In seeking higher returns, family offices take the “direct” approach

As family offices grow in size and power, the more progressive ones are
using a direct investment strategy to earn higher returns.
Wealthy families that once hired asset managers to handle their investments are now acting more like PE firms themselves.
To plan for future growth—and future generations—family offices are directly investing, or co-investing, in their own deals
rather than participating as limited partners.
There are several reasons for this:
1. Family offices want to reduce the fees associated with private fund managers. These fees typically include a 2%
management fee and the 20% carry where the managers take a fifth of the investment’s profits.
2. Family offices want more control. They’re abandoning the practice of black-box investing where they turn their money
over to an investment management company and let the firm conduct all dealmaking.
3. Family office goals can be substantially different than those of a traditional investment management firm. PE and venture
capital firms, for example, typically want a shorter timeframe from sourcing a deal to execution to exit. This compressed
timeframe is often misaligned with the longer-term wealth-building objective of family offices. Family offices tend to see
investment as a way to build capital over the years via a dividend or income strategy.
For these and other reasons, more and more family offices are going their own way. Last year, the Family Office Exchange
surveyed 80 family offices and found that 70% were engaged in direct investing and, interestingly, outperforming buyout
firms by a sizable margin. The family offices reported that their direct deals returned an average of 15% in 2015, more than
double the returns of PE firms that year.
Going It Alone Takes Planning and Process
Designing an effective direct investment program is job one for a family office. One of the first steps should be
implementing a policy statement that is agreed upon by all family participants. The policy statement outlines what the
family wants to achieve from its investment program such as increasing wealth for the next generation or diversifying into
new lines of businesses.
Once the policy statement is designed, the planning process can begin in earnest. This next phase includes determining
the types of investment the family office wants to pursue, the size of those deals, the industries the family wants to operate
in, and the desired holding period. A family office may decide it only wants to support socially responsible companies or
invest in a specific industry where it currently has unique expertise. Typically, this will be the industry in which the family
amassed its wealth in the first place.
Another critical element of successful direct investment program is the internal staffing and infrastructure the family
office must put in place to execute on its deals. Many family offices are not sufficiently equipped from both a people and
technology perspective to do direct investments. Many underestimate the work that a PE manager must do to create value.
As family offices compete directly for quality deals, they will need to up their game to contend with the PE and investment
managers they relied on in the past. The years ahead will be especially challenging for family offices in an already complex
and dynamic market.
Jeremy Swan is a principal and leader of the Private Equity Industry practice at CohnReznick LLP. He can be reached at Access CohnReznick’s full four-part series, The Role of Family Offices in Private Equity.


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