The Rise of Family Office Direct Investing

The first of our series of Chambers High Net Worth articles on worldwide trends in private wealth showed that the ultra-wealthy had, on average, increased their wealth since the onset of the Covid-19 pandemic, and discussed some of the key macro-economic factors which might have driven this increase, particularly the strong performance of equities and other investment assets. This article can be read here.

This article looks at one of the ways these Ultra High Net Worth Individuals (UHNWIs) are allocating this new wealth: direct investing in private businesses.

Many ultra-wealthy investors and Family Offices are making large allocations to private equity investments, and particularly to direct investing in private companies.

Almost 70% of respondents in the UBS Global Family Office survey said they saw private equity as a key driver of portfolio returns. That might be because greater availability of private capital via private equity and venture funds has allowed growing businesses to stay private for longer; investors who stick to public equities lose out on much of these companies' growth potential.

Respondents to a recent Goldman Sachs report on Family Office investment trends reported an average 24% allocation to private equity. More than three quarters of respondents in the UBS survey said they had at least some exposure to private equity in their portfolios, with 45% saying these investments were either wholly or in part made by direct investing.

Often, direct investment opportunities come from Family Offices' strong networks. UHNWIs who made their money through operating businesses may access early-stage investment opportunities through their contacts in industry and with other ultra-rich investors. Family Office investment professionals can provide access to co-investment opportunities through links at the private equity houses and investment banks they worked at before going in-house.

"The connections that the family has with investment bankers or other advisors are going to play a role," says Brent Berselli, partner at Holland & Knight LLP; "we see connections within the private equity sphere as generating additional leads, not necessarily to invest within the fund, but perhaps to come on as a co-investor, or to gravitate toward another direct investment opportunity that stemmed from that original relationship."

Many UHNWIs see themselves as having the entrepreneurial gene, and those who have built and exited successful businesses often feel the desire to repeat the trick by investing in start-up businesses and applying their knowledge, expertise and extensive networks to help these businesses succeed.

Other UHNW families use direct investments as part of their impact or social investing strategies, or as a way bringing their children into the decision-making process around the family's investment activity. "Certainly, returns are going to play a part in that analysis, but we do have Family Office clients that engage in direct investment investing for impact purposes or education for the next generation of their family," says Berselli. "We've seen that, more and more, where a younger member of the family has a particular interest in one industry or another, often in the tech space, that the Family Office may start to gravitate toward those types of direct investments."

When these opportunities arise, Family Offices have plenty of cash on hand to invest. They typically hold outsized cash positions relative to other types of asset managers, giving them dry powder that can be committed quickly without having to raise capital or seek debt financing. Respondents to the Goldman Sachs survey reported an average cash and fixed income position amounting to 19% of their assets under management, and the Family Officers who responded to the UBS survey said cash made up 13% of their portfolios on average.

This high allocation to cash allows Family Offices to counterbalance the liquidity risk inherent in private company investments. Family Offices also work over longer investment time frames, allowing them to tie up more capital in illiquid alternatives.

Around 80% of Family Office respondents to the Goldman Sachs survey said their primary mission was "capital appreciation for multigenerational wealth transfer." The Family Office investor's ability to work on a generational timescale allows them to tie up more capital for longer and realise more of a business' growth potential.

In the US, "the first and foremost risk that Family Offices need to be aware of when they are sourcing direct investment opportunities is to be very, very careful that they are doing so in such a way that's going to maintain their exemption from state and federal securities law registration requirements," Berselli says.

A particular risk arises when Family Offices make co-investments "almost by piggybacking off of other Family Offices, and try to share resources and share the due diligence." Co-investors "need to be very, very careful that you're not jeopardizing your Family Office exemption and being deemed to manage money for others outside the permitted Family Office holders," Berselli adds. "You also need to be just very cautious that they are not going to fall into a situation where they could be deemed to be almost a broker-dealer, and that they're sourcing this transaction or raising capital for another company which could expose them to additional potential liability, particularly if the deal does go South." These and other risks can be mitigated with careful planning and structuring, Berselli says.

Family Offices who make high-value direct investments require their professional advisers to combine expertise in traditional private wealth issues with the transactional capability needed to execute these complex deals.

Chambers High Net Worth recognised this in the 2021 edition with our new Family Offices & Funds Structuring categories in the UK and USA. Law firms and lawyers ranked in these categories have the capability to support Single Family Offices with the corporate structuring, tax, regulatory and dealmaking expertise these increasingly sophisticated clients require.