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citrincooperman.com

CITRIN COOPERMAN'S 2019

Independent Sponsor Report WHAT’S INSIDE This is Citrin Cooperman’s third Independent Sponsor Report. The report analyzes the results of an online survey of 162 professionals in the independent sponsor sector and the insights from interviews with independent sponsors and capital providers. These individuals shared their views on topics such as deal flow and mechanics, capital sources, deal economics, liquidity events, and industry outlook.


2019 INDEPENDENT SPONSOR REPORT

CITRIN COOPERMAN

Executive Summary



Even in the short time since the launch of our first Independent Sponsor Report in 2017, we have seen significant developments in the independent sponsor landscape. The model continues to increase in popularity, the sector

such as deal sourcing, relationships with capital providers,

is becoming more professionalized, capital providers and

deal economics and liquidity events.

company owners are embracing independent sponsors in greater numbers and the market is providing opportunities that

We are happy that our prior Independent Sponsor Reports have

independent sponsors are uniquely poised to seize.

provided benchmarks and guidance to independent sponsors and capital providers and to hear that many of you have used

Doors that were formerly closed to independent sponsors are

the reports as an educational tool for those who are learning

now open.

about and transacting business in the space.

It is against this backdrop that we continue the analysis we

This year, we delve into independent sponsor economics in

began in 2017. Our survey of independent sponsors from

greater detail than ever before, with the hope that by sharing

across the country continues, exploring a wide range of topics

this information, all parties – those new to the space as well

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as established players, independent sponsors as well as capital

2019 INDEPENDENT SPONSOR REPORT

excited to see what is on the horizon for independent sponsors.

providers – will have a greater understanding regarding what the market will bear. We also hope that these detailed benchmarks

We are indebted to our survey respondents and our esteemed

and data points will help lead to further standardization of

group of external contributors, both independent sponsors

economic terms within the sector.

and capital providers, for sharing their insights with us and for making this year’s Report possible.

In addition, this year, our survey respondents and contributors shared their thoughts on the path forward: the outlook for

We hope that you enjoy the Report, and we look forward to

independent sponsor transactions, the evolution of deal

discussing our findings with you.

economics and the potential effects of a recession. We are Sincerely,

SYLVIE GADANT, PARTNER, CITRIN COOPERMAN

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2019 INDEPENDENT SPONSOR REPORT

CITRIN COOPERMAN

The Research This is Citrin Cooperman’s third Independent

Sponsor

Report.

This year’s Report incorporates

FIRM LOCATION The Firm Location of Surveyed Independent Sponsors:

results from an online survey and

interviews

with

40%

leading

29%

independent sponsors and capital providers.

16%

15%

15%

West

Southeast

Southwest

This year, through our online survey, 162 professionals in the independent sponsor sector shared their views on topics such as deal flow and mechanics,

Northeast

Midwest

capital sources, deal economics, liquidity events and industry outlook. The survey was conducted in May and June 2019, and interviews with leading independent sponsors and capital providers were conducted in August 2019. One hundred and forty respondents identified themselves as independent sponsors. The majority of this year’s independent sponsor respondents (58 percent) are at firms that have been in existence five years or less. Most firms (66 percent) represented in this year’s Report have two or three principals, and 25 percent have only one principal. The majority of firms have one professional who is not a principal. All major regions of the United States are represented by our respondent population.

Some statistics used throughout the report may reflect rounding. 4

42+58+z

FIRM LONGEVITY

58%

42%

5 Years or Less

6 Years or More


CITRIN COOPERMAN

2019 INDEPENDENT SPONSOR REPORT

TYPICAL EBITDA RANGE

TYPICAL EBITDA MULTIPLE

Typical EBITDA for Companies Invested in or Targeted:

5+56+18417

Typical Acquisition EBITDA Multiple for Transactions Closed in the Past Year:

54%

18%

$2mm - <$5mm

28%

4%

$5mm - <$10mm

14%

18%

<$2mm

3%

$10mm - <$15mm

<4x

1%

5%

$15mm or more

56%

4x - <6x

8x or More

6x - 8x

Not Applicable

INDUSTRIES TARGETED

65%

62%

52%

34%

28%

27%

22%

22%

16%

13%

Other

Tech, Media & Telecom (TMT)

N/A Industry Agnostic

Transportation/Logistics

Healthcare

Aerospace/Defense

Tech-Enabled Businesses

Consumer Products/Services

Commercial and Industrial

Business Services

Distribution/Manufacturing

Industries independent sponsors focus on*:

10%

* Multiple responses allowed 5


2019 INDEPENDENT SPONSOR REPORT

CITRIN COOPERMAN

Liquidity Events Not surprisingly, many (79 percent) of the “younger firms” (defined as those in existence for five years or less) represented in our study have not had a liquidity event. Among “older firms” (defined as those in existence for six years or more), 33 percent of them have had five or more liquidity events.

Of those firms that have had liquidity events, 18 percent have returned an average realized equity multiple of greater than 5x.

MULTIPLE OF INVESTED CAPITAL Average Realized Equity Multiple of Investment Returned to

3+3+8292113185z Investors:

3%

3%

5%

18 %

29%

13%

21%

6

8%

Never <1x 1x - 1.9x 2x - 2.9x 3x - 3.9x 4x - 4.9x >5x N/A


CITRIN COOPERMAN

2019 INDEPENDENT SPONSOR REPORT

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The Popularity of the Independent Sponsor Model “There’s been a proliferation of independent sponsors in recent years. They’ve become more mainstream, the model has become more accepted and there is a lot of capital to support good independent sponsors.” – Brian Kerr, Managing Director, Mezzanine and Private Equity, ORIX USA Corporation

More professionals are becoming independent sponsors than

drawn to it because it gives them the ability to drive and direct

ever before.

their destiny. It allows them to tailor strategies and time exits to take advantage of unique market conditions. It provides

“Ten years ago, there were just a couple hundred of us,” said

deal-by-deal economics and does not constrain them with

Richard Baum, co-founder and managing partner, Consumer

limited hold periods. And it allows them to avoid many of the

Growth Partners and an independent sponsor since 2005.

restrictions that weigh upon committed funds.

“Now there are a couple thousand.” The flexibility of the independent sponsor (“IS”) model is The benefits of the model are undeniable. Professionals are

66+51+39+27+22+2

WHY BECOME AN IS?

Why respondents became independent sponsors:

66 %

51%

39%

27%

22%

2%

Flexibility

Desire to sponsor deals

Wanted better economics

Able to participate in upside

Precursor to raising a fund

Other

particularly useful in the current market. As one of our independent sponsor contributors Zubin Avari, managing partner, Charter Oak Equity, noted, “If we had a committed fund, we’d need to deploy capital regardless of where we are in an economic cycle. We’re currently in a frothy market, which means it’s a great time to sell but not to buy. As an independent sponsor, we don’t have to deploy capital on a predetermined timetable.” The model also enables independent sponsors to be opportunistic about the types of investment opportunities they pursue. “We look for value where we can find it, but if we were in a fund, we’d have to limit ourselves to certain types of deals,” Mr. Avari noted. In addition, the model enables principals to sponsor deals and participate in the upside without the limitations of a committed fund.

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2019 INDEPENDENT SPONSOR REPORT

As in prior years, the biggest challenge for our independent sponsor respondents is finding deals at attractive valuations (cited by 72 percent). Not surprisingly, younger firms are slightly more likely than older firms to cite other factors - such as remaining viable without an ongoing source of cash flow - as their biggest challenges.

After years spent as an advisor to family offices, Greg Robinson, cofounder and managing partner of RLG Capital, decided to become an independent sponsor. “I realized I was sourcing a lot of opportunities for my clients but couldn’t put my own money in. I wanted to become a principal, and not only an advisor.”

access to capital, the independent sponsor model makes a lot of sense and can offer better economics than a private equity fund,” said Sylvie Gadant, partner, Citrin Cooperman. addition,

funds

with

greater

than $150 million in assets under management

have

considerable

compliance costs that lower returns. The

independent

5+19+3145z 7+73+20z

Do you plan to raise a fund with committed capital? “Younger” Firms (defined as those in existence 5 years or less)

4%

19%

“If you have a good track record and

“In

PLAN TO RAISE A FUND

sponsor

model

avoids those costs while allowing the potential for significant upside. It’s not surprising that the model has become increasingly popular over the last few years.” Even still, many independent sponsor respondents have considered whether to launch a committed fund. Younger firms are more likely to consider raising a fund with committed capital than their older peers.

45%

Yes, within 2 years Yes, eventually No Not Sure

31%

“Older” Firms (defined as those in existence 6 years or more)

20%

7%

Yes, within 2 years Yes, eventually No Not Sure

73%

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Deal Sourcing “Independent sponsors are gaining penetration with boutique and regional investment banks and are considered as credible buyers despite the fact that there’s an abundance of private equity capital available in the market.” – Brian Kerr, Managing Director, Mezzanine and Private Equity, ORIX USA Corporation

Boutique investment banks or business brokers remain

would have met our investment criteria, we reach out to the

the top deal sources for our IS respondents. Other sources

intermediary and ask them to keep us in mind for their next

such as service providers and operating executives lag far

transaction. It is all about staying ‘top of mind’ with them,” Mr.

behind. This breakdown has been similar over the years of the

Avari explained.

Independent Sponsor Report. RLG Capital has some deals that come in through advisors Like many of our respondents, Charter Oak Equity frequently

like investment bankers. “However, those deals tend to be

sources deals from business brokers. “We have an active

heavily shopped, and we don’t want to overspend because we

outreach strategy for brokers which has made a meaningful

know the market is frothy,” said Greg Robinson, Co-founder

difference in terms of the deals we see,” said Zubin Avari,

and managing partner.

managing partner. Mr. Avari agrees. “I think it’s very difficult for an independent “We comb through databases and publications to find brokers

sponsor to win in a competitive auction, and I’m not sure you

who bring one to two deals to market per year. In addition,

really win because you are paying the highest price in a well-

when we see deal announcements on a transaction that

marketed transaction,” he added.

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Some capital providers may also shy away from deals sourced through auction. “We generally prefer to not work with independent sponsors if the deal is shopped by an investment banker, with a few

2019 INDEPENDENT SPONSOR REPORT

DEAL FLOW SOURCES Most significant sources of deal flow:

84%

exceptions,” noted Gretchen Perkins, Partner, Huron Capital Partners. “From our perspective, our work with independent sponsors has the best chance of being successful when the situation involves an opportunity that hasn’t been broadly

34% 31% 28% 25% 24%

shopped,” she added. Given these factors, it is not surprising that many of our

8%

contributors emphasized the value of proprietary sourcing.

7%

Proprietary deals also often command better economics. “You will get better terms for a deal if it’s truly proprietary because then it’s an asset you control,” said Richard Baum, cofounder and managing partner, Consumer Growth Partners.

Boutique investment banks

Service providers

Company owners/managers Industry research/cold calling

Some independent sponsors find proprietary deals by working

Operating executives

Regional/national banks

closely with company owners or management long before a

P/E firms

Other

sale. For example, at RLG Capital, deal sourcing often comes through

raise the necessary capital.

concerted relationship development with CEOs, whether or not the company is for sale. RLG Capital may take an unpaid

Our IS respondents review a large number of investment

advisory board position and advise the CEO over several years.

opportunities in a typical year, more so than in years past. Fifty-

“If the company develops a strategy that we can help execute,

two percent of this year’s IS respondents say they review over

it might turn into a natural conversation about a sale,” said Mr.

100 investment opportunities in a typical year, whereas last

Robinson.

year only 41 percent said they typically reviewed that many.

Consumer Growth Partners provides advisory services to

Respondents continue to be selective about the opportunities

several clients on strategy, performance improvement and

they pursue, with nearly three-quarters submitting 10 or fewer

competitive positioning in addition to pursuing traditional

IOIs. Fifty-seven percent enter into one or two LOIs in a typical

independent sponsor deals. All of the firm’s advisory clients

year.

have a transaction in mind down the road, at which point the firm can put on its independent sponsor hat and help the client

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2019 INDEPENDENT SPONSOR REPORT

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What Types of Deals are Independent Sponsors Looking For? For independent sponsors, selection criteria for deals varies

creation,” not merely implementing a roll-up strategy. “We

significantly.

are targeting good, solid, American businesses,” noted Dean Emmerton, co-founder and managing partner. “We are

“Given intense competition for deals, many independent

not targeting the highest growth opportunities, but we are

sponsors are looking for deals that aren’t perfect, deals with

taking them from flat to two percent, five percent or even 10

some hair on them,” said Sylvie Gadant, Citrin Cooperman.

percent growth,” he added.

Others are seeking different types of transactions. “Our goal

“At RLG Capital, we’re able to do a deal at more than 8x EBITDA,

is to look for opportunities where we can create value or a

but we’ve never spent more than 6.5x,” said Greg Robinson,

value story that isn’t being well articulated,” explained Zubin

founder and managing partner. “We also like to invest closer

Avari, Charter Oak Equity.

to home [in Utah], rather than seeking out international opportunities which are expensive, require considerable

Emko Capital is looking for deals that allow “organic value

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travel and involve so many factors out of your control.”


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2019 INDEPENDENT SPONSOR REPORT

In each year we have conducted this survey, the number one

diligence,” said Sylvie Gadant, partner, Citrin Cooperman. “We

reason why transactions do not close is because of due diligence

seldom just confirm the acquisition target’s revenue, earnings

findings or concerns about deal fundamentals (cited by 79

and working capital levels. More often than not, we discover

percent of this year’s respondents). A little less than half of

issues during due diligence that negatively impact the proposed

respondents cite significant changes to financial performance

purchase price. Revenue recognition, inventory valuation, sales

post-LOI and the seller choosing to retain the company as the

tax compliance, and state nexus are usually on the top of the

next most frequent reasons why deals do not close.

list of culprits. Sellers should consider retaining a CPA firm to conduct a sell-side due diligence review to avoid surprises after

“Oftentimes we perform exploratory due diligence on

they go to market,” she advised.

independent sponsor deals instead of confirmatory due

TRANSACTIONS CLOSED TO DATE

Transactions anticipated to close in the next 18 months:

Transactions closed as an independent sponsor: # CLOSED

NONE

18-MONTH OUTLOOK

1-2

3-5

6-10

>10

# CLOSED

NONE

1-2

3-4

>5

PLATFORMS

15%

29%

34%

12%

11%

PLATFORMS

2%

84%

13%

1%

ADD-ONS

40%

21%

22%

8%

10%

ADD-ONS

20%

59%

13%

8%

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2019 INDEPENDENT SPONSOR REPORT

Do Independent Sponsors Need to Specialize? Through the years of the Independent Sponsor Report, respondents and contributors have been divided over the question of whether specialization is important for independent sponsors. The debate continues this year. “There are many independent sponsors who are generalists, but as a generalist, you may bring less value to a capital provider and may get less favorable economic terms,” explained Richard Baum, Consumer Growth Partners. “We aren’t looking for our independent sponsor partners to be experts in the art of performing the transaction closing mechanics,” said Gretchen Perkins, Huron Capital Partners. “It’s far more valuable when they bring industry or operations experience and connections or if they bring with them someone to be CEO or chair the board who has long-term knowledge and experience in that industry. We are looking for an independent sponsor who can help share the load of actually managing the company, and in those instances it may make sense to share economics,” she added. ORIX USA Corporation’s Mezzanine and Private Equity Group is market agnostic, investing in transactions spanning diverse industries. “We rely on our independent sponsor partners to deliver expertise relative to our investment,” said Brian Kerr, managing director. “We are looking for partners who bring operational expertise, domain knowledge or private equity experience with a similar asset or a similar business model.” For those independent sponsors who are generalists, a successful model can take different forms. Charter Oak Equity is a generalist, as they have a broad skill set and a long, successful track record. “We augment our skill set with specialists when required,” noted Zubin Avari, managing partner. “Independent sponsors don’t need to be specialists,” noted Evan Gallinson, managing director, Merit Capital Partners. “Most of the independent sponsors I see come from a lot of different industries and find an executive with industry knowledge. For us, the differentiator is really whether the price is attractive. In some industries like aerospace you may need specialized expertise, but in many of the ones we focus on – like manufacturing or distribution – it’s harder to require specialized expertise.”

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CITRIN COOPERMAN

2019 INDEPENDENT SPONSOR REPORT

CASE STUDY: Third Time’s the Charm The private equity firm Huron Capital had been approached

“We brought in an operating partner with deep industry expertise

twice to buy InterVision, a company that provides IT solutions,

and we built trust with the company founders who wanted a

infrastructure and services for the cloud ecosystem.

buyer that would take the company in a direction they agreed with and not fire employees,” said Greg Robinson, co-founder

“We historically have not been big IT investors,” noted Gretchen

and managing partner, RLG Capital. The IS firm won exclusivity

Perkins, partner, Huron Capital, and so the firm passed on

and then approached Huron Capital.

the investment twice: first when it was brought by a sell-side investment banker, as Huron didn’t have the resident knowledge

“When RLG Capital approached us, we were confident that we

and experience in the space, and then again when it was

could have a successful investment working with them because

brought by another source, for the same reason. Both times, the

they brought tactical expertise, knowledge and connections,”

people who brought the deal lacked domain knowledge and an

said Gretchen Perkins.

operating partner. The deal closed in 2016 (and at the time of close, RLG Capital The third time, the independent sponsor firm RLG Capital

split into two entities, RLG Capital and Bridger Capital). There

approached Huron Capital. InterVision would be the second

have been five add-ons since then.

leveraged buyout for RLG Capital (and the fifth portfolio company the firm invested in).

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2019 INDEPENDENT SPONSOR REPORT

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Capital Sourcing The top capital sources for independent sponsor respondents are family offices, high net worth individuals and mezzanine funds that co-invest. Younger firms are likely to rely more heavily on high net worth individuals than their older peers. Older firms are more likely to rely on mezzanine funds, buyout and one-stop funds than their younger peers.

CAPITAL SOURCES BY FIRM LONGEVITY

71%

68%

57% 57%

48% 45% 45%

43% 29% 29%

35% 19%

14% Less than 1 year

6% 6%

1-2 years

72% 56%

13% 10%

61% 59% 44%

46% 33%

26%

21%

15%

10%

5%

3-5 years

39%

34% 30%

21% 7% 7 % 4 %

Over 5 years

Family office

“Mequity” funds (mezzanine funds that co-invest)

High net worth individuals

SBIC funds

Buyout funds

“One-stop” funds that underwrite all the debt and equity

Own funds

BDCs

Institutional investors (pension funds, insurance companies, etc.)

Other

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CITRIN COOPERMAN

Many IS respondents and contributors noted that their choice of

2019 INDEPENDENT SPONSOR REPORT

on the deal itself,” explained Zubin Avari, managing partner.

capital provider is often deal-dependent. While Charter Oak Equity has done a deal with a large family office For RLG Capital, the type of transaction dictates which capital

that has a track record of doing deals and an institutionalized

provider the firm approaches. If the firm plans to retain control

investment process, the firm is wary of partnering with a

of the portfolio company, they will bring in a family office. “One

funding source that has not done several deals in the past, Mr.

of the advantages of working with a family office is they don’t

Avari explained.

want to be hands on, and we can take all or almost all of the management fee and have an active board role,” explained Greg Robinson. However, if growth is part of the investment thesis, the firm will partner with a private equity fund that will often have a control position. “We will source and structure the deal and develop debt options, but the private equity fund will often be the control investor,” explained Mr. Robinson. For smaller deals, the firm will retain a controlling interest, use more leverage and put up all the equity themselves. “It allows us to stay invested for as long as we need to which gives us considerable flexibility,” he added.

Emko Capital’s first independent sponsor transaction was funded by ORIX USA Corporation’s Mezzanine and Private

Other firms rely on mezzanine funds or SBICs.

Equity Group (which invests its own balance sheet capital in junior debt and equity financing options for lower mid to mid-

Mezz equity funds are a good fit for Consumer Growth Partners

market companies throughout North America), with smaller

because they enable the firm to purchase a controlling interest

investments from family offices and high net worth individuals.

or the whole company, with a capital structure of one-third

As a new independent sponsor, Emko Capital looks for “passive

equity and two-thirds debt. “These funds are very resource-

LPs who allow us to be hands on and who are patient capital,

constrained so we can bring them specialized expertise and

not those who are looking for a quick turnaround and exit,”

serve as an extension of their resources,” noted Richard Baum,

explained Dean Emmerton, managing partner.

co-founder and managing partner. “They also generally can’t take management fees so there’s no required split.”

Going forward, Emko Capital plans to migrate to a pre-selected group of capital providers that are family offices and groups

Charter Oak Equity has sourced capital from private equity funds,

like ORIX USA Corporation.

mezzanine funds, high net worth individuals, family offices and hybrid funds that only work with independent sponsors.

“We don’t want to pass the hat a thousand times. That would

“Hybrid funds analyze independent sponsors like an LP would,

take a lot of brain power and resources to manage,” added Mr.

conducting more diligence on the independent sponsor and less

Emmerton.

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2019 INDEPENDENT SPONSOR REPORT

CITRIN COOPERMAN

HIGH-NET-

SBIC & MEZZ

WORTH

BUYOUT

FUNDS THAT

FAMILY OFFICE

INDIVIDUALS

FUNDS

CO-INVEST

entive to do deals/appetite for risk

1,567

1,567

1,026

1,768

additional capital needed for the transaction

1,567

1,567

1,026

1,768

ho controls investment

1,567

1,567

1,026

1,768

me company with long title metrics here

1,567

1,567

1,026

1,768

me company metrics here

1,567

1,567

1,026

1,768

me company with long title metrics here

1,567

1,567

1,026

1,768

me company metrics here

1,567

1,567

1,026

1,768

me company with long title metrics here

1,567

1,567

1,026

1,768

me company metrics here

1,567

1,567

1,026

1,768

me company with long title metrics here

1,567

1,567

1,026

1,768

me company metrics here

1,567

1,567

1,026

1,768

me company with long title metrics here

1,567

1,567

1,026

1,768

me company metrics here

1,567

1,567

1,026

1,768

NARIO

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CITRIN COOPERMAN

2019 INDEPENDENT SPONSOR REPORT

CAPITAL PROVIDER ANALYSIS Please note that the below are generalizations and do not apply to every provider or transaction.

By the Numbers: IS Relationships with Capital Providers Of our independent sponsor respondents: •

41% have closed transactions where it was the first independent sponsor transaction for their equity funding source.

63% often use repeat funding relationships.

42% introduce an opportunity to their potential equity co-investor post-LOI, after they have exclusivity. 36% introduce the opportunity after the management presentation, pre-LOI.

65% typically serve as lead sponsor managing portfolio companies. 16% share sponsor duties with lead investor.

On the company board, 84% of IS receive the first call from management compared to their capital partner. 8% share responsibilities.

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2019 INDEPENDENT SPONSOR REPORT

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Broken Deal Costs

31+26+19+17+4+3

COVERING BROKEN DEAL COSTS

PAYING FOR BROKEN DEAL COSTS

What is your typical arrangement for covering broken deal

If you pay for broken deal costs, how do you pay your share?

costs with your equity funding source?

31%

26%

19%

60%

17%

4%

14%

3%

10%

7%

4%

3%

1%

IS covers broken deal costs

I pay with my own funds (service providers discount

IS covers broken deal costs prior to partnering with

their fees)

the equity funding source and equity funding source

Service providers roll fees into the next deal

covers broken deal costs thereafter IS and equity funding source share broken deal costs Equity funding source covers broken deal costs Other Target company agrees to cover some of the broken deal costs in the event the target company cancels the deal

I pay with my own funds (no discounts provided by service providers) N/A (I don’t pay for broken deal costs) Other 100% contingent fee arrangement with service providers The portfolio company pays for broken deal costs

When a deal falls apart, most of our IS respondents bear at

“Funded sponsors rarely pay for costs incurred prior to their

least some of the costs. Thirty-one percent cover costs in all

involvement in a transaction, but they do often share costs once

scenarios. Twenty-six percent cover broken deal costs prior

they are involved,” said Sylvie Gadant, partner, Citrin Cooperman.

partnering with their equity funding source but the equity

“Division of broken deal costs often varies based upon the

funding source covers thereafter. In 19 percent of cases, costs

funding source. Private equity firms are more likely to share or

are shared. These findings do not vary significantly by firm

bear the burden, but others such as family offices don’t want to

longevity.

do a capital call just for transaction costs.”

Most independent sponsors (60 percent) pay for broken deal

“Years ago we asked our independent sponsor partners to pay

costs with their own funds, and in most of these cases, service

travel and their attorney fees, and we picked and paid for the

providers discount their fees.

diligence providers,” explained Evan Gallinson, Merit Capital

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CITRIN COOPERMAN

2019 INDEPENDENT SPONSOR REPORT

Partners. “But now many independent sponsors are taking a

“We push back on broken deal costs during negotiations if an

more active role in leading diligence and want to pick their

equity funding source wants us to cover them,” said Richard

diligence providers. In those cases, we ask them to share

Baum, Consumer Growth Partners. “As an independent

the costs because we don’t have a relationship with the due

sponsor, we don’t have any funds earmarked for broken

diligence firm and can’t negotiate with them.”

deal costs. However, part of funded sponsors’ annual GP management fee is earmarked for such costs, and, as such,

However, some independent sponsors take a hard line on

we think they should pay most, if not all, of them.” 

broken deal costs. “Broken deal costs are important to us,” said Zubin Avari, Charter Oak Equity. “We ask our capital partners to foot the preponderance of them. If we do share them, we argue that we should pay a small share because, if we split them 50/50, then the incentive is for us to do a deal regardless of diligence issues. That doesn’t align anyone’s interests.”

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2019 INDEPENDENT SPONSOR REPORT

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Deal Economics In prior years of this Report, we noted the variation in deal

interest – in greater detail than ever before, with the hope

economics, in terms of how fees and carried interest are

of providing additional benchmarks and guidance to both

determined, as well as what percentages and absolute

independent sponsors and capital providers.

numbers are at play. In the area of closing fees, we found the greatest This variation was – and is still – driven by several factors,

standardization (typically two percent of enterprise value),

including the fact that economics are negotiated on a deal-

with some variation in whether those fees are rolled into equity.

by-deal basis, the type of capital providers involved in a

Management fees have greater variation, often dictated by the

transaction (and how many) and the size of the investment.

type of capital provider. Carry remains the “Wild West” of IS

In addition, many respondents and contributors noted that

economics, with considerable variation in percentages, basis

proprietary deals, specialized expertise and solid track

for hurdles and catch-up provisions.

records can also improve independent sponsors’ economics. This year, we examine the three types of independent sponsor compensation – closing fees, management fees and carried

“Over a decade ago, we spent the majority of our time convincing capital providers of the independent sponsor business model. And then we used to have a long negotiation about each aspect of economics. Now there’s more standardization and the market has a better idea what to expect.” – Zubin Avari, Managing Partner, Charter Oak Equity

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2019 INDEPENDENT SPONSOR REPORT

Equity Contributions: A Snapshot EQUITY CONTRIBUTIONS

CONTRIBUTED CAPITAL SOURCE

61+35+4B 49+5+406B 12+24+27101314B 57++201B22

Are you typically required to contribute equity by your capital

When you contribute capital, where does the money come from?

provider?

6%

4%

40%

35%

49%

61%

5%

Yes, always

Yes, sometimes

Contribute own funds

Raise equity from other investors

No, never

Roll closing fees into equity

Other

EQUITY PARTICIPATION AT CLOSE

EQUITY VESTING PERIOD

What is your firmâ&#x20AC;&#x2122;s typical equity participation on the closing date?

14%

When does your equity vest?

12%

1%

20%

1 3%

24%

57%

22%

10%

27%

2-5%

100% upon closing

6-10%

11-15%

Tiered vesting based on

16-20%

>20%

the performance

<2%

After equity sponsors receive predetermined return

Other

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2019 INDEPENDENT SPONSOR REPORT

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Closing Fees Closing fees are most often a percentage of transaction value,

firms may really need this cash. We’re happy to roll over

typically two percent of enterprise value, for the majority of IS

a portion of our closing fee but reluctant to roll all of it,

respondents. As a dollar amount, nearly half of IS respondents

especially if it’s a proprietary deal.”

receive $251,000 to $500,000. ORIX USA Corporation expects its independent sponsor Thirty-eight percent of IS respondents always roll a portion

partners to bring some amount of outside capital and roll

of their closing fee into equity. Twenty-six percent always roll

closing fees into equity. “Independent sponsors should want

their full closing fee into equity. There were no substantial

to put their own capital into the deals they say they believe in,”

variations in these percentages based upon firm longevity.

explained Brian Kerr, managing director.

“If independent sponsors fully roll their closing fee into equity, they are giving up an important bucket of cash compensation,” noted Richard Baum, Consumer Growth Partners. “Younger

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CITRIN COOPERMAN

2019 INDEPENDENT SPONSOR REPORT

CLOSING FEE CALCULATION

21+66+265B 7+30+4815B 1+10+539324B 26++19143B38

How is your closing fee typically calculated?

2%

TYPICAL CLOSING FEE

6% 5%

How much is your typical closing fee?

15%

21%

7%

30%

48%

66%

Flat number

% of transaction value

No closing fee, but greater management fee in year 1

<$100,000

$101,000-$250,000

$251,000-$500,000

>$500,000

Other

No closing fee

ENTERPRISE VALUE PERCENTAGE

If your closing fee is a percentage of enterprise value, what is it?

ROLLING CLOSE FEE INTO EQUITY

Do you typically roll your closing fee into equity?

1%

24%

3%

10%

14%

3%

26%

19%

9%

53%

38%

<1% 2% >3%

1%

Always in full

Always a portion

3%

Sometimes

Never

N/A

Other

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2019 INDEPENDENT SPONSOR REPORT

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Management Fees For over 40 percent of IS respondents, their annual management

“I believe independent sponsors should get closing and

fee is typically a percentage of EBITDA (five percent for nearly

management fees,” advised Brian Kerr, managing director.

half of respondents) with a floor and a cap. As a dollar amount,

ORIX USA Corporation. “We expect our independent sponsor

the fee typically ranges between $101,000 to $500,000.

partners to act as private equity groups, with that level of

Variation in management fees tends to be driven by the type of capital provider. Family offices, high net worth individuals,

professionalism. We want them to commit their resources and spend significant time managing the investment.”

mezz funds, SBICs and other passive LPs typically allow

“We don’t want an independent sponsor diverting its focus

independent sponsors to take a full management fee but may

from our investment team because they aren’t earning enough

include a floor and a cap.

in a management fee,” added Mr. Kerr. “Even in instances

For private equity funds that take management fees themselves, they often require independent sponsors to split the management fees. “Management fee negotiations with private equity groups can be more contentious because they often take a management fee themselves and view it as a fixed pie to split with an independent sponsor,” explained Dean Emmerton, Emko Capital.

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where we are very involved, we have never sought to share the management fee.” After years of LP pressure, some private equity firms no longer take management fees at the portfolio company level and therefore do not want independent sponsors to take such fees either.


CITRIN COOPERMAN

2019 INDEPENDENT SPONSOR REPORT

MANAGEMENT FEE CALCULATION

4 2%

18%

15%

EBITDA PERCENTAGE

11%

Flat number with escalations

% of EBITDA with no floor and no cap

Other

Flat number

% of EBITDA with floor and cap

% of EBITDA with floor but no cap

How is your annual management fee typically calculated?

9%

5%

TYPICAL MANAGEMENT FEE

7+6+491220B 5+46+432B

If your annual management fee is typically a percentage of EBITDA, what is that percentage?

20%

What is your typical management fee?

2%

7%

5%

6%

6%

12%

43%

49%

0% at 1% or less

2% 4% 6%

46%

3%

<$100,000

$101,000-$250,000

5%

$251,000-$500,000

>$500,000

N/A

N/A (have not closed deals)

N/A (no management fee)

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Carried Interest Independent sponsor economics are like the Wild West. Terms often vary based upon type of capital provider, but in terms of carry, in many cases, there are significant variations with no rhyme or reason.” – Dean Emmerton, Managing Partner, Emko Capital

Carried interest is the area of IS compensation with the

Several contributors and respondents noted that philosophies

greatest variability. Its range varies, with minimum carried

on carry have changed over the years.

interest most often between 10 and 24.9 percent and maximum most often at 20 percent or more. Sixty-one percent use full catch up provisions, and twenty-two percent do not use catch ups. IS respondents are somewhat more likely to use IRR (internal rate of return) than MOIC (multiple on invested capital) as the basis for a hurdle rate, which is most often between 8 to 9.9 percent. For those IS transactions with potentially longer hold periods, a MOIC hurdle can allow more flexibility.

“Years ago, it was somewhat normal course to get 20% carry after a return of capital and a modest 8% preferred, but, in today’s market, on the size deals we are looking at, the carry is likely to step up as return thresholds are realized,” noted Mr. Kerr. “Some independent sponsors are pushing for additional carry, but there are limitations to what the market will bear,” he added. Gretchen Perkins of Huron Capital agrees. “I think there is a cap on what independent sponsors can expect to earn in

“If we are not in a control position on the investment and

transactions. There’s only so much equity to go around. For

want to stay in a deal longer, it’s harder to hit our hurdles if

most private equity firms and family offices, we want the

we are using IRR and so we prefer using an MOIC structure,”

actual managers of the business to get most of the extra

explained Greg Robinson, RLG Capital.

equity because we want to align incentives so they benefit

Dean Emmerton of Emko Capital agrees. “We want to be based more on cash on cash returns and not IRR because the latter creates time pressures that may not fit the types of deals we do. We want the economics on the back end to be worth it.” ORIX USA Corporation’s Mezzanine and Private Equity Group builds its economics around MOIC and not IRR, says Brian Kerr. “IRR matters, but we’ve always structured the IS carry thresholds based on MOIC.” Merit Capital tends to use IRR but takes into account the time factor so they also use a combination of both IRR and MOIC, explained Evan Gallinson.

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from the equity value they create,” she advised. “We hope the additional skills and experience of the independent sponsor create an opportunity to drive above-market performance, and so we tier the economics to increase as performance increases. Said another way, they can get a bigger percentage of the pie as they help us grow the size of the pie.” “I think independent sponsors have a meaningfully larger percentage of the pie today than they have had in the past as the market has become more professionalized and evolved, and the sponsors themselves have become much more additive,” Ms. Perkins stated. “I think all of these developments are good for the market and good for the underlying companies.”


CITRIN COOPERMAN

2019 INDEPENDENT SPONSOR REPORT

MINIMUM CARRIED INTEREST

MAXIMUM CARRIED INTEREST

5+10+33182923B 1+3+114537B 12+39+27166B 8++1958536B1

What is the minimum amount of carried interest you can receive

What is the maximum amount of carried interest you can receive

on a typical deal?

on a typical deal?

3%

2%

1%

3% 3%

5%

11%

9%

37%

29%

33%

0% at <5%

18%

<5%

45%

5-9.9%

5-9.9%

10-14.9%

10-14.9%

15-19.9%

15-19.9%

20-24.9%

20-24.9%

25% or more

25% or more

N/A

N/A

HURDLE BASIS

HURDLE RATE

Which basis do you use as your hurdle?

What is the typical hurdle rate before carried interest kicks in?

3%

6%

16%

12%

5%

6%

1%

8%

19%

40%

27%

58%

No hurdle

IRR

No hurdle rate

>5%

MOIC

Combination: IRR & MOIC

5-7.9%

8-9.9%

10-11.9%

12% or more

Other

N/A 29


2019 INDEPENDENT SPONSOR REPORT

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2019 INDEPENDENT SPONSOR REPORT

CATCH UP PROVISIONS

61+17+22B Do you typically use catch up provisions?

22%

17%

Yes, in full Yes, in part No

61%

Sample Independent Sponsor Carried Interest Below are some of the most common carried interest arrangements used by our IS respondents: IRR - BASED

IRR & MOIC-BASED

10% carry after 8% preferred return

13% carry after 8% preferred return with full catchup

15% carry with 8% preferred return

20% carry with 5% minimum return

20% carry with 8% preferred return, then 50-80% catchup for sponsor, then 20% carry

10% carry after 8% IRR, additional 5% after 2.5x MOIC and additional 5% after 3x MOIC

10% after 8% preferred return, 15% after 2x MOIC, 17.5 after 2.5x, 20% after 3x with full catchup at each hurdle

10% after 8% preferred return, 20% after 2x MOIC, 25% after 3x MOIC, 30% after 5x MOIC

20% for 3x, 25% for 3-4x, 30% for 4x+, with 8% hurdle with a catchup

25% carried interest, subject to preferred return equal to the greater of 15% IRR or 2x MOIC

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2019 INDEPENDENT SPONSOR REPORT

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Looking Forward Near-Term Outlook for Deal Environment

35+17+48B 17+42+41B

CAPITAL SOURCING

EXIT ENVIRONMENT

Over the next 18 months, I believe capital sourcing will be:

Over the next 18 months, I believe the exit environment will be:

17%

35%

41%

48%

28+29+43+B

42%

17%

More competitive for independent sponsors

More favorable for portfolio companies

Less competitive for independent sponsors

Less favorable for portfolio companies

About the same

About the same

TARGET COMPANY VALUATION

Over the next 18 months, I believe target company valuations will be:

44%

28 %

32

29%

More attractive for independent sponsors Less attractive for independent sponsors About the same


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2019 INDEPENDENT SPONSOR REPORT

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2019 INDEPENDENT SPONSOR REPORT

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Outlook: Anticipating an Eventual Recession

“An eventual recession will undoubtedly impact independent sponsors, causing deal flow, increased competition and perhaps a winnowing out of less experienced or less successful independent sponsors.” – Sylvie Gadant, Partner, Citrin Cooperman

Nearly half (47 percent) of our independent sponsor respondents

In addition, the dwindling supply of companies will have a

expect the next recession will happen in the United States after

significant impact on the deal market.

2020. Thirty-one percent expect it will happen in 2020.

“Many businesses will decline or stagnate because of economic

Regardless of the exact timing, independent sponsors are

conditions and business owners will not want to sell at lower

currently entering transactions with this prospect in mind.

multiples,” advised Gretchen Perkins, Huron Capital. “The

As one independent sponsor respondent noted, as the “risk of recession steadily increase[s], deals done in this window will be very risky because of the high purchase price right before entering a downturn.” Several respondents and contributors noted they expect valuations will continue to remain high, even after a market correction and tightening of credit markets, given the amount of dry powder that will need to be deployed. Greg Robinson of RLG Capital anticipates that a frothy market will cause funds to take a break for a year or two which will

number of companies for sale or seeking capital will decline and therefore deal flow, deals done and dollars deployed will also decline.” “Less supply of deals is not good for independent sponsors because it is much harder to compete for deals when there are fewer around,” added Richard Baum, Consumer Growth Partners. However, for those independent sponsors with a good track record and strong relationships with capital providers, some believe the landscape will not change significantly.

mean fewer capital sources available. “We’re seeing it even

“Keep in mind the IS model wasn’t as prominent in the last

now, with some funds avoiding new platform investments

major recession,” stated Brian Kerr. “As it pertains to new

because they don’t want to overpay and instead just doing add-

investments, there may be some bias from lenders to work with

ons,” he observed.

funded groups, but I believe an IS with right capital partner

Other forces will also be at work. “With the exception of distressed opportunities, in a recession, good deals become scarcer and need more equity because the lending market contracts. Funded groups may come down-market since they have to deploy capital and that can also increase competition for traditionally marketed deals. I expect during these times independent sponsors that have been sourcing deals outside of processes will continue to find opportunities,” said Brian Kerr, ORIX USA Corporation.

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can mitigate that. Operationally I’d like to think that with fewer portfolio companies, independent sponsors will be able to move nimbly and work closely with the company management teams.”


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2019 INDEPENDENT SPONSOR REPORT

“In a recession, deal volume will go down, but I think independent sponsors will still do okay. When there’s a bit of chaos out there, independent sponsors can find unique opportunities.” - Evan Gallinson, Managing Director, Merit Capital Partners

“Even in a recession, there will be opportunities well-suited to independent sponsors. Many small and mid-sized companies will continue to have room for growth and increased profitability. Others will tap out at certain levels of sales and not know how to scale. These needs won’t disappear in a recession. And for these types of companies, independent sponsors can bring the expertise, strategy and oversight needed to grow and scale.” – Sylvie Gadant, Partner, Citrin Cooperman

“Given the proliferation of independent sponsor firms, the flexibility the model offers investors and increased professionalization of the field, I believe capital will be targeting this business model, even in a recession. I think the independent sponsor model will endure.” – Brian Kerr, Managing Director, Mezzanine and Private Equity, ORIX USA Corporation

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2019 INDEPENDENT SPONSOR REPORT

Closing Thoughts The goal of our first Independent Sponsor Report in 2017 was to shed a light on a sector which, as one of our external contributors described, was the “Wild West” of private equity. Back then, the independent sponsor space was a largely unchartered landscape, one without a playbook. In the years since, the sector has continued to evolve, with the model increasing in popularity and sponsors becoming more accepted by company owners and capital providers. There has been greater standardization in certain economic terms, such as closing and management fees, and less in areas like broken deal costs and carried interest. We have been happy to witness this evolution, both through our own dealings in the space and through this Report. And it is our hope that this Report will continue to serve as a playbook for those transacting business in the space, whether they are new entrants or established players. As we’ve seen through the years, independent sponsors are highly adaptable, cleverly opportunistic and often fearless. The independent sponsor model is here to stay, and we think its future is bright.

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2019 INDEPENDENT SPONSOR REPORT

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2019 INDEPENDENT SPONSOR REPORT

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About our Contributors Sylvie Gadant, Partner, Citrin Cooperman | (O) 973-218-0500 | sgadant@citrincooperman.com Sylvie Gadant is a partner with Citrin Cooperman’s Private Equity and Capital Markets Practice and is the Transaction Advisory Services (TAS) practice leader. She coordinates and leads buy and sell-side due diligence engagements for private equity firms, independent sponsors, family offices, and strategic buyers. Prior to joining Citrin Cooperman, Sylvie was the principal-in-charge of the TAS practice at a Top 20 national accounting firm, where she also spent more than 10 years in its audit and advisory practices. Learn more at: www.citrincooperman.com Zubin Avari, Managing Partner, Charter Oak Equity | (O) 203.221.4752 | zavari@charteroak-equity.com Zubin Avari has been with Charter Oak Equity and its predecessor fund since 1998. He serves on the boards of Seaboard Folding Box and Licaplast, and is a member of the Financial Accounting Standards Board’s Private Company Council. In his tenure at Charter Oak Equity, Zubin has served various operational roles at portfolio companies including executive chairman and interim CFO. Prior to joining Charter Oak Equity, he spent three years at Crowe Chizek (now Crowe Horwath). Learn more at: www.charteroak-equity.com

INDEPENDENT SPONSORS

Richard Baum, Managing Partner, Consumer Growth Partners | (O) 914-220-8337 | rbaum@consumergrowth.com Richard Baum co-founded Consumer Growth Partners (CGP) in 2005 as an investment and advisory firm with an exclusive focus on the retail and branded consumer products sectors. CGP is typically the first institutional investor in a company, but also serves as a primary business advisor to companies contemplating a capital transaction over a one- to three-year timeframe. Prior to co-founding CGP, Richard spent many years as one of Wall Street’s leading equity research analysts covering specialty retail. Learn more at: www.consumergrowth.com Dean Emmerton, Managing Partner, Emko Capital | (O) 215.356.4003 | dean.emmerton@emkocapital.com Dean Emmerton is a co-founder of Emko Capital, an industrial-focused private equity group where he leads the industrial investment efforts. Previously, he was an associate partner at McKinsey & Company focused on B2B Sales & Marketing in Industrials and Aerospace, and a manufacturing engineer for specialty chemicals and plastics at Milliken & Company and Celgard, LLC. Dean holds an MBA from Harvard Business School and a BS in Chemical Engineering from the University of South Carolina. Learn more at: www.emkocapital.com Josh Kowitt, Managing Partner, Emko Capital | (O) 215.356.4003 | josh.kowitt@emkocapital.com Josh Kowitt is a co-founder of Emko Capital, an industrial-focused private equity group. Prior to founding Emko Capital, he was an associate partner at McKinsey & Company where he led aviation, airports, and aerospace client service. Before McKinsey, Josh founded and sold multiple businesses, including Collegeboxes which is now owned by U-Haul. Josh holds an MBA from The Wharton School, and a BA from Washington University in St. Louis. Learn more at: www.emkocapital.com

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CITRIN COOPERMAN

2019 INDEPENDENT SPONSOR REPORT

Greg Robinson, Managing Partner, RLG Capital | (O) 435.565.1272 | greg@rlgcap.com Greg Robinson has over 30 years of business experience as a management consultant, entrepreneur/CEO, wealth advisor, and private equity investor. As a management consultant at Bain & Company, McKinsey & Company, Price Waterhouse and EHS Partners, he advised corporate clients on matters of strategic and operational significance to improve business performance and profitability. Greg co-founded RLG Capital in November 2013, where he and his partners have closed on investments in 16 companies. Learn more at: www.rlgcap.com .citrincooperman.com Evan R. Gallinson, Managing Director, Merit Capital Partners | (O) 312.592.6114 | egallinson@meritcapital.com Evan Gallinson joined Merit in 2005. Evan previously worked in investment banking with BMO Capital, William Blair & Company, and PriceWaterhouseCoopers, where he focused on mergers and acquisitions advisor work for middle market companies in a variety of industries. Evan received an M.B.A. from Northwestern University’s Kellogg

CAPITAL PROVIDERS

School of Management in 2002 with a concentration in finance. In 1997, he received a B.B.A. from the University of Michigan with a concentration in finance and accounting. Learn more at: www.meritcapital.com Brian Kerr, Managing Director, ORIX Mezzanine & Private equity | (O) 610.937.0443 | bkerr@orix.com Brian Kerr has spent 19 years working with lower middle market corporations and entrepreneurs on financial and strategic projects, including balance sheet recapitalizations, debt and equity alternatives, leveraged buyouts, and mergers and acquisitions. Prior to joining ORIX USA, Brian was the founder of Clairemont Capital Group, a lower middle market private investment firm. Before forming Clairemont Capital Group, Brian was a managing director at Cornerstone Capital Holdings and Penn Mezzanine. Learn more at: www.orix.com Gretchen Perkins, Partner, Huron Capital | (D) 313-962-5806 | gperkins@huroncapital.com Gretchen Perkins has over 30 years’ experience in the finance and business development sectors serving a variety of capital market participants. Prior to joining Huron Capital, Gretchen led the acquisition sourcing efforts at Long Point Capital, a middle market private equity fund. Gretchen also served as Vice President – Business Development for IRN, Inc., a market research firm, and has held senior business development positions at Fleet Capital Corporation and GE Capital Corporation. Learn more at www.huroncapital.com ABOUT THE WRITER: Melissa McClenaghan Martin President, M3 Strategic Alliances | (O) 917-715-8909 | melissa@m3strategicalliances.com Melissa advises firms on the creation of business development, thought leadership and women’s initiative opportunities that increase firms’ visibility, reach and revenue. Melissa has 20 years of experience working with financial services firms, and her thought leadership and consulting span various sectors including private equity, hedge funds, venture capital and real estate. Learn more at: www.m3strategicalliances.com

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Thank You Thank you for taking the time to read through this report. We hope that you found the information valuable and insightful. If there is anything you would like us to include in next year’s report or if you have any questions, please contact Sylvie at sgadant@citrincooperman.com.

REPORT ISSUED BY

CONTACT INFO

SYLVIE GADANT

T: 973.218.0500

Partner – Transaction Advisory Services

E: sgadant@citrincooperman.com

Profile for Citrin Cooperman

2019 Independent Sponsor Report - The Path Forward for Independent Sponsors  

Citrin Cooperman's 2019 Independent Sponsor Report presents the results of a survey of independent sponsors from across the country, discuss...

2019 Independent Sponsor Report - The Path Forward for Independent Sponsors  

Citrin Cooperman's 2019 Independent Sponsor Report presents the results of a survey of independent sponsors from across the country, discuss...