The hybrids: GPs seek to work with Australian family offices

It takes five years for an olive tree to become cash generative. With some of the groves at Boundary Bend – which has more than 2.2 million trees across 6,000 hectares on Melbourne’s western fringes – only two years old and an olive oil retail strategy barely off the ground, the company needed long-term capital. In Proserpine Capital, a private investor from the same city, Boundary Bend found it.

That was six years ago. Proserpine invested about A$5 million ($3.8 million) to help the grove managers buy the land they cultivated out of bankruptcy with a view to creating a fully-integrated business. Boundary Bend is now Australia’s largest producer of premium extra virgin olive oil. It accounts for 55% of all extra virgin olive oil sales nationwide at the retail level.

“We call ourselves a private investment company, not a private equity firm, because we have a longer investing timeline,” says Damian Berry, a director at Proserpine. “With Boundary Bend, we knew it would take three years to optimize the cash flow profitably. It is now worth A$400 million and the value of the investment is probably 7-8x what we paid for it.”

Proserpine has completed 15 deals since 2011 and has A$150 million under management. It invests on behalf of an institutional investor that commits capital to fund-of-one structures and offers co-investment on a deal-by-deal basis to eight high net worth families. The firm has stayed below the radar due to its relatively small equity checks – A$20 million is considered large – and reluctance to go marketing.

The status quo may not last. Proserpine is currently in discussions with several fund-of-funds about raising a fund of A$100 million or more. A hybrid approach like this appears to be one of few ways in which Australian GPs can attract capital from both the family office and institutional LP constituencies and hope to achieve sustainability. The model is not private equity as many emerging managers know it.

“Private equity managers have not been that successful in getting family office money,” observes James Burkitt, CEO of The Table Club, a global family office network that started in Australia nine years ago as a forum for sharing ideas and investment opportunities. “A lot of the families are deal hungry but they want to invest in specific areas and they won’t do blind pool funds in their own patch. And then the check sizes from family offices are small; a GP might get much more from a superannuation fund.”

Nevertheless, the dynamic in Australia’s lower middle market is shifting. Super funds have become victims of their own scale, often struggling to commit to smaller domestic managers due to check size constraints. At the same time, with some GPs moving up in the market and others dropping out a collection of new managers are looking to take their place. Family offices have sensed an opportunity.

“This is an attractive part of the market for family offices to invest in on a risk-return basis. There are a large number of companies in this part of the market and a smaller amount of capital being deployed. As a result, pricing is more attractive,” says Mark De Ambrosis, managing director at Armitage Associates, a growth investor established last year with the support of a family office. “On top of that, family offices understand that you have more ability to move the needle with these smaller businesses.”

Follow the money

There were about 310 family offices and high net worth individuals (HNWIs) in Australia with assets of A$100 million or more as of June 2016, according to The Table Club. The 200 largest family offices have A$241 billion between them and over half of that resides with the top 50.

A single family office is said to become economically viable when wealth approaches the A$200 million mark. While members of the top 200 tend to have their own CIO or equivalent professional advisor and those in the top 100 would have teams covering different asset classes, Australian family offices are still largely controlled by the first and second generations. As a result, the patriarch is very hands on, seeking to play an active role in investments, which is another reason they like go direct.

Even among multi-family offices, there is a resistance to blind pools. Hume Partners has no exposure to private equity, something CEO Ross Burney puts down to the relatively old age of its clients. He says this may change as control passes to the younger generation, and given the high valuations in listed markets, opportunities are currently being discussed. “We would only do deal-by-deal,” he adds. “Most likely we would find the opportunity ourselves, analyze it ourselves, and club the investment ourselves.”

The networking role played by groups such as The Table Club and the Young Presidents’ Organization (YPO) in bringing high net worth capital into deals can be transformative for a GP. Indeed, connections established through the YPO are said to have helped in last year’s buyout of vitamins and health food retailer Mr Vitamins, which was led by Josh McKean, of Ironbridge Capital, and Trent Peterson, a former Catalyst Investment Managers executive who has been focusing on deal-by-deal investments.

They formed a single asset fund and a dedicated investment manager, the ownership of which is split equally between McKean, Peterson, Ironbridge co-founder Greg Ruddock and Brett Blundy, a retail industry veteran. Blundy anchored the fund, contributing 25% of the corpus, and was followed by other HNWIs and family offices that are part of his network. These investors put in two thirds of the capital.

“The YPO network gives access to particular influencers in the high net worth community,” notes one industry participant. “If you get into that community and have a deal go well you will get to show others. If you have exclusive access, the dialogue becomes more about sharing ideas than selling a product into a channel.”

Yorkway Equity Partners experienced a similar phenomenon with its investments. The business was established in 2014 by boutique advisor Yorkway Partners to share potential deals with HNWIs. It bought a majority stake in BMT Tax Depreciation, working alongside CHAMP Ventures, in 2015 and then took a minority position in fiduciary services provider One Investment Group last year.

“Neither Paul [Batchelor, Yorkway co-founder] or I had done this before so we pooled our contacts lists and saw everybody. There would have been more than 100 names on the list,” says Marcus Lim, formerly of RMB Capital Partners, who helped set up the investment business. “We ended up with a small number of true believers who referred us to their friends. It helps to have people championing investments with their business contacts.”

Flexibility first

The challenge for many PE firms is harnessing this networking power into a workable business model. Assuming an agreement can be reached on fees, the local standard appears to be a 1% management fee and 10% carried interest. Several investors note that it is difficult to incentivize a team on these terms when targeting mid-market deals. Furthermore, fees are only charged on invested capital, which could result in a GP pursuing sub-standard investments for the sake of putting money to work.

Yorkway decided against requiring investors to fund due diligence costs, concerned that asking for fees upfront would be a stumbling block. It chose to present investments as fully-formed packages with diligence completed, pricing negotiated and terms agreed. However, the firm does receive a one-off establishment fee in recognition of the fact that there are no charges on uncommitted capital and broken deal costs.

Perhaps the most limiting aspect of deal-by-deal is that a GP approaches investments without the absolute certainty that it can finance them. Auctions are out of the question and founders sometimes get cold feet on learning that, once negotiations are completed, the manager must go out and raise capital. A number of the best-established deal-by-deal investors globally have therefore supplemented their resources with pools of committed capital.

Meanwhile, in Australia, Armitage has adopted a hybrid approach much like that of Proserpine. De Ambrosis, previously of at M.H. Carnegie & Co, formed the firm as a partnership with Trawalla Group, the family office of the Schwartz family. Trawalla represents committed capital, having participated in both investments made so far. A second family office also took part in one of these, and while Armitage is not actively fundraising, it is talking to other investors about joining future transactions.

“The traditional private equity model doesn’t necessarily lend itself to investing in all lower middle market opportunities. Many owners don’t want a traditional closed end fund structure investing in their business where there is an artificial 2-5 year investment timeline,” says De Ambrosis. “Family offices provide a more flexible source of capital, in terms of not just investment tenure, but also being able to take minority positions and work alongside owners to help them grow their business.”

In addition, the Armitage pitch to these middle-market companies is based on value-add that can be channeled through the family office network. Thanks to the network, Iron Capital, an alternative financing provider for the industrial equipment industry, now has the ex-head of General Electric’s fleet and equipment leasing as its chairman. Two other professionals with expertise in industrial equipment joined the company’s board, having invested personally alongside Armitage and the two family offices.

Other deal-by-deal investors make similar claims. For example, the chairman of Mr Vitamins is an alumnus of the Blundy retail empire and the company has access to a CFO and a property specialist who work on a part-time basis.

It is unclear where this willingness to play an active role in deals actually leads. Family offices and HNWIs are routinely pitched investments by intermediaries, but a couple of PE executives claim to have been approached in recent months by headhunters acting for family offices that want to develop their direct investment capabilities. At the same time, the traction deal-by-deal managers have built up suggests there is a demand for outsourced teams that can identify, execute and manage investments.

“Family offices and the larger high net worth investors have morphed out of the stage of just doing their own thing,” says Craig Gribble, managing partner at placement agent Allen Partners, as to why there appears to be more interest in middle market private equity. “They are not at the point of doing funds, but there is an acceptance that funds are inevitable if these groups are doing well.”

Tough transition

The transition from deal-by-deal to blind pool can’t happen without a meaningful track record and existing investors convinced that the strategy justifies more capital than they can provide. Ideally, a manager would be able to approach prospective institutional LPs with a first close or strong indications from its deal-by-deal investors that they will roll into the fund. The hybrid approach of institutional committed pool plus high net worth co-investment is a means of retaining support on both sides.

Mercury Capital remains an oddity in the Australian market, having succeeded in raising its debut vehicle almost entirely from family offices and HNWIs before bringing some institutional investors into Fund II. Fund size is clearly a factor, with GPs wary of taking on the burden of reporting to dozens of family offices writing small checks. “Some firms fail to grasp the amount of time required to service HNWIs who want regular phone calls as well as quarterly reports,” another placement agent notes.

As family offices move into their third and fourth generations, they are likely to evolve along similar lines to their US counterparts, becoming increasingly institutional as professional managers are hired to invest on behalf of family members who have no direct link to the businesses responsible for their wealth. While the aversion to blind pool funds may remain, allocation strategies will be more formalized.

For now, though, among the younger middle market GPs working deal-by-deal, there is a clear dividing line: on one side, those that are able to raise institutional capital – domestically and overseas – and expect the same LPs to back a blind pool fund; and on the other, those that are coming up with more bespoke solutions aimed at the high net worth community.

Bridgeport Capital falls somewhere in between. The firm was set up to acquire Underground Cable Systems and then bought home doctor service Dial a Doctor, raising a separate pool of capital for each one. Last year it took full ownership of Hawkesbridge Private Equity, assuming responsibility for three funds with a predominantly institutional LP base. A new fundraise is planned in the next 2-3 years, with a similar set of target investors.

“When we bought Underground Cable Systems we spoke to family offices with backgrounds in engineering and the electricity sector. That makes sense,” says David Plumridge, managing director at Bridgeport. “Taking a lower mid-market buyout fund to them would be difficult.” 

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• Topics
• Australasia
• LPs
• Fundraising
• Buyouts
• Australia
• Family office
• Proserpine Capital
• Armitage Associates
• Bridgeport Capital
• Ironbridge Capital
• Co-investment
• Mercury Capital