A downturn in the deals market can make many participants shudder. PE firms worry about the denominator effect and their ability to raise more funds. Bankers and other advisors fret over lower bonuses and possible layoffs. But one group that often takes advantage of the environment are family offices. We explain more below.
These investors are in it for the long-haul and by long-haul we don’t mean a 10-year Continuation Fund. We’re talking a view toward generations down the road.
“In times of change and challenge, the flexibility and the long-term perspective that families bring can allow them to compete and win even more effectively than in more stable markets,” says Paul Carbone, co-founder of Pritzker Private Capital.
Carbone stepped back from day-to-day management of the firm at the start of the year but continues to chair the firm’s management and investment committee
“Family capital doesn’t have to worry about buying and selling a company in three or four years. They don’t have to worry about conforming to a very specific strategy that’s in their fundraising documents. They’ve got the flexibility in structure, duration and approach that allows them to look through the current challenges.”
The investment time horizon for most family offices—typically 100 years—certainly can present certain advantages over investor types, says Belinda Schwartz, partner at Herrick and chair of the firm’s real estate department. But like much in the business world and life, nothing is guaranteed.
“There are these stories told about family businesses that the first generation makes the wealth, the second generation builds the wealth and the third generation loses the wealth. Obviously, the goal is to prevent that from happening,” she says.
Family offices also generally don’t leverage their deals, so they’re less affected by rising interest rates than other PE investors are. “They’re patient capital; they’re not looking to churn,” Schwartz says. “If they see an opportunity, they oftentimes have the liquidity to transact, which not everyone can.”
Family offices can be formidable competitors to private equity, and in recent times, private deals are becoming even more of interest to this group. In fact, a recent survey by Dentons showed that 60 percent of family offices believe private markets provide the best investment opportunities. They’re as much on the hunt as any institutionally-backed PE firm.
The survey found that healthcare was the most attractive area for family office direct investing, followed by technology, commercial property and industrial services. The top two challenges of direct investing for family offices were taking on too much operational risk and finding high-quality dealflow.
Family members are heavily involved in investment decisions, according to the survey, with only eight percent of family offices deferring entirely to their staff on investment decisions, and 30 percent of the respondents reporting that important investment decisions are made by staff in collaboration with family members.
“If you’re working in a family office, you have to realize that the capital is the family’s capital,” says Edward Marshall, global head of family office for Dentons.
Putting Capital to Work
Broadly speaking, over the last five to seven years, Carbone says there’s been significant growth in the number of family offices and the amount of capital invested by family offices. Families have developed more sophisticated investment approaches and are bringing in more investing talent to help deal with the challenges of investing in an overcapitalized market. Families are also looking to grow their capital, not just preserve it, and they’ve deployed more capital in alternatives, venture capital and private equity direct investments, he says.
Previous generations held more of their capital in operating businesses—including the businesses that created the families’ wealth—and families converted those operating assets to financial assets, leaving subsequent generations with more financial capital. The families then had to develop more approaches to managing and deploying their capital.
“You don’t always have that next gen that wants to run the business,” Carbone says. “Increasingly you’re seeing that they want to do things differently. They want to have a different impact on the world. They want to use their capital differently. They want to spend their time differently. They don’t necessarily want to run the widget factory that grandpa or grandma established. So when there’s generational transition like that, families often think about selling the family company.”
For sellers and intermediaries, family offices bring different characteristics to the table than traditional private equity buyers. Traditional PE has time boundaries for its investment, capital raising burdens, and is paid only if that capital is deployed and harvested. Family capital is permanent—it doesn’t need to be handed back—which means family offices have maximum flexibility in investing that capital.
“Our capital appeals to family sellers and founders fundamentally differently than traditional private equity capital,” Carbone says Pritzker Private Capital. “Families are attracted to our kind of capital because we can do things differently. We can help the family build the business the way the family would like it built, and be a partner with a value system and philosophy that’s more consistent with theirs versus traditional private equity.”
The ways in which families amass their fortunes are also changing.
“There are more and more creators of capital who have a financial background like private equity, asset management and hedge fund people,” Carbone says. “So there’s more and more meaningfully wealthy families who created their wealth not through a manufacturing or other operating business, but by being savvy financial investors.”
Over the next 10 years, Carbone expects that the number of family offices and the amount of family office capital will continue to grow, as will their investing capabilities through adding professional investment staff. But finding value in investments will also become more difficult, so family offices will also need to question whether they’ve staffed up enough, he says.
Carbone also expects to see “massive” transitions of capital to the next generations of families over the next five to 10 years, combined with a different investment perspective from the next generations compared to previous generations. “They expect different impacts from their capital.”
Broadly speaking, the next generation in family offices will avoid certain industry sectors and put their capital into sectors that have a positive environmental and social equity impact on the world, Carbone says. “Right now we’re seeing that next gen have an influence in the investment criteria and where the family’s capital gets deployed.”