Private equity is becoming a more popular alternative to preserving capital as public markets face macroeconomic headwinds. In this article, we dive into why it is an attractive option for family offices and examine the three most common ways family offices can get involved.
What is private equity?
Private equity is an alternative investment class in which investors buy shares in privately held companies. Their primary goal is to generate higher returns that outperform public markets. Think of them as high risk, high reward. And in the perfect scenario, that would be the equivalent of investing in Steve Jobs and Steve Wazneyick in the 70s before Apple Inc went public in 1980. As an alternative investment, private equity is not accessible to the public, as their financial information is not subject to regulatory oversight. Instead, access is limited to institutional and accredited investors with a minimum of $250 000 to participate in private funding rounds.
While the term private equity is synonymous with venture capital and hedge funds, it also holds appeal for family offices.
Why private equity is attractive to family offices
Since private investments are unlisted, their valuations are less affected by the volatility of macro conditions. There are several other reasons why family offices find private equity attractive. According to family office expert Katherine Hill Ritchie, the most common benefits are the time frame and the purpose of the investment.
Over what time time frame do private equity funds operate?
Most private equity funds operate within a 10-year life cycle. The first 1- 2 years are for raising money from Limited Partners (LP), with a promise to generate a profit at the end of the term. Then 3 – 5 years are spent sourcing and acquiring high-growth companies. Overlapping this is 3 – 7 years spent investing significant time and resources in improving the acquired companies. Finally, private equity funds must sell to generate a profit by creating exit strategies, such as IPOs, M&A or stock buybacks.
Family offices are not beholden to the same operational constraints, nor do they have to answer to LPs. A family office could acquire a company and hold it for 30 years and never intend to sell for various reasons. A great company can sit on a family’s portfolio for generations. In addition, family offices can determine how much or how little they choose to be involved in the acquired company.
What’s the purpose of private equity funds?
The sole purpose of private equity funds is to generate a profit for their LPs. They are famous for the two-and-twenty fee arrangement – where the firm charges an annual 2% fee for managing the investment, and if a deal is profitable, they take 20% of the profit.
Family offices look to preserve and grow wealth across generations. Their appetite for private equity is driven by more than just profiteering. Factors such as the family business and industry expertise play a role. With family wealth often created through entrepreneurial success, many family offices gravitate naturally towards private equity. They want long-term investments that align with their values and investment goals.
Three ways family offices can invest in private equity
Family offices can invest in private equity in several ways. The most common methods are direct investment, co-investing, and investing in a private equity fund.
Direct investment: Family offices can make direct investments in private companies. In this approach, family offices have greater control. They can choose how much they want to get involved in the business and plan their existing strategies. And since it avoids the fee requirements associated with private equity funds, it could lead to higher returns. However, direct investments can be the most challenging. It requires specific skill sets, such as deep industry knowledge – to perform proper due diligence and risk management. In addition, the significant capital commitment and sourcing the best deal flow may not be feasible for all family offices.
Co-investment: Family offices can invest alongside a private equity firm as partners in deals. This way, family offices share the due diligence and risk management burden. It also allows them to gain exposure to the best deal flows while leveraging the expertise and resources of the private equity firm. The downside to co-investing may include a lack of control over the investment, incurring due diligence costs and management fees.
Investing in a private equity fund: Finally, family offices can also invest in a private equity fund managed by a private equity firm. This approach is more passive and provides portfolio diversification across multiple investments. Family offices can access top-performing private equity managers that may be difficult to access otherwise. But investing in a fund involves paying management fees and profit sharing to the private equity firm, which can reduce returns.
In short, as traditional investment vehicles face macroeconomic headwinds, private equity is becoming increasingly popular among family offices because the shares in privately held companies tend to generate higher returns that outperform public markets. Family offices investing in private equity have advantages over private equity firms in terms of time frame and purpose. Whether family offices choose to invest in private equity via direct investment, co-investment or in a private equity fund, each method requires significant due diligence, specialised knowledge, and a large capital commitment, they tend to be well-positioned to engage in this asset class comfortably.