High risk, high reward and high interest: Private placements in family office portfolios

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Private placements appeal to a small, select group of investors, among them family offices. And they are big business in the investment industry.

“As ultra-high-net-worth investors, family offices get approached or offered — whatever word you want to use — private placements relatively often,” says Athas Kouvaras, portfolio manager and client relationship and development manager with Richter Family Office in Toronto.

The reason is that these families’ wealth allows them to make investments, anywhere from a few hundred thousand to several million dollars, in these high-risk/high-return “singular bets” on companies that often are not yet publicly traded, he adds.

The market is massive and encompasses all sectors of the economy, from manufacturing, mining and energy to technology and retail.

Yet it’s difficult to put a solid number on private placements, which are part of the much larger private investment realm including private debt, equity and venture capital funds, says Thane Stenner, senior portfolio manager with Canaccord Genuity Wealth Management in Vancouver.

“It’s big … hundreds and hundreds of billions of dollars, probably,” says Stenner, who works with family offices. And the deal flow is prolific. “We probably see without exaggeration three to five private placements come across our desk a day.”

Typically, private placements involve deals to buy shares, warrants or debt in a privately held company that is seeking to raise capital without the high costs of going public. They come in two types: non-brokered and brokered.

Non-brokered private placements are generally more common, higher risk and involve smaller allocations offered through one or a few advisers to a small group of investors, says Jason Sleeth, managing director at Canaccord Genuity in Toronto.

“Most non-brokered private placements haven’t gone through a rigorous exercise of due diligence to keep costs low,” Sleeth says about billable hours for lawyers and other professionals. Canaccord saw about 1,400 private placements last year, he adds.

The majority are non-brokered, seeking $2 million or less in funding. Brokered private placements are larger, generally aiming to raise $10 million to $50 million, and involve more due diligence, Stenner says. “They are where investment banking teams of dealers get involved doing more valuation on the company with comparables in the marketplace.”

The case for private placements

While presumably less risky than non-brokered private placements, brokered deals can still potentially go bust. Yet they also offer the potential for outsized returns, he adds.

As family offices are typically focused on preserving wealth, one might wonder: Why would one consider these speculative investments? Although true family offices do not need private placements, and indeed some do not have any exposure in their portfolio, many do.

“There is a case to be made for doing them,” says Kouvaras, who through Richter’s multi-family office practice works with families who hold private placements in their portfolios.

Private placements can play a small but significant role in portfolios, as most family offices have the financial heft to safely allocate capital without harming their overall wealth. “Our first job is to keep clients wealthy,” he says. “The definition of that is after fees, taxes and inflation, they’re compounding wealth at a moderate rate.”

In turn, diversified allocation to stocks, bonds, real estate and even private equity and venture capital funds suffice.

Yet many family offices have entrepreneurial streaks, given their wealth was often created via a private business. In turn, they may have a keen interest in private placements relating to their experience and interest, Stenner adds.

“They also understand that concentration of capital, while involving higher risk, also offers a much higher reward,” he says. “That’s why they’re intrigued.”

Plenty of research needed

It’s common for family offices to allocate about 5 per cent to 20 per cent of their portfolio to private placements, he says. “They have a lot of capital in public markets and real estate, and so they have an interest in investments that offer more juice, or alpha.”

Private placements also are offering a value opportunity after last year’s frothy market conditions, Stenner adds. “Maybe a year ago a deal was raising capital at $10 a share and now it’s trying the same deal at $3 a share,” he cites, as an example.

Stenner cautions that plenty of research is required, often by the family office or trusted third-party advisers, because “there is still a lot of crap that comes through that pipeline.”

As well, the process of investing in private placements is time consuming and often inefficient in many respects, Sleeth says. For example, “it involves a lot of paper pushing,” he explains, adding that websites such as DealMaker aim to provide more coordinated, digitized access, “but nobody has stitched it all together in one place.”

That could soon change due to technology making it easier to connect businesses, investors and capital together in a standardized and secure fashion, Sleeth says.

Sober second thought, and lessons learned

In the meantime, many family offices like those Richter represents will continue to be pitched — and intrigued by — private placements.

Advisers, in turn, will continue to provide sober second thought. “As long as they understand what the downside is — and it could be severe — then they will allocate capital appropriately,” Kouvaras says.

Still, some learn hard lessons when a deal goes awry. “Sometimes, though, it works the other way with a couple of spectacular wins, where people go, ‘My goodness, why am I investing in stocks when I should be doing a lot more of these?’” Kouvaras says. “That can often be much more harmful,” leading to larger, even more concentrated allocations.

He says he covers multiple case scenarios, with much less emphasis on upside than downside. But many want to invest all the same. “So if they come to us and say, ‘But I like these singular bets,’ that’s okay,” Kouvaras says.

In turn, he may suggest a measured approach of smaller allocations to a half dozen private placements or more, as opposed to the same sum invested in only one or two.

“All things being equal, we always push for diversification.”

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