Why family offices like emerging managers

Being validated by one family office can be the springboard from which you then succeed in building an entire investment firm. But what’s the best way to get in front of them and convince them of your new firm?

Most newly established fund managers will dream of the following scenario.

A family office decides to invest with you right from the start.

They then introduce you to other family offices, some of whom decide to also invest.

With the backing of these entrepreneurial investors, you quickly gain critical mass and credibility. This then allows you to draw in serious institutional investors.

Fast forward two or three years, and your fund management company won’t be emerging anymore, but an established one. It will have been family offices that helped you to write the early chapters of your success story and reach the next level within two to three years, rather than five to seven years.

But why would family offices be interested in backing new fund managers?

How can you, too, get a family office signed up for your emerging fund management enterprise?

These are questions that the following article will analyse in more detail. It is based both on our own experience at Sarnia Asset Management, and sector-specific intel we collected by visiting a number of conferences recently.

Why Do Family Offices Invest With Emerging Managers?

The reasons why family offices are interested in emerging managers usually include:

1.     Access to products that are not available elsewhere

Large banks and wealth managers tend to offer mostly “me-too” products these days. That’s simply in the nature of these large, bureaucratised institutions.

It’s often emerging fund managers that come up with ideas that are ahead of the curve, and which fill in niches that others aren’t covering.

As one family office representative put it at a recent conference for emerging managers: “We need to turn to emerging managers in areas where there are no product offerings.“

Offering something that is different, is the #1 route to get family offices interested in you.

2.     Better terms

Plain and simple, a family office that decides to back an emerging manager at the outset will usually be able to negotiate special terms for themselves.

Getting away with paying lower fees than other investors in the same fund is a huge draw.

(In case you are wondering about the legalities and practicalities of such an arrangement, more about this towards the end of this article.)

3.     Better service and a real partnership

The state of the finance industry is nowadays such that even investors who can allocate tens of millions count as relatively small investors.

A family office that can write a cheque for five million or ten million would struggle to get regular meetings with well-known hedge fund managers. A Chris Hohn or a Bruce Griffin is not going to sit down with someone who doesn’t have the firepower to contribute nine-digit AuM. However, a cheque of such a size would make a world of a difference to an emerging manager. It will ensure that the family office gets very regular, easy access to the portfolio manager and the rest of the team.

As one family office representative put it: “With emerging managers, you can form a real partnership and be in an ongoing dialogue.“

4.     Access to IP and data

There may be circumstances where a family office will be interested in the intellectual property and data of the emerging manager.

E.g., a family office might agree with an emerging manager that it gets so-called co-investing rights. I know anecdotally of one high-profile Silicon Valley billionaire whose family office asks fund managers for the following: “Whenever you have an outstandingly good idea and assuming there is capacity to increase the total investment beyond the abilities of the fund, let me know. I might then invest additional money directly into the target company.“

Other situations might involve a family office backing an emerging manager that is focussed on a particular industry, because it aligns with the family office’s general investment focus. In such a case, getting access to some of the expertise and data of the fund manager can create a lot of value-add for the family office.

Or, it could be as simple as a family office wanting to educate their staff about a particular sector or investment style, and seeking regular meetings with the fund manager to learn from them.

There are endless possible variations to this theme!

5.     Finding alpha

Pure and simple, emerging fund managers are “hungrier”.

They work twice as hard as established fund managers to achieve success, both for themselves and their investors.

An executive of a multi-family office with two dozen clients told me: “Over the course of the last five years, it has become increasingly difficult to find alpha. We have realised that emerging managers have far greater agility in finding better investment ideas. That’s why we back their newly launched funds.“

Emerging managers are the place to find outstanding investment performance – which is even proven statistically!

How To Find Suitable Family Offices

Like anything involving building a new fund manager, the above is all easier said than done.

The family office sector is famously opaque:

• 90% of family offices don’t even have a website.

• There is very little data available about most of them.

• Family offices tend to be suspicious of outsiders.

Much as family offices are the best possible backer for an emerging fund manager, they are also the hardest part of the market to get into.

Are you among the folks who are cold-calling and cold-emailing family offices?

One family office representative joked at a conference: “If you have a masochistic streak, put into your LinkedIn job description that you work for a family office. You’ll be inundated with emails.“

I know of family offices and principals who count the number of cold pitches they receive every month not by the hundreds but by the thousands. Needless to say, they don’t usually react to any of them. Cold calling and cold messaging won’t get you anywhere.

Family offices require

• warm introductions by trusted service providers and partners

• recommendations by other family offices

• personal trust built through ongoing dialogue

Ideally, you find ONE family office as your sponsor.

Anyone who has worked in the world of investing should have one or the other suitable contact they can lean on. Once you have found ONE family office that backs you in some shape or form, you have received the validation needed to make it easier to get in touch with others. Family offices know other family offices, and once one of them backs you, they will be able to give you introductions. They will have it in their self-interest to give you such introductions, because once they are invested with you, they’ll want to see you succeed!

Can’t find that that first family office to back you? Sorry, but then you may simply not be creative enough and not yet ready to set up a new fund manager. There are tens of thousands of family offices. If you are successful in managing investments and entrepreneurial enough to build a new firm, why would that be a problem that you cannot resolve?

Once you are in touch with one or several of them, always keep in mind that they are keen on personal relationships. Investors invest with people who they know, like, and trust. Or as someone from a multi-billion family office told me a while back: “In our industry, the human touch is under-rated.“

When a family office decides to back a first-time manager, it’s all about backing the people. They are under-writing the individuals who are in front of them – and knowing full well that their new firm will still require building up and building out.

One effective way to build a relationship with a family office is to spend more time and focus on learning what they are seeking. Don’t go into a meeting to deliver a monologue about your amazing strategy and why you are such an investment hotshot (they will see a dozen others that day who all claim the same). Spend at least the first 20 minutes asking them questions such as:

• What are they seeking?

• How does your idea fit into what they usually invest in?

• Are fees a subject that they are sensitive about?

Family office representatives often spend just the first two minutes speaking about themselves. Make them speak about themselves more, and then tell them how you can solve one of their problems and add value.

At the right moment, you should also speak to them about….

Sweeteners!

Outside of paying lower fees, family offices will often be interested in speaking to you about any form of sweetener you can offer.

This can involve a family office backing your first fund with a specific amount, if in exchange they are given an equity stake in the manager. Such so-called seeding deals are common, and can create a true win-win situation for both parties.

However, how to structure such seeding deals and what price to pay for them is an incredibly difficult question to answer. If you try to google the subject, you’ll find some general information. Overall, though, the structures and prices used for such agreements are incredibly opaque. (I have spent two years researching the area through personal contacts and will share a separate article about it sometime – so sign up to our email list to hear about it.)

As an emerging manager, you need to be careful not to give away too much equity too early. Such a seeding deal can also turn out to be an expensive way to get off the ground: “Participation in the general partner is something that a LOT of family offices do, but it is costly to the manager.“

Instead of an equity stake, you can also offer to a family office

• a seat on the Investment Committee of your fund

• privileged access to the fund team

• a share in the revenue of the manager (instead of equity)

• equity where you have a right to buy it back (if they absolutely want equity)

Again, there are endless variations and everything is subject to the specific needs of that family office and negotiating an individual solution with them.

In case you are wondering how to provide an investor with special terms but without creating another share class for your fund, read up on the term “Side Letter”. This is a standard practice in the industry, where (as an example) an emerging manager pays back some of the fees to a fund investor. It’s perfectly legal if properly handled, and the lawyers drawing up your fund’s prospectus will be able to include the relevant wording in your documents.

In any case, an emerging manager should not hesitate to discuss (or offer) such sweeteners. Family offices tend to be more entrepreneurial in their approach, and actively welcome such possibilities as they can add extra value for them. For an emerging manager, such an agreement can turn into the crucial aspect that they will need to offer in order to find that first sponsor in the world of family offices.

Surviving A Family Office’s Due Diligence

An emerging manager offers the advantages set out above, but they usually lack in other areas.

Check my colleague James Faulkner’s recent article about operational due diligence, to give you an idea of the stringent requirements that emerging fund managers need to work towards. Naturally, not a single emerging manager will be able to tick all these boxes from day one.

The due diligence carried out by a family office ahead of backing an emerging manager will differ somewhat from normal due diligence. One family office representative I listened to during my research summarised it as follows:

“Lacking the formal requirements in some areas means there will be more due diligence on the people. We do a lot of reference checks. We even use Kroll, to make sure their stories check out. The entire story simply has to be cohesive, and it has to be meaningful. Why should I care about their firm and their product? This is really the #1 question I want to have answered.“

It’s All Worth The Effort

Capital invested by family offices tends to be long-term capital – often even, permanent capital!

They will want to see a truly credible team building something that is incremental to what already exists in the world. If that’s what you can deliver and you are willing to deliver it in the form of a true partnership, then you WILL find interest among family offices.

Keep in mind that this sector of the financial market is all about trust. Or, to put it the other way around, it’s about suspicion. Family offices are notoriously suspicious of your motives, and of the risks that dealing with unfamiliar parties brings to them. They are also often worried about the popular perception that family office money is “dumb money” and “easy” which in turn drives their suspicion. Because of these worries, you are often best-advised to start your conversation with them by showing them your best, most conservative investment strategy.

On the other hand, being validated by one family office can be the springboard from which you then succeed in building an entire investment firm. That’s why it is all worth it.

What’s the very best way to get in front of them and convince them of your new firm?

Bring your enthusiasm for portfolio management *and* entrepreneurship to the table. Keep in mind that it really needs to be both of these factors, rather than one. Someone who is interested in portfolio management but finds managing a company to be a pesky aspect of their work will be unlikely to convince their counterpart to join them on their mission. Equally, someone who wants to build a fund management company but has no real interest in portfolio management will be unlikely to succeed either. If your firm doesn’t have that double-enthusiasm and double-expertise sitting in a single individual, make sure that it’s covered by a duo.

Authentic, infectious enthusiasm is the one aspect that only you can bring to the table. For everything else, keep following our articles about building an emerging manager. The intel we share on our website will help you save a lot of wasted time and money – and get you off the ground faster.

Disclaimer: This blog is intended for informational purposes only. This blog is not intended to invite, induce or encourage any persons to engage in any investment activities and is not a solicitation or an offer to buy or sell any stock, investment product or other financial instruments. If in doubt, please seek financial advice from an independent financial adviser. Sarnia Asset Management is licensed by the Guernsey Financial Services Commission (GFSC). Past performance is not an indication of future returns. Investments carry risk, including the risk that you will not recover the sum that you invested.