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A version of this article first appeared in CNBC's Inside Wealth newsletter with Robert Frank, a weekly guide for the high-net-worth investor and consumer. Sign up to receive future issues, straight to your inbox.
Family offices are increasingly shunning private equity funds and buying stakes in private companies directly, according to a new study.
Half of family offices plan to do “direct deals” — or invest in a private company without a private equity fund — over the next two years, according to a family office survey conducted by Bastiat Partners and Khris Capital.
As they grow in size and sophistication, family offices have become more confident about finding and negotiating their own private equity deals. Since family offices – the investment and in-house services companies of high-net-worth families – are usually founded by entrepreneurs who have started their own companies, they often want to invest in similar private companies and leverage their expertise.
More than half (52%) of family offices surveyed prefer to conduct deals directly through syndicates, with other investors taking the lead, “reflecting a cautious approach and reliance on the expertise of established sponsors,” according to the report.
“Family offices are gradually being recognized as an economic force in private markets,” the report states.
The big challenge family offices face as they undertake more direct deals is what is called deal flow, or the volume of potential deals. Since most deals are either unattractive or unsuitable, family offices may see 10 or more deals for every successful deal, according to the report.
At the same time, family offices are fiercely protective of their privacy and prefer to remain largely unknown to the public. Without a public profile, they are less likely to be included in deal offers or banking calls and miss out on potential investments. 20% of family offices surveyed cited “deal flow quality” as a key concern.
One solution, according to the report, is for family offices to start developing more public profiles and reaching out to each other more to attract deal flow. According to the survey, 60% of them consider communication with other family offices to be “important,” and 74% are looking forward to “more introductions.”
Another challenge faced by family offices doing direct deals is due diligence, according to family office experts. When a fund or private equity firm invests in a private company, they often have teams of bankers or in-house experts who are able to analyze the company's financials and prospects. Family offices typically lack the infrastructure necessary to conduct rigorous due diligence and take risks in purchasing distressed companies.
To formalize the deal process, more family offices are creating boards of directors and investment committees. According to the survey, 54% of North American family offices have established investment committees to help screen investments.
When it comes to their favorite private investments, they like to venture “off the beaten path,” focusing on niche and emerging asset classes. For example, family offices are increasingly investing in estate tax liens, fertility clinics, real estate sale and leasebacks, whiskey aging, and litigation financing.
According to the report, “These approaches provide family offices with access to private investments that offer attractive yields, cash returns and low correlation to traditional markets.”
