Family Offices: Navigating Hidden Risks in Direct Investments

Family offices, the in-house investment and service firms of high-net-worth families, have increasingly been making direct investments in private companies. However, these direct deals could mean taking on more risk than family offices realize if they aren't leveraging their resources effectively. A new study from The Wharton School highlights the challenges family offices face when making direct investments and offers strategies to mitigate these hidden risks.

Direct deals, when family offices buy stakes in private companies directly rather than through a private equity manager, have become hugely popular. According to the 2024 Wharton Family Office Survey, half of family offices plan on conducting deals in the next two years. However, many family offices may not be fully leveraging their strengths as investors or taking adequate precautions to manage the risks associated with direct investments.

The survey found that only half of family offices making direct private investments have private equity professionals on staff who are trained to structure and identify the best private deals. Additionally, only 20% of family offices doing direct deals take a board seat as part of their investment, suggesting they lack forceful oversight and monitoring. This lack of professional expertise and active involvement can lead to suboptimal investment decisions and increased risks.

Family offices pride themselves on their patient capital, investing in companies for a decade or more to take advantage of their "illiquidity premium." Yet when vying for investments in private companies, family offices often stress that they don't need a fast exit like private equity firms. The majority of family offices surveyed (60%) said their overall time horizon for their investments is longer than a decade. However, nearly a third of family offices surveyed said their time horizon for direct deals is only between three and five years, indicating a disconnect between their long-term investment philosophy and their direct investment strategies.

To effectively manage the risks associated with direct investments, family offices should leverage their strengths as investors and adopt robust governance frameworks. Establishing clear policies, fostering transparency and communication, and maintaining a long-term perspective can help family offices navigate challenges and preserve their legacy across generations.



One strategy to mitigate risks is to strengthen the investment team by hiring or training staff with private equity expertise. This can help family offices identify and evaluate potential investments more effectively, understanding the nuances of private company valuations, deal structuring, and risk assessment. Additionally, taking a board seat allows family offices to have a more hands-on role in the investee company's operations and decision-making processes, enabling better monitoring of the company's performance and helping mitigate risks.

Family offices can also leverage their networks and partnerships to gain insights, share best practices, and co-invest in deals. This can help diversify the investment portfolio and provide additional resources for due diligence and monitoring. Establishing clear investment criteria and processes, including defining sector focus, deal size, and risk tolerance, helps family offices maintain a disciplined approach to direct investing. Regularly reviewing and updating investment theses ensures that direct investments remain aligned with the family's long-term objectives and risk tolerance.



Differing generational values and priorities can also impact the selection and management of direct investments. A study by The Wharton School found that only 12% of family offices surveyed invested in other family-owned companies, suggesting that younger generations may prioritize non-family-owned businesses with innovative products or services. However, this approach may overlook the potential for strategic partnerships and synergies with family-owned companies. To mitigate these risks, family offices should foster open dialogues across generations, leveraging diverse perspectives to make informed investment decisions and ensure long-term alignment with family values and objectives.

In conclusion, family offices face hidden risks in making direct investments, which can be mitigated through strategic assessment and management. By leveraging their strengths as investors, adopting robust governance frameworks, and fostering open communication across generations, family offices can effectively navigate the challenges of direct investing and preserve their legacy across generations.