Are we in a new Family Office bubble?

Maybe I'm just cynical, but at my MM, we have rarely seen family offices compete for deals in auctions and it seems there are more and more being formed weekly, if not daily. I'm astounded at how much capital is now going into the market to try and compete with traditional PE and strategics, particularly in the MM (I see some value in the LMM and even more in the sub $10mm EV space).

Now, one pitch from some family offices has been "we aren't trying to compete with PE because we are different (e.g. longer holds, less transactional, more passive ownership, better people, etc.)". But, let's be realistic here, there are only so many unbanked deals that happen in the MM (and even LMM), and to assume that they are going to fall into their laps seems quite ignorant.

Now, some have assembled teams that are focused on business development and trying to identify and execute one-on-one with family-owned and closely-held businesses. But, they are spending millions of dollars chasing deal flow with an expectation that they will actually close proprietary deal(s) and that these investments will actually perform well.

On the other hand, they are going into auctions with conservative capital structures and playing the "better partner" scenario, which is difficult in a market where leverage is dictating double digit returns on almost any decent asset.

I get that family offices can save significant fees if they start doing deals direct, but I just don't think they realize just how hard that is. The patient capital approach will resonate in certain deals and with certain management teams, but with the proliferation of quantity of family offices, there will likely be several to the table if that is an optimal transaction partner.

Until they start differentiating themselves (e.g. Pritzker Rosewood, Metropolous), I don't see a rapid transformation for the majority of deals.

NOTE: Sorry for the rant and poor grammar, on a place post-pitch and tired af.

Comments (26)

Dec 11, 2018

It's an interesting thought. I haven't fully thought these below points out, but throwing them out there.

  1. You'll start to see more family offices operating like traditional private equity funds. They'll have teams full of institutional investors, and will structure their teams and processes in a manner not dissimilar to the funds that they came out of. They will be willing to participate in auction processes, and less shy of leverage. I work at a family office that has the ability to deploy large amounts of capital, and we frequently participate in auctions and don't turn our backs away from leverage. You could even argue that some FOs may be willing to embrace more leverage because they're is availability for an equity cure.
  2. Probably see a rise in what I would call "mini BDTs". PE funds raising from exclusively LMM/MM family offices with $50mm-$500mm, as opposed to BDT which is working with larger families. These funds will cater to the needs of families specifically, fund structures will be different (longer life, potentially differing fee structures), and largely draw upon families that realize they may struggle to compete, but also want to get PE capital out the door in a manner more catered to their needs.
  3. MM investment banks will grow family-office focused coverage groups. Already starting to see this. This will bring greater deal-flow to FOs, and likely lead to greater amounts of club deals. This will allow families to play in larger deals and compete more with traditional MM PE funds. This could either increase activity in point #2, or cannibalize it. Haven't thought that out fully.

I realize I'm biased and fairly bullish on family capital, given I work at one.

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Dec 11, 2018

Should also add that there seems to be a lot of growth in independent sponsors. I think it's more likely that these guys continue to grow for a while, and then fall off. Independent sponsors are feasting off of FOs that are relatively nascent. While there's some argument to be that these independent sponsors will help FOs leverage their resources from a human capital standpoint, I also think that they will help FOs cut their teeth in PE, and they will then graduate to direct investment on their own. Also seems likely that FOs will cement relationships with a handful of ISs and the total number will fall off after continuing to grow for a bit.

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Dec 12, 2018

If I'm a cynic, you are an optimist, a good format for discussion. Without giving away anonymity, what do you use as key selling points or differentiators? That was part of my criticism that hasn't been addressed.

Also, aren't IBs inherently incentivized to show more deal flow to PE vs. FO?

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Dec 12, 2018

Agreed, and SB'd - think it makes for a fascinating discussion. I'd say we use the more generic differentiators you mentioned above, that includes:

  1. Long term capital (patient or permanent), minimum 10 year time horizon. This allows us to be a true partner in long-term strategic vision as opposed to a myopic focus on short-term initiatives
  2. Derivative of the above, but ability to play in cyclical industries and aggregate
  3. While we don't pitch ourselves as a more passive investor (our team all comes from control PE funds, and we operate similar to one), we do pitch ourselves as less disruptive given the long-term focus. Also, we tend to position ourselves to function well as a transition partner for founders and other family-owned business that want to exit over a longer time horizon but don't want to loose total control over their legacy

To your second point, I don't think so. I think that as you've cited, there may be some turbulence in family capital in the short-middle term, but long-term family capital is here to stay. For several reasons:

  1. Increased wealth concentration among ultra high networth families
  2. More deca and centi millionaires created in the past decade than ever before
  3. Post financial-crisis distrust of "wall street" by large families, particularly those in certain industries and geographies (this is a factor for both families looking to invest capital and founders looking to partially or fully exit their businesses and seeking a capital partner)
  4. Fee efficiencies from families directly investing

Those, among with a myriad of other reasons would lead me to believe that family capital is here to stay as a major player in the private equity scene. I think banks realize that, and if you agree that family capital will continue to gain share as a capital force, then I think it's short-sighted to be dissuaded by what may be short-term volatility in the space. It's not dissimilar in my mind to several BB's building out a greater regional/MM practices. May not be as efficient in the short-term, but will pay dividends 10 years out

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Dec 12, 2018
  1. Out of curiosity, what's your (or other family offices you're familiar with) due diligence and deal approval process like? Is it similarly robust as PE firms where there are long memos/ppts with model, analyses, etc, that are then formally presented to a full investment committee comprised of internal partners and external advisors? It feels like banks are increasingly pushing buyers to close quickly (I've seen multiple processes someone signing <2wks after LOI). I'd think for family offices the ability to make decisions quickly is a differentiator there. Sometimes it feels like PE firms do a lot of analyses and research to answer the inevitable obscure question that isn't material to the investment philosophy, which slows down closing (or at least make it more painful), because everyone on the IC wants to sound like they're adding value. Or maybe it's just the firms I know...
  2. Regarding being "less disruptive", is that really true? How does it play out if a portco sees two or three months of earnings decline? Do you just acknowledge the shortfall and say "that's okay, lets give it a couple more months before evaluating what's happening" or are you still pushing them to make change fairly quickly? There are so many PE firms that all at the core, have similar investment strategies, and I tend to think on average the PE professionals at one firm isn't significantly smarter than another firm. Some obviously do much better than others, and I tend to think a big part of that is the PE firms working harder by pushing their portcos harder than others. If family offices aren't engaging as much, as they sacrificing some returns?
Dec 12, 2018
  1. That's a good point, but not always true for us. Most of the time, our process is very similar to a PE shop in terms of formal DD, full and comprehensive operating models, fulsome memos, etc. That being said, when the situation calls for it, we have had instances where we've moved quicker than your average PE shop would be able to (with family buy-in), but most of the time, we're running a traditional PE DD timeline.
  2. Sorry - I wasn't trying to paint that picture. What I meant was that we DONT pitch ourselves as less passive than other PE funds. By less disruptive, I mean if we're going to stay in the capital structure for a long time (or in perpetuity), and you are a founder, we are the least disruptive way for you to exit your business (Buy 60% today, you have put options for 10% year 2, 10% year 4, 10% year 6, 10% year 8, etc.). Just mean that if a founder wants to exit, we can provide a one-stop solution that doesn't cause a major distraction every time you want to step further away from the business.
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Dec 13, 2018

Excuse my ignorance, what does BDT stand for in this case?

Dec 13, 2018

BDT Capital Partners

Dec 12, 2018

It's interesting that you think family offices have an inherent disadvantages in these processes / investment styles.

From what I know, it seems like most family offices are run by ex-partners from various control PE funds (your traditional buyout type shops). Even looking at some of the more recent family office openings like Declaration Partners (David Rubenstein's Family Office), all of their senior investment professionals are from top-decile funds that did traditional buyouts.

Thus, I would expect them to perform on a similar standing as independent private equity firms.

Dec 12, 2018

No, they have just re-allocated some of their hedge fund $ to PE. Most are long term holders and intend to ride out any market cycle in PE. I have seen more hiring by family offices on the PE investing side.

Dec 12, 2018

I certainly agree with the problem: too much capital chasing too few deals and someone is going to get exposed. The question to me is, maybe it's PE shops that get exposed as often as family offices. I could see the FO getting exposed via poor returns for "trying this at home" without paying the pros, or I could see the FO performing alright compared with LPs (net of fees obvi) in which case the PE firms' fees come into question. Not sure why the latter scenario would surprise anyone, there's been plenty of criticism of GP fees.

Dec 12, 2018

Do you think it has to do with the poor performance in public markets and the ridiculous fees PE funds take while also lacking any visibility at all on performance.

I am sure people will continue to take PE in house until that industry is easier for someone to understand/ has less tricks to never show investors performance until redemption.

Dec 12, 2018

Very funny how when a PE fund is out raising, their most recent fund is marked up at a 15-20% net and then ~1 year post newly closed fund the original fund will be down to 8-12% net and their new fund will be at 15-20% net.

I think some PE funds definitely do crush and provide value over the long run (whether by buying at a good price, operating improvement, financial engineering, etc.), but the majority really just try to make some cap structure arbitrage + cut some costs and sell the business "improved"...there will be a big shake out in the next recession as funds can't exit and it puts a huge drag on their performance BEFORE they are able to go out and raise their next fund.

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Dec 12, 2018

This is interesting. Given how standardized and rote the PE investment process is becoming, I was wondering how long it was going to take before LPs / investors eventually started looking to invest their capital directly instead of going through PE firms.

I wonder if we'll eventually see the emergence of an Angel List for PE stage businesses.

Dec 13, 2018

I don't have much to add to this, but I'm currently a summer analyst at a family office who market themselves as a private equity fund. The business is primarily split into two separate arms, one is pure public equities being managed (global macro strategy) and the second arm doubles as a 'private equity' investor, making investments in the LMM, primarily in local consumer retail businesses sub $100m in enterprise value.

The team is incredibly lean. The father of the family in question is a director and sits on the advisory panel - but is in the office maybe once a week, if at all. Big investments have to be approved by him, but he's relatively easy going and leaves the investment decisions to the investment team. He requested exposure to a particular blockchain project which isn't coming to fruition as he had hoped. The CEO's background is in real estate investment advisory and the VP was a senior associate at an EB investment bank. The remaining analysts are all entry-level hires straight from school.

Although I'm enjoying my time here, I don't feel like it will equip me with the necessary analytical skills. There is certainly no structured training, it's more about picking up whatever you can. Would be interested to hear from anybody else with experience at a private equity style family office.

Dec 13, 2018

I work at one too, feel free to PM

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Most Helpful
Dec 13, 2018

I have been working at and managing capital for a single family office ("FO") for ~2 years. I've come to know the landscape well. Unfortunately, you can not generalize the entire landscape. Family offices are more like HFs in the sense that there are many strategies / areas of focus whereas in PE/VC everyone fits a cookie cutter description (fund size X investing in company/stage Y, investment lifecycle Z)...

Typically you have several differentiating factors:

  • Overall AUM size (the larger, $500M AUM+ guys are playing at a different level)
  • Single Family Office vs. Multi-Family Office
  • Source of the wealth (family owned operating company throwing off cash vs. professional asset management (PE/HF/RE/Etc.) success resulting in significant assets with limited cash flow generating operating companies)
  • Are family members actually working there / on the investment staff or is it all managed by non-family members hired by the family
  • Ability to generate its own deal flow vs. not being truly capable of doing so (probably the largest differentiator)
  • Strategy (more on this below)

The FO I work at is more sophisticated than many we interact with. Family capital comes from a patriarch who was a megafund MD for ~20 years in the 1980's - 2000's. We have ~6 investment staff / 12 back office. Staff is a mixture of family members and non-family members. All have at least 3-6 years of institutional experience (PE/VC/IB/Consulting) before joining the FO. We do not have a specific strategy. We look for types of situations vs. specific deal. As such, we look at and invest in:

  • Fund LP Positions (5% of time): We have LP stakes in >35 funds across stage/geography/industry. The primary purpose of this is extending our knowledge network vs. returns. We will mostly allocate to areas outside our core expertise. Additionally, often times many <$500M funds will do fee-free/carry-free co-invest. So often we will become a $500k - $2M LP and invest > fund commitment in co-invest opportunities, significantly lowering the overall fees for the fund
  • Direct Privates (45% of time) LBO / structured minority investments in growth stage businesses, generally already profitable or will be in next 18 months (max out in the $10M - $15M EBITDA range, more often working with $5M - $10M EBITDA companies)
  • Co-Invests (25% of time): This is a mixture of investing with funds we are an LP in, backing fundless sponsor deals (in particular, given our FO background, we have a large network of Principal level individuals that leave very good PE firms but can't raise their own fund yet), and investing with other family offices looking to fill out a round/syndicate of capital
  • Direct Public Equities (20% of time): We maintain a small concentrated long value strategy (5-10 positions). There are immense advantages to family offices in this area I won't dive into. However, two examples: if the family has philanthropic initiatives, you can donate appreciated public securities tax free, thus saving capital gains, and re-buy in with liquidity generated by fund LP stakes, and you can get very low cost credit lines on up to 70%-80% of public equity security assets, thus giving the FO a lot of flexibility for any short term cash needs, etc.
  • Special Situations (5% of time): We don't actively hunt for these. They come to us. Often it is a very unique opportunity that has a shorter time fuze or is not a fit for typical financial institutions. Maybe it is a family doing a transactions and they will agree to a six month 20% annual PIK interest loan while they wait for some liquidity, maybe it is an under the radar re-cap on a VC stage company with great structure, maybe it is a unique long-term idea that is in an industry not suitable for most fund managers, maybe it is something international in Asia/Africa...

What I really notice sets FOs apart from others is actual investment capabilities and deal flow. There is an immense number of very successful families in the world. However, many of them generated their wealth via an operating company and I think Warren Buffett has spoken extensively on the topic that many CEOs are not great capital allocators. Thus, you often find FOs built around a specific company that can't do much outside of their exact industry/circle of competence. Second, many can't generate deal flow. Also, they don't have real service provider networks (legal/accounting/debt/Etc.) / back office capabilities setup to enable robust transactions work to be done.

On deal flow, a premise of the OP is needing IBs. The FO I work at looks at almost zero bank deals. Our team is too lean to manage these relationships and we would submit too few IOIs, thus making us largely disadvantaged in any process we would want to pursue. That said, we actually do get differentiated deal flow. The reality is that an immense landscape of opportunities open up when you become industry/stage/geography agnostic vs. thinking like a fund with a cookie cutter mandate. To do this effectively you need to have the proper investment staff though.

I think a fundamental thing many people on WSO are not realizing is how much investment activity takes place outside of investment banks. IBs are not gatekeepers, they are simply driving the market towards more efficiency for specific types of deals. They serve a vital role and we will work with them selectively and use them if/when we look to sell companies.

Additionally, another thing about FOs is they don't have to be as active as PE funds. I was talking with an old colleague recently at my past fund. I was complaining as I am about to close a proprietary LBO (fingers crossed) of a ~$5M EBITDA business with very good valuation/structure. We first met the company in summer 2017. It has been more work than I've done on any deal at any firm (even $1B LBO when I was a PE associate a while back). My old colleague basically said he would rather do banked deals and pay 1-2x higher EBITDA multiple, but because they are so much more efficient he can close 2 a year vs. 1 for me and maybe he makes 2.5x MOIC on both vs. my 3.5x. Thus he'll generate more aggregate gains vs. me. This is likely pretty accurate. However, at my FO, 100% of invested capital is evergreen family balance sheet, so the opportunity cost is very high. In my former colleague's case, he is fighting for carry and needs to deploy capital at a certain speed to keep growing AUM. In both examples, you can find pros/cons, but the reality is incentives and rewards are very different between traditional PE and FOs.

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Dec 13, 2018

Great post. Very interesting.

Back when I was in PE ($1bn fund size), proprietary deals were always the holy grail, but seemed fairly elusive (I think we only did a couple such deals during my tenure). How are you guys sourcing non-banked deals? Is it mostly through personal networks / connections?

Dec 13, 2018

Personal networks and reaching out to biz owners directly to see if they'll sell.

Dec 13, 2018

I've seen some shops come up with a thesis and attempt to acquire their way into businesses that align with that thesis. It can be tough sledding as you referenced and the hit rate is generally low unless you have an operating partner with an angle and relationships in the space (e.g. IIRC GTCR has done quite well with this model).

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Dec 13, 2018

Thanks for your thoughts. I was speaking more in regards to direct investing (or at least co-investing) compared to non-M&A strategies.

I agree with you that bankers aren't always required to get a deal done. That being said, I think they certainly help get the deal done and we've been brought on in several one-on-one deals this year just to run diligence, push terms in the PA, etc.

To your point, an important element is not just getting proprietary reps, but also closing deals. I've seen several LMM PE funds that overlap your size range expand their efforts to get prop deals done with little to show for it. While we can all agree it is a multi-year courtship in most instances, that is an enormous time suck for leaner teams (most FOs are leaner - yours sounds more like an exception from what I have seen).

Moreover, now you are forced to compete for closely held businesses with IBs (want to run process), traditional PE Funds and independent sponsors (who may already have other capital providers lined up), mezz or minority equity funds, etc.

With more and more money chasing LMM deals, I don't see this as a viable long-term strategy.

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Dec 13, 2018

This is in line with my experience. The hit rate on proprietary deals was so low I wondered why we even bothered.

I think it's a bit more viable at the early stage / venture level, but of course that's a whole different asset class.

Dec 13, 2018
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