It’s true that no two family offices are the same. However, as private equity became fashionable over the last decade due to its unprecedented performance, family offices by and large took note. A recent UBS Global Family Office Report highlights that more than two thirds of family offices view private equity as a key driver of returns.
Traditionally, family offices participated indirectly in lower middle market investments through funds managed by outside firms. With few exceptions, these funds were controlled by a sponsor, where family offices played a passive role. However, over the last handful of years, family offices have made a push to pour more money into direct investments giving them a chance of greater returns and greater control. According to FINTRX, family offices participated in an estimated 9,000 direct deals at the end of 2019, from just a few thousand at the beginning of the year. A FINTRX report from August 2020, showed that at least 49.7% of all family offices in North America made direct investments.
A more recent report from 2021, shows which sectors are attracting this increase in direct participation:
What advantages do family offices have in the direct investing game? For one, family offices don’t have to participate in the traditional 10-year fund schedule. They can employ longer term investment objectives and aren’t locked into a fixed period for making investments and exiting the holding. When the investment horizon is 100 years, there’s less of an emphasis on timing an exit. Through direct investing, families remain in control over the specific investments they want to be invested in. Also, the economics can look more favorable as family offices can forgo the typical 2% management fee and 20% share of carried interest that is usually realized in GP fund arrangements.
Additionally, within the broader private equity investment class, family offices are increasingly taking note of search funds. A 2020 Stanford Graduate School of Business study found that the aggregate pre-tax IRR of 401 qualifying search funds was 32.6%. The aggregate pre-tax return on invested capital was 5.5x. Outside of the attractive return profile, search funds sit at an interesting intersection for family offices. Family offices are able to receive direct investing exposure and the associated benefits, (e.g, fewer fees, more control within investment parameters, etc) but also eliminate the burden of searching for management, as the searcher takes that active role within the acquired company. We’ll have more on this another day.
Current Family Office Environment
The LMM recently spoke with Dennis Caulfield from FINTRX (a family office data and research solutions company) and Chip Weinberg of Weinberg Capital Group to ask about current market conditions. We’ll start with 2021 data from FINTRX.
“In 2021 family offices have been more active overall in terms of lower-middle market private equity investments by transaction count. Our data noted a 22% increase in transactions executed over the first five months of 2021 compared to the first five months of 2020. As one would expect, this is likely due to the impact of Covid-19 last year. Concurrently, our data noted a 350% increase in investments made directly into the hospitality industry, insinuating that family offices might be warming back up to investments in the industry. Our data also shows a slight pull back in commercial real estate investments throughout the start of 2021.”
With regard to company sizes, FINTRX noted that there was a 6.25% decrease in family office direct investments in companies employing between 1-25 people, a 38% increase in family offices investing in companies that employ between 25-100 people, a 47% increase in companies employing between 100-500 people and a 6% decrease in investments in larger companies with 500+ employees.
Anecdotally, Dennis mentioned that,
“Over the multitude of conversations with family office investment professionals, I've gathered a clear interest toward more progressive and forward thinking opportunities. Recently, more and more groups that previously took a fairly conservative investment approach have been expressing interest in opportunities throughout the blockchain, crypto currency, deep technology and cannabis sectors. In general, as these family office have become more and more sophisticated and well capitalized, they have been increasing their direct transaction activities - cutting out the high fees associated with PE funds and allowing them to take a more hands on approach.”
Meanwhile, Weinberg Capital Group continues to focus on areas where they have decades of experience in industries such as manufacturing, consumer products, and value-added distribution. The family office has participated directly in private equity investments dating back to the 1970s, when Chip’s father Ronald, started buying and operating companies before private equity was a term. Weinberg Capital is now an evolution of those efforts and unlike private equity firms, they can offer greater flexibility in terms of both timing and structure. The firm targets companies in the $2 to $10 million EBITDA range.
Chip relayed that things have obviously changed quite drastically from a year ago. In the middle of COVID, the family office wasn’t focused at all on deal flow, and was just trying to keep business lines operational. When we asked him for a lesson learned from the pandemic he mentioned,
“[it’s] important to not over lever any business. Most of [our] companies were in good shape because they used prudent leverage.” He also emphasized the, “importance of backing great management. [Their management teams] helped get them through the tough times, they didn’t panic, knew what to do and were excellent in dealing with stress.”
In terms of the current environment, Chip estimated that deal flow has doubled from what he normally sees. He thinks part of the increase in activity is being driven by pent up demand from COVID and the fear of capital gains changing. When I asked him to speculate on the near future, he told us that they’ll continue to target the same industries. He thinks infrastructure would be a good play for those who have experience in government contracting work, but the firm’s core focus remains in manufacturing, distribution, and consumer. Weinberg Capital will continue to position itself as a kinder, gentler and more empathetic option for entrepreneurs who want to sell. The firm takes a more people and customer focused approach, which is ingrained in the culture. Chip relayed that this ethos and key differentiator isn't going anywhere.
You can learn more about Weinberg Capital Group by clicking here.
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