Family offices and venture deal flow – the holy grail
Kjartan Rist for Simple Magazine
For family offices looking to grow their venture portfolios, generating, and managing deal flow is a significant challenge. From building a pipeline of startups to filtering out the most promising deals, what’s the best way to approach it?
Family offices have traditionally flown under the radar when it comes to venture investing, but their involvement and profile in the space are rising. As of 2021, around 80% of family offices were making venture investments regularly – up from 40% a decade ago. And the amount they’re investing has increased, averaging around 12% of their portfolios last year, up from 10% the year before.
For family offices looking to grow their venture portfolios, generating, and managing deal flow is the first big challenge. According to the Harvard Business Review, only around 1% of venture deal flow ends up as investee companies. So out of every 100 opportunities, just one will make it into the portfolio, and if you want to invest in a diverse range of businesses, then thousands of potential deals need to land on your desk.
Achieving the holy grail of deal flow means not only building up a substantial pipeline of startups, but also ensuring they match your areas of interest, and having a team with the capacity to assess and ultimately filter out the best potential deals. How you approach the deal flow process will ultimately make or break your venture ambitions.
Scaling up the deal sourcing machine
Deal flow can originate from a whole variety of sources, but for a family office starting out, it is likely to be opportunistic, primarily originating from referrals from other family offices, entrepreneurs, professional services firms, or as an LP as part of a venture capital fund. As you look to increase your involvement, the challenge is to build a deal sourcing machine, incorporating inbound and outbound leads, that will enable the portfolio to scale.
Every family office is different and it’s important to choose an approach that suits your ambition for the asset class and the resources at your disposal. If you keep it all in-house then you need to approach it as a venture fund, with all the complexities and demands associated with that. If you outsource it, working through a Fund of Funds or venture capital partner, then it will be simpler, but you may lose some control and access in the process. Many family offices choose a hybrid model, as discussed here before.
Venture is unlike any other asset class, and many family offices have burnt their fingers due to a lack of strategy and properly worked-out thesis. An activist mindset is required from the sourcing stage, with hands-on assessment and analysis to iron out problems, shortcomings, and issues. As family offices have a wide range of interests and commitments, the question is whether they can marry these with the complexity of venture investments.
Defining your strategy
Taking a step up from opportunistic deal sourcing requires family offices to put the foundations in place, in terms of strategy, framework and investment thesis, to ensure that they’re attracting the volume of deals – and the right kind of deals. Failure to get this right by investing too fast and without the right strategy and structure in place can mean higher risk, poor companies, or bad deals, which fail to achieve the returns that you were hoping for.
Will you take a generalist approach, or focus on specific sectors where you have experience or prior knowledge? What will your criteria be in terms of business maturity and size, business model and geography? And do you have a philosophy in terms of the type of founder, or founding team you want to back, and their role in supporting and nurturing portfolio businesses? Asking these questions upfront will ensure you develop the most appropriate access model to attract the right kind of startups, as well as a diversity of potential deals to reduce the risk of being overexposed in any one sector.
Achieving quality deal flow
In general, deal flow is divided into inbound and outbound. Inbound encompasses organic deal flow, resulting from any brand building or thought leadership work, alongside referrals. Whereas outbound encompasses work you do to identify promising startups by market mapping, events, networking, or via relationships that you develop with startup hubs, accelerators, seed funds etc.
Achieving quality deal flow, both organic and through pro-active engagement, is dependent on building a brand, reputation, and relationships on many levels across multiple ecosystems. Venture has become increasingly fragmented in recent years, so developing a presence and a recognised brand takes time. There aren’t any shortcuts; the key is to get out there to meet and engage with as many people as possible, so that you gradually zone in on the most useful and valuable contacts.
Driving inbound deal flow is all about building your reputation and voice online through social media and PR. Online and in-person networking are also invaluable to build connections with the right people within your focus areas and start to generate more introductions and referrals. Many family offices underestimate the challenge of building venture networks, but this is absolutely core to your success in generating the level of deal flow you need to be successful.
Deal assessment process
Once you have a healthy flow of potential deals coming in, you need the capability to filter companies fast, to ensure that your team spends time on the best and most qualified deals. Putting the work into defining your strategy upfront will make this process infinitely easier, enabling you to quickly discount any opportunities that don’t fit with your strategy and thesis.
Once outliers have been discounted, deal assessment requires in-depth and time-consuming analysis and due diligence, on top of nurturing and building relationships with early-stage companies and their founders, which can take several years in some cases. As your knowledge and network grow, this process should become quicker and more streamlined, as you will have more sector experience, benchmarks, referrals, and reference points to draw on. Getting it right takes skill, experience, and tenacity, so if you’re looking to keep your venture sourcing in-house, it is advisable to hire somebody who knows what they’re looking for.
Nurturing a growing portfolio
And the work doesn’t stop there, as the next stage is to constantly manage the growing portfolio alongside continuing with your deal sourcing. As sectors, business models and technologies evolve, it is important to continuously reassess and develop the investment thesis, as well as carry out continuous risk assessments of the number of venture engagements on your books, and the inherent risk in the portfolio. Market conditions can change rapidly, as we saw recently with the pandemic, so family offices need to be prepared for unpredictability. It requires close management, to avoid becoming overwhelmed by admin, portfolio issues and problems.
Does a blueprint exist?
Each family office is different and there is no one-size-fits-all venture model or approach to deal sourcing. It comes down to the different priorities and strategy of the team, and the resources they have available. Family offices need to be clever when deciding on their involvement to find a ‘model’ that enables them to succeed with deal sourcing and their overall venture activities.
Family offices investing in venture capital need to be in it for the long haul, be highly motivated and prepared to start a journey of continuous learning. Across sourcing, nurturing, and exiting companies, a plethora of skills is required. Overall, it requires commitment, deep involvement, and a readiness to look beyond economic cycles. Speed is rarely the solution, and family offices need to be prepared to stick with it, to grow their reputation and network over time.
Venture capital is all about sourcing companies that can offer new solutions to big problems, thereby having an outsized impact on society. Picking winners isn’t easy and there is no substitute for experience, and taking a long-term, considered approach. However, the rewards can be significant. Put the work in and you’ll not only help to build the next generation of category leaders, but also, of course, see considerable returns.