Family offices increasingly investing in private company deals

A version of this article first appeared in CNBC’s Inside Wealth newsletter with Robert Frank, a weekly guide to the high-net-worth investor and consumer. Sign up to receive future editions, straight to your inbox.

Family offices are increasingly bypassing private equity funds and buying stakes in private companies directly, according to a new survey.

Half of family offices plan to do “direct deals” — or invest in a private company without a private equity fund — over the next two years, according to a family office survey from Bastiat Partners and Kharis Capital.

As they grow in size and sophistication, family offices are becoming more confident about finding and negotiating their own private equity deals. Since family offices — the in-house investment and service firms of high-net-worth families — are typically founded by entrepreneurs who started their own companies, they often like to invest in similar private companies and leverage their expertise.

More than half (52%) of family offices surveyed prefer doing direct deals through syndicates, where other investors take the lead, “reflecting a cautious approach and reliance on the expertise of established sponsors,” according to the report.

“Family offices are being gradually recognized as an economic powerhouse in private markets,” according to the report.

The big challenge for family offices as they do more direct deals is so-called “deal flow,” or the volume of possible deals. Since most deals are either unattractive or not suitable, family offices may see 10 deals or more for every one that works, according to the report.

At the same time, family offices fiercely protect their privacy and prefer to remain largely unknown to the public. Without a public profile, they aren’t likely to be included in deal offerings or banker calls and miss out on potential investments. Fully 20% of family offices surveyed cited “quality deal flow” as a primary concern.

One solution, according to the report, is for family offices to start developing more public profiles and network with each other more to attract deal flow. According to the survey, 60% view networking with other family offices as “important,” and 74% are “eager for more introductions.”

The other challenge for family offices doing direct deals is due diligence, according to family office experts. When a private equity fund or company invests in a private company, they often have teams of bankers or in-house experts able to dissect a company’s financials and its prospects. Family offices typically lack the infrastructure for rigorous due diligence and risk buying into troubled companies.

To formalize their deal process, more family offices are creating boards of directors and investment committees. According to the survey, 54% of North American family offices have established investment committees to help vet investments.

When it comes to their preferred private investments, they like to venture “off the beaten path,” focusing on niche and emerging asset classes. Family offices, for instance, are increasingly investing in real estate tax liens, fertility clinics, sale-leasebacks of real estate, whiskey aging and litigation financing.

“These approaches provide family offices with access to private investments that offer attractive returns, cash yields and low correlation to traditional markets,” according to the report.