Family Offices and Direct Investments

Richard C. Wilson

Welcome to our second year of Family Office Monthly, a concise newsletter
covering the evolution of the family office industry and investment needs of the
ultra-wealthy.

In this edition of Family Office Monthly, we will explore direct investing and how
ultra-wealthy families and single family offices are making more direct investments.
In future editions, we will explore how families structure direct investments, the
different types of direct investments as well as other aspects, but for this edition
we will provide an overview and examine the benefits and reasons for this trend.

Direct investments refer to those investments made into a corporation in minority or majority form, without using a traditional fee-based private equity, venture capital, or hedge fund vehicle. There are many types of direct investments which involve debt financing, convertible debt financing, equity and debt funding, angel investing, venture capital type growth capital investing, and more traditional platform strategy and build and flip private equity strategies. Direct investments are often made with the intent of attaining at least partial control and influence over the management and activities of the company or asset.

You have likely seen examples of direct investments in the news or in your business as sovereign wealth funds, institutional investors, and ultra-wealthy families have made huge investments in companies and ventures and that activity has been heating up in recent years. There are many reasons that more investors are pursuing direct investments, but the primary cause appears to be a shift in the institutional investor mindset away from paying standard fund fees and adhering to strict terms and
toward investing directly outside of the limited partner fund structure.

At our family office conferences and in my day-to-day conversations with wealthy families, I hear a strong desire to invest directly. In the aftermath of the financial crisis, many investors who had felt that they were well-diversified and protected from a broad market downturn were shocked to see most or even all of their allocations lose money. Furthermore, many investment funds were more correlated to the overall market than was assumed, had less transparency than investors desired and fared worse than was expected. Now, almost exactly five years after Lehman Brothers declared
bankruptcy, family offices have been looking for ways to protect their families from huge market downturns, have greater control of assets, diversify their portfolios and cut expenses, especially management and performance fees.

Direct investments have emerged as a model for family offices looking for alternatives to the standard investment vehicles. Of course, investing directly in an asset is not a new strategy but the formal structures and management that family offices are using to make these investments is a recent development that has spurred family-led direct investing around the world. Single family offices are allocating more capital towards direct investing than ever before and so it is important for family offices to be familiar with this trend and thinking of ways to serve families that want to invest directly

The benefits of investing through an investment fund or traditional investment products like ETFs, public equities and bonds are well-documented and valid. However, single family offices are uniquely positioned to make direct investments and in many ways direct investing is a great fit with the single family office structure. Single family offices are often
managing the money of a successful entrepreneur or business executive and many of these families have experience running a business. That makes the idea of investing directly in a startup, a real estate project, a corporation and similar hands-on allocations very appealing and familiar territory for the family. Furthermore, direct investments allow the single family office to directly control a real, tangible asset and avoid the costs of a pooled, externally managed fund, namely management and performance fees. So not only is the family able to invest directly in an attractive asset but they also enjoy the full profits of the venture.

I interviewed Greg Kushner of U.S.-based multi-family office Lido Advisors for The Family Office Book: Investing Capital for the Ultra-Affluent, and he commented that the pooled fund structure works well for some types of investments but,
for other smaller ventures, the opportunity to have a controlling interest in a property or asset is a tremendous incentive to invest directly. I asked Greg if he found that family offices are making direct investments into real estate or accessing these
types of investments through fund vehicles. He explained, “Well, I think it’s a combination. Again depending on how deep the pocket of the family office is and if they can have the team of people to do their own vetting of these investments, I think there is, in general, a preference towards individual purchases so that the family has control over the outcome of that particular property. Yet, I am sure there certainly are plenty of families who recognize that there is going to be certain—we call them maybe trophy level type of properties—certainly large office or apartment buildings or the kinds of deals that
the large funds are going after, where it’s just not practical for the family to commit enough capital to control those kinds of assets, so they would go through the fund vehicle in recognizing that they don’t have the same level of control that they would if they owned the individual property.” As Greg described, family offices often make investments both directly and through a fund structure, depending on the investment team’s analysis of the deal. There is every reason to believe that investment funds will continue to attract immense pools of capital from family offices, but direct investments will also be
a growing part of most family offices’ portfolios.

I hope that you enjoyed this edition of Family Office Monthly and we will continue to explore the different aspects of direct investing, co-investing, club deals and other allocations often made by family offices.

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