Despite the record-breaking DJIA and rising corporate profits, the volatility of public securities is causing many single and multi family offices to flee traditional stocks and bonds. Instead, the families are looking to private alternatives for their investments.
“It has become clearer to many family offices that privately-held companies are not as susceptible to the same risk as public investments,” said Howard Romanow, COO and CFO of Island Management, a family office for a fourth generation family with more than 100 years of ownership experience. He added, “Additionally, as the public markets have become more efficient, it is increasingly difficult to get above-market returns on a consistent basis.”
Cue private equity. Since private equity firms are the pros at specialized, private investments, it would make sense for families to line up to become LPs. Or at least one would think.
As it turns out, many family offices are bypassing PE firms. “Although many more family offices are looking for private investments, many are hesitant to invest in PE firms because they do not see the benefit of the structure,” Romanow explained. “If you are capable of directly investing, the idea of fees, the illiquidity of the fund, the lack of control, and the desire to quickly sell the winners and hold the losers is not appealing.”
Little Direct Competition
If family offices begin direct investing en masse, should private equity firms be worried about rising competition? Romanow does not believe so. He explained, “When it comes to the types of businesses we are acquiring, there is less competition — the companies that are interested in the value-add of a family office are less interested in a private equity firm, and vice versa.
“The reality is that we typically do not participate in auctions,” said Romanow. “Overall, we are focused on fewer, more hands-on investments that we will hold for far longer than a typical PE firm. We are not confined by any holding period limitation or structural limitation, so we can be as creative with an investment as we want. This allows us to review each opportunity as a unique investments and not have to be confined to a specific industry or investment type.” He added, “We tend to look at ownership in terms of generations rather than five-year investment periods.”
Romanow was certain to add that family office investment strategies run the gamut. While Island Management may be interested in long-term investments, there are many other family offices that are keen on pursuing more traditional private equity-style models. He explained, “Because of the timeline and strategy of most private equity firms, we would be much more likely to partner with another family office than a private equity firm. But, much of it depends on the family. If a family’s investment objectives are like a PE firm, a partnership with a PE firm might make more sense.”
Private Equiteers Moving to Family Offices
Rather than competing around investments, family offices and private equity firms may soon be competing for investment managers. Romanow explained, “Although it is still a relatively young trend, you are more frequently hearing of private equity professionals leaving firms to move to family offices.”
The alignment of supply and demand is near perfect. On the demand side, family offices have begun to “tap existing private equity professionals to source opportunities, conduct thorough due diligence, negotiate transactions, and work with the acquired companies.”
On the supply side, many private equity professionals are finding it an offer they can’t refuse. As the PE industry has evolved and changed — especially in response to tax questions and realization of carry — the idea of working for an office under a more flexible policy is significantly more appealing to many PE folks.
Romanow explained, “I spent 15 years in private equity before joining Island Management. When I decided to move to a family office most of my reasons were centered on the issues I saw with institutional private equity funds — decreasing fund returns, ability to generate carry, limited holding periods, the difficulty of raising new funds, registration requirements, the conflict of LPs-GPs, and the fact that we were regularly selling the best companies for a quick return.”