“Club deals” are officially having their day.
The trend in direct investing among family offices has driven this rise of club deals or what’s more commonly known as co-investing. In 2021, club deals represented 92% of all family-office-funded startups globally.
Rob Follows, who established his own family office based in Barbados, has been doing direct investments and co-investing for years. “It can be a lot of fun," he said, "but it's only for the family offices that really want to roll their sleeves up and get involved in operating businesses.”
Follows takes a strategic approach when deciding whether to share a deal: “If we have enough equity, liquidity, the diversification fits our profile, and we have enough knowledge and expertise in the area, we'll do it on our own.”
The benefits of co-investing are about more than money, Follows said. Co-investors can spread risk on a large deal. Those who bring expertise and networks can add overall value. There are also scenarios where synergy between investors makes a deal viable. Follows points to a recent co-investment he made.
“It’s a life insurance deal in 14 jurisdictions. We don’t want the whole thing. Our intention is to sell off the U.S. asset because the compliance is too high. One of our co-investors will benefit from first right of refusal. It's value-add for them and for us.”
Due diligence is another core pillar of a club deal. Samira Salman is a family office executive and adviser with a background in corporate tax law and deal diligence and structuring. Salman advises families to use three elements to perform rigorous due diligence on both the opportunity and co-investors: a checklist, human intelligence and intuition
“A diligence checklist is critical," she said. "If you don’t have one, Google it and ask other families to share them with you. The checklist is a living, breathing thing. It needs to be added to and refined on a deal-by-deal basis. This becomes really important when something goes wrong. What could you have seen differently or asked about?”
Co-investors can benefit from group due diligence, since each will draw on different experiences and networks, Salman said. The human factor, she said, is often the most valuable. If you lack expertise, Salman advises calling other families who have done deals in the space.
But in the end, you have to trust your instincts.
“There are times when we check off everything," Salman said. "It looks like an amazing opportunity, and you've run it by other families in that sector, but you feel in your gut that something's a little bit wrong. I've never met an investor who said, ‘I regret trusting my gut.’ ”
When co-investors reach the deal table, Salman said, it’s important to be tactical about appointing board members, rather than handing out seats to family members. “Search for board members who have experience managing during bad times, not only good," she said. "You want to make sure you at least have somebody that understands the nitty-gritty numbers. You also want someone with experience in helping grow companies or turn companies around.
"It's not always the person who wrote the biggest check that has the best expertise to direct the board.”
Managing Director Tommy Mayes of SunGate Capital, a single-family private equity and investment office based in Florida, cautions family offices to understand and ensure that they have the resources for the heavy lifting involved in direct and co-investments. “It's a common misconception that an LP investment and direct or co-investing in a deal takes similar resources," Mayes said. "The talent and time required to diligence, underwrite, close and manage a direct investment is infinitely greater.”
After the deal is done, the administrative burdens increase — monitoring, management, tax and board meetings. That's why Mayes focuses on two things when first considering a deal: a check size that matches the resources required, and core competencies.
“A lot of times, families will want to put $1 [million to] $2 million," said. "I advise a minimum direct investment of $5 million with direct or co-investing. You've got to put enough money in to justify the extra work.”
Investing in a family’s core competency is another critical factor for both Mayes and Follows.
“A lot of families that venture outside things that they're good at tend to have less robust outcomes,” Mayes said. “I'm a big fan of families finding their core competency and zeroing in on that.”
Follows suggests family offices investing outside their competencies develop their own group of one to two sector-specific experts who source and perform diligence on deals, participate in equity and support leadership to ensure alignment.
“First-generation family offices have an advantage because they’re experts in the industry they created their wealth in," Follows said. "That person will often be very interested in deals they understand because they know everybody in the space. It’s easy to diligence and hire leadership they trust.”