The champagne was flowing at a Hamptons gathering last month for members of Tiger 21, an investment club for the ultrawealthy. After some schmoozing, talk turned to a hot topic: do-it-yourself deal-making.
Some attendees invested directly in real estate. One sunk money into an amusement park (he lost big but his kid had fun, he joked).
For these and many other rich people, hedge funds, private equity and other traditional velvet-rope investments are no longer enough. They're looking to "go direct" — Wall Street-speak for putting their money straight into a business.
Direct investing is a well-worn strategy for billionaire families like the Dells and Pritzkers, who have multiplied their wealth by buying into private enterprises. But it's now trickling down to mere centimillionaires, who may lack the funding and financial know-how to build their own family offices, as public-market valuations grow ever larger.
The drive is also rooted in envy: Wealthy investors have watched people who took early stakes in successful startups such as Uber Technologies and Airbnb accumulate massive riches, at least on paper. Then there's the simple prestige of owning a piece of a company and having more power, in theory, than they would in a passive investment.
‘Bit Smarter'
"Some wealthy people don't like being in investment pools where they don't have a say," said Felix Herlihy, a managing director at Cascadia Capital, which specializes in the kinds of middle-market transactions family offices favor. "The thinking is by going direct, their performance over time will be superior. In a way, it's saying, 'I'm a little bit smarter.'"
In a poll last year of 157 families with more than $250 million, 66% said they wanted to do more direct investing. And such deals may even become more common among the less wealthy: U.S. Securities and Exchange Commission chairman Jay Clayton said last month he's considering an overhaul of rules meant to protect mom-and-pop investors in order to allow them to invest in private companies.
The trouble is that going direct means different things to different people — from buying shares ahead of an initial public offering to taking a majority stake in a business. And the risks to investors can vary wildly.
Moreover, the gap in returns between illiquid investments and highly traded stocks and bonds has never been smaller, said Michael Tiedemann, chief executive officer of Tiedemann Wealth Management.
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Buyer Beware
"There's a ton of money out there still waiting to be deployed," he said. "If the deal has reached your desk, and it is not an industry that you were an operator in, chances are it has been looked over and passed on by those who know much more about the competitive landscape than you."
But it's that competitive landscape that has the ultrarich looking to go direct, said Arthur Bavelas, who organizes lunches in New York to facilitate direct investing. Companies looking for money pay him a fee to present opportunities, and he promotes the event to his list of 800 wealthy families, who attend for free.
"They want deal flow that's ripe with opportunity and hasn't been picked over by others," said Mr. Bavelas, who has held about four dozen such gatherings this year. While he doesn't offer an opinion on investments, he has put his own cash into a handful of presenting companies, including one last year for Finix Solutions, a wealth administration platform for alternative assets.
Other investors find deals through the more traditional route: wealth advisers and banks, who are adding direct investing to their white-glove services for the rich — and getting lucrative fees. For a family with $100 million to invest, upper-end advisers charge about 40 to 50 basis points — $400,000 to $500,000 — annually.
Through a program called Morgan Private Ventures, JPMorgan Chase & Co. offers some clients — typically those with more than $200 million to deploy — a chance to invest in companies that are raising funding rounds, or with private equity and venture firms seeking to fill excess capacity in pools that invest alongside their funds. That's led to client investments in South Korean e-commerce giant Coupang, restaurant delivery service Deliveroo and electric-bus maker Proterra Inc.
An investment into a young entity gives a family "a front-row seat on how that company is performing, the edge that that company's technology or business model or product brings to the market," said John Duffy, global head of institutional wealth management for JPMorgan's private bank.
At Goldman Sachs, private wealth clients with as little as $10 million got the opportunity to put money into Cadre, a real estate tech startup partly owned by Jared Kushner. The bank's investors committed $250 million to buying properties on the platform, getting a small equity stake on top of that.
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Conflicting Interests
Multifamily offices can bring their client base together for deals. Wesley and Paul Karger at Boston-based Twin Focus Capital Partners, which has more than $4.5 billion under advisement, encourage their 30 families to get to know one another. When one client asked if the company would want to pitch in on buying a $10 million office building in Massachusetts, Twin Focus helped them model the risks, get financing and close the deal. It also brought along two other families to help fund it, said Paul Karger, who leads the firm's direct-investing efforts.
None of these arrangements is without conflicts. Banks, paid to raise money by a startup or seeking to curry favor with a private equity fund, have an incentive to fill the fundraising rounds they bring to market. An advisory firm that sources deals from one client to offer to other families it works with have a vested interest in keeping the original party happy, said Lawrence Calcano, CEO of alternative-investment network iCapital.
"The bar is high for any adviser showing direct investments to their clients, and the bar might be even higher still if the source of that investment is another client," he said.
And while direct investing may be all the talk at soirees like Tiger 21's gathering in the Hamptons, Cascadia's Mr. Herlihy offers a word of advice: "Most of what we do I don't think people brag about at cocktail parties. There is a saying about good investments: 'The more boring the better.'"
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