Investment

Family offices pull back from deals as outlook worsens

Family offices are pulling back from corporate deals across the world following a sharp rise in inflation and the cost of capital. What happens next? 

Weekly transactions, monitored by Family Capital, have fallen by 20% following a reversal in sentiment. The value of VC deals in China fell 44% in the first four months of the year, according to Preqin. Prices paid for VC shares on the secondary market fell by an average of 20% in the first quarter, according to Forge Global.

It takes a very different mentality dealing with zero and negative growth, versus growth investing over the last fifteen years

Lex van Dam, chairman of SFO Alliance, the family networking group, will host its annual conference on 8-10 June in London. He is planning for an extensive discussion on how delegates can deal with the new environment.

He says: “It takes a very different mentality dealing with zero and negative growth, versus growth investing over the last fifteen years. Casualties, of course, include high-growth tech-heavy businesses. That’s where valuations and capital availability have been hit the worst, even if end markets are not changing that much. 

“The double whammy is they need cash and can’t get it at a sensible price. But it’s not just tech. The global environment and rising rates are hurting pretty much every business.”

US family office adviser Stephen Martiros stresses the situation is not universally bad. He said: “I would expect markdowns to be on a company-by-company basis, not across a portfolio.” 

Markdowns are eating away at the confidence which produced annualised VC returns of 30.5% over three years, according to Pitchbook. VC firms are  taking far longer to raise funds. Private equity has dry powder worth more than $1 trillion. But PE managers also have to deal with large tranches of high-yield debt and leveraged loans at portfolio companies. Credit spreads on high-yield recently moved ahead of their ten-year median, seen as a bearish indicator.

       A report by start up advisers Y Combinator warns that founders need to brace themselves for a sharp slow down in fundraising. Crossover hedge funds have already cut back purchases.

Family offices are relatively liquid but they still face the painful prospect of deciding which of their portfolio companies deserve more capital and which do not. They need to be prepared to offer guidance, and governance, to company founders who are facing a potential crisis for the first time in their lives.

There are examples of opportunistic purchases by cashed-up family enterprises, such as Todd Boehly’s $3 billion purchase of Chelsea FC, and there will be more. But a sharp decline in their forttunes has given pause for thought. According to the Bloomberg Billionaires Index, the fifty richest individuals in the world have seen $560 billion wiped off their net worth this year. Elon Musk has put his proposed $44 billion bid for Twitter on hold.

What is to be done? In a research document called Adapting to Endure Sequioa Capital, the VC veteran, says families first need to comprehend the problems they are facing. “The world is reassessing how business models fare in a world where capital has a cost, and how much capital to give companies for profits years into the future.”

Software, internet and fintech stocks have fallen 60% compared to pre-pandemic levels. The Fang+ index of leading internet stocks has fallen 29% this year. Crypto and SPAC prices have fared far worse. 

Recession in US tech has now spread to house building, whose shares are 30% off their highs. The UK has seen a drop in mortgage demand to pre-pandemic levels. Supply chain problems, high commodity prices due to the Ukraine war and Covid in China are taking their toll. Previous growth forecasts are redundant, as rising costs ripple outwards.

This is not, as yet, a disaster. We are seeing a resurgence in value stocks as investors seek reassurance from companies with strong cash flows and balance sheets. Even Boehly’s Chelsea would fall into this bracket, given the strength of its following. 

But Sequoia’s message is that strength alone is not enough, if the situation deteriorates. Companies need to evolve to survive – anticipating problems every step of the way.

It says they need to be prepared to cut expenditure on projects, R&D, marketing and other expenses in thirty days: “Don’t view the cut as a negative, but as a way to conserve cash, and run faster.” 

Y Combinator produces similar advice: “If the current situation is as bad as the last two economic downturns, the best way to prepare is to cut costs and extend your runway within the next 30 days.”

Decisive action, effectively communicated, can create a competitive advantage. Sequoia cites racing driver Ayrton Senna: “You cannot overtake 15 cars in sunny weather, but you can when it’s raining.” 

Companies need to be ahead of the curve, at all times. According to former General Electric chief Jack Welch: “If the world outside your company is changing faster than the world inside your company, the end is near.”

Redundancies across the tech sector are bad news for the economy. But recruitment becomes easier for companies with cash to spare. Founders ahead of the curve are also best positioned to hang onto their best staff.  

Investors were bemused at the decision of Instacart, the Asian grocery delivery giant, to cut its value by 40% to $24 billion with an eye to an IPO. They are uneasy at attempts by Klarna, the buy now, pay later, giant to raise money at a third below the last funding, reported in The Wall Street Journal

But they are each realistic in their expectations, providing a platform for growth from a lower level. Sequoia points out corporate crashes generally start with founders driven by consensus and the glories of the past, as opposed to those prepared to work out a response to a crisis and communicate their aims. 

This is why family office shareholders need to do their best to challenge entrenched views at their portfolio companies. They may even come across opportunities to back exceptional founders who need money to take over a weak competitor. 

The big question is whether founders, and families, will dare to take advantage of them.

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