The Rise of Direct Investments by Family Offices: Are They Taking on Too Much Risk?
In the ever-evolving world of high-net-worth investment strategies, family offices are stepping into the spotlight by increasing their direct investments in private companies. According to the latest 2024 Wharton Family Office Survey, this burgeoning trend represents a significant shift away from traditional private equity management. However, a deeper examination reveals that many family offices may be venturing into this arena without adequate preparation and risk assessment.
The Allure of Direct Investments
The appeal of direct investments is clear: family offices can potentially enjoy higher returns while avoiding the hefty management fees typically associated with private equity funds. With a legacy rooted in entrepreneurship, many family offices see direct investing as a route to leverage their operational expertise and business acumen grown from years of running successful companies. The Wharton survey indicates that nearly 50% of family offices are planning to make direct investments in the next two years.
However, despite this enthusiasm, only 50% of the surveyed family offices have professional private equity staff on hand to help identify and assess potential investments. This leaves them exposed, lacking the necessary expertise to navigate this complex investment landscape effectively.
A Concerning Trend: Short Time Horizons
Family offices pride themselves on their capability for long-term investments. A majority report a time horizon of over ten years for their overall investment strategies, aiming to capitalize on an "illiquidity premium." Ironically, when it comes to direct investments, one-third of family offices indicated that their investment horizon is just three to five years. This discrepancy suggests that they may not be fully aligning their strategies with the very aspects of private capital that offer them unique advantages.
Furthermore, a mere 16% of family offices are committing for ten years or more on direct deals. As noted by Raphael "Raffi" Amit, a prominent management professor at The Wharton School, this approach raises eyebrows: “They’re not taking advantage of the unique aspect of private capital — the more permanent and flexible nature of it.”
Watch Out: Oversight is Lacking
Monitoring and oversight are crucial, especially when making direct investments. Alarmingly, only 20% of family offices engaged in direct deals are taking a board seat to ensure proper governance and oversight. This lack of involvement might hinder their ability to influence and monitor the companies they invest in, creating potential pitfalls down the road.
Family offices leaning toward syndicated and club deals could dilute their oversight even further by allowing other investment firms to lead. This approach makes these families less influential in shaping the future direction of their investments, stripping them of the very control that they likely sought by investing directly.
Focus on Management: A Double-Edged Sword?
Interestingly, family offices place a premium on the quality of the management team when considering investments. An overwhelming 91% consider management experience and expertise as their primary criteria for investment. While this focus is commendable, relying solely on management without due diligence on the product or market can backfire—especially in a rapidly changing economic landscape.
Concluding Thoughts: The Road Ahead
The trend toward direct investments by family offices is indeed one of the most compelling developments in the investment world, as they seek to tap into the kind of opportunities that can lead to substantial returns. However, as the Wharton survey reveals, the inherent risks—insufficient professional oversight, shortened investment horizons, and a lack of board involvement—may outweigh the benefits of this approach unless family offices adapt and strategize effectively.
At Extreme Investor Network, we encourage family offices and high-net-worth individuals to take a step back, reassess their strategies, and consider a diversified approach that not only embraces direct investments but also leverages the expertise of external professionals and long-term commitment. The true art of investing lies in the balance of risk and opportunity—prioritizing both is key to achieving sustained success in today’s competitive markets.