Private equity firms have long been sources of investment for startup companies and organizations seeking to scale their operations. However, another investor — the family office — is growing increasingly present in the business landscape.
Family offices typically accumulate large amounts of capital, especially if they’ve been running strong for several generations. They use that capital to buy other organizations and assets in hopes of preserving their wealth over the decades to come.
Family office investments have different objectives, making it challenging to outline their goals in a one-size-fits-all template. Some may seek to purchase smaller organizations within their industry sector, while others want to expand to additional markets.
The growth of family offices in the investment sector is significant. They’re competitive and often use similar tools to identify suitable investments as private equity and investment firms do.
However, family office investing doesn’t come without challenges, and they often have objectives different from a private equity firm or institutional investor. The differences can be advantageous to startups and smaller organizations that can benefit from family office guidance.
Let’s examine a few family office investment characteristics, differences, and objectives in contrast to their private equity peers.
Most family investors aim to multiply their wealth for future generations, often holding investments for the long term. They don’t purchase small companies with the idea of swooping in, making a few changes, and selling them at a profit. They form partnerships with promising organizations to nourish future growth.
Targeted organizations may welcome investments from a family office that wants to stay on board as a partner. They’ll benefit from the monetary inflow of a family office and guidance that the investor can provide. In addition, they won’t need to worry about the family office making immediate drastic changes to the company’s business model.
Usually, the family office is content to learn the organization’s operational strategy and make suggestions for improvement. As the relationship develops between the company and the family office, they’ll take actions that benefit both organizations.
Family offices are careful with existing customer and vendor relationships. They don’t want to run off long-standing clients with significant shifts in products and services. They’re willing to endure a few years of less-than-stellar performance in exchange for returns in future decades.
Another common component of family office investments is their preference for environmental, social, and governance (ESG) friendly assets, particularly when younger generations select the organizations they want to invest in.
Companies that work toward a better future by supporting environmental or social initiatives, like slowing down climate change, are favored.
However, not all family offices possess the same values. Other family offices may actively invest in companies that aren’t ESG-friendly because they don’t agree with the policies or anticipate more substantial returns from non-ESG organizations.
One problem that arises in family office investments is a lack of similar values. Like all families, not every member will share the same opinion. Problems occur when most of the family office has a specific belief and one or two members differ. Usually, the majority wins, even if the decision isn’t optimal for the family office.
Sometimes, family offices buy smaller organizations or companies ripe for investment to provide family members a means of succession. This is especially true for family offices with several insiders critical to the organization’s success.
Only one person can take the top role when it becomes time for the family office CEO to retire, so they purchase other companies for dedicated family members to run.
In other cases, a new investment is an educational opportunity for younger family members. A small organization of fewer than 10 or 15 employees can be ideal for a young family member in the early stages of their career. They’ll learn to manage a team and develop customer, vendor, and employee relationships.
Typically, the stakes aren’t as high for a small family investment, so minor mistakes won’t be as costly as those in a larger company.
Sometimes, the goal isn’t to prepare family members for executive positions. Instead, family members with a strong eye for numbers and performance can act as the company’s investment portfolio leaders. They’re the ones who narrow down investment opportunities and make the final decisions.
A cohesive family investment unit that shares the same goals can strengthen the family office.
Private equity funds often follow similar incentive structures. They’ll make a majority investment in a company and whisk out the existing executives in favor of a new team that shares their vision for the organization’s future. The new management team will make all-encompassing changes to the company, ideally improving its valuation.
In exchange for their allegiance to the private equity firm’s goals, the executives will receive carried interest or incentive shares that financially benefit them if they’re successful.
Since most private equity firms only hold their investments for several years, a significant gain in the company’s value can be very lucrative to executives in just a short period.
In contrast, the long-term nature of a family office’s investment usually doesn’t carry the same incentive structure. Instead, the family realizes the financial benefits of their investment as the company scales.
It may take several decades to realize returns. In the meantime, the family office may be subject to more risk and growing pains until the fledgling investment becomes profitable.
The final difference between private equity and family office investors is their transparency. Private equity firms often follow playbooks they’ve spent years developing. Strategies are strikingly similar among private equity firms, although they may invest in different industry sectors or markets.
In contrast, most family offices maintain confidentiality in how they select their investments. Objectives differ tremendously from one family office to another, so it’s not easy to compare strategies among family offices.
Family offices that build their wealth over several decades look to preserve it for future generations. They typically have a longer-term horizon than private equity firms, choosing opportunities for future growth rather than quick returns.
As family offices generate more capital, we’ll see them play a more significant role in the investment community.
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