What families and HNWIs want from direct PE exposure

Richard Hill, who leads multifamily office Stonehage Fleming's direct investment activities, speaks to PEI about how the firm likes to invest and increased competition for private wealth capital.

Why would a client want to invest in PE directly, as opposed to via a fund?

A typical private equity fund will be seven-year fund with two one-year extensions, so you’re looking at nine to 10 years. A venture fund [could be] 12 to 15 years. It’s a really long-term horizon. If you want to allocate your capital to a programme of private equity funds that, over time, develop a self-financing private equity pot, then it’s perfect. But if you want to see your results more quickly, then you need to consider investing direct – because in a direct investment, your money might be out within three or five years. Some clients do both.

richard-hill_stonehage fleming
Fleming: Always room for advice-led approaches for private wealth clients

Clients can select what they want to invest [in]. We show our clients our dealflow, and they make the investment decision I think it’s the psychology of control – the psychology of making their own investment decisions, knowing exactly what they are investing in, and the investment on average being a shorter time frame. Clients are often successful entrepreneurs or family offices that are used to making decisions. They often don’t like delegating this to a third party manager.

What are your average deal sizes?

We’ve put about $430 million to work in our programme (across 23 investments). We’ve honed what we’re doing and because our clients come from a broad church, they have different interests, different risk profiles, different experience in different sectors, different geographies. We don’t want to say, look, we’re just going to show you fintech deals, or we’re going to show you consumer deals. There are good specialist investors with that focus. We tend to look quite broadly across the market and we segment the deals by risk profile.

Venture/growth equity: we focus on investments of between $2 million to $10 million per deal. These are minority interests in companies, typically around 10 to 20 percent of the equity. Late Series A, early Series B is a perfect time for us. We don’t want to be too early because it’s just too risky – we want to see revenues of at least $2 million to $3 million, proof of concept, commercialisation of product and evidence of product-market fit. We don’t want to be too late either, because a  $10 million investment in a successful Series C company, you just have a small percentage ownership. We want to have a position of influence so we can protect our clients’ interests.

How are you thinking about the impact of rising interest rates on your business?

I’ve always felt that there is less competition doing slightly smaller deals and more opportunity for genuine returns. A lot of the returns in bigger private equity funds has come from leverage, and that impact of that leverage if you have growth over a period of four or five years results in big cashflow generation.

What we’re doing is smaller ticket sizes where there’s less competition and more genuine growth opportunities without the need for finance or multiple expansion [between entry and exit]. It’s quite simple: you go into a business paying X times revenue or profit depending on the stage of investment, exit at the same multiple, in five years’ time, if you’ve grown at 40 percent a year, there’s your return. There’s no leverage in there at all from us, no interest costs. I think the size plays really well to family offices because they’re not generally looking to put hundreds of millions of dollars to work in a deal. They’re looking at smaller deals or opportunities with less competition. It’s about picking the right deal, but also being in the right part of the market.

There’s increased competition for private wealth capital from the likes of KKR, Blackstone, Ares Management and others. How does the Stonehage Fleming offering differ?

There’s always going to be a room for [an] advice-led approach. Investing in private markets is challenging so our clients want to know what we think. We’re never going to be one of the big distributors, which is not what we do. We’re trying to do something different. We’re competing for wallet, for sure, but I think if we continue to be smart about how we do things and how we present ourselves to our clients, and keep those long-term relationships, we’ll always have their eyeballs.

It’s really important [for] people and firms in our [family office] world that want to do well, they exist because they’re good at forming relationships. Clients value that. If you’re looking at private dealflow, how do you know what’s good and what’s not? Many clients see plenty of dealflow, [and] they’ve got no way of determining what’s good and what’s not. They might have an opinion but they may not have the time or resources to investigate it properly. We’re saying: “We’ll tell you what we think and why it’s better than the alternatives that may be available. This is the reason why we’re offering it to you, and this is the reason why we’re putting our own money into it.”

Richard Hill is chief executive of Stonehage Fleming’s corporate finance, which includes the multifamily office’s direct investing business.