Publications

- June 1, 2018: Vol. 5, Number 6

Capital flows to club deals: Like-minded investors pool money and expertise to make direct investments

by Beth Mattson-Teig

Investment clubs — groups of like-minded investors who pool capital to acquire stakes in property or business interests — have been around for decades. These days, those clubs are proving to have deep pockets and a big appetite for real assets.

“Anecdotally, I think club deals are becoming a lot more attractive,” says Monte Lee-Wen, president and founder of the PPA Group, a real estate investment company based in Austin. In the past, family offices were more apt to invest directly with a sponsor and general partner. “Some family offices feel that they have been burned on some of those kinds of transactions, and they are looking for other families that, one, have a stake in the deals that they’re doing and, two, that have expertise,” says Lee-Wen.

The Lee-Wen family formed its own real estate–focused family office, Casoro Capital, in 2015. It invests alongside other high-net-worth families in multifamily real estate, with sponsors throughout the country.

Interest in club deals is rising along with global wealth. The global population of high-net-worth individuals has continued to grow at a steady pace in recent years. According to the 2017 Capgemini Global Wealth Report, global wealth of high-net-worth individuals is on track to exceed $100 trillion by 2025. Worldwide, the high-net-worth population expanded by 7.5 percent in 2016, while the wealth held by that group increased by 8.2 percent.

PIGGYBACKING ON EXPERTISE

Clubs run the gamut from a group of college buddies buying a rental house to high-net-worth individuals and family offices putting millions of dollars to work to create income and preserve wealth for future generations. At their core, club investor networks are built on relationships. People prefer to invest with other like-minded people they know and trust.

“You tend to see the same funds in every deal because they already know what the terms are going to be. They already know what the structure is going to be like, and no one is going to throw a monkey wrench into that,” says Michael Felman, president and CEO of MSF Capital Advisors. It is not a cookie-cutter process, but the learning curve has already been established, people know how things work, and they know what to expect, he explains.

MSF Capital Advisors is a family office advisory that includes the Felman family and about 60 others. The firm focuses on direct investments through club or syndication deals that include buying real estate and private companies. At MSF Capital, typically one family takes the lead or acts as the sponsor, and then the deal is syndicated or filled in with the other families in the network. If MSF Capital cannot fill a deal within its own network, it may go outside to other families or institutions.

Club deals are about more than money, however. These days, a lot of liquidity and capital is available in the market and, in many cases, cheaper capital. Club investments are about finding a partner who has expertise and relationships in a particular sector, such as real estate, healthcare or cybersecurity. “In many cases, you are not just looking for capital, but you also are looking for what that party can bring to the table besides money,” says Felman.

This past summer, MSF Capital did a large private-equity club deal to acquire a third-party pharmacy benefits manager. The deal was led by a family with ties to one of the largest healthcare distribution companies in the United States, and one of its goals with the acquisition was to expand the business in China. One of the two other families who went into the deal had connections in China. “So, it wasn’t just the capital. They believed they could help them open up doors in China for their business,” says Felman.

Many of the families or individuals in a club made their wealth in one specific area. “So, when you have a group of 10 different investors, most likely you have one that really understands that space, and the others are able to piggyback off of those people to help with the due diligence,” adds DJ Van Keuren, vice president of family office capital at Hayman Family Office.

In some cases, a club member may also have experience with a sponsor or sector where they walked away from a deal in the past, and they can share with the group their reasons for doing so. “It helps create a system of checks and balances, where it is totally an objective analysis, because families are putting their own money in, and they are not getting paid a commission or incentive to get the deal done,” says Van Keuren.

ADVANTAGES OF CLUB DEALS

One of the big drivers behind club deals is the ability to place capital alongside other investors who have the same goals and objectives. Families, for example, tend to have a big focus on wealth preservation and generational growth. “Families love to work with other families because there is a respect and understanding,” explains Van Keuren. They know the person sitting next to them has been successful and knows what it takes to build a business, he adds.

“We know where each other comes from, and we know how hard it’s been and how much work it has taken to build our wealth, and we want to preserve and protect it,” agrees Lee-Wen. “So, our interests are very similar versus just going with an outside GP sponsor that is more about their promoted interest and their fees.” That is not to say family offices are not focused on their return on investment, but family offices working together tend to have interests that are more aligned, he adds.

Some club investors like having more control and choose to make specific investments instead of putting money into a large, generic pool fund. Club investors also can customize deal terms and structures for their own priorities, rather than conforming to the stipulations of a fund manager.

Another big incentive is lower fees and costs. “Fund fees and terms have been under increasing investor scrutiny since 2008, and sophisticated investors have teamed up to organize specific deals on their own. This allows them to bypass fund subscription conditions and limitations,” says Matthew Sullivan, a vice president with the Opal Group. The firm organizes a variety of family office events, including the annual Family Office & Private Wealth Management Forum.

CLUBS CONTINUE TO DIVERSIFY

Some families are continuing to expand and diversify club investment portfolios across real assets — real estate, infrastructure, energy, timber and agriculture, as well as private equity investments in companies across industries. “Especially with the recent volatility in the stock market, we have seen a real uptick in the number of people who are reaching out looking for these types of deals because they are looking for a safer place to park their money,” says Joy Schoffler, chief strategy officer at Casoro Capital.

Clubs also are finding more investment opportunities as the real assets sector continues to mature. Ten years ago, for example, investors were just beginning to get comfortable with natural resources as an asset class, so it was not surprising to see initial investments focused on primary commitments. Now more opportunities exist to do deals directly with high-quality management teams, notes Ryan Sullivan, co-head of real assets for Aberdeen Standard Investments in Boston. “Secondly, and importantly, the depth and quality of the deal flow is beginning to support that trend, just given how the private real assets sector is continuing to evolve,” he adds.

The private real assets team at Aberdeen Standard Investments focuses on energy, mining, timber and agriculture. The two main ways Aberdeen Standard invests are through primary commitments to fund managers or through direct deals, such as co-investment or club deals. “The direct-deal component of what we have done has been accelerating over the last couple of years, and I would expect it to continue to accelerate into the future,” says Sullivan.

There is more depth and quality of deal flow occurring in the energy space, notes Ryan Sullivan. U.S. investors are comfortable investing in energy, whether that is upstream, midstream or power generation. They understand the asset class, and it attracts a much deeper pool of private equity investors overall. Oil prices also are more stable than they were two years ago, which has made investors more comfortable with placing capital in the market.

Some of the deals that are a tougher sell for family offices include early-stage venture deals. Many families like to invest in cash-flow-positive companies; clubs are wary of oil and gas or mining deals, for example, that are more exploration oriented and carry more exploration risk.

CLUBS AIM FOR ALIGNED INTERESTS

Club deals also work best when interests and strategies are aligned. Getting 10 people to share the same vision and be on the same page is very difficult. Not every family wants to buy and hold. Some want to buy and sell in five, 10 or 15 years. So, it is important everyone understands the time frame going into a deal. The goal and strategy need to be clearly defined within the structure for that investment, and there also need to be provisions for people who want to exit a deal.

“Typically, these are families who are used to being the boss,” says Felman. These co-investment deals work best with a small number of families invested in a deal, so there aren’t “too many cooks in the kitchen,” he adds. Most club deals include between three and seven investors. Getting two or three to agree on the structure and who might act in the majority- or general-partner type of role is not easy, he adds.

“It is critically important for us just to make sure that the other folks in the club have a similar time horizon and perspective as us,” agrees Ryan Sullivan. It also is important to have a very defined value-creation plan in place from day one. What are the various metrics the investment club wants to monitor, and how does it want to collectively measure those? “Getting all that up front makes everyone’s lives easier, particularly the management team running the asset on a day-to-day basis,” he says.

Problems often arise with the structure of the deal. Minority investors find out too late they don’t have the protections to exit a deal, or lack the ability to take over the control of a deal if the lead investor exits. So, structuring the deal is as important as the deal itself. Club deals need to include contingency clauses, such as a buyout clause that allows the lead investor to purchase the interests of the other partners if they should want to exit the investment in the future.

OVERCOMING CHALLENGES

Some of the problems that pop up in club deals are the same issues that plague other investment structures. Direct investment often involves buying illiquid assets that take time to sell, which can create a problem if one partner wants or needs to exit an investment.

Casoro Capital is preparing to launch a nontraded REIT, Upside Avenue, in May that will provide a solution to potential liquidity issues. It will offer greater liquidity for families that are looking for more of an income-producing investment product. Because it is structured as a Regulation A+, it is open to a wider pool of accredited and nonaccredited investors. “We’re always trying to solve the liquidity issue because that is one of everyone’s main concerns — being locked into an investment for seven to 10 years,” says Lee-Wen.

Casoro Capital has been doing three to five club deals per year. With its non-traded REIT coming online and some new relationships the company is forming with other family offices, the firm hopes to expand that capacity to seven or eight deals per year.

Another challenge is finding good deals in sectors or markets with high levels of liquidity and competition from institutional investors and private equity funds. Specific to commercial real estate, cap rates are very low, with property values likely at or near the peak of the cycle. Finding good deals at an attractive price is another challenge because of constrained supply and a lot of capital chasing the same deals.

The PPA Group is putting in four to five offers each week on multifamily properties, and it may take two months before it wins a deal at the right price. “With club deals, what I like is that other families are doing similar things, and they have their ear to the ground,” says Lee-Wen. “It’s great when the club network helps to identify off-market deals. That definitely helps us to expand our pipeline.”

Another trend creeping into private real asset investments is sponsors that were doing co-investment and club deals directly are using that as a stepping stone to raise capital for a fund. In some cases, an individual or two have worked with a high-quality real assets manager and then formed their own firm. Their strategy is to do more deals on a club basis and then ultimately think about raising their own commingled fund.

“I personally think that is going to be a really interesting trend to watch in real assets, especially drawing on parallels we have seen in private equity,” says Ryan Sullivan. “It is not just, ‘Hey, let’s club together and do this deal;’ it’s a little bit more of a programmatic relationship with a sponsor, where there is an ability to do a couple of direct deals, and then they ultimately want to go and raise a fund, and their club investors can be helpful in raising capital.”

Beth Mattson-Teig is a freelance writer based in Minneapolis.

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