The emerging role of family offices in M&A and investing

March 2020 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

March 2020 Issue

Today’s finance and M&A environment is fast paced and multifaceted. The world is becoming a more complex place and so is investing. Funding today comes from a variety of private and public sources. Increasingly, family offices are becoming an important part of the investment community and assuming a greater role in investing and M&A.

So, what is a family office? Generally, a family office is an adviser or fund that invests on behalf of an individual or multifamily group of high net worth individuals. The investment focus of family offices often, but not always, follows the path that led to wealth creation by the family. Today’s family office is generally more professionally managed and more focused on the investment criteria and philosophy of the millennium than its founders.

Family offices are not new. They can be traced back to the sixth century when a king appointed his steward to manage the royal wealth. However, family offices as we know them today can first be seen in the money management structure established by JP Morgan to manage his family wealth and also in the family office founded by John D. Rockefeller in 1882, a family office that exists to this day.

Since their beginnings, family offices have become more sophisticated and various types of family offices have emerged. The most notable types are the single family office (SFO) and the multifamily office (MFO). There are also embedded family offices (EFOs) which are linked to the family business. EFOs have little separation between the family and its assets. SFOs and MFOs are generally distinct from the primary family business and are separate legal entities. Their assets are held separately from the family and the family business.

The process is generally a progression as additional members and generations are added to the family, resulting in a professionalised management of family wealth conducted through SFOs. In many cases, as the family members and their assets diverge, the original EFO evolves into an SFO. Sometimes these SFOs open their investment funds and management services to a few non-related families and become MFOs.

Although there is no specific lower limit on the amount of family wealth managed by family offices, generally, because of the cost of professional management services and the focused investment objectives found in family offices, the amount of family wealth under management in a typical family office is generally at least $200m.

However, the best way to determine the minimum amount of funds under management required to establish an SFO is to consider the contemplated asset allocation and structure, the related operating costs, including the cost of advisory and other professional services, and the desired target return. SFOs that have focused, simplified structures utilising outside professional services with more conservative target returns focused on asset preservation and income may be run successfully with as little as $25m in family wealth under management.

Because of the varied ways that a family office may be defined, and because of the typical predilection of family offices for privacy, it is difficult to estimate how many family offices exist on a global basis. Privos Capital estimates that there were more than 20,000 SFOs and MFOs worldwide by 2019, managing more than $25 trillion of assets. But despite some differences in the estimates, it is safe to say that there are at least 10,000 SFOs in existence globally with a majority of these established in the last 15 years. These SFOS controlled in excess of $4 trillion in assets as of the end of 2018. Whatever the actual numbers, there is a consensus that family offices represent more capital than that held by venture capital, private equity and hedge funds combined.

The increasing concentration of wealth to the top 1 percent of the population, a trend that exists in the US but which has long been existent in emerging economies, has fuelled the growth of family offices, both in the US and other developed economies, but also in emerging economies.

SFOs can sometimes be identified with a single ultra-high net worth individual. Silicon Valley and the tech industry has generated several SFOs associated with tech entrepreneurs, including Vulcan (Paul Allen), Iconiq Capital (MFO most closely associated with Mark Zuckerberg), Bayshore Global Management (Sergey Brin), Cascade Investment (Bill Gates), Hillspire (Eric Schmidt) and Clarium (Peter Thiel).

The business and financial strategy of family offices begins with the business that was the source of the family’s wealth. But for larger and more established SFOs and MFOs, it branches out to a more diversified investment management philosophy, while retaining a focus on financial planning for family members that may include the management of philanthropic planning and strategies. An example of this is the strategy used by the Rockefeller family office which expanded from oil exploration and distribution, to refining and oil & gas products, and from there into banking and other financial services, and real estate investment. Concurrently, at the behest of the family, and also to facilitate tax strategies, the Rockefeller family office established foundations and funded charities and endowed educational institutions.

Family offices also provide advisory services relating to financing and business promotion, including investments as part of angel investment funds, hedge funds, venture capital funds and private equity funds. Through such vehicles, family offices may invest indirectly or as co-investors in debt syndications, loans and equity investments at seed and growth stages with entrepreneurs, bridge financings and structured financings. Family offices may also directly engage in M&A transactions, including acquisitions of businesses that are extensions of family businesses, management buyouts and general business development, including joint ventures and strategic partnerships, particularly with other private family-owned businesses.

Increasingly, partly because of a desire for greater control, reduced fees and greater returns on invested capital, family offices are engaging in direct investment in businesses. Correspondingly, family offices are investing less in funds, particularly hedge funds, which in recent years have not had performance records successful enough to justify their high fees.

According to UBS’ ‘Global Family Office Report 2018’, almost half of the family offices polled said they intended to make more direct investments in 2019. This trend toward direct investment has been particularly focused on sectors and industries where the family wealth was created or where the family office has particular familiarity and expertise, including familiarity with the local legal and governmental environment.

A direct investment strategy, however, requires that the family office implements a formal investment committee process to identify, review and consummate transactions, as well as a committee to monitor and guide portfolio companies on an ongoing basis. The private direct investment process has three parts: making, managing and monetising investments. Family offices need to have the right resources, including the right legal, accounting, tax and other advisers, available to understand what is required to minimise the risks and maximise the value of the direct investment opportunities.

Family offices make investment decisions based on a unique combination of considerations. These considerations include the need for free cash flow for distribution to family members, tax considerations which may include intergenerational tax planning and philanthropic planned gifts, and personal goals that reflect the political, social and religious predilections of the family. In family offices these considerations must be viewed and balanced against the different competing interests of each of the family members.

Family offices are generally patient investors. Unlike venture capital and private equity investors which have a four to seven-year time horizon, driven by a need to return capital to the investors in their funds, family office investors generally have longer time horizons and look more toward long-term capital appreciation. Family office sponsors have a longer time horizon, which allows management teams more time to implement growth strategies and to ride out volatile economic conditions. In fact, during an economic downturn, family office investors may double-down on their investment in companies as a show of faith in management and the vitality of the business plan.

As they have expanded their direct investment strategies, SFOs have begun to adopt some of the business practices employed by venture capital and private equity firms. A recent poll of SFO executives indicates that most of them are expanding their business development outreach programmes, attending more venture capital and private equity conferences to gain access to best practices and market trends, including trends in pricing and transaction structures and terms, as well as to access deal flow and other business opportunities. These opportunities may include co-investing and participating in club deals, as lead or minority investors, both with other SFOs and other financial market participants.

Family offices which engage in direct investments increasingly are assigning significant roles to the younger generations in the family. These millennials are interested in direct investments in start-ups, including start-ups in new millennium focused businesses engaged in information services, FinTech, including blockchain-related companies, artificial intelligence (AI), artificial reality (AR), and the Internet of Things (IoT). However, family offices, because of their need for wealth preservation and desire to achieve long-term value, are also interested in traditional conservative investments in real estate, retail, manufacturing and healthcare.

Millennials managing family offices tend to have a greater social awareness and a willingness to make sustainable and impact investments. More than most hedge, venture capital or private equity fund managers, family offices consider issues such as environmental concerns, gender equality in management and employment, privacy and cyber security, as well as political and economic volatility, as these issues affect potential business investments, as well as companies already in their investment portfolio.

Robert C. Brighton Jr. is a shareholder at Becker & Poliakoff. He can be contacted on +1 (954) 985 4178 or by email: rbrighton@beckerlawyers.com.

Robert C. Brighton Jr.

Becker & Poliakoff