E282: Why LPs are Investing into Independent Sponsors

What role do independent sponsors play in today’s lower middle market private equity ecosystem? David Weisburd speaks with Tom Duffy about how TIFF partners with independent sponsors, why deal-by-deal investing can improve alignment, and what differentiates high-quality sponsors in a rapidly growing market. Tom explains how sourcing, economics, and hands-on diligence shape long-term GP relationships and inform future fund commitments.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00David Weisburd?

  So give me a sense for where Tiff is today as a business.

• 0:04Speaker 01

  Yeah, so to give you a sense of where Tiff is as a business today, David, I really do think it's impactful to start with a little refresher of where we came from and what we do to give your listeners a better idea of the value add that we bring to the table here at Tiff. So Tiff was founded over 30 years ago, really to provide investment solutions primarily to nonprofit institutions at the time, where we specialized in outsourced CIO solutions and private market solutions. We have two distinct business lines. We have our OCIO or outsourced chief investment officer business that manages the full wallet share of our client portfolios. That's what we've been doing since inception, since 1991.

• 0:47Speaker 01

  Always had a strong focus on alternatives and private markets. And then that second business line that we have since 1997, we've been offering standalone private equity and venture capital strategies, which is where I focus today. And those strategies combined, we've grown to a roughly $9 billion organization with over $3 billion of that in privates, where we continue to serve our historic nonprofit E and F base and also expanding our footprint into the wealth management and family office community where we've seen a lot of demand for the types of strategies and customization that we can bring to the marketplace. They deliver what we view as as high quality investment returns consistently and over long periods of time for them.

• 1:29Speaker 01

  So many of these large institutions, they they're just overpowered with with so many resources and so many people on staff that these these smaller and midsize firms just don't have. And they viewed that as such an inequality and wanted to help out any ways they could to that community.

• 1:46David Weisburd?

  We were just chatting offline and you mentioned that you were at the McGuire Woods Conference and there was over 1,000.

• 1:55David Weisburd?

  Independent sponsors at this conference. Tell me about that conference and what does that tell you about the space today?

• 2:02Speaker 01

  Yeah, so Tiff has really several avenues of sourcing great sponsors and making sure we consistently fill our pipeline of top investors to keep that deal funnel full of new ideas. One of those sourcing advantages or avenues is through industry events and conferences like McGuire Woods, which we've been attending for several years now. And for anyone who hasn't been there before, really picture a giant conference hall full of a few thousand people at individual tables, essentially speed dating with a 30-minute timer, then you move on to your next table and so on and so forth for two to three straight days. David, I lost my voice within the first three minutes, which was fun to battle through.

• 2:46Speaker 01

  And it's important to note, this event has grown drastically over the last five, 10 years since we've been going, in part because McGuire Woods as a firm has really done a terrific job, but also because this segment of the market has been experiencing really massive increase in size.

• 3:03David Weisburd?

  So give me some numbers. How big has this independent sponsor market gotten in the last few years?

• 3:10Speaker 01

  The independent sponsor model has existed in various forms for decades. Its success over the past several years, both in terms of deal-by-deal returns and in serving as a pathway to raising a committed fund. It is starting to attract more seasoned investors who have left established PE firms to launch their own independent platforms or hang a shingle, as we like to say. This shift has really raised the overall quality of professionals in the market that was previously populated largely by younger investors without an attributable track record or ex-bankers or consultants who are seeking to transition into investing, or even operators pursuing deals in their niche areas of focus.

• 3:56Speaker 01

  Even as recently as a decade ago, when we started in this segment of the market, David, we started back in 2014 at Tiff. Encountering an independent sponsor at the time was a relatively rare occurrence. But today, this universe has grown. It encompasses a huge, wide range of independent sponsor types and profiles. There's even a large ecosystem of lawyers, lenders, intermediaries and investors who are catering to these sponsors, and that's expanded as well, which really highlights the maturation of this place.

• 4:28David Weisburd?

  How do you know you're not being adversely selected when it comes to these independent sponsors? Aren't they just funds that couldn't raise?

• 4:34Speaker 01

  Some people even ask us a different question is, are we worried by how much this market segment has grown? The easy answer to that question is, is no, and I'll take a minute to explain why. As this market has expanded, sure, by definition, more low quality or undifferentiated managers are entering the market. But at the same time, there's more experienced and high potential managers are launching as independent sponsors, which is really great for us. In our view, having a clear view of what defines an exceptional sponsor is essential for long-term market success. Success begins with having a long-term tenure team with what we feel needs to be at least

• 5:18Speaker 01

  eight to 10 team members who all have the ability to source sponsors and at the same time evaluate each underlying deal and then build long-term relationships with what we feel are exceptional investors. And at Tiff, we've been able to check all of those boxes as one of the earliest institutional investors in this space, and we're continually looking to improve and adapt moving forward to the marketplace.

• 5:41David Weisburd?

  Maybe if you go upstream to why there's so many high-quality independent sponsors today, what's changed in the last five years?

• 5:51Speaker 01

  The avenue of every sponsor out there is totally different. So it's hard to paint a broad picture here. We've invested alongside several sponsors who have stayed as independent sponsors for a long time. So let's talk about what drives that decision for someone to remain a sponsor instead of going on to raise a fund. Clearly, there's some benefits of this space. First and foremost, you have way more flexibility in the sponsor model. So you don't have to build out the infrastructure of a full firm. You don't have to build an entire team and you don't have to go through certain industry registrations depending on your size. Second, the economics of the sponsor model can be, can really be very attractive.

• 6:34Speaker 01

  You can earn carry on a deal by deal basis instead of cross collateralizing carry seen in a typical PE fund model. And third, you can really be as thoughtful and selective as you'd like to be because you're not on the clock with committed capital from LPs like you would be with a blind pool fund. Now, with all of that said, for everything that I just listed as a benefit, those can also be viewed as negatives over time, pros versus cons. As you start to make more and more investments, at some point, you might eventually like the idea of hiring more team members. So you're not in the weeds on every single deal model and in presentation.

• 7:16Speaker 01

  And if you want to hire a team, most people want to see a future and a career path that can best be illustrated and brought to life through the vision of launching a fund in a real platform.

• 7:25David Weisburd?

  Talk to me about the fees that independent sponsors charge, both management fee and carry today. What's the market look like?

• 7:37Speaker 01

  So one of the key benefits of investing alongside independent sponsors is that there's a great opportunity for aligned economics and fee structures. And here's what I mean by that. Similar to the broader private equity universe, terms in the independent sponsor market continue to balance manager and investor interests. So in our view, terms for independent sponsored deals are more clearly structured to align interest between investors and sponsors. So for example,

• 8:09Speaker 01

  Tiered carry structures and monitoring fees that are based on EBITDA are now relatively standard across deals we see in the market. That ultimately creates stronger incentives for equity value creation compared to most private equity investments that you see. So rather than charging a flat fee and significant carried interest for minimum performance, independent sponsors must actually grow EBITDA in return high multiples of money to generate their significant wealth. On occasion, we see an independent sponsor try to negotiate a premium carry. These negotiations are typically not successful and would only apply in really truly outsized return scenarios.

• 8:50Speaker 01

  So before reaching out to TIF, I want sponsors to know that we are in this together. We're on the same team. Plain and simple, our end goal is to partner with high caliber investors over the long term and generate strong performance along the way. We don't want this to be a one deal and done relationship. Again, I mentioned this earlier in one of our other questions, but our work with independent sponsors can and often does lead to fund commitments down the line if and when a sponsor is ready for a blind pool commitment, and it has successfully done that many times. This opportunity set creates a great chance, not only for us to find and make excellent

• 9:33Speaker 01

  investments, but also serves as an exceptional underwriting tool for a future potential fund partner, for an emerging manager, which is another key tenet of the TIF investment philosophy. This is something that's very differentiated about TIF's approach with independent sponsors. Another topic that's important to reiterate that many independent sponsors do already know is that we've been doing this for a long time. Since TIF's first direct investment alongside an independent sponsor in 2014, we've learned really many lessons over the years, and we have a lot that we can bring to the table in helping these sponsors through their lifecycle, whatever that may look like.

• 10:15David Weisburd?

  It reminds me of that old joke, the best way to diligence a manager is to make an investment.

• 10:23David Weisburd?

  This is kind of what you guys are doing, which is you're not actually investing in the fund. You're investing in a deal with the manager, which it gives you a much deeper ability to diligence a manager and figure out whether you want to be in with him or her for three to five years on a deal or in a marriage across fund cycles. Tell me about what you're trying to ascertain in those one or two deals that gives you a better sense in terms of underwriting the manager that you wouldn't be able to otherwise do in a traditional fund investment cycle. One thing that I've learned from talking to hundreds of investors, founders and business leaders is that planning for the future isn't just about growing assets, it's also about protecting the people who matter most. Life comes with a lot of important milestones.

• 11:05David Weisburd?

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• 11:47David Weisburd?

  one of our key pillars is finding and investing alongside emerging managers in Fund One, Two or Three, where historically, performance is at its highest compared to when they get into their later Fund Vintages. Being able to have done an investment alongside someone is one of the best ways to determine if it's worth going into Fund One as an emerging manager or Fund Two. Some of the key things that we're looking for.

• 12:14Speaker 01

  Is do we like them as investors? Do we like them as people? Is there a transparent relationship that's built around trust and and long-term trust especially? We need to know, we're not in this for the short term. We're not in this for just one deal. We ideally want to be partnering with sponsors for the long term. If you think about some of our first two sponsors that we partnered with back in 2014, two of them, we're actually still invested with today in their funds since they launched an institutional strategy. That's not the case for for all of them. But it's been about a 50% ratio of managers that we've backed and done deals with as an independent sponsor

• 12:55Speaker 01

  to those who have gone on to become a funded manager where we've been one of their first institutional investors. Those are all key things that we think we can glean and get this real deep insight into that others aren't able to if they're not backing them as sponsors.

• 13:09David Weisburd?

  Perhaps a very basic question, but when you look at diligencing fund managers, whether through by doing independent sponsor deals first or directly in the fund, one of those components obviously is trust, trying to ascertain how truthful and trustworthy the manager is. What are some of the other components they're trying to gain either by doing independent sponsor deals or directly by diligencing funds?

• 13:37Speaker 01

  So a lot of people's diligence process, what I've gleaned over the years from working at various firms and talking with peers, so much of it focuses around people process and in philosophy, right? How do they function as a team? What does the long-term roadmap look like? Is there a plan in place for a key person risk when one person moves on when retires? Who's going to fill their shoes? Those are the key, basic things that most firms look at. And of course, we look at it too. But there's always a lot of other things that we're looking at the hood at as well. Is there an attributable track record that we can point to? Are there references, warm references from others in the industry who have worked with them before or peers who have looked at them?

• 14:22Speaker 01

  We spend a lot of time on that. If you give us five references, we'll likely make 20 calls. We go above and beyond in that sense because this is again, a long-term relationship. We don't want this to be a one, two, three year thing. Private market investments is a long-term commitment.

• 14:41Speaker 01

  Other factors that we look at, what's extremely important to us because we put so much time into it on our end is sourcing. Everybody says they have a differentiated sourcing process, but let's dig into the weeds. What does that really mean? And what are you doing? That's different than the hundreds or thousands of other firms that we could be investing in. And finally, one important question is, how do they deal with adversity? What have they learned from any potential mistakes or bad investments? It's not a deal breaker if there is a bad investment in their track record. We want to look at that and dig in and say, what have you learned? What have you done since then? And what's changed?

• 15:21David Weisburd?

  And are the GP commit and the percentages, are those contingent on the situation of the investor? Or are there strict minimums on that? And how do you think about the GP command on these deals?

• 15:34Speaker 01

  These sponsors tend to commit a significant amount of capital to their own deals, which really does create an increased alignment that leads the sponsor to view each deal as critical and focus deeply on the company's operations and growth to drive great outcomes. What we typically see, and there's no broad blanket answer, but speaking averages here, these type of sponsors tend to commit 5 to 10% to their own deals compared to traditional private equity GPs who on average can be closer to the 1 to 5% of their total funds.

• 16:11David Weisburd?

  And a lot of these independent sponsors come from very pedigree firms, KKR's, Apollo's, Blackstone's. For those that don't come from pedigree funds,

• 16:26David Weisburd?

  how do they position themselves? Or how do they get from zero to one? How do they do the first deal? And walk me through maybe some of the hacks or some of the best practices when it comes for managers that don't come from pedigree funds?

• 16:41Speaker 01

  A particular focus for Tiff is identifying trained and motivated investors that have more often than not spun out of established private equity firms. And a lot of them are specialists in a specific sector, industry, or geography, et cetera. These investors, we like to say they're frequently at the inflection point of their careers, having developed this applicable experience required to not only identify, but also underwrite and operate a portfolio company, all while remaining highly motivated to prove themselves.

• 17:21Speaker 01

  To point back to your question, not every sponsor comes from a top pedigreed, highly established PE firm. That happens to be the middle of the fairway type of sponsor that we're looking for. If that's not you, if you're an independent sponsor listening to this, that's not the only criteria you look for. We want to see people who are really trained and specialists in a specific area and have this expertise that's needed to identify and operate this type of business. So if you can show us you have a track record of one, two, or three deals, whether it's as a sponsor already or in a past life, that's attributable directly to you and what you've done, we want to take a look at that.

• 18:04David Weisburd?

  Because it really goes back, you're really diligencing on the same aspect, which is, does that manager have a right to win? Now, it has a deal attached. In many ways, the most differentiated platforms also highly correlated to different takes to the same space. So if everybody's Blackstone, Apollo, then you could argue, how truly differentiated are they versus somebody that might be an operator or the endless amount of ways somebody could differentiate themselves?

• 18:33Speaker 01

  That's exactly correct. There's countless ways to differentiate yourselves, and we want to see experiences from all sorts of backgrounds so we can add to the diversity of thoughts and opinions and types of investments that we have on our platform. So you're exactly correct with that.

• 18:51David Weisburd?

  How would you categorize the world of independent sponsors today?

• 18:59Speaker 01

  So David, I've listened to a number of your podcast episodes over the past few years, and it's occurred to me that there isn't a lot of time spent talking about the independent sponsor landscape. So maybe to kick off this question, I can explain to the viewers, what is an independent sponsor, why we like them, and then flow into where does this segment of the market stand by, where does it stand today? So an independent sponsor, it's really a subset of lower-middle-market managers who raise capital on a deal-by-deal basis instead of blind pool commitments. And they typically target smaller family or founder-owned companies that are less than, on average,

• 19:41Speaker 01

  about $10 million in EBITDA at-entry investments. We find this segment of the market attractive for a lot of reasons, including less competition for deals, greater opportunity for operational improvements at these underlying companies, and then better alignment of incentives with managers. And even with these key benefits that I just referenced, most of our institutional peers still don't invest in this segment of the market. I recently came across a statistic from Citron Cooperman. It's a study that showed across all independent sponsor

• 20:19Speaker 01

  deals from, I think it was 2021 through 2024, only about 5% of lead investors were institutional investors like TIF. This space is still dominated by family offices, or mezzanine funds, or high-net-worth individuals backing these deals. So why do institutional investors avoid this space that we find so attractive at TIF? Simply put, it's a complex market to navigate. It really requires a combination of both company and deal underwriting, as well as manager-level underwriting. And it's a substantial amount of time and effort to navigate.

• 20:57David Weisburd?

  You're really doing two things at once, which is you're underwriting the deal, and oftentimes these have short circuits. Ideally, I know you like to have at least 60 days, but sometimes it is 30, 45 days, even shorter. And then you're also underlying the manager. So it's almost like having to align two things. It's almost two times as hard, or probably realistically four times as hard as just underwriting a fund.

• 21:21Speaker 01

  One of the things that truly differentiates how we approach this market is that we have a double layer of diligence on every deal. And we have a purpose-built team that does this. We want people on our investment team who have both sponsor and manager diligence expertise, as well as individual deal diligence expertise. What we like to say is that our diligence is very much sponsor first. Before we look at the deals, we want to underwrite who we feel are we want to underwrite investors that we can build long-term partnerships with. After we underwrite the sponsor and approve them for our platform,

• 22:02Speaker 01

  then we'll look at the underlying deals that they bring to us, which on average is a handful of each year. And when we do approve them, we're not required, like some of our competitors, to invest blindly in every single deal because we do that double level of diligence. We want to underwrite every single deal that comes through our independent sponsors, and that's what we do, and that's differentiated at Tiff.

• 22:25David Weisburd?

  Tom, this has been absolute masterclass on independent sponsors. What would you like our audience to know about you, Tiff, or anything related to independent sponsors?

• 22:33Speaker 01

  Yeah, of course, and a lot to unpack here. Starting with sponsors, when we think back on our decade-plus of active investments in this space, we see the independent sponsor market as more attractive today than when we began back in 2014. The market is deeper and more professionalized. Valuations still remain well below mainstream PE levels, and institutional competition is still limited. This combination of depth without crowding really creates a fertile ground for identifying attractive opportunities to generate outsized returns. And as Tiff enters its second decade of independent sponsor investing,

• 23:18Speaker 01

  our conviction has really never been higher. And a little bit on on Tiff at nine billion and growing. We're big enough to do some exciting things on the investment front, but we're still nimble enough to focus our capital on the most attractive areas and the most inefficient areas of the markets where we can feel like, where we feel like we can generate the most outsized returns. This really plays to our advantage as larger firms are trying to push billions of capital out each year and are forced to invest upmarket where returns have historically been more muted. Tiff's truly a special space. I get to work with a lot of smart and humble and funny individuals who care deeply about our mission and generating great investment returns

• 24:03Speaker 01

  in a close collaborative environment. So again, thank you, David. This was terrific and I was really thrilled to be on this podcast with you.

• 24:12David Weisburd?

  It was great to have you on. Huge fan of what Tiff is doing and looking forward to sitting down again soon.

• 24:18Speaker 01

  Terrific. Thank you, David.

• 24:20David Weisburd?

  Thank you, Tom.

• 24:21Speaker 01

  That's it for today's episode of How I Invest. If you're a GP with over one billion in AUM and thinking about long-term strategic partners to support your growth, we'd love to connect. Please email me at [email protected].