As the sun sets on a roller coaster year, many family offices are reviewing their investment strategies with a view to safeguarding their portfolios for the future. Covid-19 has thrown all the chips in the air and, while the arrival of a vaccine gives hope that the end of the pandemic is in sight, nobody knows where the pieces will eventually land, for the public markets, property and other mainstream investment classes.
As they review their exposure to risk and their options for the future, family offices must think laterally, to diversify their portfolios across alternative and traditional investments, ensuring both security and high returns in the coming years. And with digital innovation and entrepreneurship set to lead the recovery out of the current downturn, investing in startups through venture capital (VC), should be central to these considerations.
As with most areas of the economy, the outlook was ominous for VC in Q2 of 2020, as the world shut down, and numerous deals were put on hold. However, the sector has experienced a remarkable turnaround in the months since, with a report by Pitchbook showing that Q3 of 2020 was one of the strongest quarters on record, and another survey predicting that investment in European technology startups is poised to reach $41 billion by the end of the year, a slight increase on 2019.
During unpredictable times, VC offers the advantage that its performance is completely uncorrelated with public equity markets. VC investment has been booming in the last few years, despite stagnant growth elsewhere, with over $100bn raised by venture backed businesses in 2018 and 2019, the highest totals ever. At the other – perhaps more important – end of the equation, funds are delivering, with venture-backed exits, which includes IPOs, buyouts and acquisitions, hitting a record $256.4 billion in 2019, nearly double the 2018 total, which was itself a record at the time. This included high profile exits such as Uber, Lyft and Slack.
Furthermore, experience tells us that periods of recession can be times of intense innovation and entrepreneurship, with increased unemployment driving individuals to set up on their own, with nothing to lose. General Motors was founded out of the 1907 downturn, Burger King out of the 1953 crisis, and more recently, Uber, Airbnb and Slack built their success out of the 2008 credit crunch. Indications are that this recession could be having a similar effect, with figures in the US showing a 43% increase in business applications this year. Many of them will soon be looking for funding.
Grasping the digital opportunity
If Covid-19 has taught us anything, it is the unparalleled role that digital technologies now play in our lives. From productivity and videoconferencing tools, to telehealth and online shopping platforms, digital enablers have without a doubt been the winners of 2020, with rates of innovation and adoption accelerated dramatically. In fact, according to McKinsey, companies have expediated the digitization of their operations by around three to four years – just in 2020.
This acceleration only reinforces the idea that software is by far the fastest area of innovation in the global economy, and arguably the only area that is currently innovating. The billionaire entrepreneur Peter Thiel has argued that the rapid advances we have seen in computer science and communications have masked disappointing progress in energy, transportation, biotech, disease prevention, and space travel, and that this accounts for the near stagnation in real incomes and wages we have experienced in recent years.
But perversely, this bodes well for venture, as it means the opportunity space for innovation and hence venture capital is infinite in scope. The venture model works best with software, and software’s fast iteration cycles and presence in cyberspace mean that governments struggle to regulate it. Software is currently the best way for hyper-talented individuals to build something of value, in some cases worth billions of dollars.
While in previous eras, these individuals would have needed to amass a workforce of thousands of individuals, size is no longer the deciding factor, with emerging technologies giving individuals and small teams the clout to take on the slow and risk-averse incumbents, who are struggling to adapt to change. While many of the big listed companies are failing to perform, new startups are ready to strike with new ideas, technology and innovations. And venture capital is the best way of riding the back of that shift, by investing in the success stories of the future.
Furthermore, both family offices and VCs share a passion for ‘building’ companies and supporting entrepreneurialism. Indeed, several leading VC firms, including Bessemer Venture Partners, Greylock Partners, Frog Capital and Atomico, have emerged from family offices, while in Europe prominent banking and investment families such as the Warburgs, Rothschilds, and Wallenbergs have had direct and indirect exposure to venture investments for centuries. Many wealthy families have built their fortunes through entrepreneurship or by investing in (or managing) early-stage businesses, and thus have it in their blood.
With, according to some estimates, around $6 trillion held in family offices globally today, interest in venture is also driven by a generational shift in who manages this money. With a younger, more tech-savvy generation taking over the running of many family offices, research from Concentric uncovered a huge and growing appetite for VC among these funds. The generation currently taking the helm have an innate understanding of and affinity with tech startups and disruptive business models, and many are in search of higher yields from their investments. As a result, they are gravitating towards riskier products with better returns such as VC, which also offers the allure of excitement and potential blockbuster investments.
John Moore, Managing Partner at boutique consultancy Moore & Moore Investments, explains the attraction of VC amongst certain family offices. “We are increasingly seeing a diversification of appetite to risk from family offices who balance prudence with higher risk placements alongside VC-backed or even pre-VC opportunities. Such investments are typically in the technology space and focus on scalable SAAS solutions and high return opportunities that offer the prospect of the classic unicorn return of 2-50x in some cases. There is often a social as well as economic impact in these investments.”
Reducing risk through an activist approach
Despite this growing enthusiasm, the perceived risk involved in venture is still a barrier for some in the family office space. After all, the nature of entrepreneurship is that a huge percentage of startups will end up failing – as many as 90% according to some estimates. But this doesn’t have to be a dealbreaker. Pick the right venture partner, who takes an active rather than a passive approach to investing, and this risk can be reduced dramatically.
Where ‘VC 1.0’ simply involved spotting and then monitoring portfolio businesses with the hope of picking a few winners, ‘VC 2.0’ – or activist venture – is about being a facilitator and adding real value to start-ups, providing them with the support they need to grow. Capital is a commodity these days, but the ability to provide non-financial support, such as contacts, skills and expertise, has the power to make as much as an impact as the cash – if not more so – giving entrepreneurs access to resources they wouldn’t otherwise have at such an early stage, greatly increasing their chance of success – and the success of the fund as a whole.
Uncertain times naturally spark nervousness amongst investors of all ilks, as the old tried and tested ways of doing things cease to be reliable. But rather than stashing your cash under the mattress, it’s at times like this that venture capital comes into its own. While it might be considered an ‘alternative investment’, if we drill down to the basics of what an investment is – it’s a conscious decision to deploy capital in the expectation of a reasonable return. And, more than ever, VC is able to compete in the risk-return balance, by taking a thoughtful and analytical approach to committing capital, to the businesses that are changing the world.