Are family offices starting to eat VCs’ lunch?
With companies staying private longer and the number of listed companies continuing to decrease, more family offices are taking an active interest in private markets generally, and venture capital specifically, compelled by the opportunity to invest in transformative technologies and exciting new business models.
This is also fuelled by the overall size of the family office market, which has grown significantly over the last decade, both in terms of increased wealth as well as the number of family offices. The average single-family office deploying funds into venture capital now has circa $989m of assets under management; for multi-family offices, the figure is around $1.9bn.
So how will this increased influence from family offices on venture capital affect an already shifting venture ecosystem?
The evolution of venture investment
Today’s venture capital landscape is truly global in nature and rife with innovation – around everything from investment structures and deployment models to deal sourcing. Non-traditional venture investors such as Tiger Global are helping to reshape the sector with approaches predicated on rapid capital deployment, reducing founder friction, and accepting a lower return profile.
The venture industry is also being accessed by new players such as asset managers, PE funds, hedge funds, listed companies, corporates, and of course, family offices. Moreover, some of the ‘traditional’ backers, endowments and pension funds are even showing themselves willing to disintermediate the traditional value chain, cutting out the ‘middleman’ altogether by investing in startups directly.
However, success within this asset class still depends upon the ability to select, nurture, build and exit companies. It is very hard to get right, and while there’s a romanticism around investing in fledgling startups, new investors must remember that 70% of these portfolio businesses fail between years two and five, while three-quarters of venture-backed companies never return cash to investors.
Fast learners and sophisticated operators
Historically, family offices have always had a presence in venture capital. Indeed, some of the world’s leading venture groups such as Bessemer, Venrock, EQT and Atomico were all originally funded by family offices.
Most offices start by investing into a fund of funds, allowing them to gain limited access into established venture funds, while also making ad-hoc investments based on recommendations from their network, before finally investing directly into the venture funds or the startups themselves.
Investment volumes are on the rise, and, according to UBS, approximately 70% of family offices plan to increase their allocation to the venture asset class. Their presence has been roundly welcomed by the startup community, which is becoming more and more open to direct investment from family offices, citing strategic benefits, access to operating businesses, networks and, in particular, the ‘patient capital’ aspect.
This is a crucial differentiator. Family offices have a less urgent need for liquidity than other investors, and they’re able to justify their lower liquidity requirements backing companies with superior returns to those in the public markets. In this way, they’re unconstrained by traditional fund cycles, making them an attractive and logical partner for entrepreneurs, innovators, and venture funds.
Buoyed by their successes, it’s no surprise to see that family offices are dedicating more time, resources and capital to venture capital, not to mention building in-house expertise to become even more sophisticated venture investors. Direct investments have almost doubled over the last 18 months. The average family office venture portfolio now has 17 direct investments and ten fund investments, and within the next two years, the typical office will make around 18 new investments.
Persistent barriers to the venture profession
However, as we’ve previously covered, not every family office has enjoyed smooth passage into the venture investment world. Many have struggled with the asset class and how best to approach it. The venture profession also requires focus, skills, networks and experience, all of which take time. Irrespective of the available capital, a successful venture franchise cannot be built overnight.
One persistent barrier to overcome is talent, which remains in short supply due to the ‘apprentice’ nature of the profession. To become a skilled VC – and to train others effectively – you need to understand all the aspects of the investment process, portfolio management, value-enhancing activities and eventual exits, along with sufficient time on the ground to get full exposure into the venture investment cycle. Many founders are relatively inexperienced and rely upon investors’ wisdom and guidance to steer them through difficult moments (such as a pandemic!).
Referrals can also be an issue for family offices. With the fight over deal flow increasing, the most experienced venture investors have established pipelines of inbound and outbound opportunities built around a strong referral community, club deals, repeat founders, access and networks to hubs and incubators bustling with top entrepreneurial talent. Once engrained in the system, investors can foster and sustain a continuous pipeline of attractive companies and entrepreneurs, but this process takes years to nurture and requires close attention – not always easy for diversified family offices juggling different asset classes, priorities and dynamics at the same time.
An increasingly competitive landscape
Venture capital is ideally placed to address many of the challenges, problems and bottlenecks we are facing in the world today, and a vast percentage of the leading tech businesses today have taken on venture capital – usually at a formative stage in their journey.
Now, as the venture ecosystem matures, it is increasingly well-placed to filter businesses and entrepreneurs, providing the best and brightest with the capital and support they need to make a strong start on business building. But VC is also the ‘ugly duckling’ of all asset classes – receiving the least resources and requiring the most work. It can be a steep learning curve, and family offices need to be prepared to go the distance.
Furthermore, following several years of extraordinary growth across the European venture ecosystem, there are lingering questions about when this growth might start to flatten. With such a significant inflow into venture capital – both in terms of new entrants and increased depth of capital – will we find ourselves in a situation where everyone is trying to eat everyone else’s lunch, and every deal becomes a dogfight?
If this comes to pass, the danger is that less experienced family offices, or those attempting to make direct investments, may lose out in the battle for access to the best deals.
Share the lunch, split the cheque: the future of family office venture capital
Family offices possess several key ingredients for venture capital success: capital, patience and commercial history. They are not constrained by fund cycles and liquidity. They are usually designed to protect and grow wealth for future generations – ideal for investment in young businesses looking to solve pressing societal, financial, productivity and environmental challenges.
However, offices need to be patient when it comes to building a presence. It is a very heterogeneous sector, and each office needs to identify a suitable model and strategy to fit their existing operation. Moreover, Champ Suthipongchai makes a valid point when he argues that, before they dive into the VC pool, family offices must first clearly establish why they want to invest in venture capital.
For family offices looking to expand their venture capital footprint, partnerships will be crucial to success, both in selecting the right fund managers to work with and getting early access to the right deals. Co-investments – with family offices investing alongside VCs – could be the order of the day, giving offices a chance to increase their exposure, deploy more capital at reduced rates and better economics, and diversify within funds at a lower cost through Special Purchase Vehicles.
Family offices will undoubtedly continue to permeate the venture ecosystem. However, rather than just eating the lunch of existing VCs, there is a clear opportunity to form partnerships that are not just mutually beneficial from an investment perspective, but that serve to build better companies for generations to come.