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Direct Investment: The Family Office's New Frontier

Family offices that invest directly are proving viable competition for private equity firms.

For decades, private equity firms have faced competition primarily from corporations and public market investors, but a new trend is proliferating. Over the past few years, family offices that traditionally have acted as limited partners instead have been investing directly in businesses, cutting out private equity firms, bypassing the associated management and performance fees, and buying larger pieces of companies. While this shift has led to increased competition for private equity firms, it also is causing investment banks to consider family offices as an option when advising a company that is interested in being sold or raising growth capital.

A longer-term approach sets family offices apart as they are patient capital providers content to hold investments that are performing well while willing to look beyond short-term fluctuations. The tendency to hold companies for a longer period of time is appealing to management teams who wish to stay in place after acquisition and who often own equity in the company. Additionally, in many cases, family offices consider legacy issues and use their personal experiences and expertise to help support the companies in which they invest. This approach is typically attractive to founder-owned businesses.

In terms of investment size, family offices can compete against other private equity firms within the middle market. In 2014, 77% of investors polled by McNally Capital said they preferred direct deals over private equity funds. That same year, 84% of family offices said they planned to make a direct investment in a private company within the next two years. In fact, family office activity has risen since the recession, from 38 direct investments in 2008 to 77 in 2015. Since 2008, there have been 486 family office investments.

Number of Family Office Investments per Year

Source: PitchBook

As companies consider moving away from private equity firms, the family office-direct investing model is enjoying great success. Spearheading the trend is the Pritzker Group, which has been investing family money directly into companies for 14 years and acquired four platform companies in 2015. The Pritzker Group focuses on manufactured products, services and healthcare investments, and is best known for creating the Hyatt hotel chain and the Marmon Group, which was bought by Berkshire Hathaway Inc. for $4.5 billion in 2007.

“We have increasingly expanded our dialogue with family offices as we recognize the popularity of the family office-direct investment model,” said David Clark, head of the Financial Sponsors Group at Raymond James. “Over the past 12 months, we have sold three businesses to family offices and continue to include them in our processes as they often represent a unique fit for our clients who are looking for a more patient, long-term capital partner.”

Private equity firms remain an attractive option, however, particularly for companies with strong growth prospects. To combat the competition, firms are moving toward an industry-specific structure that allows them to develop the expertise needed to be more strategic in the way they acquire, support and grow companies. But while private equity firms’ track record in generally achieving fast returns has allowed them to remain in the majority*, family offices will continue to grow and should be considered a viable option for companies thinking about selling or raising private funds.

Sources: Mergers & Acquisitions, New York Times, McNally Capital
*Past performance may not be indicative of future results.
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