How Families Can Effectively Harness the Advantages of Their Capital While Avoiding the Pitfalls and Hazards of Direct Investing – By Paul Carbone

This article was originally published in Family Capital on December 14, 2023.

This piece is the third in a three-part series published in Family Capital based on, “The Antidote to Private Equity,” a chapter I wrote for Reshaping Reality: Unlocking the Potential of the Single Family Office. The investing of a family’s wealth is often seen as a technical necessity for a family office. However, I believe that how families engage with their capital can have significant implications for family dynamics, cohesion, and purpose. In particular, moving from a passive to active investing strategy, including at the extreme to a direct invest program, can help families achieve attractive returns, build better companies and, importantly, better align their capital with their values, mission, and purpose.

In my first piece, I explained how family capital has inherent advantages over traditionally structured capital and how direct investing can improve family cohesion and dynamics. My second piece discussed how actively investing with purpose, impact, and focus can help families recapture their legacies and better engage their next generation. In this piece, I take the final step of discussing the strategies and tactics families should implement (as well as the approaches and pitfalls they should avoid) to ensure the success of their active, direct invest strategies.

The advantages of family capital stem from it being both i) permanent and proprietary and ii) imbued with a family’s values and ethos. These differences from traditionally structured capital allow it to better meet the flexibility, duration, and compatibility needs of certain seekers of capital like family- and founder-owned businesses. When capital providers can better address the needs of those seeking capital, a competitive advantage can be achieved even in overcapitalized and commoditized markets like we have today.

Despite some of the disadvantages of traditionally structured capital, there is no doubt that traditional private equity has long been a successful business model that has generated consistently strong returns. However, when implemented with the right goals, strategy, team, and tactics, family capital providers should be able to consistently win new opportunities, allowing families to reclaim their sense of purpose, consistently generate attractive returns, and ensure their companies operate in sustainable ways. 

The key to a family accomplishing this winning trifecta of outcomes centers around effective planning, strategy/team/tactics alignment, and disciplined execution. Appropriate alignment across the investing business is the foundation upon which a successful family program is built, and this alignment begins with the family’s goals and values. From there, the aligned strategy, team, and tactics can then be developed. Any chink along this alignment chain can have meaningful, unintended consequences and potentially disastrous results. Beyond getting the program set from goals to tactics, consistent and concerted execution is also critical to achieving great results.

Families need to recognize that the investing business is as much a human capital game as it is a financial capital game. In particular, families need to incentivize their teams appropriately by focusing on net returns and sharing the upside (and risk) of their investments, while also solving the possible investment team/family timeline mismatch for investment holding periods. Finally, families need to identify talent that aligns with their values and investing strategy, otherwise their talent will set their values and strategy for them.

There is nothing easy about implementing a successful direct invest program, and this approach is certainly not for all families. Finding, winning, building, and overseeing companies is a very long cycle process. In fact, working down from the top of the new opportunity funnel to landing a new direct investment at the bottom of the funnel is less than a 1% proposition. That is why being concerted, disciplined, proactive, and determined is imperative to being a successful investing family. There is nothing opportunistic about successful, consistent direct investing.

Today, an increasing number of families are executing active, direct investing programs using a variety of models and structures to support their specific family goals. For example, some families prioritize scale, breadth, and sophistication to address the market opportunity, while others use alternate structures that employ third-party capital alongside their family capital to broaden their reach and improve their ability to attract and retain a talented team. Families may also partner across generations, with other like-minded families or public market investors to create both public and private investment groups with sufficient capital and scale to compete. Regardless of approach, families must ensure that their strategy, team, and tactics give them a right to win in today’s highly competitive direct invest market. 

Unlike the natural posture of many families, being publicity shy is not a virtue in the family direct invest market. Families who have had success executing these strategies typically have advocated for the inherent advantages of their capital and assumed a more public profile to pursue their investing. Families need to educate intermediaries, lenders, and advisors about their advantages and then execute accordingly. By doing so, investors advance the cause of family direct investing for all market participants, and help define a distinct, new family capital asset class within the broader private capital market. 

If implemented with discipline and alignment, family capital and family investing have a number of inherent advantages that can help families reacquire and retain what they value most, while also generating an attractive return. By addressing some of the fundamental and systemic deficiencies of traditionally structured capital, family capital in many ways is the antidote to traditional private equity.

Paul Carbone is the Co-Founder and Vice-Chairman of Pritzker Private Capital. From 2012 to 2022, Paul was President and Managing Partner of Pritzker Private Capital and its predecessor.

The original article can be found at the following link: https://www.famcap.com/2023/12/how-families-can-effectively-harness-the-advantages-of-their-capital-while-avoiding-the-pitfalls-and-hazards-of-direct-investing/