But, as panellists Herbert “Bud” Scruggs of Cynosure Capital, Benedetta Balducci of Federated Hermes GPE and Merifin Capital’s Heidempergher told Florin Vasvari, Professor of Accounting and Academic Director of the London Business School’s Institute of Entrepreneurship and Private Capital, family offices are becoming an increasingly more important source of investment for all forms of risk capital funding, from classic buyout funds, to private debt funds, real estate and venture.
Recent Goldman Sachs figures show that family offices have on average a 44% allocation to alternative assets, of which 26% are for private equity. That’s far higher than institutional investors, and almost in line with their allocation to public market equities (28%).
There are thousands of family offices globally. Estimates vary, depending on how they are counted, but family offices are said to manage anywhere between $6 trillion and $10 trillion. For comparison, the total global assets under management of private capital markets, mainly including PE funds, debt funds, infrastructure funds and real estate funds, is around $11.6 trillion.
Balducci talked of a virtuous circle, where, as family offices become more comfortable with private equity, private equity is learning to become more comfortable with them. This can mean that if the two work together well over one investment, they are likely to want to work together again in future, not only across new deployment opportunities, but also via higher allocations as LPs of this asset class. Their allocation to PE is however different from that of large and more traditional institutional investors, in terms of higher risk appetite and more significant demand for diversification, as well as a more entrepreneurial approach to investing and appreciation for a quicker deployment pace.
ESG is important to everyone
Private equity firms say the days are long gone when the industry could make huge returns by financial engineering alone - or by leveraging up, breaking up, slashing costs and selling off non-core businesses. While all those techniques are still part of the toolbox, the real profits are to be achieved by driving growth: professionalising management, improving workplace culture, investing in new products and more efficient processes, expanding into new markets and geographies and, above all, through digitalization.
Carmen Alonso, head of U.K. and Iberia for Tikehau Capital, for example, pointed to the opportunities for growth presented by three current trends: reducing carbon emissions, improving cybersecurity and digitalization and what she called “re-onshoring.” Alonso was in discussion with LBS Associate Professor of Management Practice and IEPC Academic Director Luisa Alemany. She said Tikehau is supporting companies that are looking to secure and to decarbonize their supply chains by bringing back to Europe the production and technologies they had previously found cheaper to produce in China or elsewhere.
Such trends are seen as in the interests not only of investors, but of all other stakeholders as well.
Increasingly this means a focus on Environmental, Social and Governance (ESG) issues, not least because GPs’ own investors insist on it. PE managers and venture investors alike say they will work with management at their portfolio companies to meet ESG targets they believe will add value. Even direct lenders, whose main focus is inevitably on financial returns, often find themselves under pressure from their own limited partners to include ESG terms and provisions in their lending conditions. Some will offer borrowers lower interest rates if they commit to measurable improvements.
It’s a ten-year cycle; don’t take 2021/22 as the base
Venture capital firms raised a total of $27.5 billion in the first quarter of 2023, according to the latest figures from alternative assets database Preqin, down 67% from the same quarter in 2022. It was certainly a dramatic fall. But Shmuel Chafets, founding partner of Target Global, told a panel on opportunities and challenges to VCs in a tough climate that to judge the state of the industry on the basis of just one year in a ten-year cycle was just “wrong, wrong, wrong.”
The market would normalise over time, as the market gradually re-priced and stabilised and VCs and founders eventually learned to take the hard decisions, cutting their losses and letting companies fail.
Chafets and fellow panellists Megumi Ikeda, managing director at Hearst Ventures, and Octopus Ventures’ Maria Rotilu, were in discussion with the IEPC’s Luisa Alemany. All noted the very different dynamics that were emerging today in contrast to the “crazy” months of 2021 and 2022, when money was pouring in not only from established professional VCs, but also from so-called “tourists”. These opportunist investors thought they could outsmart the market, often coming in on excessively founder-friendly terms with no real safeguards and without demanding seats on the board. They were now pulling back.
The panel said there was a flight to quality, a “bifurcated market,” where VCs might still make a conviction investment in a perceived winner but would not pour money into every new business for fear of missing out to a competitor. Investors were now able to take a lot more time to decide. Meanwhile, with such uncertainty over valuation, some VCs were working with founders on internal rounds, raising money from existing investors, rather than going out to market for the next institutional round.
Rotilu, as a very early-stage investor, said she saw slowdown as an opportunity to build businesses, working with founders to solve problems and to get incentives and rewards in place before they become too big. While many would fail, there would be a few winners.
Technology investing
The conference heard from Deep Shah, of technology focused private equity firm Francisco Partners, who pointed out that previous big advances over the past two decades had been accompanied by huge rallies in technology stocks amid excitement about how the new development will disrupt other sectors of the economy. With AI, however, the focus was on the impact on technology itself. And it had come at a time of a big correction in tech stocks.
Nevertheless, over the longer term, technology values would continue to grow faster than overall GDP.
Falling valuations also made investment in quality companies more attractive. There were great opportunities for investment in fallen unicorns. Improving the efficiency of under-managed and often mismanaged companies with the right products provided opportunities for good returns.
Shah saw a number of key investment opportunities: getting involved in succession processes where a founder was looking for a good home for his company; and investing in corporate carve-outs and add-on acquisitions. Take privates were also looking more attractive, now that valuations were becoming more realistic.
Business plans would likely include investment in the sales force, reducing costs, seeking suitable add-on acquisitions, and, increasingly, the application of AI to improving efficiency.
Japan, MENA and Africa all seeking further investment in Venture
The venture capital industry started out in the U.S. Despite a long period of low activity and hesitancy following the dot.com crash and the great financial crisis, it has now taken root in Europe. Elsewhere in the world, development has been slower.
The conference heard that in Africa in particular – with its four main markets of South Africa, Nigeria, Kenya and Egypt – venture and growth capital have been relatively late to take off, but that interest has grown in the last five or six years. There has been a lot of investment in improving productivity. Growth capital has tended to come from U.S. investors while early-stage funding is more local, often from development finance institutions as well as domestic GPs and managers, so that the industry has seen a mix of financial sources.
It is easy for outsiders to make the mistake of imagining Africa as one big market. In fact, said Gbenga Ajayi, Africa partner at QED Investors, there are 53 countries in Africa (or 54, depending on who you ask). They are at very different stages of economic and political development and with vastly different cultures. The conference was told that start-ups tend to focus first on their domestic market. Only once they grow do they start looking at possible regional expansion – though not pan-African.
Meanwhile the MENA region, while largely sharing Arabic as its official language, still covers huge disparities of wealth, economic development and population density.
Khwarizmi Ventures managing partner Abdulaziz Al-Turki pointed out that while North Africa and Jordan largely rely on foreign investors, the venture is quite new in the six countries of the Gulf Cooperation Council and began with injections of government cash. As recently as 2019 some 60% to 70% came from government backed funds. But recently this has shifted with the sector becoming much more attractive to family offices, HNWIs and some foreign investors. The government funds now account for about 20%.