Most family offices are investing in subprime venture. Here’s why

The venture market is booming. But are investors like family offices making any money from the sector? According to a venture and economic specialist, apparently not. Instead, most of them are investing in what he calls subprime venture.

Georges van Hoegaerden, managing director of the US-based The Venture Company and a seasoned Silicon Valley investor, says the big money returns in venture are mostly a mirage. He reckons much of the sector is a classic case of the emperor wears no clothes adage. “At least 99% of venture capitalists don’t produce positive, consistent, and monolithic venture style returns for their limited partners,” he told Family Capital.

A lot of family offices do not understand the nature of the investible asset – trading is not investing

He calls this underperformance subprime venture.

In a recent blog, van Hoegaerden, picked up on a remark made by a managing director of a US family office, who said in an article by Axel Market Review: “We don’t believe that it makes sense to compound the operating risk of growing a smaller company and the risk from an ownership transition with the risk of a leveraged capital structure that could have bad consequences for a company if it misses a beat.”

Van Hoegaerden reckons the “leverage capital structure” in venture leads to subprime returns. “Startups that work with subprime venture capitalists that have fragmented their investment risk and from the beginning cannot support the runway to upside are entirely subject to the ‘blessing’ of debt financing.”

And too many venture capitalists can’t find genuinely innovative startups because of their mindset, says van Hoegaerden. “Venture capitalists can’t find outliers because they deploy a uniform investment thesis, cobbled together by collusion, and endless deal fragmentation to protect downside risk. Venture capital has turned subprime because outliers and uniformity are simply incompatible.”  

Although some family offices might realise, like the example above, the downside of debt finance in startups, van Hoegaerden, who speaks to many family offices, says most of them don’t get the sector.

“A lot of family offices do not understand the nature of the investible asset – trading is not investing. Investing is the pursuit of upside from foresight, a deliberate pursuit of deep yet narrow risk. Trading is hedging, a musical-chair game of broad-based risk escapism.”  

He adds: “The question is, which family offices have the wherewithal to support venture capital. Few, if you do not have a $1 billion-plus fund to feed the capital requirements of a prime innovation portfolio to produce diversification of risk you will instead be relegated to drowning in a morass of subprime risk yielding subprime returns.”

So how do you achieve prime returns in the venture world? Van Hoegaerden links prime returns to innovation, which he believes is almost always exaggerated and rarely achieved. “To invest in prime requires an attachment to, and appreciation of, a higher normalisation of truth ignited by a vehement dissent to the status quo, not by regurgitation of the norm. Prime innovation has unique capital requirements, unique to every investment.”

And an example of this prime innovation and returns? Van Hoegaerden reckons Telsa hits the button, but not when most investors were piling into Elon Musk’s startup. “Most investors were their after Telsa crossed the chasm. That’s a private equity risk, not a venture capitalist risk,” he says.

Given the prevalence of subprime returns in venture, how does Van Hoegaerden explain the boom in money piling into the sector and the rise in the number of startups?

“It’s the hope. Can you explain why a lot of people go to Vegas? It’s the hope,” he says. “But hope isn’t a strategy.”