Permanent Equity Weekly #49

The four kinds of buyer. Private equity, fundless sponsors, search funds, and permanent capital — each sourcing capital differently, and therefore each offering a different certainty of close. The clearest short explanation in the corpus of why who is buying changes what the deal is.

Notes

• Typically, financial sponsors can be broken down into four groups: Private Equity, fundless sponsors, Search Funds, and permanent capital sources. Each type of buyer comes with different sources of capital, different time horizons, and different leverage profiles, so it is important for sellers to think about what their ultimate goals are when considering selling their business. Looking for the highest possible payout up front? A firm that uses tremendous amounts of non-recourse debt will likely win the bidding war. What about sellers who care about the business’s health post-close? All things being equal, a buyer who employs less debt or no debt would be a better choice.
• Certainty of close always matters, so it’s important to note where each group sources their capital, both debt and equity, and what type of leverage they will employ. During economic expansions, capital flows are strong and transaction risk is lower. Said differently, when it’s relatively easier to procure both debt and equity, certainty of close is less of an issue. But during tougher economic times, like we’re in today, being able to close is far more important than the price or the terms. Without the ability to close, nothing else matters.
• Traditional private equity groups are largely dependent on their lenders to finance levered transactions. Search funds are beholden to their limited partners to commit additional capital once they have identified an attractive acquisition target, and often employ meaningful amounts of bank debt. Fundless sponsors, by definition, need to source both equity and debt for each transaction.
• Private Equity Sponsors
  • Large number of Limited Partners commit capital to a fund which is deployed into operating businesses
  • Typically use moderate to high levels of debt mixed with low to moderate amounts of equity
  • Holding period ranges from 1 to 7 years
• Fundless Sponsors
  • No committed equity behind the individual(s) or group looking to acquire a business
  • May have a plan to hold the business long term, but most likely will look to sell to harvest their investors’ capital
  • May or may not want to operate the business, and may be looking to simply purchase the business with existing management or provide new management post-close
  • Typically uses moderate to high amounts of debt, as well as seller financing
• Search Fund Sponsors
  • Have intended, but not committed capital from typically smaller limited partners including family, friends, and family office capital
  • Will typically operate the business post-close
  • Typically uses moderate levels of debt to fund the transaction and may ask for seller financing
  • Small number of Limited Partners who invest with the ‘searcher(s)’
• Permanent Capital Sponsors
  • Family Offices, conglomerates, permanent capital investment groups
  • Typically have longer time horizons and are able to fund transactions with cash equity and little to no financing risk, although style is buyer-dependent