Art of the Deal-by-Deal Fund
Deal-by-deal investing has become an increasingly popular strategy for financial sponsors in Europe. Unlike the traditional private equity (PE) approach of raising a fund and deploying it over the course of several years, deal-by-deal firms raise capital for each opportunity separately. Each transaction is funded with capital sourced from the most suitable investors with terms tailored to the situation.
In the right situations, the deal-by-deal model can offer advantages, particularly in a dislocated market. PE firms that raise capital from limited partners (LPs) under pre-agreed conditions can be constrained from making more opportunistic investments that would have an attractive return profile in a turbulent market. In what has become a spot market for mergers and acquisitions (M&A), a deal-by-deal approach could yield significant returns to investors whilst benefiting all stakeholders.
Summary
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Lincoln International discusses the emerging trend of deal-by-deal investment structures in Europe.
Lincoln International expects deal-by-deal structures will become increasingly common in Europe in the coming years. This would match the growth of the model in the U.S. where research by Co-Investment Partners indicates that such structures account for 25% of deals.
The emergence of this trend is underpinned by several factors:
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A deal-by-deal approach allows a financial sponsor to match the capital commitment and structure to the opportunity under consideration. Unconstrained by the inflexible terms of a fund that could have been marketed five or more years prior, a financial sponsor can provide a tailored solution for a specific situation. This approach can tackle issues relating to capital structure, terms and timing that traditional PE firms prefer to avoid. In a market where the cost and availability of debt financing hinders the ability of limited funds to invest, a deal-by-deal sponsor can create a bespoke and actionable solution for selling shareholders.
Ed Cottrell, Partner at Bay Tree Private Equity, explained the benefits of the model “as an alignment of the interests of all key parties at the time of the deal for the benefit of all, including investment term, risk-adjusted return, commitment to the specifics of a deal (not just a wider mandate), deal risks and often the provision of sector and business model expertise including from the LPs.” |
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Many sponsors are attracted to the return profile of an opportunity but are sometimes unable to commit to a transaction due to the timing of a fundraising process. Near the end of a fund’s lifecycle, a financial sponsor can be capital constrained. Conversely, in the early months of a new fund, a sponsor may want to pursue a certain type of deal to kick off a fund. Recently, Lincoln has observed some financial sponsors decline opportunities due to fund timing or wanting to have a “statement” first deal in a new fund. |
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A deal-by-deal structure aligns incentives between investors, the general partner (GP) and management teams in a much more intimate way than that offered by a traditional PE fund. Stakeholders aligned on a company’s business plan can think big, make bold decisions and have the peace of mind to deliver on the business plan without the fear of a GP exiting an investment “early” to mark a return or due to wider fund-related issues. |
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Financial sponsors utilizing the traditional fund structure are already increasingly using co-investment from LPs. A significant pool of capital is available to sponsors with strong track records. Since LPs often all but demand to be given co-invest allocation in a traditional fund structure, it can be easier to move towards a deal-by-deal funding model where LPs can select the individual investments in which they want to deploy capital. |
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In a traditional fund structure, fees are charged at usually 2% of committed capital. In a slow deal environment, investors can be charged a significant portion of their funds before any investment of their committed capital is made. Conversely, in a deal-by-deal structure, investors are only charged fees for the duration of their investment, often via a monitoring fee paid by the target. A deal-by-deal structure avoids a situation where a sponsor raises a fund but does not deploy some of the capital for many years, whilst still generating fees on the undeployed capital. The deal-by-deal structure therefore provides a preferable fee structure for investors. |
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The special-purpose acquisition company (SPAC) market, notably popular in the U.S. prior to 2022, did not take off with the same vigor in Europe. The complexities of public transactions and associated obligations put off several European investors. Investing in private targets without taking them public – as an alternative to a SPAC – though the deal-by-deal structure has administrative benefits and avoids the disclosure and regulatory burdens of the public markets. |
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The challenge from sellers – that deal-by-deal funds have less certainty over funding – is becoming less of an issue due to the increasing sophistication and number of these funds. The deal-by-deal approach is growing increasingly competitive with drawdown times comparable with traditional PE. Funds utilizing the structure have become professionalized in their approach to fundraising for a specific asset. Many firms work with the same investors on a regular basis and as these relationships mature, the positive returns and experience will likely result in more willingness to commit to deal-by-deal funds. |
Lincoln’s Financial Sponsors Group has experience advising across a range of private capital structures and is keen to meet with financial sponsors pursuing this strategy or considering it.
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