Family offices are increasingly bypassing traditional PE funds and co-investing directly alongside independent sponsors. Here's the thesis and what to expect.
A family office co-investing alongside an independent sponsor is like two people who both want to fish the same quiet lake that nobody else has found yet. They are better partners than competitors. They are not fighting over the same water. They are splitting the work, sharing the intelligence, and both going home with something real.
I have sat across from family offices that spent years writing checks into PE funds and receiving quarterly letters. You know the ones. "The portfolio performed in line with expectations." Which is technically accurate. And tells you almost nothing. Then they did their first deal-by-deal co-investment alongside an independent sponsor, and they actually knew what they owned. They knew the business. They knew the operator. They could read the monthly P&L themselves and form a view.
That experience tends to be clarifying. Here is what the shift looks like in practice.
Traditional private equity funds charge management fees, typically 2%, on committed capital including undeployed capital waiting for deals. A family office that commits $10M to a fund might pay $200K per year in management fees while $7M of that commitment sits undeployed. By the time the fee drag compounds over a deployment period, the net return hurdle is meaningfully higher than the gross return. The math is not invisible. It is just often not discussed in the fundraising meeting.
Blind pool commitment is a related issue. Committing capital to a fund means trusting the manager to find and execute good deals over five to seven years. The family office sees the track record but does not see the next deal before capital is deployed. For family offices with specific sector expertise or strong views on deal quality, that opacity is not a feature.
Full deal-level transparency before committing. The capital partner receives the investment memo, the financial model, diligence materials, and management team background before making a decision. If the deal does not meet your criteria, you pass. No penalty. No hard feelings. No blind commitment required.
Economics: typically no management fee on co-invested capital. Capital partners pay carried interest on realized profits, typically 20% above a preferred return, but not the ongoing management fee drag that erodes fund returns before a single company is acquired.
Sponsor alignment: the independent sponsor has their own capital at risk alongside yours. This is meaningfully different from a large fund where the GP's economics are driven primarily by management fees, not carry. The sponsor does not get paid in any significant way unless the deal creates value. That is the alignment you are looking for.
The best LMM co-investment relationships are not purely transactional. Family offices with operating experience in specific sectors, healthcare, manufacturing, services, can meaningfully improve diligence quality and post-close value creation. A family office with a portfolio company in the same sector as an acquisition target can provide market intelligence, management talent referrals, and commercial introductions that a financial-only capital partner cannot.
Independent sponsors who build genuine partnerships with family offices access better diligence, faster commitment, and more consistent deal flow support. The relationship compounds. The first deal teaches both parties how the other thinks. The second deal moves faster. The third one is almost easy.
Sourcing. How does the sponsor find deals? Proprietary off-market flow built through direct owner relationships is more valuable than deals sourced exclusively from brokers running competitive processes with 20 bidders and a standardized CIM.
Operations. Can the sponsor actually run or improve a business post-close? In the lower middle market, operational deterioration after close is a real risk, one that a financially sophisticated but operationally limited sponsor does not catch until it becomes expensive.
Track record. Prior deals, exits, realized returns, capital partner references. For newer sponsors, evaluate the quality of the deal thesis and the depth of sector knowledge. You can learn a lot from how someone talks about a deal that did not go well.
Reporting. Quarterly reporting minimum, with direct access to portfolio company financials. If a sponsor is reluctant to be transparent about reporting, that reluctance is information worth having before you commit.
Smaller deals mean less institutional competition and better entry multiples. A business selling at 4x EBITDA in the lower middle market would trade at 7x or 8x if it were twice the size and in a competitive auction process. That spread is the illiquidity premium, and it is real.
Businesses in this range are often dependent on one or two key people. This creates transition risk that must be managed through deal structure and operating partner deployment. It is a risk to price and manage carefully. Not a reason to avoid the category.
Exit optionality is broad: strategic buyer, larger PE recapitalization, or management buyout. Businesses that get professionalized during the hold period command meaningfully better exit multiples than they traded at entry. That spread between entry and exit is where the return is built.
Berkman Woods works with family offices and private capital providers on deal-by-deal co-investment activity in healthcare, specialty contracting, professional services, and niche manufacturing in Texas and Oklahoma. If you want to understand our deal flow and how we structure these relationships, contact us.
Related: Family Offices · Co-Investors
