Cutting Through the COVID-19 Chaos: Strategies for Making Direct Investments and Co-Investment Opportunities in Uncertain Times

Date: May 13, 2020
Welcome everybody. Thank you for joining us for today’s discussion on family office, direct investing and coinvesting in this changing market and during these crazy, crazy times. A few housekeeping items before we get started. We would like this session to be as interactive as possible. And questions could be submitted through the Q&A function on Zoom. We will be able to see those questions, and we’ll try to answer them as much as possible as we work our way through, through the slides. The presentation will be distributed after the webinar, and we do have CLE credit pending, and so if you are in, you know, New York for your jurisdiction, please listen at the end for the validation code, which we will give. By way of introductions. I am Jake Townsend. I am a partner in the Chicago office at McDermott. A big part of my practice is working with family offices on a wide range of their investment activities, from direct investing, as well as through structuring investment vehicles and structures within the family office. We have a great panel today. We, going to join us is Paul Carbone, who is president and managing partner of Pritzker Private Capital. Thank you, Paul, for joining us. Maybe you could say a few, few additional things about the exciting things you guys are doing at Pritzker Private Capital.

Yeah. So, Pritzker Private Capital is a family investment firm. We, we invest on behalf of select members of the Pritzker family, other families, and select other long-term investors. We’re a majority and a minority investor organized on a sector basis with an operations team, about 40professionals total. We’re a family that invests in other family businesses. And that will be mostly what I talk about today, is that family capital in today’s marketplace. And, obviously, credit is an important part of today’s world in terms of credit investing. But I’m going to stick to equity, not debt. So family equity investing in family found or owned businesses will be the topic, I’ll cover today.

Great. And, also joining us is today is Rami Turayhi who is a partner in our New York office in our fund group, and he works closely with PE funds structuring, the funds themselves, but as well as their co-investments. So, Rami, maybe you could give a little bit of additional background as well.

Yeah sure. Thanks, Jake. So I am, as Jake noted, a partner in the New York office. I focus primarily on fund formation, both sponsor side work and, okay, to some extent, a limited partner and investor representation as well. Most of our work is on private equity fund formation. I also dabble in hedge fund and venture capital structuring as well. We, you know, at McDermott we do a good deal of family office related funds work, which is sort of an unusual niche for a fund formation practice because of our private client base. And so we’re uniquely attuned to some of the aspects of the invested funds that relate to family offices. Today, I’ll be focusing mainly on investment and joint venture structuring in the context of, sort of, broader direct investment.

Great. Well, let’s get started. Paul, maybe you could start us off with what you are seeing about, sort of, particular opportunities or challenges in what has got to be one of the craziest markets we’ve, we’ve, you’ve seen maybe in your lifetime.

Yeah. You know, I’m sure in all our lifetimes. I mean, obviously, we know, we know the big picture. All of us. The combination of a global pandemic, government-imposed shutdowns, massive stimulus, all creating, sort of, unprecedented economic collapse. What I wanted to comment, on this slide in particular, that’s the obvious. And what does that mean beyond the GDP declines? We’re seeing a couple of things in the marketplace in terms of the broad set of risk and opportunities. So first, fundamental structural changes going on. Changed consumer behavior and experienced acceleration of industry evolution. So think, what’s going on here with internet purchasing, telemedicine? What’s going to happen with automation? What’s going to happen in the oil industry? So, fundamental structural change that’s happening, then you layer on top of that a time duration. So how do you think about that fundamental change? What’s fleeting? What’s long lasting? So think quick service restaurants. Massively impacted today, but that’s not going to be a fundamental structural change. How the food is served in the quick service restaurant may change. Think about travel, sports, physician practice management companies. Those have been just basically shut down. But that’s coming back. You’re going to need dental services, etcetera. So, it’s structural change with an overlay of duration that has to be evaluated. And then at the same time, you’re going to see fundamental restructuring of industries. Consolidation is going to happen. Supply chains were massively disrupted, and that’s going to have an impact in terms of how people operate going forward. So, massive change, massive complexity, therefore significant risk. But at the same time, we’re going to talk today a little bit about the opportunities that present themselves in the midst of that risk. Jake, do you want me to just keep going?

Yes. Yeah, that’d be great.

So next slide, please. So let’s, let’s look a little bit of at categorization of opportunities in today’s world, and I’ve created three buckets here. We’re seeing opportunities in all three of these. So, bucket one, distressed companies, fundamental restructuring, recapitalization being required. Second category that we’re seeing, solid companies, they’re looking for a partner in the storm. Family might have owned a business for an extended period of time, but this market is creating angst. All of their assets are in the company. They want a partner in the storm, and often they’re looking for supplemental capital as well. And then the third bucket we’re seeing, we’re having some really interesting discussions. Strong companies who are looking for partner and/or capital to go on the offense. They’re seeing opportunities, and they want to have a colleague and a partner to help them execute. And again, we’re seeing opportunities across all three of these. Major family with an operating company wants to talk to us about going on offense. Founder who wants a junior partner exited from the business. Major investor who has shut down their vehicle and needs a liquidity on the equity investments they have made. Plus, you know, the fourth category might be divisional divestitures. We’re seeing more and more that his company’s reset their portfolio of companies in their businesses. So, that’s a, that’s a quick categorization of opportunities. You know, people have talked about deal flow being significantly reduced. There is no question about that. Lenders are refocusing, traditional equity sources are distracted. But in every market, there are opportunities. There are sellers today, not as many as there were six months ago, but there are sellers today. Now, those sellers have more limited options. And that creates, to some degree, an opportunity. And in fact, in this sort of market, family capital could be even more differentiated than it has been in times past. And differentiation in today’s market could really create preference among the sources of capitals that sellers have to choose among. What’s interesting is we’re beginning to see family businesses, families talking about partners or third-party capital when normally they never would have contemplated that option. So, you’re seeing interesting opportunities in today’s market. The complexity and the convoluted nature of today’s market create real opportunities, I think, for deployers of capital. By the way, we really would love to get questions from people so jump in, so this is made a little bit more interactive. Would love to answer what you want to hear about. So next slide.

So, so let’s turn to, to returns in today’s world. Clearly there’s an increased scarcity of capital than in times past. So, that capital merits appropriate return. And the first subpoint here, I just wanted to make, make clear, which is, and explain what I mean by the point, which is, is what I notice with many families is, return is relative. So if I can generate 500 basis points over some benchmark with treasuries or whatever, that, that I as an investor feel good. And I, I think that’s a very slippery slope approach to investing and creating return. In our opinion, returns are absolute because risk is absolute. You push your chips on the table, you acquire a company you deserve to be, and should be compensated for the risks you take. It is not a relative game. It’s an absolute game. Now there is, there are questions about the construct of return. How do you think about a stable coupon versus a variable upside return? The composition of return is clearly something you want to think about the based upon the market environment. But the absolute level of return is not relative. The absolute degree of return is not relative. Importantly, family capital has characteristics which, to certain sellers makes it more attractive. All dollars are not equal. That’s true in good markets in bad markets, but in more difficult markets, I think it’s particularly true. There’s value to the capital that families provide because of the inherent nature of that capital, and that should be rewarded by sellers seeking that kind of capital. And the other thing I’ll mention, is, this subpoint, which is, in these sorts of markets and opportunities, the ability to acquire a franchise business, a fundamentally attractive business, will happen, because of certain reasons why sellers have to sell. You will, we will, all of us will have the opportunity to acquire franchise businesses. Those businesses are going to require a premium, good markets, bad markets. But you don’t always get the opportunity to acquire these franchise opportunities. So, there’s real opportunity here in this difficult market to acquire some interesting businesses. You’re not going to get them for a steal, but, but that opportunity only presents itself because of the complexities in today’s world. Now, I don’t know if you wanted to come in.

And I was going to say, this is where, this is where that, you know, I as the lawyer, I’m going to come in with the downer, which is, you know, that, and that’s the next bullet point, which is the downside potential is real. And while there are absolutely opportunities in this market, we have been definitely working with families over the last couple of months since the crisis began, with some of their direct investments, who that, you know, that we’re really challenged by this market. And that, you know, presented a whole new of wave of, of challenges, both for the underlying business, but for the family office to think through their direct investment. And that really related to family offices, families that took a control position, for example, in some of their investments. As they are, you know, as they were evaluating and working a working with the company now that was evaluating bankruptcy options, it had, you know, everything from membership and participation on the board through just understanding what that bankruptcy process would be with working with the bankruptcy court. And then ultimately, with an eye to would, were they going to have to sell the assets through a bankruptcy option, or what were the other alternatives? And again, bankruptcy is not the only option. There are a lot of other different ways that we were, sort of, creative in finding solutions. I’ll bring up some other ones as we as we work through the slides. But I guess, I just wanted to sort of stop and say, you know, for is as much as there is the opportunity and no doubt that there is challenge, there are challenges and headwinds in this environment, you know, the downside, the downside of direct investing is also, is also real. And families that entered the business in one, for one, in one area are now finding themselves becoming experts in, in insolvency and bankruptcy laws as they work through a bankruptcy of some of these investments. So maybe next slide.

Which, which again, it sort of comes in, in most commonly when you are having these, sort of, majority control investments where the family either controls the board or has significant participation on the board. So again, that that would be, sort of, just, that would be the area where there’s, where there’s, sort of, the biggest shift as you deal with a distressed asset. Paul, I didn’t know if there was, sort of, other, other areas you might want to, sort of, talk about with respect to, I mean, the next two slides sort of go together, which is sort of a majority control investments and then, you know, we’ll talk about minority investments as family offices consider direct investing.

Yeah, just a few comments on this slide. This is the minority of the market today. The control investing is not happening like it was in the past, obviously, in large part because of distracted providers of capital, but also because of the debt, the new transaction debt market just doesn’t exist today. Now that will change, but doesn’t exist. The other thing you see commonly in early phases of a downturn, is buyer and seller evaluation disconnects. Very common. And in fact, what you have is buyers think about history and what they, their businesses, I’m sorry, the sellers think about history and what their businesses were worth, buyers think about the reality today. And there’s a disconnect. And so, you’re seeing comeback of bridging solutions, like earnouts where there’s variability in outcomes and variability of compensation as a result. And when that doesn’t exist, seller provides the financing. So those bridging solutions now are much more prevalent. There’s no rulebook for those, but they’re, they’re very much a part of the marketplace today. Don’t, don’t forget, there’s a lot of capital on the sidelines today. It’s waiting to come back to the marketplace into this particular marketplace, the control marketplace. But today it’s not, this is not an active market.

And I think also an aspect that’s also, sort of, complicating things is, you know, for the buyer, really figuring out what that go forward value is in these, sort of, uncertain times. I mean as you, you talked about at the outset, some businesses, some industries are going to be coming back and are just taking a temporary hit. Others are going to be impacted long-term. So that, that’s, that disconnect of the buyer seller evaluation is really, sort of, you know, this, this downturn is sort of unique in that its really creating a lot more uncertainty between what that value is going forward just because the markets are so unknown.

Correct. I want to look at the more prevalent form of the market today, the minority investing. Next slide. So, this is where we’re seeing lots of activity, and I think, candidly, I think lots of opportunity. The minority investing where a seller who owns control, just would not part, it would take a lot to part of a majority seller with his or her company in most, most times. This is a less threatening, more acceptable, sort of, source of capital and a partner today. And the discussions are mostly related on minority investing. The way these are structured is all over the map. You’ve got perpetual and maturing preferred structures. You’ve got exchangeable notes, convertible notes. But a common feature of structured equity, minority equity is a dividend plus warrant structure. And what that does is basically minimizes the needs of determined fair value between buyer and seller. Return is calculated through a coupon or, or dividend, and then the upside coming from a warrant structure. Importantly, there’s much less capital in the minority form today from traditional sources. Families, in particular, can play a very active role in minority investing. Traditional PE often is limited in terms of how much minority capital they can deploy. Interestingly, go ahead.

Oh, no, I was going to say and then also with minority investments, you’re going to have the regular slate of, of legal issues that arise with the minority investment around governance and control, liquidity drag rights, tag along rights, you know. So, so there are, you know, in addition to sort of the, the economic structure you’re building, sort of the legal structure and framework and protections that you’d be building around a minority investment as well that would be reflected in the, in the governing documents.

Yeah. Today, just interestingly, in terms of returns, majority versus minority, today there isn’t a huge disparity in terms of providers of this capital. You can get, you can get interesting returns in a minority structure. The disadvantage of this is families often aren’t aware of minority capital as a common option for sourcing capital. They think of debt, traditional debt sources of capital. They think of selling their business as a way to create liquidity. But this third option is not as, is not recognized as much with families. And so there’s an education process that has to go on. Jake, I don’t know if you want to comment on that last part.

Yeah, you know, and yes. So the last piece I would just sort of say that’s something we’ve seen in the last year, in the last couple of months. And it’s not unique, but it’s happening because we’re in a period of transition. And that is, you know, control investments becoming minority investments. And as, you know, and as you say, vice versa, that, you know, that we’ve seen some control investments that rather than, when we, when we have found additional sources of capital, company that a family had it once controlled, you know, then, because there was a new investor, they gave up control for that additional capital. So again, it’s just something that you’d start to see the line between these minority investments and majority investments, you know, they are permeable. And that over time and given the, you know, the performance of the company could, could change. Again, in other in other circumstances, minority investments through additional capital contributions, all of a sudden, a minority investment becomes a majority investment. So, I mean, I think that was just the point here for family offices to realize that you might start in one category and end up in a different category. But, you know, which I think maybe, maybe take us to the next slide, where we can really focus on, you know, highlight a couple of the areas where family offices really are, you know, where, you know, how family offices need to start to think about direct investing in this environment and some unique characteristics that they have.

Yeah, to your prior point. There are real risks, obviously, in direct investing, and you have to marry a right strategy, right team, right resources to make sure that you’re managing and moderating the risk profile to this sort of investing. And the reasons for that are several folds. One is, this is a long cycle game. You need the human capital. This is not just money; this is a human capital game. Way say here, less than a 1% business. We typically are looking at over 100 opportunities to find one that fits our profile on criteria. And so, you have to find a meaningful number of opportunities. You have to have human capital to go sit through those opportunities. And then importantly, once you make the investment, you’re just under the playing field. That you’re, you are, the game has begun, and you have to play a 9 inning, 11 inning, 15 inning game, and that requires human capital. It requires expertise, oversight. We acquire middle market companies. Companies valued between $200 million and $2 billion enterprise value. Even in those sorts of companies, talented executives need support and assistance in executing their strategy. The other thing that comes into play in terms of long cycle is the dialogue. You’re never going to convince a family to sell unless they want to sell. And the dialogue is based upon trust and understanding. And so that takes time in order to harvest a dialogue in a relationship in years to come, you have to begin to plant those seeds today. This is not a quick transaction, typically. Now importantly, family capital has unique advantages over traditional sources of capital. in a frothy market, some of those advantages get diminished because they get overpowered by high prices, high multiples that attract family sellers. Capital takes on more of a commodity nature. But in these more difficult markets, family capital’s real advantages to a seller become very obvious and evident, and in particular, its sellers who care about their companies after close. If a seller, family seller wants last nickel, whether it’s good market or difficult market, the family capital as a buyer is going to be no different. Everybody’s money is the same. But if the family cares about their company, their legacy, their name on the door, and cares about who manages and runs the next chapter of that business, family capital has real advantages to a seller. And we list here at the bottom, at the last point, some of those elements. Long duration, ability to make the right decision at the right time for the right reason and not let the business model drive decision making, flexibility and structure, an understanding of family culture and values. All stirred together make that capital much more valuable to certain sellers, especially in today’s market.

And I think that as family offices, sort of as family capital, thinks about how to participate in direct investing, you know, Paul, I’m reminded of your slide at the points he made at the top of the presentation about why a company is looking for that capital. You know, in terms of certain families, might be better suited in terms of helping a company through a distress situation, which might be different than a family that was really looking for a longer-term partner. So again, I think family offices, as they evaluate their team, their capabilities, sort of have that additional overlay of why is, what, what are the right targets, as as a way of sort of identifying the opportunities here in this in the current market. Which I guess leads us to our next slide, which is sourcing.

You know, at many of our sessions on direct investing over the years, sourcing, as always, you know, is always top of the list of how do people find deals, how to people source deals out of the family source deals. And so, I can’t imagine that’s changed, and would appreciate your thoughts on where deal sourcing is happening these days.

I mean, what we’re seeing today is, is, in a hot market, obviously, the flow of opportunities. The bankers do a terrific job in finding opportunities that fit your criteria of family business sellers and bringing them to you. In today’s world, we’ve got an army of underutilized, underemployed bankers and brokers because that traditional process doesn’t exist like it did three, four, five months ago. That’s a good thing if you’re willing to go create your own opportunities. Go out into the marketplace, outreach to the marketplace, remind the marketplace of who you are and how you operate and how you’re different. And it’s this is, this is an interesting conundrum for families and family offices because they’re, often family’s normal practice is to keep a low profile, to, to stay below the radar screen. That is not a great posture, especially in today’s market, to find opportunities. As Warren Buffett likes to say, you know, the best opportunities find their way to you, but very few people have that aura. And so you’ve got to go out and create opportunities, develop a dialogue, be helpful in outreach to the marketplace. And being top of mind. Again, you’re not going to convince the family to sell. But when the family decides they want to sell and decide they need a partner in capital, they want you thinking about, you want them thinking about your name. And again, I go back to the last point, which is remember, the 1% rule. This is, this is a very difficult market to find that right opportunity, and it requires a lot of legwork and a lot of looking at opportunities to find that one that makes sense.

Yeah, it’s a, it’s a long, it’s a long process with a lot of a lot of hours in it. And, you know, and then thank you, Paul. I think that gives us a really good sort of snapshot of where there are, sort of, you know, in the direct investing space, where, you know, where the market currently is and where, where, there are some challenges, some headwinds. I would like to, sort of, turn now to serve another a key area where we’re seeing activity. And that’s really in the co-investment space. So, maybe Rami, you could talk, talk a little bit about co-investing with PE funds.

Thanks, Jake and co-investment here really, I mean, we’re sort of limiting co-investment to a particular meaning. It’s sort of a … terms means a bunch of different things. In my world it typically means a private equity fund sponsor looking or seeking to raise money from either existing or new investors and its funds in order to investigate a particular investment or a collection of a limited scope of investments. We’re seeing it, so increasingly now as capital is getting a little more constrained, we’re seeing sponsors starting to come to us and think more seriously about different types of co-investment. Investors have, you know, over the past decade or so, been itching for more and more co-investment. In the event this is really only accelerating a trend that was already occurring irrespective of one of the more recent related market changes. Investors part of interested in co-investment because typically carried advantageous terms. Your, sort of, typical co-investment has no or low management fees and no or low carried interest. The real role of co-investment is to provide a quick source of capital that complements or supplements on capital from the traditional PE fund. So, for instance, in the middle market private equity firms that we often advise may have amended to go out and make $50 million, $100 million, $500 million, whatever, $1 billion dollar investments and see a deal that’s maybe double the size that ordinarily would want to take, but think it’s still a great opportunity. So, in those instances they come to us and say, hey, we’re thinking about forming a co-investment vehicle. Depending on the terms from the main fund vehicle they could, they could either go out and source new capital, go to their existing capital. So if you are invested in a private equity fund at the moment, it’s the useful thing to tell sponsors that you are interested co-investment. In some cases some family offices will pre negotiate a side letter, either access to opportunity, contractually or, you know, a first look. And they could range from just being good of a limited right to turn … up to something that actually requires a certain prorather or other allocation. And investors When you’re looking at co-investment, you should be careful and to review co-investor rights, both at the main fund level and within the co-investment structure itself. In particular, you want to focus on prioritization. Typically speaking, main fund documents don’t permit the co-investment vehicle to, to be prioritized over the main fund for the obvious conflict of interest issue. You know, they want to know that their capital, which typically generates, is charged a fee, is treated at least comparably, if not favorably to co-investment. But you will want to take a look at what each fund, main fund documents say about co-investment when you’re investing a separate vehicle. Also, you of course want to look at conflict of interest more broadly, especially if there are multiple vehicles involved. You’re just time allocation. Who gets access to what news, sort of, following an opportunity, etcetera. Something kind of interesting that we’re seeing more and more of, which again predated COVID, but we’re seeing some acceleration of it now, were sort of more unique, non-traditional co-investing vehicles. So, in addition to sort of your typical co-investment, that would be a management vehicle that investigates single portfolio investment alongside the main fund. We’re seeing types, other types like the overage vehicle. So again, you know, it would say, in the event that you have an opportunity that exceeds X dollars of enterprise value, you will look to us first, for capital. We’re seeing opt in, opt out vehicles where limited partners have additional rights which are tech, not technical. In main fund vehicles when you get to actually, they can choose different investments. That does sometimes have issues with respect to its going to be there securities laws or limit liability for those investors. But we’re seeing a bit more of that. And we’re also seeing limited scope of co-investment. So again, if you have a fund that invests in energy or health care, they may raise a pre co-investment vehicle that is focused solely on a particular sliver of healthcare or sliver of, of energy that they want additional exposure to. So, if you have sort of asset class allocation issues and you want more exposure to a particular subclass, you could get that exposure through co-investment. And all these things I explained are open to negotiation. A typical sponsor, you, if you go to them with an idea, worst case they’ll say no. But oftentimes they come to us as counsel and said, what do you think? What are the pitfalls, etcetera? Can we do this? Because from their perspective, even if they don’t get carrying or management fee, having that sort of access to quick capital, which in family offices, you have an advantage being will deploy that capital. Frankly, that is a big deal for sponsors, even more so now that other sorts of capital are drying up. I just know direct con-investment, Paul, your view, as you discussed earlier, through many of the smaller family offices this is probably, you know, a bit too much in that they don’t have the internal infrastructure to manage and oversee their investment, which is partly why we see one of the smaller family offices investment management vehicles to be co-investment traditionally. For larger family offices, direct co-investment and direct investment in general, to me, that’s more, there’s more potential. I think, Paul, do you want to speak to you, I think, the issues related co-investment that you see?

Sure. We labeled these as, as watch outs. Its often families want to co-invest to dollar average down their fee structure that they’re paying a third-party manager. I think families just have to be very, very careful that they don’t inadvertently over concentrate. If a vehicle has 10 companies in the invest—co-invest dollars into three of those you’ve created, you’ve created, potentially, over concentration. And if those three companies turn out to be lesser return opportunities, you’ve created an issue of your overall return structure. You’ve advantaged yourself from a fee point of view but disadvantaged yourself from overall return point of view. The other is, other watch out is the expertise in picking and choosing the co-investment you get offered as a family. You have to be very, very careful. We’ve seen some families say, I just want a piece of all coinvest to get the fee, fee dollar averaging down, but not create a concentration or risk by selecting the wrong coinvest. And then finally, as I mentioned before, traditional PE majority investing is significantly down. The likelihood of getting coinvests in today’s market is much, much lower because there just isn’t much capital, majority capital being deployed today. So those are just a few, a few watch outs.

And I think that brings us to the sort of the next slide, which is, you know, you, but, but co-investing with a private equity fund isn’t necessarily the only co-investment that family offices are doing in exploring. Family offices themselves are sort of exploring about creating co-investment vehicles with other family offices, really trying to capitalize on, you know, the benefits of, of that family capital that we’ve talked about earlier. But pooling that together into a co-investment vehicle. As was sort of talked about, saying that there’s a range that we can see in these, in these types of vehicles ranging from more of a pooled capital vehicle where, just like a committed capital, where a family will come in with a set commitment, versus more of that opt in optout structure, where families can participate more on a deal by deal basis. You know, at the heart of the any, any, any of these, similarly, we’re still back to those same minority investment. The legal documents have to be very specific about governance. Who participates, who controls? As well as, as, as, Rami pointed out, there are securities laws as well as corporate liability considerations, as well as sort of keeping an eye on Investment Advisor Act and Investment Company Act issues as well. So, there is, you know, on top of the legal governance piece, there’s also sort of some securities and other regulatory overlay that you need to be careful as you look into that opt in opt out vehicle. You know, as a practical matter, I think one of the difficulties about the opt in opt out structures, or sometimes we call the pass the hat models is that they can be slow in terms of making sure that there’s a responsiveness of being able to evaluate and, and figure out who’s participating to make sure that they could be, you could be responsive to, you know, to a deal opportunity. And then similarly, on the governance side, you want you want to make sure that, that it’s clear who’s taking sort of a lead in the investment. Who’s taking ownership over that investment and really taking control over it or responsibility for it for the group. If you guys don’t have other items, I think we’ll, we’ll shift. Then a little bit more to some, some of more industry sector focus. So, sort of away from structures and now, sort of, talking about specific industries that we’ve, you know, seem significantly impacted here in the current market.

Yeah and maybe I’ll start off. So, in the PE space terms of what we’re seeing from our client base, we, because McDermott’s extensive health care platform, have quite a few healthcare focused PE funds. Also, a large of percentage of real estate funds as well. So actually, we’re seeing a mixed bag in terms of the impact industry lies on these funds and what they’re, they’re doing in response to COVID. Some, some types of healthcare technology, biotech, venture capital type funds are actually in somewhat, in some cases, not just doing okay, but are actually quite prime for this type of situation, because there’s a renewed interest in some of these underlying investments. Others, obviously oil and gas, materials, consumer discretionary, leading way to leisure, retail are having quite a different response right now. And so the, as Paul noted earlier, while there are opportunities for distressed companies and assets and some of these industries, we have not yet seen prices adjust. And sort of interestingly, we’re, we’re at the late end of a business cycle in any event, and for a while now, private equity funds in particular and this includes co-investment, they’ve had an easy time sponsors raising capital because there’s a ton of folks out there with capital. You have a much harder time deploying that capital for, for fully investments that are well priced, sort of, for the medium to long term, in part because we’re sort of at the tail end of this business cycle and received inflated price, inflated asset prices. And so, it will be interesting to see how this shakes out. My sense is, based on discussions with clients that it’s going to take some time for the new the reality to sink and for prices to adjust as Paul noted earlier.

And these other, these other comments on this slide, we can talk if people have questions, but, but areas of particular interest, I think today include these four: packaging, food, healthcare services, logistics services. Getting product to the marketplace, the way the marketplace wants to be served. We own a pallet rental business that that gets the product from the food manufacturer to the distribution center and to the retailer. And that business is performing extremely well even though we’re going to have a massively down Q2, it’s performing well. So, there are really interesting pockets of opportunity in today’s world where there’s real performance and sustainability of performance, even amidst the carnage of the economic environment today.

But, yeah, I think, I mean clearly, I think of folks were given the market volatility, you know, I think a lot of folks, a lot of investors and family offices are looking and thinking about distressed investment opportunities. And so, I think that that is, sort of, the focus for family offices will also then be on, on figuring out where and how their capabilities match with potentially distressed investment targets. But I would also, sort of, I’m going to jump to the bottom of the slide and really sort of flag, flag that the sale process of acquiring a distressed asset. Again, it could be done through, you know, equity infusions and equity investments before, before a company officially files bankruptcy, but I think we’re going to see an uptick in in actual bankruptcy filing. So I think, you know, there may be a shift in the coming weeks and months, to opportunities that are going to be out of the actual bankruptcy court. And would just sort of flag that you know, that that is a unique process through the bankruptcy court through 363 sales of buying assets directly from the bankruptcy court. Rami, I don’t know if there was sort of additional items you want to talk about with respect to distressed assets in the PE context.

Yeah, and so we’re getting more phone calls from our sponsor clients discussing for the potential shift toward the stress opportunities within their existing PE or new PE funds that they’re raising, including co-investment vehicles. What’s interesting here, from your perspective, as sort of the investors in either the funds or in a co-investment vehicle, you’ll want to pay particular attention to existing investment objectives at the fund level to ensure that if these funds start pivoting towards something that is maybe not within their typical hand but makes a lot more sense in this environment, first and foremost, are they permitted to do so under the terms of the LPA, the PPMs they provide to you? You know, some of these folks, because they’re a little a little anxious to, to continue to provide oversight outside returns might start moving towards, sort of, the fringes of what their investment objective ordinarily permits. And so with that, though, if it is the case that they don’t have a very narrow investment objective and don’t have the ability to take on certain types of distressed investments or certain types of riskier investments, this is a gravitation towards co-investments conversations, because you can then go to those sponsors. And, you know, whether you do that through a new successor fund they raise by providing capital or by investing in, sort of, co-investment that focuses on specific types of vehicles or managed account, you may be able to get exposure to things that are not typical, you know, the purview of these funds.

Great. Rami, another asset class that I know is of sort of high, high interest in importance to families is real estate. And that’s, you know, a lot of families have, have a lot of real estate and real estate investments. Could you, sort of, maybe turn and, sort of, talk a little bit about where you see these for real estate in in the market today?

Sure. And we do quite a bit of real estate funds, we’re both sort of the traditional PE funds structuring and also, sort of, on the joint venture structure, which we’ll speak to the next slide. Just generally in the real estate world, we’re seeing sort of continued interest and strength in the multifamily residential sector. Obviously, there are rent payment issues that are on top of people’s minds, but there’s… for the foreseeable future still a supply demand imbalance, especially in major cities, respect to, sort of, why, you know, housing for large lot of population, especially at the mid to lower end of population, socioeconomically. Commercial and retail are the more interesting. I mean we’ve already, prior to COVID, commercial rents in major cities were declining in many submarkets. Landlords having a difficult time filling lots of office space. Retail also suffering from the move to online purchasing. We’ve seen some funds that were focused on either commercial and/or retail, especially in major cities, have a very difficult time raising capital over the past year or two. In part, because investors were skittish about what they were seeing when they could just walk, if you’re investing in a New York, New York City retail, you could just walk through segments of Manhattan and see the empty storefronts. And it doesn’t take too much to, sort of, figure that might have, might have an impact on certain types of investment. That being said, sophisticated real estate investors are still finding opportunities. But there is sort of, COVID does have, does seem to be essentially accelerating existing trends, and… I also would note that the designations of Core, Core Plus, Value-Add, Opportunistic. In the real estate world, are sort of having different meaning now. What was once a core, core plus asset that you did very little working limited risk, that may end up changing as some of these larger tenants start facing their own bankruptcy headwinds. So, just because something was theoretically stable when the real estate investor invested in it years ago or recently, does not mean that’s still the case. So what those categories mean will start to shift over time. And just sort of touching on the regulatory aspects of real estate. One thing that we come across as we deal with family office investors that often time don’t understand, especially for their own family office funds, what can they invest in? What can they bring third parties into? One thing is interesting and worth noting is that real estate, under certain case law, can be considered to be something that’s outside of what is typically defined as a security under the securities acts. And so, as a result of that, you, investors and especially family office bonds may be able to invest if they are only investing in real estate, may be able to stay outside the Investment Advisors Act, the Investment Company Act by investing solely in a property in a certain mortgage associate of real property and still admit third party investors without breaching their investment adviser obligations. And so far, if anyone’s interested in discussing that further, we had, McDermott spent plenty of time in various family officers talking about their existing structures. And what that means in light of their desire to sort of expand beyond just the family office set of investors and bringing third party capital.

Did you want to talk about joint venture terms?

Yeah. Thanks, Jake. Moving on to joint venture terms, specifically. It’s interesting to note, for joint ventures typically are far more bespoke than managed funds. There have we negotiated between parties depend, in part, on the sophistication of the various parties. It is, you know, as a note of caution, do require much more oversight by active investors, including family office investors. And so you want to have at least some internal infrastructure that can, sort of, manage the day to day, at least actively oversee these investments. What we typically see in terms of terms are include a budget veto rights, a right to force a sale, drag/tag rights. So, something more akin just of M&A, often times. Then will you see the typical managed fund account? I think to note the typical joint venture investment could adapt, can also avoid certain securities lost issues since the investments are being actively managed or, sort of, a number of theories that suggest that if all the investors are actively managing the underlying investments, the interests are not… the securities which could make investment in these types of structures a little more attractive to family offices.

Great. Thanks, Rami. I wanted to, one last topic I wanted to cover in the, in this presentation and it’s, it’s more of a process driven piece and that’s related to due diligence. You know, diligence itself has been, you know, been, been electronic now for a number of years through virtual data rooms. So in, in some respect, diligence isn’t really going to change. And in fact, it was well suited to be done virtually, but clearly the face to face, the conversations, that that has to change. So, so Paul, and actually interested in getting your thoughts on how you guys are finding diligence these days, how you’re talking with management team’s and getting through this all virtually.

Sure. This is a real question that’s being discussed by acquirers, deployers of capital, real time today is are you willing to deploy capital through Zoom? In a locked down world, you can’t do some of the procedures that you normally would. And so the question is, will you really write a check without doing some of the key historical processes that you’ve implemented in the past? So, what we did here is broke down due diligence into its constituent parts, and I think some of this will be readily done and easily done in today’s locked down world. The fact checking. Does the company have the income that they say they have? Does the company have the facilities? What’s the litigation log? Etcetera. So the fact checking is, as Jake mentioned, you can do a lot of that virtually. Forecasting and predicting future outcomes. The key to underwriting in today’s world. I think the difficulty here it doesn’t relate to the lockdown, the difficulty here is how do you forecast in a massively changing world? That’s a different question but can be done more virtually than, than otherwise. The issue really becomes this third point. Assessing the execution. Can the company execute on the plan that they have presented? What’s the implementation risk? And this really boils down the on management. And management is a core part of acquisition due diligence. And can you, in fact, do that through Zoom? I question that. You’ve got to understand management, their, their backgrounds, their capabilities, their intents, their motives, assess how they behaved in historical, in similar situations in the past. So this one, I think, is the most complex in terms of doing due diligence in a locked down world, but is doable, but more difficult. And then finally, the key, the last key element of due diligence is balancing the risk that you see in the investment with the return potential and stirring that together. And that’s a judgment factor. That has nothing to do with virtual. But is assessment based upon your history and past practices. So, I think it’s a doable in today’s world to deploy capital, but you were going to have to modify procedures in particular related to management teams.

And you still want to look him in the eyes, Paul.

And normally, you’d shake their hand too, but you can’t do that today either.

So, well, great. I want to thank Paul and Rami for the presentation today. This was fantastic. Certainly would open it up, didn’t make sure that, you know, we didn’t get any questions along the way, so if there are any questions that folks have, we’d be happy to answer them at this point. But again, please submit him through the Q&A function. As I mentioned at the top of the copy, the presentation will be made available on distributed to you afterwards. For the New York CLE, which is pending, the code will be BLUE13. Capital B, BLUE13. And, and of course, as always, we want to make these webinar series as relevant and applicable to you guys as audience members, so would certainly welcome to have you guys send us ideas for additional topics of for future webinars. But otherwise, I want to thank the panel again today. Want to thank the entire tech team for making this happen virtually. And again, I hope everybody has a good day. Thanks very much.

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