David

Tell the ISCP Club a little about yourself and your firm and your experience working with the independent sponsor community:

I’m Patrick Floeck, Principal at Valesco Industries. I’ve been in the industry over a decade, beginning my career in leveraged finance with a focus on lending to lower middle market, PE-backed companies. I’ve now been with been with Valesco for over 5 years. I’m currently heading up the business development, marketing, and investment origination efforts for the firm, and also work closely with portfolio companies through board positions.

Valesco is a 25-year-old firm that began as an independent sponsor focused on performance and operations that has since migrated to fund management. Currently investing out of our second fund, Valesco has made 8 platform investments, 3 of which were to support independent sponsors. Independent sponsors are a significant part of the business development platform for Valesco as they provide a unique opportunity to partner with other like-minded professionals that bring different value sets to the partnership.

What do you think about the longevity of the independent sponsor model? How has or will the availability of capital for independent sponsors change, especially considering the pandemic:

The independent sponsor model has grown significantly and is now so engrained in the M&A community, I think it absolutely will remain as a strong participant in the industry. There are record amounts of capital being invested in private equity that requires larger funds to rely on independent sponsors as a channel to source good quality investment opportunities and leverage that resource to deploy more capital with fewer internal origination resources. The pandemic has already delayed much of the M&A activity and therefore will undoubtedly make it more difficult for independent sponsors to obtain equity and debt capital, but those that are diligent with a thoughtful investment thesis, and most importantly direct origination relationships, should prevail. I believe that is one of the highest degrees of value and independent sponsor can bring to the table; an investment opportunity through a proprietary relationship that is not being auctioned by and investment bank.

Some capital providers will only partner with an independent sponsor who brings specialized expertise to a deal and others don’t mind if the independent sponsor is more of a generalist. Where do you fall on that spectrum and why:

For Valesco, partnership is the largest concern when we enter a new investment, which comes in many forms with different parties. Each party will bring value to the partnership whether it is the seller, the management team, an independent sponsor, a co-investor, etc. Therefore, we do not necessarily have a concern if an independent sponsor is specialized or more general in nature, but rather they bring value to the partnership. That can be in the form of a proprietary opportunity through a direct relationship, specific operational skills or industry background, or experience with roll-ups and integration to build upon a platform. Whatever it may be, we look to see whether we can do it ourselves, or if the value is accretive to the whole partnership and all parties involved. At the end of the day, one thing has always held true; People do business with people they like. Therefore, when developing a partnership with an independent sponsor, we need to get along well and provide value to each other, and the company, to generate success.

Where have you found independent sponsors add the most value to your firm at each of these stages -- as a deal source, during due diligence, and also post close:

Picking up from my answer to the previous question, independent sponsors we have worked with have provided value in all of these areas; again, it just depends on the experience of the sponsor. We have partnered with independent sponsors who had a very clear investment thesis around a specific industry and knew the business model very well and how to attack the industry to be a top performer. We have also partnered with others who have a very well-run deal sourcing process that allows them to find good quality investment opportunities that are under the radar and often priced at a discount to market. Others have been in the private equity space for a long time and have strong relationships and diligence resources that make underwriting quicker and more efficient. The two fundamental rules for independent sponsors – always add value and never be an impediment.

Has the current environment taught you anything new about how deals can be better structured in the future:

One thing that has become very apparent is the necessity to put a responsible capital structure on a business, with the right balance of senior debt, subordinated debt, and equity. We will often get approached by independent sponsors that try to over-leverage a business and use subordinated debt in place of equity to try and gain a larger percentage of the common equity. This model works great in a growing economic environment, but when the world stops and revenue goes to zero, there is not as much room to draw additional capital for liquidity, nor is there significant equity standing underneath the debt. Periods like these highlight the value and benefits of performance driven economics – the better the business does, the greater the sharing of rewards. Structures with high, front end economics misalign risk and reward. At Valesco, we always strive to have the right balance of equity and debt which typically results in 3x senior debt and 4x total debt, and an appropriate amount of granted and performance equity for the sponsor that incentivizes partnership.

What has been one of your greatest success stories in partnering with an independent sponsor:

We currently have two active investments with independent sponsors that are performing well. One has been impacted by the pandemic but has a very strong long-term value proposition and we believe it will result in success for our independent sponsor partner and us. The other is a newer investment and is seeing growth through the pandemic and will result in what could be a record year for the company. Both relationships with the independent sponsors are unique and different in their own ways, and both bring value to the partnership. They are groups with whom we enjoy working and continue to look at new opportunities. We have many success stories from our days as an independent sponsor and we are excited to add a few more being the capital provider in the partnership.

Among our favorite stories, is one in which we were the independent sponsor. After courting a business owner and his wife (and partner) for over five years, including three near closes, we completed the acquisition of a niche, value added distributor with a long-time fund partner. Over the next five years, the enterprise value increased from $80mm to over $200mm. The successor management team (CEO, CFO, CSO, Ops Director) was put place, ERP was implemented, supply chain and warehouse operations were completely overhauled, margins increased at a faster rate than revenues, acquisitions were made – the list of accomplishments in partnership with management and the sponsor went on and on. There was plenty of hard work, challenges, and disappointments. But, to an outsider, it was hard to tell investor, executive team, and independent sponsor apart. It was a lightning in a bottle partnership.

Interviews