At Main Street Capital Network (a syndicate of 120+ SMB investors—individuals, family offices, and funds), we periodically send a newsletter to acquisition entrepreneurs we've connected with. This week's article discussed the differences between running a self-funded search and the independent sponsor model. I'm sharing it below with the Searchfunder community in case others find it helpful.

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Self-Funded Searcher vs. Independent Sponsor

Those looking at larger deals often ask me about the trade-offs between running a self-funded search and the independent sponsor model.

In this email, I want to highlight the critical differences:

1. Investor economics

2. Your role with the target company

3. Transaction size

4. Investor base

Investor Economics

Self-funded searchers get a significantly larger share of a transaction's economics vs. independent sponsors, often ending up with 60-80% of the company, whereas independent sponsors get economics more in line with traditional private equity (management fee of ~5% of EBITDA, 20-30% carry above a hurdle, etc.).

For a more detailed review of the economics of both models, I recommend these resources:

- Self-funded investor terms: Investor Economics in Self Funded Search Acquisitions​

- Independent sponsor investor terms: McGuireWoods Independent Sponsor Deal Survey​

Your Role

Generally speaking, independent sponsors are compensated for finding a good deal and overseeing the target company, acting more as a chairperson than a CEO. The target company's manager will often remain in place, or the independent sponsor will be responsible for finding a new manager to run the business. That being said, some independent sponsors choose to act as CEO/Manager of the company they purchase. This is most common when they have relevant industry experience. Investors are comfortable with this, but it's not an expectation.

On the other hand, investors expect a self-funded searcher to be the CEO of the target company and stay involved with the business daily.

Transaction Size

Independent sponsors are generally focused on businesses with $3M+ EBITDA. Given their size, instead of financing 75-90% of the deal with SBA debt (as self-funded searchers tend to), these deals are often 50-60% funded by debt provided by an SBIC or traditional bank lender.

Equity Investor Base

An extensive universe of SBICs, private equity funds, family offices, etc., co-invest in independent sponsor deals. These investors rarely allocate capital to self-funded search deals, given the target company size, less investor-friendly economics, and the fact that it is a relatively new asset class.

Conversely, the self-funded equity investor universe is much smaller (and more weighted towards individuals). Still, given the size of self-funded deals, this isn't necessarily an obstacle outside larger transactions. This group of investors is usually also comfortable investing in independent sponsor deals.

Final Thoughts

There's no doubt that closing a larger deal is significantly more challenging. Getting an LOI accepted for a $10M+ deal in which you don't have the equity capital in hand is not easy. Additionally, getting past the credit committee of an SBIC or a bank making a traditional commercial loan is much more challenging than getting an SBA-backed loan approved.

With that said, no rule says you must stick with one path. On multiple occasions, I've met with self-described searchers who found a bigger deal and went the independent sponsor route or self-described independent sponsors who found a smaller deal and went the self-funded search route.

As long as you understand the path to closing a deal under either model, you can let the acquisition target you find dictate your final decision.

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You can learn more about Main Street Capital Network here.