-led companies that often lack professional capabilities like software to manage customer relationships — means there can be complexities that don't show up in bigger firms, but that's the opportunity, according to Peter Martenson, managing partner of Aviara Partners, which raises financing for independent sponsors. 

"You have to be able to look through some of that hairiness," he said.