Investment Strategies

FEATURE: Trends Converge Making Direct Investing More Appealing To The Wealthy

Eliane Chavagnon Editor - Family Wealth Report October 10, 2014

FEATURE: Trends Converge Making Direct Investing More Appealing To The Wealthy

A number of factors are causing more and more wealthy families to embrace direct investing, and many players in the industry are seeking to capitalize on this trend.

The trend of family offices and other accredited investors engaging in the world of direct investing is intensifying: according to a 2012 study by the Wharton Global Family Alliance, average portfolio allocations by single family offices to direct investments rose from 6 per cent in 2009 to 11.4 per cent in 2011.

And in a 2010 survey of 62 families advised by McNally Capital, 83 per cent said they are planning to increase or maintain their direct investments in private firms over the next two years, while 59 per cent said they prefer to invest in direct deals as opposed to more traditional private equity funds.

There are a number of factors driving this phenomenon, one of which relates to the digitization of business development and deal sourcing activities, making private market investments more accessible.

Meanwhile, Mark Selinger of the international law firm McDermott Will & Emery, noted how, because of the financial crisis (and the increased difficulty in raising new or follow-on funds), families have been more successful recruiting top talent away from established funds to run their direct investment activities. At the same time, families are simply seeking greater control over their investments – particularly in light of dissatisfaction with funds due to illiquidity and faltering returns, for example.

Selinger defines direct investing as: “...A family investor, either an individual or more typically a family office or family-controlled investment vehicle, investing directly in a privately-held company.”

He added: “The investment can be in a passive minority share, in common or preferred stock, or in a significant or controlling interest, which typically would be in the form of a highly negotiated preferred stock instrument. This instrument often includes control or veto rights, as well as representation on the company’s board of directors.”

On that note, direct investing is also a way into the impact investing sector, allowing wealthy individuals and families to get involved with a firm whose philosophy they are passionate about, for example.

“This is an area where we're seeing increasing involvement with families, but bringing to that a level of sophistication which makes them much more competitive and able to play in the same arena as the funds,” Selinger, a partner at McDermott in New York, told Family Wealth Report.


McDermott recently expanded its global direct investing practice to capitalize on the growing trend of wealthy families becoming active players in more complex transactional matters.

“They are taking more active and often lead roles in transactional matters, rather than just either investing in funds or being passive investors,” Selinger said. “Families have effectively doubled their allocation to direct investments - in a pretty short time.”

But these transactions require a great deal of legal consideration through each layer of the structure. Such wealth may be of the first or several generations, but its scale, as well as the scale of investing, may require a range of international tax, estate planning and family succession expertise, McDermott said.

The firm's direct investing practice brings together professionals from its corporate, tax and private client practices to provide high net worth clients with legal services as they invest in and operate businesses globally. Matthew Sperry and Matthew McKim were recently recruited to help the firm expand its work with wealthy families in Asia, Europe and Latin America, as well as the financial institutions that cater to such families.

Speaking from his experience working in the private equity field, Selinger noted how, ten years or so ago, wealthy individuals and families – even those with great business success – sometimes lacked the track record or experience to net the best investment opportunities.

Deal execution, deal expertise and deal sourcing are areas where, “if you're serious about direct investing, you'll have to devote some time and resources,” Selinger said. “And that creates a threshold in terms of how big a family is or how much money is going to be allocated because, depending on the asset class, you need a certain amount of money to be able to play.”

Being more discoverable

An example of a firm that is tapping into this trend is Axial, an online network for professionals who operate, advise, finance and acquire private companies. Peter Lehrman, chief executive and founder, recently spoke to this publication about how family offices are increasingly embracing “discoverability” when it comes to sourcing investment opportunities.

Indeed, keeping a low profile has been a challenge for the sector – which is historically very elusive – when looking for greater access to direct investment opportunities.

But the democratization of information on the internet, as well as the emergence of online platforms, is “changing the game for investors and business owners,” Lehrman said previously. “With so much available information out there, getting found is key.”

“Like many investors, the recession reset asset allocation strategy for family offices,” he added. “Disillusionment with public markets and distrust of institutional investors has resulted in many family offices looking for a more transparent and less fee-bloated investment strategy. While family offices have traditionally invested in a variety of private equity funds and other alternative managers – playing the role of limited partner – lately, we’ve seen a shift toward direct investments.”

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