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Why startups should not be raising capital from family offices

Why it’s not a good idea for startups to raise capital from family offices.

September 1, 2021

Why startups should not be raising capital from family offices

Entrepreneurs are often faced with the question of where to find funding for their businesses.

In the US, the venture market is well developed, and there are many financing options out there, dependant on your type of startup and startup stage.

However, not all sources of financing are created equal. Many entrepreneurs who face difficulties raising from VCs or Angels are lured into events connecting startups and family offices with great promises.

We think it is a bad use of your energy as a founder, and you should avoid it, especially at an early stage.

This is counterintuitive as family offices manage a lot of money and are looking for investments. Thus it's essential to understand why your startup should not be raising capital from family offices.

Let's start with understanding what they are.

What is a family office?

A family office is a company established to manages a single or a group of wealthy people's finances and investments.

There are various types of family offices, depending on the source of the wealth, number of benefactors, and management style.

However, they all have one thing in common; a primary focus on managing personal assets and investments, leaving the business management to other internal functions or professional service providers.

The family office team would usually consist of the primary benefactor, investment managers, chief of staff, an accountant, and administrative support. Some offices are very small, with just a small handful of people; some are essentially large conglomerates with hundreds of employees.

The primary goal of the family office is to ensure the long-term financial security of their benefactors, especially after they have passed away.  

This means that a family office is primarily concerned with preserving the assets of one or more wealthy families, not growing their investments.

The average family office has assets under management of $1.2 billion distributed between different asset classes.

This sounds like a lot of money, so why not approach them for fundraising?

Family offices have loads of money but invest little in startups.

As mentioned above, the average family office has assets under management of $1.2 billion distributed between different asset classes.

They would usually limit their investment into the venture capital asset class to around 5–10% of the assets, which comes roughly to $60 million of investable funds.

The most prominent VC firms demand a far more substantial commitment from their LPs, and even that is per fund (and not as an aggregate).

This means that few family offices can invest directly in top-tier VC funds and must either put money into smaller ones or distribution funds (funds of funds).

In any case, this diverts the family office management attention from VC as an interesting asset class.

Family offices know little about investing in startups

Family offices know a lot about investment, but not in startups. For example, the family office would have a specific goal to invest in global stocks, bonds, or private equity funds.

They also have advisers who specialize in these areas, and they often have a more extensive network. But, this is not for a startup business.

The family office's primary focus is on managing the assets of its benefactors.

It is primarily concerned with preserving them, meaning that they are not interested in investing their money into growing your company.

They are not experts in startup deals. They don't have the process to support efficient business due diligence.

They lack the talent to evaluate innovative markets and technology simply as that is not their focus.

Family offices have all the time in the world. Your startup doesn't.

Most VC funds are limited by a ten years life cycle. This means that VCs have ten years to make a return on their investment.

Family offices don't have this restriction, and most of them invest in illiquid assets, which means that they can keep the money invested for many years if needed.

This has some advantages: family offices can wait out difficult periods in the market and patiently invest in long-term projects.

But, this also means that they don't have any sense of urgency about returns, which creates misalignment around the board table in terms of strategy.

A VC would push for aggressive growth and exit. The Family office might push for more conservative growth with a longer time horizon.

Having a strong family office on your cap table as an investor might deter VCs for that reason.

Family offices have very little value add to early-stage startups

Except for money, you need network, help with hiring, help with getting customers, and operational excellence. Your VC investors would promise all these and more.

In reality, very few VCs actually deliver on this promise. However, family offices don't even have the experience of witnessing successful companies grow.

Thus, they lack the strategic thinking needed in advising startup founders.

Do your best to avoid giving a family office a seat on the board of directors if you raise money from them.

How to deal with family offices that offer to invest in your company

Many analysts in family offices will approach startups for deal flow discussions.

As your company needs funding, you shouldn't refuse any proposal from a family office, but you should put strong limitations that would protect your startup and your focus.

Take note of the following if you do get into a discussion:

  • Don't waste your time with bogus processes.
  • Only engage with family offices investing in startups
  • Always run thorough due diligence on any investor, but be extra diligent with family offices.
  • Only allow the family office to join an investment round, but never let them lead an investment round.
  • Don't allocate a board seat for the family office and limit its control of the company.
  • Be very diligent of custom “Protective provisions” that are not common in the VC industry.  

Conclusion

If you're a startup with difficulty raising funding from angels and VCs, family offices might seem like the perfect solution.

However, they are not experts in investing in startups; instead, their primary focus is on managing the assets of benefactors.

Furthermore, this means that family offices do not have experience witnessing successful companies grow.

They are not prepared to advise startup founders with decisions about innovative markets or technology because they haven't seen it before.

A strong piece of advice if you do get involved with a family office is to be diligent during due diligence - more so than what would be necessary when approaching other types of investors such as VCs.

If all else fails, try your best to avoid giving a family office a seat on the board of directors if you're able to raise funding from other investors.

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