“Middle Market Private Equity is an inefficient market.”
– Bob Frisch , Frisch Capital Partners
This statement could not be more true. What one capital provider offers or proposes to an Independent Sponsor on his transaction verses another capital provider is always different and in many instances dramatically so. It is critical Independent Sponsors realize that the market is inefficient. This one fact often means the difference of an Independent Sponsor getting a great deal or just an average deal. Investment Banking boutiques such as Frisch Capital capitalize on the inefficiency of the private equity market for our clients assuring our Independent Sponsor gets the best deal possible.
If you pull up the website for almost any debt or equity fund or many family offices they have their investment criteria clearly stated. What industries or regions they prefer, ranges for revenue, EBITDA, margins and more. While the investment criteria may vary slightly between each capital source, it is the nuances of these differences that make the market inefficient.
In just one of the Independent Sponsor transactions that Frisch Capital worked on this year, we went out to scores of potential capital sources where we knew their investment criteria (size, margins, geography, etc.) fit that of our Independent Sponsor’s transaction. While some turned it down others said “yes” and they wanted to go further. Out of the ones that said “yes”, we ended up with a number of proposals.
Here is “the kicker”—no two proposals were close to being the same. They were all dramatically different...an efficient market? … no way! Don’t let anyone tell you it is. Frisch Capital takes advantage of that inefficiency and gets great deals for our Independent Sponsor.
To put it simply the most common, and costly, mistake Independent Sponsors make is not taking advantage of the market’s inefficiency. By not doing so Independent Sponsors hurt themselves in two ways, one of which can be catastrophic.
First, Independent Sponsors often speak to only very few capital sources on their deals. Why? Because Independent Sponsors have a lot to do as they continue due diligence, negotiate with the seller and begin preparing plans post-closing. Independent Sponsors also aren’t in the middle market capital raising arena every single day like Frisch Capital is. They don’t have the time or the energy to contact and reach out to a large number of capital sources.
However, the real mistake is often made when an Independent Sponsor starts depending on one capital provider (out of the handful he might contact) that shows interest. That capital provider tells the Independent Sponsor how the deal “should” be done and how all the other capital providers will look at the deal the same way as they are (implying that the marketplace is efficient). Needless to say, they are wrong and with over 20 years of experience raising capital for Independent Sponsors here at Frisch Capital we have proved the fallacy of that belief … every time.
By believing the market is efficient, Independent Sponsors often continue down a path with a single capital provider. The capital provider starts using up valuable LOI time with phone calls, questions , diligence lists etc. As a result, the Independent Sponsor doesn’t have time to go out and get a better deal and soon sees the window closing to even try to get a better deal. He is stuck and worse yet he has no back ups should his one capital provider walk away (Which happens more often than you might suspect). In addition, there is no competition to hold the capital provider’s feet to the fire.
Frisch Capital Partners always makes sure there is competition and our Independent Sponsors have back-ups on their deals. One of the most important services we provide to our Independent Sponsor clients is this competition and "certainty of closing".
To go back to our example above, after going out to capital sources, we had two top contenders with proposals we were considering, but after one month they both backed out. However, Frisch Capital had back-ups; we had continued to pursue other capital sources all along. This meant that when the two backed out, there were two others ready to take their place. We closed the transaction and by realizing the inefficiencies of the market we also got a fantastic deal for our Independent Sponsor client.