In recent years the search for returns in a low-rate environment has driven most investors to look for returns in higher-risk instruments.
This can be mainly seen in the growth of portfolio allocation in private equity funds that is estimated by various sources to account for around 20% of total wealth, up from a negligible amount only 10 years ago. More recently a large number of HNWI has decided to take a closer look at direct private investments. In the ten years until 2018, family offices have grown from 1,000 to approximately 10,000 according to an EY report, providing professional expertise for a more sophisticated capital allocation strategy.
Direct investing in businesses for HNWIs and their family offices is about more than saving management fees and retaining full returns. It seems to be significantly related also to personal elements such as taking a direct presence in a venture, providing direct expertise in specific industrial fields, nurturing an entrepreneur-to-entrepreneur dialogue with the target’s owners. Indeed, a growing number of HNWIs today are families who, in the booming M&A environment experienced in recent years, have sold their historical businesses, so bringing a more entrepreneurial mindset than a pure financial investor.
For these reasons, direct investment has taken a different path from traditional private equity investment, providing mainly long-term patient capital alongside existing entrepreneurs who typically keep control of the company. Such new investment flow has been consistently growing so that minority investments as a whole (either by private equity funds or family offices) is estimated to have increased in the last decade from around 15% to a stunning 30% of total M&A flows according to a BCG study.
Such proposition can often be a highly interesting one also for target companies and their entrepreneurs. It provides a like-minded industrial attitude in discussing the company’s projects, it brings on-the-field experience from the investor’s successful track record, it often allows existing owners to maintain control, it may provide a longer-term horizon and more flexible exit agreements.
However, financial investment into someone else’s business has different features and complexities from running a company directly.
Professional experience is key to maximise successful outcomes from the investment and avoid the minefield of unclear governance and unsatisfactory results. Too often, in a typical minority long-term investment, after the initial enthusiasm to share objectives and put experiences together, the nitty-gritty phase of defining shareholders’ agreements, financial returns, management compensation and so on may turn into missed opportunities or, worse, unsuccessful partnerships.
A co-investment between HNWI and professional private equity houses, that are also increasing their appetite for differentiating longer-term minority investments, is sometimes a winning proposition for both parties and for the target company.
As the private capital trend seems to consolidate, it will be interesting to see how the current uncertainty of the Covid-19 emergency can affect the willingness of HNWIs to make direct investments.
On one side, an increasing risk perception might reduce allocation in higher-risk instruments but on the other side, as most HNWIs are or were entrepreneurs, who better than them can understand and support business challenges in a changing environment? Moreover, capability to have a long-term view to follow the recovery cycle will be an even more relevant feature in the new scenario.
So, it is likely that demand for direct investments will become even stronger from companies; on the other side, HNWI allocation strategy may change in the short-term if HNWIs reduce their appetite for risk while becoming more and more strictly complementary to private equity strategies.
by Andrea Cacciapaglia
Managing Director, Investment Banking | UBI Banca