Family offices don't just invest in private equity - the very structures used in this asset class are being adopted by FOs themselves as complexity makes older models less appealing.
(Editor’s note: An earlier version of this feature was published yesterday on WealthBriefing, sister news service to this one. To register for the Highworth database, see here.)
Family offices have become keener on private capital markets recently. Enthusiasm for private equity, debt, real estate and other non-public asset class areas has even prompted a few red warning lights to flash.
Whatever the outlook for private equity and similar assets might be, it seems that there is a clear trend of family offices' own structures resembling those of private equity firms; they are also forming their own PE units to handle private equity investments.
The fact that family offices are keen on private capital markets means that FOs are taking on the shape of the organisations they invest in, Alastair Graham, who founded Highworth, the family office database with which this publication is exclusive media partner, said recently.
“If a family office wishes to co-invest with other family offices, it might want to take the role of a general partner which manages limited partnerships on behalf of the co-investors,” he said.
“Private equity and real estate investment are asset classes which have become increasingly popular among family offices in recent years. Illiquid investments such as these may typically be held in closed end structures which will often mean that a limited partnership is the family office’s preferred corporate status,” he said.
Private equity is certainly influencing investors in several ways. It is a favoured asset class for 81 per cent of the SFOs on the Highworth Database and has enjoyed the most rapid growth in recent years, both directly and through funds. Highworth carries profiles of up to 1,100 SFOs, of which 800 are in Europe, the Middle East and Africa. In 2020 several hundreds of further profiles of SFOs are scheduled to be added to the database. The firm reckons that in aggregate, these SFOs oversee a total of $2.2 trillion in assets under management. (It should also be noted that this is the aggregate AuM in 2019 of 1,100 SFOs located outside the US. If there are about 8,000 SFOs globally at present, on a simple extrapolation basis, the total indicative AuM would be $17.6 trillion.)
There is certainly evidence that family offices create subsidiaries or associate firms focused specifically on private equity and venture capital.
Graham gives examples such as that of the Mulliez family of France which invests in PE not through its family office, Mobilis, but through Creadev SAS which has invested €1 billion in private equity and venture capital since its establishment. The firm is driven by an evergreen fund which has an annual investment capacity of €200 million ($224.8 million). Creadev SAS is a société par actions simplifié, a structure often used by families because of its relative simplicity compared with a socIété anonyme.
On a yet larger scale, another family of retailing billionaires, the Brenninkmeijers, the wealthiest family in The Netherlands and owners of the C&A chain, invest in private equity not through the family office, Cofra Holding AG in Switzerland, but through Bregal Investments LLP and its six Bregal associate companies, based variously in London or New York.
Another Dutch family, the De Rijckes, who made its €2 billion fortune in drugstores, choose to invest in private equity and VC not through its family office, De Hoge Dennen Holding BV, but through De Hoge Dennen Capital PE BV, while its real estate investments are made though De Hoge Dennen Vastgoed.
“The practice of managing large scale private equity investments in corporate structures separate from the family office is also evident in Asia. Although Fung Investment Management, the family office of the Fung brothers of Hong Kong, does undertake some PE investments itself, more commonly a separate vehicle, Fung Capital Asia Investments, is the more ambitious player in the PE market. Fung Investments’ AuM is in the range $1 billion to $2.5 billion, with alternatives comprising a significant portion of this," Graham said.
A close fit
To some extent the limited partnership structure – also used in hedge funds of some kinds – is a natural fit when some of the newer family offices are run by people who have made their fortunes in these sectors. And in the US there has been a trend of investment firms, mostly famously that of hedge fund tycoon George Soros, morphing into family offices. They have done this to avoid falling under the regulatory umbrella in the US by ceasing to manage non-family members’ money.
In the US, practitioners tell this publication that a private equity, limited partnership structure has been the default option for some time, because it made more sense to be set up that way rather than as a corporation, given that for years the US corporate tax rate had been significantly higher than in most other major industrialised nations (35 per cent or higher, depending on how it was calculated).
However, when the Trump administration cut the corporate rate to 21 per cent, it prompted some speculation that a few of the very larger SFOs might adopt a form of corporate status for tax purposes. As far as this publication knows, that does not appear to have happened to a great extent yet.
Single family offices aren’t typically run to make a profit beyond financing necessary spending to keep the structure viable. The situation can become complicated when taxes are involved. Following a recent US court ruling (Lender Management v. Comm. (December 16, 2017), investors may no longer be able deduct investment expenses, including those passed through from an investment partnership. As a result, it might be wise to restructure these costs into a management company as long as it is a genuine family office with substantial staff rendering financial services to extended family members and outside clients. (Source: Forbes, June 28, 2018)
When family offices arose, as they first did in the late 19th century in the US (the Rockefellers and others) the structure tended to be that of the trust, given that trusts were already well established in English Common Law.
“Trusts continue to be popular, but the family office space is not a `one size fits all’ market. A variety of different legal forms are required to meet the evolving needs of family offices. Limited partnerships are very well suited to co-investment vehicles in which fund manager, family offices and institutional investors may be investing alongside each other,” Joe Truelove, director - fund administration, Trident Fund Services (Guernsey), told this publication.
As family offices have become larger, with more individuals involved in running and benefiting from the process, private equity structures, and the notion of being a limited partner having certain rights, and some limitations too, have tended to become more popular, he said.
“A reason for the rise in these PE-type structures is that many family offices have grown and now employ people with a private equity background, so they are familiar with how PE structures work. And as family offices often invest in private equity, this also reinforces the bond with the idea,” Truelove said.
With a private equity fund, the general partner will be paid a management fee and if performance is worthy then they also receive a carried interest fee (described as a performance fee in the hedge fund world) - this incentivisation scheme can also be provided to professional managers employed within family offices to manage their affairs, he continued.
Complexity can also push the PE-structure trend. Truelove argued that in the case of families containing a large number of siblings and cousins, for example, it is easier to make them all limited partners because this can also limit potential conflicts over time.
“Our private client colleagues regularly come across opportunities where private client introducers such as multi-family offices come close to running collective investment schemes, sometimes unintentionally – for example they are in a position to arrange deals with multiple unrelated investors co-investing and hence they may need to have those structures formally regulated or manage them in such a way that they would be if they were regulated,” he said.
Meanwhile, there is also continued use by families of protected cell companies, Truelove said. PCCs, likened to the structure of a tree trunk, are a single legal entity made of a core and several “cells” with separate assets and liabilities. A single legal entity that operates segregated accounts, or cells, each of which is legally protected from the liabilities of the company’s other accounts.
It may also be the case that the private equity industry, being more used to increasingly sophisticated ways of charging a fee, appeal to family offices. This is particularly the case as investment activity resembles that of a fund. A family’s investment portfolio may be pooled in several partnerships, such organised by an asset class category or a line of a family. Another benefit of using this structure, practitioners say, is that it aligns the interests of the non-family members with those of the family when it comes to creating incentives to boost returns.