Family office perspective: a new breed of PE emerges

This second instalment of our two-part feature looks at family office demands when it comes to private equity, and their current approach to deal-doing. Read the first part here.

One key draw for traditional private equity will always be expertise. However, this particular edge is increasingly already found within family offices. "The sophistication of family offices has improved because a lot of offices have invested heavily in building up capability, mainly recruiting out of investment banks. Many family offices are now equipped to undertake the investments themselves, rather than through third-party managers. This is combined with a resistance to being tied with a fund for the long term and paying fees when they feel they are capable of doing the job themselves," says Nick Warr, head of private wealth at law firm Taylor Wessing.

The Rampart Capital team feel confident in doing private equity themselves: "For one of the private equity-style deals we are doing at the moment, we have set up an oil operating company with a view to buying up distressed oil assets. We have hired ex-Glencore people to manage the operating company – they are going out and buying assets globally," says Tim Rigby, director of Rampart.

By working in partnership with family offices, deal-by-deal managers can leverage their client's expertise when it comes to investing and can often access their networks to find interesting dealflow. "Traditional funds are normally receiving institutional money, but that is not very helpful in finding off-market dealflow. Whereas family office dealflow is more relevant as first-generation family offices are still active entrepreneurs," says Talis Capital's Matus Maar.

This approach also addresses family offices' desire to be more involved in the investment process. "Investment decisions on Roycian deals are ultimately in the hands of my investors; they pick and choose which deals they invest into. Of course, I help by informing and advising but I don't make the ultimate investment decision," says Del Huse, founder of deal-by-deal manager Roycian.

The lady doth protest too much
When combining all these factors – family offices' increasing demand for direct deal exposure and the emergence of new players acting on this appetite – the increase in competition for private equity funds seems clear. However, many of these independent managers assert this is not the case. "I am not really competing with mainstream private equity," says Huse. "Some of Roycian's dealflow is proprietary and might be considered ‘mainstream', but a lot of it are deals where mainstream private equity does not suit the business or the situation."

Huse highlights how his transactions differ to those of traditional players: he says some of his deals are quicker than the norm (having completed an MBO deal recently in just 17 days); Roycian has done management buy-ins (now less popular with the industry); large minority deals; deals requiring longer-term hold periods; and situations where the vendor simply does not want to deal with typical private equity funds. "For certain deals, the rate-of-return profile on offer is too low to generate a typical private equity-type IRR, but is still at a level where cash-generative companies can provide high double-digit cash yields for my investors, which is appealing to certain of my private investors in a low-yield economy."

If not competing with private equity, which as an industry prides itself on sourcing quality deals and is frequently looking off-market to do this, where are independent managers finding transactions? Huse counts three main sources of dealflow. "The first is intelligence from corporate finance intermediaries on deals, such as a ‘private' private equity deal, where, for example, the vendor does not want any information leaked to the wider market. The second is referrals from private equity firms themselves, where a particular deal does not fit their criteria, say, because of its size. Third is somewhat esoteric or ‘miscellaneous', for example, deal introductions from management executives in my network, or, increasingly, the Roycian investor base itself is becoming a source of deals."

Vasile Foca, managing director of Talis, also prefers off-market deals: "We do not really compete with private equity – we do not go into auction processes. Instead, we prefer to work off-market with managers or selling shareholders."

Threat level
Taking this all into account, should the private equity industry feel threatened by this new breed of deal brokers? James Goold, a private equity partner at Taylor Wessing, believes traditional players still have a key advantage: "In the current environment, speed is everything. The major disadvantage of deal-by-deal comes where uncommitted capital is used to fund the deal and a mini-fundraising exercise has to take place. That time-lag and lack of funding certainty this brings can work against a deal-by-deal bidder in a competitive situation – if the seller becomes aware of it, that is. This issue is less prominent in off-market situations where this strategy is more doable."

Sourcing quality dealflow appears as though it will be the main competition arena for private equity and deal-by-deal managers. But another, less obvious, battleground is emerging – human capital. For established private equity firms, experienced team members with healthy track records are looking to take advantage of the new playing field. "The timing is ripe for spin-outs," says Warren Hibbert, managing partner at Asante. "We've seen a few come out in the past 12 months. They need to test the market without raising a formal fund, so receiving backing from high-net-worth individuals, family offices and sovereign wealth funds on a deal-by-deal basis is a good way to test the water."

Indeed, of the new players detailed in this article alone, the majority have come from well-known private equity firms. Del Huse was most recently at Oakley Capital, having joined from Endless, and Vasile Foca of Talis Capital hails from Electra Private Equity. There are many more: Chrystal Capital was set up by James Innes, previously at LivingBridge; Codex Capital Partners' founder David Currie worked at Investec; Ashridge Capital's founder David Sherratt was previously at Kaupthing Capital Partners; True Capital's founder Matt Truman has worked at Deloitte and JP Morgan; while Connection Capital's Claire Madden was previously with 3i.

There will, of course, always be a place for traditional private equity investing on behalf of institutions. But that job is increasingly reserved for large-cap managers able to take on the large cheques that pension funds want to deploy.

But when it comes to the mid-market, it is all to play for and there are lots of new, smart, rich kids in town who want to play. For traditional mid-market private equity firms, one of the best ways to keep ahead of the new competition is to increase fund sizes to secure continued institutional investment, while being mindful of the rising number of institutions moving into direct investing themselves. The other key to success for those with family office LPs is to work with them on a more personal level – talking to them, looking after them and understanding their needs. If neither of these are possible, vanilla mid-cap firms had better start speaking to recruitment agents, because their team members may well be thinking about joining the new kids' gang.

 

Flexible and opportunistic

Perhaps the key advantage of the deal-by-deal strategy is better flexibility and a more opportunistic approach to investing. The way in which independent managers have evolved neatly highlights this. Vasile Foca, managing director of Talis Capital explains: "Talis has evolved over the past six years. When we set up in 2009, deals were in our comfort zone: commodities-related, agriculture and oil and gas - these were things we understood. Then the idea evolved further and we started looking at software-as-a-service (SaaS). The first SaaS portfolio company was added in 2012. We did more research into SaaS, as well as e-commerce and digital ventures, and identified new areas in the digital market. Now our strategy is more focused on cyber security, fintech, e-commerce support services and business intelligence sold as SaaS. A few other areas are evolving too - shipping for instance, where we saw a dip in that market and wanted to take advantage of it."

Tim Rigby, a director at Rampart Capital, agrees: "It's about being unconstrained. We do not have an asset allocation model, instead we look at every opportunity on a case-by-case-basis. We do not need to hold X amount of each asset type. By having rigid asset allocations, you end up investing in things you should not invest in. We do not do that. And, we are happy to have big positions if it is the right thing to do."

This flexible and more creative approach means these new players can offer services that traditional players are unable to. "Our flexibility also allows us to do what private equity and venture capital cannot," explains Matus Maar, co-founder of Talis. "When we look at tech start-ups, for example, we see ourselves as a hybrid between private equity and VC - we create a platform and then can consider bigger ticket companies to add to that platform. VCs do not have that firepower and private equity does not have platform capacity," he says.

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