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Family offices in Canada are asserting more autonomy over their investment decisions, including the benefits and risks associated with investing in distressed private companies.

“The acceptance of private equity fund fees and the blind pool risk associated with trusting a firm to make sound investments at some future date has wavered a bit in recent years,” says Mike Stritch, chief investment officer at the BMO Family Office in Chicago.

“Today, some family offices desire to be more hands-on in terms of understanding the investment and possibly even operating the company, rather than settling for a passive purchase,” he adds.

Family offices in Canada are investing more in private markets, including private equity, of which distressed assets are a sub-asset class, says Yannick Archambault, a Toronto-based partner with KPMG in Canada and national leader of the firm’s family office practice.

They are also investing in private credit, infrastructure and real estate, and this investment is being conducted through a combination of direct deals and pooled funds, he adds.

Family offices are investing in distressed businesses in multiple industries, both for turnaround purposes, and for longer-term returns, says Greg Thompson, executive chairman of Focus Asset Management, a privately owned high net worth wealth management firm in Toronto.

“It’s across the board. There are families that have been committed in rescues of a failed real-estate venture. We’ve even seen it affect technology. We’ve seen great ideas that couldn’t get off the ground, or somebody has had great technology but they couldn’t execute it properly – then a family office came in to take it to the next level,” he elaborates.

Less post-COVID distress than expected

An anticipated surge in distressed investment opportunities as a result of the global pandemic, however, has not materialized.

Although family offices have expressed interest in purchasing distressed companies suffering financially because of COVID-19, there have been a relative lack of opportunities to do so, says Stritch.

Family offices that were ready to deploy capital very early during the pandemic were probably able to buy some discounted assets, especially those that were more readily tradable. But as governments around the world stepped in with fiscal and monetary assistance, it became harder to find distressed properties, he notes.

“The distress story hasn’t really played out yet because it wasn’t as prolonged of a downdraft for the economy as was initially suspected,” says Stritch.

Anamika Gadia, a Toronto-based partner in Deal Advisory with KPMG in Canada and leader of the firm’s restructuring and turnaround practice, says the risk-return profile of a distressed investment is very different than that of a non-distressed investment.

The distress story hasn’t really played out yet because it wasn’t as prolonged of a downdraft for the economy as was initially suspected.

Mike Stritch, BMO Family Office

Higher risk distressed assets have lower valuations, and often these assets can be purchased at a deep discount that prices in the level of distress. Having a sophisticated team, with the necessary industry and management level experience, provides the potential to turn the acquired business around to provide a healthy return, she elaborates.

A key benefit of private direct investing is greater control. “If you want to be a majority investor, you have control over who is the CEO. You can have control over the strategic direction. You can even have control over the types of future financing the company will do, so that you don’t get diluted,” says Thompson.

There are potential fee savings, but, “This is not about saving fees. This is about having more control over what you’re doing. If you think about the risk-reward in this segment of the market, the fees become a pretty small part of the overall success or failure equation,” stresses Thompson.

Disadvantages of distress investing

A disadvantage associated with direct private investing is that if members of the family office sour on their investment, they cannot as readily sell it as they could a publicly listed equity in a public market.

There is also more concentrated risk with a single direct investment versus a diversified fund structure, although industry knowledge and specialization might help mitigate that risk. For example, it could make sense for a family office that had been a lifetime operator of hotels to acquire a distressed hotel franchise as a potential direct investment, says Stritch.

“By and large, we see that the traditional owner-operator types are typically going to be oriented with the industry where they made their wealth in a lot of cases,” says Stritch.

A sophisticated family office that is willing to take on the risks of private investing must either have somebody in the family with expertise in making those kinds of decisions, or else they will need to hire a professional, or work with an outside expert, says Thompson.

“You need somebody that is heavily engaged on your team to do this. This is not like buying a fund that’s managed by a fund manager, or buying a public equity where it’s run by the CEO and the board, and if you don’t like what’s going on, you sell it,” he explains.

This is very different, requiring an active type of investing in a challenging situation that requires guidance. “The risk is that if you take your eye off the ball, or you don’t have time, things may not go well,” warns Thompson.

Working together with other investors

There are potentially significant upsides to having family offices work together for investment purposes.

“The biggest advantage is that you have more than one set of eyes behind what you’re doing. If you have three or four family offices working together, typically there’s at least one person in that group of family offices that knows their way around. They’ve seen all kinds of different investments in businesses. They’ve seen failure a number of times,” says Thompson.

“The other big opportunity is that you can then rally a bigger dollar amount to go after a little larger investment and get a more professional management team if that’s what’s required to turn the company around,” he elaborates.

Like-minded families tend to work together. “Often you’ll see family offices operating in small, private networks having conversations about their respective investment strategies,” says Archambault.

At some point family offices that discover they are aligned to the same philosophy and values begin to appreciate collaborating together. They will pool capital and share risk for even larger acquisitions with, in most cases, a long-term focus, he adds.

Downsides of collaboration

But there are also potential downsides associated with working together.

Whether the arrangement is formal or informal, a shareholder’s agreement will be required to accommodate all of the investors with respect to issues like profit sharing and voting rights, and to deal with potential conflicts. It might be that success doesn’t happen quickly and more money is required, or another change is deemed necessary in the strategy, which could lead to frustration among some members of the group, Thompson notes.

Logistical considerations that the families will need to consider in that shareholders’ agreement include, “What type of partnership is it? Who is in control? Who makes decisions? What happens if things don’t go the way somebody wants?” says Stritch.

Precise statistics about the extent of private family office investing are not available.

Family offices are very private about what they do and there is insufficient data for Canada from that perspective, says Archambault.

Family direct investing will only typically represent a small part of an asset mix for a traditional family office. But even if it is only, say, three or four per cent of the asset mix, if the investments are good, they could end up delivering a lot of bang for the buck in their return, says Thompson.

“These are investments that can do very well if you get them right,” he stresses.

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