The Latest Family Office Trend

FEATURE | DIRECT INVESTMENT

DIRECT INVESTMENT The Latest Family Office Trend

By Anna Maria Nekoranec

ingle-family offices currently account the market. “Over the last five years people neurship and investing. We want to build a for more than $2.4 trillion in invest- have become more leery of the big funds family of businesses and continue legacies Sable capital, according to Family and have attempted to make their own started by great family entrepreneurs.” Capital, making them sizable competition investment decisions,” Rupp said. “I think to the private-equity industry.1 Over the that the trend is people attempting to man- Another dynamic that has caused Clearwell past five years the trend in this capital age their own private-equity investments to use more direct investing is what appears base has been toward direct investing. versus going with co-mingled vehicles.” to be a trend in the private-equity fund Historically, family offices have focused on In addition to poor performance by private- market. It seems that the deployment of fund investments. The 2008 downturn neg- equity funds, desire for more transparency capital from a fund perspective has not atively impacted those allocations. Driven and dissatisfaction with fee structures have accelerated, but the cycle of raising funds by poor performance, high fee structures, led family offices to become increasingly has, Cortner said, and going more “direct” and a lack of transparency, family offices attracted to the sector. Control is a major leads to more transparency and control. increasingly have allocated away from factor in this trend, Rupp said. private-equity funds and toward direct Challenges to Entering the Direct- investing. The projected future low-return “Private equity is viewed as a sexy business Investment Market environment for traditional private equity because families believe that they can A number of challenges face the family groups has further fueled this interest. utilize control to affect a better outcome— office seeking to do direct investing. These the key is having the right tool kit to exe- include portfolio strategy, staffing, deal The Direct Investing Environment cute,” Rupp said. “The key question is sourcing, deal execution, competition, Direct investing can be described generally whether or not the returns will be as good defining the investment process, and asset as a private investment in real estate, oper- as if you went with a financial manager.” management. Many family offices prefer to ating businesses (growth capital or lever- maintain small professional staffs. As a aged buyouts), venture capital, and direct Indeed, two key considerations—transpar- result of the inherent intensive nature of lending. Each asset class brings with it a ency and fees—compelled the Vinik Family the direct-deal business, these offices tend different risk-return profile and requires Office (VFO) to develop a direct-investment to struggle with the asset class. For exam- a broadly skilled investment team. These program, said Noam Abrams, who works as ple, deal sourcing can be a full-time job. If asset classes historically have been domi- vice president for VFO. the family office is thinly staffed, then once nated by private-equity funds. As an a deal is sourced, the staff must turn its increasing number of families monetized “We like to know what we are investing in,” attention to diligence and execution, caus- their assets during the 2000s, there has Abrams said. “We like to know where our ing the sourcing process to grind to a halt. been a proliferation of family offices that money is going. Why pay a substantial Similarly, once the deal is complete, it is are beginning to become a force in the management fee and carry for something necessary for staff to manage the invest- direct market and competition for tradi- that you don’t know? We believe that we can ments and reporting. Again, without ade- tional private-equity funds. In addition, get better alignment doing one-off deals.” quate infrastructure, this can put a traditional registered investment advisors significant strain on the office, particularly are seeing more interest from clients in this Others start direct-investing programs as a when the investments are performing sub- alternative asset class and are finding it means to educate the next-generation client par and require additional attention. challenging to access and vet transaction families about risk-adjusted investing, flow for them. according to Ryan Cortner, a principal at the Family offices also face challenges through Clearwell Group. “We believe that there is a competition with existing private-equity Why Are Families Entering This Market? moral imperative to teach family members funds. Most funds have well-developed Jeff Rupp, president and managing direc how to take smart risk and expose them to infrastructure with significant staff. This tor of View Capital in Dallas, shared his the portfolio companies so that they can infrastructure can give them a substantial thoughts on why family offices are entering understand the dynamics of both entrepre- advantage over a family office with a smaller

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© 2016 Investment Management Consultants Association Inc. Reprinted with permission. All rights reserved. FEATURE | DIRECT INVESTMENT staff. It will enable them to execute the trans- Direct investing requires a specific set of action more quickly, which can be a major selling point for a deal that is being marketed professional“ skills that includes sourcing, diligence, by a broker or an investment banker. accounting, legal, and board/strategy experience. ” As Abrams put it: “There is a lot of competition from private-equity funds and very ing, legal, and board/strategy experience. In addition, they do not have a defined high prices are being paid for large, mature The professionals in the industry tend to time horizon when they have to sell the buyouts. There are many players bidding earn significant compensation as a result of investment. Unlike private-equity funds up prices.” the need for years of experience to obtain that need to harvest investments in a three- the skills necessary to execute and manage to five-year time horizon, family offices can According to Cortner, another challenge deals. The team may need to be carried for hold investments indefinitely and can pro- facing family offices is defining investment a year or more before the operation makes vide partners with liquidity when needed. parameters. A well-thought-out investment its first investment and significantly longer In fact, as the result of tax efficiencies, fam- thesis coupled with stringent investment before it breaks even. In addition, the teams ily offices often are better served by holding criteria helps mitigate the challenge of fam- tend to be specific to an asset class. For investments over an extended period of ily members “lobbing bunnies over the example, if a family builds a team to invest time. “Without the time constraints of a fence for one to chase,” he said. “We sup- in real estate, that team may not have the traditional fund, we can support growing port high integrity entrepreneurs when we right experience to make growth-equity businesses with the right amount of capital believe a business can generate a positive investments in operating businesses. at the right time,” Cortner said. impact in addition to investment returns.” Another often-overlooked key consider- Some families also have the advantage of Initial Entry into the Market ation for the family office is how a direct- industry expertise. In many cases, a family As a result of these challenges, a number of investment program will impact the estate office that has created its wealth from a spe- family offices enter the direct market plan of the patriarch/matriarch and the cific vertical can significantly outperform through baby steps. This entails seeking heirs. Because these assets are illiquid, it is traditional private-equity firms in the sector. co-investment opportunities with funds critical to understand how their value These families tend to see the best deal flow where they have existing relationships. might affect the estate at the time of the in the space, have well-developed networks Co-investments enable the family office to patriarch/matriarch’s death, paying close that can be leveraged for sourcing, diligence, leverage the work of the fund’s staff, they attention to whether or not there is suffi- and staffing, and have deep operational provide transparent transactions, and they cient liquidity within the estate to cover the expertise as a result of years in the industry. generally have lower fee structures than the estate taxes. In addition, one of the most traditional 2-percent management fee and challenging issues of a direct-investing pro- What Types of Investments 20-percent carried interest that is the gram is what happens if these illiquid Are Families Making? industry standard. The independent- investments are either inherited by a wife The types of investments being made are as sponsor model is another vehicle that has or by children who may not have a deep varied as the family offices making them. emerged for family offices. Independent understanding of their nature or manage- Rob Blabey, the former chief investment sponsors are individuals with either indus- ment. Without a developed family-office officer for the Collier family, put it this way: try or private-equity experience, who iden- staff with experience in this area, less- “If you have seen one family office, you have tify and put under contract single deals and than-optimal value maximization may seen one family office.” Some offices, such then seek financial groups to provide fund- result and create problems for the heirs. as Dobbs Management and Blue Water ing. They often provide family offices with Worldwide, focus on specific verticals industry expertise or increased deal flow. Inherent Advantages for Family Offices where they have in-house expertise or have Despite the reservations outlined above, developed expertise through partnerships Key Considerations for the Family family offices have a number of inherent with other families. Dobbs Management Office Seeking to Do Direct Investing advantages in this asset class. First and leverages years of experience in the auto The cost of entry is one key consideration foremost, they can be flexible. Because motive industry. Blue Water Worldwide for the family office seeking to enter the most are not required to put money to (BWW) has created a holding company that market. How much are they willing to work, as are funds, they can be patient and makes specific investments in real-asset ver- invest in a team that will be able to source, wait for the right opportunity. In addition, ticals in conjunction with other families that do due diligence, and manage the invest- they have the ability to be more flexible have expertise in those verticals. Currently, ments once they are made? Direct investing from a structuring standpoint. They can be they are concentrating on the aggregates requires a specific set of professional skills more conservative with leverage and can business, power transmission, and class A that includes sourcing, diligence, account- invest in different parts of the capital stack. warehousing in emerging markets. Others,

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such as the Vinik Family Office, carefully that would grow and throw off significant Conclusion analyze the market and have a more surgi- cash flow far into the future. Integral to this This trend toward more direct investing cal strategy. strategy was investing in conjunction with appears to be here to stay. How it evolves families that have significant expertise in will be driven by the individual nature of “We are opportunistic,” said Abrams. the targeted verticals. So far, this strategy the individual family offices. Whether fam- “We are open to venture, buyouts, and real has paid off. The company is targeted to ily offices will achieve tremendous success estate. The risk-reward trade-off needs to make around $300 million in revenue with in this sector or experience challenges that make sense. Who is the management team, more than $50 million of earnings before will be difficult to overcome remains to be what is their track record, and how much interest, taxes, depreciation, and amortiza- seen and may never be known. As Rupp are they investing—these are all key consid- tion in 2015; it has been able to grow net shared: “Part of the problem is that you tend erations. We like a good opportunity for asset value at a compound rate in excess of to only hear about the family success stories. growth with a clearly identified downside 22 percent per year. You never hear about the bad deals.” and an aligned management team that is committed. We shy away from the fray and Characteristics of Successful Direct- Anna Maria Nekoranec is the chief execu- look for things that are off the beaten path.” Investing Operations tive officer and co-founder of Align Private Some of the larger family offices that Capital, LLC, which provides tailored Current Trend—Family-to-Family entered the space early have become a private-equity solutions to families. She is Investments force in and of themselves. A great exam- the co-author of How to Buy a Business: More and more families are seeking to ple is MSD Capital, the direct-investing Entrepreneurship through Acquisition. She partner with other families in club deals or arm for the Michael Dell family, which earned a BA from the University of Virginia to leverage one family’s expertise in a space. opened in 1998 and has offices in New and an MBA from The Wharton School, BWW, which is run by Benji Griswold, is a York, Santa Monica, and London. MSD University of Pennsylvania. Contact her at prime example. Griswold’s family started Capital focuses on special opportunities, [email protected]. Alex Brown and Sons and Brown Advisory. private equity, and real estate; it created Struck by the entrepreneurial bug and the the gold standard in the industry and has Endnote 1. David Bain, Family Capital “Single Family Offices need to find an interesting long-term a reputation that surpasses that of some Manage a Lot of Money Here’s a Guestimate” (July 15, investment vehicle for the family, Griswold of the best funds. Others such as the 2015), www.familycap.com. founded BWW about seven years ago with Griswold family have created permanent funds from his family and other families. capital-holding-company vehicles where The strategy was to create a Warren Buffett- family members oversee strategy, execu- like holding company to make investments tion, and management.

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