Introduction
Family offices are the biggest chunk of Limited Partners. They are the chief source of financing for multiple Private Equity, Venture Capital, and Real Estate funds apart from other Limited Partners like Insurance Companies, Sovereign Funds, Pension Funds, etc. The trend of Family Office outsourcing their operations’ activities is fast catching up.
Family Offices are now opening to the concept of direct investing and its time for them to be open about the concept of outsourcing too like their General Partners investees
Family Offices and Direct Investments
Private Equity as a new asset class was coming up well and operated under the rules of incentives like 2/20. Simply put it means there would be 2% of management fees of the AUM and 20% would be charged from the profits. Under these arrangements, there was a limited risk for General Partners for the lower than expected returns but had a significant incentive if returns turned out to be positive. This also incentivizes parking money quickly, without proper due diligence as it increases the AUM.
After a cycle of investments, it was evident that the biggest players were investing in hoards in the same assets. Many times it was as simple as investing in companies that everyone else was also investing in. Not only there is an upward risk of diminishing returns, it did not require a huge exercise in due diligence.
Family Offices decided to take away the fun, by just investing in these companies directly rather than parting fixed and variable incentives by involving in a General Partner. With direct investments, Limited Partners still carry the same risk and rewards for the investments but significantly cut the costs of management fees by General Partners. Now Family Offices are increasingly looking to enter into the next wave of investments themselves like evaluating smaller companies. These evaluations so far have been simpler and formulaic, like a given revenue and profitability in specific industries and they will invest. But it’s just a matter of time that Limited Partners acquire experience and expertise in making these decisions and go for the complex deal-making themselves.
Family Office Outsourcing: How Outsourcing aids, the trend of direct investments by family offices
Outsourcing provides analysts on-demand to take care of activities like finding a deal, providing documentation for that, and supporting manager search and finalization. This works better than getting in touch with multiple private placement players, who may have limited options for investment opportunities that emerge from their personal or professional networks only. Outsourcing helps in organically reaching all the targets and managers that qualify for an investment thesis.
Operations’ activities that could be outsourced by Family Offices
Family Office Operations Outsourcing Potential
Almost all the operational aspects of fund management could be successfully outsourced by family offices bringing down the operations cost significantly. It also improves the flexibility related to the investment analysis process. Here are the major activities that a player like Magistral can help a family office outsource:
Direct Investments
Family offices are moving towards direct investments more confidently than ever before. Though it’s still limited to general rules of investing and in industries where the comfort of family office lies. It’s quite common for family offices to be looking for revenue beyond a given threshold, profitable operations, and some years of existence in business. The way Family Offices make these investments are majorly dependent on independent brokers or private placement players bringing in the deal. They will broadcast their requirements and then get in touch with all brokers who could bring in the deal, mostly on variable broker fees arrangement.
A better way of working would be to proactively reach out to the universe in search of the target company. Outsourcing helps here as it could be done at a fraction of the cost that is payable to a broker on a successful deal. It also ensures that a substantial portion of the target universe has been approached, rather than relying on the breadth of a professional and personal network of brokers and private placement players. Players like Magistral offer services of Deal Sourcing that is immensely useful in this situation and brings the business impact at fraction of the cost
Apart from finding out the direct investment targets, Magistral also provides documentation and deal support for the deals. SEC-compliant documents like pitch decks, Confidential Information Memorandum, Financial Model, Valuation, etc. are produced for a deal to get investment approval or finding co-investors.
Manager Research and Due Diligence
For the areas where the family office does not have the expertise, looking for Fund Managers is still the preferred way of investing. Once the investment thesis has been identified, the major chunk of work involves reaching out to the Fund Managers who satisfy the given criteria. Manager Search can be done in the professional network or again through a private placement player or a database, but none of the methods ensure the reach-out to the almost complete universe. Outsourcing helps in reaching out to all the suitors and that too at fraction of the cost. Reaching out to all the suitors ensures that deal is done with the best fund manager out there and that too after negotiating the best arrangement for fixed fees and incentives.
A typical process here requires understanding the requirement of the family office and its investment strategy. It is then proceeded with an exercise of list generation of all the managers who satisfy criteria in terms of AUM, Geographical Focus, Returns Generated in the past, Quality of Management, etc. Once the shortlist of Fund Managers is drawn, a reach out to undertaken to these managers collecting all the fund related documents for an exhaustive due diligence exercise. Documents and data are then analyzed by an experienced analyst to provide an objective opinion on where the Fund Manager stands. Magistral uses a proprietary tool that carries a weighted average of multiple parameters related to Fund performance to recommend a fund that carries the minimum risk for higher returns.
Magistral has analyzed Funds like Hedge Funds, Real Estate, Private Equity, and Venture Capital in the past. A recent analysis of multiple Hedge Funds across the Middle East and China, by Magistral team, led to an investment of $300 million for a client.
Emerging Investment Opportunities
Investment opportunities have grown in numbers apart from each opportunity growing in terms of complexity. For coming up with an investment thesis that ensures consistent high returns, it’s imperative to scan the universe continuously. Today, a host of family offices evaluate multiple industries and investment opportunities to make the strategy for investments. Tracking multiple types of Real Estate, Hedge Funds, Crypto Assets, Sovereign Bonds, Equity, and several other types of investments require analyst capacity. Outsourcing provides that capacity so that there is no opportunity that quickly picks up and misses the attention of the Family Office Manager.
Currently, Magistral tracks all global S&P industries for its clients and provide them with quarterly reports apart from their other areas of interest. We also continuously update the returns potential of each tracked industry and investment opportunity.
Finding Co-investors for an Opportunity
As a Family Office, you have found an opportunity that you are sure will generate superlative returns over a period of time, but it requires a minimum ticket size of say $ 25 million to enter. A stake into VC funds like Softbank of Carlyle might require that kind of a sum to invest. It means a Family office will need to reach out to similar investors to pool the money to enter the investment vehicle.
An outsourcing player like Magistral can facilitate the conversation by reaching out to the right co-investors
Risks involved with Family Office Outsourcing Operations
Family Office Operations Outsourcing Risks and Solutions
Even General Partners like Real Estate, Private Equity, and Venture Capital are still warming to the idea of outsourcing which is typically considered low cost and also low quality. Family Offices will require even more time to get comfortable with the idea. The prime reason for Family Offices not outsourcing is not the lack of quality or that outsourcing does not make business sense. It is the fear of the unknown. They have never tried it and they don’t know what it might bring. Well, it might bring sizeable business benefits. For Family Offices to get over their fear of the unknown, Magistral offers a small pilot of all its services at minimal costs before a larger engagement is discussed. It ensures there are no performance-related risks in operations outsourcing deals. If you are a Family Office and are interested in exploring the idea, please drop an inquiry at here
Apart from a general fear of the unknown, several other reasons stop a Family Office from outsourcing. These are:
Data Security
A Family Office fears that details of a deal might leak outside. This fear stems from a lack of understanding as to how a family office service provider works. An outsourced service provider like Magistral takes all the care related to confidentiality. The work happens in a watertight environment digitally by analysts. No information can leave the systems unless otherwise approved. These cloud-based security tools are quite sophisticated. Apart from this, a workplace that is physically secured is also arranged on the clients’ request. Also, it all becomes safer when understood that an analyst is working only with one client at a time and thus has no incentive to leak any information
Costs
An outsourcing arrangement not only improves the quality and flexibility of operations but also brings with it significant savings in terms of costs. Potentially a 30-70% reduction in cost is a very reasonable expectation.
Quality
Family Offices typically have small teams and thus may not be very comfortable with all the investment avenues available. Outsourcing can provide reinforcements to the existing team in terms of expertise and more hands. Also, investment insights generally lead to better investments and more returns.
Language
All analysts usually have native fluency in English which is good enough to interact with most of the commercial world. If required language expertise can be provided for Spanish, German and Chinese for both spoken and written assignments
Expertise
Expertise is available in specific areas related to fund-raising, fund-strategy, Financial Modeling, Due Diligence, Research, Strategy, Marketing, IT and Portfolio Management is available on demand. The team can be put together quickly as per the needs of a deal and then dismantled once the deal is finalized
About Magistral
Magistral Consulting is a specialized outsourcing player that has helped multiple family offices and limited partners in outsourcing research and operations. For more information check www.magistralconsulting.com
About the Author
The Author, Prabhash Choudhary is the CEO of Magistral Consulting and can be reached at prabhash.choudhary@magistralconsulting.com for any queries on the article or any business inquiry