Understanding how VCs and family offices can work together

Investments 03.06.2022

Understanding how VCs and family offices can work together

Kjartan Rist For Simple Magazine

The story of family offices has always been closely aligned with the evolution of venture capital. Prominent families have been making direct and indirect investments in new enterprises for centuries. Illustrious names such as Phipps, Rockefeller, Wallenberg and Zennstrøm have given rise to some of the biggest players in the VC industry today, such as Bessemer Ventures, Venrock, EQT and Atomico.

Like venture capitalists, family offices tolerate and understand risk. Both recognise that it takes capital and patience to build new category winners. And with more family offices now looking to diversify away from public markets and traditional assets towards investment into emerging sectors and companies, there’s every reason to push for closer alignment between these two interlinking worlds.

As UBS highlights in its 2021 Global Family Office report, macroeconomic headwinds are encouraging offices to explore alternative means of deploying capital. The research shows that venture is now the second most popular type of private equity investment amongst family offices.

And yet, we could argue that venture capital remains an under-exploited opportunity within family office asset allocations. Within a vast and crowded market, like-minded VCs and family offices struggle to find one another. And even when they connect, there isn’t always a clear understanding of how the other party likes to operate, or indeed, how to work effectively together.

Choosing an investment strategy

Family offices can use three main models to access the venture industry – direct investment, investment into a fund of funds, or investment into a venture capital fund.

Alan Merriman, Founder of Elkstone Partners, suggests that a combination of direct and fund-oriented investments represents an ideal way for offices to learn the ropes. “You won’t understand venture until you invest directly and get exposure to founders and the pressures they face. Whereas with VCs, you get a finger on the pulse regarding market valuations and what is hot and cold. For our office, the direct investment makes us better at choosing VC partners, while learning from VCs makes us better at direct investment.”

Of course, determining the best route into the venture will depend on each family office’s structure, lifecycle, prior experience and internal expertise. While the number of in-house VC professionals is on the rise, pursuing a proactive direct investment strategy is extremely resource-intensive, limiting the number of deals most offices can realistically make.

As John Moore, Founding Partner at Moore & Moore Investments, explains, “Family offices are at a disadvantage – compared to specialist VCs – when carrying out market research and due diligence within narrow deal-making windows. They’ve generally made their money in a specific industry, and while they recognise the need to diversify, they have neither the time nor inclination to assess specialist venture opportunities in fields they know nothing about.”

Hence, research suggests that family offices typically end up taking a similar road as they look to build up their understanding of the VC industry. According to Barry O’Brien, Head of Family Office Practice at SVB Capital, “Most [family offices] start by investing in fund of funds to gain access to established venture funds, while also making ad-hoc investments from friends & family, and finally invest directly into venture funds and startups.”

Understanding how family offices can access venture capital

According to O’Brien, regardless of which model they adopt, the universal challenge almost all families face is how to access the best venture deals. As he notes, “You need a strong network of fund managers, founders, and/or FOs to share deal flow.”

Moore spends much of his time helping family offices establish trusted relationships with VCs. He suggests that finding the right partners is a particular problem for family offices starting out on the journey into venture investment. “Family offices might try to attend conferences or join relevant professional networks to gain exposure, but it’s a risky approach for an audience who tend to feel more comfortable operating out of the limelight. They need specialist advisors to open doors and guide them – and they won’t get this service from their private banks or generic wealth managers.”

With 1,000s of family offices, most of them maintaining a low profile, it can be similarly problematic for VCs to identify and approach suitable investors. As Ron Diamond, Founder of Diamond Wealth, recently explained to The European VC podcast, “It’s hard for emerging managers in VCs to get into the FOs because there’s no list. You can’t just go to Pitchbook and find out – these offices are deliberately staying below the radar.”

In the quest for better deal access, trusted intermediaries and advisors will have an important role to play in connecting family offices and like-minded VCs. 60% of family offices currently rely on their existing network for deal flow, limiting their exposure to the wider VC industry.

Encouragingly, however, there are signs of a change in mindset within multi-generational offices, where venture investment is currently the top-ranked area for next-generation involvement – surpassing philanthropy for the first time.

Choosing the right partners

Given the difficulty in pursuing a 100% direct investment strategy, it seems inevitable that we will see more family offices putting their trust in external VC partners to achieve their investment aims and diversify their risk assets.

When choosing a venture partner, offices need to pay careful attention to how each fund is constructed – particularly the implications of how and where capital is being deployed. For example, some funds will draw down investor capital over a 3-4 year period, whereas others will require the total commitment upfront. The latter may be appropriate for well-lubricated family offices pursuing a passive strategy with a VC partner they trust to get on with the job, but it won’t be suitable for those who want to know where their money is going – and why.

Working with VC partners also necessitates a different mindset for making direct investments. As Merriman points out, “If you’re allocating to a VC, you’re allocating to a professional specialist manager and putting your trust in their skills. You’re not meant to be second-guessing them.”

Similarly, Diamond suggests that family offices and venture investors don’t always see things from the same perspective. “Family Offices look at things through a different lens – for example, from a multi-generational standpoint. They might get a lower return, but succession, impact, or philanthropy is important to them. It’s a more holistic view than the way a VC may look at the world.”

Accordingly, the family office/VC partnerships most likely to prosper will be those where there is a close alignment of values as well as commercial interests.

Relationships that deliver for both parties

Once a partnership is active and underway, maintaining an effective relationship requires ongoing collaboration and a regular flow of information. Family offices cannot expect the same level of insight that they will get when dealing with direct investments. But as a limited partner in a VC fund, they still have a right to know how their investments are performing.

“We opt for quarterly check-ins with our venture partners,” says Merriman. “Monthly is too frequent, but quarterly allows you to get into a rhythm. And it should be a two-way process. Offices must think about how they can bring value to the VC too – for example, sharing their own market insights or affording trusted VCs access to their professional networks.”

Further, while VCs need to ensure that they’re not too aloof and ensure that senior fund managers are accessible to investors, Merriman argues that there’s no room for snobbery when it comes to relationships. “It isn’t always essential to speak to the senior VC. Associates and analysts will one day become VC partners, and potentially a vital source of future investment opportunities.”

One area where VCs can add ongoing value to family offices is by helping them navigate the wider industry, signposting attractive deals ahead of time, or acting as a trusted advisor when offices are approached with new opportunities.

According to Moore, this aspect of VC/family office relationships needs to improve. “Too often, partisan advice takes precedence overacting in the office’s best interests. I’ve only found a handful of the VCs willing to give a clean bill of health to any deal that’s not theirs.”

In addition, he believes that family offices may be more trusting of their VC partners if fee structures can be made more transparent and tied more closely to performance rather than management. “Even the most passive investors don’t want to be taken advantage of, and the history in the space has often been opaque fee arrangements. One of my jobs is to advise offices and help them strike the best deal, while still ensuring that VCs are adequately compensated and have the money they need to do the job properly.”

Finally, while establishing the right relationships with VCs will extend family offices’ access to the wider venture world, improving deal flow and further diversifying their investment opportunities, constructing a venture portfolio isn’t something that can be rushed.

“It can take at least a decade to build and establish a portfolio of venture capital funds”, says Merriman. “Offices need to carefully consider every new relationship they form with VCs – from the type of VC, their geography or specialism, to how they construct portfolios and evaluate company performance. It’s an illiquid allocation, so you have to build your portfolio with a generational mindset, ensuring that it’s giving back as well as taking along the way.”

Powering the engine to deliver societal change

It’s an incredibly exciting time for family offices to be investing in early-stage companies. Many of the most pressing issues facing society can only be solved with technology, and the past decade has demonstrated beyond doubt that tech innovation is faster and more efficient in the hands of venture-backed startups and entrepreneurs.

Not only that, but the VC world is finally learning to be proactive – adding value beyond just providing capital. Indeed, the pandemic served as a wake-up call about the need to provide founders with greater support, expertise and network access. It is a credit to the VC industry that so many startups have emerged unscathed from such a prolonged global crisis.

With this decisive break from the laissez-faire approaches of the past, venture investment now looks particularly well-suited to family offices as they seek alternative means of deploying patient capital. While the way in which individual offices construct their portfolios will differ, and the two partners won’t always share the same priorities, this will not stop them from forming fruitful symbiotic relationships.

As venture investment allocations increase, it’s time for family offices and VCs to start working more closely together. Doing so will not only lead to better and more lucrative investment decisions – it will bolster connectivity and deliver vital network effects, to the benefit of early-stage companies everywhere.

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