Sanjay Mehta on family offices investing in startups

By Sanjay Mehta

What is so attractive about Flipkart, Unacademy, CoinDCX, Swiggy, Byju and Oyo—the new age companies? The answer is their nonlinear business growth and venture capital. For investors it's perpetual activity to find that one-in-a-thousand team whose ambitions to grow the idea nonlinear way and dominate market segments.

Nonlinear ideas become successful after massive scale. Social networks, messaging, e-commerce and gaming have seen huge amounts of venture capital investment.

Investing in a startup by family offices or family-owned businesses is a well understood opportunity. These startups can be directly or indirectly strategic to their business or pure play investments in alternative asset class. Some 80% act like angel investors with a spray and pray thesis. Very few sophisticated family offices have dedicated investment teams and return goals in alternative assets like startups.

However, family offices are no longer considered tourist investors in the startup space. They find direct investment in startups attractive because small bets can create big winners. It’s exciting to fund the future and engage with founders directly.

Family offices today want to invest directly rather than participate in blind pools. They take selective bets with the deal to gain in-depth understanding. Every family office now wants to leverage their core expertise of building business from the ground up and forging a network of connections to help their portfolio.

Investing in startups is glamorous, but the question most family office investors have is: “How does one get access to credible deal flow?”

While a deal flow can be generated from several sources, the proposals that are likely to garner the most attention are the ones from companies or entrepreneurs where a previous investment has been successful, or where there is a solid existing relationship with other family offices. Unsolicited proposals from untried startup founders are likely to be given short shrift by most established investors.

Investing in seed-stage startups can be exhilarating and highly lucrative, but it can also be incredibly risky, hard work and time-consuming. Startup investing is a 1% business, which means that to invest in one deal VCs look at evaluating 100 random deals. The success ratio improves as more credibility gets added into the deal flow.

Random Deals: 500 Deals, 50 Meeting and Five Investments—these are opportunities which are unsolicited and come directly from founders

Validated Deals: 100 Deals, 50 Meetings and 10 Investments—these are deals which come through investment bankers, angel networks and fund managers

Referred Deals: 50 Deals, 50 Meetings and 20 Investments—these are syndicated deals being led by other family offices

Based on the India Sentiment Outlook Survey 2021, family offices are all set to accelerate their investments in startups this year with tech-based startups particularly being in high demand.

Startup investment Risk is 1X and upside is unlimited

There are legendary stories to share in the venture capital industry, like Peter Thiel was the first angel investor in Facebook with a $500,000 cheque that turned into more than $1 billion in cash. For family office investors the upside is asymmetric. I have been investing in startups for a decade and it has been a financially rewarding journey. Read here about 280X returns from Oyo Rooms

Family offices which are active in the startup space are usually sophisticated with lots of connection, knowledge and investment capabilities to nurture these risky assets.

It’s not necessary to do extraordinary investments to get extraordinary exits. When you sell any asset like gold, real estate etc there is a price discovery basis on the market. In the startup world, we do not have a ready reckoner to look upon. The valuation does not have any science as it is not based on fundamentals as in case of public listed equities. Price usually is an educated guess based on expert observations within the prevailing market with perceived risks.

While we are still discovering the best practices on exits, here are some exit opportunities that are most important for family offices:

Financial exit

When a VC (financial investor) buys out the family office equity stake. I find this as this as the best possible double-digit exit returns what one can make.

Strategic exit

When an acquisition (strategic buyer) happens resulting in buy out of the family office investment. I find this as average exit where in limited cash returns can be expected.

AcquiHire exit

When startup which is going south and forced merger happens with an equity swap to stop further erosion of family office invested capital.

Family offices are a source of patient capital in comparison to venture capital which comes with a time deadline. Besides capital, the families can also provide an entrepreneurial orientation to these budding entrepreneurs.

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