Family Offices Continue Quest to Go Direct

Today’s M&A environment is as fierce as ever. Even the most venerable private equity firms admit that it’s tough to find the right deals today without overpaying. Today’s market dynamics do not bode well for the growing number of family offices that have launched direct investment platforms over that last few years.

However, despite the tough market conditions, it doesn’t look like family offices have been deterred. According to the 2018 FOX Global Investment Survey presented by the Family Office Exchange, of the 109 family offices surveyed for their annual survey, 30 percent are planning to increase their pace of direct investment over the next year. What’s more, family offices surveyed already held an average of 15 direct investments and entered an average of two new deals in 2017.

“This group has really grown over the past several years,” says Jason Bass, a managing director at Harris Williams & Co. “When we build a buyer’s list for a process we almost always create a category for the patient capital buyers today. This group is competitive and cannot be overlooked.”

Family offices going direct is in part being driven by sellers more frequently wanting the option of patient capital that a family office is able to provides. Family offices often have flexibility on timing and structure. They are also commonly willing to take a minority stake. “There are business owners who want a long-term investor. It makes good sense to look at a family office as a partner in some cases,” says Howard Romanow, COO and CFO with Island Management, a family office that invests in lower middle and middle market deals.

One of the biggest reasons family offices have become more active in direct investment is because they have been able to amass a lot of wealth during the bull market and now they are looking to diversify their holdings. “More and more families are making more money and they need to make sure they are diversifying their assets so they are looking at different ways to invest their capital,” says Romanow.

PPC Partners (formed by the Pritzker Group), is a leader in the family direct investment market. Recognizing that family-run businesses are increasingly looking for patient capital and families offices are experimenting with different strategies to create more value, PPC raised its first investment vehicle that includes outside capital. The fund, PPC Fund II closed with $1.8 billion of capital. PPC Partners will continue its strategy of acquiring and operating family- and entrepreneur-owned businesses within the manufactured products, services and healthcare sectors. PPC Partners was formed by Pritzker Group as its exclusive acquirer of middle-market companies. PPC Partners invests on behalf of certain Pritzker and other long-term focused family and institutional investors.

Importantly, the new PPC Partners investment vehicle has a significantly longer term strategy versus traditional private equity funds. This will allow the firm to continue to hold investments in its companies for as long as they see fit.  

“Over the past few years, I have seen families probing different strategies and I think that’s healthy. It’s not a one size fits all model. Some families should partner with other families and let them lead, some should only do co-investment and some can go direct, but you absolutely have to hire accordingly to go direct. It’s a very complex business,” says Paul Carbone,president and managing partner of PPC Partners.

However, while the appetite to invest directly appears to be strong, there are several challenges. According to the FOX survey, performing due diligence (44 percent), getting adequate internal resources in place (42 percent), high deal valuations (43 percent) and sourcing deal flow (36 percent) are the top challenges family offices face when they try to invest directly.

Family offices that are going direct are trying their best to meet those challenges. Getting the right professional resources is a step in the right direction. At the beginning of the year The McNally Capital, Botoff Consulting, and Mack International published the results of their 2017/2018 Compensation Survey of Investment Professionals in Single Family Offices. Data was reported for 303 investment professionals. More than 90 percent of family offices surveyed invest directly, with 86 percent of family offices managing those investments internally versus using a third party advisor. Recognizing that competition for good managers is stiff, more than 40% of family offices surveyed provided salary increases greater than 4 percent to investment professionals, exceeding the national average of 3.1 percent.

“We continue to see a growing number of family offices investing directly and commanding a stronger market presence. This dynamic requires family offices to staff themselves accordingly, making the availability of best practices and competitive compensation data increasingly necessary,” says Beth Rahn, vice president and head of family capital at McNally Capital.

Romanow agrees, saying he sees more of his peers hiring professional staff to make investment decisions. “The biggest difference from seven years ago is that family offices are more frequently hiring professionals from the investment world to help them make investment decisions,” says Romanow. “Some have learned that direct investing is possible, other realize that co-investment opportunities is right and still others believe that investing in private equity is still the right move for them. Every family office is different, but having the professional help to make those decisions is important.”

Family to Family

Family offices are smart to gear up now. With baby boomers hitting retirement age there will be more and more businesses coming to market for sale or looking for investment. “The family seller market is robust. It’s dwarfed by the number of companies PE firms are selling into the market, but it is growing,” says Carbone.

The trick is still finding the right deal flow, as evidenced by FOX survey where high valuations and sourcing deal flows are listed as top challenges. “We look at some transactions we can’t go near. We have had to be patient and we really have to seek out the right target. Companies that used to trade at 6 to 8 times EBITDA are now trading at 12 or 14 times EBITDA without a good reason. We have to find deals where we have an angle or can roll up our sleeves because there’s a little hair on the deal. That’s the environment. ” says Romanow, who will look at deals from traditional intermediaries, but also from other family offices, business brokers, independent sponsors, commercial lenders, CPAs, and attorneys. Island Management will also pro-actively look for companies to invest in in the lower to middle market in specific industries.

The Investment Bank Role

While working with family offices isn’t exactly an investment bank’s bread and butter, more are recognizing the demand for patient capital options. “Smart investment bankers are recognizing this trend and trying to get between family sellers and family buyers. And they are forming dedicated groups to cover the family office space. They are putting together buyer lists that have a third column of long term capital providers. We aspire to be on the top of that list,” says Carbone.

Carbone says part of the appeal to sell to family offices is that direct family office buyers have applicable and relatable business experiences. In fact, PPC’s most recent deal was the purchase of C.H. Guenther & Son, Inc., a fifth-generation food company located in San Antonio, Texas with 19 locations around the world. The owner only talked with PPC. “We want to partner with family businesses as these are the types of deals we can get excited about. Families selling to other families is a good thing,” says Carbone.

Regardless of how the deals are sourced the bottom line is we will likely see different types of investment strategies from family offices in the future. “Family offices are testing different strategies and hiring more sophisticated talent to better compete. There are table stakes to going direct and the hiring of experienced professionals is right up there. It comes with the sophistication required to succeed in a crowded market, which is a good thing,” says Carbone.