Debt is easy (relatively speaking). It always will be. The debt portion of the overall capital structure is what most traditional bank financiers chase all day long. Equity, on the other hand, is much more difficult. Most people understand these principles when it comes to mortgage financing, but–for some reason–these principles are often woefully ignored when it comes to acquisition finance. Here are a few examples from recent vintage in our discussions with would-be clients looking to fund an acquisition:
The list could go on-and-on. The so-called independent sponsors of the world will always have more difficulty in raising equity over debt. Investors (especially debt investors) like to see some form of equity skin in the game. Theirs is a world of capital preservation, not capital appreciation. If they wanted appreciation, they would come in as equity holders. Debt lenders will take a first look at the assets of the business as a collateralization mechanism for the debt. Next, they will take a look at the person assets of whoever owns the equity–typically using things like Personal Guarantees on the loan. What about for those looking to raise the equity needed to put a sufficient “skin” into an merger or an acquisition? Here are some high-level thoughts for getting funded in this manner.
First, independent sponsors can take on many forms. Some are completely fundless, others come with some funds but may need more to round out a management buyout. Depending on the amount they bring to the table, the “rounding-out” can be done in an easier manner. Second, capital is not created equal. There is a big difference between accredited, individual investors and institutional investors–not just by definition. The way both groups treat investments can vary widely. There are some online investing platforms (including SearchFunder.com, among others) that are looking to change the way independent sponsors source their capital, the reality is that most individual accredited investors are likely not the best route for sourcing acquisition equity capital. In contrast, more and more private equity funds are looking to management buyout and savvy independent sponsors to bring them off-market deals.
In a world where investment bankers auction off deals to the highest bidder, independent sponsors can be a bright light in the dark room for sourcing quality, off-market deals. We are seeing more of these types of deals and engaging with some. However, the big question mark as it relates to getting funded is the sponsors themselves. When you reach out to an investment banker or finder and say things like, “I can get up to $200,000,000 in committed debt, what can you do to bring me the equity?” you are likely to receive major push-back. The process to raise the equity for larger transactions is going to be a slog as it can take a very long time. In addition, both investment bankers and private equity fund managers are going to see through a comment like that. They will see the sponsor for what they are: someone not sophisticated enough to know how deal financing actually works. At the end of the day, independent sponsors require an awkward mix of humility and sophistication.