Proper Use of Funds & Fiduciary Duties in Independent Sponsor Deals
February 10, 2025
by an investor from University of Oxford in Hamburg, Germany
Hello Searchfunder Community,
As I prepare for my first investment in an independent sponsor deal, I was wondering how I could best ensure funds are being used as intended (e.g., to acquire a company) and fiduciary duties are upheld throughout the lifecycle of the deal.
For those with experience:
- What is standard practice in terms of wiring funds?- What oversight mechanisms help verify fund usage?
- Any red flags or warning signs to watch for?
- Do you require specific financial reporting, escrow, or audits?
- How can smaller investors ensure fiduciary duties are fulfilled throughout the deal?
Looking forward to your insights—thanks in advance!
from University of Washington in Manhattan, New York, NY, USA
**2. Oversight Mechanisms to Verify Fund Usage** - **Regular Reporting:** Require the independent sponsor to provide regular financial reports, including cash flow statements, profit and loss statements, and balance sheets, on a quarterly or semi-annual basis. - **Milestone-Based Disbursements:** Structure funding in tranches linked to milestone achievements (e.g., due diligence completion, acquisition closing, integration achievements). - **Board Representation:** Negotiate for a seat on the board or advisory board that allows you to be actively involved in the oversight of operational decisions. - **External Auditors Forensic Advisors:** Utilize third-parties to assess/ test financial statements and adherence to budgetary controls Follow the cash.. *3. Red Flags and Warning Signs** Be vigilant for the following warning signs: - **Lack of Transparency and Delay:** An unwillingness to disclose financial information or operational details can indicate potential mismanagement. - **Frequent Changes in Management :* High turnover among key personnel in the sponsor or target company can signal instability. - **Overly Aggressive Projections:** If financial models appear overly optimistic without supporting data, reassess the assumptions. - **Poor Communication:** Inconsistent or infrequent communication from the sponsor may suggest issues in management or governance. **4. Specific Financial Reporting Requirements** establish specific reporting and audit/review
requirements, including: - **Monthly Financial Statements:** Request timely and accurate monthly financials, along with variance reports comparing budgeted vs. actual performance. - **Annual Audits:** Seek annual audits or reviews by an independent firm to ensure compliance and safety of financial practices. - **Performance Metrics:** Agree on KPIs (Key Performance Indicators) that align with your investment strategy to measure the success of the deal continually. Get these at least monthly ### **5. Ensuring Fiduciary Duties Fulfilled** - **Defined Roles and Responsibilities:** Clearly outline the roles and responsibilities of the independent sponsor regarding fund management and operations. - **Compliance with LLC Agreements:** Ensure that all parties comply with the operating agreements, which should delineate fiduciary duties and ethical expectations. - **Regular Communication:** Establish a schedule for regular updates and meetings to ensure alignment between expectations and activities. - **Legal and Regulatory Compliance:** Hard to do but run credit and social media screens on the principals - **Limit Conflicts of Interest:** Watch for related-party transactions to properly disclosed and managed.. Get to know the controller all partners controller and CEO of portfolio company. Consult with savvy advisors up front and don't rely on just what was agreed once you wire. Maintain leverage and guard the cash.
from Dartmouth College in 80 S Main St, Hanover, NH 03755, USA
most (not all, but most) independent sponsor deals do not employ GP/LP structure, but utilize LLCs and structured equity structures to effect similar but not identical governance and economic partnership dynamics. Importantly, the default fiduciary responsibilities are much more "open" so contracting to a "fiduciary" standard in these partnerships can be more elusive. Reporting is also pretty "open" so best practice is to set expectations in writing from the sponsor and those should be reflected in the partnership agreement (regular, synthesized, objective reporting is often an afterthought in independent sponsor deals once the deal gets going if not documented up front). In terms of diligence - no substitute for triangulating to others who know the sponsor and/or who may be participating in the investment with you. Great post and topic!