Picture this: Your family builds a tremendous business in Nebraska over four generations making black socks. You make more black socks for more people in the western world than anyone. The next generation isn't interested in socks. One daughter is touring nationally with her punk band. The son is off in Africa combating disease with Doctors without Borders, and the other son... well... remember Woody Harrelson on Cheers?
It's time to think about selling the company. You grew up with a guy who went into law and has some Chicago money connections. He shepards you through a sales process and the family nets about $390 million after taxes. Congrats. Many years and many socks later, your family's financial future is secure.
So what to do with all the money? First off, you go into hiding--because now the phone is ringing off the hook and you never realized you had this many friends. Who to trust? You've never dealt with these expensive suit Wall Street types and don't want to. They certainly come calling the day the deal is announced. Vultures! They didn't care about you when you needed commercial credit, but now--now they want to manage your money. No thanks. Instead, you gather up the only three people in the world you trust--the regional lawyer, your daughter-in-law who just got her MBA and does financial planning in town, and the guy you went to college with who daytrades. Do they have the world's longest track record of investing at this scale? No, but they sure as hell aren't going to screw you over. They're high quality people that you trust.
Trust and relationships are everything at this stage--not necessarily even return. You know your family will have security for generations to come, and you're more concerned about people doing right by you than beating out the S&P by an extra 50 basis points.
Welcome to family office investing.
The problem is that there are fantastic opportunities out there with completely trustworthy managers. They don't know you exist and you don't know them. Your team does a good job hustling around to find good teams, but the reality is that your dealflow is more dependent on your network than it is any kind of objective criteria. The whole thing is setup to fail. Thanks to the SEC, you don't know who's actually fundraising, what kind of performance they have, and you'll never get reached by their marketing.
They don't know you because your team/family barely has a website--and even if it does, it's not SEO optimized. You have no Twitter acount and there's no new stream of information about your criteria. If anything, your site is actually setup to hide more information than it gives out. Unlike a venture capital firm that states its criteria on its website and has forms, e-mail addresses, etc to encourage outreach, your site does a lot better job of saying "Go away!"
So how are you supposed to ever get the top dealflow?
Enter a whole cottage industry of researchers, placement agents and conference producers who aim at connecting money to money, and charging quite a fee in between. If you were raising a fund, you pay the price of admission--because... well, what else are you going to do? If you didn't know a bunch of multi-million dollar family offices, how in the world were you ever going to raise?
That gives a distinct advantage to anyone who already comes from or has connections to money. The interesting thing is that being connected to wealth isn't necessarily a driver of good venture capital performance--why would it be? Maybe the reason why venture capital as an asset class has underperformed is because the overriding criteria for having a fund in the first place is the ability to to raise one--not giving good advice, sourcing good deals. It seems just as driven by the willingness to pay a lot of money upfront to all of these middlemen.
Sure, you assume that this money has vetted the basic skills--but how accurately is a family that made its money in socks or mining or whathaveyou going to determine such a thing? I know how hard it is myself because I used to vet VCs for a living when I was on the insitituional LP side.
Sometimes, the family hires some really fantastic people to run the investment of their assets. In fact, one of my largest investors from a family office were former private investment people themselves, and their due dilligence was off the charts. It was thorough, thoughtful, and relevent--but I know this isn't always the case.
Look no further than the Madoff scandal to show that when you build your dealflow entirely based on trust, or willingness to pay tolls, as opposed to sophisticated investment due diligence and analysis, things can break down. One unscrupulous person in the chain can create disaster, and so can a whole network of well intentioned people that are betting on someone because someone they know did.
That's actually how the startup investing world used to work. If you were an entrepreneur, getting connected to money was terrifically hard. VCs put up stark, barrier laden websites--and a whole lot of people were willing to charge you money to get in front of them. Things changed. VCs opened up through the use of social media, and people like Jason Calacanis, regardless of what you think of his personality, actively campaigned against the toll takers on the road to capital. Nowadays, particularly in cities like NYC and SF, access to capital has never been so entrepreneur friendly. Entrepreneurs don't have to pay a lot to get in front of a VC--and its not like those venues ever created the highest quality intros on either side anyway.
I would also argue that when it's easier to hear about all the potential opportunities, you make better decisions about who to back. For entrepreneurs, knowing more VCs equals better options--better fits from a working style and expectation standpoint and better terms. Open is better for both sides. Angel groups started dropping their application fees or making them minimal. Open Angel Forum created a costless way for the best startups to get in front of the best capital. They were supported by professional services firms, like lawyers, who were more than happy to get in front of both sides and who has the capital to do it. Angellist, Gust, etc all made searching for and comparing deals much easier.
So wouldn't it follow that doing the same thing would be better for funds raising capital--and might enable new and promising venture investors to get access to more capital--and for the capital to find and vet the best firms?
What would VC fundraising look like if there were family office groups that participated actively on social media? Everyone would know who they were and they could have a short form that you could apply to pitch your fund to for free? I would argue that returns might go up if VC fundraising was a lot more meritocratic and if the big Limited Partners got to see everyone who was fundraising at the same time.
For myself, I've been lucky. I just happened to have a pretty sizable network in NYC and online. I've raised capital from a forward thinking family office investor who found me on Twitter, an investor who saw my initial launch press because he was paying attention to the market news, and a friend of a contact that I ran into in a co-working space. Still, it seems so random and inefficient. What are the chances that I have more Twitter followers from the Limited Partner world or that the next time I'm at GA, I'll randomly stumble into another institutional capital connection. The whole thing seems like a terribly inefficient way for LPs to fund the best funds and vice versa--and I know it's a huge barrier and distraction for some smart, connected individuals to get into the VC fund world.
If anyone has any solutions to this, as a former institutional investor myself, I'm all ears--especially if we think that the best fund opportunities are the smaller ones. These are the ones who can't afford placement agents and expensive conferences, but I'd argue they're the ones that family offices and insitutional LPs should spend the most time talking to.