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The New Kid on the Block – Here to Play, Here to Stay: The Institutionalization of the Family Office

Nov 26, 2018

If you believe Albert Einstein’s saying “The measure of intelligence is the ability to change,” then family offices are looking very intelligent these days -- like their investment strategy and approach, family offices continue to evolve. While family offices making direct investments is not revolutionary, more often today they are bypassing investments in a fund structure and investing directly; many times taking a control position in an investment. Although investing direct presents opportunities for higher returns, complete transparency and discretion, it does not come without its own set of challenges. Direct investing requires a unique and not insignificant list of barriers to entry.  The family office playing this hand must have a more robust infrastructure versus a skeleton team of investors, including talent for deal origination, valuation, financial and operational due diligence and more.

A large factor in the acceleration of family offices institutionalizing further and investing directly was the ’08 financial crisis. While alignment of LP and GP interests has always been a focal point, the financial crisis catapulted a new approach to the forefront: investing directly and avoiding paying fees to outside managers, specifically, retaining up to one fifth of the returns through carry.

According to Pitchbook data, over the past ten years, U.S. family offices participating in direct deals has increased almost 70% and more than 175% since the 2008 financial crisis. On a global level, the data further highlights the shift, with a 96% increase in direct deals over the last decade, while increasing by more than 210% since the ’08 financial crisis.

Deal Count Activity - Globally

Source: Pitchbook

For family offices, going direct presents several benefits including:

  1. Economics: Family offices can cut their costs by bypassing the 2% management and 20% carry on profits through direct investments and
  2. Transparency: By investing directly, the family-office team will have full transparency into the business they are purchasing, as they will be the sole owners and operators of that business.

However, the competitive advantage(s) of family offices to a seller cannot be overlooked and is something many investment bankers have seen an uptick in when marketing a deal. 

  • Sticky Capital: Family offices have the ability to invest long-term. Unlike a traditional private equity fund, which has LPs to answer to and a fund expiration date, Family Offices are investing on their own behalf and have the ability to be longer-term capital as compared to a private equity fund. 
  • Family-to-Family deals: Successful family-owned and operated companies revel in the idea of selling to a like-minded family entity. While the seller has decided to sell, they can be emotionally attached to their business. Selling to a family office offers a layer of familiarity to the seller; whereas, private equity funds can be perceived to be more impersonal and transactional – wanting to acquire the business, ramp it up, and sell at higher multiples in three to five years.
  • Creativity and flexibility: Family offices have less red tape, especially as former private equity individuals who have experienced the good, the bad and the ugly, and tweak their approach at the FO for the better. They can get creative in their leverage profile, timeline and structure of a deal.
“Family offices have an interesting angle where they can play like private equity but are able to be more flexible in deal structures and seek to preserve their investments across generations, unlike PE firms which have contractually short (3-5 year) time horizons.  This alternative can be attractive to owners seeking a longer-term partner who can help them grow their business without the pressure of short-term capital cycles.” - Michael Mas of Pinecrest Capital Partners

Private Equity Intelligence | Q4 2018

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