Private View Blog: Why direct investing is the wrong approach for most private equity investors

The idea of direct investing has a dynamism and narrative drive, missing from a boring old balanced portfolio. However, direct investing is not for everyone and for many, if not most investors, private equity funds are a more than adequate way to access the private capital space. 

We say this from a position of neutrality; as a private investment office working with a number of families, the multi-asset portfolios we build for clients include private equity funds, but we also provide advice on their direct investments. There is definitely a space for both in the world of wealth management, but not every client needs to do both.

More talk than action

The truth is there is a lot more talk about direct investing than action. This is because direct investing is superficially appealing but actually very hard to do in a sustained way. 

The first issue is deal flow. The very phrase “deal flow” is like catnip to a certain sort of investor. The idea that you have access to deals, preferably off-market, which no one else has seen, which will return many multiples on your investment, is incredibly appealing. But such deals are incredibly rare and most of the off-market opportunities you see have, in fact, been circulating around the sector for months. 

The second issue is due diligence and, in particular, due diligence at speed. Direct investment deals are singular and idiosyncratic. Your due diligence capabilities will need the bandwidth to cover just about every sector and every legal structure and to do so very quickly. Funds have built up entire teams to put an opportunity through its paces within a couple of weeks and to do so on repeat throughout the year. Few private investors have built up this capacity and this amount of stamina. 

Still fewer have the discipline to ditch a deal at the 11th hour, despite having invested significant financial and human capital in it already. But it’s the willingness to discard a poor opportunity, despite the cash already deployed in researching it, that marks out a good investor from a mediocre one. Unless you, as a private investor, have a ruthlessly clinical investment committee at hand, you will risk making investments driven by emotion and sunk cost rather than by opportunity.

Running a company

Finally, there is the ongoing management challenge to deal with. Good investors don’t view the moment the deal is signed as having any special significance. The paperwork is not the investment – the life of the business after the documents are signed is what will make or break the venture. There are not all that many investors who really want to get involved in the day-to-day issues of running a business: cashflow, IT, HR challenges, marketing and sales strategies. And should the CEO suddenly fall under a bus, how many private investors really want to step in and sort out the mess?

Some investors are up for all of this. Many of our clients have made a huge success of their direct investments, but usually because they have invested upfront in the infrastructure required and are able to take the necessary long-term view. But other clients conclude they can achieve something not dissimilar with lower volatility and drama through a fund structure. Yes, they lose the ability to control the deal but they also lose the hassle and challenge of running businesses. 

For all these reasons, a fund can be a decent way to access private capital opportunities. We advise our clients to dial down the noise about what others are doing, to think carefully about the route that suits them best and to invest accordingly. 

Charlotte Thorne is founding partner of Capital Generation Partners