Private Fund Education for Family Offices: Manager Selection, Fund-of-Funds and Diligence

A family office is a private organization that manages the financial affairs of one or more wealthy families. It may be a single-family office serving one family, or a multi-family office serving several. Many family offices consider private funds, which are pooled vehicles that are not sold on public exchanges, as one way to access private equity and other private markets.

Manager selection is the process of deciding which fund managers to consider, and why. A fund of funds is a private fund that invests in other private funds rather than directly in companies. A secondaries strategy generally involves buying existing interests in private funds from earlier investors. Due diligence is the structured review of a manager's team, strategy, operations, fees, legal documents and risk controls.

Private fund investments are speculative and illiquid and can lose all of their value. Most are offered only to accredited investors under SEC Rule 501(a). Categories include individuals who meet income or net worth tests, holders in good standing of Series 7, 65 or 82 licenses, and, for certain private funds, knowledgeable employees of the fund. After the August 2020 amendments, spousal equivalents may also qualify together with the individual. Entities and family offices with over $5 million in investments or assets can qualify, as can SEC-registered investment advisers and exempt reporting advisers. Eligibility depends on the facts, so families should confirm it with their own licensed advisers.

Family offices have traditionally built relationships with managers over time. They often start with introductions from trusted peers, attorneys, accountants or consultants, then compare managers against the family's goals, time horizon and need for access to cash. Many keep written criteria so each manager is reviewed the same way.

Diligence is usually layered. Investment diligence looks at strategy, team experience and how decisions are made. Operational diligence looks at administration, valuation practices, custody, compliance and cybersecurity. Legal review covers the offering documents, fee terms, conflicts of interest and investor rights. Some families do this in-house, and others use outside specialists.

Some families choose to invest in managers directly, while others use a fund-of-funds structure to spread selection across several managers. Each approach involves trade-offs. A fund of funds may add a layer of fees and a layer of oversight, while direct selection may require more internal time and expertise. Offerings are generally made under Rule 506(b), which prohibits general solicitation, or Rule 506(c), which permits general solicitation but requires that all purchasers be accredited and that the issuer take reasonable steps to verify their status.

The right independent fund manager may help a family office think through how a private fund could fit alongside its other holdings, its governance and its liquidity needs. A good conversation often clarifies the questions before it supplies answers. Nothing about this is a promise or guarantee of any outcome.

A first conversation is generally an exchange of information. Expect questions about the family's objectives, decision-making structure, eligibility and experience with private markets. You can expect to receive an overview of the manager's approach and the offering documents, which are the only source of terms for any offering made by the issuer.

Questions worth asking include: How are managers or underlying funds selected and monitored? What does your diligence process cover, and what does it not cover? How are fees, expenses and conflicts disclosed? How are valuations determined? What reporting will we receive, including K-1 tax forms where a fund is a partnership? How long might capital be tied up? Past performance does not guarantee future results, so also ask how the manager thinks about risk. Review everything with your own legal, tax and investment advisers.