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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: Bloomberg Professional
- Sprache: Englisch
The practical guide to direct investing strategies and best practices The Complete Direct Investing Handbook provides comprehensive guidelines, principles and practical perspectives on this increasingly attractive private equity investment strategy. Interviews with leading family office investors, qualified private equity buyers, and top direct investing advisors provide essential insights, and attention to the nuanced processes of direct investing. The books is a hands-on resource for family offices and those investors interested in generating returns through private company ownership to be more effective in creating returns in a complex market. Direct investing best practices are explored in-depth, with guidance on strategy and the evaluation and assessment of various investment opportunities. The process begins with a codified and specific investment goal, and a robust strategy tailored to the investor's individual needs. Useful insight on 'narrowing the field' helps investors select the appropriate opportunities to meet their investment goals, and practical tools help streamline the process of capital deployment and in turn providing more opportunities to achieve desired returns. Despite the growing interest in direct investing, there is little public information available to investors and there is a lack of transparency into practical standards. This book bridges the gap between strategy and execution, with comprehensive guidance and real-world insights. * Define and craft a focused investment thesis and appropriate timeline specific to your needs * Identify the right type, size, duration, and risk profile aligned to your investment objectives * Gain perspective on real-world direct investing and a deeper understanding of the risks and rewards * Better understand best practices and institutional investment rigor to develop bespoke processes and policies that create better outcomes for independent investors Historically, extraordinary wealth has been created through equity in privately-held enterprise. Today, family offices and direct investors are looking more and more toward large capital deployment in early-stage and growth-oriented private equity investments, but are constrained by a lack of informed, established practices. The Complete Direct Investing Handbook provides the much-needed guidance and tools that can improve direct investment outcomes.
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Seitenzahl: 561
Veröffentlichungsjahr: 2017
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Table of Contents
Cover
Title Page
Foreword
Preface
Acknowledgments
Part I: Direct Investing and the Family Office Test
Chapter 1: Introduction to Direct Investing
2008: A Wakeup Call for Investors
Role of the Family Office and Private Investors
The Opportunity
Best Practices
Key Considerations
Conclusion
Notes
Chapter 2: The Emerging Presence of Private Capital in Direct Investing
The Family Office Marketplace
The Unique Benefits of Private Capital
Increased Interest in Private Equity
Conclusion
Chapter 3: Co-Investment Strategies in Direct Investing
Defining Co-Investing and Providing Context
Insights on the Popularity of Co-Investing
Interest in Co-Investment Strategies
Roles of the Co-Investor
Going Solo: Why Co-Investing May Not Be Your Choice
The Perils and Pearls of Co-Investing
Vetting Co-Investors
Club Deals
Mini Case Study
Conclusion
Notes
Chapter 4: Private Equity Strategies: Characteristics and Implications
What Is Private Equity?
Real Estate
Venture Capital
Growth Capital
Buyouts
Mezzanine Financing
Distressed Assets
Conclusion: Putting It All Together
Notes
Part II: Direct Investing in Action
Chapter 5: Family Office Considerations to the Direct Investment Process
Source of Wealth: Lens of the Family Office
SWOT Analysis for Direct Investing
Three Phases to the Direct Investing Process
A Three-Phase Direct Investing Process
Case Study
Conclusion
Notes
Chapter 6: Designing a Direct Investment Thesis
Defining the Direct Investment Thesis
Asset Mix and the Direct Investment Thesis
Family Pathways and the Direct Investment Thesis
The Barbell Approach and the Direct Investment Thesis
Entrepreneurial Orientation and the Direct Investment Thesis
Family Investment Style and the Direct Investment Thesis
Case Study
Conclusion
Notes
Chapter 7: Sourcing, Deal Flow, Screening, and Deploying Direct Investments
Industry Professionals and Thought Leaders
Investment Bankers/Business Brokers
Professional Service Providers
Commercial Banks
Private Equity Funds/Family Offices
Screening Process
Due Diligence
Investment Memorandum
Investment Decision Process
Conclusion
Notes
Chapter 8: Direct Investments: Deal Structures, Terms, and Portfolio Construction
How to Get Started
Portfolio Construction
The Capital Stack
Equity Transactions
Types of Debt Instruments
Mezzanine Debt
Case Study: Early-Stage Solar Energy Finance Company
A Primer on Important Term Sheet Items
Conclusion
Chapter 9: Investment Monitoring, Exit Strategies, and Harvesting Returns
Introduction
Alignment of Objectives
Monitoring Direct Investments as a Minority Stake Owner
Why Timing of an Investment Exit and Not Just the Investment Return Is Critical
Importance of Company Lifecycles with Respect to Timing and Harvesting Returns
Exit Valuations and Multiples
Maximizing Liquidity of Illiquid Investments through Pre-Negotiated Rights
Exit Value Drivers
Common Exit Strategies
Mergers and Acquisitions
Working with Investment Bankers and Key Advisors to the Exit Strategy
Conclusion
Notes
Part III: Direct Investing Perspectives
Chapter 10: The CIO Perspective
Sourcing Top CIOs to Oversee Direct Investing in the SFO
What's the Edge?
What Defines Success for the CIO?
The CIO Fit
Risk Management at the Investment Level and Portfolio Level
CIO Compensation
Conclusion
Chapter 11: The Millennials and Direct Investing: A Look at Impact Investing
Who Are the Millennials and What Do They Care About?
Millennials' Respect for the Senior Generation
Growing Interest in Impact Investing
Making the Case for Impact Investing
How to Source Impact Investments
Experiential Returns: Intangible Benefits of Impact Investing
Common Challenges and Barriers to Impact Investing
Systems Thinking: Creating and Sustaining Family Knowledge
Conclusion
Notes
Chapter 12: SCIE: Sustainable Cycle of Investing Engagement
The Purpose of SCIE
The SCIE Framework
Family Purpose, Values, and Mission
Framing Strategy
Developing Strategy
Implementing Strategy
Capture and Communicate Learning
Conclusion
Notes
Chapter 13: International Direct Investing
Why Consider International Direct Investing?
Key Differences between Investing Abroad versus Investing in the United States
How to Determine Where to Invest
How Population Change Can Impact Target Market Opportunities
Keys to Success in International Direct Investing
The Role of a Partner in International Investing
Common Mistakes Made by Investors Venturing Abroad
Risk Mitigation
Foreign Families in the United States
Conclusion
Notes
Appendix A: Private Equity Strategies Summary
Appendix B: Sample Due Diligence Checklist
Appendix C: Glossary
About the Author
About the Chapter Authors
Index
End User License Agreement
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Guide
Cover
Table of Contents
Begin Reading
List of Illustrations
Chapter 1
Figure 1.1 Wealth-X's World Map of Wealth
Chapter 2
Figure 2.1 Equity Check Size and Direct Deal Team Size Indicated by Family Office Members
Figure 2.2 Industry Preferences of Family Offices Active in Direct Investing
Figure 2.3 Preferred Role in a Direct Investment Transaction
Figure 2.4 20-Year Hold vs. 5-Year Fund Recapitalizations
Figure 2.5 20-Year Hold vs. 7-Year Fund Recapitalizations
Chapter 3
Figure 3.1 Sponsor vs. Minority Co-Investment Strategies
Figure 3.2 Seeking a Control Position
Figure 3.3 Importance of Aligning Managers' and Investors' Interests
Chapter 4
Figure 4.1 Private Equity Strategies across the Business Lifecycle
Figure 4.2 Number of Private Equity Funds and Corresponding Capital Raised by Strategy, Q2 2016
Figure 4.3 Illustrative Risk-Return Profiles by Private Equity Strategy
Figure 4.4 Real Estate Investing Continuum
Figure 4.5 Venture Capital Cycle
Figure 4.6 Venture Capital Industry Mix, by Number of Deals
Figure 4.7 Relative Valuations Based on Expected Multiples
Figure 4.8 $10mm Infusion by Private Equity Strategy
Figure 4.9 Typical Capital Stack
Figure 4.10 Illustrative Targeting of Distressed Debt Investment
Chapter 5
Figure 5.1 SWOT Analysis Template for Reviewing a Direct Investment
Figure 5.2 EY Direct Investment Process
Figure 5.3 Direct Investment Process
Figure 5.4 Opportunity Funnel and Yield
Figure 5.5 Annual Deployment to Direct Investments
Figure 5.6 Opportunity Tracking Spreadsheet
Figure 5.7 Sample Due Diligence Tracking Spreadsheet
Chapter 6
Figure 6.1 Sample Conservative Portfolio Allocations
Figure 6.2 Sample Moderate Portfolio Allocations
Figure 6.3 Sample Aggressive Growth Portfolio Allocations
Figure 6.4 Four Pathways of Enterprising Families
Figure 6.5 Barbell Approach
Figure 6.6 Barbell Approach to Family Office Direct Investing
Figure 6.7 Risk Appetite Based on Ownership of Operating Business
Figure 6.8 Share of Family Net Worth Managed by Family Office
Figure 6.9 Formality of Decision-Making Process
Figure 6.10 Family Office Investment Models
Figure 6.11 Winchester Portfolio Allocation
Chapter 7
Figure 7.1 Web of Direct Investment Deal Flow Relationships
Figure 7.2 Family Office Direct Investment Deal Sources
Figure 7.3 Sourcing through the Closing Process
Figure 7.4 Sample Prescreening Memo, p. 1
Figure 7.4 Sample Prescreening Memo, p. 2
Chapter 8
Figure 8.1 Capital Stack Structure
Figure 8.2 Early Stage Energy Deal Summary
Chapter 9
Figure 9.1 Five-Year Return Calculations
Figure 9.2 Six- and Ten-Year Return Calculations
Figure 9.3 Company Lifecycle
Figure 9.4 Multiples by Industry, 2015
Figure 9.5 Direct Correlation between Enterprise Value and Exit Multiples
Figure 9.6 Add-ons as a Percent of Buyouts
Chapter 11
Figure 11.1 Scenario Analysis
Figure 11.2 System Design Example of a Family's Engaged Members and Knowledge Creation Stocks
Chapter 12
Figure 12.1 SCIE Framework
Figure 12.2 The Five Phases of the Design Thinking Process Guide Cycle
Chapter 13
Figure 13.1 International Opportunity Filter
Figure 13.2 Opportunity Set for Direct Investing Abroad
Figure 13.3 Future Population Growth
Figure 13.4 Elements of Successful International Direct Investing
Figure 13.5 Perfect Storm for International Direct Investing Success
Figure 13.6 Elements of a Great International Partner
Figure 13.7 Common Mistakes
Figure 13.8 Key Controls and Governance Issues
List of Tables
Chapter 2
Table 2.1 Family Office Exchange Benchmarking Surveys of Family Offices
Table 2.2 Active Investors with 20 percent or more in Private Equity
Table 2.3 Supplemental Exhibit: Institutional vs. Family Capital
Chapter 6
Table 6.1 Family Ownership
Table 6.2 Assumptions and Considerations for Investment Thesis to Direct Investments in Private Equity
Table 6.3 Winchester Direct Investment Data Points
Chapter 9
Table 9.1 Sample Value Drivers
Chapter 11
Table 11.1 Categories Table for Impact Investments
Appendix A
Appendix A.1 Private Equity Strategies Summary 1 of 3
Appendix A.2 Private Equity Strategies Summary 2 of 3
Appendix A.3 Private Equity Strategies Summary 3 of 3
ADDITIONAL PRAISE FOR THE COMPLETE DIRECT INVESTING HANDBOOK
Dr. Kirby Rosplock has created an indispensable resource for family offices seeking to invest in private equity. She explains how to analyze winners and avoid the pitfalls, and discusses the extensive due diligence required even after initial investment. This is the conclusive guide to direct investing, which provides investors with the information necessary to ascertain how to proceed. Rosplock has written the essential manual for what will be a major investment trend for family offices in the years to come.
Howard Cooper, CEO, Cooper Family Office
Once again Dr. Rosplock gets it right! In my experience, few have the insider's knowledge that comes shining through in this book. Not only was it helpful, it was a pleasure to read.
Wendy L Craft, COO, Favara, LLC (SFO), New York, NYC
Kirby Rosplock's The Complete Direct Investing Handbook is a must read for anyone interested in direct investing. With key insights reinforced by practical case studies from noted experts in the field, this is an essential guide for current and potential direct investors.
Joanne Pace, Former Managing Director and Chief Operating Officer, Morgan Stanley Investment Management
The world's best and brightest family offices are devoting ever more capital to direct investing. Now is the critical time for advisors, CIOs, and family members to share a common understanding on how to source, screen, diligence, structure, monitor, and harvest direct investments. Dr. Rosplock's handbook provides the roadmap.
Brian Smiga, Partner & Co-founder, Alpha Venture Partners
The Bloomberg Financial Series provides both core reference knowledge and actionable information for financial professionals. The books are written by experts familiar with the work flows, challenges, and demands of investment professionals who trade the markets, manage money, and analyze investments in their capacity of growing and protecting wealth, hedging risk, and generating revenue.
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THE COMPLETE DIRECT INVESTING HANDBOOK
A Guide for Family Offices, Qualified Purchasers, and Accredited Investors
Kirby Rosplock, PhD
Copyright © 2017 by Kirby Rosplock. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750–8400, fax (978) 646–8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748–6011, fax (201) 748–6008, or online at http://www.wiley.com/go/permissions.
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ISBN 9781119094739 (ePDF)
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This book is dedicated to the memory of my father, Thomas L. Harbeck, who inspired me to dream big and to lean into new endeavors with a passion to first ask, learn, and seek knowledge before jumping off the deep end. His keen business sensibilities and wise counsel will always be treasured and appear throughout this book.
Foreword
Family offices are in the business of exploring the investment landscape for new and creative ways to enhance returns and diversify from traditional models of investing. I have spent the better portion of my career looking at investments through both an institutional as well as a private investor's lens. The array of investment possibilities within the privately held marketplace is vast and growing, affording the burgeoning family office arena significant possibilities for investment. I see this as the new frontier of investing, and where some of the most exciting opportunities will be unearthed.
Dr. Rosplock's book, The Complete Direct Investing Handbook, provides a valuable and practical framework for approaching the direct investing landscape that appeal to both the neophyte and the most seasoned investor. It imparts not only her wealth of knowledge, but the insights and experiences of some of the private investment industry's most successful and respected leaders. The book includes valuable case studies, research, and practical tools and metrics to apply to this facet of investing. To date, there have been limited resources beyond the MBA textbooks to delve into this nuanced topic, but finally we have a playbook.
Interest in direct investing over the last decade has caught the attention of accredited investors, angels, and family offices. Yet Dr. Rosplock puts great emphasis on the fact that this specialized type of investing may not be suitable for every family office or accredited investor. She provides sage advice throughout the handbook on the importance of proper sourcing, vetting, due diligence, analysis, and structuring before deploying capital. Investing in private companies carries with it the seeds for outsized returns, but also the corollary risks. It should not be undertaken without a full understanding of the implications of those factors for the total portfolio.
Current research indicates that, despite the enhanced return potential in the private investment arena, the failure rate will still exceed the success rate for all but the most skillful investor. There has no doubt been a sea change in the investment world over the last 40 years, and the pace seems to be accelerating. As an active investor in both the private and public markets, I have found particular appeal in the nonpublic sector because of the ability to participate in a variety of investment vehicles. The bespoke nature of private investing requires creativity and investment savvy on the part of either the lead investor or the banking firm, and when done well it has the ability to enhance returns while reducing risk in the admittedly risky world of private investing. Investments can be tailored, with carrots and sticks, to provide incentives for management to reach particular milestones. I have found such instruments to have a beneficial impact on both the investor and the company.
Many family offices are uniquely positioned to take advantage of the opportunity of direct investing because they often have the luxury to be patient investors, something that seems to have fallen by the wayside in the larger world of investing, which has adopted a trader's mentality. Focusing on quarterly investment returns defies the concept of true investing, which is long term in nature. Yet it has become the yardstick imposed on the investing public, particularly since the onslaught of hedge funds. The value of making private investments is embedded in the belief that a good investment idea has merit over a period of years, not months. Many family offices are in a position to take advantage of this sound investment concept because, unlike numerous endowments, foundations, pension plans, and private equity firms, they are generally not hostage to the cash flow and exit requirements of these institutions.
The Complete Direct Investing Handbook is the go-to resource for private equity investors and family offices. It compiles insights from leading minds and provides specific examples and recommendations on best practices. Each of its contributors provides a window into an important element of investing in the nonpublic arena. I would recommend that this book be kept nearby for investment decision-makers in the family office world.
Patricia W. ChadwickPresident, Ravengate Partners LLC
Preface
If you are reading this book, it is likely that you have a curiosity for, or a preexisting interest in, direct investing, or are already a seasoned direct investor. Whichever camp you fall into, I hope this book will expand your view on direct investing and provide insights from leading experts, advisors, and consultants within the direct investing space. More than half of the book consists of original chapters from contributing authors who are leaders in the field of direct investing and/or the family office realm; thus, the book provides a wide array of thinking from the best and brightest. Additionally, the book features anonymous case studies and innovative research from multiple institutions as well as proprietary data from a direct investing survey from Tamarind Partners in 2016.
So, what inspired me to write this book? One of my first positions out of college was working in a small brokerage firm in Milwaukee, Wisconsin, as an analyst helping administer a series of private equity partnerships. I was green in my career; however, I admired the passion and interest by accredited investors to back and invest into various direct deals. I quickly learned how these investors found an affinity to invest in this manner that was typically noncorrelated to public markets. Additionally, these investments provided portfolio diversification, the opportunity for outsized returns, and the ability to access niche, specialized investments not typically offered to the public. A few became winners, others barely broke even, and the majority failed. As my career evolved and I became more involved in the family office domain, I quickly realized how important private capital continued to be in closely held businesses. Some family offices continue to have a large segment of capital committed to operating businesses, and for many the source of wealth was a function of one or more of these positions.
Later in my life, I personally deployed capital into direct deals. Some investments succeeded and some failed. Like many of you, I learned the hard way the importance of sourcing, vetting, and due diligence after investing in what I was told would be a “sure homerun” that ultimately failed. My other co-investors were also confident in what we thought had been sufficient due diligence in the investment and adequate preferences and provisions for the investors. We were completely off-base, and my original investment has yet to return my initial capital. As Oscar Wilde put it, “Experience is simply the name we give our mistakes.”
I relay this quick reference point to provide context that I, too, am still learning, and that even the best and brightest in the direct investment world likely have a similar war story to tell. I know I am not alone or special. After this experience, I decided to look further into the literature on direct investing, and found that most books are texts or casebooks written for MBA programs or focused mainly on venture capital. There are some excellent reads from top business school professors and academics, but few books focus on the narrow domain of direct investing, and none to my knowledge specically look at the subject matter through the unique lens of the family office.
My first book, The Complete Family Office Handbook (Wiley/Bloomberg, 2014), revealed the complex landscape of the family office realm and captured some of the building blocks to starting, operating, and managing a family office. During the data capture for that book, I learned the variety of family office types and diverse approaches to building a family office. Similarly, I discovered with writing and editing this book that there is a wide diversity of approaches to direct investing. There is not a one-size-fits-all approach to family office or to direct investing. Everything has to be tailored to you, and this book provides a foundation for readers to create their own unique approach.
This book is designed to appeal to the novice as well as the expert direct investor, and consequently covers a broad array of content and fictionalized cases. The book is organized into three sections. Part I provides a high-level overview of direct investing and the family office context. Part II discusses the steps and process of deploying capital into direct investments. Part III provides some additional unique perspectives on direct investing. Specifically, Chapter 1 lays a foundation on direct investing in the context of family offices. Chapter 2 discusses the increased presence of private capital into directs. Chapter 3 shares the interest in co-investing and club deals, and, finally, Chapter 4 outlines the various private equity strategies and where direct investing may fit. Chapter 5 is the beginning of Part II and outlines the various steps to execute on a direct investment. Chapter 6 discusses the steps to create a direct investment thesis. Chapter 7 shares the importance of sourcing, deal flow, and screening and deploying capital into direct investments. Chapter 8 elaborates on the deal structures, terms, and portfolio construction. Chapter 9 shares what happens after the capital has been deployed and the investment monitoring, exit strategies, and harvesting of returns. Chapter 10 is the start of Part III and examines the CIO perspective to direct investing. Chapter 11 looks at direct investing with a lens to Millennials' perspective on impact investing. Chapter 12 shares the Sustainable Cycle of Investing Engagement model (SCIE model) as a possible approach. Chapter 13 closes with describing the international approach to direct investing.
Direct investing is not for the faint of heart nor is it for every investor. A quick disclaimer is required to remind readers of the tremendous risks associated with the potential rewards of direct investing. The contributing authors and I are not endorsing that everyone should be direct investors. On the contrary: The reality is very few may want to embrace this approach to investing even if they are technically qualified. There are more losers than winners when investing in this manner, so operating with your eyes wide open to the downside risks of this type of investing is imperative. We hope this book will be a useful resource and guide to aid direct investors as they consider how/whether to deploy private capital into this niche area of private equity.
Acknowledgments
This book took a village to write, and there are many to thank for their involvement. First to the direct investors and advisors who shared their stories—this book is only possible because of your trust. Thank you to my family and especially my husband, John, who provided constant support and encouragement. Thank you to all the contributing authors who shared their experience, wisdom, and technical expertise in their respective chapters.
The contributing authors and I would like to share our appreciation to (in alphabetical order) Abdulwahab Ahmad Al-Nakib, Adam Goodfriend, Align Private Capital, Alex Lamb, Alex Scott, Alexander Monnier, Amy Fulford, Amy Hart Clyne, Andrew Pitcairn, Angelo Robles, Ann Kinkade, Anna Nekoranec, Anna Nichols, Anne Hargrave, Annette Franqui, Barbara Hauser, Barry and Nate Wish, Bengt Niebuhr, Benjamin Kinnard, Benji Griswold, Bill McCalpin, Bill Woodson, Blakely Page, Bob Casey, Bob Gould, Bob Rice, Bobby Stover, Brian Smiga, Bryce Stirton, Carolann Grieve, Caroline Davis, Carolyn Friend and Jamie Weiner, Charlotte Beyer, Chris Battifarano, Chris Cecil, Chris Chandler, Chris Cincera, Christin Cardone McClave, Claude Kurzo, Cynthia Lee, Daniel Goldstein, Darcy Garner, David Barks, David Guin, David Herritt, David McCombie, David Nage, David Shrier, David Wood, Dennis Jaffe, Diane Nakashian, Dianne H. B. Welsh, Dirk Junge, Don Carlson, Donald Sull, Doug Borths, Drew Mendoza, Elizabeth Fennell, Elizabeth Keller, Ellen Perry, Ellen Singer, Eric Knauss, Erwin Latner, Euclid Walker, Falko Paetzold, Family Office Association, Family Office Exchange, Family Wealth Alliance, Fran Lotery, Francois de Visscher, Fredda Herz Brown, George Blurton, Ginny Neal, Grant Kettering, Greg Curtis, Gregory T. Rogers, Gunther Weil, Hirotaka Takeuchi, Howard Cooper, Iñigo Susaeta Córdoba, Ira Perlmuter, Iris Wagner, Ivan Sacks, Jack Reynolds, James Gifford, Jane Flanagan, Jason Brown, Jay Hughes, Jean Brunel, Jeffrey Yin, Jennifer Eaton, Jennifer Kenning, Jesus Casado, Joanne Pace, Joe Calabrese, Joe Lonsdale, John Benevides, John Davis, John Rogers, Jolyne Caruso, Jon Carroll, Jon Van Manaan, Jonathan Lidster, Josh Lerner, Joshua Nacht, Juan Luis Segurado, Juan Meyer, Juan Roure, Judy Green, Julie Alberti, Julie Kerr, Julio Gonzalez, Justice Rines, Justin Zamparelli, Karen Koepp, Karen Neal, Karen Rush, Kathryn McCarthy, Laurent Roux and Lori Zalbowitz, Lee Hausner, Liezel Pritzker, Ligian Ma, Linda Mack, Luke Gilgan, M.J. Rankin, Marcia Nelson, Margret Trilli, Maria Elena Lagomasino, Mark Haynes Daniell, Maya Imberg, Meredith Brown, Michael Balt, Michael Murray, Michael Sallas, Michelle Osry, Mindy Rosenthal, Natasha Pearl, Nate Hamilton, Nava Michael Tsabaris, Nikki Gokey, Noelle Laing, Omar Simmons, Pam Friedlander, Patricia Angus, Patricia Chadwick, Paul Karofsky, Paul McKibben, Peter Brock, Peter Senge, Phil DiComo, Phil Strassler, Phillip Edwards, Preston Root, Preston Tsao, Proteus, Ralph Wyman, Rebecca Gerchenson, Rebecca Henderson, Rebecca Oertell, Regine Clement, Renee Kaswan, Rhona Vogel, Richard Millroy, Rick Cott, Rick Stone, Rino Schena, Robert Blabey, Robert Kaufold, Robert Krugel and Konstantin Braun, Roger King, Ronald Mayers, Sam Altman, Sam Bonsey, Sam Weatherman, Sami Karam, Santiago Ulloa, Sara Hamilton, Sean Davatgar, Sean O'Shea, Smart Energy Capital, Stacy Allred, Steve Campbell, Steven Casey, Steven Hirth, Steven Weinstein, Summerly Horning, Susan Babcock, Susan Remmer Ryzewic, TAG Energy Partners, Ted Staryk, Temple Fennell, The Alberleen Group, Tom Handler, Tom Livergood, Tom Mahoney, Tready Smith, Tula Weis, Victoria Vysotina, Ward McNally, Warner Babcock, Wealth-X, Wendy Craft, Will McEnroe, Will Trout, William Kambas, and Yirhan and Irena Sim.
Thank you to the many additional individuals involved who requested to remain anonymous.
PART IDirect Investing and the Family Office Test
CHAPTER 1Introduction to Direct Investing
Investors have more and more options than ever before for methods to deploy capital in the aim of generating financial returns. Today many family offices, high-net-worth individuals, and institutional private equity investors have amassed wealth through private company ownership.
Many of these successful business-building investors are looking for more avenues to deploy large investments in private equity–oriented investments. Today, for many investors, from early stage angel investors who deploy tens of thousands of dollars through mega funds with billions of dollars under management, the strategy is the same: Invest in the ownership directly of a privately held company or illiquid asset like real estate, and sell your ownership interest for a profit at some point in the future.
Where historically extraordinary wealth has been created through building and owning equity in privately held enterprises, options range from public securities to esoteric hedge fund strategies. Investors can typically access any type of investment that meets their objectives defined in a risk-versus-return profile. As investment risk increases, the opportunity to generate outsized returns also increases. With innumerable choice for investors, from longstanding established asset classes through newly formed financial instruments, there continues to be a sustained interest in a form of investing referred to as direct investing.
Direct investing may be defined as investments that meet the following criteria:
The investor is making the decision to participate in a specific investment that is closely held (not publicly traded).
The investment capital is funded directly by the investor (from a balance sheet under their control).
The investor will own an operating asset through a direct investment that has unique and specific operating requirements.
Investment strategies designed to capture the value created through private company ownership have typically been the domain of private equity (PE) and venture capital (VC) funds. “The MoneyTree™ Report by PricewaterhouseCoopers LLP (PwC) and the National Venture Capital Association (NVCA) based on Data from Thomson Reuters” revealed that “venture capitalists invested $48.3 billion in 4,356 deals in 2014, an increase of 61 percent in dollars and a 4 percent increase in deals over the prior year. In Q4 2014, $14.8 billion went into 1,109 deals.”1 To gain exposure to the outsized returns offered by these funds, family offices and ultra-high-net-worth individuals have invested as limited partners in a blind portfolio of fund investments. These funds, on one hand, may offer exceptional return expectations but also require large capital commitments that are illiquid for the long term with little visibility into the underlying companies for the investor. These funds also charged investors management fees and carried interest. In 2014, there were 33,429 Regulation D offerings reported on Form D filings, accounting for more than $1.3 trillion, with approximately 301,000 investors participating in these offerings.2 To achieve high returns in the PE market as a limited partner, investors must gain access to the top-performing funds that are rarely open to new investors. This leaves family offices struggling to generate returns by investing with mid-tier fund managers, in turn making direct investing into specific deals more and more attractive.
Direct investing is not a strategy that is one-size-fits-all or for that matter appropriate for all investors to consider. At the end of any investment process, investors have an illiquid investment in an operating company and “own” the business, including the operational and execution risk associated that all companies are subject to regardless of size, sector, or stage.
This is, however, an attractive investment strategy for investors who:
Have meaningful capital to deploy relative to the market in which they intend to build a portfolio
Have the ability to sustain significant losses and are allocating a percentage of their overall portfolio that reflects the reality that some of these types of investments do not work out
Are operationally minded and prepared to participate in active company investments as opposed to passive investments
Have a unique advantage as an investor in terms of a track record of success in certain industries or markets, and can be defined as a “value-added investor”
Many investors can generate very attractive returns and outcomes through deploying capital into growth-oriented private companies. One aim of this book is to help investors identify the various approaches for participating in direct investments. There are countless examples of investments in private companies that fail. There are also examples of extraordinary successes although statistically rarer in occurrence. Through the book's research, interviews, and case studies we strive to better understand the dynamics of the direct investment risk/return profile, provide a framework for how to scrutinize opportunities, and feature perspectives from industry experts and showcase some current trends and strategies.
With the growing investment options that are available to investors, direct investing is not just a trend, but historically is a fundamental economic engine for growth, innovation, and monetizing the rewards of entrepreneurship. An important intention of this book is to be a comprehensive resource on the topic of direct investing that is beneficial to the seasoned practitioner and the less experienced investor alike.
2008: A Wakeup Call for Investors
With the contractions on the private equity markets in 2008 came an increased scrutiny by investors into their holdings and an investor mind-shift about public markets. What were some of the lessons learned from one of the most catastrophic market crashes in history? A Wall Street Journal article chronicling the lessons learned post-2008 identifies six key lessons learned: (1) Ignore Wall Street's optimistic projections. (2) People in charge may not know much more than you. (3) Debt is dangerous. (4) We are more risk adverse than we think. (5) Simple is beautiful. (6) Cash isn't trash.3 There are a few more that the private investor and family office gleaned. When it came to investing in PE funds, the crash of 2008 triggered a host of liquidity issues for PE firms as the direct investing marketplace virtually dried up overnight. In particular, limited partners were unable to control the timing of divesting of assets and although many would be inclined to hold, or even reinvest, in an operating company during an economic downturn, they could not drive the timing of an exit as a limited partner in a fund.4 This meant their capital was “benched” or locked up under the provisions of the fund, inhibiting them from exiting and deploying capital at the bottom of the market.
Some of the lessons learned from 2008 highlighted previously, coupled with the frustrations of lockups for funds, certainly contribute to an increased interest by investors to make a direct investment into a privately held operating company or real estate asset where there may be increased control, visibility into company operations, transparency into reporting, and niche, off-market opportunities for growth and appreciation.
Does the current focus and attention by investors on direct investing indicate that this is a new category of investing or a temporary trend? I believe that this is not a trend, but rather that building wealth through business ownership is the most fundamental basis for how great wealth has been amassed throughout modern history. From early industrialists, such as Ford, Du Pont, Getty, Carnegie, Rockefeller, and Firestone, building and investing into operating companies has been the backbone of the U.S. economy. And advancing from the industrial revolution, business owners like Pritzkers, Gates, Jobs, Bezos, Branson, Schultz, and Page still seek new innovations, process, technologies, products, and services that drive economic growth. Great fortunes have been amassed through building and growing business and the wealth realized through owning privately held equity.
Role of the Family Office and Private Investors
The private investor most focused on in this book is the family office. The definition of family office varies widely and often depends on whom you ask; however, the general rule of thumb is that they are entities to manage wealth for multiple generations. Some are more investment focused, while others may be designed to prepare family members to collectively manage, sustain, and grow their wealth. Family offices are the first line of defense to manage the various risks that wealth exposes families to. In addition to offering potentially a wide array of services such as tax, fiduciary, and compliance needs; investment management, risk management, estate planning, and trust administration; philanthropic advisement and financial education programs for family members; and family governance and wealth transfer planning, the family office typically has a higher purpose to create continuity and cohesion for families around their wealth. Those who may be familiar with the concept of the family office may not know how to identify whether it is right for their families or their client families, and those questions are expanded in The Complete Family Office Handbook (Hoboken: Wiley, 2014).
In the United States, the Securities and Exchange Commission has increased oversight of the family office and enacted the Family Office Rule, which defines a single-family office as “any type of qualifying entity that provides investment advice to a single-family including traditional family offices and private trust companies.”5 The definition is still fairly broad, but the reality is regulatory bodies are also closing in on putting more definition around these organizations in order to monitor and track their advisory practices. What does this really mean? The increased scrutiny on Wall Street post-2008 has shredded the proverbial kimono from many family office outfits, requiring them to make a determination of the need to register. Although the exact number of family offices is not known, Family Office Exchange estimates that more than 5,000 families in the United States have family offices, and that there are at least twice that number embedded inside private operating companies.6 This number is an estimate and no grounded research on family office has occurred in earnest due the fact that the definition tends to vary. Consequently, it is difficult to put too much weight on it, but data points on the ultra-affluent are available and Wealth-X studies indicate that there are approximately 211,275 ultra-high-net-worth individuals (UHNWIs) with $30 million or more in net worth.7 (See Figure 1.1.)
Figure 1.1Wealth-X's World Map of Wealth
Source: Wealth-X World Ultra Wealth Report 2015–2016
In the family office market, a notable legacy of wealth has been spawned through entrepreneurship and business ownership. From the inception of wealth to generate significant returns in a privately held company to warrant the setup and creation of a family office to the evolution of the family office and its investments to hold onto or deploy additional capital into privately held investments—the role of the family office can vary dramatically. So what is the appetite of family offices and private investors in the direct investing marketplace? With the increase in the deployment of capital across the investment landscape, research for this book reveals that private investors, family offices, ultra-high-net-worth individuals, and qualified buyers have an increased interest and capacity to make sizeable investments across multiple sectors when it comes to directs. J.P. Morgan and the World Economic Forum in 2016 surveyed 81 families, of which three-quarters had a net worth of at least $1 billion. Collectively this group of family offices represented over $200 billion in global wealth. They learned that we asked how family offices put assets to work; 65 percent noted investing in direct private equity and real estate.8 Yet, the question remains: Is the direct investment space a prudent space to invest?
The direct investment space is not a panacea for all family offices and private investors. It is fraught with pitfalls and unforeseeable risks; yet for many family offices whose time horizons will certainly outlive one or more generation's lifetime, these possible downside risks can be qualified and managed, as these investors have distinct characteristics that broaden the overall opportunity set. For example, family office investors may be able to generate adequate returns to cover lifestyle needs and expenses on more traditional investment strategies that afford them the opportunity to take high risk that can yield high-return capital into direct investments. In other words, they have a much longer-term perspective for an investment than a traditional strategy or fund might have, which allows them to invest at both ends of the spectrum.
Key to this investment model is that the investor will participate as an owner of the investment for the life of the investment. Many times the focus is spent on the upfront activities and little attention is given to the operating needs that will be required for many years. The questions to focus on are:
Why are family offices more focused on direct investing? (The answer to this we discussed earlier.)
What are the opportunities and risks?
What are the key drivers?
The Opportunity
There is no doubt that the intrigue and interest in direct investing is perhaps at an all-time high. In fact, a Forbes article notes that individual private investors and family offices are the “rising power in the private equity,” as private investors and family offices are increasing their commitment to private equity at a time of record low interest rates, attracted by the private equity opportunity for double-digit returns that are not correlated to their public stock portfolio. In fact, Palico research, the online private equity fund marketplace, found in 2012 that family offices “account for 8% of the world's $4 trillion in private equity assets under management. That family office share is double that of just five years ago.”9 Virtually no investment or wealth management conference can refrain from discussing direct investments. The interest for investors, both private and institutional, is top of mind. The direct investment opportunity is attractive for many reasons. First, it may provide uncorrelated returns to traditional public market investments. Second, these investments have the ability to generate vastly larger returns than traditional publicly traded equities or bonds. Third, they tend to align with building and growing one or more businesses, particularly within founder family offices where the source of wealth was a function of starting. Direct investing for entrepreneurially minded investors becomes a logical outlet for deploying capital. And the opportunity of direct investing has several best practices learned and key considerations to assess its viability for each investor.
Best Practices
Over the many years of private investors engaging in direct investing, several best practices and lessons learned have been identified. Family Office Exchange (FOX) has captured their own list of best practices that they have gleaned from the Direct Investing Network (DIN) that they run for their active investor members. First, they found that investors lean to investing in deals where their capital gives them a strategic advantage. Perhaps they have first hand knowledge of a sector from prior business ownership and experience, or geographical or cultural experience, say, investing abroad, or perhaps they have an important peer group of investors or network that can bring a demonstrable edge to the investment. These advantages can be major considerations for where and how to put the family office capital to work.
Second, FOX identifies the importance to stay in “Circles of Competence,” leveraging one's ability to be flexible. In other words, FOX sees a best practice to take advantage of their flexibility. From the check size to the deal size, the investor preference to the time horizon or sector, family offices, unlike PE funds or pension funds, are not governed with the same strict investment mandates. Third, FOX finds that family office investors have to make direct investment strategically and diversify them as their assets deployed in this area scale. FOX finds their family office investors have a strategic rationale for investing in the direct investment, but as the broader wealth of the family expands, so too should the diversity of the direct investment mandate and even the investment size.
Fourth, funds can play an important role particularly where the family office investor does not have expertise or access to market information. Although not all family offices will invest in private equity funds, for segments where due diligence, access to information, or direct experience in the sector is meager, PE funds can be a valuable tool in the investment toolbox. In conjunction with a broader asset allocation, PE funds can play a productive role for some family offices. Sara Hamilton shares, “For example, U.S. families often use funds for exposure to international or emerging market countries. Healthcare, pharma, or high technology sectors, where industry information tends to be highly specialized and barriers to entry are high, are other examples of areas where families emphasize their use of funds (or experienced co-investors). In addition, being an LP in a fund not only can provide you with valuable market information about where companies are transacting, industry trends, and market cycles, but can open up investment opportunities in an industry where relationships and information can be your most important assets.”10
Further, FOX found that family offices should seek strong growth opportunities with high returns to the invested capital by the family office. They provide certain retail chains or franchises as an example of a model with highly positive unit-level economics and marginal returns for each new location opened. Family offices may find these investment opportunities attractive due to their asset intensiveness, stable cash flow, and replicable growth model. Another best practice FOX found is to utilize tax-advantaged structures whenever possible and preferable. Employing top tax counsel, family offices can own assets and manage them in a highly tax-advantaged manner relative to their overall portfolio of assets.
Another best practice FOX revealed is that there is an opportunity to capitalize on the changing demographics of wealth and business ownership. It is well documented that there is a sea change of wealth transitioning from one generation to the next; however, where has the most wealth in recent decades been created? Research from Wealth-X determined that 46 percent of wealth created in the last 20 years came from three primary sectors in the United States: financial services, real estate, and food service. Among these top three industries, 60 percent of business owners are over 65.11 As family firms and business transition, there are great opportunities for direct investors into these domains.
Finally, FOX identifies co-investment with peers and partners with solid domain expertise as a best practice. A means to an end, co-investment is an important outgrowth of the interest in the direct investing space. Nate Hamilton notes, “For some families, it is a way to leverage capital, due diligence, and sourcing capabilities within areas where they already have existing core competencies. However, several of the most sophisticated investors cited co-investment deals as opportunities to partner with families that know more than they do in a particular sector or industry.”12 The FOX report indicates that the industries where families seek to partner with co-investors include healthcare, technology, real estate, and energy. More on co-investment strategies is covered in Chapter 3.
Key Considerations
The best practices from Family Office Exchange highlight some invaluable lessons learned and align with several key considerations gleaned from the research for this book. The following section provides further considerations for deploying capital into directs. Because there is no crystal ball to forecast the future when it comes to directs, it is important for the investor to analyze and form an independent view as to why an investment will perform well before deploying capital. The most successful investors profiled in this book are able to create a tempered view of the potential positive outcomes of an investment and be very disciplined in forming a view as to why an investment will not perform as expected. Assessing, managing, and pricing risk is a daily function for direct investors. To follow are several key considerations for investors considering or deploying capital into direct investments.
Recognize that direct investing is not a cost efficiency for PE fund investments. Making a direct investment outside of a VC or PE fund many times will be costlier to the investor up front. Most independent investors decide between hiring full-time resources internally to lead their investments or hiring outside consultants or experts. Yet the rationale to invest in direct investments in order to reduce fees as justification to invest in this manner is fraught with folly. Chapter 2 explores further the direct investing landscape and specifically the family office's role in this domain. Chapter 3 provides a broader understanding of co-investment strategies and club deals and the strategic opportunities of collaboration with co-investors.
Be a learning investor and look to trusted, strategic advisors and co-investment opportunities for greater intelligence. Another important consideration attractive to certain family offices and private investors is that they often provide a unique insight and operational support for an investment. Following the theme that these investors have created wealth through successfully building companies in the past, direct investors tend to be very operationally minded and active in a portfolio of operating companies. The term value-added investor applies to this approach where successful investors likely have cultivated a network of experts that can bring knowledge, advice, or step into an operating role or that provide a segment of the expertise that gives them deeper insights from operating experience than the lay investor. Many times we talk about the direct investors' “unfair advantage,” or the fact that they have a leg up or superior intelligence of how to navigate a specific sector or strategy. What makes the investors' contribution of capital more attractive to a company or management team is the likelihood that the investors bring industry, market, product, people, investors, or lender relationships that the management team would not have access to on their own. When deployed effectively these value-added characteristics of the direct investor provide for a distinct advantage for a privately held company. Chapter 4 discusses the various private equity strategies and walks through the private equity life cycle.
Have a clear investment process and thesis. Where investors are planning to execute on a handful of deals in any given period, it is recommended for the investor to have a disciplined investment rigor where they seek input from internal and external experts and not bear the investment decision alone. In this situation the upfront work to get into an investment is significant and many times will drive up costs to hire industry experts to assist with due diligence. This is, however, money well spent if part of a process is designed to mitigate risk by picking the right investments, valuing them correctly, structuring the appropriate terms, and backing the right management team. Chapters 5 and 6 introduce the process of direct investing and how to develop an investment thesis.
Bet on the jockey, not the horse. This phrase denotes the importance of valuing the leadership and management above all else when considering any direct investing opportunity. This brings up the final point that the process of direct investing has two sides, the investor and the management team. There is a reason that the private equity market rallies around the cry of “bet the jockey, not the horse”—the “jockey” being management and the “horse” being the business or the sector. The operational risks for these types of investments are a major factor that may lead to a failed investment. But the management team also desires to have a quality investor the same way an investor requires a quality management team. Often the means to deploy capital may not be enough of a strategic advantage. Do their values, ethics, business acumen, leadership style, and experience match their role and the opportunity? There are incredible business opportunities all around us, but they may be all for naught if the key leadership is not the proverbial right jockey for the job. In Chapter 7, the book investigates further sourcing, vetting, and analysis of a direct deal, and the due diligence on the leadership is also a key component of this analysis.
Pay attention to the terms and structure of the deal. No matter how much you may know about the deal and its opportunity, the key terms and structural considerations are where the rubber meets the road. Understanding which provisions are most important to you and why, where you fall in the cap table, and what your upside and downside risks are is critical when it comes to the deal terms and structure. Chapter 8 explores in more detail the “art of the deal” when it comes to structuring, terms, and portfolio construction.
Be prepared that direct investments are operationally intensive. There are a variety of considerations the family office and private investors need to take into account when considering direct investing. The single greatest risk to owning an operating company is execution risk. Execution risk is the risk that a company's business plans and thus the investor's associate capital will not be successful when they are put into action. The dynamic in the direct investing marketplace is one of collaborating with management teams who will be driving the day-to-day management of an operating business. These are investments that ultimately require significant care and feeding and it is very common that investors underestimate the scope of involvement required in making an investment a success. Despite going into an investment with the best intentions, there may be situations where a president or CEO needs to be terminated and, in particular with a smaller company, the investors many times will be the most likely candidate to fill the operational void when a decision like this must be made. Chapter 9 covers the operational oversight considerations, exit strategies, and how best to harvest returns.
Hire slow and fire fast. The difficult truth in the direct investing universe is that bringing on new employees in any business is not a sure thing. Take time to properly vet and conduct due diligence, background checks, and probe deeply into references before moving forward. Consider a first 90-day plan so that new hires are clear about alignment, goals, and metrics for evaluation. Conversely, when problems arise and there is a demonstrated pattern of infractions, do not fool yourself that somehow the employee will be turning over a new leaf. This is not the time to make excuses but rather to gather a plan for consequences and perhaps an exit. Personnel issues in direct investments can make all the difference with achieving intended growth plans. Chapter 10 provides some key insights on this front through the lens of the direct investing CIO.
Direct Investing means different things to different generations. Millennials are keen on direct investing; however, research indicates that theirs goals are not just about profits, but about progress. The desire to leave the world better than what they were born into is a common theme among the Millennial research, and they are finding opportunities through impact or socially responsible investing into directs a means. Chapters 11 and 12 explore the Millennials' role in direct investing, specifically impact investing and the SCIE model as a means to deploy impact-related investments into directs.
Direct investors are thinking globally, not just locally. Direct investing is more commonly done in your “geographical backyard”; however, increasingly investors are exploring more opportunities abroad to take advantage of dislocations in the marketplace. Yet, global direct investors beware—the bounty that exists is often connected to regulatory, cultural, legal, and international business standards unique to each geography. What applies for a direct investment at home likely does not apply when investing in emerging markets. Chapter 13 closes the book with insights, examples, and lessons learned from investing in directs abroad.
Direct Investing is not for everyone. Direct investing can be a roller coaster; from increases in operational intensity and oversight to disappointments with meeting milestones or requirements for additional follow-on capital. Despite writing a book about direct investing, we are keenly aware that direct investing is a niche, not the norm, and certainly not appropriate for most UHNWIs or family offices. Conversely, the majority of family offices should assess several considerations from risk to time horizon, to diversification, to appetite for volatility in a closed environment, to having to step into an active leadership role should the investment veer south. Thus, think long and hard before committing capital to this segment of private equity. A best practice is for family offices to ask the questions, “Does the direct investment strategy complement or play to the family office's strengths?” and “What ultimately are we attempting to achieve and for whose benefit?”
Conclusion
This chapter provides the basic tenets of direct investing, including the definition of direct investing for the purposes of this book and the background of direct investing. This chapter discusses the important wakeup call that 2008 provided and the ramifications it had on the direct investing marketplace. Further, this chapter more broadly defines the primary audience for this book, the family office, and the role of the family office and private investors in direct investing. Finally, the chapter discusses the opportunity direct investing presents and some of the best practices when it comes to deploying capital into direct investments. The chapter closes with some key considerations for deploying capital into direct investments. Now that a foundation for direct investing has been formulated, Chapter 2 will expand on the opportunity, attractiveness, and broader investor considerations for the nuances of direct investing.
Notes
1
