As the appetite for venture capital investing increases among family offices, it is important to take a closer look at the origins and structural differences between a family office and venture capital fund to assess their relative strengths and weaknesses in the context of risk in private capital technology investments.
Family offices are the guardians of their families’ wealth. The family office was set up to consolidate various functions, such as legal, accountancy and assets management under one roof. This makes commercial sense above certain level of assets. It mitigates potential conflicts of interest by bringing them in house.
VCs’ sole function is to source, analyse, select and deploy their capital in the best early-stage privately owned opportunities. VCs have clear mandates, pre-agreed with their investors. They have dedicated staff and procedures that select the companies in accordance with their investment mandate.
In many cases, family offices follow the guidance of their owners. The family office investment structure and decision-making process may be simpler and much less formal than the VCs. It is more common to see opportunistic decision-making in family offices. They can chase situations and commercial opportunities that attract the attention of the owner.
Generally, VC funds operate under a limited time horizon vis-à-vis their return on investment. Their track record is paramount to successful fundraising for future funds. Family offices are subject to less stringent financial returns timelines as generally they are not chasing capital for the next funds.
The main advantage of VCs in comparison to family offices, in the context of investment in risk tech in private companies, are their processes, dedicated teams and focus on the specific vertical of tech risk investment.
Direct investment into risk tech companies requires skill and a state of mind that may not naturally reside within the traditional family office. Family offices have evolved to compensate for their relative lack of specialisation in comparison the VCs.
In many cases family office invests pursuant to specific knowledge expertise, information or relationship that was obtained by their founder. It is much simple and natural for a family office to explore direct risk investment into a company that operates in an industry the founder is familiar or feel comfortable with. Family offices tend to form co-investment partnerships, informal syndicates that serve to diversify the risk and gain a better bargaining power.
Family offices are building in-house venture expertise, according to A Roadmap to VC Success, the first of four parts in a new benchmarking series called Family Offices Investing in Venture Capital—2021-2022 by Campden Wealth and SVB Capital. In the 2020 study, the average family office staff included one venture capital specialist, and family offices expected that, within five years, one more would join the team. Today, staffs include two venture capital investment professionals.
Investors relationships with the founders of target companies are a sensitive issue. Naturally, both parties to an early-stage risk capital financing transaction must build trust to get the deal over the finish line. Sometimes we see that VCs approach to tech founders creates friction with the founders.
In extreme cases, it may become counterproductive to the company’s founders’ performance motivation and results. On the other hand, in many cases family offices have a more rounded approach to founders. Accordingly, the family office may play an important role in mentoring founders throughout their journey.
All said, there is no real alternative to the VCs ability deploy capital coupled with financial discipline. It is a necessity since VCs are in constant competition on the segment of risk capital in private tech companies. This competition drives constructive chase for better returns on capital deployed. Family office direct investment into risky private tech companies is still a fraction of the risk capital deployed by VCs.
Ultimately VCs and family offices co-operate. It is very common to see combinations of angel investors, family offices and VCs on the same cap table. In many cases, angels and the family offices lead the seed investment. VCs may not be on the cap table at this stage. However, if the company survives and reach later rounds, then the situation reverses, and VCs join and lead the rounds.
The track record of the VC industry clearly shows that VCs are involved in the vast majority of successful exits. However, this outcome does not come without its costs. Many VCs lose money or hardly break even. Their outcome is highly dependent on their management teams and other factors that may not be within their control. However, for a family office that does not have the expertise and excess required to embark on direct investment into private risk tech companies, VCs should be an option to be taken very seriously.