Direct private investing can be an avenue for families to apply their expertise and networks into nascent ideas—as well as to develop a deeper relationship with the companies in their portfolio. But what works for one family may not work for another.
How can families craft an investment policy that supports their wealth and legacy goals? What should they be looking at when evaluating direct investment opportunities?
In this episode of Life & Legacy, Felicia Law and Gabriel Bochi, from the Wealth Advisory Practice at J.P. Morgan Private Bank, discuss different approaches families can go about when considering direct private investments in companies.
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Felicia: Hello everyone, welcome to this new episode of the Life & Legacy Podcast Series. My name is Felicia Law, and I run the North Asia Wealth Advisory Team for the Private Bank. I’m here today with my colleague Gabriel Bochi, Senior Advisor from our institutional wealth management team known as “23 Wall.” Hi Gabriel!
Gabriel: Hi Felicia! Really excited to be here today.
Felicia: The topic of this episode is “vetting private investment opportunities.” I remember a few years ago we hosted an event in Hong Kong on single family offices. One of the panel speakers, a client of the Private Bank, shared her family’s experience in making their first private investment. Her family had established a family office shortly after selling a family business. At that time there were three people on the team, a chief investment officer, an executive assistant and herself. They made a US$50 million investment in one deal that was referred to them by a family friend—and conducted very limited due diligence. The deal ended up not being a successful investment. The family regretted not having a process in place to evaluate private investment opportunities and make decisions.
Gabriel: Indeed. Direct investing requires a lot of discipline so before considering any direct private investments in companies, it’s very important to define a framework:
1) First, the family should define a thorough investment policy. What should it include? Well, things like what sectors you want to invest in, what countries, what stage (from venture all the way to pre-IPO), minority vs. majority stakes, investment size, invest alone versus co-invest with partners.… There are many questions to be asked: Are your investments purely financial? Or do you want to participate in the company’s governance (board seat) and contribute to the company’s strategy and growth?
2) In parallel, families need to build an investment committee that can hire the right team of investment professionals who will be in charge of implementing the investment mandate.
Felicia: I cannot agree more, Gabriel. When putting in place an investment policy, the first few things that comes to my mind are:
- For example, the family needs to set clear goals. Are their motivations purely financial, or are they interested in something else such as to support a good cause or using the investment as a networking opportunity?
- Also, it is paramount to determine the family’s role. For each investment, what would be the roles and possible involvement in the target company or partnership? Will they be a purely passive investor? Will they be expected or required to join the management team or the board (and, if so, who will be the most suitable person for this role)? Do the founders and management team have a proven track record in managing and running a business?
Gabriel: Well said, Felicia. On top of that, I believe building a framework to gather information, conduct due diligence and formulate strategies is equally important.
Felicia: Of course. Information is power. One of the most difficult questions for families to answer is how much time and resources should they allocate to evaluate private investment opportunities. In most cases, the size of the potential investments would often be the main determining factor here. Gabriel, where should we start when building that framework? A document checklist perhaps?
Gabriel: Possibly, but the devil is in the details. Depending on the type of opportunity, not all the information will be made available. For example, start-up companies may only have a term sheet, simple accounting ledgers, and a short write-up about the founder’s vision. On the other hand, a company that is going through its third round of fundraising may have a lot more information that can share with prospective investors.
Felicia: True. In most of the cases, the due diligence checklist should include, at least, the following three different types of information:
- Basic documents. I’m talking about term sheets, private placement memorandums, partnership agreements, marketing materials…
- Also, documents relating to the existing structure and the management team. This includes things such as ownership structure diagrams, corporate documents, organization charts, biographies of the leadership team…
- And, obviously, financial and industry data. Any thorough due diligence process should carefully examine audited financials, management accounts, financial projections, macro data about the industry and, in general, anything pertaining the competitive landscape where the company operates.
Gabriel: That’s a good list. What about co-investment opportunities?
Felicia: I am glad you brought this up, Gabriel. With regards to co-investment opportunities, families should also understand the expected co-investment structure, securities registration requirements (if applicable), co-investment underwriting expectations and target returns, use of co-investment capital raised and allocation policy. Knowing your partners is key. Are there other institutional, professional investors involved? Are they experts in this type of company or investment? What is their track record? And finally, are you aligned with them? Do you see yourself having a productive business partnership with them?
Gabriel: Felicia, I would also stress that gathering information should be an ongoing process. Some families find it helpful to have a template outlining all the information and data they require from target companies on a regular basis. Having access to the relevant information would empower you to assess risks. Your lawyers should have put in place adequate protective mechanism in the legal documents to safeguard your interests.
Felicia: One final comment from me on investment policy and framework. Exit strategies. Do we have one and if so what is it? Does the company have plans for an IPO or a possible buyout? What is your target holding period of each investment? There is a quote attributed to Henry Kravis, co-founder of KKR, that says “don't congratulate us when we buy a company, congratulate us when we sell it. Because any fool can overpay and buy a company.”
Gabriel: (chuckles) That’s a fair point, Felicia.
Felicia: Right? After all, in most cases, financial investing in private markets is about the profitable return of capital. Gabriel, let’s spend some time to talk about something you briefly touched upon at the beginning of this episode—forming an investment committee and forming a team.
Gabriel: Sure. In our conversation with clients, one question that often comes up is who should be put on a team to review investment opportunities. For example, I have a client who is in his late 70s and he has been working with his eldest son on vetting these private investment opportunities. They have been doing this for decades and have a very impressive track record. In fact, this was the patriarch’s way to encourage his son to develop interests in investments and to sharpen his business skills. I also worked with another family who formed an in-house due diligence team comprising a chartered financial analyst, a very experienced lawyer and an accountant. This family uses an investment committee comprising both family and non-family members to make private investment decisions.
Felicia: Gabriel, I suppose there is no right or wrong answer to this question. Each family is different and what works for one family may not work for another. Finding the right people and retaining those talents are super important.
Gabriel: Yes, Felicia. I would suggest that we start with setting clear goals or expectations as well as putting in place adequate compensation packages to motivate team members.
Felicia: Agreed, Gabriel. Well, and with that we reached the end of this episode! Thank you to our audience for joining us in this episode. Your J.P. Morgan Wealth Advisors are here to engage with you and your family on topics of Life and Legacy. We look forward to hearing from you.
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