Family offices looking at investment options often gravitate toward deals that play to their strengths. That’s why Five Points Family Ventures, a single-family office established to manage the assets of the Hawkins family, which owns Crown Automotive Group, likes using independent sponsor deals to invest in lower middle market businesses.
“Our family has built very successful middle market businesses in legacy industries over 60 years: businesses that are easy to understand and hard to run,” says Sam Goodman, president of Five Points Family Ventures. “That’s exactly what the lower middle market is.”
In an independent sponsor deal, the sponsor raises capital on a deal-by-deal basis, as opposed to through a fund. Many of these deals target the lower middle market.
“For us, it’s a perfect fit,” Goodman says. “We understand sales processes, we understand how to manage complicated workforces, we understand all the things that middle market and lower middle market businesses in legacy industries have to navigate every day. We’re a good partner from an institutional knowledge standpoint. We also have really good connectivity in the communities that our own businesses serve, and we have often proved to be helpful post-closing through customer introductions, thought leadership or assistance with M&A. Sometimes we’ll join the board, or we’ll provide assistance in an informal capacity.”
There are a number of reasons that family offices and independent sponsor transactions can be a good match:
* Smaller deals.
“The deal size is naturally smaller. PE firms tend to focus on the biggest investors. In the independent sponsor world, there’s a wide range, but the majority of deals are usually between $3 million and $50 million of equity capital,” says Jason Beren, CEO of single-family office the Eastbridge Group. “That means a mid-sized family office writing a seven-figure check can be an important partner to the group.”
Family offices can get their diligence questions answered by management with higher priority than if they are a relatively small contributor to a much larger fund.
* Tax efficiency.
Another reason independent sponsor deals are a good fit for family offices is that they are more likely to be structured with U.S. taxes in mind. Many PE deals have non-taxable entities such as pension funds and sovereigns as their main investors, and they are evaluated and paid based on pre-tax returns. Investors in independent sponsor deals, by contrast, tend to be high-net-worth individuals and family offices, so there is more incentive to structure the investments in a tax-efficient manner.
“You are more likely to find deals that have a preferential tax structure in the independent sponsor world, especially QSBS [Qualified Small Business Stock] structures,” Beren says.
* Mutual benefits.
The benefits of the relationship between family offices and independent sponsors go both ways: Independent sponsors like family offices as investors, as well.
“When sponsors raise money from institutional capital that are writing larger checks, they tend to come with more requests: adjustments to fees, or a seat on the board,” Beren says. “When sponsors raise money from a syndicate of family office groups, there’s less likely to be a main anchor capital partner that is controlling the deal and asking to share operational or board-level control.”
Despite the benefits, it’s important to make sure independent sponsor transactions are a good fit for a particular family office’s investment style. “Independent sponsor deals require a level of nimbleness that a lot of family offices are not accustomed to,” Goodman says. “Funds are open for a year or two at a time. You have a long time to make a decision on whether or not you want to allocate. That’s not this world at all. You often have a month or two to make a decision. You have to move quick.”