Selling to Independent Sponsors

Selling to Independent Sponsors Fact, Myth, & Trends Spring 2017

Intro/Bio - Clavis Capital Partners Todd Dauphinais Biography Founder of Clavis Capital Partners, a Dallas based private equity firm focused on investments in the lower middle market manufacturing and industrial services sectors. Previous experience as an Investment Partner and Head of North American Operations at Aster Capital, a $200m early stage investment management firm based in Paris, France. Served as President and CEO of EFI Electronics, Inc., a manufacturing firm focused on the design, manufacturing and sale of complex electrical/industrial products on a global basis. Led the North American Corporate Development and Merger and Acquisition team at Schneider Electric; completed and integrated 12 acquisitions ranging in size from $6MM to $250MM. Holds an M.B.A. with honors from the University of Notre Dame and a B.B.A. in Finance from Texas A&M University. Overview of Clavis Capital Partners Founded in 2014, Clavis focuses on investments in under-resourced, lower middle-market manufacturing and industrial businesses with enterprise values from $15m to $100m. Clavis made its first acquisition in October 2015 of Solair Group, a leading global supplier of after-market maintenance tooling products and services to major airlines, military, and maintenance, repair & overhaul (MRO) companies around the world. In August of 2016, Clavis acquired Alliance Tank Service, a leading manufacturer of above ground steel storage tanks for the petroleum, agriculture, asphalt, and chemical industries. Confidential 2

Agenda Who am I and Why am I Here? Goals for the Session Description of Independent Sponsors Selling to Independent Sponsors - Fact vs. Myth Things to Look for When Selling to an Independent Sponsor Confidential 3

Goals for Session Explore the Various Types of Fundless Sponsors Discuss the Evolution of the Fundless Sponsor Model Compare & Contrast Independent Sponsors and Traditional Private Equity Why Would You Want to Sell to Independent Sponsors? Things to Look For When Selling to Independent Sponsors Confidential 4

What is an Independent/Fundless Sponsor? An Independent Sponsor is an individual or group that sources business acquisition opportunities but does not manage a dedicated pool of equity capital Independent Sponsor Traditional PE Exit Search for Deals Exit Raise Pool of Capital (1-2 years) Operate Business Raise Capital for a Specific Deal (1-6 weeks) Invest Capital Search for Deals Invest Capital Confidential 5

Types of Independent Sponsors Independent Sponsor (Investing Background) Heavy PE or Investment Banking experience usually in previous fund Capital connections from previous employer/ relationships Capital sourcing experience Deal execution experience Valuable relationships for capital, banking and deal advisory Independent Sponsor (Operating Background) Heavy operating experience Former C-level management Very active in operations Generally in later stage of career; more mature Industry specific connections Industry knowledge and expertise Very credible with capital providers Search Fund Raised small amount of capital from multiple investors for deal sourcing and operations Principals are typically earlier in career Looking for a business to run day to day Capital backers often get first right of refusal for investment in search fund targets Broad capital connections Family Office Often invest with other family offices, PE funds or Hedge Funds Starting to source more direct and independent sponsor-led deals Operational contacts and deal sourcing contacts Confidential 6

Advantages to Being Fundless Ten years ago, Fundless Sponsors were primarily people who couldn t raise a fund on their own. Now Fundless Sponsors are choosing not to raise a fund. Debt and Equity Capital is Readily Available The marketplace has evolved to where it is no longer necessary to raise a fund in order to close PE deals in a timely manner Historically high amounts of un-deployed capital are chasing deals Regulatory Burden New financial regulations in response to the financial crisis created a more regulated and scrutinized fundraising environment Significant time, effort and cost are associated with raising and managing a fund Time Commitment It takes a considerable amount of time to raise a committed pool of capital, which can be better spent sourcing proprietary deals for investors Mitigate Misaligned Incentives Traditional funds are financially incentivized to deploy capital no matter the cost in order to collect additional fees The fundless sponsor model targets quality deals where they can drive value, lets the investor choose which deals to invest in and has lower fee structure Confidential 7

Rise of the Independent Sponsor The Independent Sponsor model has been around for 30+ years The 2008 financial crisis, increased regulatory scrutiny (brought on by Dodd-Frank disclosure requirements), as well as an explosion in debt and equity capital overhang has led to significant growth in the independent sponsor model (35% CAGR since 2008) Multiple mid-career Private Equity professionals have left their previous funds to start new firms, bringing with them capital connections and transaction expertise Limited partners are looking for ways to increase direct deals through independent sponsors at a rate never before seen; LPs valuing operation experience brought by many independent sponsors LPs are tiring of investing into blind pools with no input into investments Larger funds returns have lagged the broader market Tired of paying large management fees to private equity funds Investors are fueling the growth of the independent sponsor model by continually searching for ways to invest in PE deals without paying large management fees. Confidential 8

Rise of the Independent Sponsor Result is a Whole Class of Very Experienced Independent Sponsors Just the group above represents over 200 transactions completed Confidential 9

Recent Growth of Independent Sponsors The number of independent sponsors has doubled in the last five years; Now represent a significant share of the market and a dominant percentage of the lower end of the market Fundless sponsors raised over $4 billion in capital in recent years to execute specific transactions While the total number of independent sponsor firms is unknown, most data suggests that there are over 1,000 fundless firms now in the market actively pursuing deals Middle Market Deals Closed by Independent Sponsors Number of Independent Sponsor Firms 16% 1,000+ <5% 2010 2016 By many accounts, independent sponsors are the dominant player in the lower middle market 200 We ve got north of 650 independent sponsors in our database. Four years ago the number was 200. Chris Sheeran, Huron Capital 650 2012 2017 Source: Blackford Capital, Huron Capital, PitchBook Confidential 10

The Independent Sponsor Ecosystem In response to the significant growth of independent sponsors, several organizations have sprouted to serve the needs of the independent sponsor community: Capital Funds Targeting Independent Sponsor Partnerships Other Capital Sources SBIC Funds Family Offices Traditional LP s Insurance, Pension Funds Hedge Funds Traditional Private Equity Funds Organizations Networks ISOD Independent Sponsors of Dallas Independent Sponsors of Chicago Independent Sponsors of LA Confidential 11

Where Do Independents Go For Deal Flow? Independent Sponsors often cultivate alternate relationships with advisors and firms in the lower middle market to generate deal flow: Large Investment Banks Advisors & Business Brokers Service Providers Online Networks Proprietary Traditional Private Equity Independent Sponsors Confidential 12

Advantages of Selling to Independent Sponsors Motivated Buyers Buyer Focus Dealing with Decision Maker Speed and Flexibility Operating Experience Personal Attention to Portfolio Unlike PE firms that are compensated on fund size, Independent Sponsors are compensated based on completed deals; As a result, these buyers are more motivated to get a deal done than traditional PE firms which may have competing interests While traditional PE firms may have multiple deals at a time (or may be fundraising their next fund), Independent Sponsors traditionally are working on getting 1 deal - your deal - closed exclusively Unlike traditional private equity funds, Independent Sponsors don t have Investment Committees and multiple (faceless) partners that need to be satisfied to approve a deal; You are dealing directly with the decision maker While securing funding might add some time to the process, the lack of an Investment Committee, other partners and competing deal priorities actually decreases the time needed to complete a deal with an Independent Sponsor. Independent Sponsor also are generally more flexible in structure than traditional PE firms Independent sponsors are specialized investors with direct experience in their niches. This allows them to bring true operational experience to their portfolio companies and add more value (the second bite at the apple) Business owners and brokers benefit in the long run from partnering with investors who pride themselves on being operationally focused and bring true value With fewer investments, IS spend much more time with their portfolio companies Confidential 13

Fact vs. Myth Confidential 14

Common Misperceptions in Selling to IS Concerns Funding Independent Sponsors wont be able to secure the financing to get my deal completed Valuation Independent Sponsors wont pay a fair/high multiple for my business Certainty to Close Traditional private equity funds are more likely to get to the closing table than independent sponsors Value An Independent Sponsor wont bring as much value to my seller as a traditional PE firm will Confidential 15

Funding Concern: Independent Sponsors wont be able to secure the financing to get my deal done Fact: Capital is readily available to complete deals; Experienced Independent sponsors have significant capital relationships and multiple options to choose from to complete transactions Independent Sponsor Funding Partners Mezz / Equity Funds Unitranche funds SBIC Funds Family Offices Traditional LP s Insurance Funds, Pension Funds Hedge Funds Traditional Private Equity Funds $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 Dry Powder ($B) $1,384 $1,466 $1,241 $1,239 $995 $1,067 $1,056 $987 $1,006 $952 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Clavis Recent Experience Recent transaction closed terms sheets from 4 different equity groups Investment groups included: family office, institutional fund, insurance company, hedge fund Current transaction secured equity and mezz debt commitment with 1 presentation Source: PitchBook Confidential 16

Valuation Concern: Independent Sponsors wont pay a fair/high multiple for my business Fact: Market conditions, competition for deals, and quality of targets determine multiples regardless of buyer Independent Sponsors are Paying Competitive Multiples More competition in the lower middle market is driving higher multiples Independent sponsors only get paid if the deal gets done causing them to bid at or above market to win deals Independent sponsors can justify paying higher multiples because they can operate the company to drive EBITDA Investors can stomach higher multiple deals in the lower middle market knowing that independent sponsors will drive EBITDA value more than traditional funds Independent sponsors and LP s can then benefit from multiple arbitrage once they cross certain EBITDA thresholds Independent sponsors are winning deals, so clearly they are paying the multiples that the market demands 12.0x 10.0x 8.0x 6.0x 4.0x 2.0x 0.0x Average Purchase Multiples 10.3x 10.4x 9.7x 9.7x 9.1x 8.5x 8.8x 8.7x 8.8x 7.7x 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Middle Market Deals Closed by Independent Sponsors 16% <5% 2010 2016 Source: Huron Capital, PitchBook Confidential 17

Certainty to Close Concern: Traditional PE funds are more likely to get to the closing table than Independent Sponsors Fact: There is no credible research to support the theory that traditional private equity will close with more certainty than independent sponsors; Deals fail to close for a number of reasons regardless of the buyer Reality Blackford Capital, a 17 year old independent sponsor firm, found that approximately 43% of independent sponsor failed deals failed due to deal concerns and material changes Deal Concerns & Material Changes Due Diligence & Legal Issues Financing Issues 19% 38% 43% 81% of deal failures were attributed to due diligence, material changes, legal, operational, structural, etc. which are not specific to independent sponsors 0% 10% 20% 30% 40% 50% Source: Blackford Capital Confidential 18

PE Adds More Value Than IS Concern: Independent Sponsors wont bring the same value to my seller as a traditional PE group Fact: In some cases, independent sponsors can add even more value than traditional private equity groups because of their hands-on experience and involvement Reality Operational Experience Independent sponsors bring direct operational experience from previous leadership and management positions Industry Experts Traditional fund managers incentivized to invest in deals based on quantity, which results in most of them being generalists. LP s are finding quality returns investing in independent sponsors with expert knowledge in their niche industry Top Tier Contacts Since independent sponsors are industry specific with previous operational and investment experience they can bring more contacts who provide higher quality results for issues related to capital, operations, sales, etc. Hands On Approach Trying to drive company value forces independent sponsors to be very hands on and provide real world experience and knowledge to make smart decisions, streamline workflow, and drive true business value Confidential 19

And One More Thing. Your Goals as Advisors Complete sale of Company Secure highest value possible Happy client Shameless Plug In my experience, sellers are happier with independent sponsor buyers due to their hands-on approach and operational value The Independent sponsor culture generally fits very well with sellers Confidential 20

Things to Look for When Selling to an Independent Sponsor Confidential 21

Key Characteristics To Gauge in Independent Sponsors General Experience Do they have previous investing and/or operational experience? Track Record Have they done a deal before? As an IS, fund manager, or both? Value Add Industry Expertise Motivation Culture Fit Age Synergies What future value do they bring to management and the company? Have they worked and/or invested in this industry before? How knowledgeable are they of the market? Is there a strong incentive for them to close quickly? When did they last close a deal? How long have they been searching? It s important that the buyer and seller can work well together once the deal is done and they are more hands-on with the business. Older or Younger? Investors value experience. It helps if the IS has a prior business or contact that could provide an opportunity for synergy on both sides. Confidential 22

In Conclusion Confidential 23

Summary Independent Sponsors Are Changing The PE Landscape For The Better The number of new independent sponsors joining the market is growing at a rapid rate Historic levels of dry powder waiting to be deployed resulting in less concerns when it comes to sourcing capital for independent sponsor-led deals The Private Equity market continues to show better returns than other investment classes and more independent sponsor deals are getting done than ever before Investors are worried high purchase multiples will make it difficult to see quality returns at a future exit date Although the market is very competitive for quality deals, Independent sponsors have proven that they can identify good opportunities, offer competitive valuations, source the capital, close deals, and add value post-transaction Independent sponsors are changing the PE landscape by matching traditional PE returns, due to more direct operations experience and lower costs The Great Recession accelerated the change in industry fundamentals. While the standard private equity model will likely continue to thrive, LP s started searching for ways to better align incentives with the standard private equity fund. They generally disliked the sizeable annual management fees, wanted more transparency, sought investment discretion and tried to fix other inherent GP/LP model flaws. John Fruehwirth, Rotunda Capital Partners Confidential 24

Q & A Confidential 25