Investment

Some thoughts on venture investing for family offices – is there a bubble and is it about to burst?

Family offices backing tech-driven venture capital opportunities are generating higher returns, at a faster rate, than at any time in history.

According to an analysis of median returns by data provider PitchBook, startup investors are doubling their gains in 1.2 years based on the point at which the next funding stage takes place.  The scale of start-up funding has hit a level not seen since 1999.

The IPO of office services giant, WeWork, planned for September, will be a crucial test of market sentiment

Venture fund inflows have hit a record, lifting the average fund to $205 million, against $140 million in previous years. Softbank has just raised $108 billion for its second Vision Fund from Japanese investors, sovereign wealth funds and companies like Apple, Microsoft, Foxconn and Standard Chartered keen to enter a network where business deals go begging. 

The bull market in tech venture results from a Great Disruption, where technology is helping newcomers to compete with established companies, or develop new markets. 

In an era of low interest rates, investors are disinterested in bonds and cash, while opportunities from disruption are more appetising than mainstream companies.

Technology first made an impact on the consumer, media and retail sector and now it is hitting healthcare, manufacturing and banks.

Data provider CB Insights estimates there are 360 tech-driven unicorn ventures, each worth $1 billion-plus, backed by cheap funding. An arms race is accelerating, as platform providers compete with each other to tool up more heroes from zeroes. 

Initial public offerings for 48 tech-fuelled ventures in the first half of this year provided 83% of their exit capital and freed up money for new ventures. Uber, Lyft and Pinterest disappointed but the majority of stocks – such as Beyond Meat, Slack, Zoom and Pagerduty – soared.

Electric scooter rental firm Bird was founded in 2017 and soon ran into flak from traffic authorities, fearing accidents. It has several rivals. But its fundraisings have put a value on the company of $2.5 billion. 

Executives from large companies like Microsoft, Amazon, McKinsey, Fidelity and Goldman Sachs are quitting steady jobs to set up e-businesses.

According to one UK venture capitalist: “What is so encouraging is the quality of the management teams raising money for brilliant new propositions. Few want to go into banking and law and those going into management consulting are doing it as much for the training as anything else and plan to get into venture after a couple of years.”

London’s status as a financial sector has contributed to the growing clout of its fintech sector. Digital bank Revolut of the UK raised $250 million, implying a value of $1.7 billion. This year, it plans to raise $500 million, implying a $5 billion valuation. Its backers say it will grow a bigger business than Barclays. Martin Gilbert, former co-chief of Standard Life Aberdeen, has been tipped to become its chairman.

In 2011 billionaire Mark Cuban gave credibility to tech savvy Jason Wilk by putting $300,000 behind his AllScreen venture for a 20% stake.  Four years later it was bought for $85 million. Cuban now backs Wilk in an app called Dave, which warns clients when they risk an overdraft. Wilk also wants to set up a challenger bank.

Other successful entrepreneurs set up venture funds. Blake Grossman played a leading role in building Barclays Global Investors into a quant powerhouse devoured by BlackRock in 2009. He now inspires ventures backed by Thirdstream Partners.

The big question is whether family offices are tooled up to take advantage of new opportunities. It’s certainly no problem for family offices created by tech entrepreneurs, some of whom are investing at a faster rate than venture funds. 

They are led by Omidyar Network, for eBay founder Pierre Omidyar; Kapor Capital, for Lotus founder Mitch Kapor; Webb Investment Network, for Maynard Webb, chief executive of LiveOps; J.Hunt for early-stage investor James Hunt and Bezos Expeditions, the venture capital business run by Amazon’s Jeff Bezos.

This throws up co-investment possibilities for US family houses who are not in the tech loop. Alternatively, they are turning to independent sponsors like VisioCap and Tygon Peak, to access deals direct, rather than using venture funds charging a 2% base fee, and 20% of performance.  

Claudine Cohen of advisory firm CohnReznick says independent sponsors can succeed by matching family offices to ventures interested in longer-term funding, as well as putting together co-investors. 

Asian investors are also proactive, setting aside a budget to take a punt on higher-risk tech projects. The Chinese government has been particularly keen to favour technology deals to increase its global reach. 

Family offices in Europe do not see the same potential in tech-driven deals, not least because they are far away from the action. They can sense the misery of a crash more easily than the joy of a boom.

According to the chief investment officer of a UK-based family office: “Tech is a US story, and we’re not involved. I’d make the observation that a lot of money has been raised for them, and that’s pushed up values to unrealistic levels.” He added that tech-backed ventures were highly-priced and likely to collapse when funding dried up.

A venture capital manager said: “There is certainly tons of capital around which is driving prices up – double where they were three years ago.” 

But he thought there was more growth in prospect: “The quality of deal flow is very high.” He despairs at the level of scepticism: “It’s the old European problem that few institutions will write a large cheque for a loss-making business.”

Another UK family office was more upbeat, saying there had never been a time when companies could scale up so cheaply.  But he conceded this makes it easy for competition to develop, later in the economic cycle: “A binary outcome is inevitable.  The company will amaze or flame.”

Legal firm MJ Hudson confirmed: “Venture investing is a competitive sport. If someone has an advantage, it should be expected that a rival will likely try and copy it.”  

Family office adviser Stephen Martiros of Martiros Strategies sees potential in tech-based venture, but stresses the importance of homework. For him, seasoned venture funds are the default position.

He is wary of companies where early-stage investors are selling stock ahead of an IPO: “The information advantage is usually very one-sided. Given the often-times opaque process and asymmetrical information, it brings to mind the greater fool theory. 

“Family offices should avoid investing in private sales of the stock of pre-IPO companies unless they deeply understand the industry, technology and valuation metrics.” 

On balance, sentiment is likely to continue supporting tech-driven venture capital, given the depth and breadth of the opportunity, now spreading into AI applications. 

But investors would also be wise to monitor fund flows, to check the way the wind is blowing. 

The IPO of office services giant, WeWork, planned for September, will be a crucial test of market sentiment. So will the success, or otherwise, of Softbank’s global drive.

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