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Ten Characteristics of Successful Direct Investing Families

Date:
Jun 21, 2018

Investing directly and operating in real estate and operating businesses is an increasingly important focus for many family offices. For the past decade, FOX has been tracking family office interest in direct investing, through FOX studies and our highly-engaged FOX Direct Investing Network.

The following are excerpts from an article on direct investing from the 2018 FOX Foresight publication which provides an overview on trends and FOX research surrounding the direct investing space. While specific mandates vary from family to family, we have identified several common traits direct investing families share.
 

1. Direct investing families are driven by more than financial returns. They’re motivated by a range of considerations—strategic to personal

Financial returns alone are not enough to motivate a family to focus on direct ownership. Direct investing requires a significant investment in time, energy, and resources, and therefore, families that enter this space often seek other benefits as well.

For many families, direct investing can be an opportunity to leverage the family’s entrepreneurial roots, engage the next generation, or achieve social impact more broadly.

"Direct investing has proven to be a great way to engage the next generation. It's much more tangible and real than following stocks, reviewing financial statements, and debating whether to invest in Coke or Pepsi" (FOX Member)
 
2. Families typically prefer a few select sectors, but mandates can be broad and opportunistic

Families who are focused on capturing a knowledge advantage through their direct investments favor sectors they know well. However, many are open to exploring new areas, especially if accompanied by other families who are experts in those areas. As a result, families are proving to be both strategic and opportunistic in shaping their direct investment portfolios.

 

3. Families seek opportunities to co-invest with other families

While some larger family offices prefer to do deals on their own, most families are open to co-investing with peers. Families are typically looking for more than expertise; they also want to invest with families they know, respect, and trust.

"A good deal with a great partner is better than a great deal with a good partner" (FOX Member)
 
4. Families are showing flexibility around control; minority stakes are increasingly common

While some families remain focused on control deals, there is growing comfort with minority investments. Especially if a deal is in a favored sector and comes from a trusted source, families are open to flexible structures and don’t need to be in the driver’s seat all the time.

 

5. Personal networks are the primary sources of deals for most families

Families typically shy away from auction processes, and they place a lot of importance on proprietary deal flow. As a result, they increasingly look to leverage their personal networks for deal flow versus relying on traditional deal sources, like investment banks and professional advisors.

"I once took 400 hours to get to know 2 families. It took a lot of time and effort, and travel on my part, but there's no other way." (FOX Member)
 
6. Families are gravitating towards deals that are uniquely suited for private capital

In screening deals, families typically apply multiple filters. If a deal is in a favored sector and if it comes from a trusted source, it’s likely to stand out in the sea of business plans that are flooding family offices. Another filter that can be equally important is the situational dynamics behind the deal. Unlike a traditional private equity fund, families can leverage a long-term investment horizon and stay committed to a company until a strategic vision is fully realized.

 

7. Families appreciate that there are practical challenges associated with partnership

Because relationships are extremely important, and it takes time and effort to build quality ones, it can be challenging to move forward on a deal that does not come from a trusted source. Given the many new entrants in the direct investing space, there is a perception that best practices are not being universally applied and better provisions for minority rights need to be incorporated into legal documents.

"If something happens to the lead investor, I want to have a say over who replaces them on the Board. I saw a family get burned by this once, and I'm not finding that enough families are focused on this issue." (FOX Member)
 
8. Building and managing a high-quality pipeline is the top challenge

Although rising valuations in the market are a source of concern for many families, it does not appear to be significantly impacting the pace of investment activity. Finding quality deals and prioritizing which deals to spend time on is of greater concern for most families.

 

9. Families are focused on building strong relationships with management teams and finding ways to support them as value-added partners

Several FOX members have noted that the real work begins once the investment is made. This is typically true irrespective of the actual ownership position taken. Even families that take a more passive role want access to key decision makers and the ability to influence them. Given their background as owner-operators, families are uniquely suited to advise management teams and add value to invested companies.

"If you need to rely on your contractual rights to influence a management team, you are doing something wrong. The first step is to build trust, and some quick, easy wins are critical." (FOX Member)
 
10. Families offer unique advantages as investors in private businesses

Families are well positioned to support invested companies as current (or former) owner-operators themselves. But they are being sought out as buyers of private business for reasons that go beyond industry expertise and operating skill. They also offer capital that’s both patient and flexible, and this is very appealing to business owners that take a long-term view on their companies.

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For more on direct investing, download the complete article, Appeal of Direct Investing.