Family offices are in a great place to take advantage of valuations in the current venture capital market environment, according to the author of this article.
The following article makes the case for why family offices are in the driving seat when it comes to investing in relatively illiquid areas such as venture capital, forms of real estate and private equity, to name just three. The commentary comes from Ragavan Arunachalam, senior associate at Collyer Bristow, the law firm. The editors are pleased to share these views; the usual editorial disclaimers apply. Email firstname.lastname@example.org and email@example.com
The great Sage of Omaha, Warren Buffett, once stated the following: “Widespread fear is your friend as an investor because it serves up bargain purchases."
Whilst such musings have been a staple of the famed contrarian for some time, they seem particularly resonant given the current COVID-19 crisis. We are certainly living in a time of widespread fear and, as a consequence, potentially a time of unprecedented opportunity. What will become clear in the coming months is that, in the private equity space, not all players are equal when it comes to grasping those opportunities.
That said, I would not wish to downplay the difficulties that we will all face in the coming weeks, months, and indeed years, but there are several reasons for family offices operating in the private equity space to be positive. In particular, when compared with traditional venture capital, family offices may be better placed to take advantage of the inevitable recovery.
There are at least two reasons why this may be the case. Firstly, family offices are traditionally more agile, insofar as they can usually close deals more quickly than a venture capital fund. Unlike a VC fund, which might have an institution as a cornerstone investor, and therefore an extensive list of criteria that need to be satisfied, a family office might have a smaller investment committee with more flexible parameters.
The context as to why agility might be important is as follows - the market before coronavirus was too hot. There was too much dry powder chasing too few genuinely good deals. As a consequence, investment opportunities were overpriced, and there was a feeling that the prudent investor was a cautious investor as the next big shakeup was around the corner - well, it’s here and, perhaps counter intuitively, investors no longer need to be afraid! Whilst that might sound glib, those private equity investors who move fast may be rewarded. They could pick up fundamentally sound businesses, which are momentarily struggling due to COVID-19, and so secure investments that are good value over the long term.
Secondly, family offices might fare better in the long run because they can hold their positions for longer. Whilst a traditional VC fund might need to exit at a particular time, a family office may not be working under the same constraints. The road to recovery will be a long one, and whilst there is value to be bought now, that value may take time to crystallise - time that not all VC funds have.
The above is not to suggest that family offices will have it all their own way. The COVID-19 crisis will undoubtedly dry up liquidity in the market. In this environment leverage is going to be harder to source as it becomes more difficult to borrow money from more traditional (and therefore conservative) sources looking to weather the current storm. That said, VC funds, with their greater resources should be better placed to convince debt providers to back them and their projects. This ability to defray risk and enhance returns should not be underestimated.
Furthermore, family offices traditionally back more mature investment opportunities. They usually want to see evidence of profit, as well as revenue, before they are prepared to commit. Whilst this approach safeguards them from the high rates of attrition faced by those investing in start-ups or less mature prospects, it also limits their exposure to the kind of explosive growth VC funds can sometimes tap into. In a similar vein, family offices sometimes focus on more traditional sectors whereas it is likely that the COVID-19 crisis will bring non-traditional investments to the fore. The ability to successfully identify and carry out due diligence for emerging opportunities may be something that VC funds, with their sometimes more forensic approach to investment, will be better placed to do. The strong governance processes which sometimes contribute to the inflexibility of VCs may therefore ensure they do not back the wrong horse.
The fear currently gripping the markets will eventually subside. To grasp the opportunities at hand, investors will need to harness the best of both agile and rigorous investment processes favoured by family offices and VC funds.