Family offices are stepping up with capital to fill in a large—but narrowing—investment gap between private equity’s pre-COVID days and now.

The influx of private and public capital coming into the industry in the pre-COVID era has waned, leaving an approximately $50 billion gap that family offices are slowly filling in, said Stephens Managing Director Brad Nelson.

Upstream, minerals and royalties, midstream and oilfield services are all sectors family offices are willing to tap into, he said.

“But they're very careful about how they come in. They're methodical,” Nelson said.

He added that one trend Stephens is seeing is partnerships between different families. Multiple families may come together to collaborate on a deal or share ideas on its structure.

Nelson dove deeper into the kind of energy investments family offices are looking for at Hart Energy’s Energy Capital Conference with Oil and Gas Investor’s Deon Daugherty in this exclusive interview.

Deon Daugherty, editor-in-chief, Oil and Gas Investor: Hi, I am Deon Daugherty, editor-in-chief of Oil and Gas Investor, and I'm here with Brad Nelson, managing director at Stephens to talk a little bit about family offices. Brad just wrapped up a panel and he's going to give us some more insights here for you. So Brad, I guess let's begin. What has in recent years attracted family offices to the oil and gas space?

Brad Nelson, managing director of investment banking, Stephens: Sure. Look, it's been an evolution. Probably 10 to 15 years ago, the number was very small, and there's kind of several buckets of family offices. You've got family offices that are basically derived out of energy companies that are largely based in Texas in Dallas and Houston. They certainly understand the energy sector very well, and they may have a sidecar or kind of an in-house family office, and they of course have been making investments into the space for, in this case, many decades. And then you've got that kind of swath of family office capital, and then you have the generalist families. And these are families that are largely all over the country that have been investing in other sectors for decades and decades. And that is the crowd of families that we have seen kind of make their way into the energy space. Conventional energy, I would say lately, or it's largely more into upstream minerals and royalties. They're certainly comfortable with midstream and then OFS kind of depends on the situation. They can get comfortable with that sector as well.

But look, it's been a natural evolution for the last seven, eight, nine years, and in our opinion, it's been kind of a mix of, these investors have been investing into so many other verticals that a lot of those valuations in those other verticals, whether it's tech or other things, the valuations are actually pretty lofty in those spaces. And then as we saw institutional capital pull away from the space seven, eight, nine years ago, we've seen what that has done to valuations. So valuations overall in the space have come off and frankly, there's just a big hole. There's a big capital need. And so it wasn't a quick process at all. I would say that it was pretty slow, call it six to 10 years ago. And then we've seen that activity pick up in the last four or five.

DD: So between some institutional investors fleeing the space and some general investors fleeing the space. And that's both for public capital and then for private equity as well. Have family offices been able to fill that hole? I mean, with private equity alone, it's significant, I mean, on the order of $50 billion.

BN: Yeah. Yeah, absolutely. I mean, the coastal capital that was invested in the space going into ‘08, ‘09, and then ‘14 through ’16, and really ‘14 through ‘16 was pretty staggering. I mean, you had some of the biggest well-known private equity groups on both coasts that at that point in time were somewhat all in. A lot of the bigger institutions up there had dedicated energy funds and they never really had dedicated kind of one-off funds. They'd had name the group and then they'd have their own just generalist fund. But over the last, at that point in time, they all had energy funds and those largely went away. And to your point, that was a massive number. So we've seen that pull back completely. There's maybe a couple groups on the West and East Coast that are kind of trickling their way back in, but it's a big number that went away. Now you add in the family office capital and they are coming in, but they're very careful about how they come in. They're methodical. It's not like they've got some big swath of AUM [assets under management] capital that they're now wanting to put into the space. It's kind of a slow trickle in. So from our standpoint, I think if you ask some of our clients in the industry in general, the hole still hasn't been completely filled. So I think there still is a lack of capital in the space, but it's a big number to fill.

DD: Could you quantify in some way the emergence of the family offices? Are they spending more money or are there more families involved? How has that evolution come about, if we can put a number of sorts on it?

BN: Sure. So the number of family offices outside of the family offices that had always been putting capital into the space, those groups, they were near zero five or six years ago. There just weren't many at all. Again, they were looking at other verticals, not too far in the rear view mirror was the lack of returns for our energy space. It just didn't look good. I think the trust level was a little bit low in terms of just capital discipline and can these companies really make money over a sustained period of time and through cycles? So I think there was quite a bit of damage in my opinion, that needed to be repaired in that time period. And then, yeah, now there's probably, in our opinion, and of course we don't canvas the entire market, but we think there's somewhere around 80 to 100 families that are outside of the conventional names that have been in the space for a long time that they will look at energy deals.

And I'm speaking broadly, this is upstream, midstream, and OFS. But yeah, it's a pretty sizable number. And I would say that they are putting pretty sizable amounts of capital to work. The other trend that we're continuing to see is a lot of these families do like to pair up or club up with other smart families. Of course, all these families will do their own unique level of diligence, but it is helpful when people are sharing ideas and kind of group thinking about a deal, whether it's maybe not even at the asset level, maybe it's more at the structural level about the deal itself and the structure and the terms, things of that nature. So we'll see them collaborate on that side as well.

DD: And are they all U.S.-based families or does it run all over the world? Where are these folks coming from?

BN: So it's largely U.S. We do have a couple offices in Europe. We have been having conversations with families in Europe for the last probably three to four years. That has started to pick up as well. But I would say in any transaction, if a client or a company is wanting to talk to say the family office network, it's still probably 80% to 90% domiciled here in the U.S. and then maybe the balance in Europe.

DD: Okay. That's very helpful. When you look at today's market, it's rather volatile. How do these family offices view volatility? Because in theory, they were interested in the space in recent years because of the stability and the returns and whatnot. So how do they view the situation now that it's not offended, but more precarious, I would say?

BN: Sure. Well, our view is there's always some level of noise in the market, and at times it's louder than other times. And the way we think about it, and I know the way that our clients think about it is that we're going to be in this next deal, whatever transaction that may be, for seven to 15 years. So when you have that kind of mindset and you couple that with, we're going to get out of the gate here with a really healthy balance sheet, so you've got time and you've got low leverage, the volatility kind of day-in, day-out doesn't impact a whole lot of their thinking. Again, they're trying to grow something for the next 10, 12, 13 years. So if oil or gas goes up two, three, 5% or down 5% in any given period of time, I mean, they're certainly going to think about that and they're going to be aware of it, may factor a little bit in valuation, but I would say not as much as you would think because people are thinking long term.

DD: Okay, taking the long view reduces risk. That makes a lot of sense. Yeah. Okay. And then finally, what sort of assets or basins or sectors are these folks mostly interested in?

BN: The family office space is probably, again, from where we sit, mainly looking at the upstream sector. So they're looking at that sector. And then within that of course is minerals and royalties. Obviously you have less people, you can hedge obviously the product as well or the hydrocarbon. And so there's a little bit less perceived risk. And then the other thing with the upstream sector, there's always a lot of M&A. So it's not like you're planning on getting into a deal and needing to get out, but you are, even though you're in a private deal, there still is some liquidity comfort in there knowing that if you're building something, somebody is eventually going to want to buy it. So from where we sit, it's largely upstream, minerals, royalties and midstream. Again, same thing with midstream. You've got maybe revenues coming from various pipelines or various systems.

You've got little concentration risk, you're more taking kind of tolling kind of fees, if you will, maybe not so tied to the hydrocarbon. So we see family offices gravitating to those two or three sectors first, and then a little bit to the OFS and the OFS side. It's always a little bit tricky. They do kind of get whipsawed a little bit more. The companies do. They've got very, very good moments in time. And then they also have some pretty poor moments in time. And then of course, on the OFS side, there's really nothing to hedge there.

DD: Right. Okay. Well great. Excellent perspective. Super insight. Thank you very much, Brad. I appreciate your time today.

BN: Thank you for having me.

DD: Absolutely. And thank you for joining us. Hope to see you soon.

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