Direct private equity investments are increasingly preferred by family offices. Here, Nick Warr (head of Private Wealth) and James Goold (head of Private Equity) at international law firm Taylor Wessing explain why.
The nature of family office investment in the private equity industry is undergoing a noticeable shift. Whilst family offices have traditionally been passive investors in the private equity industry, the scale of available private investment capital and current market pressures are altering the relationship and transforming the private investment capital landscape as we see it today.
The value of family offices
According to Knight Frank’s Wealth Report 2015, 172,850 ultra high net worth individuals (those holding over $30m) worldwide hold a combined wealth of $20.8 trillion. Of those, 60,565 are located in Europe, with a total wealth of $6.4 trillion – a figure which surpasses that in America and even Asia. London tops the city rankings, remaining the single biggest centre for global UHNWIs, and is expected to maintain that position for at least the next decade. The importance of encouraging and sustaining family office investment therefore cannot be underestimated in light of the substantial sums of money available.
Whilst previously the relationship was harmonious, family offices are increasingly investing on their own, cutting out the private equity middle man. A number of reasons have been cited for this growth in direct investment. Family offices are said to be more and more frustrated with the lack of understanding by private equity funds of the families themselves, their cultures and goals. Poor communication and reporting by General Partners used to dealing with institutional investors has also been noted. Tied to this is the greater desire from family offices for control of investments, both in terms of choosing and managing the target, and the length of the investment. In the wake of the financial crisis, there is also a pervading attitude of “why pay for what I can do myself”, resulting in some objection from family offices to the fees and carry payable on private equity investments. Investing on a deal-by-deal basis or with an independent sponsor gives the family office far more control: they can pick the target, investing in companies which suit their expertise and do not risk potential damage to reputation (a key consideration for UHNWIs); they can invest as much as they want for as long as they want, and can exit at a time which is right and natural for the company; and, more importantly, they can often generate greater returns as there is no need to sacrifice funds for GP fees and carry.
The role of private equity
None of this, however, means that family offices should discount the value of investing via the traditional private equity infrastructure. Private equity funds offer a huge range of benefits to all investors, be they institutional or family offices. Many funds are now sector agnostic, and as such have large, varied portfolios (not dissimilar to the historic “conglomerate” approach of large listed companies). To family offices, they offer access to opportunities and investments which would otherwise not be available, be that because of the size of the investment, the industry sector, the lack of expertise, or simply because private equity funds have the necessary industry knowledge to identify and exploit new opportunities. Typically investing for three to five years before exiting, private equity funds and their managers have vast experience in increasing value in assets over a shorter period of time and can offer sizeable returns for their investors. The structure of fundraising in the private equity industry also carries a major advantage. Whilst it does mean that funds may not necessarily be drawn down as soon as they are committed, in an industry where speed is everything, the ability of private equity funds to call on committed capital and transact swiftly can give these funds a distinct edge over deal-by-deal sponsor bidders whose ability to transact is dependent on deal-specific fundraisings.
In the face of increased pressures from family offices in relation to transparency and fee arrangements, private equity funds are by necessity becoming more flexible. Fund managers are becoming more amenable to the idea extending holding periods before exiting their investments. Some are also willing to offer co-investment opportunities on a deal-by-deal basis, whilst others are open to more creative fee structures and arrangements. This allows a hybrid investment, with the family office investing directly, but relying on the fund to perform due diligence and to lead the deal. When making such direct co-investments, it is also open to the family office to negotiate additional rights, such as more stringent reporting obligations and veto rights over matters affecting its rights and economic returns and over key business decisions. The co-investment portion also commonly escapes the traditional fee arrangements which apply on committed funds.
Whilst many family offices are deciding to brave the investment market on their own (often with the benefit of a seasoned investment team sourced from the private equity industry), there are still considerable advantages to be gained from investing via or alongside a private equity fund. Indirect and co-investment structures offer greater stability, the benefits of a wealth of asset management experience, diversification of portfolios, and access to the cream of the investment opportunity crop. With funds increasingly offering more flexible investment terms to family offices to harness their capital resources, the ongoing benefits of investing through and/or alongside a specialist private equity fund will not see the family office investor abandon its traditional relationship with the private equity industry altogether. With the increasing resources (in terms of capital and investment management skills) available to the family office, though, that’s not something private equity can take entirely for granted.
About the Authors:
Nick Warr is a partner in the private client department at Taylor Wessing. He specialises in advising ultra high net worth individuals and families with interests mainly on fiscal and succession planning.
James Goold is a partner in the UK private equity team at Taylor Wessing and specialises in private equity and M&A transactions, with experience in the UK, EU, and internationally.
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