Co-investing among family offices in private, direct deals is on the rise. The percentage of family offices with three or more people responsible for sourcing, screening, monitoring, and exiting direct investments has nearly doubled from 2010 to 2014. According to Ward McNally, an advisor to family offices on joint investments, in 2010, nearly 22% of family offices reported to have 3 or more staff members that were responsible for direct investing – a figure that has jumped to 37% in 2014.
A 2014 UBS and Campden Wealth family office report found that four-fifths of family offices studied had participated in co-investing. The report also found that family offices in Asia-Pacific were the most likely to co-invest, while European and North American family offices were less likely to participate in co-investing and direct investing. However, data suggests that co-investing is trending upwards for all regions.
So why would family offices consider co-investing? Here are some benefits as well as potential challenges family offices may face when co-investing.
Benefits of Co-Investing for Family Offices
1. Lower Fees
Traditionally, family offices work with fund managers who would be responsible for sourcing the deal flow, selecting investment opportunities, and generally overseeing the entire investment process. Asset managers typically go by the 2/20 model – a fee structure that charges family offices anywhere from 1.5% to 2% in management fees and 20% of a fund’s profits.
With co-investments, family offices can forego hiring fund managers and avoid these fees. In theory, this sounds like a great reason for family offices to directly invest instead of working with asset managers. However, as we will later highlight below, this strategy also has its challenges.
2. Pooled Expertise
When family offices evaluate potential asset managers they’d like to invest in, it is very common for them to understand the fund’s investment thesis. However, it is unlikely that family offices will understand in depth all the private investments that their asset manager is making. Therefore, when family offices come together to co-invest in a certain private direct investment, they are now responsible for conducting their own due diligence and overseeing the investment process. With the first-degree communication that exists between family offices and the investment opportunity, family offices are forced to really understand the businesses in which they invest.
Family offices each have different expertise and strengths in various industries. Co-investing may allow family offices to tap into this collective knowledge to expertly invest in a wider range of industries, increasing efficiency and maximizing resources.
3. Enhanced Negotiating Ability
When family offices come together to co-invest for a single investment opportunity, this puts them in a better position to better negotiate investment deals given the larger collective amount of investment dollars they now represent.
Co-investing also allows family offices to have a say in where their investment money is spent. This is in contrast to investing in a blind pool managed by someone else.
Challenges Family Offices May Face When Co-Investing
1. Conducting Proper Due Diligence
Conducting due diligence on an investment opportunity is a long and arduous ordeal. Investors typically have request information from the managers and/or entrepreneurs, analyze and review the business opportunity and financials, and evaluate both qualitative and quantitative factors.
Family offices that decide to co-invest may assign certain tasks to each family. However, in the case that the family offices do not have the expertise and know-how to conduct proper due diligence, this important step may be a hindrance.
2. Access to Deal Flow
Seven out of 10 single-family offices cite referrals from professionals as a very important way of sourcing new investment opportunities. While referrals and personal introductions can be helpful, they may not provide enough deal flow for family offices to select potential investments.
However, family offices open to considering investment opportunities outside of their circles may use technology to cope with this limitation. Online alternative investment platforms such as DarcMatter allow family offices to securely and quickly access various investment opportunities with the click of a button.
3. Coordinating with Multiple Parties
Family offices typically co-invest with other family offices with whom they have established relationships. When co-investing, it is common for family offices to make sure everyone’s values and goals are aligned. This will be important as family offices work closely together when making investment decisions.
As opposed to investing in asset managers, where family offices only have to work and correspond with one other party, co-investing involves communicating and working with many parties at once. Working with many chefs in the kitchen is no easy feat, and family offices should recognize this and be prepared to work closely with fellow family offices.
4. Responsible for Ongoing Reporting
Whereas asset managers would be responsible for any ongoing reporting, family offices who co-invest will have to take this work in-house. This might not be a problem for family offices who already have the dedicated staff and infrastructure for this purpose, but for smaller, single family offices, this resource allocation should be taken into consideration.
While there is no evidence yet that direct investing leads to higher returns, many family offices are increasingly working together to co-invest in direct investment opportunities. Co-investing for family offices is on the rise and will continue to play an important role in providing capital for businesses.
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