The term sponsor has many uses in business and finance. Sponsors are most commonly individuals or entities that provide support to another individual or organization. That support can be in the form of active management or in name only.
Here's a closer look at sponsors, why they are important, what investors should know about them, and an example.
Understanding sponsors in business and finance
A sponsor is an individual or entity that provides services and support to other individuals or organizations in the business or financial sectors. For example, a sponsor can manage an investment vehicle, like a limited partnership (LP), mutual fund, special purpose acquisition company (SPAC), or exchange-traded fund (ETF). The sponsor often oversees the fund.
A sponsor can also provide financial support through direct investment or assistance in raising capital from other investors. For example, in venture capital investing, a sponsor is often the lead investor in a funding round to raise seed capital for a startup.
Why sponsors are important
Sponsors play vital roles in the business and finance worlds. One crucial role is helping companies raise capital to fund their operations and growth. For example, venture capital firms sponsor funding rounds for startups, while investment banks help sponsor a company's initial public offering (IPO). These sponsors enable companies to raise capital from other investors to finance their ongoing operations and expansion initiatives. Sponsors bring credibility to the deal and often take a stake in the company during the seed investment round or IPO. That endorsement is a stamp of approval for institutional investors to participate in the deal.
Sponsors also manage pooled investments like mutual funds, ETFs, private equity funds, and real estate limited partnerships. The sponsor manages the fund or partnership, including handling all the regulatory and tax filings on behalf of investors. The sponsors are paid to manage the investment, including management fees and sometimes a percentage of the investment's return.
What investors need to know about sponsors
Sponsors help companies or investment vehicles raise capital from other investors. They are often paid to help companies or deals raise capital, so investors in a sponsored deal or investment vehicle need to ensure they understand a few important factors before investing with a sponsor.
First, they should check out the sponsor's track record. If a sponsor's prior deals have a poor performance record, it's a red flag. Likewise, if the sponsor doesn't have an investment track record because it's their first deal, that might be another red flag.
Investors should learn about the sponsor's compensation structure. They should see if the fee structure aligns with market norms or if the sponsor will get an outsized percentage of a deal's profits -- even if the investment underperforms their projections.
Evaluating a deal sponsor is as important as analyzing the potential investment because the sponsor's involvement can have a significant impact on the investment's eventual outcome.
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An example of a financial sponsor
Sponsors help create investment opportunities for other investors. For example, a commercial real estate investor found an opportunity to invest in a multifamily community in a strong market. The investor needed to raise $1.25 million from other investors to help fund the remaining equity investment needed to close the deal. Bridge financing at an attractive rate had already been secured to fund the majority of the deal's cost. The sponsor worked with a third-party platform to bring the deal to their investor network. The sponsor provided prospective investors with information about the deal, including the property's recent financial performance, the business plan, the funding strategy, and the investment return potential.
After closing the investment, the sponsor managed the property for limited partners, acting as the general partner in the investment. They:
- Oversaw the execution of the business plan.
- Provided regular progress updates to investors.
- Made required filings.
- Secured a compelling offer to exit the investment upon completing the business plan.
The sponsor ultimately returned almost $1.9 million in cash to investors, representing a significant return on their original investment.
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