Research by former family office executive Brian Laung Aoaeh has said investors can benefit from forging partnerships with venture capital firms, rather than trying to fly solo.
He warns that many family offices investing in funds and deals need more expertise to compete with a raft of savvy rivals.
According to a Silicon Valley Bank survey, VC returns for family offices soared to 24% in 2021, against 14% the previous year. The survey found that family offices want to increase their allocations. But the fear of missing out is not always a good reason to invest.
The expertise of founders in complex tech-driven sectors like quantum computing, cryptocurrencies and biotech is really hard for family offices to assess
For ten years prior to 2018, Aoaeh worked for KEC Holdings/Ventures, a family office owned by fintech pioneer Jeffrey Citron.
He managed the operational turnaround of a fine-dining restaurant and a private jet chartering company, while dealing with alternative investing. He also developed a standalone venture capital fund for Citron in 2011.
He has now co-founded a VC business, Refashioned Ventures, specializing in supply chain deals. Also a partner at Newark Venture Partners, his focus is on earlier stage investing. His research is entitled: Towards a Partnership Model for Family Offices and Emerging Venture Firm Managers.
Several well-resourced family offices whose executive team have forged co-investment deals have shown how partnership and co-investment can work.
Pritzker Private Capital has pulled off a series of deals in the US with other family offices. The Reimann family recruited an executive team to develop a private equity business called JAB Holding with the backing of other family office offices and former investment banker Byron Trott.
Andrew Coors is the fifth generation in the US brewing family. In January, he told the Family Office Association, he felt more confident investing in his gas storage company, Steelhead Composites, than stock market funds: “I know the company I own.”
But years are needed to develop the right stuff. The expertise of founders in complex tech-driven sectors like quantum computing, cryptocurrencies and biotech is really hard for family offices to assess. Investors should not be overconfident they are equipped to invest in them directly just because they have done well with a few tech funds.
According to behaviour scientist Daniel Kahneman, a Nobel prize winner, we put too much confidence in snap judgements, rating them as highly as a considered view.
“Overconfidence arises because people are often blind to their own blindness. They sincerely believe they have expertise, act as experts and look like experts. But all the while, they may be in the grip of an illusion.”
Family office deliberations, reinforced by peer group discussions, tend to centre on wealth preservation, even though startups often spring from left field.
Aoaeh says: “Family office principals and executives might frequently dismiss investments that go on to perform phenomenally well while investing too often in startups that fail.”
Family offices sometimes invest large sums in VC early on, when they are overconfident, then ease back as they develop second thoughts. They can end up with portfolios, which lack diversity and scale, reducing their chance of backing sufficient startups offering super returns – a key factor behind VC outperformance.
Research by Cambridge Associates, based on the performance of endowments, suggests family offices should invest 20% of their portfolio in VC to best serve future generations. But family offices struggle to achieve this. The current US average is nearer to 12%.
Aoaeh warns that accumulating the volume of research, and expertise, needed for VC strategies can be daunting for family offices.
Most family offices are siloed, receiving advice from a narrow range of advisers, bankers, lawyers, tax experts and peers. They struggle to justify the cost of hiring VC talent: “Relatively speaking, this puts family offices at a great disadvantage.”
Some executives at large family offices develop sufficient expertise, at risk of creating complexity. But principals still need to sign off deals: “Decisions often, but not always, require the final approval of a family office principal who is insufficiently connected to the work that goes into assessing a specific startup investment.”
By comparison, when it comes to researching sectors, sourcing deals and building networks, Aoaeh says VC firms tend to be “tremendously bright, and well-informed.” They strive to foresee events that are hard to foresee when seeking out startups.
Emerging VC managers are defined as those who have launched up to three funds. They can offer a beneficial partnership to family offices, on flexible terms, because they are hungry for capital and not, as yet, turned into marketing machines.
Their managing partners tend to be young and drill deep into their chosen sectors, to keep up to speed, and find talented corporate founders.
According to SVB, 61% of families expect the highest VC returns to come from emerging managers over the next decade.
Aeaeh says a direct investment in a fund, accompanied by co-investing deals, can be viewed as a good way forward by VC managers.
“Family offices that invest as limited partners in a fund and co-invest alongside the fund get to benefit from the depth of their own expertise as well as the depth of the managers’ expertise. In my past life, I regret we did not co-invest more often with the managers we backed.”