An ever-growing number of family offices want to invest into private tech companies. They’re usually motivated by a combination of financial returns, a search for strategic benefits with their core operating business, and passion about tech. But how should they go about it?
Dr. Joel Palathinkal, CEO of Sutton Capital, observes that high-quality founding teams and GPs are often difficult to access for single family offices who are not directly plugged into the right ecosystems. Generically, I recommend either invest in funds or build the competency to go direct. But don’t do it half-heartedly. “There’s nothing in the middle of the road but yellow stripes and dead armadillos,” quoting author Jim Hightower.
You can use multiple strategies. Thomas Wisniewski, Managing Partner, Newark Venture Partners, said,
“Prior to launching Newark Venture Partners, I was a direct family office investor in about 30 start-ups. My return multiple is excellent, nearly 5x. But I also invested in a number of VC funds in parallel. Why? Investing in promising tech start-ups directly can appear “easy” given the vagaries of the available data and the long hold periods: everyone has a supportable opinion and it will take 5-10 years to know who was right! Consider that successful VCs need to look at 100 companies in order to choose one. And for 10 investments carefully made this way, more than half will be a total loss, or provide no financial return. VC is truly a very separate, unique and complex asset class that requires real expertise to achieve returns. For an FO looking to start making direct VC investments, investing in and forming a deeper partnership with a VC fund (or several) makes a lot of sense. It provides screened deal flow, leveragable expertise, and portfolio diversity. If you put skin in the game by investing in a fund, many fund managers will be happy to provide coaching, expertise and valuable access.”
I see 7 main ways that family offices can invest in early-stage companies, which I’ve ranked in order of increasing level of time and effort required. The first three are often implemented without dedicated team members:
1. Invest in VC funds (or funds of funds) exclusively.
Advantages: VC funds offer professional, experienced management, and crucially netting of carry. This is particularly important given the high dispersion of returns in individual venture investments. Virtually every financial advisor will tell you not to invest directly in stocks unless you’re a professional stock-picker. If that’s true in the liquid, transparent public markets, all the more so is it true in the illiquid, opaque private markets.
Disadvantages: You pay a management fee and carry. You need to do proper due diligence on the funds. You don’t have the discretion to make decisions on a per-company level. In addition, small retail investors normally cannot invest in funds because their checks are too small. However, a number of platforms now facilitate direct access to a broad array of VC funds, e.g., see my list at How do you attract family offices and other large investors to your direct investing platform?
2. Invest in companies via syndicates, particularly via online investing platforms.
Leading online investment platforms include AngelList (see Versatile VC’s syndicate here), Republic, and Republic Capital). Certain multi-family offices also offer co-investment vehicles to their clients (e.g., Partners Capital, Brown Advisory, Jasper Ridge, East Rock).
Advantages: These established platforms provide steady, pre-diligenced, often high-profile deal flow, with standardized levels of deal details and disclosures. You have full control to choose whether to participate in any specific investment, normally through a special purpose vehicle (“SPV”). The platform decides on the SPV’s behalf if and when to liquidate the investment and distribute the gains (or losses). This enables you to put money into only those investments where you have highest conviction and optionally think you can add the most value.
Disadvantages: Platforms normally charge carry and management fees. Carry is calculated on each investment and not the entire portfolio, even if you invest in multiple SPVs. For example, if you invest equally in 10 companies, and 9 fail and one is a 10x winner, you’ll end up paying materially higher fees on the winner than if you had invested through a fund structure. Jeremy Kuo, Partner, Stonks Inc., tweeted, “there’s still a high amount of adverse selection on the platform [AngelList]…Syndicates of all kinds incentivize spray and pray activity in the short term. Short term, the incentive is for syndicate leads to syndicate many deals with very low personal commits – or even deferred commit amounts to scouts. I’ve seen many uneducated Limited Partners join the platform, invest in a few deals and leave shortly thereafter.” See A Word of Caution to AngelList LPs, which discusses how many investments you see on AngelList (and other platforms by extension) are bridge rounds. Also see Not All Alternatives Are Created Equal. For more on SPVs from the point of view of a VC, see Why tech investors need to look beyond seed-stage SPVs.
3. Invest in funds, and tell them you’re evaluating them based in part on the number of direct opportunities they’ll provide.
If you are a material LP and are actively involved with the fund, this gives you much of the insight and influence you’d have with your own staff, without the difficulty of building an in-house VC operation comparable in sophistication to your independent competitors. Ben Gordon, Managing Partner, Cambridge Capital, observes that family offices “can establish separately managed accounts (SMAs). Under this scenario, they can invest a pool of capital with a manager, who will allocate the funds on a discretionary basis. The advantage for the family office is that they can gain a fixed allocation, e.g. $5 million per deal in the next 4 deals, without the 10-year time horizon that a fund often requires.”
Advantages: No extra cost on your direct investments, except to the extent that the fund charges fees on SPVs.
Disadvantages: You’ll still face the challenge of getting and responding positively to a request for coinvestors (“syndication”) before others invest ahead of you, since companies which have secured a reputable lead VC tend to fill up their syndicate extremely quickly. Veronica Wu, Managing Partner, First Bight Ventures, said, “Family offices often say they want to invest in deals, but rarely do because they simply don’t have the right resources. Unless they are willing to set up a team to diligence and review deal flow, investing in funds is probably a better option for them. Even top programs like YC don’t guarantee outlier performance.“ See How VCs structure a syndicate and recruit coinvestors.
You can pursue a combination of 2) and 3) with other family offices. Your primary filter should be the sophistication of the lead investor, and how much capital they’re investing. For example, 10 East enables investors to co-invest in one-off deals and niche funds alongside the institutional-grade family office of Michael Leffell, former Deputy Executive Managing Member of Davidson Kempner. They offer vetted private credit, real estate, niche venture/private equity, and other one-off investments typically unavailable through traditional channels. The principals have a 12+ year track record and 355+ transactions under their belts.
4. Invest in a fund’s management company or General Partnership (i.e., the entity which manages the VC fund), not just as a passive Limited Partner.
You can anchor a new fund. Another option is to extend a working capital loan to a GP, with a pre-agreed-upon multiple, secured against their future carry. Investing at this level is part of the strategy for Coolwater Capital, the “Y Combinator for emerging VCs”. Coolwater has incubated and helped launch >200 funds which have collectively raised >$2b, including at.inc/, Deciens Capital, and Preface Ventures.
Advantages: Potential long-term upside from the General Partner’s success in general, not just from a particular fund.
Disadvantages: Far more complex to negotiate. See Should you give an anchor investor a stake in your fund’s management company?
Your last three options below require setting up a dedicated person or team, because you’re primarily competing with institutional players which pursue, exclusively, each of the strategies below. In addition, many family offices find it hard to execute these strategies without giving up some of their traditional deliberate obscurity. It’s hard to market your firm without a website and other conventional marketing tools.
5. Actively look for coinvestment opportunities in any rounds led by reputable VCs.
Advantages: no management fees or carry. In general, this is by far the most crowded strategy. The reason is simple: The historically best-performing VCs consistently outperform, a consistency which doesn’t exist in most other asset classes. When you can invest alongside these top funds, you’ll likely outperform.
Disadvantages: Terri Chernick, formerly CIO of the Koffler Group, said, “The founder/ VC ‘food chain’ is a rapacious scrum! (By scrum, I am referring to rugby and not software). Unless you are an active player in that food chain, you are only going to get the dregs.” Adverse selection is a real issue: When VCs are the most confident in an investment, they’ll write a bigger check and invite only their closest allies into the round. Joining syndicates is a hard strategy to execute well without suffering the “winner’s curse”, because the VC industry has so many followers (price-takers) and so few price-setters. I’ve had literally hundreds of meetings with people over the years saying, “Just call me when one of your companies is looking to fill out a round!”
6. Publicize that you’re focused & value-added in a specific industry, looking for coinvests, and build relationships with all the founders & VCs in that industry.
Advantages: This is the standard approach used by professional VCs who are not lead investors. You’re going to get inbound, high-quality requests more often with this focused origination approach. Note the bar is high for truly adding value to companies; just giving generic advice is insufficient.
Disadvantages: You’ll need to actually deliver on your promises.
7. Lead rounds.
Advantages: Investors who lead get the best deal flow, because they are the engine of our entire ecosystem. One experienced family office CIO said to me, “If VCs are fighting it out to get into the best deals, family offices [who are not operating like professional VCs] will only get the rejects.”
Disadvantages: You are competing with institutional VCs, so you’ll need resources and people comparable to those that the independent VCs have. That means hiring people with an expertise level that would allow them to run an independent VC. Only a small number of family offices have the asset base to justify doing this. In particular, the average VC looks at 87 companies before investing in 1. So you’ll need to budget for a lot of meetings which result in no checks being written, and also look into automating your investing process as much as possible. One option to mitigate: Clade, a collaborative platform to help investors directly diligence deals with their internal colleagues or other peer investment groups. Jonathan Lipton, co-founder, estimates that their users save over 30% of their time just by avoiding meetings and Zoom calls which don’t result in checks being written.
I see a lot of investors putting money into companies with surprisingly little knowledge of their financials or other basic information. Right now, almost anyone who put money into tech in the last 13 years looks pretty smart. However, this is perhaps not a wise long-term strategy. Mike Ryan, CEO, Bullet Point Network, observes, “If you are selecting specific companies for direct investment, including co-invests offered by platforms, Funds or SPVs, or in directly sourced deals, you need to vet the investments yourself either using your own team or an outside provider, because you don’t have a fund manager to rely on. While it’s impossible to paint all early-stage VCs with one brush, it’s generally true that their superpowers center around sourcing great deals and evaluating founders at an early stage. When it comes to investing in later rounds at higher valuations after the business is in scaling mode, it can be dangerous to commit to these coinvestments without doing serious independent work on the outlook for the company compared to its current (typically high) valuation.”
I highlight three concerns I particularly suggest you diligence when coinvesting in an investment:
- Many times the VC fund is invested in a prior round, and benefits from the paper markup and reputational benefit upon completion of the round.
- Funds sometimes want to commit to a larger investment ( or to fill a pro rata) to maintain their status or influence.
- In an SPV, usually the organizing entity is earning fees. This means the SPV organizer is motivated to offer as many SPVs as possible with wide dispersion of returns, because they always have upside optionality on each SPV.
A number of firms offer outsourced investment due diligence and analysis as a service. The big strategy consulting firms have built significant practices doing this; Tiger is reported to be Bain’s #1 client globally. Specialized firms like Accordion Partners offer outsourced transaction modeling and execution. Bullet Point Network has an analyst team for hire, built on a patented software platform, and is led by former Goldman Sachs partner and Harvard endowment investment committee member Mike Ryan, quoted previously. Their technology allows you to attach research directly to the underlying strategic drivers of future financial results & exit multiples, instead of losing it in your email archives; and analyze the likelihood of all reasonable scenarios for future financial results & exit multiples. However, Andrew Ackerman, Venture Partner, Dreamit Urbantech, observes this, “presumes that the family office can fill the top of the funnel effectively. If they source a small number of startups and they all are weak, they may perceive the outsourced due diligence as ‘too harsh’ rather than a reflection of the fact that outstanding, investable startups are very rare, especially if the family office is new to the game.”
Rami Idriss, Managing Director, Aurora Asset single family office, said, “For family offices, their technology investment direction should be a function of their strategy. If they value control and direct access to founders, they can go through the direct route. However they need to be staffed accordingly. On the other hand; if they have other operating businesses and are happy to be passive investors, they can become LPs in funds. As a middle ground: they can invest in funds where the manager is vetting the first batch of deals, and they can co-invest along their side in their best deal flow.”
Further reading:
- How do you attract family offices and other large investors to your direct investing platform?
- Family Offices Are Active and Optimistic Investors in Venture Capital, According to SVB Capital and Campden Wealth Report
- The Family Office: A Comprehensive Guide for Advisers, Practitioners, and Students (includes chapter on VC by Joel Palathinkal)
Thanks to Andrew Ackerman, Jesse Bloom, Greg Weyerhaeuser Piasecki, and Jonathan Lipton for very thoughtful feedback, and to Brian Aoaeh, VC and author, Towards a Partnership Model for Family Offices & Emerging Venture Firm Managers (source of the quotations above from Ben Gordon and Tom Wisniewski).
Disclosures: I’m an investor in OpenDeal Inc (doing business as Republic ), the parent company of Republic Capital, which is a registered investment advisor. My investment is via HOF Capital, where I was formerly a Managing Partner. Also, Ben Gordon and Tom Wisniewski are investors in certain past entities where I was a principal. I’m a Member of 10 East, a sponsor of my blogs, and Advisor to Bullet Point Network.
Cross-posted at WealthManagement.com.
This document and the information contained herein is provided for informational and discussion purposes only. This post is not intended to be a recommendation for any investment or other advice of any kind, and shall not constitute or imply any offer to purchase, sell or hold any security or to enter into or engage in any type of transaction. Past performance is not indicative of future results. All examples of past investments included in this presentation are purely for illustrative purposes and may not reflect the complete list of investments made. There is no guarantee that any fund will achieve the same exposure to or quality of portfolio companies held by any existing syndicate or fund. An investment in venture funds or private companies involves a high degree of risk and is suitable only for sophisticated and qualified accredited investors.
