Family investment firms are taking on third-party investors to compete for larger PE deals.
Pritzker Private Capital recently gathered family office investors in Aspen, Colo., to look at how wealthy families are upping their game to compete for quality deal flow in a hot private equity market. The conference highlights a growing trend among wealthy families to establish hybrid private equity vehicles that raise third-party capital in order to match the breadth and sophistication of traditional private equity firms, while still leveraging the connections and other competitive strengths typical of family investors.
“We’re a family investment firm with private equity characteristics,” says Paul Carbone, president and managing partner of Pritzker Private Capital. He notes that the firm’s outside investors are mostly other wealthy families, which he calls a committed club. Part of the appeal is the club’s focus on investing in family businesses—comfortable turf for this type of investor.
According to Mr. Carbone, his firm’s approach reinforces the family pedigree while allowing it to recruit an “institutional quality team” and providing flexibility in determining the right hold period for an investment.
Taken together, he says these elements provide the group with a competitive advantage over traditional PE firms, and are best exhibited by its investment in CH Guenther, a fifth-generation, “north of $1 billion” family business based in Texas. Pritzker did not have to compete for the investment opportunity, in part because it was able to meet the family’s need for liquidity and management’s desire for a partner interested in growth, such as the investments it subsequently made in human capital, facilities and add-on acquisitions.
“Think about the difference between our owning a business for 15 years and that same business being owned by three different PE firms with five-year hold periods. The same business would likely look significantly different,” Mr. Carbone says. “We can invest in ways and durations that others won’t or can’t and get up to a higher point on the mountain with our businesses. We understand the power of compounding and building value over time.”
New Strategy, Old Roots
The movement by wealthy families to make direct investments in companies is a reprisal of a 600-year-old practice that started with “the Medicis and other grand families of Europe,” according to John Rompon, a family office private investor and managing partner of Marjo Investments LLC.
“After the Great Recession, wealthy families began to make direct investments at a quicker pace,” he says, adding that only about 15% of family investors “have demonstrated the ability to consistently make and manage large investments professionally.”
This suggests a future cap in the number of large, third-party-backed family funds, but also a substantial potential reservoir of capital from families who lack the capacity to lead, but may be able to contribute contacts or industry expertise based on the original source of their family wealth. Deep industry experience in areas such as real estate, technology or manufacturing can be a key differentiator for family funds, both in building relationships with prospects and adding real value to the investment opportunity.
According to Mr. Rompon, the arrangement provides necessary capital for lead families to use less debt, acquire larger companies, retain companies over longer periods, and hire top-tier investment teams. “Even billionaires start to run out of money if they continue to buy companies but less frequently sell them,” he says.
However, navigating the relationships with other wealthy families to become third-party investors can be tricky. Mr. Rompon points out that many co-investing families “accumulated great wealth by exercising control over a company,” and that it can create a challenging dynamic if they’re being asked to play a more passive investor role.
A Significant Trend
There are other challenges to seeking investors for a family PE fund, including potential additional disclosure, reporting and other requirements regulated by the Securities and Exchange Commission. This means that wealthy families accustomed to private trusts and similar arrangements risk public scrutiny of what they have long considered private matters.
Still, Ryan Harris, a partner with Kirkland & Ellis, reports there has been “a significant trend in the last 12-24 months in families inquiring about these vehicles and starting to implement them.”
According to Mr. Harris, part of the driver is that larger PE firms and other institutional investors are now offering longer hold periods, mitigating what has been a traditional differentiator for wealthy family PE funds and private offices. In response, a family fund leveraging third-party capital can be competitive on larger transactions, but also focus on founder deals in industries where they have actual operating experience, and offer flexibility and creativity in how the deal is structured.
“The primary difference is the more bespoke approach,” Mr. Harris says. “Funds raised by family office investors can have more flexibility in how they structure their vehicles.”
While the current hybrid model for third-party-backed family PE funds focuses on seeking other families as investors, a potential for expansion could be to target like-minded institutions that see the benefits of a more flexible approach to hold periods and deal structure. But experts warn that privacy-minded wealthy families may want to steer clear of public pension funds and other entities subject to freedom-of-information disclosure laws.
Either way, the trend of family PE groups matching the sophistication and resources of traditional firms is gaining momentum and has the potential to disrupt that model. “The old days of families passing the hat is not a sustainable model in today’s market,” Mr. Carbone says. “Families are deploying capital directly and using a more innovative approach that reflects a need for speed, flexible capital to write a bigger check and a professional team to go toe-to-toe with other firms. We see more and more families taking this approach.”
