In recent years, family offices have increasingly turned to direct investments in private companies, viewing this strategy as a means to achieve superior returns typically associated with private equity. The 2024 Wharton Family Office Survey sheds light on this trend, indicating that direct deals are becoming a prominent component of family office investment portfolios. However, this shift comes with pitfalls that many family offices may not fully comprehend.
Direct investments allow family offices to bypass traditional private equity managers, potentially capitalizing on their extensive entrepreneurial backgrounds and insights derived from running family-owned businesses. Yet, despite the allure of high returns and reduced fees, the survey highlights a concerning lack of preparedness among many family offices when it comes to sourcing and monitoring these investments.
A startling statistic from the Wharton survey reveals that only 50% of family offices engaging in direct investments have private equity professionals on their teams. Those without trained professionals may struggle to identify and structure lucrative investment opportunities effectively. This gap in expertise can lead to missed chances, highlighting a broader issue where many family offices may be venturing into uncharted territory with inadequate support.
Moreover, the survey indicates that just 20% of family offices involved in direct deals take board seats. This lack of active oversight raises questions about their level of engagement with portfolio companies. Without board representation, family offices might find themselves at a disadvantage, with limited insight and influence over pivotal management decisions. Raphael “Raffi” Amit, a professor at The Wharton School, emphasizes the uncertainty of whether the direct investment strategy will yield the expected results, making it crucial for these investors to enhance their diligence and oversight.
Family offices often pride themselves on their capacity for patient capital—holding investments for decades to benefit from the “illiquidity premium.” However, the realities of their direct investment strategies reveal a disconnect. While the majority (60%) maintain that their overall investment horizon exceeds ten years, nearly one-third admitted that their timelines for direct deals are much shorter, between three to five years. This inconsistency may prevent family offices from fully capitalizing on the long-term advantages that direct investments can offer, ultimately undermining the very principle that attracts them to this approach.
Amit’s insights reflect a broader concern that many family offices may not be leveraging their unique advantages effectively. The inclination toward shorter investment horizons indicates a potential misunderstanding of the nature and value of private capital—highlighting a crucial area where family offices can grow.
Strategic Approaches to Deal Sourcing
The avenues through which family offices source direct investment opportunities further complicate the equation. Most family offices rely heavily on their professional networks and family office networks for finding deals, rather than adopting a proactive approach. Coupled with a preference for later-stage investments—specifically, Series B rounds or later—this reliance could limit their exposure to groundbreaking startups and innovative ventures that are in their infancy.
Investing alongside other family offices or ceding control to a private equity firm in syndicate or “club deals” also raises questions about whether these entities are taking full advantage of the potential rewards available through direct investment. This strategy might present a lower-risk alternative, yet it obscures the unique benefits that independent direct investing can provide.
When deciding how to allocate capital, family offices tend to prioritize the quality of the management team over the product itself. A significant 91% of respondents stated that management experience is their primary investment criterion. This focus on the executive team can be a double-edged sword; while strong leadership is essential, it risks overshadowing considerations related to the actual product or service being offered. Such an approach could lead to missed opportunities in emerging markets or disruptive technologies.
As family offices navigate the complex landscape of direct investments, they must acknowledge the inherent risks and challenges associated with this emerging trend. While the potential for higher returns and reduced fees is enticing, the findings from the Wharton survey underscore vital areas for improvement, particularly regarding expertise, oversight, investment timelines, sourcing strategies, and decision-making criteria. By addressing these gaps, family offices can enhance their capabilities and ultimately unlock the true potential of direct investments in private companies, ensuring a more successful investment journey moving forward.