Creating Alignment Between PE Funds and Their Family Office Investors
In November 2024, Barron's reported that “Family offices are betting big on private equity.” For us at the private equity firm, Mauloa , that’s nothing new. Most of our capital has come from family offices and ultra-high net worth individuals, since we do not have any institutional investors. From inception, family offices have been active partners with Mauloa, not seen as random capital sources. For example, our chairman, ProShares cofounder Louis Mayberg, serves on our investment committee, and his family office plays an integral role with our funds. Additionally, an LA-based consortium of six family offices has its CIO serve on our investment committee, ensuring clarity long before any subscription agreements are sent out. Collectively, we generate cash flow for all stakeholders, while providing unlevered, non-controlling growth capital to middle market companies (those with revenue from $10M-1B).
Since 2007, we’ve worked diligently with our family offices to not only evolve our approach but to ensure they’re proud to be a part of it. For as Warren Buffett said to his earliest investors, “If you don’t feel this way you shouldn’t join, because I don’t want you unhappy while I’m happy or vice versa.” Now on our third fund, here is what we’ve learned about creating alignment between private equity and family office investors.?
Everything starts with trust between the family office and the private equity principles. From there, it boils down to four questions: How is the money being invested? How is the fund structured? How do investors stand to benefit? What is the time frame?
How is the money being invested??
Since private equity is essentially a service provider to its family office investors, firms must clearly articulate the size, sector, and structure of their investments. What gives the PE firm an edge or makes it uniquely valuable in the marketplace? Complicating matters, many PE firms wind up saying annoyingly similar things about “partnering with management” and “growing the company,” especially in the crowded middle market.?
For us, we’ve found that how we structure deals is a key differentiator, since we don’t use debt, take control of the company, or try to exit after a predetermined number of years. We’re also intentionally smaller ($15-30M per investment), which expands our investment universe, though we prioritize companies in close proximity to our Washington DC and LA offices. Our family office partners have played an active role in shaping our approach: At Mauloa, we think that cash flow is sexy and invest in service-oriented businesses that can produce endless streams of it. Without using debt or taking control, we serve as a strategic capital partner to US companies that generate over $3M in free cash flow from at least $20M in revenue, boast strong corporate cultures, and are led by people that we "like, trust, and admire."
However, we’ve taken great strides to tighten our thesis and more clearly define our investment criteria. This includes sharper quantitative parameters and sector discipline. But most of all, we are far more strict on the qualitative side. Learning from past mistakes, we now delve deeply into a company’s culture and the integrity of its leadership. This year alone, we’ve walked away from several deals that had great numbers but didn’t check the box when it came to people. While this may sound simple, anyone with experience knows that it isn’t, like laying down a great poker hand when necessary.
How is the fund structured?
Most PE firms have a committed fund operating under the “2 and 20 model,” 2% management fees on funds raised and 20% of profits generated. The downside to that for investors is that their capital is usually tied up for a decade, and that’s only if the fund performs well.
At Mauloa, we have a committed fund but also invest via sidecars (special purpose vehicles) on most deals. So, on a $100M fund, we’ll ultimately deploy at least $200-300M. When we introduce a fund, this affords newer investors a “test drive” by making a smaller initial investment into a sidecar, typically $500K or 1M at first. Once they get comfortable with our approach (often after receiving a couple of distributions), they’ll usually invest a larger amount into the core fund if it hasn’t yet closed, since there are lower fees incentivizing them to do so. And, as additional investments are made, the core fund becomes even more sought after because it's a portfolio of companies that generate diversified streams of cash flow.
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How does the family office stand to benefit?
In most cases, family offices expect PE firms to produce market-beating, risk-adjusted returns that they couldn’t achieve on their own. Since returns can take a while to realize, in the interim, PE firms must be able to source deals and add value to their portfolio companies.
One of the biggest financial incentives for our investors is yield from quarterly and annual distributions. Our portfolio companies are unlikely to discover a cure for cancer, but they will generate a lot of cash. As Charlie Munger once said in reference to See’s Candies, “There are a large number of businesses in America that throw off lots of cash, but which cannot be expanded very much,” though he prefaced it in saying, “By the way, we really shouldn't complain about this because we've carefully selected a bunch of businesses that just drown in money every year." These are the companies in which Mauloa invests.
However, this aspect isn’t always a fit for investors. One family office passed because their main business already generates a lot of cash, so Mauloa didn’t fit their risk profile. They wanted to invest in moonshots, taking big swings alongside much larger family offices.
Our family offices can do whatever they want with their money, but they choose to invest with us because we help them support the backbone of America’s economy: small and medium-sized businesses. Our portfolio companies provide jobs and serve as pillars in their communities. Our investors make money while also knowing that we don’t burden our companies with debt and instead help them grow organically over the long-term.
We are proud of Mauloa’s approach, but it isn’t a fit for all investors. For example, a Texas-based family office passed on us because they wanted to back the likes of KKR and Apollo. They wanted to say they were invested in the biggest PE brands, which also helped them derive certain social benefits.
What is the time frame?
Most PE funds last for a decade, though they can exist for much longer when portfolio companies are difficult to sell. When interest rates rise and the economies slow down, PE firms can get “stuck” with companies, so it is especially important to gain alignment with family office investors on this topic.
This is perhaps our greatest differentiator, and it’s absolutely critical that we achieve proper alignment here with family offices. We are perfectly fine holding the investments indefinitely, which is why our firm is named Mauloa, which means “endless” in Hawaiian. Along the way, our family office investors receive annual distributions, which can grow to be multiples on their invested capital. As most people are quick to detect, we model much of our approach after Berkshire Hathaway and Warren Buffett, who has said that his ideal holding period for investments is “forever.” A perfect investment for Mauloa would be something comparable to See’s Candies, which originally cost $25M and has returned over $2B in free cash since 1972.
For any family office looking to invest in PE funds, these are important areas in which to gain alignment before deploying capital that could be tied up for over a decade.