Family Office Direct Investing

Being a multi-family office ecosystem, the topic of direct investing is one that is crucial to our clients and, indeed, a topic that comes up frequently in our discussions with clients. In this scenario, direct investing occurs when a family office invests directly in private companies, real estate (RE) projects, or other private investments rather than investing in publicly traded stocks or bonds.

Family Office Formation: How do Family Offices Invest?

The investment strategies used can vary, depending on the specific goals and risk tolerance of their clients, but the following are some common ways family offices invest:

  1. Direct investments: investing directly in privately-owned companies or RE projects, providing capital to fund growth or development.
  2. Private equity: investing in private equity (PE) funds that invest in companies with high growth potential. In this case, a private equity fund is a long-term focused pooled investment vehicle where the advisor pools investor money together in order to make investments on behalf of the fund.
  3. Hedge funds: investing in hedge funds, which use various strategies to generate returns.
  4. Real estate: this includes investing in commercial properties, residential properties, and RE funds.
  5. Public equities: investing in publicly traded companies through stocks or mutual funds.
  6. Fixed income: investing in bonds or other fixed income securities, which can provide stable income and lower risk than equities.In practice, offices typically use a combination of the above strategies to diversify their portfolios and manage risk while seeking to achieve their clients’ financial goals.

How Do I Set Up a Friends and Family Investment Fund?

Setting up a friends and family investment fund involves creating a legal structure to pool money from investors, usually family members and close friends, to invest in various assets. Here are some general steps to set up a friends and family investment fund:

  1. Define the investment strategy: Before setting up the fund, you need to define the investment strategy. This includes identifying the types of assets the fund will invest in, such as stocks, RE, or PE, as well as the expected return and risk level. It is crucial at this stage to also consider what the fund structure will be.
  2. Determine the legal structure: Next, you need to determine the legal structure of the fund. The most common structures are limited partnerships, limited liability companies (LLCs), or a simple joint venture.
  3. Develop the offering memorandum: An offering memorandum outlines the investment opportunity and contains information on the fund’s investment objectives, risks, fees, and expected returns.
  4. Identify investors: The next step is to identify potential investors who may be interested in investing in the fund. Typically, this includes family members and close friends who are accredited investors, meaning they meet certain income or net worth requirements.
  5. Raise capital: Once you have identified potential investors, you can start raising capital. This involves pitching the investment opportunity to investors and providing them with the offering memorandum and any other relevant documents.
  6. Manage the fund: After raising capital, the fund needs to be managed according to the investment strategy and the legal requirements of the chosen structure. This includes selecting and managing investments, providing regular reports to investors, and ensuring compliance with securities laws and regulations.

What is PCAP Investing?

PCAP (Personal Continuous Automated Portfolio) investing is a type of investment strategy that uses algorithms and automated systems to manage and optimize an investor’s portfolio continuously. It is a passive investing approach that seeks to maximize returns by investing in a diversified portfolio of low-cost index funds and exchange-traded funds (ETFs).

PCAP investing relies on sophisticated algorithms and computer models that constantly monitor market trends and adjust the portfolio accordingly. This allows for a highly personalized approach that takes into account the investor’s individual risk tolerance, investment goals, and time horizon.

The Rise of Family Office Direct Investing

Direct investing has been on the rise in recent years, as wealthy families seek to take greater control over their investments and generate higher returns.

The Trend

One of the reasons for the growth in direct investing is the increasing number of wealthy families around the world. According to a report by UBS and Campden Wealth, there are now more than 5,000 family offices globally, with a total net worth of over $5.9 trillion. These offices are looking for new ways to invest their wealth and generate higher returns, and investing directly offers an attractive alternative to traditional investment vehicles.

The Rationale

Overall, direct investing can provide a number of benefits to wealthy families looking to take additional control over their investments and potentially generate higher returns. However, it also requires significant resources, expertise, and a high tolerance for risk, which is why many offices engage a team of experienced professionals to assist with the investment process.

Tax

Direct investing can have different tax implications depending on the type of investment, the structure of the global family office, and the jurisdiction where the investment is made. The following are some general considerations:

  1. Taxation of investment income: Direct investments in privately-owned companies, RE, or other private assets may generate income that is subject to taxation. The tax treatment of this income will depend on the type of income, the jurisdiction where the income is generated, and the structure of the investment. In general, income generated from direct investments is taxed at the ordinary income tax rate, which can be higher than the tax rate on long-term capital gains from public investments.
  2. Taxation of capital gains: Direct investments can also generate capital gains when the asset is sold or disposed of. The tax treatment of capital gains will depend on the holding period and the structure of the investment. In general, capital gains from direct investments held for more than one year are taxed at a lower rate than ordinary income.
  3. Tax implications of investment structure: The structure can also impact the tax treatment of direct investments. For example, if the office is structured as a pass-through entity, such as a partnership or LLC (whether the partner is a general or limited partner), the income and gains from direct investments will flow through to the individual investors and be taxed at their personal tax rate.
  4. Tax planning: Offices can benefit from tax planning strategies, such as structuring investments to take advantage of tax incentives, like tax credits for investments in certain industries or geographies, or structuring investments to minimize the impact of taxes.
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Analyzing The Investment Strategies of Ultra High Net Worth Individuals

Ultra-high net worth individuals (UHNWIs) typically have access to a wide range of investments, including PE, hedge funds, RE, and other alternative investments. Their strategies are often influenced by their personal goals, risk tolerance, and investment preferences. Further, UHNWIs typically have a range of strategies at their disposal, including diversification, a focus on long-term investments, risk management, philanthropy, and ESG investing. These strategies are often influenced by personal preferences and financial goals and may change over time as market conditions and personal circumstances change.

Family Office Private Equity and Direct Investing

Family offices often invest in PE and make direct investments in private companies (including scenarios such as a buyout) as part of their overall investment strategy.

Family Offices’ Deal Sourcing Strategies

Family offices use various deal sourcing strategies to identify potential opportunities. Here are some common strategies:

  1. Personal Networks: Offices often rely on their personal networks to source deals. They may leverage their relationships with other wealthy individuals, entrepreneurs, and industry experts.
  2. Investment Banks and Brokers: You may also work with investment banks and brokers to source deals. These firms have extensive networks and can provide access to potential opportunities that may not be available to individual investors.
  3. Professional Networks: Offices may join professional networks and associations to meet other investors (including institutional investors) and entrepreneurs. These networks can provide access to a broader range of opportunities and can also serve as a source of research information.
  4. Direct Outreach: Offices may also proactively reach out to companies and entrepreneurs to explore potential opportunities. This can involve attending industry conferences, networking events, or even cold-calling potential targets.
  5. Online Platforms: Some offices use online platforms to source deals. opportunities and can be an efficient way to identify potential targets.
  6. Industry Research: Offices may also conduct their own research to identify opportunities. They may use market research reports, industry publications, and other sources of information to identify emerging trends and potential deals.

Allocation To Cash and Investment Horizons

Family offices typically allocate a portion of their portfolio to cash to provide liquidity and to take advantage of investment opportunities as they arise. The exact amount allocated to cash will depend on your investment objectives, investment activity, risk tolerance, and overall investment strategy. Some offices may hold a larger allocation to cash during times of market uncertainty or volatility to provide a buffer against potential market downturns. Offices generally have longer investment horizons than other investors, such as hedge funds or mutual funds. This is because offices often have a multi-generational investment outlook and are focused on building wealth for future generations. As a result, these offices may be more willing to invest in illiquid assets, such as PE or RE, that require a longer holding period.

Risks Amid Opportunity When Making Direct Investments

Direct investments can offer significant opportunities, but they also come with risks that need to be carefully managed. Here are some risks that you should consider when making direct investments:

  1. Concentration Risk: Direct investments can often result in a higher concentration of risk in a single investment or sector. Offices should carefully consider the risks associated with the investment and ensure that they have a diversified portfolio that can mitigate concentration risk.
  2. Liquidity Risk: Direct investments can be illiquid, which means that it can be difficult to sell the investment or exit the position in a timely manner.
  3. Operational Risk: Direct investments require significant operational resources to manage, including due diligence, ongoing monitoring, and reporting. You should have a strong team in place to manage these operational risks and ensure that they have the necessary expertise to manage the investment.
  4. Regulatory Risk: Direct investments can be subject to regulatory risk, which can include changes in tax laws, changes in regulations, or legal disputes. Offices should carefully consider the regulatory risks associated with the investment and ensure that they have appropriate legal and tax advice.
  5. Valuation Risk: Direct investments can be difficult to value, particularly for illiquid assets. One should have a clear understanding of the valuation methodology used for the investment and ensure that it is transparent and consistent.
  6. Manager Risk: Direct investments often require active management, which means that the quality of the management team can have a significant impact on the success of the investment. Offices should carefully evaluate the management team and ensure that they have the necessary expertise and experience to manage the investment effectively.

Chambers Legal Rankings and Market Insights on Family Offices

Chambers’ rankings and reports provide valuable insights into the legal and business aspects of family offices. They can help you identify leading law firms and practitioners who have experience in working with offices and can provide guidance on legal issues such as governance, succession planning, and investment strategies. Additionally, Chambers’ reports and rankings can help you stay informed about industry trends and best practices.

Forging A Path to Direct Investing Through Technology

No discussion about investing would be complete without adding the impact of technology. Here are some ways that technology is helping family offices invest directly:

  1. Data Analytics: Advanced data analytics tools can help you analyze vast amounts of data, identifying trends and patterns that may be difficult to identify using traditional methods. By leveraging data analytics, you can gain insights into potential investment targets, assess risk, and make more informed investment decisions.
  2. Deal Sourcing Platforms: Technology platforms such as AngelList and SeedInvest provide offices with direct access to a wide range of investments. These platforms allow you to screen potential investments, view company information and financials, and make investment decisions online.
  3. Due Diligence Tools: This is an essential part of the direct investment process, and technology has made it easier than ever before to conduct comprehensive research. Online platforms such as DealRoom and CapLinked provide offices with secure virtual data rooms, allowing them to securely review and analyze confidential information.
  4. Portfolio Management: Technology platforms such as iLEVEL and eFront provide offices with portfolio management tools, allowing them to track the performance of their direct investments and analyze investment data. These platforms can help you identify potential risks and opportunities, optimize their portfolio, and make more informed investment decisions.
  5. Collaboration and Communication: Technology platforms such as Slack and Zoom provide users with efficient communication and collaboration tools, allowing them to work together more effectively and make more informed investment decisions. These platforms can help offices streamline their investment process and improve communication with their investment partners.
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Succession Planning and Wealth Management

Effective succession planning and wealth management can help ensure the long-term preservation of a family’s wealth and legacy. By identifying goals and objectives, developing a succession plan, educating the next generation, establishing a governance structure, and regularly reviewing and updating the plan, families can ensure that their wealth is protected for generations to come.

Real Estate Strategy and Management

Effective real estate strategy and management can help families maximize returns and mitigate risks associated with these investments. By identifying investment objectives, allocating assets appropriately, conducting proper research, financing investments appropriately, effectively managing properties, and having a clear exit strategy, families can make informed investment decisions.

Transaction And Investment Counseling

Transaction and investment counseling is a service provided by family offices to assist high net worth individuals and families in making informed investment decisions. This service may include advice and guidance on a wide range of investment transactions, such as mergers and acquisitions, PE investments, venture capital investments, real property transactions, and other types of investments.

Family Direct PE Models

Family direct PE models refer to the approach where a family office invests directly in privately-owned companies rather than investing through a third-party fund manager.

Lean And Opportunistic

“Lean and opportunistic” refers to an investment strategy that focuses on capitalizing on short-term investment opportunities while keeping overhead costs low. This strategy is often associated with offices that have a more flexible and agile investment approach, in particular, single-family offices.

In-house Dedicated Team

An in-house dedicated team refers to a team of professionals that are employed by a family office to manage their investment portfolio and other financial affairs. These professionals may include investment analysts, portfolio managers, accountants, lawyers, and other specialists who work together to manage the office’s assets.

Hybrid Outsourced Solution

A hybrid outsourced solution refers to a combination of in-house expertise and outsourcing to external service providers to manage various aspects of an office’s operations. In this approach, the office maintains a dedicated in-house team to manage core functions such as investment management, financial planning, and risk management, while outsourcing other functions such as accounting, legal, or technology to external service providers.

Family Office Direct Investing Ramps Up in Private Equity

Investing directly in PE has been on the rise in recent years. This trend is driven by several factors, including the desire for added control over investment decisions, the potential for higher returns, and the ability to access exclusive opportunities that may not be available through traditional channels.

The Rise of Family Office Direct and Co-investing

Family office direct and co-investing have been on the rise in recent years as offices seek to gain greater control over their investments, generate higher returns, and access exclusive investment deals.

As discussed previously, investing directly in a company or asset means that we proceed without going through a third-party fund manager. This approach gives offices more control over the investment process and allows them to negotiate better terms. Direct investments may also offer higher potential returns but can carry higher risk.

Co-investing, on the other hand, involves partnering with other investors to invest in a particular company or asset. This approach allows offices to share the risks and rewards of the investment with other investors, while still maintaining a degree of control over the investment process.

Benefits Of the Co-investing Approach

The co-investing approach has several benefits, some of which include:

  1. Increased Diversification: Co-investing allows family offices to invest in a wider range of companies or assets than they might be able to on their own. This can help to diversify their portfolio and reduce risk.
  2. Access to Expertise: Co-investing can provide access to expertise that may not be available in-house. For example, offices may partner with other investors who have specific industry knowledge or experience.
  3. Shared Risk: Co-investment allows one to share the risk and potential rewards of an investment with other investors. This can help to reduce the overall risk of the investment.
  4. Cost Savings: Co-investing can be more cost-effective than investing on their own. By pooling resources with other investors, offices can potentially negotiate better terms and reduce transaction costs.
  5. Access to Exclusive Opportunities: Co-investing can provide access to exclusive opportunities that may not be available through traditional channels. For example, offices may have the opportunity to invest in a company alongside its founders or management team.

What’s The Strategy: Direct Investing Strategies for Family Offices

The strategies can vary widely depending on the goals and preferences of the family. However, some common strategies include:

  1. Sector or Asset Class Focus: Some offices may focus on specific sectors or asset classes, such as RE, PE, or venture capital.
  2. Long-Term Focus: Family offices often have a longer investment horizon than traditional investment funds. This can allow them to take a more patient approach to investing and focus on building long-term value rather than short-term gains.
  3. Active Ownership: Many offices take an active ownership approach, seeking to have a significant influence on the companies in which they invest. This can involve taking board seats, participating in strategic decision-making, and providing operational expertise.
  4. Co-Investing: As we discussed earlier, co-investing can be a valuable tool for offices looking to diversify their portfolios, access expertise, and reduce risk.
  5. Direct Lending: Debt financing directly to companies can offer higher yields than traditional fixed-income investments and can be a valuable source of financing for companies that may have difficulty accessing traditional bank loans.
  6. International Investments: Many offices have a global outlook and may seek to invest in international markets. This can offer diversification benefits and access to new investment possibilities.

Setting Goals

Setting goals is a critical step for any family office, as it helps to provide a clear direction and focus for the investment strategy.

Getting Into the Game

Getting into the game can be a significant challenge, particularly those that are new to this area of investing. The following are some key steps that you can take to get started:

  1. Develop an Investment Policy Statement: An investment policy statement (IPS) is a critical document that outlines the office’s investment objectives, risk tolerance, and investment strategy. It provides a clear framework for investment decision-making and can help to ensure that all stakeholders are aligned on the investment strategy.
  2. Build a Strong Network: Getting into this game requires access to high-quality deal flow, which is often sourced through personal and professional networks. Family offices can build a strong network by attending industry events, joining investment associations, and leveraging existing relationships.
  3. Build an In-House Team or Partner with an Outsourced Provider: It is crucial to have the expertise and resources to conduct research, negotiate deals, and manage investments. This can be done through building an in-house team or partnering with an outsourced provider that has the necessary expertise.
  4. Establish a Strong Governance Framework: Investing directly requires a strong governance framework to ensure that investment decisions are made in a disciplined and transparent manner. This includes establishing investment committees, creating investment decision-making processes, and implementing appropriate reporting and monitoring mechanisms.
  5. Be Prepared for Long-Term Commitments: Investing directly often involves longer investment horizons than traditional asset classes, and you will need to be prepared to make long-term commitments to their investments.
  6. Continuously Evaluate Performance: You will also need to continuously evaluate the performance of their investments to ensure that they are meeting their investment objectives. This includes monitoring portfolio performance, conducting regular reviews of individual investments, and adjusting the investment strategy as necessary.

Overall, getting into the game requires a significant commitment of resources and expertise. However, with the right strategy and approach, family offices can achieve attractive returns and achieve their investment objectives.

 

For more advice on Family Office Direct Investing, reserve a consultation with

one of our advisors in our Contact Us section to the right.

–Arin Vahanian

–Peter Harper