The Art of Fundless Sponsorship

The act of using other people’s money to bootstrap yourself into a deal is an alluring notion. Everyone wants to do it, but it’s not easy to pull off.

As more Private equity firms go up market, the middle market, especially the lower end, is covered by smaller funds and fundless sponsors.The fundless sponsor plays a valuable, pollinating role in the creation of actionable deals in the middle market ecosystem.

They do heavy lifting on the front end of the deal, building trust with the company and coming up with structure of the deal. Fundless sponsors sometimes don’t get the respect they deserve, especially from private equity firms.

Mezzanine funds more highly value the contribution of fundless sponsors. All fundless sponsors have the same goal – to own a controlling interest in a company.

To get to that point, they need to create value and have credibility in the eyes of the lender. Smart mezzanine lenders want to do business with fundless sponsors that bring high value to the table. Here is how you do it:

1. Ensure your deal has relevance to your domain expertise – Fundless sponsors need to focus on companies they understand, where they have background in the industry. Knowledge is power, especially in the eyes of a mezzanine lender. You need to be able to articulate a strong investment rationale as a buyer to build credibility.  When you have an insider’s knowledge of how a specific company works, and what industry challenges it faces, a lender will have comfort in your investment rationale and vision.
2. Have a large back end– This means you need at least 20% to 25% of seller paper or earn out in your deal structure. 100% cash out deals are difficult to finance by any lender with a fundless sponsor. The deal needs to align with the lender’s leverage multiples and equity percentages. The larger the back end to the seller, the less cash the fundless sponsor has to put in to close.
3. Bring some cash to the table –Fundless sponsors can’t be penniless sponsors. You need to have a respectable amount of cash so the lender sees you as a person of financial means. You don’t need to bring the same size of check as a private equity firm would, but the check needs to be large enough to build credibility in the eyes of the lender.
4. Develop a growth plan –there is no better way to be seen as a value-added buyer, than to have a fully developed, strategic growth plan. When you are able to articulate a cogent growth story or roll-up story, you have credibility in the eyes of the lender. This differentiates you as builder of businesses as opposed to just a financial engineer.
5. Find the right mezzanine lender – many mezzanine lenders partner with fundless sponsors. In these deals, a mezzanine lender can go deeper in the capital structure and get more upside. Mezzanine lenders are almost always in a minority ownership position, regardless of how much cash they lend. They are also more reliant on the skill set of the fundless sponsor for relationship building and business building, than a PE fund would be.

Follow these steps, and become a master in the art of fundless sponsorship. If you do this successfully, you may become your own equity sponsor.