Most wealthy families will have been enjoying exotic holidays in recent weeks, but their investment offices have remained busy: for instance Bregal Capital, steward of the Brenninkmeijer family fortune, bought software business proALPHA in August. That followed some notable family office deals in spring, including Fleming Family & Partners’ acquisition of UK energy efficiency business FIT and a Wheatsheaf Investment-led £13 million fundraising round for clean water company Ostara.
To Mike Reid, managing partner at Frog Capital, such deals illustrate how family offices as a whole are starting to rethink their private equity strategy. “Over the last 10-15 years the limelight has been taken by the rise of private equity. But the credit crunch has reminded us how influential large family business and wealth is.”
That’s proving particularly true in the current investment climate, he argues. As LPs become increasingly reluctant to stick to the traditional passive investment model, they’re seeking more visibility and more control over how their money is ultimately deployed – and gradually building up their capacity to do deals directly, industry sources suggest.
“Families are definitely more reluctant to go into blind pools,” said David Barbour, co-head of private equity at FF&P. “And there is certainly a great deal of talk about co-investments and direct investments.”
There are a variety of reasons for this evolution, including a general reduction in the returns achieved by traditional funds, the greater transparency and perceived lower risks of direct deal-making, and the ability to better control the outcome of investments and acquisitions. John Rompon, managing partner at McNally Capital – a Chicago firm that provides investment advice to families – suggests more pragmatic factors are also at play.
“You could fill a room with estate planning lawyers and they’re not going to come up with a better way to transfer wealth over generations than by acquiring companies. There is simply no more efficient way to transfer a large amount of wealth than through corporate acquisitions.”
In addition, he argues, the asymmetry of information between private equity funds and investors has drastically reduced – families can now access a lot of the information they need on lenders, debt levels, company balance cash flows and multiples. This has lifted many of the barriers that prevented them from doing direct deals, he suggests.
“If you look at the balance sheets of most family offices, you’ll notice that the assets that are most underleveraged are their knowledge, network and experience. Investing in funds does not leverage any of these three things. Investing in private companies does.”
CLIMBING THE LADDER
Family offices are getting closer to deals through incremental steps, explains Reid.
For some, the first evolution has been to progressively disengage from fund of funds, in an effort to avoid layering management fees. Co-investments alongside their own GPs, increasingly pushed for, he says, are not always taken on, as some remain wary of getting overexposed to a single deal.
Rather, Rompon suggests, families are increasingly looking at partnering with like-minded peers to co-invest in their own deals. “Families benefit by having an indeterminate holding period: they can hold an investment for a year or for 50 years, and make the optimal decision based on that. Co-investing with families thus makes sense because each side on the transaction has the same open-ended holding period.”
Some families still lack the internal resources to structure such deals, suggests Nadine Koniski-Ziadé, global head of investor relations at Quilvest Private Equity, which offers tailored investment solutions to an LP base predominantly made up of family offices.
But dedicated asset managers could help them get up the learning curve, she argues. “Even within very large family offices, in-house private equity teams rarely [number] more than five or six staff. So we know our role is going to be to coach some of them for a period of time to get a better understanding of the asset class.”
Over time, she says, it is only natural that some of them would ‘graduate’ from the asset management model, whereby the more experienced ones will develop enough capabilities to source and manage deals internally.
Good case studies, adds Reid, include Switzerland’s Symphony, as well as the offices of the Clarks and Blackwell families in the UK, which have all developed their own capabilities to invest in private equity. Some of them have even grown into diversified managers, he says, even creating different investment subsidiaries. Grosvenor Estate, for example, has a global property business, but also invests directly in renewables and agriculture through its Wheatsheaf Investment division.
A NEW SORT OF CHALLENGE
But not every investor will succeed by following this strategy, Barbour cautions. “Some of the family offices doing private equity directly as an immediate reaction to having unpleasant experiences with blind funds will find it very difficult and may have some nasty experiences.”
Without deep experience and established networks in a given environment, he suggests, it remains a challenge to create the necessary dealflow. Equally, finding the right partners to co-invest with is not always straightforward, he says. “There is a whole middle ground of family offices who want to go direct, but are struggling to do that because they’ve not staffed up and are quite reluctant in general to have that fixed cost.”
In addition, Rompon concedes, direct private equity investing requires skills not every family office will naturally be equipped with. “Most of them made their wealth through management; they were very hands-on. But when you invest in a company rather than manage it, you have to learn how to govern. You have to hire the right people, train them, incentivise them [and] replace them if necessary – which is a skill-set not everybody has.”
With appetite for co-investment on the increase, GPs are being forced to adapt to the requirements of more demanding LPs, Reid says. “Incumbent GPs will probably be selling a different thing. Before, family offices were thinking of coming into funds purely as a financial investment; now they’re looking for market insight and dealflow information. GPs are becoming much more like service providers.” He cautions that this new role, in addition to requiring more work, could eventually lead to some GPs ending up with smaller fund commitments.
Unfortunately for them, Rompon thinks this trend will only continue. “Once family offices start making direct deals, they seem to never lose the taste. They may alter their strategy – rather than just making direct investments they’ll switch to co-investments with other families – but that’s still direct deal-making. What I rarely see is families who begin to do direct deals and then go back to just making fund investments.” Whichever way you look at it, that will not be a welcome development for GPs.