Family Office Direct Investing. Spring 2012

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Noah Holmes
8 years ago
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1 Family Office Direct Investing Spring 2012

2 Summary Family offices began direct investing in the early 1900 s and their approach gave rise to the venture capital industry after WWII The modern day venture capital industry is far different from its origins; performance data suggests the old investment paradigm is more effective Family offices have unique advantages and opportunities from direct investing and can benefit from the proven approaches of the past The Harbor Light family has taken an approach that fits our needs and values and reflects the origins of family office direct investing in the past

Origins of Family Office Direct Investing Direct investing began in the early 1900 s among wealthy families and individuals By 1930 s family direct investing was more formalized, many hiring

3 Origins of Family Office Direct Investing Direct investing began in the early 1900 s among wealthy families and individuals By 1930 s family direct investing was more formalized, many hiring investment managers Development capital had many benefits that aligned with family values and needs Legacy of family investing continues today at leading venture capital and private equity firms J.H. WHITNEY & CO.

The Early Days of Venture Capital First venture capital firm founded after WWII by Georges Doriot ( father of venture capitalism ) Doriot style of investing stressed collaboration; portfolio

4 The Early Days of Venture Capital First venture capital firm founded after WWII by Georges Doriot ( father of venture capitalism ) Doriot style of investing stressed collaboration; portfolio companies were members of the family VC was a cottage industry from 1950 to 1980 of small firms each with a few General Partners General Partners incentives were closely aligned with their investors and portfolio companies If you did a good job, you could create companies whose products would be beneficial to mankind. - Founder of Sutter Hill Ventures, oldest VC firm on the West Coast

the VC industry VC 1978: $200M VC 88: $3,000M Venture firms structure and incentives became distorted and misaligned Other 44% Pensions

5 From Cottage Industry to Asset Class New regulations in the 1980 s fundamentally changed institutional portfolio management Institutional capital poured into venture capital between expanding 15x Wealthy families and individuals were crowded out of the VC industry VC 1978: $200M VC 88: $3,000M Venture firms structure and incentives became distorted and misaligned Other 44% Pensions & Endowments 24% Individuals & Families 32% Individuals & Families 8% Other 34% Pensions & Endowments 58% Source: Gompers, University of Chicago GSB

6 Venture Through the 1990 s Tech Boom Commitments to VC exploded again with 1990 s tech/internet bubble $180 $160 Total # of VC funds After bubble burst, many smaller funds forced to exit the industry $140 $120 $100 Avg. VC fund $M Surviving VC funds are now far larger than the funds of 1980 s by ~5x $80 $60 $ Industry continued to change and no longer resembled a cottage industry $20 $ # Funds >$300M: Sources: Cambridge Associates, SVB Capital, NVCA

require larger investment opportunities VC fund raising increasingly focused on largest institutional pensions/endowments 1990 2010

7 Venture Capital Today: Bigger but Better? Size and structure of the VC industry now significantly different than 20 years ago VC s are raising ever-larger funds, which require larger investment opportunities VC fund raising increasingly focused on largest institutional pensions/endowments Total Capital $B $38 $490 # of Firms Investing Avg VC Fund $M $39 $150 Avg $M / Investment $1.8 $6.7 Largest Fund Raised $B $1.7 $6.3 Source: NVCA VC s focused on hottest deals; fund managers focused on brand name VC firms

The Future is Not What it Used to Be Smaller funds have historically outperformed larger funds Fund Performance: IRR % (1990-2010) 15.

8 The Future is Not What it Used to Be Smaller funds have historically outperformed larger funds Fund Performance: IRR % ( ) 15.9% Smaller funds outperformance due to: Stronger GP incentives from carried interest More focused investment strategy Greater emphasis on proper valuations Fewer home run exits required for success 4.3% Large Funds Small Funds Source: Sante Ventures Correlation of Capital Raised vs. Exit Value Many smaller funds embody the approach and values of Development Capital in the past

9 Venture Capital vs. Development Capital Today s Venture Capital Yesterday s Development Capital FEES High; based on capital under mgmt Low; based on budget needs INCENTIVES Misaligned due to fee stacking Aligned with long term carry TIME Short term; 4-8 year cycle Flexible; long-term if needed FOCUS Looking to raise next fund Committed, stable capital base ROLE Passive due to Board stacking Collaborative and accessible INVESTMENT Large; require home run exits Flexible; what company needs

Back to the Future: Harbor Light Capital Harbor Light family office formed its own direct investment firm in 2008 Structure and approach similar to

10 Back to the Future: Harbor Light Capital Harbor Light family office formed its own direct investment firm in 2008 Structure and approach similar to venture firms of the past HLCP is a vehicle for growth, diversification, and tax-efficiency Continues family legacy of creating value and doing well by doing good

Benefits of Family Office Direct Investing High Return Generate enough growth to protect the net worth of future generations, since families often multiply faster than assets do.

11 Benefits of Family Office Direct Investing High Return Generate enough growth to protect the net worth of future generations, since families often multiply faster than assets do. Uncorrelated Asset Diversify portfolio and build real value in real companies, whose value is often uncorrelated with other asset classes. Tax Efficient Transfer assets to future generations in a highly effective and tax efficient way. Intangible Assets Maintain and expand the highly valuable relationships, skills, and experience that led to initial wealth creation.

12 Direct Funds and Tax Efficiency Illiquidity discount is applied to investments within Direct Funds $600 Tax Benefit of Direct Fund Investments Book value of a Fund declines in early years due to cost accounting Gifting ownership of Direct Fund becomes very tax advantageous Estate tax burdens are greatly reduced for Direct Fund investors $500 $400 $300 $200 $100 $0 Actual Value of Investment at 8% Annual Return Tax Value of Direct Fund Investment at 8% Return Tax Savings Opportunity Year Figures above are approximations for illustrative purposes

13 Closing Remarks Family offices began direct investing in the early 1900 s and their approach gave rise to the venture capital industry after WWII The modern day venture capital industry is far different from its origins; performance data suggests the old investment paradigm is more effective Family offices have unique advantages and opportunities from direct investing and can benefit from the proven approaches of the past The Harbor Light family has taken an approach that fits our needs and values and reflects the origins of family office direct investing in the past

Private Equity Compensation. Intro

Private Equity Compensation. Intro Private Equity Compensation Steve Kaplan University of Chicago Booth School of Business 1 S. Kaplan Intro Mechanics and details of PE compensation. Proposed tax changes for PE compensation. How those tax