While many of our competitors in the private equity world are funded predominantly by institutional capital (pension funds, insurance companies, sovereign wealth funds, public retirement funds, endowments), all of CapitalWorks’ funding is from successful families. This has been our heritage and our unique niche in the private equity world since 1999.
Families have different objectives and distinct preferences
We believe that families have different investment objectives and distinctive preferences. Over the last 15 years, we have tried to articulate those preferences at every CapitalWorks Annual Meeting:
- Patient and discerning capital
- Seeking transparency about investment process
- And focused on after-tax returns (tax efficiencies)
- Willing to collaborate for investment advantage
- And share insights and networks
Family offices want to invest directly
We are also noticing a new trend among family offices. Increasingly, they want to invest directly and control privately held businesses within industries where the family has special expertise or interest. Our investment banking friends from Robert W. Baird, KeyBanc Capital Markets, Lincoln Partners and Western Reserve Partners, confirm the emergence of the family office as a credible bidder in many of their recent sale processes.
Because the family office is bidding directly and is not burdened by management fees or carried interests to private equity sponsors, they are conceptually able to pay a higher price and still net the same return as limited partners in a fee paying fund. However, concept and reality have not meshed in recent sale processes and few family offices have been willing to pay the high price to become the successful bidder.
Advantages for families in M&A
The family office or family capital pool has several other advantages in the M&A process versus private equity:
- Hold time — there is no fund life for family funds
- Capital structure — flexibility to over equitize/leverage is less important
- Tax efficiency — after tax returns are key
- Continuity — management teams can see a long runway
- Cash flow — can run businesses for free cash flow; no need to sell business to capture returns
Family offices partial to Midwest manufacturers
With families growing ever more sophisticated, it’s no surprise we’ve seen an uptick in family investment in our sphere of Midwestern industrial companies:
In November 2013, Stephens Private Equity, a Little Rock based family run fund, completed the acquisition of Eiko, an environmentally friendly lighting distributor. This past April, the Pritzker Group acquired Technimark, an innovative packaging company. In June, TASI Holdings, a worldwide diagnostics company, was acquired by Berwind. Additionally, family offices such as Bratenahl Capital Partners are more active than ever in searching for new opportunities. These acquisitions underscore the growing interest in direct investment.
Family funds enjoy cyclical and tax advantages
The family investment vehicle also has a cyclical advantage. Much like Warren Buffett and Berkshire Hathaway have become the preferred provider of public company capital in periods of Illiquidity (2000-2003 and 2008-2010), these families likely emerge as preferred partners when private equity firms are sidelined due to lack of access to senior and mezzanine leverage.
Family groups with liquidity should be able to capture bargains in these periods of limited third party funding.
Finally, family funds offer significant generational tax planning and “dynasty” advantages on account of the flexibility to hold a good asset in perpetuity, especially a business that can generate tax favored cash flows.
Where families might suffer disadvantages in direct investment
However, there are several downsides to families going direct. The most daunting is infrastructure. To replicate the investment, marketing, due diligence, transactional and governance capabilities of private equity sponsors is challenging and expensive.
Also talented private equity professionals may not find the captive family office culture as appealing as the more independent and opportunistic private firms. Compensation of talented staff through tax advantaged “carried interests” may be more difficult because many families want to hold, not exit.
Finally, deal flow to private equity sponsors from investment bankers, especially proprietary opportunities, often emerge from a quid pro quo system of “paybacks” for private equity awarding lucrative sell side investment banking assignments. The family investment vehicle is less likely to have this kind of transactional leverage.
Still, families are a force
One thing is sure, the family investment vehicle, whether a dedicated fund or an opportunistic pool, is emerging as a significant participant in the M&A and capital formation process.
Your insights are welcome
Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.
Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemails, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.