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As an Independent Sponsor who launched his firm in 2006 and started building a portfolio of companies prior to the Great Recession, I see many similarities to the current economic crisis resulting from the pandemic. While the genesis of these downturns and the shape of their recovery may differ dramatically, the impact on investments and the response of investors is likely to be similar.
While being an Independent Sponsor has a lot of great attributes (flexibility, deal by deal economics, etc.), one of the main challenges is not having discretionary capital to call to support great opportunities or to defend existing investments. In good times, the Independent Sponsor can generally find needed capital. During a downturn, however, many formerly bullish LPs will lose their conviction, interest or even alignment with the independent sponsor.
Isn’t this, however, exactly the time that you want a partner to be there for support? While you may not have faced this issue yet, it is coming for many investors. During the last downturn, when we saw numerous add on acquisitions that would have dramatically enhanced the value of the platform investment, banks were more cautious on financing and investors were unwilling to write additional equity checks. Similarly, if a portfolio company stumbled and needed additional capital, our “partners” who had also provided debt for the initial investment could no longer find their “equity” hat. They funded more expensive mezzanine debt which put a larger burden on the cashflow of the company and put us as sponsors further back in line.
As an Independent Sponsor you may find you and your recent acquisition may be in a position similar to one of these cases:
Case A – you partnered with a family office to make an acquisition in 2019. The family office is no longer bullish on the space. The family office is expecting portfolio bankruptcies to tick up. Cash flow to service debt is drying up. The family office is no longer interested in exploring add-on acquisitions. You don’t feel this family office is equipped to manage distressed portfolios and lacks the track record to explore new commitments.
Case B – you partnered with a BDC to make an acquisition in 2018. While you started your partnership with an equity investor who also supplied the debt, all additional capital needs have been funded by debt. Deterioration in the credit markets and recent performance by the portfolio company now tests the relationship with the BDC. When you began the partnership you were at 3.5X leverage. Now through two months of COVID-19 you are levered at 8X and your “partner” is behaving as though you caused the virus!
Case C – you have an acquisition under LOI and had selected your debt and equity partners. Challenges in the portfolio of your partners drew their focus elsewhere and they are going pencils down on new transactions. Now your exclusivity period is expiring in six weeks and you need to reexamine how you will execute on this transaction. The QofE needs to be paid for and attorney fees are ever present.
In each case a fresh set of eyes and a new capital partner with plenty of dry powder may be the solution for survival or success.
Boyne Capital has its roots as an Independent Sponsor and was able to execute and thrive through the previous recession. Boyne Capital will persevere and support its portfolio and add to it through this crisis and economic downturn.
Please give us call if you come to the conclusion that you may need a new partner moving forward.