Early Stage Investment Innovation: Building Services for Family Offices
My management team and I have spent the past nine months building access to early stage investment assets for family offices. Perhaps the simplest definition of a family office is an organization that assumes the day-to-day administration and management of a family’s financial affairs. The experience has been challenging, exciting and rewarding — and has taught us all a lot about the process of innovation and the ideal customer.
The longest bull run in history in the past decade, and the exponential share of this wealth that has gone to the top 10 percent of income earners, specifically family offices or ultra-high net worth individuals (UHNW), is starting to impact the way that many of these organizations invest and manage their assets. Globally, UHNWs control around USD14.7 trillion in total combined wealth. This is roughly broken down by region as follows: U.S. USD7.1 trillion, Asia USD2.6 trillion, Europe USD2.3 trillion with the balance spread across various developing economies.
Apart from the significant increase in wealth, another interesting trend has emerged, and this is the desire to increase diversification away from traditional asset classes, specifically those being the domestic equities and fixed income categories. This diversification has mainly found a home in real estate, private equity and commodities, and this trend is influenced by a greater desire for direct investment and greater control (i.e. less dependence on traditional wealth management companies and related funds).
What the recent data says
According to a recent survey published by Family Office Exchange “… less than a third of family office respondents report that they use quantitative modeling to determine asset class allocations and position sizes … (and) only 65 percent of family office participants are relying on the traditional building block of asset classes … with 35 percent considering other asset categories.”
The insight here is that as capital flows into other asset classes, it is not strictly governed by the traditional asset allocation models, but is impacted by personal choice, quality of service offerings to meet investor needs, sector knowledge and preference, and liquid/illiquid parameters.
Another interesting insight from the survey was the increase of direct investment and the preference for active management of these investments. The survey reports that “one-third (32 percent) of their long-only publicly traded securities are managed passively (either through an indexed mutual fund, separately managed account, or ETF), with 40 percent managed actively.” In addition, “more than three-quarters of those surveyed (81 percent) invest directly in real estate or operating businesses, with nearly half (47 percent) investing directly in an operating business (outside of the core business, if there is one).” Finally, there was one other data point that I found interesting from this survey and that was that “Family office interest in direct investing is strong with 30 percent planning to increase the pace of their direct investments and only 10 percent planning to decrease it.”
The role of impact investing on the next generation
Two other noteworthy trends within the family office that are worth touching upon are the role of impact investing and the influence of the next generation of family members. Impact investing is now better appreciated and is no longer dispatched as the category of hand-outs for tax write-offs. On the contrary, it has earned its place at the table alongside financial returns and is now part of the decision-making process, often with an equal voice. Similarly, the next generation are impacting asset allocation choice, and the way that investments are actively managed.
Applying product design
So, now that we have understood some of the trends, how does this affect the category of private equity in general? And specifically, how does this impact early-stage investing as a sub-category of private equity, which is the area of finance that I am most interested. I want to understand how fund managers and providers of private capital should develop their offerings in order to attract more capital into their respective sectors, while understanding the needs of their customers.
Traditionally, private equity custodians said to UHNW’s “Give us your capital, and we will give you returns.” Nice and simple. Effective too. Private equity has delivered on its promise and the returns speak to this over the past four decades, including both later-stage private equity and venture capital. But now with a changing landscape, where UHNWs want more say in the allocation of capital into specific opportunities how will this impact the market?
Evolution of capital
Most family offices share some common challenges when thinking about allocating capital and making investments, and these most likely fall into the following areas: managing costs while improving efficiency, regulatory oversight, risk management and reporting, compliance, and cross-border issues. In addition, with the desire to be more active decision-making processes, we should add access to professional due diligence as a core issue.
These trends and issues outlined above start to paint a picture of private equity in general making space at the table for limited partners and family offices to directly participate in the investment process. This can happen in a couple of different ways.
First, co-investment alongside funds that are already supported by the respective family office at LP level. This is already becoming more common with family offices allocating capital to funds that allow for significant co-investing, with estimates of around 43 percent of funds now allow for co-investing.
Another opportunity is for the research and related due diligence to be made available to investors so that they can make their own direct investment decisions, independent of what the fund manager is doing.
Then of course, there is a hybrid of the above, where family offices are able to participate at the deal origination and sourcing phase, where they bring deals to fund managers to evaluate and co-prepare due diligence.
So, as we continue along this journey of making early stage investing a transparent and identifiable asset class, we remain focused on building various products and services to fit the investor and entrepreneur. Not easy task — as innovation is invariable full of unknows — but a rewarding one.