The European family office considers the trend of direct investing among FOs and what lessons should be learned.
The following commentary from Blu Family Office, a wealth management house that is headquartered in Richmond, southwest London, is part of a series of commentaries the organisation will be sharing with readers. The editors are pleased to share these views and invite readers to respond. They can contact the editor at firstname.lastname@example.org
This article examines the trend in trend in direct investing for family offices. This is a trend that this news service has tracked for some time in different parts of the world.
It seems quite natural to think that family offices would endeavour to make direct investments into companies via equity or debt. After all, most family offices made their very fortune by building businesses and taking outsized risks on specific investments. The talent of building one business surely is transferrable to investing and building another, so the argument goes. According to a recent survey, about 25% of single family offices invest in private companies and more than two thirds want to increase their direct investments. (ref: https://www.axial.net/forum/family-offices-are-making-more-direct-investments/)
So, are direct investments the next best thing since sliced bread and are family offices better or particularly suited to make such allocations? Well, it certainly makes sense to find alternatives to paying a 2 per cent management fee and 20 per cent performance fee to someone else (via private equity or debt funds) and gain more control over what type of investment and for how long to stay in before selling out. But one cannot under estimate the amount of work it takes to find, structure and agree economics for an interesting deal.
Our family has more than 20 years of experience in making direct investments and, without fail, every one of these deals took longer than expected to complete; took huge emotional tolls on everyone involved; and often didn’t turn into the huge successes we were all lead to believe.
It’s easy to get excited about a deal. The people selling, or shopping deals, tend to be very enthusiastic and very good at painting tremendous pictures of the “deal of the century”. Driven by the thought of making a great investment and reaping many multiples of the capital invested, negotiations for economics always hit a major snag: how much to pay for a very uncertain outcome? And that’s the most important thing to remember: no matter what they tell you, no matter how excited you are, no matter how much money you can make, it can also all go tits up. If you then look at the many months of work you had to put in (note: I have never seen a deal close in less than six months!), the energy and emotional turmoil, it hardly seems worth the fuss.
But what if it works and what if you have a specialised skill set or particular experience in a sector or type of company? Sure, it’s a nice thought, but unless you (the principal) have this knowledge and the energy to build another business, you are going to have to pay someone else to provide this expertise and do the work. These people won’t be cheap and more than likely also want a free lunch, e.g. a large salary and a piece of the upside. That can certainly take the fun out of it, or at least change that all important risk and reward skew.
Fact is, unless you have a particular edge in something, there really is no reason to engage in areas where others have a clear competitive advantage (e.g. staffing) or, worse, where there are significant barriers to entry (e.g. resources). For a family office, this means that unless you are in the business of private equity or feel that you need to do something that utilises your skill set from past careers, there really is no economic reason to make direct investments.
Companies are companies, whether they are private or public. There can be size effects and certainly some businesses are riskier than others, but there really is no scientific reason why private ownership should outperform publicly listed companies.
The excess return that one expects from doing a whole lot of work and taking the risk of an illiquid investment, where it may be very difficult to get out, just does not seem to make a lot of sense when there are so many other investments one could be making without the headaches and risk. We may very well be better off just putting our money into the stock markets.