With the venture capital industry still facing headwinds as we turn to the second quarter of 2010, start-ups and emerging technology firms need to find new sources of expansion capital.
Last year, U.S. venture capital firms raised just $15.2 billion from 120 funds, a 47 percent decline by dollars committed and the slowest year for fundraising since 2003, according to Thomson Reuters and the National Venture Capital Association. During the same period, there were just 12 venture-backed IPOs. This marked the slowest year for U.S. venture-backed IPOs since 1975.
Increasingly, this vacuum in the marketplace is being filled by family offices. Having suffered market losses in 2008 and early 2009 from investments in supposedly safer asset classes, family offices are focusing on venture capital and private equity. Rather than rely on external managers, family offices are now investing themselves, rapidly becoming a critical source of new venture capital.
This is not a new idea. The great founding industrial families of the United States were among the first venture capitalists in this country. The Rockefeller family, the Hillman family and several others were the critical backers of the VC firms, starting after WWII and continuing through the emergence of Silicon Valley in the 60s & 70’s. These families shaped the VC industry we know today, prior to being supplanted by pension funds, endowments, insurance companies and other institutional players as main source of VC funds. So, in many ways, this trend is really about venture capital getting back to its roots.
Hallmarks of a Family Office VC Deal
What is the ideal formula for a family office transaction in 2010? Of course not all deals were created equal, but the following attributes resonate for family office investors:
Technologies That Contribute To Society: Family offices gravitate toward themes that are important to them on a personal level. Often these will be technology areas that complement or augment their charitable/foundation work. Deals that bring an element of social responsibility, including advances in health care and the environment, are often well suited for family office investment.
Filling the Financing Gap: Whereas traditional VC firms have polarized to early stage and late stage investments where perceived risk-to-investment ratios can be kept very low, family offices are often more comfortable engaging with firms that are in their adolescence. These companies often have seasoned management and established products, but lack the funding and support necessary to break through to the next level. In fact, venture financing can be such a challenge that entrepreneurs have referred to this stage as the “valley of death.” For start-ups with a solid plan, family offices offer a path to the promised land.
Products vs. Concepts: Unlike early stage VC investors and angels, family office investors are typically drawn to more established businesses with real-world products and services that can be readily brought to the market.
Rules of the Game
The most successful family offices in the venture space organize themselves for this type of investing from the outset. A venture strategy cannot be a sideline; it needs to be a concerted effort that is integrated into a much larger portfolio strategy. Based on our experience working with family office investors, we’ve found the following to be the most important steps:
Organize Institutionally: Often, direct family investment in private equity has been an ad hoc pursuit than a sustained institutional strategy. On the other hand, investors who build a more visible institutional profile will reap immediate dividends, such as deeper, more diversified deal flow. Moreover, because the company will view their investment as “validating,” the family office can negotiate attractive terms and assume an active role on the board – customary prerogatives of the VC firms.
Take a Lead Role: Once investors identify a company in which they want to invest, they may find that the management would like them to be a “lead” investor, who negotiates the term sheet and sets the price for all investors in the financing. Historically, the lead role was played by a new venture capital fund, but as these investors became scarce, a new strategic or institutional investor from a family office is equally welcome. If families wait for another lead investor to step up, they may miss an opportunity.
Build Strategic Partnerships: Family offices bring a unique ability to engage with strategic investors, who also share their long-term view. When partnership deals are structured byintegrating family office and strategic investors, the result can be a level of cross-fertilization that fosters outstanding commercial opportunities for the company.
The tectonic shifts in the venture economy are placing a heavy premium on new investment. The drought in funds, combined with the need among family offices for uncorrelated and outsized returns, is creating a perfect landscape for those with the ability to implement a solid venture strategy. Along the way, these families may also channel the spirits of their predecessors of the past century to reignite the spark of innovation that will build our economy for generations to come.
Bruce E. Roberts is managing director, Roberts Mitani, LLC, a global investment banking and strategic advisory firm based in New York and Tokyo.
