The Great Reset — Why Family Offices Should Embrace VC In 2023
The cheap money era saw the venture industry swell up to dizzying proportions — fuelled by low interest rates, crypto investments, unprofitable tech stocks and the short-lived rise of back-door listings i.e. SPACs. Investors could do no wrong.
Even the most established of venture firms fell victim and/or participated in these trends. For better or for worse, FOMO was real, diligence became sentiment-driven and only now are we starting to see the repercussions of these decisions unfold.
This fertile economic environment saw family offices seduced into the picture. As valuations continued to swell and venture firms invested on the basis of peer participation, it was a practical solution to enter the space efficiently and (hopefully) pain-free.
“The Times They Are A-Changin” — Bob Dylan
As valuations across VC-backed companies continue to fall, it forces the industry to be introspective. Many nontraditional investors have pulled back from investing into venture capital funds and directly investing in start-ups altogether.
We’ve seen a number of fund managers without unique propositions or networks have their deal flow commoditised. This begs the question of “why would I invest in your fund?” when LPs are essentially presented with the same opportunity across the board. Perhaps it is for strategic value? Say insights or education, but very few actually offer a bespoke and comprehensive package or have the ability to build direct one-on-one LP relationships.
Back in 2015, when I first started investing in early-stage companies, there were (at most) a handful of venture firms. Since then, we have seen a myriad of funds explode onto the scene. Namely, because capital has been cheap and easy to come by. In fact, it’s almost been easier to be a GP than a start-up founder. As a quick-fix value prop, we’ve seen GPs jump on to trends, throwing buzz words and popular themes into their investment theses. All in an effort to be as commercially appealing as possible, yet typically leading to an undifferentiated value prop.
Very few of these GPs are really able to do what the venture industry was meant for — accessing and investing into top quality, unique deals that are not easily available to the market at large. Don’t get me wrong, some funds do an exceptional job, but if you really dig a little deeper it’s because they have reputably built a network-driven approach to attracting, sourcing and investing into great companies. And some of the best opportunities come from emerging managers — the hungry, gritty and determined GPs who have built a value proposition on the grounds of their unique access to networks. Plus the market data supports this, with better projected returns as they place more importance on reputation than management fees.
Most nontraditional LPs a.k.a. family offices have not been inclined to invest in venture funds, on the basis that they could do no wrong directly investing into companies themselves. Now that this has changed, we have a new challenge in the form of the current market environment. However, it is common knowledge that great companies are founded during challenging economic times. What this means is that well-managed venture funds of the 22'/23' vintage (incl. 24') are said to perform well — as valuations continue to fall.
“But remember, anybody can get it. The hard part is keepin’ it” — Dr Dre
The difficulty for family offices is not only PTSD from the performance of their direct investments, but more so the lack of access to high-potential venture funds. According to data from a recent FO conference I attended, if they were to go it alone they would need at least $250M to properly source, evaluate and make direct venture investments - with due diligence requiring not just expertise but an expansive network and perspective.
All things considered, investing in a venture fund would make more sense, right? However, it is no longer a game of ‘the most established player wins’ which adds a new paradigm as emerging GPs come to the fore. This brings additional complexity through the challenges of fund diligence, relationship building and post-investment relationship management.
And so, for the Avengers fans out there; just like when Thanos snapped his fingers wearing the Infinity Gauntlet, exterminating half of all life in the universe; macro and micro factors have snapped together to impact the venture world.
Except this time, it is a welcomed change.
And while it won’t be pretty, it helps to reset the industry back to where it needs to be, so that it can provide the value that it should provide, in ways that it should never have deviated from.
