While pink papers are filled with reports of family office investments in startups, it doesn’t mean these investors are taking a structured approach towards venture investing. For most family offices, the VC space may not be their major asset class exposure, but the time spent talking about it (both socially and formally) is huge. We have seen a few differentiating approaches taken by family offices in this space…
FOMO: The ‘fear of missing out’ style of investing germinated from a constant fear that family offices might be missing out on amazing deals. Hence, they consistently spend a lot of time meeting founders or investment bankers and they love to cover as many deals that are sent to them. All this usually happens without any planning or strategic thought. Not helping the process are so-called family office advisers who try to artificially create scarcity and exclusivity for each deal, while quietly pocketing anywhere between 1% to 4% as placement commissions.
Social comfort: This style stems from the comfort of knowing that somebody has done due diligence on the deal. Usually, the family offices may have their own networks with whom they would like to share deal flow or take inputs. The biggest concern about such an approach is the assumption that the group has adequate knowledge or ability to assess business models and scalability. Also, you would need experts in a few sectors so that the group can add value over a wider scope of deal domains. Another issue is that write-offs or bad investments are not discussed or avoided so that social relationships are not affected.
Institutional template: This approach is seen in some family offices where a formal structure has been put in place. In this style, allocations are made towards funds, direct investments and proper assessment parameters are laid down. The office cannot deviate from the template and suggestions are not welcome. Naturally, this inflexibility creates some problems along with many advantages. The structure does give a sense of comfort to the family that they have a robust system in place.
So, what role does a true family office need to play? The adviser needs to understand the family’s wishes and plans and then advise on a combination of approaches with adequate flexibility while retaining a proper structure. The adviser should be free from any conflict of interest while creating such a platform.
Some of the key parameters that need to be covered are…
Sector focus: The endeavour should be to have a diversified allocation across promising sectors. So, there have to be exposure limit checks in place as part of the allocation process and the risk assessment platform. The fact that the family will not have a clear understanding about a sector should only stall any direct investments, but allocations via funds should go ahead.
Funds vs direct investments: Ideally, the family office should start by investing with experts via AIFs and slowly get into direct investing. In the early stages, it should invest directly only in sectors that are related to its main business so that it can mentor the companies, if needed. Unrelated sectors should be best approached via fund managers or via co-investing with funds.
Stage focus: This is a purely risk-return and investment ticket size decision. Early-stage investments in VCs have a higher risk, while pre-growth and growth stage investments are lower in risk. Growth-stage companies have more robust financials and business models. As you move from early to growth stage, the ticket size for direct investments is magnified and may not be in the comfort zone for many families; funds remain the only option.
Manager selection: A formal selection process is needed, which may be customized for each family. This helps in taking decisions based on facts rather than perception-based ones.
Family offices will play a key role in the development of India’s entrepreneurial talent, but this adds a responsibility of making sure that the role brings in benefits for both the family office and the supported startup ecosystem. An unplanned approach may create a group of disgruntled family office investors.
Munish Randev is founder and CEO, Cervin Family Office and Advisors Pvt. Ltd.