FOA - Entrepreneurship in the Family Office.pdf - Summitas

Entrepreneurship in the Family Office
While these options can also be attractive, they all represent various
degrees of separation from what is ultimately creating value, which
are the enterprises receiving capital. The farther from the value
creation we go, the more people there are along the way to take
a piece.
Conversely, as you move closer to the initial value creation in a
company, returns can increase. For example, several studies show
that a well diversified portfolio of direct angel investments is
expected to earn 27%. 1 Few families take advantage of the returns
from angel investing as it is often misunderstood, time intensive
and difficult to do directly, and few choices exist to invest indirectly.
This is changing however as new seed stage investment managers
are developing innovative strategies to achieve diversified returns
of over 30% while providing access to early stage companies for
larger investors (a topic for another paper).
While these returns are attractive, they can be even higher when
you continue to move closer to the source of value creation and
actually found the enterprise internally. To illustrate, by the time
angel investors purchase equity in a pre-revenue company, the
typical pre-money valuation is between $1 and $2 million. 2 An
investment of $100k in a company with a $1.5 million pre-money
valuation will result in the SFO receiving 6.25% ownership in the
company (.1m/1.5m+.1m). Startup companies will typically raise
enough to give away only 30-35% in their first round of financing.
However, many of these companies (not only internet) will have
spent less than $100k to get to this point. Their $100k has earned
them 65-70%, while yours will earn you 6.25%. You would have to
invest $100k in ten more companies to achieve the same level of
ownership as the founders, risking 10x more capital.
What is the entrepreneurs’ response to this? Their response
(correctly) is that their capital and time went in when this was just
an idea- their idea, and when no one was sure it would work. Your
capital goes in when things are much further along - there may be
a product developed, a great team, and maybe some customers
or revenue. In other words, the founders reduced risk and created
value with their work and creative insight. (They will also spend
the next four years building the company, but the market shows
that management can be brought in for the same salary and much
less equity once a company has funding, which implies the bulk of
founder’s equity is due to founder status).
1 Robert Wiltbank, “Returns to Angel Investors in Groups”, Kauffman Foundation, November 2007, Right
Side Capital Management, LLC, “Historical Returns in Angel Markets”, 2010
2 Payne, Bill, “Valuation of Pre-Revenue Angel Deals”, October, 2010
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