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In this episode, our speakers discuss why a family office can be a compelling alternative to PE investment and reveal what companies should know before engaging with a family office.
Entrepreneurs seeking investment may find a family office (FO) a compelling alternative to private equity (PE).
According to Preqin, family office deals currently represent 2.5% of total M&A deals, a small share but one that has been steadily increasing since the great financial crisis. The Economist estimates family offices manage assets worth an estimated US$4 trillion, with individual offices averaging $500 million to $1 billion in AUM according to Forbes.
Our guest is Katherine Hill Ritchie, Director and Board Member of Nottingham Spirk, a 50-year-old innovation firm with a family office. Katherine has 18 years of finance, investing and family office experience and started her own firm working with family offices and alternative investment funds and companies. Katherine is also an Angel Investor and advisor who supports and invests in female and diverse founded venture capital funds and companies and is on the board of several organizations. She has spoken at over 100 global investment conferences, lectured at universities, and was recently awarded a lifetime achievement award for her family office work.
Eight things companies should know about FOs:
FOs can and do compete with PE for direct investments.
FO fund structure, investment thesis, acquisition requirements, portfolio and shareholder mix are frequently opaque.
FOs have flexibility to change their focus.
FOs are not beholden to a 7-10-year exit timeline.
IPO is not always the exit strategy for a FO.
FOs don’t face the same regulatory requirements as funds.
FOs may or may not care about ESG requirements for their investments.
Companies must build relationships with FOs to ensure alignment of objectives.
For your convenience, full text transcript of this podcast is also available.
Winna Brown
According to Prequin, family office deals currently represent about two and a half percent of global M&A transactions. This is really a small share, one that’s actually been steadily increasing since the financial crisis. The Economist actually estimates that family office managed assets are worth approximately four trillion dollars in aggregate. Individual offices averaging over five hundred million to a billion in AUM, according to Forbes. In this episode, I’m going to speak to Katherine Hill Ritchie. Katherine has eighteen years in finance investing and family office experience, and in fact started her own firm twelve years ago to focus on working in family offices and also alternative investment funds and companies. Today. She’s a director and board member of Nottingham Spirk, a 50-year-old innovation firm and family office. Katherine was also an angel investor and advisor, and she supports, invests in female and diverse venture capital funds, and she’s also on the board of several organizations. She’s spoken at over a hundred global investment conferences, lectured at universities, and is recently awarded a Lifetime Achievement Award for her family office work. In this episode, we’ll explore with Katherine why entrepreneurs may find a family office a more compelling alternative to private equity and reveal a few things that you need to be aware of before engaging the family office.
Brown
So, Katherine, thank you so much for joining us today and congratulations on your Lifetime Achievement Award for family office service, and very excited to have this discussion with you today. So, welcome to the podcast.
Katherine Hill Ritchie
Well, thank you. I’m glad to be here. It’s exciting to speak with you.
Brown
Excellent. So, Katherine, historically we’ve seen that family offices have invested passively in private equity (PE) and have really benefited from the lucrative returns that PE offers. However, more recently, we’re seeing trends that family offices are actually now starting to manage their own investments and they’re investing directly in private companies. So, given this backdrop, to what extent are you seeing family offices compete with private equity deals?
Ritchie
That’s a great question. And you know, it’s so interesting because I’ve been in this industry for 18 years, you know, when I was getting my MBA, interned at Morgan Stanley Private Wealth Management and even back then, early 2000s, we didn’t call people family offices, right? So, and when I started working in the investments world, we had your high-net-worth individuals, and then I started to go to conferences and I worked for family offices that allocated to funds, as you said, and I met a bunch of other family offices who also allocated passively to funds. So, what was interesting is that a lot of those families had already maybe exited from a company, had some kind of large liquidity event or inheritance, and maybe moved to a passive investment strategy.
But as my career has gone on, and especially I noticed after the financial crisis, 2009, 2010, 2011, when communicating to family offices all over the world, you know, I lived in Geneva, I’ve lived in New York, London, there were more families that were not happy about the fund managers’ promise, you know, to protect their capital in down markets. And so a lot of families said, well, wait a minute, you know, I can do this myself. So, a lot of the family offices that I had known that were more passive decided, well, I’m going to get involved myself. And what I learned, which was interesting, which I didn’t know is that there are a lot of family offices that have always invested direct companies. However, they are kind of hidden, because they may own an operating company and have a family office embedded in it and so they don’t have a website, you don’t even realize it, you don’t know that it’s all held by one company, maybe there’s a holding company with a generic name. So, what was fascinating to me is that there have been those kind of family offices all along, but there is a greater movement now to get in directly or do co-investments with each other, with funds, with independent sponsors, but it’s been growing. And, I would say a lot of the families that were interested in investing directly didn’t necessarily use the typical routes. They wouldn’t necessarily work with a banker or a broker. They would do these things quietly. They had their own networks, because if they’ve owned companies in this industry for decades, they may quietly buy or sell companies, and the market might not know about it until after. So only recently have I been aware of bankers actually even coming to me and saying, Katherine, you know, I’ve got a company I’m selling and they actually would prefer to sell to a family office, which I thought that’s kind of interesting. So, there are families who are now competing directly with private equity. Now, some of them are very transparent. You can tell there’s one shareholder, it’s a family office. Then there are others that you got to read between the lines, but their websites, and they may fully appear like a fund, except when you dig in, you’ll find out there aren’t multiple shareholders. And then there are others that are a family that’s maybe anchored the fund and then maybe they’ll take some outside capital. But it’s just so interesting because more and more family offices are competing directly with private equity on deal flow, either going after the companies directly or part of auction processes from banks, just like there are private equity funds that don’t want to participate in the auction process from the investment banks, there are families who don’t want to do that as well, but just like that on the other side, there are family offices who go after those type processes just like a private equity fund would.
Brown
If I think about the sectors where they’re very experienced and have deep knowledge and history, is that one of the reasons potentially that investment bankers are now kind of reaching out and saying, hey, this family office, I know they have this big history in this sector. I think they’d be interested in this asset; is that one of the triggering factors do you think?
Ritchie
Definitely. Because I think if you can see if there are press releases or news about transactions or who owned companies, it makes sense to go back to someone or a family office that has a history of investment in acquisition in that industry, to go back to them again and say, you know, is this something you’d be looking for? And, what’s interesting, though, is that, unlike funds, where you go to their website, they have a stated mandate exactly, you know, what their acquisition requirements are. They might have an EBITDA, an enterprise value target, families may have that, but they also have the prerogative to change their mind. Unlike a PE fund where, you know, it’s written in your offering documents, your subscription documents, your fund is going to invest in X and have specific requirements, which they’re not really allowed to vary from, you know, legally you’ve agreed that’s your strategy. But a family can change their mind. So, the flexibility also sometimes can cause a little bit of confusion, because maybe they decided, you know what, we’ve had enough in this industry, we’re going to redirect our focus and mission on a different industry or different geography. So, keeping in touch with family offices, it’s really more of a relationship because you may find in time that they could change what they’re interested in investing in. With funds, they have a process and they stick to what they do, you know, they’re not allowed to vary from it.
So, it’s a different kind of relationship I think when bankers or companies are looking to be acquired because relationship is really more important in the family office space, where funds, of course they like relationship, too, but they are so specific, you know, you can even send them an email saying the company is XYZ and they’ll say, yes, I want to call, or no because it does or does not fit the requirements, where a family may say, oh well, I’ll consider that, it might be out of my wheelhouse but it could be interesting. So, it’s a different type of relationship you can develop with them.
There’s also a couple other interesting dynamics to discuss here, which are time frame and purpose. So, a lot of private equity funds, you know, have your 7- to 10-year life cycle, they raise money, then they take maybe two years or so, maybe three to find companies, then they may use their operational expertise and, you know, in that five to seven years improve them and try to sell them again, right. And that’s well known. Well, there are families who could acquire a company and hold it for 30 years and never intend to sell because they think, oh, this is a great company that fits in my portfolio, it will have a lot of crossover and synergies with other companies that I own and there could be no intention of selling it, which is a very different kind of proposition for someone who’s selling a company, or maybe even just selling a piece of the company, maybe not selling it 100%. Because you did well, who’s going to be my investor, and what is my purpose, do I care if it’s sold again in five to seven years or does this family portfolio of companies really have great overlap with mine and maybe I don’t mind if they keep it for 20 or 30 years, or maybe I’m just looking for an exit and I want the highest price. So, that’s interesting, too, because what I have seen, I mean, this is anecdotal, but private equity will definitely pay up and pay more, but because they have to allocate, right, so they have to compete and they have to allocate, and there’s pressure. When a family can say, nope, I don’t need to allocate this year at all, I didn’t put any money out, because I only have myself and my family of shareholders. There’s no pressure to allocate. So, in fact, if I don’t like the pricing, I can just bow out if I want and not invest this year. So those are some of the differences to think about when you’re looking to sell to a private equity fund or a family office.
Brown
Okay, so as an owner of a private company, part of it is the time horizon, part of it is the relationship, you know, what am I looking for, can I do business with this, these people or this fund? And then I guess the other side is, what am I looking for in terms of the experience and the value-creation side? You know, do I want to be left alone because I know what, I know what I’m doing and I just want the money, or do I really want someone to be alongside me to help improve the business? And so, really thinking about the criteria of what you’re looking for in a partner will be very helpful to help you think through whether it’s a family office that you’re better suited to or a private equity fund.
Ritchie
You’re right, and some family offices will be more active than others. There are some family offices who just want to acquire and let the business run as is, but then there are others who might be far more involved and have operational expertise and want to reorganize the company like a PE fund. It comes down to really getting to know that family and seeing if there’s a cultural fit, because you want to get to know them and see exactly what they intend to do, because they could be on either end of the spectrum. Where private equity funds, pretty much, you know, a lot of them have the same kind of mandate and purpose, family offices could vary greatly, so you really need to get to know them.
Brown
If we think about family offices and how they source potential deals, and I think of private equity, I mean many private equity firms have a global reach, they either specialize in certain verticals or regions. Does family office focus its investment strategy on a global scale or is it more regionally focused? I mean, how are they structured and how do they think about their investments?
Ritchie
That’s a great question. So, you know, I’ve worked for some US families here in the United States, but I’ve also worked for some international families, and I lived abroad, and also it depends on the history of the family, because if they are maybe from a particular region, you know, like an emerging market, I would say, again this is on average, your average US wealthy family office, unless they have some tie to a particular region, they’re just not going to go start investing in some emerging market unless they have hands on the ground or a particular reason to be there. They’re just not going to do it. The US has got and, well, North America, you know, not just the US, but has an incredibly deep market and incredible opportunities plus, you know, the laws here, bankruptcy and Texas and all of that. So, unless there was an incredibly compelling reason, a lot of them just stick here; or if they want some exposure, maybe then they would go through a fund. But there are family offices who are global and are from various regions of the world. And so, if they have experience there, they speak the language or they have a team there, then they might be much more open to that. But that’s what I’ve seen, which is pretty interesting, even when I lived in Europe, they might just stick to Europe. Maybe they have some exposure to US stocks through a fund or they might have somebody who specifically covers that, but they know their backyard better, but it’s not to say that there are family offices that invest globally. Maybe they are a shipping family. So, they are experts in shipping, so they might invest globally from a shipping point of view, but they’re not going to invest in a third-world company in an industry outside of shipping because they don’t know that industry. So, it’s a little bit different and a lot of it has to do with their roots, or if they’re willing to hire experts or put a team on the ground there and that’s what I’ve seen.
Brown
Excellent. Okay. And so, I mean that also is going to be a really interesting deciding factor when you’re looking for a potential investor, right? I mean, what is the geographical area that they invest in? You know, what is their pattern, etc.? And you know, if you’re a global company or you’re hoping to expand globally, what is that support that you need to align with your future strategy and help you get and achieve your goals. So that is also something to consider when you’re thinking about your future partner, if you will. So, Katherine, what would be your word of advice, I mean, if you were in the shoes of a private company and you were thinking about the next stage of growth and, you know, you’re reading in the headlines all about private equity and you’re reading all about family office, how would you recommend that someone actually sits back and makes this decision and kind of does the analysis? What are the critical factors that will impact the success of their decision?
Ritchie
I mean, that’s a great question because not everything is as it appears on a website. I would say in private equity, it’s probably pretty true; but in a family office, their internal strategy may have changed, maybe they didn’t update it and you may not have heard about all the transactions they’re doing. So, it’s really, really relationships, relationship-based in family office. So, I would say also, it makes sense to talk to everybody, as many groups as you can, and especially when you talk to a family office, talk to them about their process. I mean private equity firms will tell you their process and a lot of times, like I said, it’s quite transparent on their websites, but with the family office you really want to ask them what is your process like? How long do you take to acquire? How long do you keep companies? What is your intention to do with this? But also, the cultural fit. How well will I work with these people? How hands-on are they going to be, because it could vary greatly? And also, they may change their mind, so you may find out six months later that they are no longer going to be interested in acquiring your types of companies or they’re going in a new direction. So, it’s kind of different where, you know, the private equity funds are quite static when they’re working on a particular fund; a family office might change their mind. So, you have to just kind of keep that in the back of your head to keep in touch with them, you know, as often as you can in the process because they could always change their strategy and go in a different direction because they can. They have the, you know, it’s their money, they can do what they want, if they change their mind, they change their mind. So, it makes sense to get to know them and really understand the, you know, kind of internal culture and philosophy and to stay on top of that, because they could very well go in a different direction, and it’s not evident to the public.
Brown
Got it. And one thing I’m curious about, I mean clearly the capital markets are very hot right now. We see really a lot of IPO activities, back activity, etc. Clearly, private equity will oftentimes exit, you know, through the capital markets. Is that a strategy that family offices also follow, or do they tend to stay away from the capital markets?
Ritchie
Well, I think if that makes sense as the best pathway, then they will do it. Then an IPO, it can be an attractive exit. But not always, because as I said, some of these family offices have owned businesses for generations. Because one of the interesting, it’s a nice problem to have, but it is the, okay, we sell a company, now what, we’ve got to find something else to do with the money, means we have to invest in something else. So, it’s all about timing, it’s about purpose, it’s about, you know, the intent, our own taxes. A lot of times, oh my gosh, I don’t want to sell this and pay a bunch of taxes because I don’t need to sell it, going the IPO route is definitely attractive in some instances and some time it could be the best way to go, but it’s not always the most interesting pathway for them in terms of ownership because a lot of these private companies, maybe you sell off a piece of it, maybe you don’t sell off a hundred percent of it. So, they can explore all these avenues and I think it depends a lot on all those things I said: timing, taxes, intent, purpose, generational transition, you know, maybe grandpa needs to retire and granddaughter is going to come in and so, wait a minute, let me shake things up or sell this off and, okay, maybe, you know, doing an IPO would make sense, but so it depends on all of those things.
Brown
Okay, you mentioned a couple of times around purpose, and I’m curious as we work a lot with private equity firms and, you know, businesses globally, purpose, sustainability, transparency; these are all top of mind and it’s a really big focus out there for everyone to think about how they can not only create value financially, but also create nonfinancial value for all stakeholders. And so, I’m curious. I acknowledge that family offices obviously don’t have to answer to LPs (limited partners) and they don’t have to necessarily answer directly to the same stakeholders that private equity or corporations do. Having said that, what are you seeing as a trend around family office and the focus on sustainability and long-term value?
Ritchie
Millennials will inherit, you know, trillions and they are a very large cohort, you know, bigger than my cohort, Gen-Xers, and they have an enormous influence and they look at the world slightly differently than I do or the baby boomers or the silent generation after that. So, what does that mean? So there seems to be a real interest in impact investing. Now, we could have a whole other conversation. I was on a webinar two weeks ago specifically talking about returns and impact investing because it doesn’t necessarily mean concessionary returns, and that’s not what they’re, you know, these millennials, yes, they can be generous philanthropically, but a lot of them still want to make money, too. So, they want to invest in impact investments, ESG (environmental, social and governance) investments, but make money at the same time. They’re not looking to make concessionary returns or give it all away. So, the point I’m trying to make is that that’s an interesting dynamic, because there are grandparents and there are your baby boomers who said, no, you know, I do want to think about the world and think about the impact the companies I invest in make on the planet or people or social justice issues and racial justice issues and dynamics between women’s rights and things like this. There are people who care about that, but then, there aren’t, there are families who don’t care at all. They don’t care. They’re going to invest in whatever they want. They don’t have to answer to anybody. So those families still exist, but there’s an interesting dynamic to see the future inheritors, a lot more of them seem to be interested in impact in ESG-type investments.
Brown
So it comes down to call it who’s inheriting the family office and running with it and what is their purpose and, you know, we’re seeing the generational change come through but notwithstanding that, and that, I guess, that is a, as I said, generational change and focus, but there is no regulatory requirement. No compelling reason that they need to go down this path and embrace sustainability and ESG and DEI (diversity, equity and inclusion), so is it possible that a family office exit or investment is a way for the CEO of a company to avoid the coming regulations that we see on the horizon around these big meta topics, is a family office a way to hide?
Ritchie
If you think about private companies or if it’s something done by a family office, unlike compared to a public company where you’ve got disclosures, you’ve got analysts on Wall Street covering you where they’re digging up everything they can, you’re right, it is a way to hide. But I would say what’s interesting is to see the social pressure from others and I think, I believe the moral obligation, that if you are that wealthy, you can help contribute to the good of the world because you’ve been successful. Why wouldn’t you? But, you know …
Brown
Yeah, I mean, but I hear you, though. There’s no, I agree. What they choose to invest in is their prerogative. They earn the money. They can direct the money in whatever direction they wish to do so. It’s just interesting because there’s the nuance, if you’re private equity, you’ve got LPs, and you’ve got to answer to LPs, and you got to answer to the stakeholders and that pressure is not just a social pressure, but it’s also a financial pressure, right?
Ritchie
Oh, absolutely.
Brown
And so, whereas if I think of a family office, they have the money so they don’t have the LPs, and so they don’t need to worry about that. Having said that, to your point, there’s a mounting social pressure in amongst their peers who have other funds and are doing, you know, great things and from the future generation that’s going to be coming in to take over the family office. So, it’s not the same kind of pressure or, you know, and it’s not regulatory, but it’s coming in a different way.
Ritchie
Something that’s kind of funny, which is, it’s just strange I will say about this, about the family office world is that, you know, it’s very opaque. There are a few that are transparent or in the press or have great websites and baby talk about their holdings, but a lot of them are really private. Certain private equity funds or venture capital funds or hedge funds, you can find out through their filings how much assets they have under management, the companies they own. Well, you can’t do that with a family office and they might have sub-corporations and shell corporations, and all those kinds, you don’t even know, and then there’s some that they aren’t a family office at all. They may be trying to get investment from you or trying to find a job. So, it’s so nuts because people say, oh, I’m the blah, blah, blah family office. Well, how do you prove that? So, a lot of it is from your network. I’ve got friends all over the planet where we will call each other and say, hey, have you heard of this group or do you know them? It’s really odd. It’s very odd for me. And that’s when you have to get to know people to find out, actually, are they real? You can’t take it always for face value, unless it’s a famous last name, a famous person and you know who they are. You’ve got to really take a little bit of time and get to know them and I don’t think that exists in any other industry.
Brown
Yeah, so really, really important, so almost like buyer beware or, you know, private company beware, because the due diligence that you need to do to make sure that they are the family office is the real thing is probably critical and probably a lot more work and effort than going to a private equity fund. But another avenue is the fact that there are now investment bankers that are very well connected to family offices. So, potentially going through that safer route, presumably the bankers have done their due diligence, but that’s a really good point. How do you know? Because it is, it’s not public, so you do need to be very careful on that front. A very good point. Well, Katherine, thank you so much. We really appreciate your time and giving us this insight behind the closed doors of family offices to really understand, you know, the intricacies, right, and the layers that may not be necessarily obvious to the general public. And, you know, this, these are important investment decisions that are being made, so understanding that insight from behind the curtains has been very valuable. So, thank you very much for your time today.
Ritchie
Thank you for having me on. I’m glad to share my experiences with you and I just think it’s a very, very fascinating world.
