Growth of Family Offices in Private Equity

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By Dan Weinmann,
Managing Director

There are several types of buyers in M&A sell-side transactions.  One group is strategic buyers who are companies that are in the industry of the seller, and could either be direct competitors or in an ancillary business that would be complementary with the seller’s business.  A second common group is financial buyers, which are typically thought of as “private equity groups” or PEGs, which are a group of investment professionals with capital that typically purchase a portfolio of companies in which they own the majority of the equity, but the management teams actually run the day to day operations of the business.

PEGs actually come in many forms, but the most common is a traditional 10-year fund. 10-year funds are generally a group of investment professionals representing the PEG firm, which acts as the general partner, and they raise capital from limited partners (LPs) such as pension funds, endowments, asset managers, or high net worth individuals.  They have a 10-year time horizon to put the committed capital to work and return those funds with profit to the LPs.  During that time, they need to find privately held companies to purchase, buy them, grow them, and then sell them all within the prescribed 10-year fund timeframe (with some limited ability to extend).  If the fund general partners are successful and make a return for their investors, they are able to raise additional successive funds, and the cycle continues.  On average, funds may hold their investment companies for five years due to the timing pressure of returning capital and showing returns early enough to raise the subsequent funds.  Because PEG firm professionals make their money from fees for managing and investing the committed capital plus a portion of the upside return on the investments that they make, PEG funds need to continue raising funds or their firm and income streams would end.  This means that they have pressure to sell companies that have further growth potential to satisfy their fund timing or capital raising initiatives.  Fund professionals lament about how difficult it is to find, chase, bid on, win, and close these investments in good growing companies, only to have to prematurely sell and start all over with a different company that may not have the upside of the one they were just forced to sell.

Because of the time pressure of working within a timed fund, many private equity professionals are choosing to go the “fundless” approach and either raise money on each transaction from LPs that know them from prior investments, or have an alternative source of capital that doesn’t necessarily have the same timing. Evergreen funds recycle the money that is returned to the LPs so that the investment pool doesn’t expire.  Funds raised by groups of high net worth individuals may not have the timing pressure as a fund with pension or endowment investors.

Another source of capital that has emerged somewhat recently and been growing in popularity for many of these timing reasons is Family Offices participating in the private equity buyout arena.  Family offices are private wealth management advisory firms that serve high-net-worth investors.  Family offices can invest on their own or in conjunction with other family offices, usually through a separate “private equity” entity that is funded by the family capital.  One big advantage to most family office buyout structures is that they have no specific “hold” period, which means they can hold an investment for as long as there is opportunity for growth and return on investment.   Just because they have a theoretically unlimited hold period doesn’t mean that they will hold it forever.  Family offices generally have private equity professionals and/or investment advisors running their private company investments and will look to take advantage of opportunistic transactions as well.  What separates them from the funds is that they don’t have the pressure to exit prematurely when there is still strong growth in the forecast.  They are often considered “patient capital” relative to traditional PEGs.  This aspect is appealing to many sellers.

Whatever the source of capital, private equity represents a large and growing opportunity for business owners to partner with professionals experienced in growing businesses.  They bring resources both in capital and strategically to the companies that they partner with, and allow the business owners to take risk capital off the table while staying involved in the business for as long as they would like to contribute, and allow them to step out of the company knowing their succession plan is being handled by equity-aligned partners who have helped in this transition many times before.

Common considerations for partnering with private equity when EdgePoint advises business owners include:

  • The seller is able to cash out 80-100% in a transaction with an opportunity to reinvest equity alongside PEG (with a 3-5x their money expectation in 5 years – “second bite of the apple”)
  • Private equity buyers provide the highest valuation in many auction processes
  • As-Is and Where-is Transaction - Employee continuity and Company culture are maintained post-transaction (legacy maintained)
  • Seller and/or executive management team can continue to operate the business with day-to-day control
  • A private equity will form a board of directors comprised of relevant industry executives and business leaders to facilitate strategic growth and leverage relationships
  • Because of the leveraged roll-over, owners can roll 10-20% of their proceeds to secure 20-49% of equity in the new entity
  • A private equity transaction allows the Seller to dictate his or her own terms for continued employment with built-in succession help or retirement in the near term following the transaction
  • Owners treated more like “senior partners” than employees post-transaction.

 

Family office backed private equity is strong and growing.  A survey of 139 single-family offices from Grant Thornton found that 86% of those that already invest in private equity want to increase their commitments over the next three years. The survey found the median office has $276 million in investable assets, and the 109 offices that have invested in private equity since 2009 have allocated more than $8 billion in capital both in committed capital funds and direct investments. Slightly more than two-thirds invest in funds and just over half invest directly in Companies. Another 29% co-invest with funds directly, but alongside funds. Many family offices were funded by operating businesses that made the family wealthy, so there is a good fit and understanding of business owners.  In some cases, there can by synergy or industry knowledge with the family office’s operating business as well.

Whatever the source of capital – committed capital funds or family office capital, private equity represents a flexible and potentially valuable transition option for business owners considering transition.  Committed capital funds are abundant and eager to put capital to work and will often be the highest valuation even when in competition with strategic buyers, and can add strategic-like value post-transaction.  Because of their longer hold timeframes, family offices provide the flexibility of longer term strategies and organic growth alongside a deep capital provider that may also have knowledge and experience in the industry.  Both sources of capital offer a flexible and potentially lucrative transition option, without the perceived competitive issues that come with strategic buyers.  This expansion of the buyer universe that has been occurring has contributed significantly to the robust and active sellers’ market that currently exists.

© Copyrighted by Dan Weinmann, Managing Director of EdgePoint Capital Advisors, merger & acquisition advisors. Dan can be reached at 216-342-5860 or on the web at www.edgepoint.com.

 

 

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