As the private equity industry has grown, so has competition for deals. The number of active PE funds in the U.S. and Europe has risen to roughly 2,000 from around 600 at the turn of the century. But the number of PE firms is only part of the story. Limited partners have begun to recognize the benefits of investing directly in operating companies. Why not cut out the middlemen and reap even bigger rewards?
LPs had a collective “aha” moment around 2013. Direct LP investment volume more than doubled that year from 2012, and deal activity hasn’t come down since. Last year saw a record number of direct deals totaling more than $4 billion in value. Meanwhile, LP co-investments alongside PE firms reached a record 87 transactions last year with $35.7 billion invested—a drop-off from the $110.7 billion in LP co-investments in 2016.
The trend of going direct appears to have staying power, particularly among family offices, whose money operates under different rules than institutional fund capital. Family offices don’t need to worry (as much) about fund economics or return timeframes, since they are their own LPs. They often can move more quickly on deal opportunities than their institutional counterparts, where return assumptions dictate the kinds of offers PE firms can make.
Because family offices don’t need to return capital to outside investors, they can take a longer view of their investments. They often can afford to make higher offers for companies they might own for 10 years or more. Family money can also appeal to sellers who don’t want to be part of a Wall Street portfolio. Family-owned businesses may be open to selling to family offices, which are less likely to demand big changes or cost cuts.
Companies aren’t the only ones warming to family offices—so are investment professionals. Working in private equity can be highly demanding. As family offices become established investment houses, more industry professionals are forwarding their resumes. The perks are tempting: no time on the road fundraising, no capital deployment timelines, no pressure to write big-enough checks, less turnover and less bureaucracy.
Family offices also have drawbacks. Capital calls, and capital availability in general, may be an issue. Their private equity counterparts can produce money at a moment’s notice, and PE fund commitments are considered more secure because they come from a pool of capital raised solely to invest in businesses. PE firms also have demonstrated their ability to scale companies, though family offices may prove adept at that over time.
As family offices attract Wall Street-level talent, they also will grow in stature. In response, the PE industry is recognizing the need to provide long-term capital. A number of PE firms have raised funds with 10-plus-year time horizons. Private equity might lament the added competition from families—and the reduction in fee revenue—but there’s another benefit to be had: more potential buyers when it’s time to sell.
This edition of Midpoints originally appeared in the November/December 2018 issue of Middle Market Growth. Find it in the MMG archive.