Our guest for this week’s episode of M&A Masters is Jon Finger. Jon is a Partner at McGuireWoods LLC in Dallas, and his practice focuses on private equity and corporate transactions. He and his partners were the first in the area of independent sponsors to create a private equity practice dedicated to independent sponsors. Jon and his partners also created “Deal-by-Deal”, a podcast that focuses on the independent sponsor community of the M&A market.
Jon says, of this independent sponsor relationship, “Many of these sellers are selling their baby – this has been, and will be, their legacy. Finding independent sponsors who are really appreciative of that is a big part of what we look for in our network for the clients that we want to be working with.”
We discuss the importance of building a network and prioritizing the independent sponsor relationships, as well as:
- The difference between independent sponsors and other buyers
- Perceptions of private equity
- Finding creative ways and best practices to partner with independent sponsors
- The ideal client of the independent sponsor community
- Hybrid models of independent sponsors and private equity funds
- And more
Listen now
MENTIONED IN THIS EPISODE:
TRANSCRIPT:
Patrick Stroth: Hello there, I’m Patrick Stroth, President of Rubicon M&A Insurance Services. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today, I’m joined by Jon Finger, Partner and McGuireWoods. McGuireWoods is a full service law firm with over 1000 attorneys and 24 offices throughout the US and beyond. Jon’s practice focuses on private equity and corporate transactional matters from McGuireWoods, Dallas office. It is in the area of independent sponsors, where Jon and his partners were the first to create an M&A practice and ecosystem dedicated solely for this segment of private equity. So it’s a real great pleasure to have a true pioneer in a new class of business for private equity. Jon, thanks for joining me today.
Jon Finger: Thank you, Patrick. Pleasure to be here.
Patrick: Now, before we get into the practice of with independent sponsors, which literally did not exist until you guys came along, let’s start with you. Tell us how you got to this point in your career.
Jon: Sure. Really appreciate appreciate you giving me the opportunity to join you today. So I’ve been I’ve been practicing for about about 20 years. And about halfway through my career, which had predominantly been representing lower middle market, committed private equity fund clients, we saw a lot of activity within that independent sponsor community. And at that time, it was still evolving. The models obviously been around for some time, but it was really, I think, evolving into what has become today. And it just happened to be around the same time that myself and a few of my partners were changing law firms. And around that time, what we dedicated ourselves to was building our network. And so we had this network of capital partners, family offices, private equity mez funds, etc.
And as we built that network, what we found was, there was an incredible intersection with the independent sponsor community. And so as we were building the network, and our practice was evolving, what we like to think was our secret sauce was our ability to introduce investment opportunities to our network of capital partners. And so we were going to trade shows, we were calling on companies, we were doing all these different things. And we saw a lot of great success out of that. The reality is, it’s very time consuming. And so ultimately, what the a bit of a lightbulb moment was, the independent sponsor in our network can be doing a lot of that spadework if you will, for us. So as we started to see, okay, if we spent more time harvesting our independent sponsor relationships, and really finding opportunities that they had, that we could then introduce to our capital partner network, it really made what we were doing much more efficient.
And so we weren’t having to necessarily go out there, find those investment opportunities, we were leveraging the independent sponsor community. And so what really led to where we are today, I hearken back to that where it was a situation that we were at the intersection of capital partner, and deal opportunity. And so it really allowed us to differentiate ourselves with our network. And we we continue to do it today, with I think, really good results. And that that was probably the biggest pillar of what led to where I am in my practice today, where a lot of my work is, is with independent sponsors.
Patrick: And let’s get a little bit more detail with the independent sponsors. How are they different from private equity or other other investors or acquirers out there?
Jon: Sure. So lots of different ways, no doubt. I think the first thing I tell you is, of course, you know, every independent sponsor is different. That’s the beauty of it. That’s the fun of it. But as a general matter, right, independent sponsors don’t have a committed fund that stands behind them that they’re able to draw down capital for each deal. So you know, the independent sponsor, let’s say they’re putting in 500 grand sometimes seven figures. The reality is, most videos we work on me independent sponsor is putting that level of capital. And there’s another, you know, $10-20 million in equity capital and obviously lender coming in.
So the biggest difference right is they don’t have that committed fund behind them. What that also means is, it allows the independent sponsor to really identify the capital partner that makes the most sense for each opportunity and each situation. And so, you know, use the word the scope bespoke if you want. Luckily, I got the right on the second try there, but so it allows them to bring more of a bespoke nature to each opportunity that gives them that flexibility and differentiates them from a traditional private equity fund. Another I think area that I would want to really highlight with the independent sponsor is it’s a segment of private equity. But there is a perception out there with some sellers, that it’s, you know, big, bad private equity, right? And what does this mean for my business, and so a lot of our independent sponsors, really had the ability to play off that, and, and just, you know, many of them are entrepreneurs, many of them sold their business, and now they’re looking to acquire a business.
And just that ability, I think, that they demonstrate to relate to those sellers is another way that they’ve been able, I think, to differentiate themselves from more institutional, private equity. And, and it’s, it’s really something where I think the independent sponsor has also capitalized on these market dynamics, if you will, where you have the sellers, and you know, it’s it’s definitely a robust M&A environment, as you know, but there are a lot of other things that it allows the independent sponsor to come to the capital partner, and also have a situation where you can really be creative with the economics that the independent sponsor is, is receiving on each different deal. And so, you know, maybe it’s not a two and 20 structure, right. And so there are a lot of those different optionality, if you will, that the independent sponsor brings brings to the table, I’m sure we’ll, we’ll talk more about some of those things. But I think high level, those are probably some of the bigger differentiators.
Patrick: Well, I the perception out there. And this is why it’s so important, I’m so happy to have you here in the lower middle market with with sellers that need to know about all these different options out there on alternatives is where to go. Unfortunately, a lot of organizations, they, the owners, and founders who aren’t in M&A every day, if they don’t know any better, they default to, you know, a strategic, which may not have their best interests at heart, they may default to an institution, or you know, they may be fearful of private equity, and just shut the door on that completely. And that’s, that’s not at their advantage. And so it’s very important to understand that there are these great options out there.
And you know, quite frankly, until I learned more about your practice, I had a notion about independent sponsors where they were the sole source of capital, and so they only targeted smaller deals, they didn’t have the, you know, the reserves. No, they tap on that, and then they can leverage that to their interest, which is also I think their interest is is aligned with with the sellers. Explain how you guys develop this practice, just from the ground up. I mean, it because, and we’ll get into this a little bit more, but I mean, this is a pretty fragmented sector.
Jon: That’s the beauty of the sector. From my perspective, it is it is an endless ocean of opportunities for us to develop relationships, and add value to be independent sponsors. I think, as I look back on how the practice developed, you know, again, the reality is this model has been out there for a long time, back when it was, you know, a guy or gal with a deal who just, you know, was raising capital from his neighbors. And then it was called fundless sponsor, right, which I’ve really tried to push hard to get away from that one, because, you know, it does have a bit of a pejorative nature, but the reality is, it’s not true. I mean, these independent sponsors, yeah, they don’t have a $300 million fund behind them, but they’re writing meaningful checks on these deals.
So, you know, I think that evolution of, you know, bringing helping bring credibility to the market was something that really helped us develop the practice, but I think a few things I would point out kind of getting back to what I was talking about before. What we have the ability to do is, is really eliminate a lot of the friction in the system where, you know, independent sponsors may have the need to hire a placement agent sometimes right? For a given situation. And there may be instances where, look, what we’re trying to do is connect our capital partner relationships with our independent sponsor relationships. To be abundantly clear. We’re lawyers, we’re not bankers, we can’t get paid introductions, introductory fees, placement fees, so that friction’s gone, right, we’re just trying to put the right groups together to get deals done.
And so that was a really, I think, powerful message and continues to be. But of course, one of the things that independent sponsors always struggle with is dead deal risk, right? That’s part of the equation that they don’t have the ability to just have $100,000 dead deal expense and just draw down from a fund to pay it. And so, for us, it was being selective around developing relationships, that we really wanted to have 5, 10, 20 years down the road, and be creative with ways that we could truly partner with those independent sponsors. And so whether it’s discounting fees or finding other creative solutions, where it’s not okay, just write me a check. That ability, I think, to be shoulder to shoulder with the independent sponsor was was really powerful. What we did with our network was, as we found different opportunities to connect our networks, we created essentially YPO for independent sponsors, which are regional chapters of independent sponsors that get together, share best practices, and and ultimately find opportunities to connect people with deals.
Those chapters led to us developing our independent sponsor conference a few years ago, which in 2019, we had over 800, solely independent sponsors, and capital partners. And it was a great opportunity to get everyone together. And it was all people who wanted to be there because of who was there. Right. And, and that obviously had great benefit to us, not from a charging registration fees, but from a developing our network and our client base. And so that has really, I think, allowed us to take a leadership position in the independent sponsor community, and develop that practice, where I do think we’re regarded as the preeminent firm with independent sponsor transactions, either on the capital partner side, the independent sponsor side, and really just knowing what’s market, right. And that’s a critical component to all of these deals. We’re in the middle of our latest deal survey.
So we’re leveraging both our expertise, but now we’re taking that opportunity to get input from our network of what’s market on all different sorts of components of the deal. And so that’ll be coming out down the road. And then I think the last thing I would tell you about really being a true partner to the independent sponsor is, in the next few months, we’re going to be launching independentsponsorforum.com, which is our, I think, what we’re trying to do is find that next way to develop a true platform for the independent sponsors and the capital partners, that has a lot of great content, and really allows us to demonstrate, again, that leadership position within the community. And so that’s kind of, you know, starting from day one to where we are today, I think some of the, the hallmarks along the way that have really allowed us to grow the practice.
Patrick: One of the things I really appreciate what you’re saying I’m I’m a marketing guy at heart, I really enjoy messaging and the importance of communication. But, you know, you built the practice, largely not on just the relationships, but just the trust that you’re going to execute. You’re not getting paid just to be around and do introductions, but you’re literally your interests are aligned with the independent sponsor, and you want the best for them and it’s a small community, so clearly you are doing something right, because all you have is your reputation and you deliver. And execution I think is is important, particularly for a lot of firms out there, where they may have a lot of resources, have a lot of other things to offer and make a lot of noise, but at the end of the day it’s execution.
And this is a class of private equity that cannot afford as you said, you know, misfires And so that I think is critically important that you’re coming in and you’re delivering that. And then just through that great reputation now, the community is expanding, and you’re not sitting back. McGuireWoods is finding more ways to add value through information and best practices so that more deals happen faster, smoother, cheaper, happier, and and that aligns a lot of specialty firms. And so it’s such a pleasure to have a firm like yours to highlight on that. Now, one thing I will say is I’m very proud of our platform here at M&A, M&A Masters Podcast. But we’re not the only podcast out there that is talking about mergers and acquisitions and everything. Jon will talk about your your show, because that’s actually how I found you,
Jon: Sure. No fantastic. So one of the I think ways that we’ve been trying to transition and continue to grow a lot of what we’re doing. A couple of my partners, Greg Hawver and Rebecca Brophy really are spearheading deal by deal. And so it’s a podcast that’s focused on the M&A environment, but in particular, the independent sponsor community. And so we’re really trying to, I think, highlight, a lot of best practices within the independent sponsor community, also highlight different independent sponsors and capital partners. But to your point, particularly with what’s been happening in the pandemic, having that ability to find different ways to connect with your network, they’ve done an incredible job. And it’s, it’s, it’s definitely something we’re super proud of.
Patrick: Yeah, I consider the silver lining of the pandemic, the evolution of, you know, the the Zoom, and the podcast and the communication, because there are messages out there. And it’s just, you know, finding the right channel where there’s an area of interest. And I will tell you, there are over 1 million podcasts out there. And there wouldn’t be that many if there weren’t such a diverse amount of interest out there in need for information. And something that’s, you know, quite frankly, quite, quite easy to deliver. Jon, let’s talk about, you know, give me a kind of a profile of your ideal client with the independent sponsor. I know very similar to there are other things out there. If you’ve seen one independent sponsor, you’ve seen one independent sponsor. Is is there, you know, for others that are listening out there, give us an idea, what’s the ideal profile of a client from McGuireWoods with this practice?
Jon: Sure. So to your point, is, is definitely spot on. So within the independent sponsor community, there’s no question that there’s no one size fits all for what the what the ideal client for us is, in the sense that a lot of our clients in the independent sponsor world spun out of blue chip, private equity firms, they have that pedigree of doing deals, and now they’re doing deals as independent sponsors, they have been, and I think, will continue to be a great client base for us. At the same time, a lot of our independent sponsor clients are entrepreneurs who founded and sold a business. And now they want to go out and do it again, maybe they’re looking at bigger deals, maybe they sold their business to private equity, and started to understand that model better. And frankly, a lot of our independent sponsor clients who’ve been wonderful, are true CEO level talent, that, you know, maybe they made a lot of money for private equity.
And they have a Rolodex within a market or within a segment to say, I want to go out and do a roll up in this space. And that allows them with that domain expertise to really be a powerful and successful independent sponsor, and a great client for us. I think, when I look at some of the, I think, common characteristics, I would look at the independent sponsor who really wants a different value proposition who isn’t just looking for a lawyer that can draft a document for them and, you know, get them to closing. We’re looking for the client that really wants us to be their partner. And so whether it’s to the point about helping them find capital, helping them find, build out that executive team, helping them find the right provider, I mean, frankly, for services they need in conjunction with a deal.
We’re doing a lot with our CPA network, as you know, and I’m sure we’ll probably get into later, the prevalence of rep and warranty insurance on basically all deal sizes is huge right now. And so, where they say okay, who are the right firms to talk to, to go out to get a policy, our ability to say, okay, we’ve seen Patrick in action on X number of deals, and he’s really the value add guy around what’s important in this policy? What’s your history? What’s the claims history with this insurance? So I guess what I would say is that ability for us to really help develop the ecosystem and find independent sponsors that value, that benefit that we can provide is always huge for us.
But building those long term relationships, right, it’s we want that client, that’s not just coming to us for one meal, that over the next 20 years, we’re going to do 3, 4, 10 deals with them, and develop that trust. And that relationship, that’s probably the most important thing. And then ultimately, right, just doing the right thing, just finding people who they’re going to treat people, well, in particular, these sellers, many of these sellers, right. They’re selling their baby, right? I mean, this has been, and will be their legacy. And I think finding independent sponsors that are really appreciative of that is a big part of what we look for in our network. For the clients that we want to be working with.
Patrick: Well, there’s a couple of things you brought up there that we’re definitely going to segue into. And, one of them is, first of all, you cannot remove the human element with these transactions. You know, most people out on the street, they think M&A, they think Amazon buying Whole Foods. Company by company. This is people working with people. And you know, within that you got humans that are fallible, and there’s fear, there’s greed, there’s all these other emotions that come into these, you know, life changing in some cases, transactions. I mean, they’re they’re very, very big deals for people. And you cannot dismiss that. And so you’ve got that element where you met with reps and warranties insurance, the amount of risk, these deals do not happen in a vacuum, there is tremendous financial risk that can be out there for the seller, who is personally financially liable to their eventual buyers.
And when a business owner is not used to M&A, it comes a realization that it is they can’t hide behind their corporate veil, it is their personal assets, their wealth, their retirement, literally their house could be at risk. And that realization comes to them a lot of times after they’ve gone through due diligence, they’ve been trying to work with the other counterparty and work together. And all of a sudden, boom, I’m responsible for you with my wealth for something I may not have known about. And in the typical response for a real, savvy, educated, experienced buyer is, well wait a minute, I’m making, you know, 10s of millions of dollars bet that your memory is perfect. And I’m afraid I just can’t do that. And so you’ve got that conflict where you’ve got a buyer that doesn’t want to get stuck, you know, with a lemon, and the seller doesn’t want to be kept on the hook indefinitely, particularly for things they don’t know about. So you’ve got that natural tension that can devolve to being adversarial is really a danger out there.
And what’s been great is the insurance industry came in with an insurance policy that transfers that risk away from the deal parties over to the insurance company. And the benefit to a buyer is, hey, if you have a financial loss as a result of the breach of the reps, you have certainty of collection, and you’re not going to have to clawed back and have ill will toward your target company who is probably now partner of yours, okay, for the seller. The policy can replace 90% of an escrow. So less money from the purchase price is being set aside and goes right to the the seller’s pocket. So they get more cash at closing, even better to get the peace of mind that they’re going to keep more money because there’s not going to be the risk of a clawback and as you know, is a product that has stood the test of time and is being used, you know, quite a bit now throughout the M&A community.
The news that I want to share out this is that this product was reserved solely for deals that were $100 million transaction value and up, you had to have thorough diligence, you had to have, you know, audited financials, you know, do extensive third party diligence of which was very, very expensive, so it wasn’t a fit for the sub 100 million dollar deals. That’s changed, thanks to technology, thanks to competition, eligibility standards for rep and warranty insurance have never been simpler. The cost has never been lower. And the claims it’s been sustainable where the claims have not overwhelmed the industry so we can see these lower rates continuing for a very long time. And there may have been players in the M&A space that maybe thought about rep and warranty a year or two ago, and had a not so good experience. That’s not the case now. And the more people understand about that, the better. But again, you don’t have to take my word for it. Jon, good, bad or indifferent. share with me your experience with rep and warranty.
Jon: Sure. Excellent. Give you you know, I won’t choose your word I’ll tell you mine, right. It’s been it’s been phenomenal. And I think what I would say you hit on it, but I think my biggest takeaway that what, what I appreciate, and frankly, what my clients appreciate, is, if you’re doing a $20 million enterprise value deal, you can get rep and warranty insurance. And frankly, I’m doing one right now, that’s about 14 million. Right. And so, I think that that’s definitely something that my clients have not really understood as well as they should have. It’s not just the 50, 75, $100 million deal, you can really get a policy on a $20 million deal. That, you know, frankly, a lot of the time, as you alluded to the sellers rolling over, right, maybe they’re the CEO, whatever they are, and the idea that there’s going to be some sort of friction, right, or post closing dispute is just, it’s heart wrenching. It’s difficult in whatever word you want to choose. And having that ability to, for lack of a better phrase offload the risk, right.
But it’s, it’s to me, it’s less about offloading the risk. It’s offloading the friction, right? It’s, it’s having that ability to say, okay, let’s really focus on what’s best for the business going forward, let’s focus on growing the business. And if we ran into a issue with a customer, let’s not be focused on was there a breach of a rep, let’s focus on how do we make that relationship better. And so our experience with rep and warranty it with, if I look at my deals, it’s it’s probably two thirds of my deals, it’s probably maybe more, maybe less. But you know, two thirds of my deals have rep and warranty insurance. And it’s a great product. It’s it really has developed and mature, where it’s an incredible tool for all the reasons you stated, but I just can’t I can’t overstate the impact of having the ability post closing, not to have that immediate dispute, particularly when, as we all know, that first year that integration period, that can be the most difficult, challenging, time consuming. And frankly, it can it can really have a determination about how things and how relationships evolve. And again, just taking that out of the equation, to a, to a full extent, or a partial extent, is extremely helpful.
Patrick: Yeah, what’s real tragic, and, you know, these disagreements are all avoidable. Yeah, you know, insurance is not the magic bullet is gonna cure all ills, but just having that there lowers the temperature in the room. And then, you know, as we go on with life, I mean, there’s so much concern in M&A now about, you know, communication and culture and those types of areas that we didn’t think about 10-15 years ago. And so anything we can do to enhance the relationships, I think, is a definite net positive. Now, john, as we’re talking today, you know, we’re getting through the first half of 2021, we’re, you know, fingers crossed, we can see the end of the pandemic out there. I mean, it’s, it’s possible now, more so than before, you know, and in this, you know, circumstance, you know, what do you think, what trends do you see either for independent sponsors, specifically, or for M&A in general, for the balance of 2021? What trends do you see?
Jon: Sure, I think that maybe I’ll think a bit of the easier one is this is a very robust M&A environment. And I don’t think anything on the horizon for the next nine months, leads me to believe that’s going to change anytime soon. There’s just so much in the way of tailwinds going on with the economy going on with the reopening trade, etc. So I think generally M&A, it would be very surprising if we didn’t have a very strong year. On the independent sponsor side. I think you’re going to continue to see a few things. One, the the attractiveness of the deal by deal model in the independent sponsor framework, I truly believe will continue to grow over the next however many months and years. And so much of that comes back to, there’s so much dry powder out there, people are desperately trying to find different opportunities to get capital to work.
There is undoubtedly on the capital partner side, an interest in diversifying their private equity dollar investments, right. And so maybe they’re not going into the next Apollo or BlackRock or whatever it is, and finding an opportunity to be have more discretion over where their money is going. You know, and maybe it’s understanding the be independent sponsor oftentimes brings more proprietary deals brings more attractive deals, but at the end of the day, brings deals with the capital partner can say, yeah, I want to put my money behind this one. And that’s a different construct than just putting money into a private equity fund. So I really do think you’re going to continue to see that demand side from the capital partners. And then the independent sponsor, there’s a lot of reasons of course, why the model is so attractive. And it’s going to continue to be so and I think you’re going to continue to see increased supply of independent sponsors out there.
And so those factors together, I think, will generate a lot more independent sponsor transaction activity. Another trend I tell you that we really see and have seen is a bit of a increased focus on what I would call hybrid structures. So there’s definitely some good things about the committed private equity fund model, there are some good things about the independent sponsor model. And a lot of our capital partner relationships and clients are looking for as well as independent sponsor relationships. And clients are looking for opportunities to bring the best of both to their structure. And so there are a lot of different hybrid structures that we’ve been working on, that both sides of the equation are very interested in. And I think that’s going to continue as we project forward.
The last thing I’d probably put out there around the independent sponsor community is I have seen as the proliferation of independent sponsors continues, I have seen a greater focus with our independent sponsor community on being a bit of a more of a domain expert, and focusing more of their attention on I’m not just looking for a deal in manufacturing, business services, consumer healthcare, technology, you know, I’m going to be a SaaS guy, or I’m going to be looking at opportunities where I can bring my manufacturing expertise to bear and so I do think that the generalist independent sponsor will always have value. But I also feel like we’re going to continue this see this trend of independent sponsors being more focused on certain industries, where it ultimately just I think, allows them to bring greater value to their capital partner relationships.
Patrick: Well, I think the idea, first of all, that continuing innovation and iteration of the structures is is really encouraging because it’s not just one way or the other, let’s find a third way. And that seems to be prevalent. And I think that naturally, as you have more buyers coming into a space, you know, as with anything else, you’re going to have to differentiate yourself. And and I think that only as more value. More competition is always is always a real good thing. So great, great insights there. And we got to keep an eye out for that. Jon, how can our audience members find you and McGuireWoods, not only you know, for the McGuireWoods Dallas, but also for the upcoming conference that you’re going to be having? I believe it’s in October. And if you can restate again, the podcast.
Jon: Sure. So the podcast is Deal by Deal. Those will be coming out on a very regular basis. Our conference will be late October, in Dallas at the Ritz Carlton again, we have some really neat improvements going on this year. For more information. Pretty simple, independentsponsorconference.com. And then also keep your eye out for independentsponsorforum.com. We’ll be rolling that out in the next couple months as well.
Patrick: Jonathan Finger of McGuireWoods. It’s been an absolute pleasure. Thanks again for joining us today.
Jon: You betcha. Thanks, Patrick. I appreciate you.