Why Are Family Offices Engaging More in Direct Investment?
Businesses that are seeking financial support to grow or restructure are facing real challenges at the moment; a combination of Brexit uncertainty and turbulent economic markets has meant financial institutions have become increasingly risk averse, pulling back from investing where they might previously have done so.
According to Ian Borman, partner at Winston & Strawn this has meant that, for businesses that aren’t well-known or well-placed, or perhaps under significant stress, securing finance has become more challenging than ever.
Below Ian discusses with Finance Monthly the growth in family offices that have been resorting more and more to direct investment, touching on the complexities surrounding direct investment but also the social and ethical benefits smaller businesses can gain.
Direct investment by individuals and family offices is far from a new concept. Decades ago, my grandfather, a solicitor in the North of England, managed a portfolio of small loans to local businesses for a widow. But in the past several years, the needs of private businesses for capital and of family offices for returns have combined to accelerate this area of the finance market.
Historically, this activity has been focused on the SME sector, which itself has played a larger and more significant role in economic growth than one might think. For instance, in the UK small and medium-sized enterprises account for 99.3% of all private sector businesses and employ approximately 16.3 million people. In 2018, UK SMEs delivered a combined annual turnover of £2 trillion, accounting for 52% of all private sector turnover. Many SMEs are conservatively run, with low leverage.
This powerful economic engine is now at risk of stalling; government figures estimate that the number of SMEs in the UK fell by 27,000 between 2017 and 2018. Slowing growth, combined with the implications of the pound’s uncertain strength, are forcing many SMEs to restructure or invest in improved efficiency. In an earlier day, banks provided a ready source of capital to meet these and other needs, but many traditional financial institutions are still facing capital pressures and have withdrawn from large parts of this sector of the market, especially early stage businesses and turnarounds. Institutional investors, for their part, inevitably end up focusing on larger opportunities.
In an earlier day, banks provided a ready source of capital to meet these and other needs, but many traditional financial institutions are still facing capital pressures and have withdrawn from large parts of this sector of the market, especially early stage businesses and turnarounds.
Meanwhile, family offices have been facing their own challenges. Traditional family office investment strategies focused on public bond and equity markets, and to a lesser extent on hedge funds and real estate. However, these investments no longer provide the returns they once did. In the search for higher yield, more and more family offices are thus looking toward the opportunities presented by direct investment.
Indeed, some family offices have taken to the private market with considerable enthusiasm. Because they are independent and less heavily regulated than banks, family offices can be much more flexible in their consideration of investments across enterprise size, geographies and asset classes. As they move toward more direct forms of investment, some family offices are focusing on sectors such as financial technology, or strategies like turnaround. Those offices are increasing their ability to evaluate and manage targeted investments by hiring specialists from banks and private equity firms.
In some cases, family offices are clubbing together, either in an ongoing arrangement or on a deal-by-deal basis, to create a critical mass of investment capital to justify employing a team of people and to provide discipline in the investment decision-making process. (This professionalism in managing SME investments can be seen in other sectors in which family offices have increased their presence, such as investments in sports clubs and oversight of other family assets, such as yachts, aircraft and art.) Family offices are also reviewing and evaluating their organisation, governance structures and support for family members to ensure that offices can successfully navigate the complexities attached to investing directly in specialist markets.
The attraction of direct investment to family offices comes from more than just an alignment of capital. Making direct investments also allows family offices to take the hands-on approach they increasingly favor in selecting and managing their portfolios. This hands-on approach allows family offices to more closely align their investment decisions with the values of the families they represent, making investments in the sustainability space and impact investing particularly attractive. Direct investment also gives family offices the opportunity to leverage their network and expertise to support regional growth.
Family offices have made a serious commitment to direct investments, allowing them to invest in an innovative, creative, and socially conscious way and providing welcome news for the SME sector and the wider economy.