By Nathan Lustig
In emerging markets, many family offices are starting to look at alternative investing opportunities, such as venture capital, to diversify their wealth. Today, the number of family offices investing funds in technology-related companies is on the rise, as more wealthy individuals in emerging markets have begun to emulate the investment strategies of their peers in more developed markets in order to achieve similar results.
According to PitchBook Data, family offices did $100.6 billion in deals in 2016, compared with $25.1 billion in 2011. These family offices are seeking opportunities that offer better returns than the public market and, therefore, investing in startup companies through longer-term private equity deals.
Private equity, which is a legal structure and a part of the wealth management arm of the family office, is a key strategy that is used to buy into startups. This type of investing provides family offices a number of financial benefits, but usually occurs once a startup is already a large company. Here are just a few reasons why more family offices, especially in emerging markets, are beginning to invest in startups.
What Family Offices Get Wrong When They Try to Invest in Startups Alone
In emerging markets, family offices can face a number of challenges when they try to invest in startups.
Most family offices don’t possess specialized knowledge of startups, because the startup ecosystems in emerging markets are very different from the traditional business climate that family offices are used to. Because of limited experience and exposure, they may not always have a comprehensive list of questions or resources at their disposal that would aid them in the decision-making process or to evaluate a deal.
For the most part, family offices tend to treat an investment in a startup company just as they would any other small business or private equity deal in their portfolios, resulting in unfavorable terms for the entrepreneurs. The approach can end up killing the startup or making the startup uninvestable at a later stage. Family offices may also limit their concentration on a handful of companies that they consider “friends,” or are in their social circle, rather than diversifying their investments and seeking out the best companies possible to invest in.
Also, family offices tend to have just a few professional staff on hand, and rarely do they have someone dedicated to the oversight of startup-investing. Approximately 78 percent of family offices have two or fewer people dedicated to evaluating private equity deals. The few staff that are on hand may be pulled in different directions and occupied, limiting the resources that are available to evaluate and assist the young companies they are investing in.
Best Practices for Family Offices Investing in Startups
One of the smartest moves a family office can make when investing in startups is to partner with a good venture capital firm. A family office may have the net worth, but the right venture capital firm has the network and knowledge to facilitate the deals. A small investment into a venture capital firm can help a family office learn the ropes so they can invest directly themselves in the future. A small investment can be the best money-saving tuition a family office can find.
There is a lot of variability among venture capital firms in terms of returns and quality of the investors involved, so a family office interested in learning about the market should find a firm that’s willing to provide that education, rather than just taking the cash.
The right venture capital firm is likely to make better investment decisions than a family office alone because it only invests in its areas of expertise. They have long established and tested processes in place that make investing in startups in an emerging market more efficient.
As more family offices diversify their portfolios by investing in startups, those who take the initiative to partner with venture capital firms will be able to take advantage of new opportunities quicker and have a competitive advantage in emerging markets. A venture capital firm can help family offices diversify, do more deals per year, as well as help evaluate appropriate amounts to invest in each company.
Over the past few years, big changes in the economic, political and business climate across regions like Latin America have spurred the creation of wealth in several countries, including Brazil, Argentina and Mexico. What’s more, the growing number of startups around the world provides more opportunities for investors to get in on the action.
As new startups enter the markets—and others seek to expand their operations—these companies are looking for investors that can help take them to the next level. More family offices are increasing their participation in the startup ecosystem and stepping across borders to grab some of the returns that these young startups can provide.
Nathan Lustig is an entrepreneur and managing partner at Magma Partners, a fully private U.S. – Latin American venture capital fund.