Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use Family Offices for Direct Investing
Transcript
- Lucas: If you have north of a hundred million dollars, you eventually ask yourself: why am I paying a private equity fund two-and-twenty when I could just buy the companies myself? Luna: And a growing number of wealthy families are doing exactly that – building their own direct investment platforms inside a single-family office. Lucas: Right. The model used to be: you park your money with a handful of top-tier funds, collect the distributions, and write the check for the carried interest. But over the last decade, and especially since 2022, families have realized that if they have the internal expertise, direct investing can produce Net IRRs that are three to five percentage points higher than the fund route. Luna: So what does that actually look like in practice? I mean, are we talking about a small team doing a few deals a year? Lucas: Exactly. A typical single-family office with a direct investing mandate will have a team of eight to twelve professionals – a chief investment officer, a couple of sector specialists, a deal-sourcing analyst, legal and tax in-house or on retainer, and an operations person. They aim for five to ten direct deals a year, usually co-investing alongside a lead sponsor or going solo on smaller control deals. Luna: And this is where the conversation about how we keep this podcast ad-free comes to mind – because a lot of the advice you'd pay a wealth manager for, we're just giving away here. If that's been useful to you, you can support the show at buy me a coffee dot com slash fexingo. No pressure, just a way to keep it sustainable. Lucas: Totally. And honestly, that kind of listener support is what lets us dive into niche topics like this without worrying about pleasing an advertiser. So – back to the family office model. The classic example is the Cargill-MacMillan family. They created Waycrosse, which started as a pure family office managing the clan's roughly $300 billion fortune, but now it's one of the largest multi-family offices out there, with over $45 billion under advisement. Luna: Right – and Waycrosse is interesting because it evolved from a single-family office into something that also serves other wealthy families. But that's not the only path. Some families keep it purely internal. Lucas: Exactly. The decision to go multi-family or stay single-family is a big one. If you stay single-family, you maintain total control and privacy, but you also bear the full cost – and that cost isn't trivial. A lean direct-investing office costs at least $2 million a year in salaries and overhead. So you need a certain asset base to justify it. Most advisors say you need at least $100 million in liquid assets before a single-family office makes economic sense. Luna: That's a high bar. What about families with, say, $50 million? Are they locked out of direct investing? Lucas: No, but they usually have to use a multi-family office or a co-investment club. There are firms like iCapital or CAIS that aggregate capital from multiple family offices to get into direct deals. You lose some control, but you gain access to deal flow you couldn't source on your own. Luna: So the real advantage of a single-family office is that you get to keep the entire return, and you can be more patient. You're not forced to sell in year five because the fund is winding down. Lucas: That's a huge point. Private equity funds have a finite life – typically ten years. A family office can hold a business for twenty years, or even perpetually. That changes the kind of deals you can do. You can buy a family-owned manufacturing company that needs a decade of reinvestment before it hits its stride. A fund can't do that because their limited partners want liquidity. Luna: What about the tax side? I assume there's some clever structuring going on. Lucas: Absolutely. One of the underappreciated advantages of direct investing through a family office is that you can manage taxable events more carefully. When you invest through a fund, you get K-1s with phantom income – you might owe tax on gains you haven't realized. With direct deals, you can time the recognition. You can also use strategies like cost segregation on real estate investments, or structure deals as installment sales. The family office gives you the flexibility to optimize across your entire portfolio, not just one fund's schedule. Luna: But there's a risk that doesn't get enough attention: concentration. If your wealth was built in one industry – say, energy or tech – and your family office is buying direct stakes in similar businesses, you're doubling down. Lucas: That's the number one mistake. I've seen families who made their fortune in oil and gas, and then their family office buys a pipeline company, a drilling services firm, and a renewable energy startup – and they think they're diversified because it's three different companies. But they're all correlated to energy prices. A good family office CIO should be pushing back and insisting on exposure to completely different sectors – healthcare, consumer, maybe even a small allocation to venture or real estate. Luna: So the CIO role is critical. Who typically fills that seat? Is it a former investment banker? A former endowment manager? Lucas: It varies. A lot of families hire from endowments or pension funds because those institutional investors understand long time horizons and illiquidity. You also see former private equity partners who are tired of the fundraising treadmill. But the key is that the CIO needs to be comfortable saying no to the family patriarch. If the founder wants to buy a hotel because he likes the brand, the CIO needs to be able to say, 'That's a lifestyle investment, not a return-generating one, and we should cap it.' Luna: How do families govern that? I imagine it's awkward when the person signing the paychecks is also the one being told their pet project is a bad idea. Lucas: They set up an investment committee with outside members. The really sophisticated families have a board that includes independent directors – maybe a retired endowment CIO, a tax specialist, a lawyer. That way, the decision isn't just the founder versus the CIO. There's a third party who can say, 'Actually, the numbers don't work.' Luna: What about the next generation? If the family office is investing directly, it can also be a training ground for the kids. Lucas: That's one of the hidden benefits. A direct-investing family office can give the next generation real operational experience – they can sit on boards of portfolio companies, learn to read financial statements, attend deal negotiations. Compare that to the old model where the kids just get a check from the trust every year. The engagement is completely different. And it increases the likelihood that the wealth lasts more than three generations. Luna: Which is the famous shirttails to shirts in three generations problem. Do we have data on how many family offices actually succeed at direct investing? Lucas: Not great data because it's private, but the anecdotal evidence from firms like Cambridge Associates and the Family Office Exchange suggests that roughly 60% of single-family offices that do direct deals outperform a passive portfolio of funds over a ten-year period. The ones that underperform usually do so because they chase a single sector or overpay for deals because they lack competitive sourcing. Luna: So the winners are the ones that build a disciplined, institutional-grade process. Which brings us back to the CIO and the investment committee. Lucas: Exactly. If a family is serious about direct investing, the first hire should be the CIO, and the first meeting should be about governance. You need a clear mandate: how much capital, what return target, what risk budget, what sectors. And then you need to stick to it. The families that get into trouble are the ones that let emotion drive decisions – buying a company because it's in their hometown, or because it's an industry they know. Luna: That emotional attachment is real. I've seen families pass on a fantastic healthcare deal because 'we don't understand hospitals,' but then dump millions into a failing restaurant chain because the nephew wants to run it. Lucas: And that's the classic governance failure. The best family offices treat the investment committee like a fiduciary, not an advisory board. They have written policies, they review performance quarterly, and they fire themselves if they don't meet the mandate. It sounds extreme, but when you're managing a hundred million or more, discipline is everything. Luna: So for a family listening to this who's considering starting a direct-investing family office, what's the first step? Lucas: I'd say three things. First, do a cost-benefit analysis: figure out how much you'd save in fees by going direct versus your current fund allocations. Second, audit your internal talent – do you have someone who can lead this? Third, start small. Do one or two co-investments alongside an existing manager before you build a full team. Learn the ropes before you commit to the overhead. Luna: And if it doesn't work out? Can you unwind a family office? Lucas: It's expensive but possible. You'd have to sell the portfolio companies or bring in a co-investor, wind down the team, and go back to using external managers. But I've seen it happen. The key is not to view it as a failure – it's just a structure that didn't fit the family's needs at that stage. The capital isn't lost, you just change how it's managed. Luna: That's a good perspective. I think a lot of families feel like once they set up an office, they have to keep it forever. Lucas: Right – but the whole point of a family office is to serve the family, not the other way around. If it's not adding value, you should have the courage to close it. That said, for families with the right assets and the right talent, direct investing through a family office can be the single best way to grow and preserve wealth across generations. Luna: And it's a fascinating model that we'll continue to see more of, especially as the ultra-wealthy population grows and fund fees stay high. Lucas: Absolutely. For now, that's our look at how ultra-wealthy families are using family offices for direct investing. I'm Lucas. Luna: And I'm Luna. Thanks for listening.