A family office organization that is particularly enamored of venture capital talks about the need to focus on results and not being bedazzled by the flashiest deals.

A hot topic at present is the enthusiasm seen among family offices for direct investing and private capital markets, such as venture capital. But there is a need for firms to have a disciplined focus on results, rather than chasing the most exciting-looking deals, industry figures say.

VC is far from being a small niche any more. A study in July 2016 by Concentric, a technology investment partnership, based around interviews with more than 300 family offices around the world, found that 70 per cent of them were actively investing or looking into VC. Of those, around 30 per cent were set up with a team and a strategy to manage in-house investments, while another 30 per cent outsourced the activities to third-party managers and the remaining 40 per cent operated with a hybrid model. The study points out that the family office love affair with VC is not new: some of the oldest venture firms were essentially developed as the direct investment arms of wealthy families, such as Bessemer Ventures, originally an outgrowth of the Bessemer Trust established by the Phipps family, or Venrock which was originally an outgrowth of the Rockefeller dynasty.

Evidence suggests that a considerable number of family offices set their aims high when it comes to returns from public and private markets, which might suggest they hope VC and private equity can be stellar performers. Single-family offices, for example, typically have an annual targeted rate of return of 13 per cent and MFOs seek 1.3 per cent, according to a survey last year by Peltz International, a New York City-based research group. (Source: Family Capital, June 1, 2016).

There is certainly plenty of money seeking an investment in VC – which raises the question of investment “overcrowding”. Capital available to venture capital fund managers has risen in H1 2017 to a record $176 billion, according to Preqin, a research firm tracking alternative assets. Recent VC performance data shows a mixed picture. Some of the poorest performing funds for vintages 2000-2003 are focused on North America but the region has seen stronger performance from more recent vintages, especially 2009-2011. Other figures show that love for VC is strong. In the US last year, VC funds raised $40.6 billion and it was the largest year for VC fundraising since 2000 when the venture industry pulled in $101.4 billion (source: Techcrunch).

Against that backdrop, maybe there is a need for family offices to take stock of what's achieveable and seek firms not often considered VC material.

It is understandable to chase after the highest-possible returns from the “next big thing” but solid gains from less eye-catching areas shouldn’t be spurned, according to a US-based family office with a focus on venture capital.

In many cases, investors are not encouraged to look at venture deals unless the rewards shoot the lights out, Nick Lewin, founder of US-based family office Crown Predator, told this news service recently.

“If you are all hot and excited about what venture capitalists do, you should be running a VC firm, not running a family office,” he said.

“What really interests me is all the stuff where you can make two, three or four times your money….but that’s not considered exciting,” Lewin said. He gives the example of how, in 2015, Crown Predator invested into a medical devices firm making breast implants (Establishment Labs) and got involved in a company and sector spurned by venture investors. Another example is Halo Maritime Defense Systems, a company that puts security around warships in harbors - crucial issues at a time of heightened concerns about terrorism.

Defense is, in fact, a sector almost entirely off the VC sector radar apart from cyber security, Lewin said. Because of this fact, a lot of VC firms just don’t consider defense a sector worth their time, he continued. This is the kind of area he likes: non-obvious, with challenges that make it difficult for venture investors to play in, and therefore potentially full of undiscovered gems.

Crown Predator, which is about a decade old, seeks to provide strategic growth capital. It does not engage in providing capital from pure ideas drawn up on a sheet of paper and it is not so much focused on snazzy technology as it is areas where instutitional capital has stayed away. Crown Predator has found these investments in sectors as diverse as biotech and healthcare, energy, media, security, sports and technology.

Lewin, whose family is the genesis behind Crown Predator,said his organization co-invests on deals with other family offices, cutting checks on amounts from $10 to $30 million in total. The willingness to work with other offices means there is a need to have a strong investment discipline so other FOs will participate on a deal as well. Also, having other FOs allows the freedom and flexibility to consider specific investments that are larger, more bureaucratic or short-term investors shun, Lewin said.

As far as his own background goes, Lewin has been a private investor since 2000. Alongside him at Crown Predator is Justin Kamm, who previously served as a board member of Establishment Labs, and as a board member and chief operating officer of the AVP Pro Beach Volleyball Tour. Kamm also works actively with management teams of portfolio companies to grow their businesses. He joined Crown Predator in 2007. A third senior figure is a man with a motor racing pedigree: Brian Vickers. Vickers has raced in the NASCAR Sprint Cup Series since 2003. A former NASCAR Xfinity Series Champion, Vickers has also invested in a wide range of sectors.

Shakeout ahead?
There has certainly been a buzz among high net worth investors, private client advisors and family offices around private capital and direct investing. Preqin's data, show significant inflows. Overall private equity fundraising reached $121 billion for the quarter and this pace puts 2017 on course to break 2007’s annual fundraising record, and with several potentially record-breaking funds in market, it looks as though momentum may be sustained into H2, Preqin said.

Crown Predator's Lewin appears to have academic evidence in support of his claim that too many people are chasing the big numbers in VC and not taking a more humble approach. According to a study as far back as 2001, in the shadow of the dotcom boom's bust, John Cochrane, resesarch associate at the National Bureau of Economic Research, stated that VC investments carry more risk than most investments in the broad public market and their returns are much more modest than commonly thought. He concluded that VC investments are not dramatically different from publicly listed small growth stocks. (That study was called The Risk and Return of Venture Capital.)

There may be interesting times ahead.

Lewin said that with VC and private equity enjoying something of a boom in terms of inflow, so a period of turbulence lies ahead if the market stalls, creating a rush of demand for financing.

“At some point there is going to be a shakeout. When that happens you are going to see a lot of really good companies that are not going to get access to VC funding. I call these sort of firms `orphans’,” he said. “Opportunities are going to be everywhere,” he said.

Elaborating on what qualities are sought among potential target firms, Lewin said he wants real signs of management structure and process in place, not just outlines on brochures. “We look at specific businesses that can prove they have a business, with a CEO in place and a vision of moving from Point A to Point B,” Lewin said.

Talk of such quality tests is important because it avoids falling into traps, he continued. The “standard VC investor is concerned about size and about their assets under management and not enough about the returns,” he continued. In fact, Lewin said, there is a strong correlation between standard VC returns and what would be a leveraged return on the NASDAQ equity market,” he said. ( (According to data via Cambridge Associates, a US firm, covering various types of VC fund by stage in a 10-year period to late 2012, returns from VC lagged those of the NASDAQ. Source: Forbes, Feb. 22, 2013.)

“We think about the world in terms of a cash-on-cash basis, rather than on internal rates of return, and that’s what family offices should do, he said. (He referred to looking at returns as expressed as multiples on an original stake; an IRR seeks to measure returns, by contrast, by taking account of the complex timings of when deals are entered and when exits are achieved.) Lewin explained: “If you get two times your cash on a two-year period, that is a 100 per cent cash-on-cash return.” By contrast, a return of say, 8 per cent over two years is not very impressive, for example, he said, citing the kind of figure that can come out of VC. (Crown Capital is unable to disclose its own performance for regulatory reasons.)

One problem with VC today is that a lot of investors, Lewin claims, are interested only in supporting first-round investing but enthusiasm runs dry at the second- or third-round stage and yet there are entirely respectable returns to be made at these stages. Family offices, given their wealth, have the resources to avoid falling into traps such as a desire to chase the big-name winners and take a more disciplined stance, he said.

The organization has the freedom, it says, to lead and/or co-invest in transactions across all dimensions of industries/sectors; segments of capital structures, and it can take controlling stakes, or minority ones. It can get into early-stage VC, later-stage venture capital and do leveraged and growth capital deals. Time horizons can be short, medium or long.

What of recent performance across VC? According to the Leland Thomson Reuters Venture Capital Index Fund Class C, which is a fund tracking performance of venture-backed firms, it shows returns of 36.7 per cent from the start of 2017 through to June 30. Over a 12-month period, the figure is 41.6 per cent. The underlying Thomson Reuters index seeks to replicate the aggregate gross performance of US venture capital-backed companies. With venture-backed firms, an important issue is the "vintage" of an investment - ie, when it was initiated, rather like when grapes are picked for a particular wine. Blending VC performance into a single measure is fraught with methodological headaches, given the timings of entries and exits on deals.