• 064 04/12/2017

    Before discussing the economics, I thought a definition of a fundless sponsor would be helpful. An article in The Economist provided an excellent example: “The typical search-fund principals are MBA graduates from an elite American university, who raise $400,000 or so of “walking around money” from investors, who purchase a stake in the fund for about $40,000 a share. The fund searches for a high-growth, high-margin target, valued at $5m-20m. The fledgling businessmen then hold a second round of acquisition financing, as well as raising debt. Their tenure as bosses lasts until they sell out.” [1]

    The article itself is concise and worth the read. Even the title is appropriate here: “Seek and We Shall Fund: Private Equity for Absolute Beginners.” The only point I would argue is that I have met many fundless sponsors that had very different backgrounds from the MBA graduate background described.


    In negotiations, you will constantly hear what one side believes is “market.” In my opinion, the variance surrounding structures is too great to consider anything standard for a specific transaction. That said, there are generally three components, which listed in order of importance, are as follows:

    Promote - in a transaction this is the equivalent of carried interest. At most private equity funds it is equivalent to 20%. The Limited Partnership Agreement stating how this is earned might read as follows:

    First, 100% of all cash inflows to the Limited Partner ("LP") until the cumulative distributions equal the original capital invested.

    Second, 100% of all cash inflows to the LP until the LP has received a preferred return on the capital invested in step 1.

    Third, a "20% catch-up" to the General Partner ("GP") equivalent to 20% of the distributions realized in step 2 plus the distributions realized in this step.

    Fourth, thereafter, cash flows in excess of distributions made in step 1, 2 and 3 (if any) are distributed 80% to the LP and 20% to the GP.

    Promote Details:

    Of the three components, the promote is probably where I have seen the greatest amount of variation. The variables to consider are as follows:

    Preferred Return: In many transactions the investors are entitled to a preferred return of 8% (although I have seen it dropping in this market) before the fundless sponsor earns a promote. The greater the preferred return, the more difficult it will be for the fundless sponsor to earn a promote.

    The Catch-Up: A catch up kicks in once the investors have received their capital and a preferred return (if there is one). At this stage, all dollars go to the fundless sponsor until the distributions equal the promote. This can be calculated to include all dollars invested, or just the preferred return (this detail can make a significant difference). It is also not uncommon to see a catch up excluded.

    Multiple Hurdles: The fundless sponsor might be willing to start with a smaller promote so long as there is potential to achieve greater upside in the event of a more spectacular outcome. As an example, a fundless sponsor might negotiate a 10% promote at an 8% hurdle rate so long as the fundless sponsor can earn a 30% promote if a 30% IRR is achieved (30% would be the “hurdle rate”).

    There are additional variables to consider surrounding the promote (or carried interest) at a fund, but with a single transaction, those are the primary variables.

    (Note: Promote, the carry and carried interest are all generally used interchangeably.)

    Click here for more examples.

    Management Fee - At a fund this would generally be equivalent to 2% of assets under management (AUM), but for a fundless sponsor the fee is hardly ever tied to AUM. Generally what you will see is a structure calling for the greater of a flat fee or some percent of earnings. It will also typically be capped. For example:

    A management fee will be payable to (insert fundless sponsor) in the amount of the larger of (i) $250 thousand per annum or (ii) 5% of annual EBITDA.

    I provide the figures above as examples of structure, but the figures can vary considerably.

    One-Time Fees - It’s not uncommon to see a closing fee included. This sum can range from $50K to $1M depending on a variety of factors. Some portion of the fee generally gets reinvested in the new entity as well. (I have seen some pretty aggressive pitches including multiple one-time fees where it starts to add up. For example, asking for a closing fee, fees for board seats, fee for a successful exit, etc.) 

    The challenge is that no two transactions will be alike. The fundless sponsor might have strong industry expertise, or be a recent MBA graduate. The deal could be secured under LOI at a very attractive multiple, or in the midst of an auction process. The fundless sponsor might be investing a considerable portion of his own net worth, or taking zero risk. All of these variables, and many others, will influence the outcome.

    If you are considering a career as a fundless sponsor, my advice would be to do as much of the work as possible before negotiating terms. An MBA student with no prior experience will get little attention, but a talented industry veteran with a transaction under LOI at an attractive valuation will have the leverage necessary to negotiate the terms desired (it’s especially true in this market).

    [1] Seek and We Shall Fund: Private Equity for Absolute Beginners


  • 063 04/11/2017
    I recently received an email asking if I was aware of a formula that could validate the information in two columns, and return the summed value for all matches. This is easier to grasp in context, which makes the video helpful. I was, admittedly, slightly long-winded in explaining the purpose of the formula. To avoid this lengthy explanation, skip to the two-minute mark once you understand the objective.


    The template used in the video is available for download: Download Template

    What you will learn in this video:

    1. How to use SumProduct as an array formula.
    2. What the double hyphen (or double minus) means in Excel formulas.
    3. How to create drop-down data validation lists.
    4. How to use F9 to audit formulas.


  • 062 04/10/2017

    Preface: I originally wrote this explanation of the IRR formula in response to a question asking, "Why is finance hard?".

    Even at the introductory level, finance requires so much new vocabulary that learning can feel like it involves a second language. In my opinion, it should be approached the same way.

    When a student is assigned a chapter for class, the objective becomes to finish the chapter. Students read it as though they were reading a language they understand. But if every other word is new, comprehension falls. A focus on vocabulary can accelerate the process even if it feels slower to stop and digest each word.

    Take the ubiquitous “IRR” as an example. A standard definition follows:

    The Internal Rate of Return ("IRR") is the rate ("r") at which the Net Present Value ("NPV") of all future cash inflows and outflows ("CF") for a project is zero.

    To someone new to finance, that definition means little. Worse still, the definition will likely by accompanied by an intimidating formula:

    IRR Formula

    To help make sense of this and demonstrate the power of really understanding new vocabulary, I created a video that explains the math by providing simple context. The math explained in the video can also be seen just below the video player.

    The video explains that if a sum invested achieves an IRR of 20%, it would mean that the investment grew at a rate of 20% each year. It follows that if an investment grew by 20% each year, the value of the investment after three years could be calculated as follows:

    Calculating the value of an investment.

    In the last step, the variable for rate "r" is substituted for 20%, and the variable for time period "t" is substituted for 3. The math should feel more approachable with familiar context. And notice that it starts to resemble the intimidating formula at the top (specifically "(1+r)^t"). Let’s take it one step further:

    IRR Formula

    (Note: For the last step, anything raised to the power of zero = 1, so we are dividing by 1.)

    (Note 2: The last step is a combination of two steps. Step 1 is subtracting the value of "CF" in time period zero from both sides. Step 2 is matching the format of the IRR formula, which is to sum all cash inflows and outflows divided by (1+r)^t. The latter is why (1+r)^0 is included in the denominator.) 

    That last line is the formula that this post starts with for one cash outflow (the investment you make), and one cash inflow (the value of your investment in “t” years).

    As a last step, let’s incorporate values for variables. Imagine you invested $10 in period zero (another way of saying “today”) and three years later received $17.28 in return. Using the formula for IRR above (where r = rate):

    IRR calculation.

    So what you are solving for is the rate (“r”) at which the value of $17.28 three years from now is worth $10 today (this is Net Present Value). If you plug 20% for r in the equation above the equation will be true. Going full circle, IRR = 20%.

    Focus on vocabulary and everything else will follow.



Models are:
A) really boring
B) pretty sweet
C) super important
D) somewhat easy
E) kind of hard
F) fun
G) all of the above



*Answers a, b, c, d, e, f and g are all correct.