Family Offices Team Up Taking Page From Private Equity

Katie Kalvoda’s interest was piqued when the 40-year-old money manager for a group of ultra-wealthy families heard about a startup urban farm that grows produce in vertical greenhouses.

Kalvoda knew early-stage investments in private companies can be risky. She eventually took a stake in the venture this year with some reassurance. The chief investment officer at Newport Wealth Management in Newport Beach, California, joined a handful of fellow family offices in an alliance that gave them more muscle to get a better price, expanded access to research and broader expertise to track the investment.

“We don’t have this wall of secrecy that we had at one time,” said Kalvoda, who previously worked at fund-of-hedge-funds Collins Associates Inc. and Citigroup Inc. “We’re a block of investors working together with more scale.”

The deal illustrates a recent trend among family offices, the little-known money managers that run the fortunes of the world’s richest individuals including computer maker Michael Dell and Microsoft Corp. co-founder Bill Gates, to team up with likeminded peers for direct investments in companies. They’re trading in some of their traditional secrecy, pooling assets and knowledge to make venture capital and private-equity deals much like buyout firms do in so-called club deals, while circumventing the fees charged by those firms.

Sometimes, the companies they back are local business seeking to make a difference in the community, other times they’re purely financial investments.

High Fees

It’s a departure from how family offices traditionally invested outside the public markets, which was by committing capital to intermediary fund managers who picked the opportunities, set the terms of a purchase or sale and oversaw the progress. Such third-party firms usually charge management fees of 1.5 percent to 2 percent, keep 20 percent of profits and require lockups of committed money for as long as 10 years.

“This is a relatively new phenomenon,” Raffi Amit, a professor of entrepreneurship at the University of Pennsylvania, said of families that collaborate in direct deals. “The jury is still out on whether this will lead to higher returns on investment capital.”

Single-family offices hold about $1.2 trillion in assets and multi-family ones manage about $500 billion, according to Bob Casey, senior managing director for research at consulting firm Family Wealth Alliance.

Big Enough

Many made their money by building their own businesses and are big enough to operate like a pension fund or endowment, with a staff to pick investments. Family offices also typically provide additional services including accounting, estate planning and concierge products.

There’s little data available yet on the investment returns of these collaborative deals by family offices, said Amit, who is chairman of the university’s Wharton Global Family Alliance, which researches family-wealth management. Families usually don’t publicize their stakes or performance.

According to a 2012 Wharton study of about 100 single-family offices, about 16 percent said they had 10-year returns, net of taxes and fees, of more than 10 percent annually. About 18 percent of respondents had returns between 7 percent and 9 percent. Among the group surveyed, 42 percent didn’t answer questions about their performance, the data showed. The Standard & Poor’s 500 Index of stocks gained 2.9 percent annually while the Barclays U.S. Aggregate bond index saw annualized returns of 5.8 percent.

Extra Value

The appeal of investing together or forming a partnership to take a stake is that fees are lower and families can better understand the business they invest in, Casey of the Family Wealth Alliance said. Family offices involved will divide the due diligence by interest and expertise to increase efficiency and maximize their resources.

“Since the financial crisis there’s been a question about whether the value-add from an intermediary fund is worth the cost,” said Ashby Monk, executive director of the Global Projects Center at Stanford University, which studies the movement of financial assets globally. “For these big families there was this perception that they were often getting screwed by Wall Street.”

Kalvoda, whose firm serves as the investment office for a group of related family members, can rattle off the details of the San Diego farming company including how its vertical-greenhouse technology isn’t dependent on soil, how it offers Californians local food they love like cilantro, and how it creates jobs in the community and benefits the environment.

Background Check

For this investment, two family offices analyzed the marketplace and the business model, while a third office determined the fair value of the company. Kalvoda’s firm did a background check on the start-up’s managers even though some of families knew the entrepreneurs personally, she said. Kalvoda declined to name the startup or her co-investors. The families she invests with usually have at least $500 million in assets, she said.

Ward McNally, whose family founded mapmaker Rand McNally, has been advising family offices on joint investments as managing partner of Chicago-based McNally Capital, which serves as a merchant bank to family offices. One of the biggest challenges is reviewing enough deals to find an attractive one, said McNally, whose firm in 2010 helped 12 family offices create an alliance called the Cleantech Syndicate with $1.2 billion to invest in clean-energy companies.

Added Staff

About 22 percent of family offices had three or more people in their office tasked with the sourcing, screening, monitoring and exiting of direct investments in 2010, according to a survey by McNally’s firm. That percentage has almost doubled as of this year to 37 percent, said McNally.

Even with added staff dedicated to direct deals, families are finding alliances valuable -- especially to locate investments globally. SandAire, a multi-family office that manages about 1.9 billion pounds ($3.2 billion), formed the Wigmore Association with other family offices in 2011 to share research. The seven members are based in the U.S., Brazil, Germany, Canada, Australia and the United Kingdom.

Some Wigmore members joined last year on two deals in private companies in the U.S. and U.K. investing more than $20 million combined. Due diligence was first done by the family based in the region of the investment opportunity and then each member interested does follow-up research themselves, said Marc Hendriks, chief investment officer at London-based SandAire. The investments are in early-stage businesses in the technology industry or startups based on a new patents, said Hendriks, who declined to give the companies’ names.

Leader Appointed

“We are strong believers in investing in pre-IPO companies,” said Hendriks, who was previously chief economist at firms including Societe Generale and Swiss Bank Corp.

The challenges of direct deals don’t end with due diligence, said Stephen McCarthy, who helps manage his family’s investments as senior vice president of New York-based KCG Capital Advisors. Families also must come up with a plan for management post-investing and appoint a leader because many of the investments may not see profits or an initial public offering for years.

Families participating in direct investments generally haven’t abandoned funds altogether. They usually allocate 12 percent to 14 percent of their portfolio to them, according to data compiled by the Family Office Exchange, a network of private families with an average of $450 million in investable assets. They also have 10 percent to 12 percent of their assets in private equity funds and the same proportion in real estate.

Separate Entity

Kalvoda said families should consider setting up a separate entity for these co-investments as she did to make sure their entire family offices aren’t forced to register as investment advisers and therefore reveal financial details. The registration requirement stems from the Dodd-Frank Act of 2010 and exempts family offices that are owned and controlled by family members, don’t advertise or provide investment advice to nonfamily investors.

The added effort to do direct investments is worth it because of the ability to create scale and tap into each other’s expertise, Kalvoda said.

“With like-minded and friendly investors along for the ride, you can leverage each other’s strengths,” she said. “When it comes to negotiating, you ultimately carry a bigger stick.”

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