About the Author
Mr. Aoaeh is a Cofounder and General Partner of REFASHIOND Ventures, an emerging venture capital fund manager that invests in early stage supply chain technology (#SupplyChainTech). He co-founded The New York Supply Chain Meetup and The Worldwide Supply Chain Federation. He is an Adjunct Professor of Supply Chain & Operations Management in the Department of Technology Management & Innovation at the Tandon School of Engineering at New York University. He is a VC-in-Residence at Genius Guild Greenhouse Fund, and a Venture Partner at Newark Venture Partners. From 2008 – 2018 he built the direct investing team at a single family office (2008 – 2011), and then built a standalone institutional early-stage venture capital firm based in New York City (2011 – 2018). He has been a charter holding member of the CFA Institute since 2017.
About REFASHIOND Ventures
REFASHIOND Ventures is a Supply Chain Technology (#SupplyChainTech) venture capital fund that invests in early stage innovations that refashion global supply chains. The fund sources deals from The Worldwide Supply Chain Federation’s global membership, and the general partners’ wide network of professional relationships in technology, supply chain, operations, venture capital, media, professional services, academia, and the public sector while leveraging their operating experience, and strong connections with corporations around the world as both potential investors and market-validating customers for REFASHIOND Ventures’ portfolio companies. REFASHIOND Ventures manages REFASHIOND Ventures Seed Fund, LP (REFASHIOND Seed) – a rolling fund on AngelList that is open to new investments from accredited individual investors, family offices and other types of investors.
Many more single- and multi-family offices are shifting capital to the venture capital asset class and away from other asset classes. In some instances such family offices are also seeking to do more direct technology venture capital investing. This is often motivated and driven by the desire of a younger generation of family members to direct capital towards innovations that will have a meaningful and positive impact in the world. It is worth examining some of the pitfalls that such an initiative can encounter with the aim of reducing the number of preventable mistakes that the people starting and managing such initiatives might make. I suggest a partnership model based on co-opetition and positive-sum partnerships rather than zero-sum rivalries between limited partners (LPs) – the family office principals and executives who wish to invest in venture capital through fund investments as well as direct investments in startups AND general partners (GPs) – the individuals launching and managing emerging venture firms to invest on the basis of novel and unique investment theses and strategies that account for the unique period of human in history in which we find ourselves. In this article early-stage investments refers to investments in Pre-Seed, Seed, and Series A startups. This report is uniquely deeply researched and is meant for senior decision makers at family offices in any part of the world seeking some help as they try to make sense of large volumes of sometimes contradictory and confusing information that is difficult to synthesize and distill into actionable conclusions.
- Author’s Note #1: This is not investment advice. Nothing in this article should be construed as legal advice.
- Author’s Note #2: The opinions expressed in this article are mine alone, except where I have included the ideas of individuals who contributed to the article. Any errors or omissions are my responsibility alone.
- Author’s Note #3: I hope that this article serves as a catalyst for further conversations; There is plenty of room for improvement, and I’d love to collaborate on expanding this work. It is already quite long, and I had to cut off some discussion to avoid making it even longer. If you want to discuss any aspect of this article, you can reach me by email at email@example.com. You can also reach me on Twitter, and LinkedIn. I would love suggestions about other material I should read on this topic and would be happy to discuss any section of the article in more depth with anyone who finds this topic as interesting as I do. (Wordcount: 25,036)
- Note: Originally published at refashiond.com on Friday, Dec 17, 2021.
Table of Contents
- A Summary of My Qualifications for Contributing to This Discussion
- A Brief History of Family Offices – What is the objective of a family office?
- A Brief History of Venture Capital – What is the main responsibility of an early-stage technology venture capitalist?
- The 3 Critical Challenges Faced By Most Emerging Venture Fund Managers
- The 3 Reasons That Make it Most Likely That A Family Office Will Fail at Tech Venture Capital
- Why Should Family Offices and Emerging Venture Capital Firms Partner?
- How Should Family Offices and Emerging Venture Firms Partner? (Half-a-Dozen Plus Three Ways)
- Market Voices: Fund Managers and other Practitioners Suggest How Family Offices and Emerging Venture Capital Firms Can Partner
- Family Offices & Emerging Fund Managers in Venture Capital: Playing The Right Game
These are exciting times in venture capital.
On November 23, 2021, the Financial Times ran Family offices become serious rivals to VC firms for funding start-ups by Stephen Foley. In the article he states that; “From wealthy individuals and family offices at the seed and early stages, to traditional asset and wealth managers getting in on pre-initial public offering rounds — not to mention hedge funds — investors that may have previously confined themselves to public markets are now clomping all over the VC landscape. Endowments and pension funds, the main providers of cash to VC funds, are also keen to cut out the middleman and invest in start-ups directly.”
I encourage the reader who is a family office principal or executive, or an investor at one of the other types of investment organizations that Foley says would traditionally have shied away from the private markets to read the rest of that article because it highlights some of the changing dynamics taking place in venture capital, shifts that are driving recent moves at firms like Sequoia, General Catalyst, Andreessen Horowitz, and others. Specifically, Foley points out that those moves are not “ . . . an illogical response to the deluge of capital chasing start-up investments, which suggests VC returns are likely to be lower than they were historically, even if they remain high relative to public markets.”
Towards the end of this article, the reader will get to hear directly from a number of investors who were kind enough to contribute to this article. Of note, Winter Mead, who runs a premiere community supporting emerging managers, partnered with First Republic Bank in 2021 to survey family office investment interest in emerging managers. The results of the survey demonstrated some interesting findings that support the increased interest in this category, including that 20% of family offices invest exclusively in emerging managers, and that 75% of family offices will invest in a first-time fund. There’s clearly interest in family offices and emerging managers understanding how to collaborate.
The purpose of this article is to help my fellow emerging managers better understand and productively collaborate with family offices, AND also to help family offices that are unsure how to engage with the dynamic and growing community of emerging venture capital fund managers better understand how they might engage more fruitfully with new venture firms pursuing unique and differentiated investment theses.
The discussion that follows applies only for early-stage technology investments, broadly speaking. Also, I am mostly thinking about emerging venture fund managers raising their very first institutional fund with family offices and relatively small institutional investors as potential limited partners.
A Summary of My Qualifications for Contributing to This Discussion
The portion of my professional experience that has direct relevance to this discussion starts in 2008. I spent the time between 2008 and 2018 at entities associated with Jeffrey Citron and his family’s family office – KEC Holdings, and KEC Ventures. That experience included: Managing two operational turnarounds simultaneously till mid-2012 – a fine-dining restaurant with locations throughout the United States, and a private jet charter company, together the 2 companies employed about 650 people and generated about $50 Million of top-line revenues; Representing the family office in negotiations with venture funds, private equity funds, hedge funds, and real estate funds in which the family office sought to make an investment as a limited partner; Assisting the family office’s CFO/COO with managing the family’s fund-of-funds portfolio between 2008 and 2012; Analyzing and making recommendations for public and private markets investments; Researching ideas that the family office considered incubating and launching – one of which was a brand new investment product for which we sought IP protection and pitched to potential outside investors and other partners; From 2011, I was entirely focused on building a standalone institutional early-stage technology venture capital fund that started from the initial fulltime team of 2 people, but that had grown to a team of 9 people in our HQ located in Midtown Manhattan by 2018 when I left to start laying the groundwork for REFASHIOND Ventures.
The topic of this article is one I have been thinking about since I started the interview process that led to the decade I spent at KEC Holdings from 2008 to 2011, and then at KEC Ventures from 2011 to 2018. It is a question I have continued to think about since 2018; How does one increase value for all the stakeholders of a mature company? How does one increase value for all the stakeholders of an early-stage technology startup? In this case; How can family offices and emerging venture capital firm managers collaborate as partners, and sometimes as friendly-rivals, in the dynamic and rapidly growing global market for technological innovation? What are some of the parameters on which such a partnership should be based?
Everyone who reads this article is benefiting from the experience and insights I have developed since 2008.
A Brief History of Family Offices – What is the Objective of a Family Office?
In The Family Office: A Comprehensive Guide for Advisers, Practitioners, and Students (Columbia University Press, August 2021), William I. Woodson and Edward V. Marshall observe that; “Family offices have been around in some form or other since civilization began in order to provide a vehicle for wealthy families to manage and safeguard their assets”. They further state; “The nineteenth century brought a surge in economic growth, industrialization, and wealth creation that far surpassed anything in history. Business empires sprang up and grew to enormous size. Family fortunes, as well as the need for family offices, expanded accordingly. Also encouraging the formation of family offices were the increased use of tax and estate-planning vehicles and the role of separate management companies.”
In describing the qualities of the people employed by family offices, Woodson and Marshall state that; “These families came to understand the key qualities needed of those who would serve them by running their family offices. Those qualities were—and remain today—loyalty, discretion, attention to detail, timely execution, business acumen, and faithful stewardship.”
Finally, Woodson and Marshall answer the question “What is a family office?” by stating that; “Family offices are entities set up by a single family, or by or for a group of families, to manage their assets and affairs. They are used to address the issues that come with substantial wealth, including dealing with complexity and helping family members achieve their goals (e.g., simplicity, purpose, legacy, family harmony, passing down wealth, investment management, philanthropy, and so on). In this context, family members are called “principals,” and the senior staff of a family office are referred to as “family office executives.” Principals are the primary members of the family that the family office supports, although there are situations where multiple generations and/or extended family members can use the services of a family office. Family offices vary in design, operations, and services delivered, depending on the needs of the principals.”
In my opinion, the most important task of any family office executive is wealth preservation, all other goals and duties are a distant second to wealth preservation. We will come back to this later. Woodson and Marshall outline 9 distinct types of family offices which can be grouped into 4 distinct classes.
In his book, The Family Office Book: Investing Capital for the Ultra-Affluent (Wiley Finance, 2012), Richard Wilson states; “Single family offices have existed in different forms for thousands of years. In the article “Family Offices in Europe and the United States” by Dr. Steen Ehlern, the managing director of the Ferguson Partners Family Office, noted that the merchants of ancient Japan and the Shang dynasty in China (1600 B.C.) both used multigenerational wealth management strategies. There are also several accounts of “trusts” being set up for the first time during the Crusades (A.D. 1100). Later, many wealthy banking families of Europe, including the Medicis, Bardis and Rothschilds, were said to have used a family office–like structure. These organizations often offered their services to other wealthy families, and in the late 1800s and 1900s they started to look more like modern day multi-family office operations. These operations grew out of single family offices that were asked to serve connected business families and out of private banks and early trust company establishments that were looking to serve more affluent clientele.”
According to Wilson;
- “Almost everyone who runs a single family office has between $100 million and $1 billion in assets, with a smaller percentage having over $1 billion and an even smaller percentage having under $100 million under management.”
- “Most multi-family offices require $20 million to $30 million in investable assets to join their platform, but due to economic conditions and hunger for business growth, some family offices are allowing $5 million and $10 million clients in the door.”
- “At the other end of the spectrum, some high-end family offices, including several we interviewed for this book, require $100 million to $250 million in investable assets to participate in their multi-family office.”
- “Due to technology and the ability to leverage taxation and risk management experts and consultants, I have found some successful single family offices with “only” $30 million to $50 million in assets.”
It should be obvious to the reader that family offices come in various flavors and sizes. One thing is constant, however; The family office’s first and primary objective is the preservation of its principals’ wealth and the smooth transfer of that wealth from one generation to the next without attracting too much attention from outside observers. However, the secretive world of family offices is undergoing some change. The secondary objective of every family office, and the various private foundations and endowments that they have created, is to grow the assets that the family, foundation, or endowment can draw upon in the future to support its activities.
That observation is supported by this December 2, 2021 article published by AsianInvestor, Succession planning, low yields among Asian family offices’ top concerns in which Natalie Koh explains that “Families are also haunted by fears that wealth does not pass three generations – a saying in different languages all over the world, and one that has been found to be largely true. Seventy percent of wealthy families lose their wealth by the second generation, and 90% by the third, according to a report by the Williams Group wealth consultancy.”
On November 11, 2021, writing for the Dallas Morning News in Family offices for ultra-wealthy with $100 million or more explode in Dallas and the U.S., Natalie Walters says “Recent data shows there are between 3,500 and 5,000 family offices in the world with one or more employees, $100 million or more in investible assets and some type of outside investment activity, according to a report from FINTRX, a family office research platform. Of those, 66% are in North America and 42% manage more than $1 billion in assets.” Walters adds that in the United States, “Texas is the state with the third-highest number of family offices, behind New York and California. Among cities, Dallas ranks third behind New York and Chicago.”
Walters quotes “Tayyab Mohamed of Agreus Group, a London-based recruitment company that works with family offices worldwide” who asserts that the financial crisis of 2008 caused a loss of trust, prompting many wealthy families to make the decision that they needed to take control of managing their wealth. As I pointed out in the brief summary of my professional experience at the beginning of this article, 2008 is also the year during which I started my tenure as a family office executive.
Writing for Crunchbase News on April 13, 2018, in The Top Ten Family Offices With The Most Direct Startup Investments, Jason Rowley states “There is some anecdotal evidence that more family offices are making their first investments directly into startups (as opposed to investing in a VC fund as a limited partner). But we wanted to know which investment groups have the most skin in the startup investing game, so to speak.” The following chart from that article summarizes the analysis.
A few weeks before the analysis above, Rowley published Charting The Adoption Of Direct Startup Investments By Family Offices on March 26, 2018 in which he observed that “In relative terms, across a range of measures, deal volume growth was higher and faster among family offices than VC funds for a significant period of time. The data suggest that family offices making direct investments into startups recently became a trend. Especially for that period through 2014, family offices were on the early side of the adoption curve for making direct startup investments. Whatever growth we see on the VC side is the product of growth in the market in general, but it’s not like VC funds are still adopting direct startup investments into their repertoire. It’s been their model for decades. For comparatively stodgy family offices, it was still the new, new thing.” The graph below summarizes that statement.
Rowley makes another interesting observation in the article. He states that, “During the several years leading up to 2015, there was a run-up in the number of deals being struck. After that high point, though, deal volume began to decline in the US, which Crunchbase News has documented, as investors eschewed writing many smaller checks to early-stage startups and instead favored fewer, larger checks with later-stage tech companies. On a global scale, projected deal volume is roughly flat on an annualized basis from 2015 through 2017, whereas reported deal data is down primarily due to reporting delays. Since there are more U.S. family offices that invest in startups than international ones, it’s not surprising to see that family office deal volume hews closer to the U.S. market in general.”
We will come back to this point later.
An underlying factor that may be contributing to the phenomenon Rowley has reported on is that of the vast amount of wealth that has been created since the dot-com bubble by technology startups and companies located in Silicon Valley and other parts of the United States and the world. As the author of 7 Family Offices Behind Silicon Valley’s Tech Billionaires, published by Trusted Insight in November 2016, states “By any measure Silicon Valley has exerted an outsized influence on the tech industry and the world as we know it. Today the valley hosts nearly 40 companies on the Fortune 1000 list, a hundred private ‘unicorn’ companies valued at more than $1 billion and thousands of fledgling startups striving to be the next company to change the world.” The author goes on to say that, “This concentration of corporate success has created a vast network of high net worth founders and executives. In fact, 41 of the richest Americans on the Forbes 400 reside in Silicon Valley, and given the positive outlook on the 2017 IPO market, that number will surely grow.”
The trend highlighted by Trusted Insight has only accelerated since 2016, as a result the phenomenon Rowley reported on for Crunchbase News is likely to have accelerated as well. Although, I do not have data to support this assertion, I argue that globally, the number of family offices with business roots in, and potentially the amount of total wealth generated from, legacy industries outstrips that from Silicon Valley specifically, and technology more broadly irrespective of geographic location. Therefore, these trends will only accelerate as more family offices that did not originate from success in technology entrepreneurship undergo a generational transition with younger and more technology-savvy principals stepping into decision-making and leadership roles about how the family office invests its capital.
My former employer, UBS is arguably the world’s leading bank to family offices. In the 2021 edition of its UBS Global Family Office Report, the bank reports that;
- The majority of family offices it surveyed have investment priorities in; Health Tech (86%), Digital Transformation (82%), Automation and Robotics (75%), Smart Mobility (74%), and Green Tech (73%).
- Compared to 2020, in 2021 family offices are more likely to express a desire to become limited partners in private equity and venture capital funds, and more express an interest in making direct investments in startups and more mature companies; “There’s a sharp drop-off in the use of funds of funds, with investment in funds and direct investments rising significantly. 83% of survey respondents invest in PE. But while 37% of them invested in funds or funds of funds in 2020, that fell to 23% in 2021. Almost half (47%) invest in both funds and direct investments, up from 31% in 2020. Meanwhile, just under a third (30%) only invest in direct PE, a similar level to 2020. As a rule, direct PE is becoming more accessible, with secondary markets providing greater liquidity.”
- There’s growing interest in technological innovation and venture capital; “At a time when many young companies are growing fast, disrupting the incumbents, there’s a quest to invest in the innovators. More than three quarters (77%) of family offices make expansion/growth equity investments, with that proportion even higher in Switzerland (86%) and the US (92%).” The authors add, “Similarly, venture capital (VC) is the second most popular type of investment. Almost two thirds (61%) of family offices make VC investments; yet the proportion is higher still in Eastern Europe where three quarters (75%) do so.”
- Despite their growing interest in technological innovation and venture capital, family offices are more likely to fund expansion and growth stage investments in startups that have already been identified as technology innovators by upstream investors such as angel investors, and pre-seed or seed-stage venture funds: 79% of the family offices surveyed said they are not likely at all to make pre-seed investments; 57% are not likely at all to make seed-stage investments, while 35% are somewhat likely to make such investments; 26% are not likely at all to make early-stage investments, which I am interpreting to be Series A and Series B investments, while 46% are somewhat likely to make investments at this stage.
- Sustainable investing is a hot topic among family offices; “More than half (56%) of families invest sustainably, although with wide regional differences. Three quarters (72%) do so in Western Europe, a cheerleader for sustainability, while Eastern Europe lags at only a quarter (26%) and the US at 45%.” and “As the most dynamic asset owners, family offices appear to be leading the evolution to environmental, social and governance (ESG) integration, planning to increase allocations to about a quarter (24%) of the portfolios.”
- Impact investing remains a relatively small, but growing, part of family office portfolios; “Generally speaking, the number of impact investments is growing, notwithstanding the fact that it remains a relatively small part of portfolios. On average, family offices state they have impact projects across approximately six areas in 2021, versus four in 2020. While education still remains the most popular area, in 64% of portfolios, climate change matches it, up from 40% the previous year. Healthcare is also an area for 61%. Other increasingly popular areas include: economic development/ poverty alleviation, agriculture, alternative food sources and clean water and sanitation.” Moreover, “Different parts of the world have different priorities. In Western Europe, over half (52%) of family offices say that climate change has already influenced their investment choices. Meanwhile, Asia (43%) and the US (38%) say they have a pipeline of direct impact investment opportunities.”
- Lastly, about one-third of the family offices surveyed by UBS state that they are experiencing upward pressure on operating costs as they invest more resources to bolster their human capital and IT infrastructure: “More than a third (35%) report significant or moderate upwards pressure on salaries, while a further third do on IT (33%).”
It is worth reiterating the observation made earlier that; Every family office’s primary objective is the preservation of its principals’ wealth and the smooth transfer of that wealth from one generation to the next without attracting too much attention from outside observers. Obviously that does not take into consideration those family office principals who have chosen to distribute the vast majority of their wealth rather than pass it on as an inheritance to their heirs. Even then, in most such cases they are distributing that wealth to foundations and endowments, organizations that also function as institutional investors that disburse some of their assets to support the ongoing operations of their parent organizations while growing their capital base in order to fund their respective parent organizations’ missions and objectives in perpetuity, if possible.
A Brief History of Venture Capital – What is the Main Responsibility of an Early-stage Tech Venture Capitalist?
In his article, Venture Capital—Patronage to Apprenticeship to Profession (The Journal of Private Equity, Fall 2019), Joe Milam states; “Investing in creative or entrepreneurial ventures is part of the human condition and goes back as far as recorded history. The patronage of the Medici family of Florence supported the work of Leonardo de Vinci, Michelangelo, and Galileo. Queen Isabella was essentially a venture capitalist, supporting Christopher Columbus in his exploration of the New World. Many of the critical inflection points in modern history that had dramatic impacts on the human condition resulted from entrepreneurial initiatives supported by wealthy individuals and families. The history of modern venture capital was catalyzed by efforts at mobilizing capital for the many companies emerging after World War II, in part from both necessity and opportunity—the need to support the GIs returning from the war and the opportunity to commercialize the new technologies that resulted from the war effort. Commercial access and use of the Internet represents the latest catalyst for the acceleration in entrepreneurial activity around the world, with a corresponding growth in individuals investing in new ventures, as well as new funds.”
Some have argued that Queen Isabella of Castille should be recognized as the first venture capitalist, and the book Isabella of Castille (Bloomsbury, March 2017) by Giles Tremlett offers strong evidence for that argument. One wonders though, if there may have been other monarchs preceding Queen Isabella, in other parts of the world, who behaved in much the same way as Isabella did when she financed the voyage by Christopher Columbus. In no way am I attempting to diminish the import of what Isabella did, I am merely positing the possibility that this practice goes back even farther in human history than we may realize.
Two books, Creative Capital: Georges Doriot and the Birth of Venture Capital (Harvard Business Review Press, March 2008) by Spencer Ante and The First Venture Capitalist: Georges Doriot on Leadership, Capital, and Business Organization (Bayeux Arts, 2004) by Udayan Gupta paint the portrait of the man widely considered to be the father of Modern Venture Capitalism based on his role in conceptualizing, launching, and managing American Research & Development Corporation (ARD) in 1946.
What we can learn from Ante and Gupta is supplemented by David H. Hsu and Martin Kenney in Organizing Venture Capital: The Rise and Demise of American Research & Development Corporation, 1946-1973 in which they state that; “In contrast to venture capital firms formed contemporaneously by wealthy families such as the Rockefellers, Whitneys, and Payson and Trask, ARD was the only non-family venture capital firm— meaning it had to raise capital from other sources. ARD was also an experiment to see if a new organizational form created by the private sector could profitably discharge the function of funding the Schumpeterian process of creative destruction. It was an experiment that had four goals: (1) to nurture new firms and assist existing firms in upgrading their technology or adding new product lines, (2) to encourage the commercialization of technological innovations, (3) to contribute to an economic revival in New England, and (4) to assist in the diffusion of privately funded venture capital as an institution.”
The contemporaneous venture capital firms that were formed by wealthy families would be considered single-LP venture funds. Today single-LP funds typically have a wealthy family or a large corporation as the single limited partner.
The venture capital landscape of today has certainly changed significantly since the days of ARD and its contemporaries. In The Q3 2021 Global Venture Capital Report: Record Funding Trend Held Strong which was published by Crunchbase News on October 26, 2021, Gené Teare observes that “Prior to 2021, global funding had not reached over $100 billion in a single quarter. Funding in 2021 has far superseded that amount, with the first quarter tracking at $135 billion, the second quarter reaching $159 billion, and the most recent quarter peaking at $160 billion.”
CBInsight’s State Of Venture Q3’21 Research Report which was published on October 7, 2021 adds some more color and context to the data from Crunchbase. Among other things, CBInsights reports that;
- “US companies raised $72.3B in Q3’21, making up 46% of global dollars — the most of any region. Funding grew 90% YoY, while also topping last quarter’s $70.3B.” The 3,210 deals that this represents was also a quarterly record.
- “Asia funding dollars rose 95% YoY to reach a record of $50.2B. Asia’s share of global equity funding rose from 26% in Q2’21 to 32% in Q3’21 — the only major region to see share growth QoQ.” In Asia, “China funding grew 26% QoQ to reach $25.5B. India funding jumped 68% QoQ and an astounding 195% YoY to $9.9B.”
- The world is birthing more unicorns at a faster and faster rate; “Q3’21 saw the global unicorn herd reach 848. This is 311 more than this time last year. In Q3’21, 127 new unicorns were born — the 2nd highest birth rate ever after Q2’21’s 140.” And; “Half of the new unicorns came from the US, with 69. Asia saw 30 and Europe 15.”
One more source of data to help us put things in context is These 6 charts show how much VC is awash in capital in 2021 published by Pitchbook on October 17, 2021. In that article, Alexander Davis states, “More often than not in today’s market, funding rounds involve asset managers, hedge funds, corporate venture and other so-called nontraditional investors invading the VC market. And companies raising those funding rounds are increasingly commanding much higher valuations, at least in part because nontraditional investors are typically less price-sensitive than their peers in the VC mainstream.”
In other words, family offices investing in the venture capital asset class are competing with venture capital firms, as well as with a more varied array of well resourced organizations each seeking the same growth and expansion stage opportunities that UBS has already told us family offices seek.
Davis adds, “Look for more of the era of high price multiples to continue as nontraditional investors bulk up. Often tagged as venture market “tourists,” this group together is sitting on $350 billion worth of investable capital, according to PitchBook estimates.”
This begs the question; What precisely is the primary responsibility of an early-stage venture capitalist? I propose that the singular responsibility of every early-stage venture capitalist is to harness extreme uncertainty AND informed, educated guesses about what we can not yet know about the future to generate outsized financial returns for the benefit of the limited partners that have invested in the venture capitalist’s fund. Assuming the reader accepts that proposition, this immediately leads to another question; How does the early-stage venture capitalist harness extreme uncertainty AND informed, educated guesses about what we can not yet know about the future to generate outsized financial returns?
Richard Zeckhauser, the Frank P. Ramsey Professor of Political Economy, at the Kennedy School, Harvard University offers a useful framework for thinking about how early-stage venture capital investors fulfill their responsibilities to their limited partners in his paper, Investing in the Unknown and Unknowable (Capitalism and Society, Vol. 1, Issue 2, Article 5, 2006). While the entire paper is worth reading, here are some observations that stand out to me;
- Unknowable situations are widespread and inevitable; Will COVID19 continue to get worse, or will it be tamed so that the world can return to a state resembling what existed before the pandemic? What will the near term impact of the Climate Crisis be on global trade and livelihoods? Are the current disruptions affecting global supply chains a temporary phenomenon, or are they merely symptoms of a more permissive underlying problem? Will geo-political tensions continue to escalate, and what does this mean for global trade and commerce? I am not certain that these are even the right questions one should be asking given the current state of affairs in the world, but they offer as good a starting point as any, in my opinion.
- Most investors avoid the unknown and the unknowable because we are mostly trained to gravitate towards certainty, where we assume that we know the states of the world and can assess and assign probabilities.
- Unknown and unknowable situations have been, and will continue to be, “associated with remarkably powerful investment returns.”
- “There are systematic ways to think about unknowable situations. If these ways are followed, they can provide a path to extraordinary expected investment returns. To be sure, some substantial losses are inevitable, and some will be blameworthy after the fact. But the net expected results, even after allowing for risk aversion, will be strongly positive.”
- To avoid speculators, investors might consider investing in situations that are unknown, unknowable, and unique (UUU) because this creates an opportunity for the investor to get in at an attractive low price.
- Success at investing in UUU situations requires that the investor has devoted some time and effort to understanding and identifying the “general characteristics of when such investments are desirable, and when not.”
- In the UUU environment, investors with complementary skills exhibit a “combination of scarce skills and wise selection of companies for investment” and they gain difficult to duplicate access to investment opportunities because of the complementary skills that they have honed over time. Furthermore “Individuals with complementary skills enjoy great positive excess returns from UU investments. Make a sidecar investment alongside them when given the opportunity” because most investors “could never learn about the unknowables sufficiently well to do traditional due diligence.”
- “The major fortunes in finance, I would speculate, have been made by people who are effective in dealing with the unknown and unknowable. This will probably be truer still in the future. Given the influx of educated professionals into finance, those who make their living speculating and trading in traditional markets are increasingly up against others who are tremendously bright and tremendously well-informed.” Reiterating an observation I have made previously in this article; One has to wonder how well the 79% of family offices whose response to the UBS Global Family Office indicates a preference for later stage investments will fare against the influx of capital from the clamoring horde of other nontraditional investors chasing alpha.
In sum: First; Early-stage venture capitalists generate returns for their limited partners by investing in the Schumpeterian process of creative destruction; Second; This is a process characterized by extreme uncertainty, with unique investment opportunities that benefit from future outcomes and states of the world that are unknown, and unknowable. Those venture capital firms that succeed in this endeavor do so by investing significant time and effort to develop skills, knowledge, collective and individual reputations, and social networks that are complementary to their investments – meaning that they have a unique ability to employ information asymmetries and a lack of competition to their advantage in the ways that are most relevant for the conversion of unrealized investment returns into cash distributions to their limited partners. Third; the best returns are to be found by investing where one is not consistently competing against many others who are “tremendously bright and tremendously well-informed.”
The 3 Critical Challenges Faced By Most Emerging Venture Fund Managers
Launching and building a brand new venture capital firm is no different from building a new startup. New venture firms face the same challenges that young startups face. Here are 3 challenges that can prove fatal to any new venture firm setting out to raise its very first fund.
First; Failing to raise a sufficient pool of capital with which to effectively implement, execute, and test the investment thesis. Emerging managers who are raising their very first fund are particularly susceptible to this problem because there is a pervasive belief amongst limited partners that the only venture funds worth investing in are funds in the top 5% measured by historical performance.
Assuming one ignores the common disclaimer in finance and investments that “Past performance is no guarantee of future results,” the evidence suggests that limited partners would do well to cast a wider net. Has Persistence Persisted In Private Equity? Evidence From Buyout And Venture Capital Funds is a November 2020 paper authored by Robert S. Harris, Tim Jenkinson, Steven N. Kaplan, and Ruediger Stucke in which they find that; Among VC funds “. . . for the overall sample, first-time funds have an average PME of 1.24 close to the average for previous funds in the 2nd quartile. Post-2000, first-time funds do even better with an average PME of 1.23 that exceeds (albeit not significantly) the average PME of those with previous top quartile funds.” PME stands for Public Market Equivalent and is a measure the authors use to compare the performance of the buyout and VC funds in their study with the S&P 500. Their conclusion calls into question limited partners aversion to first-time funds, assuming the goal is to beat the S&P 500. It is fair for limited partners to ask how first-time fund managers perform in comparison to the NASDAQ.
Second; Winning deals when there’s a large number of firms pursuing a similar or identical investment thesis, and adverse selection. For a fund manager raising a first fund, winning deals can be a tall task for a number of reasons: First, if the manager’s investment thesis isn’t sufficiently differentiated, the phenomenon Zeckhauser described comes into play. That is, the manager enters into competition with potentially better resourced peers who can offer startup founders the potential for follow-on capital if the startup goes on to raise subsequent rounds of financing, for example. If the manager lacks brand-recognition or has not yet earned a reputation that causes startup founders to proactively want to work with that manager, then, in an environment such as exists now, the new manager is mainly offering a commodity.
Adverse selection is closely related to new managers’ ability to win deals. Adverse selection can be thought of in the words of Jay Z, rapping in his song Numb/Encore with Linkin Park, in which he says “when you first come in the game, they try to play you.” Again, in situations where the first-time fund manager is not pursuing a sufficiently differentiated investment thesis, there’s a tendency for already established venture fund managers and angel investors to flood the new manager with “warm introductions” to startups the established managers and angel investors have already invested in that are struggling to raise capital. This is particularly true when the new manager is perceived to be an outsider to the venture capital and tech startup community – the situation I found myself in starting in 2011, and to a great extent still the situation I find myself in today.
The difference now is that, starting around 2015, I have invested an enormous amount of time, energy, and personal capital in: Developing a #SupplyChainTech thesis that is pretty unique and that forms the basis for the investments my co-founder and I make at REFASHIOND Ventures; Building an extensive and global social network; Bootstrapping the world’s first open and grass-roots driven community of practice for people who are obsessively enthusiastic about supply chains, innovation, and technology; Embracing the challenge of teaching a Supply Chain & Operations Management course at the Tandon School of Engineering at New York University; Embracing the challenge of writing a weekly column focused on the early-stage technology innovations with the potential to refashion global supply chains for the two years between April 2019 and April 2021 at FreightWaves, arguably the world’s most visited portal for news about freight technology.
You have every justification to ask; To what end? As Zeckhauser points out in his paper; “Similarly, the more difficult a field is to investigate, the greater will be the unknown and unknowables associated with it, and the greater the expected profits to those who deal sensibly with them. Unknowables can’t be transmuted into sensible guesses — but one can take one’s positions and array one’s claims so that unknowns and unknowables are mostly allies, not nemeses. And one can train to avoid one’s own behavioral decision tendencies, and to capitalize on those of others.”
When we get warm introductions to startups that fit our #SupplyChainTech thesis at REFASHIOND Ventures it is relatively easy for us to verify that we are not falling victim to adverse selection, either directly, based on our own knowledge, or through our extensive network. To minimize the risk of adverse selection, we encourage startup founders to eschew so-called warm introductions and to seek us out directly. We make exceptions in situations where the introduction would be coming from a potential co-investor in the same round of financing, or someone for whom there’s a thesis mismatch but who thinks the founder is so impressive and promising that they recommend we take a meeting.
Third; A failure to raise the second fund after having raised the first fund. This can happen for a number of different reasons; Operational failures. Poor investment decision-making leading to too many poor outcomes in the portfolio. Personnel issues that arise after the fact. Failure to cultivate the social network and other relationships necessary to propel and accelerate the performance of startups in which the fund has made an investment. Etc. However, for this discussion, the reason that concerns me most is that sometimes a first-time fund will fail to raise its second fund because it lacks a strong and sufficiently diverse limited partner base in its prior fund to enable it to raise the successor fund. For example, this could happen if the first fund is a single-LP vehicle, and it could happen for any number of reasons. This could also happen if an anchor limited partner that accounts for, say, 20% or more of the current fund becomes unable or unwilling to commit to the succeeding fund, and the general partner has not yet cultivated a relationship with another family office that can replace the limited partner that is being lost.
The 3 Reasons That Make it Likely That A Family Office Will Fail at Tech Venture Capital
Let us temporarily set aside family offices founded by individuals who have made their wealth by founding or being early employees at technology startups that have gone on to achieve a major exit. We may then view the remaining family offices that are considering a foray into direct or fund investments in venture capital to be outsiders.
We have already seen that interest from family offices in venture capital, and direct investments into startups is not a new phenomenon. Be that as it may, family offices’ justified focus on wealth preservation as their primary goal, with growing that wealth being the important secondary goal, leads to certain invisible traps that make it difficult for the average family office to execute an early-stage technology venture capital investment strategy successfully.
First; Many family offices newly making forays into direct venture capital investing tend to fall victim to Overconfidence Bias. This blindspot is exacerbated by the phenomenon of Adverse Selection that such outsiders to the startup and venture capital community encounter when they first start participating in the community as investors. But, that is not all, Overconfidence and Adverse Selection are amplified by an Illusion of Knowledge. Zeckhauser makes two observations relevant to this issue: First, “When individuals are assessing quantities about which they know very little, they are much too confident of their knowledge (Alpert and Raiffa, 1982);” Second, “Individuals who are overconfident of their knowledge will fall prey to poor investments in the UU world.” Where UU stands for Unknown & Unknowable. The illusion of knowledge can arise because family offices could be relying on knowledge about the state of the industry in which the family generated its wealth that is no longer relevant given more recent developments in that industry’s adoption and use of technology. Without understanding that a given startup is developing what might qualify as a supply side innovation, family office principals and executives might frequently dismiss investments that go on to perform phenomenally well, while investing too often in startups that fail.
Overconfidence, accentuated by an Illusion of Knowledge can result in family offices: Being concentrated in a relatively small number of startups – a number too small to maximize the potential to capture power law effects; Allocating too much cash into the first investment in each of the small number of startups in which the family office makes an initial investment; Not being diversified enough to maximize their odds of success given the high failure rates of early-stage technology startups; Overpaying for the startups in which they make an investment, thereby accentuating the problems I have outlined before this.
I do not mean to suggest that venture capitalists are somehow immune from Overconfidence and Illusion of Knowledge, since they are just as susceptible to those psychological biases as anyone making similar investment decisions at a family office. However, all else equal, there are aspects of venture capital practice that make it less likely that the average venture capitalist will succumb to Overconfidence and Illusion of Knowledge
Second; Family offices underestimate the amount of time, and mental, physical, and emotional energy it takes to build a successful early-stage venture capital investing practice. Most outside observers make the same mistake. The sheer volume of work required to succeed in early-stage venture capital makes it unlikely that the principals and executives of a given family office possess the predisposition, stamina, and enthusiasm for the punishing amounts of work that is required to build an early-stage technology venture practice that will match or beat even the worst independent venture capital firms in the performance brackets the family office desires most.
Third; Family office principals and executives who are new to venture capital investing generally do not understand the nuances of Power Law Distributions and Portfolio Construction. As such they fail to create internal processes and decision-making procedures that enable them to benefit from the Power Law phenomena that drive venture returns. (Author’s Note: The reader who is unfamiliar with Power Laws and the role they play in early-stage venture capital should read this and this. I have researched the issue of portfolio construction from practitioners’ perspectives quite exhaustively, including input from other VCs in a discussion on Twitter here and distilled in a blog post here NotesOnStrategy | Seed-stage Venture Capital Portfolio Construction.)
The problems encountered due to insufficient knowledge of Power Law phenomena and Portfolio Construction might arise because investments require consensus, but family office executives may defer to family office principals rather than offer their true personal opinions about specific investments the family office is pursuing; This is understandable since, for the family office executive, there’s no possible career upside to be gained from wrongly assessing uncertainty or engaging in emotionally fraught debates with family members.
Another way family offices may fall into this trap is that decisions about investments 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 their nature, the startups that generate outsized returns are highly non-consensus AND non-obvious at the early-stage of their lifecycle. As a result, family office principals are always making decisions based on incomplete and imperfect information, a situation that can be made significantly worse if the principals are not fully dialed-in, and fully engaged, with the due diligence and research that is a part of the investment decision-making process. The most likely outcome then is obvious; An anti-portfolio with too many winners AND a portfolio with too few winners.
Venture capitalists prefer to invest in startups that will benefit from network effects, and venture capital itself is a network effects AND hits driven business. This explains the behavior of many venture capitalists. Contrast this with the typical family office’s desire for privacy, discreetness, and discretion, staying away from the spotlight. Relatively speaking, this puts family offices at a great disadvantage to the venture capitalists with whom they ostensibly wish to compete. (Readers who are curious about Network Effects can access a discussion here.)
As a result family offices might source the startups in which they invest from a very narrow circle of financial advisors, investment bankers, lawyers, tax experts, and from their friends, close associates, and other acquaintances, while venture firms are constantly refining their deal sourcing strategies to ensure that they cast their nets as wide and as far as possible – adopting both push and pull strategies, and in some cases, developing proprietary software to enable deal-sourcing at scale, in addition to all the other less tech-enabled approaches they implement.
This April 17, 2015, article in the Jakarta Globe, Family Offices in Asia, the Middle East to Double, Insead Says, highlights this challenge. The author, Klaus Wille, points out that family office principals can interfere with investment decision-making in ways that are erratic and unpredictable making asset allocation problematic, as well as making it challenging for family offices to attract top investing talent. To be completely blunt about it, when it comes to deal sourcing, investment decision-making, and the ability to compete and get into the financing rounds of early-stage technology startups that independent venture capital investors consider attractive, most family offices are bringing a cute, itsy-bitsy plastic butter knife to a proverbial gunfight while venture capital firms are showing up with a range of vehicle mounted machine guns. Or, as Fred Destin, a prominent European venture capitalist put it in a discussion on LinkedIn that started with this post by Ronald Diamond, Founder & CEO of Diamond Wealth, about family offices competing with and disrupting traditional venture capitalists for startup investments, “Good fucking luck. It’s hard for us to get into deals with all the energy we throw at it, and it’s not like our terms are heavy.”
These are problems that can be solved if family offices are willing to consider alternatives to going it alone, and play the right game, when they first make a foray into early-stage technology venture investing. But before we discuss possible solutions, we must first examine why this period of human history particularly calls for such partnerships.
Why Family Offices and Emerging Venture Capital Firms Should Partner
In their January 2020 article, Venture Capital Positively Disrupts Intergenerational Investing, Maureen Austin and David Thurston, both managing directors at Cambridge Associates observe that “Families of wealth face three key questions about intergenerational wealth planning: how best to invest to sustain future generations; how best to engage the next generation; and how best to ensure family unity endures. Often each question is addressed independently.” In the rest of the paper Austin and Thurston point out that;
- “Venture capital investing offers exposure to evolving industries, often at the ground level, hedging the risks associated with mature companies ripe for disruption.” Furthermore, Austin and Thurston argue that the macro environment favors continued relative outperformance of the venture capital asset class when compared to public markets because “Technological advancements, strong entrepreneurial talent, availability of capital, and fund manager skill are creating intriguing investment opportunities across multiple dimensions.”
- Although no two families are the same, family office principals and executives should consider allocating 40% or more to private investments. Furthermore, they suggest that family offices should dedicate “half of their private investment allocations to VC, provided these families have a long time horizon and the requisite liquidity provisions to meet their spending needs. Factoring in the potential tax advantages of VC investing—such as returns being taxed primarily as long-term capital gain; opportunities to discount interests for gift, estate, and inheritance tax purposes; and possible qualified small business stock tax treatment—a 20% allocation can nicely position a portfolio for future generations.” This point is emphasized in Cambridge: Family Offices Can Outperform With More Private Investment, a February 2019 article published by Institutional Investor, in which Alicia McElhany states that, “According to Austin’s colleague, Andrea Auerbach, who leads the firm’s global private investments group, some family offices have been around for longer than endowments or foundations. “That longevity favors private investment strategies,” she said by phone, adding that tying up assets for at least ten to 15 years in private investments can improve performance.” In the same article, McElhany observes, “Cambridge arrived at a 40 percent allocation by analyzing the endowments and foundations in the top quartile of performance. The firm found that those in the top quartile had allocated at least 15 percent to private investments, while those in the top decile had steadily increased their private investment allocations over the past 20 years, coming close to or passing 40 percent.”
- “VC investors during the 2000 tech bubble experienced significantly varied results, with both big winners and big losers. Since then, the industry has evolved, and fund managers have learned valuable lessons that benefit today’s venture investors. What once was considered a bingo card approach to fund construction has been replaced with a more rigorous, risk-managed assembly of companies. VC funds are surrounding themselves with “incubator” forums and core communities of advisors, as well as setting aside capital for follow-on needs. These additional measures provide critical resources that enable start-up companies to find solid product market fit and to scale accordingly. This has had the dual effect of reducing return dispersion among managers and reducing the impairment and capital loss ratios of the underlying universe of companies.” They add, “Investing in venture funds, which each have 20–30 investments, reduces the risk from any single start-up. Diversifying across multiple funds helps to mitigate the downside probability of overall loss.”
The rest of the article by Austin and Thurston is worth reading. It contains data that puts the observations and suggestions they make into fuller and more complete context.
In their book, 21st Century Investing: Redirecting Financial Strategies To Drive Systems Change, William Burckart and Steve Lydenberg observe that “Many investors increasingly understand that the two objectives of making money and solving global challenges are not just compatible but synergistic.” They add that “Finance and investment are built on the predictability and reliability of society, the financial system, and the environment. These systems are important, really important. Stable systems promote healthy markets; unstable systems lead to reduced or negative market returns. And the decisions made daily by investors—institutions and individuals—impact the fate of these systems inevitably and powerfully whether these investors recognize that or not.”
According to Burkart and Lydenberg, System-Level Investing is investing that deliberately, intentionally, proactively, and methodically “set out to manage their impacts on the largest, most important global systems. They deliberately adopt investment strategies that seek to minimize systemic risks at these levels and promote opportunities for system-wide rewards.” While all investors affect global systems, true systems investors can be identified because they actively align themselves and their investments with society’s long term goals.
Coincidentally, there is a rising cohort of emerging managers that fit squarely within Burkart and Lydenberg’s Systems Investing framework.
For example: My friend and teammate, Kathryn Finney is Founder & CEO of Genius Guild and Founder & General Partner of the Genius Guild Greenhouse Fund. Genius Guild is a business creation platform that uses the venture studio model (Fund + Content + Community) to invest in high growth companies led by Black founders that serve Black communities and beyond. The company’s vision is to build and invest in market-based innovations that end racism. Similarly, my friend and teammate, Tessa Flippin is Founder and Managing Partner of Capitallize VC, a venture capital fund reducing racial wealth disparities through investments in Black and Latinx founders. (Author’s Note: Tessa and I serve as VCs-in-Residence at Genius Guild).
Given my past experience sourcing emerging seed-stage venture fund managers who, nearly a decade later, are now praised for benchmark beating performance, I believe that Finney and Flippin are both very uniquely positioned to execute on their respective investment theses, and with adequate capital would run circles around most family offices that decided to compete against them head-to-head. Moreover, they are each very advantageously positioned to compete and outperform other emerging fund managers pursuing similar investment theses: Finney was focused on the issues at the core of Genius Guild’s investment thesis before those issues became socially-acceptable and popular. She has gained insights, experience, and has built a network of relationships that would take more than a decade of experience for someone else to replicate; Flippin’s experience as an early-stage venture capital investor and startup founder with experience and roots that span the United States and Latin America informs Capitallize VC’s thesis, and that is not so easy to replicate either.
At REFASHIOND Ventures we believe that supply chains are a complex, global intersection of social, technological, economic, and environmental systems. If any of those subsystems fails, supply chains break down and fail too – as the COVID19 Pandemic has demonstrated all too clearly. Our investment thesis centers on early-stage technology innovations that refashion global supply chains to make them fit-for-purpose in the face of: The Climate Crisis and increasingly damaging severe weather events; Increasing geo-political tensions between the West, China, and Russia; Increasingly demanding consumers all over the world, and; Corporations that now realize that supply chains are the basis on which competitive advantage is won or lost, amid increasingly strident calls from consumers and regulators for industrial supply chains to stop and in some cases reverse the damage that man-made supply chains have caused the natural environment, causing corporate executives to seek investments in innovation and technology.
Taking things a step further, we argue that: Supply chain innovation is the basis on which all sustainable innovation occurs, AND; The goals that Sustainable, Impact, Climate, and ESG investors seek are only actualized through industrial supply chains.
Other Systems Investing areas that are attracting new fund managers, as well some established managers are: Climate Change; Diversity, Equity, and Inclusion; Impact Investing; Environmental, Social, and Governance (ESG) Investing; And Sustainable Investing.
Referring to social, financial, and environmental systems, Burkart and Lydenberg state, “Understanding these systems – and ensuring their resilience – is more important than ever. Because we live in an increasingly populated, complex, and interconnected world, a disruption in one can cause multiple others to fall like dominos in a line.”
Burkart and Lydenberg’s Systems Investing framework ties in directly with what appears to be a growing wave among family offices and their approach to how they conduct their affairs. In this March 25, 2021 article published by Forbes, Family Offices: Identifying And Incorporating Sustainability Into An Investment Strategy, the author, Mariett Ramm, who is also a family office associate who advises on investment strategies and plans states that “Generating returns financially is, of course, one of the main priorities when opting for any asset class, but I believe we cannot ignore ethical and environmental factors when it comes to responsible investing. Environmental and social considerations should no longer be viewed as negative externalities but rather exciting challenges that newer generations of family offices can embrace with open arms. It is all about making an impact.”
Buttressing Ramm’s observations, the November 4, 2021 article, Doing Well by Doing Good – The Impact of Family Offices, published by Tharawat Magazine features an interview of Tobias Prestel, Founding Partner and CEO at Prestel & Partner, Germany by the author, Tony Sekulic. Prestel makes the observation that “Today’s wealth owners are far younger; much of the world’s wealth has already been transferred from one generation to the next. Next-gens are holding the reins now, and they typically have a different mindset than their predecessors in the 1980s and 1990s. As such, they use their wealth differently.” Adding that, “The most significant trend right now is the move towards impact investing. More than any other that has come before, this generation is interested in what we call ‘doing well by doing good.’”
In a December 4, 2021 article published by Fast Company, Venture capital isn’t working for the 99%, the author, Michael Basch, who is a Managing Partner at Atento Capital in Tulsa, Oklahoma argues that venture capital can only truly fulfill its potential to transform society “if we all work together: Nonprofits and fund managers, local governments and investors, all coming together to give more Americans the chance to achieve their potential, making our nation richer not just in wealth but in opportunity for all.” That is similar to an argument I made in my January 22, 2021 column at FreightWaves, Commentary: Time to turn rest of US into innovation factory. The truth is that, more so than in the past, today a significant number of emerging managers are raising their firms’ very first funds and are pursuing investment theses to make venture capital work for the 99%, but they lack access to capital from limited partners.
Two recently published books offer different but complementary perspectives on why supply chain technology is going to be a significant pivot-point on which developments in the 21st Century will rest.
In Arriving Today: From Factory to Front Door — Why Everything Has Changed About How and What We Buy (HarperCollins, September 2021), Christopher Mims, a technology reporter and columnist at the Wall Street Journal explores how consumers’ behavior and expectations for instant gratification and convenience is stressing global manufacturing, logistics, and retail systems, networks, and platforms. This trend is not going to ease up. It is going to get worse. Coincidentally, Mims started and finished working on the book just as the COVID-19 pandemic broke. He gives readers a bird’s eye view of what the near future of global retail operations and value chains might resemble by following the journey of a USB stick from the factory that makes it in a town in Vietnam to the front door of the end consumer in suburban Greenwich, Connecticut just outside New York City.
In The Exponential Age How Accelerating Technology is Transforming Business, Politics and Society (Diversion Books, September 2021), Azeem Azhar argues that we are living in an age of technology that is accelerating beyond the ability of the average person to keep up or even understand the impact that important general purpose technologies will have on all aspects of human civilization – society, business, economics, politics, culture, technology itself, the environment, etc etc. As he states in The Exponential Age Will Transform Economics Forever, an article published in Wired UK on September 6, 2021, “for all the visibility of exponential change, most of the institutions that make up our society follow a linear trajectory. Codified laws and unspoken social norms; legacy companies and NGOs; political systems and intergovernmental bodies – all have only ever known how to adapt incrementally. Stability is an important force within institutions. In fact, it’s built into them. The gap between our institutions’ capacity to change and our new technologies’ accelerating speed is the defining consequence of our shift to the Exponential Age. On the one side, you have the new behaviours, relationships and structures that are enabled by exponentially improving technologies, and the products and services built from them. On the other, you have the norms that have evolved or been designed to suit the needs of earlier configurations of technology. The gap leads to extreme tension. In the Exponential Age this divergence is ongoing – and it is everywhere.”
In the context of the ongoing COVID-19 pandemic, what Mims and Azhar document is that our world is undergoing a transition in which how we make, store, move, and consume things is undergoing a fundamental transformation. In the context of the Climate Crisis and the challenges it poses for the future, their books raise profound questions about how industrial supply chains will adapt in a future that is more volatile, uncertain, complex, and uncertain.
According to the UBS 2021 Global Family Office Report, when family offices were asked why they are putting so much faith in Sustainable Investing, “The most popular answer is a sense of responsibility – it’s for the positive impact on society, according to almost two thirds (62%). Similarly, more than half (55%) say it’s the right thing to do for society. Roughly half (49%) also see it as being the main way to invest in [the] future.” In this specific instance, I am assuming that Sustainable Investing includes ESG and Impact Investing, and perhaps even Climate.
So far in this discussion, I have mainly had traditional family offices in mind: Traditional Family Offices may be Single Family Offices or Multi Family Offices. If they are Multi Family Offices, they may be private or commercial, some may be Virtual Family Offices. Some may focus exclusively on direct investments, meaning that they focus their investing almost entirely in the private markets. Another type of family office that could benefit from investing in the venture capital asset class and partnering with emerging managers, particularly those raising their first fund, if it is not doing so already, is the Embedded Family Office.
An Embedded Family Office does not stand alone as an independent entity but instead is integrated tightly into a privately or closely held family business. The family business could be a conglomerate or could pursue a single line of business. According to Woodson and Marshall, Embedded Family Offices resemble Single Family Offices in the activities and investments they pursue, and are mainly grouped in a category unto themselves “largely because of their association with a closely held family business.” Embedded family offices may be especially difficult to identify by outsiders because they may bear the same name as the parent organization.
Embedded family offices might start to consider investing in venture capital as a means of seeding a corporate innovation effort for closely held corporate entities of which they form a part. In many cases these closely held corporations exist in legacy industries like, transportation and logistics, agriculture, real estate, construction, and manufacturing. As advanced technology becomes more capable of affecting the way operations, supply chains, and value chains in these industries are managed, Embedded Family Offices offer their parent organizations a non-intrusive way of testing the waters with respect to establishing corporate innovation initiatives. The idea here is that the Embedded Family Office can initiate the effort, and if the results are promising after 2 or 3 years, the corporate parent can expand and scale the effort so that it has a more meaningful impact on the corporation’s competitive position and bottomline.
The potential for symbiosis between family offices and emerging managers is obvious: First, many new venture fund managers are pursuing the kind of Systems Investing investment theses that are designed to make a significant, positive difference in the world while taking advantage of and harnessing the unique ability of innovation capital to serve as a catalyst for change in exchange for investment returns. These managers have the knowledge, desire, and social networks to execute their investment strategies successfully and creating great financial returns in the process, but they lack capital to get started; Second, family offices have abundant capital and accumulated knowledge about industries and business relationships that can be additive and complementary to the networks that emerging venture firm managers have cultivated, but lack the knowledge, networks, and personnel to successfully execute an early-stage technology venture capital investing effort.
The bottomline is this: Family offices can accomplish their number 1 objective, preserving and growing multigenerational wealth, by partnering with the right emerging venture capital managers. Moreover, given that venture capital offers the most compelling long-term financial returns AND given the apparent likely future outcomes for private and public markets, according to Austin and Thurston, it seems to me that my proposition that family offices should partner with emerging venture firm managers is a no-brainer.
That leads us to the next question.
How Should Family Offices and Emerging Venture Firms Partner?
I hope I have persuaded family office principals and executives, as well as emerging venture fund managers, that it is in their mutual best interest to find ways to collaborate with one another. Here are nine ways in which a family office could approach investing in the venture capital asset class.
Before delving into tactical suggestions, it is instructive to consider the conclusions reached by Kamal Hassan, Monisha Varadan, and Claudia Zeisberger (HV&Z) in The Pervasive, Head-Scratching, Risk- Exploding Problem With Venture Capital, an article published by Institutional Investor on September 29, 2020. While the article is written with institutional investors – pension funds, funds-of-funds, foundations, and endowments as its target audience, ambitious family offices can take some pointers from the ideas the authors explore.
HV&Z argue that, “The golden rule for investors into the venture asset class must therefore be: Build a portfolio of 500 startups, with 100 companies being the absolute minimum.” They also point out that the average venture fund general partner is highly unlikely to pursue an indexing strategy – the technical jargon for the practice of building a large portfolio with as many holdings as the one HV&Z recommend, it is also pejoratively referred to as “spray and pray” investing in the venture capital community. Be that as it may, they add that, “Diversifying is also hard to execute operationally. Managing a portfolio of 100, let alone 500, investments takes significantly more effort than managing a portfolio of 20 investments. Manpower resource constraints in particular come to mind, as VC funds usually have a surprisingly small number of senior partners and dealmakers.”
HV&Z point out that, “Building a well-diversified portfolio of startups with exposure to at least 500 venture investments is easier than one might expect: Investors who have deployed consistently into venture funds for the past decade without trying to time the market have been able to do so. By investing in three or four funds every year for a decade, you will maintain an ongoing portfolio of around 30 to 40 funds, likely aggregating to more than 500 companies.”
Rather than investing in 30 – 40 funds, HV&Z suggests that this can be achieved by investing in approximately 15 venture firms, and they suggest taking industry and geographic diversification into account to obtain the best results. They point out that this a cherry-picking strategy, and so they urge limited partners to “cover the gaps between their specialized fund strategies with one or more broad-based or index funds, of which a few exist, such as 500 Startups, the AngelList Access Fund, Y Combinator funds, or the Loyal Startup Index Fund.”
I think the rest of the article is worth reading for family office principals and executives sorting through these issues.
The focus of this section of this article is on those 15 – 20 relationships that a family office might seek to establish with emerging venture capital firms. What are the tactical approaches a family office might consider employing to create each of these relationships?
- The Plain-Vanilla LP Commitment Approach: This is the easiest to implement because it simply requires that the family office make a straight-forward decision to invest in the emerging manager’s fund as a limited partner. Depending on how much interest the family office has in learning the inner workings of early-stage technology venture capital investing AND the size of the limited partner commitment, the managers of the venture firm may agree to offer more access than they would normally afford limited partners.
- The Working Capital Loan + LP Commitment Approach: This is a somewhat more involved approach. The easy aspect of this approach is the limited partner commitment that the family office makes. Once more, depending on the goals of the family office, this limited partner commitment may be smaller or larger, with a larger commitment of say 10% of the target fund size for a lead or anchor limited partner role. As I have already stated, while raising their first fund and establishing their venture firm, most general partners lack capital and typically go without a salary for two or more years. An anchor limited partner may commit to invest 10% of the fund target and furnish the general partners with a working capital loan that is secured by the general partners’ future carry from the fund, and payable from the general partners carry on that fund and future funds until such a time that the anchor limited partner has been paid an agreed multiple of the working capital loan. Securing the loan against carry ensures that the general partners do not put at risk the stream of management fees that they’ll need to meet the expenses of running the investment management company that they have set out to build.
In this case, the lead limited partner earns whatever returns they are entitled to as a limited partner in the fund AND the proceeds from the working capital loan once it has been paid back. The delicate aspect of this approach is for the limited partner and the general partner to feel that the agreed terms of the working capital loan is fair and reasonable to both parties. Risk can be managed by two anchor limited partners going in together, so that each makes a 10% commitment to the fund, and each proffers 50% of the agreed working capital budget. The goal of the working capital budget is to provide working capital to the general partner until such a time that the general partner is earning enough from management fees to cover the firm’s expenses. Therefore my expectation is that the working capital loan should be sufficient to cover at least 2 years of expenses since that is usually how long it will take to raise the fund. Since these arrangements are made privately, it is difficult to find established benchmarks for what constitutes fair terms. However, since most venture firms raise successive funds that increase in size, and if they succeed tend to attract bigger limited partners in subsequent funds, it is important that these terms are not abusive or predatory because subsequent limited partners might insist that predatory terms are unwound before a subsequent fund can close any capital and this may lead to unpleasant legal disputes and quarrels, potentially attracting unwanted attention to the family offices involved and creating reputational risk.
- The % of Management Company + LP Commitment Approach: This is even more involved than the immediately preceding approach. Here, again an anchor limited partner might commit 10% of the capital for the target fund size. Simultaneously, this limited partner will offer to make an equity investment in the investment management company that has been set up by the general partner to manage the current venture fund as well as its successor funds. For example, the limited partner might make an investment in proportion to the limited partner commitment so that that limited partner owns 10% of the underlying investment management company. The effect is that the general partner gets a capital infusion that can be used as working capital to finance the firm’s operations, in exchange the limited partner that now owns 10% of the firm may then be entitled to 10% of the carry that the general partner earns – in perpetuity, or until the firm is shut down. Usually, such an investor will not demand 10% of the management fees since that would be counterproductive – management fees are required to pay the firm’s day-to-day operating costs. A limited partner that siphons away 10% of management fees could cause injury.
One challenge that this approach can encounter is that of determining a valuation for the investment company as part of consummating the equity investment. This approach may also raise some questions as the firm grows and brings on larger institutional limited partners. This approach may raise the firm’s compliance burden.
- Using Donor Advised Funds to Fund an LP Commitment: Kathryn Finney, Founder and CEO of Genius Guild, is an Aspen Institute Finance Leaders Fellow – Class of 2021. On December 8, 2021 she published a brief article on LinkedIn in which she suggested Donor Advised Funds (DAFs) as a potential source of capital from wealthy individuals and family offices for limited partner commitments, stating: “DAFs, in short, allow a high net worth individual or entity to contribute funds or non-cash assets to be liquidated for a charitable vehicle and to take the itemized tax deduction upfront as opposed to when a donation is actually distributed. The DAF is hosted by a charitable financial intermediary, otherwise known as a sponsor, that manages the donated funds, selects investments, and often charges a hefty management fee. The donor can recommend investments to the sponsor, but since DAFs are more tax-saving instruments than truly charitable vehicles, the sponsor often has a great deal of latitude in when the funds are dispersed.”
She goes on to suggest, “a $100MM DAF that invests in women emerging managers who are building market- based venture funds. The purpose of the fund would be to fully capitalize, a.k.a. close, the funds of these emerging managers so they can focus on investing in diverse high growth companies, as well as to position these managers to generate the data and experience needed to raise a larger second fund from institutional limited partners (LPs). Carry received by the fund would be reinvested in another set of women emerging managers, creating a self-sustaining Evergreen fund that significantly increases the flow of capital to diverse businesses.”
I had never heard of DAFs before I read Kathryn’s post, so of the 4 approaches above it is the one I am least qualified to comment on. However, it seems to me to be the sort of approach that makes a lot of sense for a family office that is seeking creative ways to commit capital to venture capital in ways that allow the family office to accomplish a number of different objectives simultaneously. If you have expertise in this area I’d love to connect you with Kathryn so that you can explore her idea further. I am assuming that this approach is only available to investors based in the United States since DAFs may not be a vehicle with the same tax benefits for non-US limited partners.
- Invest in One of The New Funds-of-Funds Initiatives: There is an emerging, still small number of initiatives that are specifically designed to create pools of capital that are dedicated to backing emerging venture capital fund managers who face unique disadvantages when it comes to raising capital from family offices and other institutional investors in the private markets. Below I highlight a couple with which I have varying degrees of familiarity.
First Close Partners (FCP) backs venture funds owned by underrepresented managers (“URMs”) – especially to help them get to a “first close.” FCP invests in venture capital firms owned and operated by URMs who are people of color, women, LGBTQIA+, Indigenous people, people with disabilities, and members of other groups that have been historically underrepresented, especially (but not solely) in the venture capital industry. The venture capital funds into which FCP has invested are predominantly located in the US, Europe and Africa. FCP is helmed by: Ed and Betsy Zimmerman; Josh Kopelman – Founder of First Round Capital; Theresia Gouw – Founder of Acrew Capital, and; Admiral Regina Benjamin, MD – Founder & CEO of the Gulf States Health Policy Center and 18th Surgeon General of the United States, who are Founding Partners, and Carolina Huaranca Mendoza who is a General Partner. I am a member of Venture Crush, the community created by the technology group at Lowenstein Sandler to bring together founders, senior executives, along with venture, growth, and private equity investors. The community, which is integrated with FCP, is anchored in Lowenstein’s NYC and Palo Alto offices, and is led by Ed Zimmerman who is Chair of Lowenstein’s Tech Group. Family offices that become limited partners of FCP automatically become members of Venture Crush. FCP’s stats are pretty astounding, and Ed and Betsy Zimmerman have been investing in startups and funds for a lot longer than FCP has existed, so limited partners in FCP also get to benefit from their years of experience. Participation in VentureCrush does not depend on being an investor in FCP.
Screendoor Partners supports underrepresented General Partners of emerging venture capital funds by providing capital, access and mentorship. Screendoor accomplishes this by bringing together experienced early-stage venture investors, prestigious institutional LPs, and a critical ecosystem of professionals. Screendoor counts: Satya Patel and Hunter Walk of Homebrew; Shauntel Garvey of Reach Capital; Chris Howard and Leah Solivan of Fuel Capital; Kanyi Maqubela of Kindred Ventures; Kirsten Green of Forerunner Ventures; Charles Hudson of Precursor Ventures; Eva Ho of Fika Ventures, and; Aileen Lee of Cowboy Ventures as venture advisors. It lists Davidson College, Harvard Management Company, University of Michigan, University of Virginia Investment Management Company, Duke Management Company, The James Irvine Company, Princeton University, Hall Capital, Margaret A. Cargill Philanthropies, and Sapphire Partners as investors.
The Equity Alliance invests in diverse, emerging venture capital fund managers, with a focus on managers of color and women, through investment, collaboration, and education. It is founded by Richard D. Parsons, Chairman of the Rockefeller Foundation; Ronald S. Lauder, Board Member of the Estée Lauder Companies; Kenneth Lerer, Benjamin Lerer and Eric Hippeau, Managing Partners of Lerer Hippeau; Eric Zinterhofer, Founding Partner of Searchlight; Scott Kapnick, CEO of HPS Partners; and Michael Novogratz, CEO of Galaxy Investment Partners. Claude Grunitzky is CEO and Managing Partner.
- Use One of the New Software Platforms For Manager Discovery & Investing: There is an emerging, still small number of software platforms that are specifically designed to make it easier for family offices and other investors to discover emerging managers and invest in them through the platform. Think of these as software-enabled marketplaces for manager discovery and investment.
Revere VC, founded by Eric Woo and Chris Shen, is re-architecting the venture capital investing process and turning it into a product for limited partners by providing investors with digital investment management solutions, curated supply and demand for innovation capital, community and education. In a quote on the company’s website, Eric Woo says, “We are approaching the ‘Vanguard’ moment for venture capital, where exposure to the asset class will increasingly be through novel investment products as opposed to the very limited ways we currently have to invest.” Eric Woo recently shared some suggestions on Twitter about how family offices and other investors considering commitments to emerging managers might go about deciding which managers to back. Readers can access that thread here. We will hear more from Eric later.
Allocate, founded by Samir Kaji, is a platform that enables limited partners to discover and invest in promising emerging venture fund managers researched and curated by members of Allocate’s team. The platform enables “the entire process from discovery, investing, to post-investment reporting and transacting.”
AngelList is the parent company of AngelList Venture, AngelList Talent, and Product Hunt. AngelList launched in 2010 as an email list and most notably, at the time, helped Uber Cab raise seed capital. The company has grown significantly from those humble beginnings and now claims: 9,500+ funds and syndicates; Support for more than $7 Billion of assets managed by the funds and syndicates on the platform; 151 unicorns, and; 56% of all top-tier venture capital seed-stage deals in the United States.
REFASHIOND Ventures launched REFASHIOND Ventures Seed Fund, LP (aka REFASHIOND Seed), a Rolling Fund on AngelList on July 1, 2021. I wrote about our decision here, #WorkInProgress: Why I Am Building An Early Stage Supply Chain Innovation & Technology Rolling Fund (March 13, 2021) and here, Commentary: Rolling Funds on AngelList Are The Best Way For Accredited Individual Investors to Start Investing in Venture Capital Funds (December 1, 2021). During a conversation my partner and I had with Xinran Xiao, AngelList’s Head of Product and Engineering in August 2021, he told us that we should be thinking about AngelList as a technology company building fund management and administration products and tools for use by fund managers AND NOT as a fund management and administration company building software for managing the business.
Since we launched REFASHIOND Seed, AngelList has announced a number of new products that have made us excited about what’s ahead. I do not think there’s currently a better platform for individual accredited investors seeking exposure to the early-stage venture capital asset class, and more specifically in the many conversations we have had with individuals considering the $25,000 minimum commitment for REFASHIOND Seed, we have found the features of rolling funds very easy for them to get excited about – certainty about the regularity and predictability with which capital calls occur, the flexibility to increase or decrease their commitments based on the things happening in other areas of their lives, the knowledge that AngelList provides an added layer of back-office operations and compliance support that would be too expensive for the average emerging manager to implement, and constant and ongoing innovative new products that make fundraising easier for startup founders – making working with rolling funds on AngelList significantly easier than working with traditional funds managed by emerging managers and at least as attractive, if not more so; For example, in one instance we have been able to get an investment through AngelList’s compliance review, closed, and wired funds to a startup that is now in REFASHIOND Seed’s portfolio within 12 hours from start to finish, after Lisa and I had completed our internal due diligence and communicated our desire to invest to the startup’s founder.
- Join a Community Dedicated to Helping Emerging Managers Connect With Limited Partners: These community-driven organizations do not necessarily operate sophisticated technology platforms, nor do they all gather pools of capital to invest. However, they organize periodic events like conferences, lunches, dinners, social-hours with deliberately curated guest and attendee lists that are designed to maximize the chances that managers and limited partners meet and hopefully strike up a long-lasting relationship. In some instances they do some match-making to facilitate fundraising conversations. Some may have cohort-based education programs designed to train emerging managers and get them ready to raise. In this way they are similar to programs like those we will discuss in the next category.
Organized by my friends Andrea Hoffman and Denmark West, “Culture Shifting Weekends is an annual invite-only bi-coastal event that takes place in Silicon Valley, Silicon Alley and Miami. These are the only events of their kind in the United States that unite over 400 accomplished Black & Latinx tech executives, entrepreneurs, investors, innovators and social impact leaders in order to enable deals, collaborations and wealth creation.” Culture Shifting Weekends is organized by Culture Shift Labs, a diversity and innovation consultancy that has provided services under three pillars: Advising, Strategy, & Activation since 2006.
Founded by my friend, Bahiyah Yasmeen Robinson, VC Include “was created in 2018 to accelerate investment into historically underrepresented emerging managers – women, Black, Latinx, Indigenous and LGBTQ – to drive economic growth through the power of diversity.” It is “an exclusive ecosystem and marketplace designed for GPs and LPs to drive alpha to investors while also moving the needle on shaping a more equitable and empowered world.” VC Include integrates “7 of the 17 United Nation Sustainable Development Goals (SDGs), including Gender Equality, Industry, Innovation, and Reduced Inequalities.” Include Ventures announced a $125 Million fund-of-funds focused on Black and Brown fund managers and a $125 Million vehicle for direct investments. In addition to Bahiyah, the other general partners at Include Ventures are Keith Malcolm Spears and Taj Ahmad Eldridge.
The Draper Venture Network (DVN), where my friend Sid Mofya is Executive Director, is an “alliance of venture funds that cooperate on investment diligence, marketing intelligence, corporate and LP relationships, and co-investments.” The network was initially formed in 1990, and now boasts: 24 funds; A presence in 60+ cities; 800+ portfolio companies, and; $4.5 Billion of assets under management collectively for the funds in the network. DVN counts the following people as board members: Tim Draper – Founder of Draper Associates and Draper Fisher Jurvetson; Eric Manlunas – Founder & Managing Partner at Wavemaker Partners; Mitch Kitamura – Managing Director at DNX Ventures; Sever Totia – Partner of 3TS Capital; Nicola McClafferty – Investment Director at Draper Esprit; Enrique Penichet – Founding Partner at Bbooster Ventures, and; Sanjay Nath – Managing Partner of Blume Ventures.
- Engage with Organizers of One of the New Cohort-Based VC Accelerator Programs: Think of these programs as the venture capital equivalent of startup accelerators and incubators. They are relatively young and so expect the model to evolve as the organizations and people behind them learn more about what works and what does not, and develop a better sense of what creates value for the managers and limited partners they seek to serve. Access to limited partners that will actually invest in a fund manager’s first fund is a key differentiator for such programs. The education on its own is nice, but obviously the best managers of the past found ways to establish themselves without the benefit of such programs, so without access to potential limited partners I find it difficult to justify going through such a program unless the manager needs an outside party for accountability with doing what the manager has to get done in order to raise the fund . . . Of course, that should raise other questions, but I digress.
Oper8r was cofounded by Welly Sculley, and Winter Mead who serves as CEO. Although my partner, Lisa, and I did not make the cut for Oper8r’s first cohort in 2019, I have friends who went through that program and who sing its praises. Many have also made considerable progress raising capital from limited partners they met through Oper8r.
VC Lab by Founder Institute is an initiative launched by Adeo Ressi who now serves as CEO, having stepped down from his role as CEO of Founder Institute. VC Lab has the stated goal of helping to launch 1,000 new venture funds over the course of 5 years to support innovation all over the world. My partner, Lisa and I were part of the second cohort which started in July 2020 and lasted 16 weeks. We voluntarily dropped out about 4 weeks before the end of our cohort. The program is a realistic preview of just how much effort it requires to raise a venture fund from scratch, especially for fund managers with no prior experience at a venture fund.
Recast Capital is founded by Courtney Russell McCrea and Sara Zulkosky, and describes itself as “A platform to invest in and support emerging managers in venture.” According to Recasts website; Courtney and Sara “experienced first-hand the shift that was taking place in venture and came together with a clear view of what was needed in the industry: an institutional-grade intermediary to help investors access the opportunity presented by emerging managers, and create a way to support those managers in the process.”
The Sutton Capital Fund Accelerator selects a cohort of emerging fund managers who interact with 3 – 6 limited partners every week. The managers who have gone through the program so far have been raising funds that range in the sequence from Fund I to Fund 5. The limited partners range from high net worth individuals to institutional allocators. The accelerator organizes frequent demo days they call the Allocator Summit.
- Banks and Other Wealth Management Advisors: Most major banks have an offering that they make available to their wealth management clients. I do not know enough about these proprietary offerings to say much more. If I were advising a family office principal or executive, I would suggest going out and finding emerging managers before they are established enough for a large bank to consider putting them on a platform because that is when a commitment is most meaningful for the manager AND as such that is also when the family office can build the strongest partnership with the managers to which it chooses to make a commitment.
The offerings from SVB Financial Group, SVB Capital or the equivalent offering from First Republic Bank seem to me two of the best offerings from banks to consider for family offices seeking exposure to venture firms in the United States because, for those two banks, startups and venture capital are a significant part of their business. At a bulge-bracket bank venture capital is merely a distracting side-show relative to hedge funds and private equity and I have a hard time believing family offices will receive the best service possible, or be exposed to the most promising crop of up-and-coming new venture firms.
Limited partner investments in venture funds happen in the private market. There are bound to be other approaches to which I have not yet been exposed, or about which I have not given sufficient thought. However, any other approaches that I have not specifically discussed here can probably be categorized under one of the 9 broad approaches I have described above.
In a September 8, 2021 article that was published by Forbes, Navigating The Venture Capital Space As A Family Office, Champ Suthipongchai, General Partner at Creative Ventures makes the point that family offices should size their limited commitments to match their ambitions. While general partners usually cannot contractually guarantee co-investment opportunities, when occasions arise for a general partner to offer such options to a fund’s limited partners, the tendency is to first approach those limited partners who have made the largest commitments to the fund before approaching the others, or to offer the opportunity to all limited partners on a prorated basis.
As Suthipongchai puts it, “If your emerging manager only has five people to call, who would they be? You better be one of them. To ensure this, make sure to appropriately size your investments. You do not just want to be one limited partner on a list; you want to be the go-to limited partner that gets the call whenever the best opportunities arise. You want a partnership, not a vendor-client relationship. Simply put, your investment amounts need to be scaled to the amount of influence you expect to have. Bigger amounts equal bigger influence and more motivation for your emerging manager to prioritize you.”
In What Family Offices Should Look for in a Venture Capital Growth Fund, a November 3, 2021 article that was published by WealthManagement.com, the author Mitzi Purdue interviews my friend, Brian Smiga, Cofounder and Managing Partner of Alpha Partners. Brian suggests a number of considerations for family offices seeking to make limited partner investments, though he appears to be speaking mostly to investors considering a cherry-picking strategy of investing in 2 – 5 firms, to use the parlance of HV&Z, rather than the diversified strategy of investing in 15 – 20 relationships.
Smiga suggests that: First, family offices should choose venture firms that align with the family office’s expertise – remember that HV&Z advocates diversification; Second, family offices should select for geographic convenience – remember that HV&Z advocates geographic diversification; Third, venture firms should be selected on the basis of the family office’s investment horizon and risk tolerance – assume that pre-seed and seed-stage funds will require at least 10, and perhaps 13 or more years for their investments to mature. This is another reason Finney’s idea about DAFs might be intriguing for some family offices considering tax minimization strategies as a way to realize some returns sooner rather than later; Fourth, seek co-investment opportunities; Fifth, research and interview several funds – Smiga suggests investing in 2 funds after interviewing 20. It is worth considering that his advice is applicable only for growth stage venture funds while HV&Z appears to apply to both early-stage as well as growth stage venture funds.
To compare the preceding discussion with what is actually happening in the real world of family offices investing in venture capital, I turned to Family Offices Investing in Venture Capital 2021-2022: A Roadmap to VC Success, a report published by SVB Capital and Campden Wealth, which they describe as “the the first-of-its-kind report on Family Offices (FOs) investing in Venture Capital (VC).”
The first installment of this report was the 2020-2021 edition. With this edition they are launching the first in a series of quarterly reports based on an in-depth survey of 139 FOs across 30 countries. In the report they find that, among other things;
- The total number of venture deals with family office participation has increased steadily, from 1.9% (129 deals) in 2009 to 4.2% (981 deals) in the first half of 2021.
- As of Aug 31, 2021, $418 Billion had been invested in venture capital deals globally. This handily surpasses the previous full year highwater mark of $333 Billion that was established in 2020. The 2021 amount represents more than a 10x multiple of the $37 Billion invested for all of 2009. In terms of the number of deals this represents, 2021 (23,000) seems to be trending lower than 2020 (29,000) and 2019 (30,000). Some of this data may be slightly inaccurate since it is customary for startups to delay announcing funding rounds until they feel such announcements will play to their strategic advantage in what can sometimes be highly competitive and fought-over arenas. On the other hand, the recent past has seen an explosion of very large venture rounds, and perhaps that is really what the data reflects more so than anything else.
- In the 2020 study, the average family office that participated in the survey held “eight funds and 10 direct investments.” This year, “the average family office (FO) holds 10 funds and 17 direct investments.” The authors of the report add, “Moreover, within the next 24 months, the average FO expects to make 18 new investments (six funds and 12 direct deals).”
- When it comes to deal sourcing, “Family offices (FOs) with experience in venture tend to source deals on their own (24%) and depend on their extensive networks, including GPs of venture funds (19%) and company founders / operators (16%).” This is in agreement with observations the reader would have encountered earlier in this article, although this offers some metrics to enable us gauge the relative prevalence of various approaches to deal sourcing for those family offices that are already active in venture capital. In another sign of its growing importance, on average family offices are assigning more personnel to focus on the venture capital asset class.
- This took me most by surprise, “Survey participants identified LinkedIn and Pitchbook as the top tools/platforms for sourcing both direct investments and funds. But interviewees explained that LinkedIn is more likely used to maintain / enhance proprietary networks.” However, respondents also expressed that they are unlikely to establish brand new relationships based on outreach from LinkedIn since there’s always uncertainty about credibility, and some family offices have fallen prey to hoaxes on the platform. Other platforms I recognize from the list include Crunchbase, AngelList, and Preqin. TechCrunch and Forbes are two publications from which these family offices source ideas.
Two observations: First, by the time a startup has meaningful data on Pitchbook, CBInsights, or Tracxn, it may be too late for early-stage investors to reap potential 10x+ to 100x+ returns – our goal at REFASHIOND Ventures has always been to uncover promising startups before they appear on any of these platforms; Second, in a similar vein, by the time an emerging venture manager can be assessed based on the data usually collected and reported by one of these data platforms, it may be too late for a family office to obtain attractive terms for the commitment the family office is willing to make. This also means that most of the investment consultants that family offices employ to help them perform due diligence on funds raising their first fund are not necessarily equipped to perform that assessment since many are relying on the sort of data that those platforms seek, data most managers raising their first fund do not yet have. Investing in a firm and a manager raising a Fund I requires more curiosity and creativity than investing in a firm raising a fund that is higher in the fund sequence.
For example, of course, family office principals and executives understand that “past performance is not necessarily indicative of future results” and yet every emerging manager I know faces the dreaded question; “What is your track record?” This is an interesting question since the track record is a lagging indicator of what the manager might accomplish. Moreover, if the manager is building a brand new fund completely from scratch based on a new investment thesis, that is executed through a new investment strategy, with a new team that is implementing new decision-making processes, based on a new brand . . . Is past performance as captured in the track record relevant? Also, with no insight into how decisions were made at the manager’s former firm, the limited partner might be drawing conclusions that are completely off the mark about how much influence the individual manager had over which startups actually made it into the portfolio at that manager’s former venture firm. Rather, it seems to me that in the case of manager’s raising their very first fund, “What is your track record?” indicates a desire to avoid the psychologically challenging and time-consuming task of using other information to assess the potential of a manager raising a venture firm’s very first fund. This is particularly true when the individual manager has not built up sufficient personal wealth to start making personal investments while building the venture firm and raising its first fund. Of course, for managers raising a second or third fund for the same firm, the previous fund(s) should be examined for any relevant signs that might provide some indication of how subsequent funds might fare. Even then, as I have learned from firsthand experience, other information is just as important because of the peculiar nature of early-stage technology venture capital investing.
- The final thing that caught my attention, and that I think less experienced emerging managers could learn from in terms of the importance of Investor Relations is that, “There is a range of reasons for which family offices may choose not to re-invest in a manager they have already invested in, with the top reasons being poor performance (69%) and the availability of better alternatives (52%). Interviewees advise that, whatever the type of investment – e.g., fund or direct – venture capital investing is specialist and must be hands-on.” The authors also add that, “Other deterrents from re-investment include strategy drift (46%) and poor communication (46%).”
It should be obvious by now that the rest of the SVB Capital and Campden Wealth Report is worth reading in detail by family office principals and executives as well as emerging venture fund managers.
While the SVB Capital and Campden Wealth Report is clearly useful, for an emerging venture capital management firm like REFASHIOND Ventures that is seeking to raise its first institutional vehicle targeted at limited partners from among family offices, corporations, small endowments, small foundations, small pension plans, trusts and other types of investors, that report may not be representative enough for us because it may reflect findings that are most applicable to firms that are raising their second or third traditional fund at best, or it may have a significant representation of family offices that prefer to invest starting in a managers fourth fund or later when a clear track record has been established and the manager is no longer considered an emerging manager in the technical sense.
To find out what family offices may think about investing in fund managers like REFASHIOND Ventures that are raising their first fund, I turned to the Family Office Survey Report 2021 published on September 14, 2021 by Sam Heshmanti, Senior Managing Director, First Republic and Winter Mead, Cofounder, Oper8r. Oper8r runs a cohort-based training program for emerging VCs – most raising their first fund. Winter is also the author of How to Raise A Venture Capital Fund: The Essential Guide on Fundraising and Understanding Limited Partners – an excellent book that I recommend to everyone I know who needs a better and more granular understanding of the topic.
For their report, First Republic and Oper8r surveyed family offices across the United States and globally. They found that;
- “About 95% of the participants in the survey are U.S.-based family offices ranging from $15 million in assets under management (AUM) to $2.5 billion AUM, with a median size of $200 million AUM.” Of the family offices they surveyed, 95% are based in the United States, with New York and Silicon Valley each accounting for nearly a quarter of the respondents. Pennsylvania (14%), Southern California (11%), and Texas (8%) are the other regions with significant representation among the survey’s respondents.
- Sam and Winter state that, “Compared to the 2020 family office survey, VC allocation from family offices to emerging VCs remains strong, and the outlook remains bullish for 2021. In fact, the average family office investment allocation to VC was 10% in 2020 and has increased to 24% this year. This increase in interest may be corroborated by a recent survey by Eaton Partners, which indicates that LPs worldwide are finding alternatives more attractive.”
- Furthermore, they find that, among this survey’s respondents the allocation to VC has increased from 10% in 2020 to 24% in 2021. Furthermore 100% invest in emerging managers, and 20% invest exclusively in emerging managers.
- Sam and Winter also found that, among the family offices they surveyed, “Risk appetite also appears to have increased. In addition to the interest in investing in emerging VCs (defined as Funds 1–3), three out of four family offices indicated they’d be interested in investing in a first-time fund.” They add that, “According to survey responses, the reasons behind this push into emerging VCs and first-time funds include 1) a lack of access to brand-name funds, 2) established funds getting larger, which may create a need to fill the early-stage risk/return profile that was once filled by these established funds, and 3) the ability to deploy more capital through coinvestments alongside emerging managers.” The appetite for risk is supported by their further finding that 90% of the survey’s respondents make coinvestments, with the most active making up to 20 coinvestments per year.
If you are a family office principal or executive with an interest in emerging venture capital firms, or an emerging fund manager seeking to connect more effectively with family offices, it is obvious that the First Republic and Oper8r report is worth reading.
Sam and Winter conclude “that family offices remain a strong source of capital for the VC ecosystem and, in particular, for emerging VCs. While market data and headlines suggest emerging managers struggled with fundraising in 2020 during the pandemic, family offices in 2021 remain bullish on the fund and coinvestment prospects some emerging managers offer. While there are encouraging signs that family offices are more active, it also appears true from the survey results that family offices are leaning on early-stage VCs for sourcing and information.”
Market Voices: Fund Managers and Other Practitioners Suggest How Family Offices and Emerging Venture Capital Firms Can Partner
So far the reader has had a chance to examine and engage with only my perspective as an emerging venture fund manager. To make this article more complete I asked some friends and acquaintances of mine to contribute their response to this prompt: What is the most important way in which family offices can partner with emerging venture capital fund managers?
Following are the contributions I got by email, listed in the order in which I received them, with minimal editing by me for clarity, and clarifying notes where I feel such notes will add some value and additional context for the reader about the nature of my relationship with the respondent.
If you would like an introduction to any of the contributors simply send me an email with some background about who you are and why you want an introduction and I would be happy to facilitate a warm introduction. Of course, you may also reach out to any of them directly via LinkedIn or another social networking platform like Twitter.
Market Voices Deep Dive By: Lisa Morales-Hellebo
Cofounder & General Partner, REFASHIOND Ventures
The Unfolding Future In Fashion & Apparel is a Future of Demand Chains
About the Author
Lisa Morales-Hellebo is a Cofounder and General Partner of REFASHIOND Ventures, an emerging venture capital fund manager that invests in early-stage supply chain technology (#SupplyChainTech). She is also co-founder of The Worldwide Supply Chain Federation, an organization that is changing how supply chain professionals learn about, collaborate, and adopt supply chain innovation around the world. The New York Supply Chain Meetup is its founding chapter, attracting hundreds of attendees from around the globe to its monthly events. Lisa has been a guest lecturer on the subject of fashion supply chain innovation at MIT, Columbia University, LIM, Parsons, UC Davis, NYU Tandon School of Engineering, and George Mason University. She earned a Design degree from Carnegie Mellon University in 1995, and has gained 27 years of professional experience in tech during which she has worked at and helped scale numerous tech startups dating back to 1998: Including WorldWeb which exited in 1999; Reflect.com, and; Shopsy, a fashion contextual search engine founded by Lisa, which went through Techstars Boston in 2012. She Founded the New York Fashion Tech Lab in 2014 with Springboard Enterprises. She currently serves on the Advisory Board of Puerto Rican startup accelerator Parallel18 and the George Mason University Center for Retail Transformation.
I worked in Silicon Valley at a P&G and Redpoint Ventures backed startup, Reflect.com, that pioneered mass-customization, personalization, and on-demand micro-manufacturing, in cosmetics, skincare, haircare, and fine fragrance.
I have been obsessed with the fashion industry since childhood, perhaps since we had to sew our own clothing rather than buy items off the rack, but the portion of my professional experience that has direct relevance to this discussion starts in 1999.
This experience was foundational to my understanding of the possibilities inherent in demand chains; Supply chains that start with actual demand rather than forecasted demand, as the basis for production. Demand chains offer benefits such as increased perceived value, higher price points, higher conversion rates, increased customer loyalty, peer-to-peer marketing, higher margins, and more. The ideal demand chain is hyper local, meaning that: Goods would be produced in the United States; The increase in domestic manufacturing would create local jobs, and; Localized manufacturing would yield higher agility, quicker speed to market, and accelerated innovation cycles.
While at Reflect.com, I re-architected the user experience and branding for our skincare line. This nearly quadrupled revenue within one month of the relaunch.
I led the cross-department teams on creating the first peer-to-peer marketing campaigns for Yahoo banner ads which became the highest click-through and converting banner ads at the peak of the first dotcom era, when Yahoo was still much bigger than Google, pre-social media. I had a hunch that real women telling their real stories of creating one-of-a-kind products that worked for them would be more compelling than having models in our advertisements.
I also created the first virtual personal shopper by using data we obtained after a customer had created one product. This enabled us to push a customized, graphic email through MacroMedia Generator, extracting a hex value for their one-of-a-kind beauty product to deliver a custom “Email From Your Personal Shopper” with a recommended product just for each customer. No product existed till the customer had made a purchase.
I also led the company’s development of a brick and mortar, experiential pop-up store where customers could create the custom beauty products they had purchased. I led the translation of our online customization to a print catalogue in partnership with Spiegel; This led to a significant increase in our average order value. And lastly, I led the creation of custom and personalized cosmetic sets that we could recommend alongside seasonal outfit recommendations from our fashion brand partners.
We did all this before 2001.
In 2010 I launched my own startup, Shopsy. It was a contextual search engine that I designed and developed based on a proprietary universal taxonomy for fashion. We participated in Techstars in 2012 and raised some venture capital. It was during Techstars that I realized how few venture capitalists truly cared about or invested in fashion technology. Eventually we took the difficult decision of shutting Shopsy down.
Fashion & Apparel constitute a multi-trillion dollar global industry that: Employs 1 in 6 people on this planet; Touches nearly every other vertical; Produces up to 10% of CO2 emissions; Is perhaps the largest reason that humans are now consuming a credit card worth of microplastics every week; Is rife with toxic working conditions, slave and child labor, and; Is one of the industries every human needs to interact with daily.
It is also obscenely undercapitalized for innovation.
So, in 2014, in collaboration with Springboard Enterprises, I founded the first fashion tech innovation accelerator partnered with the C-Suite of the major brands and retailers in 2014 — the New York Fashion Tech Lab.
During that first cohort, I had the privilege of speaking behind closed doors with c-suite executives from Macy’s, JCrew, Kate Spade, Ralph Lauren, Li & Fung, Global Brands Group, Ann Taylor, Alex + Ani, LVMH, and Marc Jacobs. For the better part of a year I saw that the corporate executives worried about their supply chains in private, but focused on relatively easier to deploy front-end and customer-facing innovations since those often had a positive impact on near-term share prices, and also had a more immediate on bonus prospects by garnering attention from the press. Yet such innovations have a fleeting impact on the bottom-line, if any.
I left after the first cohort to study the apparel supply chain for a year on my own dime between 2015 and 2016. This work enabled me to draw connections between what I had done in Silicon Valley, at Reflect.com 20 years prior, with the emerging innovations of the Fourth Industrial Revolution (Industry 4.0 as it is sometimes called). That work, coupled with the knowledge I developed from numerous fashion tech innovators I connected with during that period, led me to develop a thesis on the localization of demand chains AND the development of circular textile infrastructure as crucial for the future of supply chains in the fashion and apparel industry.
Demand chains make it unnecessary to predict or forecast trends since producers can be responsive in real time to consumer demand and even co-create with customers; only producing that which is purchased.
My thesis is that the biggest opportunity lies in localization of fashion demand chains coupled with circular infrastructure and has been the subject of numerous talks I have given, such as: (Digitization of Supply Chains And The Shift To Localized Demand Chains; SynZenBe: Digital Transformation of Fashion; Fashion And BeautyTech: The New Platforms In Fashion; Supply Chain on the Brain with Lisa Morales-Hellebo; Latinx Heritage Month: Captaining Creation, Making, and Change).
I have been cited in a number of articles on the subject: The Fashion Of Nearshoring Expands, With Microfactories A Growing Trend; What if Fashion Forecasted Climate Disasters Instead of Trends?; The 5 W’s of Reshoring Supply Chains, and Lisa Morales-Hellebo: Pioneering Supply Chain Solutions Through Technology And Design Thinking.
At REFASHIOND Ventures, we believe that this type of deep study across systems, raw materials, manufacturing, logistics, workforce reskilling and upskilling, waste streams, data and automation, coupled with contextual awareness of increasing risks from the Climate Crisis and geo-political tensions, is a prerequisite for making informed decisions and successfully deploying capital on behalf of our limited partners in early-stage supply chain technology.
I have been exclusively focused on the study of fashion supply chains since 2014. I met Brian in 2016. We started working together by building The Worldwide Supply Chain Federation in 2017, since we had both come to realize that great advances in supply chain require collaboration, shared insights, and open dialogue between the BUILDERS & BUYERSTM of the best emerging supply chain innovations and technology.
In Support of Specialists
Family Offices should partner with emerging fund managers in newly emergent markets to leverage their specialized expertise and focused deal flow to get ahead of emerging market trends.
There are a number of industries that have been historically under capitalized by venture simply due to unconscious bias within the predominantly white male, Stanford and Harvard alumni venture capital community. We are not placing any blame, but rather simply stating well documented research on the lack of capital being deployed into female founders and people of color and the correlation to female founders over indexing as founders in spaces like beauty and fashion technology.
According to HBR’s Report, How Venture Capital Works, “The myth is that venture capitalists invest in good people and good ideas. The reality is that they invest in good industries.” If this is truly the case, why are massive global markets that target the half of the global population that controls household wallet spend being ignored?
The global fashion market has been reported to be bouncing back from the COVID-19 disruptions of 2020 to near $2 Trillion of revenues again in 2021 with a projected growth in overall consumption tracking towards 30%.
According to the BCG & Fashion for Good Report from Jan 2020, Financing the Transformation, “Achieving a step change in sustainability by 2030 requires deploying $20 billion to $30 billion in financing per year to develop and scale disruptive innovations and business models.”
Since this is the first time in history that supply chains have been digitized, the disruptive business models that will yield the highest returns for investors in fashion and apparel lie in early stage fashion supply chain innovations and technology, from raw materials through on-demand advanced manufacturing and the co-creation of consumer experiences.
Definitive data is difficult to obtain. However, anecdotally, current trends point to maybe just a few hundred million of investment capital being deployed globally into early stage fashion supply chain innovations and technology startups. This means there is massive opportunity and upside for investors who specialize in not just forecasting this space, but who also study the underlying design of the future of this business.
It has historically been easier for family offices to contribute to non-profits that are “tackling these issues”, but after 30 plus years of beating the sustainability drum, we have moved an inch in this thousand mile journey. The abysmal results of the status quo are well documented and are for the most part, “greenwashing.” (See also: MSCI ESG Ratings Focus on Improving Corporate Bottomline)
Family offices that truly want to leave a legacy of doing well while also doing good should capitalize on this opportunity to become limited partners in emerging specialist funds that are backing the early stage technologies that will catalyze the shift from supply to demand chains.
The future is not predicted like the weather. It is designed.
When entire global markets are being refashioned, it requires design thinking, and systems thinking from a dedicated team of specialists to identify and access the biggest and most potentially financially rewarding and transformative investment opportunities.
Traditionally, the families behind the biggest names in fashion and textiles have been either passively waiting to see emerging companies backed by traditional venture capital firms achieve growth before they invest directly, or invest through their company’s venture arm. Today, the smart money will seek out the specialist emerging venture capital fund managers who have dedicated themselves to deep study of their chosen area of specialization.
- Name, Title, Fund: Zecca Lehn, General Partner, Responsibly Ventures
- Investment Thesis: Backing US PreSeed startups focused on both Sustainability and Social Good
- Contribution: Family Offices can participate by investing as LPs to emerging funds, and helping to back them as co-investors early on. They can also help make intros to potential customers, advisors, and other talent. Making intros for GPs to other family offices helps lift the ecosystem.
- Name, Title, Fund: Charlie O’Donnell, General Partner, Brooklyn Bridge Ventures
- Investment Thesis: Brooklyn Bridge Ventures, the first VC fund founded in Brooklyn, NY, is the most accessible lead or co-lead investor for pre-seed and seed-stage startups in the NYC area. We foster an online and offline community open to founders and innovative professionals of all backgrounds.
- Contribution: Family offices would benefit from making a group of fund investments across a few different managers in order to generate deal flow for potential future co-investments. Most FO’s are not set up to respond to venture opportunities at the pace that they demand, so having a trusted partner to pre-screen founders and deals makes the most sense for them. It also keeps them exposed to the asset class in a highly diversified way even if the family ultimately is unable to pull the trigger on individual deals–which happens a lot. The risk on one individual venture deal is off the charts–and so if you’re not committing to a portfolio of them, it will never make sense.
- Author’s Note: I first met Charlie in 2012. I consider him a friend, and he is one of New York City’s most connected venture capitalists, correspondingly Brooklyn Bridge Ventures is one of NYC’s stalwart seed-stage venture funds.
- Name, Title, Fund: Chris Fortunato, Investor, Soma Capital
- Investment Thesis: Soma Capital is an early stage venture capital firm that invests Seed through IPO and has been an early investor in 18 unicorns since its founding 6 years ago.
- Contribution: The most important way for LPs to engage with emerging managers is through a proactive and engaging approach. At Soma, we want to have close relationships with our LPs to strengthen our partnership and to understand how they can add value to our portfolio. Our LPs, especially those new to the asset class, use our 1 on 1 calls to understand the inner workings of our business from investment sourcing to financing terms. The insights most are seeking to obtain won’t be gained through passive participation in the fund and reviewing quarterly fund financial statements.
- Author’s Note: Chris is my former teammate, he is the earliest member of the former KEC Ventures team outside Jeffrey Citron, myself, and Jeffrey Parkinson. He included this note to me. I agree with his overall take on this, and I feel it adds useful context that is relevant for, and within the scope of, this discussion. So I am including it here: I, too, have been seeing what you describe – family offices diving further into VC and leveraging emerging managers to shepherd them through the asset class. I am of the opinion that our inflation situation is very real and institutions managing plan assets – endowments and the like – will have to move into riskier asset classes to achieve that 8% annual net IRR which most have to target. This means some will go further into their VC allocations and many will enter VC for the first time. Emerging managers provide the same benefits to these groups as they do to family offices, as you describe. But VCs also provide a layer of insurance that helps these groups with very high reputation risk and settle the nerves of investment committees … would be curious as to what you think on this. Maybe something to discuss over coffee?
- Name, Title, Fund: Kathryn Finney, General Partner, Genius Guild Greenhouse Fund
- Investment Thesis: Genius Guild Greenhouse Fund invests in Black founders that produce alpha for their investors, their community and themselves.
- Contribution: Family offices can best partner with emerging venture capital funds by being open to meeting managers who are a bit outside the traditional VC mold, especially those who are investing in emerging markets. It’s in these markets that new opportunities lie.
- Author’s Note: Kathryn has been my friend since 2013, and I have collaborated with her on various projects and initiatives since then – including once talking for 12 hours straight about venture capital and startups to a group of startup founders going through a program she used to run in Atlanta. As I stated earlier in this article I am currently a VC-in-Residence at Genius Guild.
- Name, Title, Fund: Benjamin Gordon, Managing Partner, Cambridge Capital
- Investment Thesis: Cambridge Capital invests growth capital in outstanding supply chain companies. Additional notes about Cambridge Capital: Our philosophy is to invest in companies where our operating expertise and in-depth supply chain knowledge can help top entrepreneurs and management teams grow their businesses; Cambridge’s supply chain sector focus, unmatched network, strong historical results, and unique blend of deeply experienced investors and operators present an attractive opportunity for companies to choose Cambridge and achieve outstanding value growth; Cambridge builds on a long history of excellence in advising, building and investing in the supply chain sector; Cambridge’s portfolio includes XPO, Grand Junction (sold to Target), Bringg, ReverseLogix, Parcel Perform and others; Cambridge’s professionals have deployed over $2 billion in capital across equity investments in and acquisitions of more than 20 companies in supply chain / technology.
- Contribution: Family offices have at least three ways to partner with emerging venture capital fund managers.
First, they can invest in emerging funds. Unlike mature funds, emerging managers are much more accessible. One of the LPs at Cambridge Capital pointed out that although their family office invested a large amount of money in Blackstone, they don’t receive any input as to the portfolio, the decision making process, or anything else other than returns. In contrast, by investing in an emerging manager, a family office can gain access, insight, and value.
Second, they can invest in direct deals. Some emerging managers will allow their LPs to invest directly in deals, most commonly in SPVs. This gives family offices optionality. They can evaluate individual deals and decide on a case-by-case basis whether to join.
Third, they can establish separately managed accounts (SMAs). Under this scenario, they can invest a pool of capital with a manager, who will allocate the funds on a discretionary basis. The advantage for the family office is that they can gain a fixed allocation, e.g. $5 million per deal in the next 4 deals, without the 10-year time horizon that a fund often requires. Some people view this option as the best of both worlds.
Regardless of the format, one thing is clear. Family offices are increasingly seeking access to emerging managers. In addition to the advantages of the above options, there is one more important point: financial upside. Since emerging managers typically outperform mature managers (by an average of 6% according to a Preqin study), family offices can truly gain a win-win.
- Author’s Note: I have known Ben since early 2017, when a number of people introduced me to him after I published Industry Study: Freight Trucking (#Startups) on November 23, 2016 and Updates – Industry Study: Freight Trucking (#Startups) on December 31, 2016, describing him as “One of the best, if not the best growth stage logistics investor in the United States.” We have since become friends and collaborators. Ben was also the first person to make a limited partner commitment to REFASHIOND Ventures Seed Fund, LP (REFASHIOND Seed) – our #SupplyChainTech Rolling FundTM for individual accredited investors, family offices and other types of investors, which we launched on AngelList on July 1, 2021, one may say, “Ben put us in business.”
- Name, Title, Fund: Nihal Mehta, Cofounder & General Partner, Eniac Ventures
- Investment Thesis: Eniac leads seed rounds in bold founders who use code to create transformational companies.
- Contribution: FOs can partner with emerging VC managers by (1) investing, (2) providing deal flow, and (3) making introductions to other FOs.
- Author’s Note: I first met Nihal in 2013 or 2014. I consider him a friend, and he and his other partners at Eniac are some of New York City’s most connected venture capitalists, correspondingly Eniac is one of NYC’s growing early stage technology venture funds, with the firm having marked at least 2 IPOs and one unicorn valuation among their investments this year alone that I am aware of, and it is not as if I have been paying very close attention.
- Name, Title, Fund: Dr. Joel Palathinkal, CEO, Sutton Capital
- Investment Thesis: Sutton Capital invests in opportunities focused on Fintech, Real Estate, B2B SaaS, Deep Tech, Space Exploration, Impact Investing, Cleantech, & Climate Change.
- Contribution: Family offices should take the opportunity to establish what their goals are. After doing this, developing a strong execution strategy on their intended portfolio construction will help to achieve these goals. This execution strategy can be supported by surrounding themselves with several industry experts and seasoned investors in the same focus area. With venture capital and private equity being a relationships based business, sharing knowledge on various trends and sectors of interest is an initial way to build a strong rapport. Family offices can also partner with venture funds of various backgrounds to learn about new sectors that they might not initially have exposure to. These synergies can build trust and opportunities for coinvestment. Many funds offer coinvestment rights and exclusive access to LPs. The LPs benefit from this by getting broad exposure to reduce risk; while also having the option to coinvest into direct deals to share in outsized returns.
- Name, Title, Fund: Eric Woo, Co-founder & CEO, REVERE
- Investment Thesis: REVERE is a turnkey asset management platform that powers personalized portfolios of early-to-growth stage venture capital funds and deals. Our target audience is the private wealth community, which collectively manages and advises over $100T in the U.S. alone. The platform covers the entire customer journey from assessment, custom model portfolios, and proprietary due diligence tools – all delivered through a digital experience.
- Contribution: The information and capital divide between emerging VC managers and the family office LP segment is as wide as it has ever been. To unlock family office capital we need an ecosystem of intermediaries that are tightly integrated with the investment transaction process. Similar to how investment banks can functionally cover the lifecycle of a fast-growing company from capital formation to post-exit research coverage, new platforms must emerge to provide the full toolkit for investing in early-stage fund managers.
For their part, family offices must be willing to pay for these types of software and services, recognizing that they are necessary fees (should they intend to be long-term investors in the asset class). On the other hand, emerging fund managers must recognize that the LP fundraising process is no longer a relationship-driven arbitrage, but a pipeline-to-conversion schema that requires a sales playbook, marketing budget, and above else, data and information transparency. The amount of capital at play here is simply massive and we here at REVERE are taking a “picks and shovels” approach for fully equipping the prospector while at the same time being the expert surveyor of the investment landscape.
- Name, Title, Fund: Tom Wisniewski, Managing Partner, Newark Venture Partners
- Investment Thesis: NVP looks to invest $2-3M in seed-stage B2B software-based start-ups with a particular focus on Health Tech, Supply Chain, and B2B Marketplaces.
- Contribution: Prior to launching Newark Venture Partners, I was a direct FO investor in about 30 start-ups. My return multiple is excellent, nearly 5x. But I also invested in a number of VC funds in parallel. Why?
Investing in promising tech start-ups can appear “easy” given the vagaries of the available data and the long hold periods: everyone has a supportable opinion and it will take 5-10 years to know who was right. Consider that successful VCs need to look at 100 companies in order to choose one. And for 10 investments carefully made this way, more than half will be a total loss, or provide no financial return. VC is truly a very separate, unique and complex asset class that requires real expertise to achieve returns.
For an FO looking to start making direct VC investments, investing in and forming a deeper partnership with a VC fund (or several) makes a lot of sense. It provides screened deal flow, leverageable expertise, and portfolio diversity. If you put skin in the game by investing in a fund, many fund managers will be happy to provide coaching, expertise and valuable access.
- Author’s Note: I have known Tom since 2012, and he and I chuckle about the early days of my evangelizing about #SupplyChainTech to anyone who would listen. For a number of years while I was at KEC Holdings and KEC Ventures, I also worked very closely with Tom’s wife, Barbara Lewnowski to launch a family of innovative financial derivative products conceptualized by Jeffrey Citron and for which I conceptualized, architected, and developed a mathematical valuation model and pricing framework. Barbara and Tom are cofounders of their family office, RosePaul Investments. I am currently a Venture Partner for NVP focusing on supply chain, and related b2b marketplaces.
- Name, Title, Fund: Rachel ten Brink, General Partner & Founder, Red Bike Capital
- Investment Thesis: Latinx-led Red Bike Capital invests in consumer technologies that will shape culture and transform the economy. We support US-based founders reimagining FinTech, Ecommerce Infrastructure and Consumer Tech, capitalizing on the partners’ 30 year operating and investment experience including founding and scaling a Y Combinator-backed ecommerce startup, and sourcing deals via relationships with top founders and leading accelerators.
- Contribution: Beyond the financial upside, family offices should look at the value that emerging fund managers can offer them through direct access. First, emerging funds tend to have a “long on dealflow, short of cash” challenge, which creates a unique opportunity for FO. Emerging funds have a substantial amount of quality dealflow and allocations with plenty of opportunities for investors to have preferential access to deals and amplify their investment in those funds. Secondly, because many of those emerging funds are high-involvement operators turned investors that know founders well, they offer unique opportunities for family members of the FO to get involved directly with the founders, mentoring and supporting them with their experience. Third, emerging managers are very close to the early stage ecosystem, giving FOs the ability to identify trends and gain unique insights into what is next in the startup world: innovation, consumer behavior shifts, new technologies, consumption patterns, emerging categories. This insight can directly help the FO’s core businesses and give them a competitive edge in their own endeavors, as well as offering networking opportunities with founders and connections within the startup ecosystem.
- Name, Title, Fund: Lolita Taub, General Partner, Fund Still in Stealth Mode (Unannounced), LightSpeed Scout
- Investment Thesis: Pre-seed and seed community-driven companies in the US and Latin America.
- Contribution: The goal of family offices is to responsibly create greater wealth for its stakeholders and the best way to accomplish that is through diversification of investment. And a fantastic way to do that is to invest in and work alongside emerging fund managers who are investing outside a family office’s zone of genius and have an edge that’ll allow them to generate outsized returns. For example, family offices can fare well in investing in fund managers with access to emerging and underestimated markets (e.g., Latina-American investing in US and Latin American companies with access to differentiated quality deal flow and co-investors).
Family Offices & Emerging Fund Managers in VC – Playing The Right Game
In The Right Game: Use Game Theory to Shape Strategy, an article published in the July – August 1995 issue of the Harvard Business review, the authors, Adam Brandenburger and Barry Nalebuff state that business is a high-stakes game in which success is predicated on playing the right game, first and foremost. Similarly, for family offices making their first foray into early-stage venture capital AND emerging managers raising their first fund, early-stage technology investing is a high-stakes game for which success is predicated on ensuring that each is playing the right game.
What does this mean?
Family office principals and executives presumably: Have access to expertise about how the industries in which they generated their wealth operate; Have a sense of where the most acute problems that could benefit from technological innovation exist; Understand where there are invisible barriers that obstruct the adoption of new technology and have some ideas about how such barriers might be circumvented if there were a technology that could solve an important problem; Have relationships that can help with early customer and business development; Have an interest in making investments where their accumulated knowledge, expertise, and social and business networks can serve as an additional catalyst working in their favor. They are less adept at discerning potential disruptive innovation of either the demand-side or supply-side variety at the earliest stages when the potential to harvest the greatest returns exists.
Emerging venture capital fund managers are in the business of seeking out innovations that have the potential to create enormous value for customers, making assessments about the likelihood that such innovations will make good investments, and doing whatever is necessary to invest in such opportunities as early as possible in order to eventually harvest the greatest possible returns for their limited partners. They however are not well plugged into the social and business networks of the legacy industries that the startups in which they invest seek to transform with technological innovations. This makes it difficult for emerging venture fund managers to be helpful to the startups in which they invest in ways that meaningfully help those startups more quickly achieve product-market-fit. In many cases emerging venture fund managers do not have the same depth of knowledge and experience as family office principals and executives about specific legacy industries.
In her book, Reimagining Capitalism in a World on Fire (Public Affairs Books, April 2020), Rebecca Henderson, The John and Natty McArthur University Professor at Harvard argues that we must rethink capitalism in order to solve the “three great problems of our time—problems that grow more important by the day: massive environmental degradation, economic inequality, and institutional collapse.”
What I take from Henderson, Azhar, Mims, and Burkart and Lydenberg as well as the work of the economists Carlota Perez and Mariana Mazzucato is that we are entering a period when we will experience demand-side and supply-side innovations more frequently and at a much more rapid and insistent pace than in the past. A demand-side innovation arises because entrepreneurs seek to satisfy customer needs that are going unmet by existing products because those customers are unprofitable for established market incumbents – this is the disruptive innovation theory popularized by the late Professor Clayton Christensen. A supply-side innovation occurs when entrepreneurs change the parameters and architecture of production in ways that are impossible for existing market incumbents to imitate – this is a theory of innovation developed by Rebecca Henderson.
I put it to the reader that this century is one in which we will experience demand-side AND supply-side innovations occurring simultaneously in many more industries, across many more business sectors, within more sections of society, and across more regions of the world than we have experienced at any other time in human history.
I do not make this claim flippantly or without adequate reflection: I first examined disruptive innovation in Notes on Strategy; Where Does Disruption Come From? (July 19, 2015) and again in Where Will Technological Disruption in The Fashion Supply Chain Come From? (October 25, 2018) – which I co-authored with my partner, Lisa Morales-Hellebo. In the 2018 article, Lisa and I observe that the kind of disruption that leads to devastating losses of market share by incumbents requires the simultaneous occurrence of demand-side AND supply-side innovations.
I am also hereby arguing that citizen action driven by the climate crisis, regulatory pressure on businesses and industries driven by politicians under pressure from their constituents, and the inexorable and accelerating march of general purpose technologies are combining in potent ways to create conditions that are ripe for disruptive innovations to occur across more industries than we may currently expect. Lisa and I attempted to make this argument in The World is a Supply Chain, first published as a blog on October 18, 2019.
If I am right that we are going through a major transition in the history of human civilization, then this is a situation that is ripe for a changing of the guard in venture capital too. Yes, of course, many of the established franchises in venture capital will survive and they will continue to do just fine. However, as the Exponential Age unfolds and as the world grapples with the Climate Crisis and all the problems that accompany climate change are brought to the fore, a new cohort of venture capitalists will emerge pursuing investment theses designed specifically for these times.
In this context, I am proposing that: The primary game family offices new to venture capital should be playing is to be completely focused on identifying these emerging managers AND partnering with them in ways that provide meaningful value for BOTH the family office and the emerging venture firm, and; The primary game that emerging venture firm managers should be focused on is developing their ability to identify and back the entrepreneurs that are most likely to create the innovations that create value by contributing to the stability of society, the financial system, and the environment AND creating additional opportunities for their limited partners to take additional advantage of such opportunities where that is possible.
Family offices that are new to venture capital and emerging venture firm managers can create a lot of value for one another by mostly engaging in coopetitive, positive-sum games while avoiding the type of outright zero-sum rivalries that press and media narratives seem to be pushing.
As Brandenburger and Nalebuff observe; “Many people view games egocentrically – that is, they focus on their own position. The primary insight of game theory is the importance of focusing on others – namely, allocentrism. To look forward and reason backward, you have to put yourself in the shoes – even in the heads – of other players. To assess your added value, you have to ask not what other players can bring to you but what you can bring to other players.”
The average emerging venture capital fund manager experiences great difficulty raising a first fund to pursue and execute a differentiated investment thesis and strategy. This can make it seem as though capital is scarce.
According to The rise and rise of the global balance sheet: How productively are we using our wealth?, a report published by McKinsey & Company on November 15, 2021, “The global balance sheet and net worth more than tripled between 2000 and 2020. Assets grew from $440 trillion, or about 13.2 times GDP, in 2000 to $1,540 trillion in 2020, while net worth grew from $160 trillion to $510 trillion.” According to Family Offices: Global Landscape and Key Trends, published by Insead on April 22, 2020 “As of 2018, global wealth stood at around $206 trillion, with almost half of it in North America.”
According to McKinsey, “While economic growth has been tepid over the past two decades in advanced economies, balance sheets and net worth that have long tracked it have tripled in size. This divergence emerged as asset prices rose—but not as a result of 21st-century trends like the growing digitization of the economy” adding that “in an economy increasingly propelled by intangible assets like software and other intellectual property, a glut of savings has struggled to find investments offering sufficient economic returns and lasting value to investors. These savings have found their way instead into real estate, which in 2020 accounted for two-thirds of net worth.”
Between McKinsey and Insead, one has to ask if family offices are investing enough of their wealth in the most productive ways possible. There is clearly an abundance of capital. So much so that in spite of the breathless headlines about the record breaking year that 2021 has been for global venture capital, it is clear that venture capital is still only an insignificant portion of the global financial pie even though it’s impact on the world is outsized in comparison to other asset classes.
In Venture Capital Disrupts Itself: Breaking the Concentration Curse, an article published in November 2015 by Theresa Sorrentino Hajer, Nick Wiggins, and Frank Cicero (HW&F) of Cambridge Associates, the authors argue that, because of a regime change that was underway in the sources and extent of entrepreneurial value creation, limited partners could build compelling portfolios of venture firms by looking outside the small set of established franchise-funds that hardly offer access to new limited partners.
The trend HW&F observed then is even more pronounced now; “Given the proliferation of these technology trends and entrepreneurs, the majority of gains in the top 100 venture investments are no longer concentrated in the top 10 investments in a given year; moreover, the strong aggregate performance of the other 90 demonstrates the value of the broader venture capital industry. In every era, new firms have emerged and succeeded with focused models, relevant experience, and fresh networks that address the opportunity set before them. Indeed, some of these firms have forced established firms to innovate their own models to stay competitive. The next era will contribute its own evolutionary traits to venture capital. Investors that selectively add exposure to managers embodying these traits should be better positioned to benefit from venture capital’s own version of creative destruction.”
Moreover HW&F also observe that “Part of these newer firms’ success relates to their networks with younger entrepreneurs; however, these venture firms also deserve credit for pioneering a new wave of specialization of venture capital. While 10 years ago investors may have referred to a specialized firm as one focused only on technology, the emerging firms succeeding today have refined their focus to certain subsectors (such as IT infrastructure and ecommerce) or certain themes (transformational data assets). The sharper focus on subsectors enables firms to carve out niches in an increasingly competitive market.” That trend too is more pronounced today than it was in 2015, for example REFASHIOND Ventures’ focus on Supply Chain Technology as the basis of its investment thesis is supported by an investment strategy with The Worldwide Supply Chain Federation as its foundational lynchpin.
As I have already stated, it is up to family office principals and executives, and emerging venture fund managers to seize the opportunity presented by this unique time in history to partner more closely with one another in win-win scenarios rather than buying into media hype about zero-sum, win-lose or lose-lose rivalries.
For emerging venture fund managers, Allocate states that there may be as many as 8,000 – 11,000 family offices in the world, and potentially as many as 16,000,000 accredited investors. I think those numbers are low because, of course, many such people and organizations prize secrecy and so they may use various legal methods to obfuscate their existence and the extent of their wealth. However, the point is that there are many potential limited partners out there. Our goal should be to offer them a value proposition they cannot refuse and that simultaneously helps to catalyse our own personal and professional goals.
This is an exciting time in venture capital. This is also a challenging time for the world, one which calls for all the entrepreneurial energy of the world’s innovators and technologists to be unleashed to confront the big problems of our time.
What will we do with this opportunity?
Further Reading, & Other Resources
- The World is a Supply Chain (Blog – October 2019, Booklet – March 2020, Presentation – June 2021)
- Youtube Channels: REFASHIOND Ventures, The New York Supply Chain Meetup
- #SupplyChainTech: What is Supply Chain Technology, and Why is it the Biggest Investment Opportunity of Our Lifetime?
- Commentary: Rolling Funds on AngelList Are The Best Way For Accredited Individual Investors to Start Investing in Venture Capital Funds – Rolling funds are great for family offices too, especially those that are more comfortable with software technology and are open to new funding structures and vehicles and want to test out the asset class with commitments of between $100,000 and $250,000 before possibly making bigger commitments as the firms they have backed grow and mature.
- #NotesOnStrategy: An Early-Stage Supply Chain Tech Venture Capitalist’s Take on ESG and Impact Investing Considerations – How does an early-stage tech venture capital investor ensure that ESG, Impact, Climate, and Sustainable investing considerations factor into the investment decision-making process? I explain how Lisa and I think about this at REFASHIOND Ventures. Our approach is evolving.
- Has Venture Capital Strayed From Its Roots? – Insead Knowledge, July 2020
- Investing in Technology: Family Office vs. Venture Capital Fund – Guy Avshalom, Head of TMT, McCarthy Denning
- The Power of Diversity: Why Homogenous Teams In Venture Capital Are Bad For Business – Lisa Stone, Managing Director, WRG
- Female-managed US funds outperform all-male rivals – September 2020, Financial Times
- Why Women-Owned Startups Are a Better Bet – June 2018, BCG & MassChallenge
- Annual Equity Report 2021: Analysis of equity distribution by gender, race, and ethnicity – Carta
- Racial Equity in Financial Services – McKinsey & Company
- Diversity Wins – McKinsey & Company
- Diversifying Investments – Knight Foundation
- Private Investing for Private Investors: Life Can Be Better After 40(%) – Cambridge Associates
- Why VC is the Most Difficult Asset Class for Family Offices, Part 1 – Revere VC
- Why VC is the Most Difficult Asset Class for Family Offices, Part 2 – Revere VC
- Future Returns: Why Family Offices Are Drawn Toward Venture Capital – Barron’s PENTA
- Family Offices: Global Landscape and Key Trends – Insead, 2020
- Don’t Overdose on VC: Lessons from 166 startup IPOs – By Micah Rosenbloom and Joseph Flaherty, Founder Collective
- Commentary: Exogenous variables dominate a world with VUCA – February 2020, FreightWaves
- Commentary: Key supply chain innovation issues to consider in a world with VUCA – June 2019, FreightWaves
- Commentary: Is 2020 the year of supply chain risk? – March 2020, FreightWaves
- PSA: Most aggregate VC trend data is garbage – February 2021, Techcrunch
- Update #1: On Friday, Dec 17, 2021 at 21:57 PM EST to add the Sutton Capital Fund Accelerator to Cohort-Based Programs.