As the public markets falter, many family offices are re-evaluating their investments, with a view to maximising returns in the coming years. For some, this could mean looking at venture capital (VC) for the first time. But if you’ve never invested in startups before, it can be difficult to know where to start. Should you invest directly into founders and business ideas that you like? Or should you work with a VC fund? How can you mitigate the risk involved and maximise your chance of success? 

This guide aims to break the whole process down, so that you can get the most out of VC.

Is now the right time to invest?

First, you may be wondering whether now is a good time invest in venture given the recent pullback in VC funding. But, while many investors are taking a pause, there are rich pickings for those who are staying proactive. The market has shifted from quantity to quality, and with digital transformation gaining pace, there are fantastic deals to be done, and predictions that the 2023/24 vintage will be the best in a decade. 

Following several very active years in Europe, and around the world, there is now a huge depth of talented entrepreneurs with experience of starting businesses. And it is often during the tough times that the best, most resilient founders rise to the surface. Less experienced and committed VC managers are also being shifted out of the market, while non-traditional VCs are refocusing on their core activities, meaning those that remain are putting greater focus on ‘VC craftsmanship’, including due diligence, fundamentals, and providing hands-on support to founders.

Investors are also benefitting from lower valuations, which are back at reasonable levels following a few years where they arguably got out of hand. In 2020 and 2021 it wasn’t unusual for software companies to attract 30x multiple valuations. That has now dropped to a more realistic 6-8x in the last 12 months. That means a much lower entry point, and more room for growth for VCs, and their LPs.

Research benefits vs. risks and ensure you’re comfortable

Nonetheless, family offices must ensure that they’re comfortable with the level of risk involved in venture. Whatever the economic landscape, starting a business is inherently risky, and there is no guarantee that entrepreneurs will succeed in getting their ideas off the ground. Just like with any other type of investment, it’s important to have a clear strategy and to diversify your portfolio to mitigate the potential downsides. Research has found that as many as 75 percent of venture-backed companies never return cash to investors. 

On the plus-side, there are huge returns to be made from those startups that beat the odds. To give an example, SoftBank’s initial $20m investment in Alibaba was eventually worth $60bn when the company was listed on the stock market – that’s an incredible 3000x return. And even outside these extreme examples, good VCs typically expect a ten-times return of capital over five years. 

Decide how much of your portfolio you want to invest

Once you’re got acquainted and comfortable with the level of risk involved, it’s time to start thinking numbers. To provide a rough guide, the Campden Wealth European Family Office Report 2022 found that family offices globally allocate an average of 6% of their portfolio to venture capital – 5% in Europe – with 50% saying they intend to increase this. Think about what level of commitment you’re comfortable with based on your assets, current portfolio, and appetite for risk. If you’re just starting out it may be best to start small and then increase your commitment, as you build your network and hone your strategy. 

Define your strategy

This step is critical to ensure you achieve what you want from venture funding, both in terms of returns and enjoyment of the process. Do you want to focus on sectors that you’re interested in? Or a particular geography, or maturity of business? Or do you want to take a more generalist approach? The strategy you choose may be based on your own experience, expertise, or interests, where you feel the biggest opportunities are in the current market, or the size of investments that you want to make. 

Decide if you want to go direct or through a VC

When it comes to investing, there are three routes you can go down – you can run the whole process in house and invest directly into startups, you can invest through VC funds, or you can take a hybrid approach. 

Investing directly has its attractions. You have control over the whole process, direct access to entrepreneurs, no fund management fees to pay, plus the chance of even higher returns. However, the amount of work involved shouldn’t be underestimated. Running the deal sourcing, due diligence and portfolio management processes requires specialist skills and expertise that most family offices don’t have, and which are expensive to acquire. It also takes time to build up a deal pipeline to ensure you’ll have good diversity of investments. 

In contrast, investing via a fund enables you to hand over vetting responsibilities to a trusted third-party, while enabling you to support a wider range of businesses than you might via direct investment. If you’re starting out, this is likely to be the best approach, enabling you to build up confidence, knowledge, and networks, before starting to invest directly into startups that you like further down the line. In many cases this can be done alongside your VC fund, via co-investment deals, which mean that you can ‘double up’ by investing through the fund and with a portion of direct capital. 

Most family offices opt for a hybrid approach, with research showing that on average family offices invest 46% of their venture portfolio to funds and 54% to direct investments.

Research fee structures 

If you do decide to start with VC funds, make sure you understand how they charge for their involvement. VCs nearly always follow the same structure, which is they charge a management fee of around 2% of your investment and then earn carried interest on top, which is a percentage of the profits made – usually around 20%. 

Start allocating capital 

Once you feel confident with your strategy, start setting up meetings with funds to see who you would like to work with. A good place to start is by tapping your existing network and seeking referrals, prioritising those fund managers where you share chemistry and investment philosophy, and who best support your objectives for VC. Bear in mind that while you might initially be drawn to the big names, younger, smaller firms are likely to offer you more access to VC principals and entrepreneurs, involvement in the process, as well as co-investment deals.

Supporting world-changing businesses

Venture investing can be hugely lucrative, but more importantly, it gives family offices the chance to support the next generation of world-changing businesses. We face so many enormous challenges at present, from climate change to a growing population, shifting demographics, and financial inequality, and technology remains the best solution for many of them. Family offices investing in venture can ensure their money isn’t just working hard for them, it is also helping to shape the future.  

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