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Clubbing together

Family offices talk a lot about club deals, but are they really happening, or just figments of fund managers’ imaginations? Campden reports.
Club deals: Everyone has heard of them but few have seen them

Club deals are all the rage. At least in theory. Many families are sick of paying fees to asset managers who stick their money in a black box, wave a magic wand over it and then, well, find that the money has vanished in a puff of smoke. People with burned fingers are, predictably, keen to cut out the middleman and invest directly. The idea of teaming up with other like-minded family offices to make direct private equity-style investments has an evident appeal. But club deals are not happening as fast as you might expect.

“They are a bit like sex,” says David Barbour, co-head of private equity at Fleming Family & Partners, “it’s talked about more than it actually happens.” He points out that it’s hard to know how many deals are getting done, because they are off-market, which is after all “one of the attractions of doing club deals for family offices”, but suspects that the reality doesn’t match up to the desire.

Basil Demeroutis (pictured, right), managing partner at Fore, a property-focused club investing platform set up by eBay founder Jeff Skoll, says: “The reality is that there is a lot of chat and not a lot of action. On an absolute level, club deals have never amounted to a great deal of global capital flows. It’s still pretty much inconsequential, relative to the amount of air-time they are getting, club deals have largely been irrelevant and continue to be so.”

So why are they not happening as fast as might be expected? The appeal of club deals – investments made by a number of family offices teaming up together, and sometimes also with other investors such as institutions or wealthy individuals – is obvious. “Who doesn’t want greater transparency?” asks Demeroutis, “who doesn’t want greater alignment? Who doesn’t want fewer costs? Who doesn’t want greater control over where their capital is? These are all fundamental, inalienable desires of investors, no matter what the nationality, asset-class or size.”

“A lot of family offices had their fingers burned by the big private equity houses in 2008 because all those returns were driven by financial engineering,” says Torquil Macnaughton, a founding partner of Penta Capital, a club investing platform. He says it stands to reason that they are keen to take more control over their direct investments.

“A lot of the families back themselves to be better portfolio managers than general partners,” says James Innes, a partner at club deal platform Chrystal Capital, “so they think, hang on, why am I paying a GP 2% and 20% carry? If I’ve got the time and resources why don’t I start doing these deals myself with my peer group?”

Direct investing – whether alone or in a club – should be a winner for family offices. Those that find a profit-making operational business often have good contacts and knowledge in an industry. For example, the family office of Brian Souter, the Scottish entrepreneur who founded transport group Stagecoach, has done well out of investing in transport businesses including bus and ferry firms, as well as luxury yacht-maker Sunseeker. And Autonomy founder Mike Lynch (pictured, left) has raised a £1 billion (€1.2 billion) fund called Invoke to give early-stage funding to technology start-ups. Some family offices like to get involved in deals where the family’s core business can add value, Macnaughton says. It stands to reason that they should be able to do well in those areas.

Others see club deals as a good way to get emerging market exposure, says Barbour (pictured, below right), “which is relatively hard to get through a fund structure quickly because they take time to get in and to deploy the capital”. A club deal also spreads the risk between family offices. Innes says that families often have political contacts that make it possible for them to invest in emerging markets that institutional investors might not have: “Family offices know a lot of people who help commercially, prime ministers, oil ministers.

“They appreciate that, not only on a financial, but on a commercial level, there are benefits with being associated with each other.” Club investing means that you can leverage the contacts other families have, and they can take advantage of yours. Families, Innes adds, also tend to take a longer-term view and often get in before the herd. “A lot of people have been making friends with Myanmar for years in expectation of liberalisation,” he says, adding that the story is similar in Africa and Brazil.

So the appeals of club deals are manifold and obvious, and the financial crisis has made them even more appealing. “There is a great need for club investing,” agrees Innes. So why is it not happening? The reason is simple. “It is currently done very badly,” he says.

“Part of the problem is that it sounds great in concept and like a walk through the forest on a spring day, but there are pitfalls out there,” says Demeroutis. A collection of family offices might agree that they want to buy a company or a building together, but how do you actually do that? “How do we agree on what we buy? Even if we want to go into partnership together what does that mean?” asks Demeroutis.

“Who’s in charge? What rights do we have? It actually is quite a complex set of issues that have to be solved to do a club deal. Every time you want to do one it’s like reinventing the wheel. You’ve got to spend time with the lawyers, draft documents, figure out who’s in charge. There is no standardised blueprint for doing club deals.” Most family offices are just not set up to do it: a large one might only have 15 to 20 people on the investment team and not have the resources for labour-intensive one-off deals.

Another problem is that family offices that want to do direct investments tend to want too much control. “People who have had negative experiences with blind funds and lock-up periods and illiquidity, then tend to swing the other way – maybe too much – and say, ‘I want to have complete control over the investment decisions,’” says Barbour. Direct investing and club investing might appeal on paper, but in reality it is hard to do, even for a good-sized family office.
Family offices can also find that they are limited in terms of the asset-classes they can access. “You have to find something off-market or not competitive,” adds Barbour, “because if you are in a very competitive market and you are trying to liaise with three, four, five different parties, you are going to look like a less credible buyer in some cases than someone who’s writing a single cheque.” In emerging markets that might not be a problem, but it might make clubs less appealing in, say, more conventional UK corporate assets.

Having a number of investors also adds some complexity, meaning that clubs might be limited to simpler investments. Barbour says that some might prefer to deal in property because it is less time-intensive than a more people-led business like an intellectual property-led or a technology company. Club deals also tend to have shorter time-horizons than families might ideally want. A family office investing on its own might take a very long-term view, “but once there are four or five involved you will probably see a shorter time-horizon,” says Barbour, because the timeline defaults to the shortest of all the investors, although that “still might be longer than a private equity fund”.

The biggest problem, however, is deal sourcing. “That’s the trouble, if you haven’t got the network out there tapped into good businesses and good people that run businesses then it’s quite hard to find the deals,” says Macnaughton. “Some family offices are better than others – those that are run by good, currently active entrepreneurs tend to have tentacles into the market, but the ones that are second or third generation and quite large and have employed people to run the family like a fund of funds for the families, I think they find it a bit harder.”

Another problem for small clubs is that unless you have a massive marketing operation telling the world that you are looking for deals they are not going to drop into your lap. Even a club of families probably won’t be able to go out and find them. And once you do find a deal the logistical problems remain. All this explains the emergence of platforms that can source deals, do some due-diligence and legal work, and then run them afterwards as a GP. These can be anywhere on the spectrum from a speculative pledge fund (also known as a fundless sponsor), which is a GP that has a deal but no investor, to a more formal collection of family offices who are all bound to put money into a deal.

Fleming’s private equity arm, for example, runs the latter kind of set-up. Investors pay money into a pot of investable assets and have the chance to top up in every deal, meaning that they can “bespoke their portfolio a little,” says Barbour. He calls this a hybrid between a fund and a club investment approach. They have been doing it this way for 10 years and the latest fund has 60 investors, approximately a third of which are family offices.

Chrystal is an investment platform that was set up in 2009 and says it talks to 200 family offices. A typical deal would involve about five family offices, and they might be able to call on the expertise of other affiliated family offices for advice. Club deals only work, says Innes, if the platform works as a corporate financier advising and educating the family offices, and not just introducing them to deals, like a pledge fund would. “That’s why deals don’t get done,” Innes says. “You have to have them fully engaged from the start, and the families have to be convinced that it’s with spending a bit of money to support a platform, because then you have a proper dedicated service.”

Penta has been doing something similar since 1999 and a recent success was Esure, an insurance business. Penta bought 70% of the business for £190 million in 2010 and listed it in March 2013 with a value of £1.2 billion. “Rather than investing in a blind pool, you are not investing in an asset until you get to touch and feel it and kick the tyres a bit,” says Macnaughton.

Perhaps the most valuable thing the platforms do is manage the deal after it has been done. “It’s quite easy to do the deal on the way in, especially if there is a lead investor who is doing all the due diligence and presenting the deals in a relatively well-put-together way,” says Barbour. “The trap, if there is one, is that it is easy to do a deal, but quite hard to manage it. Some people might find that there is quite a bit of burden on them.” Platforms promise to take the strain.

So club deals are desirable – and with a bit of help, possible. If they team up with this new breed of platforms then family offices will, however, still have to pay fees for their services, which was one of the things that family offices hated about private equity houses. If you want to invest directly, fees seem inevitable. Whether this model turns out to work better depends on whether these platforms can be less of a black box and more of a trusted adviser.  

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