Family offices bet bigger on start-ups, opt for direct investments

Direct investment or co-investing with Indian VC/PE funds in companies is increasingly catching up

Till recently, most Indian family offices tended to invest in start-ups indirectly by putting their money in venture capital (VC)/private equity (PE) funds. That’s been changing since 2019, with family offices increasingly investing in companies via direct stakes or as co-investors with Indian-headquartered VC/PE funds.
 
The total numbers may not be high compared to the total investment being made by the Indian funds, but the pace is picking up (see table, “The family way”). Data based on investments made by active Indian family offices (which make at least three to four deals a year) in Indian companies hit a record $507 million in H1 2022, more than 2.38 times the previous year, according to Venture Intelligence, a research agency that tracks flows of VC/PE and family office funds.
 
The trend gathered momentum from calendar 2019, which saw over $660 million being allocated to companies directly. Although it lost steam a year later, dropping to just $200 million in 2020, in calendar 2021, family offices put in $543 million, but this year’s first half numbers suggest that this figure could be exceeded by a generous margin.
 
All told, domestic family offices’ direct investment in companies accounted for around 8 per cent of the total investment made by Indian-headquartered domestic PE, VC and family office funds at $6.3 billion in H1 2022.
 
But the reality is that only 20 per cent of the funds raised by Indian VC/PEs come from domestic capital — which include family offices (who put money directly in companies as well as through these funds) apart from  banks, insurance companies and high net worth individuals. They collectively totted up $1.23 billion in H1 2022. The rest came in dollars from global investors. So, Indian family offices, through their investments directly in companies, already constitute 40 per cent of the share of Indian capital. Its share indirectly through funds is not available publicly.
 
“Five years ago, you saw only a handful of deals. With multiple family offices having investible corpuses of Rs 500 crore to Rs 1,000 crore, the appetite for co-investing through a special purpose vehicle or in direct deals alongside PEs is surely growing,” said Parth Gandhi, founder of PE firm Bombay Capital and former partner in AION Capital.
 
Gopal Srinivasan, managing director of TVS Capital, said that among the 30-odd family offices that he deals with, a dozen would be actively looking for such an opportunity; the rest prefer the old fashioned route of investing in a fund.
 
Siddarth Pai, founding partner of 3one4 Capital and a key member of the Indian Private Equity and Venture Capital Association, avers that three to five years ago there were no co-investing deals with PE funds. But that has changed, after seven or eight years of being in operation, family offices have enjoyed returns of 5x and 10x by investing directly in companies. On the other hand, VC/PE funds by nature of their diversified portfolio clearly cannot offer such returns.
 
Pai estimates that out of 100 family offices, 20-25 would like to have such a deal but eventually only 10 per cent would actually get a deal consummated.
 
That does not mean that PEs will lose out on account of family offices’ growing appetite for direct deals. For one, no family office can have or hire expertise in as many diversified areas as a fund, which also offers greater protection from business downsides in a particular company. For another, business families tend to focus on running their core businesses and letting the experts manage their surpluses.
 
Co-investing deals are structured in various ways. One route is for a single or several family offices to tie up with a VC that brings the deal to the table and create a special purpose vehicle (SPV). In some cases, family offices also invest part of the money in the PE fund and part through the SPV to hedge their bets.

Pooling resources enables larger deals. The other plus, say fund managers who work with companies for co-investment, is that family offices pay the VC a one-time fee of 1-2 per cent for introducing the deal rather than an annual management fee for four-five years (which is the typical life of a fund).
 
Co-investment deals also have the advantage of enabling family offices to negotiate deal-to-deal on the share they are ready to give out to a PE in an upside. In the case of an investment in a structured VC/PE fund, this share is mostly pegged at around 20 per cent.
 
“The power of leverage here moves in favour of the family office rather than the VC, which should be the case,” said a senior executive of a family office.
 
Family offices have been encouraged by the success of direct deals, especially with the IPO route for start-ups opening up. For instance, Nykaa was able to rope in Sunil Kant Munjal’s family office in various rounds since 2016 as well as the family office of Narottam Sekhsaria, who invested from 2014. Both made huge gains when the company went public.
 
There are other clear reasons for a growing preference for direct investment. Tech entrepreneurs who apportion part of their wealth in start-ups prefer to invest directly in companies in the same space, which they understand, rather than putting money in a diversified fund.
 
Similar trends can be seen in traditional family businesses, too, with next-generation scions preferring to oversee direct family office investments in companies that operate in areas that they understand — and they are ready to hire top-dollar fund managers. Interestingly, many overseas fund managers are also returning and showing a readiness to work with these offices, some as partners. For the struggling start-up universe, family offices may well be the next big thing.