The author of this article examines the pros and cons of using venture capital or family office structures to handle technology investments.

Family offices get involved in venture capital – which appears a natural fit given that FOs are famous exemplars of “patient capital.” And some family offices can be offshoots of VC firms themselves or engage in so much venture capital activity that they compete with standalone VC firms. This can raise questions about whether family offices compete with VC firms to some extent, or are a complement to them. 

To examine this area is Guy Avshalom, partner at UK-based law firm McCarthy Denning. The insights shown here apply not just to the UK, but other parts of Europe, as well as North America, Asia and other regions where VC firms and family offices operate. 

The editors of this news service are pleased to share these insights. The usual disclaimers apply. Jump into the conversation! Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

A venture capital fund and a family office are evaluating early-stage tech businesses. Which organisation is likely to achieve a better return on its investment? It is worth looking at the origin and structural differences between a VC and a family office to form an opinion about this question.

Family offices originated to provide 360 support to high net worth families/individuals managing their assets. The “family office” was traditionally established to consolidate functions such as legal, accountancy, inheritance tax and succession planning, pension and life assurance planning, private philanthropy and assets management under one roof. Beyond a certain level of assets this consolidation of services dedicated exclusively to one or few families makes commercial sense. It helps to mitigate potential conflicts of interest that may arise when engaging third parties to provide banking services. The family office in its basic form manages the owners' wealth and allocates the assets accordingly. Its primary aim is to manage and preserve the founders’ capital.

On the other hand, a VC fund is a pool of funds dedicated to the deployment of risk capital into early-stage growth companies. VCs’ sole purpose of existence is to source, analyse, filter and select the best early-stage projects to deploy its capital. Venture capitalists are usually incorporated in the form of a partnership. The limited partners (LPs) provide the capital. They are usually passive and do not take an active part in the day-to-day management, operation and selection of the target companies.

VCs invest pursuant to a clear mandate that was approved by their investors and form the basis upon which their capital can be deployed. Therefore, VCs are very process focused on investing within their investors' mandate. They have dedicated staff and procedures that source and analyse companies that meet their investment mandate. It is not uncommon to receive feedback from a VC turning down opportunities based on very strictly defined investment criteria.

Preserving capital
Investment decisions may not necessarily follow a strict mandate such as the VCs. In many cases, family offices simply follow the guidance of their owners. Therefore, the family office investment structure and decision-making may be simpler and much less formal than the VCs since, generally, the family office invests its owner’s capital. Clearly, the level of the investment formality may vary from one family office to the other.

In some family offices, decision-making can be changed by its owners due to opportunistic situations which have attracted the owner's attention. It is less likely that a VC will change the mandate of the specific fund or step outside in opportunistic circumstances if the opportunity falls outside its mandate.  

Generally, VC funds operate under a limited time horizon to invest their funds and return the proceeds to their investors. They measure their performance by the return on the investors/LPs capital over a period of time. The general partners track record vis-a-vis return on capital invested is paramount to successful fundraising for future funds. Family offices are less focused on a specific time horizon for return on capital. They may not be under such strict financial returns timelines as they are not chasing capital for the next funds.  

One of the main advantages of VCs versus the family office is their dedicated team and processes to source and analyse hundreds or thousands of companies a year to select the best ones for investment.

There is a difference between family office indirect investment into tech companies versus direct investment into tech companies. Each method of exposure to the tech risk requires a different skill set within the family office. Family offices substantially increased their indirect exposure to tech risk via investment in venture capital funds. They also increased their direct risk investment into tech companies.  

Direct investment into risk tech companies requires skill and a state of mind that may not naturally reside within the traditional family office. When a family office engages with direct investment into risk tech companies it is usually done in one of a few modes of operation. They have evolved and are set to compensate for family offices' relative lack of specialisation with direct risk tech investments. 
 

Syndication or co-investment models
In many cases, a family office has specific knowledge expertise, information or a relationship relating to a tech company that forms the basis for a co investment with fellow family offices with whom they have pre-existing relationships. The relationships between the family office serves to diversify the risk and potentially gain a better bargaining power vis-a-vis the company and other investors.

Often, single family offices have experience and a track record in the business segments of their founders. It is much simpler and more natural for a family office to explore direct risk investment into a company that operates in an industry the founder is familiar with or feels comfortable with.

The relationships of VCs and family offices with the founders of target companies can become a sensitive issue for tech companies’ founders, in particular during the fundraising process and decision junctions throughout the company’s development. Naturally, both parties to an early-stage risk capital financing transaction must get to know each other and build trust to get the deal over the finish line. Due to the circumstances mentioned above, VCs approach and relationships with tech founders may create friction. In extreme cases, it may become counterproductive to the company’s founders’ performance motivation and results. Family offices sometimes have a different approach to risk tech founders. We see this in particular when it is a single-family office with a relevant track record and experience in the same or similar field. The family office may play an important role in mentoring and assisting founders in their journey.

In our experience both approaches to the market are viable. We see no real alternative to the VC volume and concentration of capital coupled with financial discipline, a specialisation that is all fuelled by competition and the constructive chase for better returns for their investors. Although family office direct investment into risk tech companies is increasing, it is still a fraction of the risk capital that VCs are deploying into tech companies.

The VCs and family offices do not operate in isolation from each other. They co-operate. Both are present in risk tech deals. It is very common to see combinations of angel investors, family offices and VCs on one cap table of early stages tech companies. Normally, however, the leading shareholders are the VCs. In many cases, the venture capitalists will invest only after the seed capital was invested and some proof of concept was demonstrated by the company. The risk capital for the initial seed money is generally raised from angel investors, single-family offices, grants and strategic (non-financial) industry partners.

VCs are not operating in a vacuum. They are subject to a very competitive environment where not all VCs return a profit. The odds in the risk tech investors are the same. However, family offices get to deploy money in other classes of investments whereas VCs, by definition, are confounded only to investments in risk tech. VCs face extreme competition; it is this competition that makes venture capital firms a driving force of the tech risk industry. Ultimately the evidence clearly shows that VCs are involved in the vast majority of successful tech exits.