Find out more about Family Office Direct Investing in our sixth episode of the Family Office Vlog Series with Asena CEO Peter Harper.
Peter Harper: Hey, guys. Peter Harper, managing director and CEO of the Asena Family Office. For those of you who are not familiar with the business, we are a multi-family office that is focused on U.S. direct investments in mergers and acquisitions for private clients and family offices.
Peter Harper: So, in the last video, we touched on the intersection between family offices and private equity, and the rise of family offices. You know, we talked about the rise of family offices over the last decade. Throughout that process, we, you know, we really touched on or partially touched on the notion of family office direct investment, right? So, why family offices have really grown to prominence, particularly in more recent times?
Peter Harper: So, today we wanted to address, at a deeper level, the idea of family office direct investing. So, what is it? How do family offices think about it? What are the risks associated with it, right, and why should you care about it, okay? So, you know, for those of you who are new to the family office world, the way in which families think about asset allocation really stems across, you know, six different areas. They’re looking at investing in public equities, fixed income, you know, traditional real estate, whether that’s into a direct asset or in through some sort of fund structure. They’re probably looking at hedge funds, definitely looking at private equity, and they are almost definitely looking at direct investment. So, that is investing directly in either a privately owned business or in some form of real estate structure.
Peter Harper: So, direct investment has really grown to prominence as a primary tool of investing for family offices because of the perceived inefficiency associated with investing by fund vehicles where family offices don’t have as much control to the underlying investment. So, what’s triggering this is just the sheer volume of capital that has been injected into this area; into this space over the last decade. A recent report by Goldman Sachs put that it currently something to the tune of 50 percent of the world’s private capital is now allocated through private or by private family offices into a private market or alternative investments. The reason for this is because you know when you invest by a fund vehicle or indirectly, there can be layers and layers of fees, so that it ultimately will reduce the return on the investment and, if you have the right team in place, if you’re going via fund vehicle, you’re getting less control you know over the investment, right? So, the rationale for direct investment is overall better efficiencies, so higher returns, and more control and involvement in the investment process. So, less surprises, right?
Peter Harper: There can also be a lot of tax benefits. You know, any time that there is one less layer of structural complexity between the capital and the asset, you’re generally going to see operating efficiencies and so, you know, both returns and tax can play a role in why the family offices are more attracted to directs.
Peter Harper: So, how are family offices today sourcing direct opportunities, right? So, you know, personal networks often they’re relying very heavily on their personal networks to source deals. However, you know, as a firm who specializes in private market deal sourcing, you know, I can say that there’s a huge amount of work that goes into creating, you know, adequate scale around a personal network to source deals; (1) you need to look at a lot of different deals, right? You need to be very clear around what it is that you want to invest in and what you don’t want to invest in, and then (2) you need to have the internal skills within your organization to underwrite, you know, whether the investment should happen, right? So, the biggest one is personal networks. A lot of folks are still going via investment, you know, maybe sourcing deal opportunities via investment bankers or brokers, right? Maybe it’s less common for family offices today because, for a lot of families, they’re either looking to build out the internal skills to underwrite and find opportunities on their own or they’re working with a fractional family office like the Asena Family Office to make that, to do that work. The larger families might have, you know, that are in the business of doing deals, might have pretty sophisticated direct outreach programs, right, to find opportunities, but I think, for the most part, it’s going to come through professional networks, right, and being out in market telling folks that, “Hey we want to do deals and we’re ready to invest.”
Peter Harper: So, what are the risks, right? A lot of opportunities, better returns, and more efficient structures. What are the risks? There are a number of risks: (1) The biggest one is probably or most common we thought of is probably Liquidity Risk: Direct investments normally come with a longer-term investment time horizon, right? The reason why a lot of folks like direct investment over fund structures is fund structures tend to have a lot limited lifespan, or it might be five, seven, or ten years. At some point, regardless of how an asset is performing, they might trade it. Whereas, if you’re directly in the opportunity as a family, right, and you like it, but it’s just not going the direction you want to go at the same time horizon, then you opt to stay in it regardless of where things are at. But still, you’re in an investment that might be heavily liquid so trading out of it can be challenging; (2) Concentration Risk: Normally, the reason folks are investing via fund vehicles is because they want to be diversified across a bunch of different assets that might have the same sort of thematic. If you’re direct into a deal, so you’re more heavily concentrated into your one opportunity rather than a basket of opportunities then you’ve got concentration risk – if the deal doesn’t, you might get bigger returns, but if the deal doesn’t work out, you’re potentially going to lose more money; (3) Operational Risk: When you’re going direct into a deal, it really is about up buying into an operating asset. So, that’s either an operating business, right, where your management team, the success of the management team, is the success of the deal or it’s, you know, a piece of operating real estate. So, the same outcome with a piece of operating real estate, you’re only as good as the folks that are running the asset; and then the final point we just had here was around (4) Valuation Risk: With illiquid assets, again it’s a lot more difficult to understand where the valuation of an asset might be at any given time, right? So, you need to have these systems in place to be able to ascertain that relatively efficiently at the right moments in time.
Peter Harper: I wanted to just touch on a little bit about this sort of interaction of direct and co-investing, right? So, ideally, I think a lot of family offices would be not investing in fund vehicles and would do primarily directs unless the families are at a massive scale. Certain family offices get to a particular size where going direct just becomes inefficient because they cannot efficiently get the capital to work, right, but for most families, one of the attractions to investing in funds today is because they’ll also then get an opportunity to co-invest, right, side by side with the fund. So, if they got a big enough check to the fund, the fund says, “Yeah, I’ll let you go directly into the deal with extra money”, so they’re going to ink out a better return because, on that direct co-invest, there’s likely not going to be any fees, right? So, for family offices, the ability to co-invest alongside a very sophisticated private equity firm that may have done all the underwriting of a transaction, right, is of significant value, right, because it can de-risk capital that’s being deployed on a substantial scale. So, benefits; obviously you are increasing your diversification. So, rather than just being concentrated in one asset, part of your capital is still going to go into a fund vehicle and get into a bunch of different assets. You’re going to access significant expertise inside of the private equity firm that may be more sophisticated than your in-house folks. You’re sharing the risk with another investor that’s got a significant balance sheet normally, and then you’re getting access to exclusive opportunities; a lot of deals that are coming that are being sourced for. You know, the more exclusive and better-performing private equity firms are harder to access, right? So, if you can get access to them, then it’s a far more efficient process.
Peter Harper: Finally, I just wanted to touch on, you know, some of what I’ve thought of as direct investment strategies for family offices, and some of this might seem pretty straightforward, but these are the things that family offices are thinking about. They are thinking about whether they should be doing a sector or asset class focus. So, some families are just saying, “Hey listen, we’re only going to invest in real estate; we’re only going to invest in a subsection of operational real estate, venture capital, private equity. Most of them have a long-term focus, right? Because they’re going direct, they’re more focused on the long-term benefits of being in direct deals. They’re active owners, right, so by investing on a direct basis, they want to get integrated with the board. They want to be closer to the operations of what’s happening, so they can keep a closer eye on their investment. As we talked about before, you know, if there is an opportunity to go into a fund vehicle and co-invest, right, they look at that as a very valuable tool to tighten up execution risk, right? And, then some folks are in all of this would just prefer to lend directly to an organization rather than invest equity: (1) It might give them senior rights in the capital stack; and (2) They’re generally going to get superior returns; getting superior returns to what they might be getting in the equity with a lower degree of risk. And then finally, for the larger families, they are very geographically dispersed as far as their focus, right? They’re looking at opportunities all around the world because they understand when it comes to diversification, it shouldn’t just be asset focused, and then having a diversified approach that considers the impact of varied geographies is important.
Peter Harper: So, then how does one get into the game, right? Families need to divest an investment policy statement, you know, what is their protocol for getting into directs. It’s a really, really critical document, right? You need to think through what makes sense; you know, a clear framework for investment decision-making needs to be set. You need to bolster your network and how your network thinks about you as far as, you know, sourcing high-quality deal framework on your ability to execute on those deals, and then you need to be prepared for long-term commitments, right? Being direct is not designed for those who need short-term liquidity. Okay, thanks, guys.