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Our Private Client team is ranked as one of the top ten in the world (Chambers Global 2013) and acts for many leading UK and international families, family offices and successful entrepreneurs and business owners, along with the private banks and wealth managers who advise them.
Both the number of family offices investing in private equity and the allocation of assets to private equity by family offices is on the increase and this increased exposure to private equity is taking place via a number of different routes.
There are a variety of types of family office, ranging from single family offices, investing on behalf of one family only, to multi-family offices investing on behalf of a large number of high net worth individuals or families. In contrast to the vast majority of private equity houses, which have reasonably firm investment periods, there is a greater diversity of approach within the family office spectrum.
The simplest route to private equity for a family office is to invest indirectly through a private equity fund. This can have a number of advantages in that, whilst the family office will want to carry out due diligence on the funds it invests into, once it has made its commitment to a fund, it will have a more passive and less time-consuming role than managing its own direct investments. However, in contrast to direct investments, the family office will be required to pay management fees and carry etc and will be tied in to the lifecycle of the relevant funds so it will be an illiquid investment.
However, investing in this way will also typically allow a family office to have a more diversified portfolio and with a range of fund structures available, including the possibility of co-investment rights, this will be an attractive option for many family offices. Some private equity houses allow investors in their fund to co-invest alongside the main fund(s) so that they can go "overweight" by investing additional funds in deals that appeal to them.
This is essentially more of a direct investment approach albeit that to a large extent the family office will be relying on the private equity house to carry out the due diligence and lead the deal. When making direct co-investments the family office will need to consider whether it requires additional rights, such as veto rights over matters affecting its rights and economic returns and possibly over key business decisions. Tag along rights are also key so that the family office can exit when the lead investor exits.
Investing directly is typically more resource-heavy for family offices as they will need the capability to source deals, carry out target due diligence, monitor individual investments and maintain relationships with management teams as well as being involved at board and strategy level. Whilst some of this can be outsourced, there will need to be people in-house who can manage the investment processes and monitor the companies invested in.
One circumstance where family offices may look particularly closely at making direct investments is where an opportunity arises in an industry or market where the relevant family generated its wealth historically and therefore has specialist expertise and connections. This may arise through the family's own network, whether directly or through another family office introducing the family office to an opportunity, possibly with an invitation to invest together.
This specialist knowledge may help a family office to get comfortable with a direct investment and, together with an ability to often be more flexible in terms of hold periods, may also enable a family office to invest where a typical private equity house cannot. It is common to see family offices investing together and this approach can help spread risk as well as sharing deal costs although the considerations set out above in relation to co-investments will apply.
Family offices may be able to be more flexible in terms of their holding periods than private equity houses which are typically driven to a large extent by the life cycle of a fund which has led to the term "patient" capital. However, this can create its own issues particularly in terms of management incentivisation.
One of the big attractions of private equity for managers is the ability to drive a company through to exit within a clearly defined timeframe and benefit from the growth in equity value at exit.
If the exit horizon is longer, or less clearly defined, then other non-exit focussed incentive mechanisms may need to be considered such as dividend entitlements or establishing an internal market for shares but it will be key to ensure that key management retain a sufficient stake in the business to remain adequately engaged and motivated to achieve growth.
The appeal of direct investing, co-investing or indirect investing to a particular family office will depend on a number of factors such as its size and internal resource, attitude to risk, experience and specialist sector knowledge. If direct investments do not appeal, there are a wide variety of fund and fee structures available through which family offices can look to increase their private equity exposure.
This article was written by Adam Crossley.
For more information contact Adam on +44 (0)20 7427 6431 or firstname.lastname@example.org