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Wealthy Families Invest Less in Buyout Funds to Do Own Deals

Family offices are doing their own buyout deals to avoid fees charged by private-equity firms.

  • Alicia McElhaney

Family offices are increasingly cutting out the middleman when it comes to making private-equity investments. Instead of allocating money to buyout funds, many are trying their hands at their own deals.

“Private equity firms - sitting on significant dry powder - are facing competition from family offices looking at deals,” said Kristi Kuechler, president of the private investor center at the Family Office Exchange. “In addition to seeking higher returns than currently expected in traditional assets,” she said that “many families are looking at direct investing as part of the ethos of the family, to encourage entrepreneurialism” and make members feel more connected to their assets.

They’re also taking advantage of talent within their offices to cut high fees associated with private-equity funds. Whether family offices have the capacity to consistently reap the rewards of direct investing in the lower end of the middle market through a successful sale remains to be seen.

Eighty-one percent of family offices have at least one person working on direct investments, according to a survey by Family Office Exchange that was released in May. The consulting firm found that 57 percent of the 118 family offices surveyed plan to increase such investments this year.

As many families have created their wealth by building businesses themselves, Kuechler said “it makes sense that the family would like to leverage that experience and invest and grow operating businesses.”

They can see higher returns on their investment because they avoid management and performance fees charged by private-equity firms, according to Kuechler. She declined to name the family offices that are investing directly in their own deals.

[II Deep Dive: Private Capital Managers Are Charging Higher Fees]

There’s another advantage for families: they’re not under pressure from outside investors to exit their deals. While private-equity firms typically own companies for five to seven years before cashing out, family offices can hold investments as long as they need to.

“The thing with a family office is that they don’t have the time horizon that a private-equity firm does,” said Dan DiDomenico, senior managing director at Murray Devine, a private-equity advisory firm. “It’s family money that’s sitting there. They can hold onto money for a longer period of time.”

Family offices increased their allocation to direct investments last year to seven percent of assets on average, from three percent in 2015, according to the Family Office Exchange survey, At the same time, the amount they invested in private-equity funds fell to five percent in 2016, from nine percent the year before.

But making a direct investment doesn’t come without challenges. The private-equity market is filled with dry powder and crowded competition for assets.

“It will be interesting to see how valuations are impacted, especially in a fairly rich U.S. equity market,” Kuechler said.

What’s more, many family offices don’t have the institutional knowledge or experience to execute a private-equity deal.

“The challenge many family offices would face in pursuing direct private-equity deals comes down to talent,” Arthur Bushonville, chief executive officer of DSC Quantitative Group, said in an email. Bushonville, whose firm has created indexes that replicate the performance of the buyout and venture-capital industries, says that investing in a private-equity fund or index is less risky for family offices.

“Likely, most family offices do not have employees with the requisite background and skillset to properly source, evaluate and monitor direct deals,” he said, “especially if the companies run into trouble.”