Startups are increasingly looking to an alternate source of equity funding and growth capital to close a significant round of private investment: the family office.
There are currently more than 3,000 family offices globally managing money for the world’s wealthiest families. Together, these offices manage a total asset base of approximately $4 trillion, and they’re starting to put more of this money to work directly into private investments. According to PitchBook, the number of direct investments by family offices in startups has almost doubled in the last five years compared to the previous period.
While many of these family offices are becoming an important source of capital for private companies, they can be incredibly secretive to protect the confidentially of the families they represent and the proprietary nature of their deal flow. This is particularly true for foreign families that wish to maintain a low-key presence for security and safety reasons.
So how can startups tap into this growing opportunity? As a family office that has invested in multiple startups over the last several years, here are our answers to some of the most commonly asked questions.
What is the difference in fund structure between family offices and VCs?
One of the biggest differences is that family offices do not have the external capital raise demands nor are they unnecessarily looking to force exits at inopportune times that are characteristic in the VC model when managers are winding down the fund. Moreover, as funds approach their maturity dates, GPs are often under pressure to liquidate investments to either obtain IRR milestones to receive carried interest or to avoid claw-backs.
Family offices exist to preserve, grow, and transfer wealth across generations. Deals are structured to focus on delivering long-term value and quite often with a uniquely-designed mechanism for achieving downside protection. Depending on the investment, the family office may look for an exit in one year, 15 years, or never – all of which are dependent on the nature of the deal, how it is structured and owned, vintage and capital market cycle, and the value being delivered. Because family offices do not have multiple LPs to answer to with wide ranging objectives and demands, they have the patient capital to allow companies to develop and ferment.
This also manifests itself in how deals are sourced. Family offices don’t adopt a spray and pray approach to investing but rather look to identify potentially lucrative and disruptive opportunities and then concentrate on these opportunities with surgical focus, providing advice, strategic introductions, and capital beyond early-stage investing. And because deals are funded on a deal-by-deal basis with full transparency to the family client, every deal needs to be very high-conviction. As a result, family offices may review hundreds of deals to filter their investable universe down to a handful of likely candidates per year.
What type of companies are family offices looking for?
Entrepreneurs looking to access funding from family offices should understand that deals are sourced by leveraging proprietary networks, colleagues, other entrepreneurs and business executives, portfolio managers, and frequently through the diligence process on other potential investments.
The importance of this network means that entrepreneurs should foster and develop a similar network, particularly as they build out their own team of advisors, board of directors, etc. In fact, this should be a prime consideration when selecting the advisors and board of directors. If the people close to you already have connections to family offices, your task is simply to know enough to ask.
For example, family offices are interested in finding companies that are disrupting old world industries. The collective network is helpful in identifying the issues that big companies are struggling with and peeling back the layers until the technology companies underneath are found.
Do family offices invest in early stage companies?
The short answer is yes. The goal is to back success. First-time entrepreneurs are given the same consideration if the business model is compelling enough and there is a clear pathway to growth and/or profitability.
Being early stage is never a disqualifier, primarily because the family office looks to be a strategic partner as opposed to a financial partner. This means doing more than providing capital to generate that incremental alpha. When working with a family office, early stage companies should be prepared to develop a long-term plan and to implement the plan to deliver long-lasting value.
This type of direct investing means that management and sound governance are high priorities, which is why many family offices require a seat on the board. Leveraging the family office network to provide strategic advice, market intelligence, and other tangible benefits requires a level of oversight. Finding the right balance between giving the entrepreneur room to grow and the need for transparency that family offices require is critical in making these partnerships successful.
What else should an entrepreneur know about family offices?
The family office is rapidly becoming an important source of capital for private companies, either as a standalone funding source, or in a complementary partnership with other investors, VCs, and institutional capital providers. But the bar to investment is much higher than with traditional sources.
Because family offices are not a fund, they have a far lower tolerance for failure — or even mediocrity. The goal is to be the last money in and to continually invest in the success of the company strategically and financially.
If your company has the right combination of strategic vision and sound management, then the family office may be the best partner for equity investment.
Paul and Wes Karger are cofounders of TwinFocus, a multifamily office based in Boston.