Why Family Offices (don’t) raise external capital

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“Have you ever thought about becoming a multi-family office?”

It’s a question that I heard a lot over the last year, as I moved to part-time work with my family office job and started advising affluent individuals and family offices (and started writing this newsletter).

But interestingly, it’s a question that I heard even more often before I decided to go part-time, especially from other family offices: Somewhere along the way, many entrepreneurially-minded family offices think about opening their doors to external capital.

After all, there’s some notable successes: On the multi-family office side, there’s Germany’s HQ Trust built on the wealth of the Quandt industrial family. On the asset management side, there’s last year’s merger of MSD Partners, the family office of Dell Technologies founder Michael Dell, and Chicago-based merchant bank BDT & Company. And many successes in both categories.

But in the end, few family offices end up raising external capital. I’ve debated this topic with a number of family office clients, almost all of which ended up not following through. But it also includes my personal experience: In both of my family office jobs, we considered opening our doors to other investors, but ended up deciding against it. 

So what makes or breaks the quest to successfully raise external capital? I think about three categories: Scale, Structure, and Service.

Scale: Think small, or think big

Most family offices think about external capital to eventually manage a lot of capital. Unless it is a passion project of one of the owners, (large) scale is the way to go: It increases the investable capital, it provides more fees to incentivize and grow a management team, and it makes the challenges of external capital worth the effort.

But the question is how a family office can get to scale - to manage a lot of capital. To me, there are two quite opposing paths: thinking big, or thinking small.

Thinking big means going all in on the fundraising effort, meaning that you try to raise external capital in an amount that moves a needle for the family office. In venture-focused Berlin, it might mean raising a venture capital fund that can be compared to the typical Fund 1 of an emerging manager, meaning double- to triple-digit millions of investable capital. 

Of course, thinking big is easier said than done: It requires Structure (think lawyers and fund admins, but also rules - more on that below), but most importantly, time commitment by the investment team and the owners, assuming they are involved and/or have a notable chunk of the economics. There’s some great examples where entrepreneurs sold their prior business and decided that their next chapter would be as an investor, resulting in them successfully raising a private equity or venture capital fund. (A prime example to me would be Discovery Ventures, founded by the co-founders of SumUp and Zeitgold - I even debated the exact topic of raising a fund with Stefan back in the day.)

In the end, entrepreneurs like the idea of raising external capital, but don’t love the idea of the time investment required to raise a large fund. They don’t want to go back to the 100-hour weeks of their founding days, nor do they want to raise the next year in fundraising meetings to grow what might already be a sufficiently sized fortune. But unless they’re willing to be in a passive role (think the anchor GP), there’s little chance of such a structure succeeding. You can’t have your cake and eat it too.

So the alternative is to think small, meaning a typically sub-scale structure. It could be a small friends & family vehicle of a few million in managed capital. It could be as small as a single co-investment SPV for a follow-on round of one of their venture assets. Including setup fees for the structure, time spent by the investment team drafting a beautiful fundraising presentation, and a necessary co-investment by the family office, is most likely not to be worth the money. But it’s a less committal way of dabbling in external capital. And this slower path, over the years, might build a track record that might actually make it easier later to ‘think big’.

Structure: Regulation, Reporting, Rules

The owner of the family office at my first family office job was one of Germany’s most famous entrepreneurs. Besides being successful with the venture he built and took public, he also had an incredible hand at venture investing: More than once he asked me to help facilitate an investment in a company which frankly I just didn’t get, but which ended up being an absolute homerun for him. And accordingly, people asked more than once if he’d raise a fund one day. But to my knowledge, he never went down this path.

In my view, for him (and other family offices where a fund seemed like a good choice), the main reason against it was the necessity for Structure.

Structure includes obvious topics, such as regulation (i.e. setting up a regulated fund) and reporting (quarterly written updates about the state of the portfolio). Those are more chores than actual blockers, and especially if you want to ‘think big’, i.e. raise a sufficiently sized fund, those are tasks that you can solve with money, either by hiring the right advisors or by increasing the size of your team. But the more important point is what we can loosely categorize as ‘Rules’.

Without Rules, owners have full flexibility on how they want to invest. They might invest in a traditional pre-seed venture deal, but they might also consider a debt investment, a private equity deal, or an SPV on which they need to pay additional fees to participate. Even with some sort of investment guideline in place, it’s their money, and they can invest how they would like, whether it’s on the basis of a due diligence memo prepared by a Big 4 consulting firm, or whether it’s simply based on their gut feeling.

With Rules in place, things are different. Owners can’t just go ahead and invest the external capital as they like. They need to justify their decision (think deal flow funnel and investment memos). They need to make sure that their investment process is bulletproof (think lawyers renegotiating R&Ws and tax advisors double-checking that an investment doesn’t trigger unwanted taxes). And they might be subject to external scrutiny, whether that is simply an auditor or even the formal veto power of a Limited Partner Advisory Committee (LPAC).

And if I know one thing, it’s that entrepreneurs don’t like it when you tell them what not to do.

Of course, you can set up a fund in which you can get around most of those Rules: I remember speaking to the investor relations manager of a somewhat infamous entrepreneur-turned-investor raising a fund. Their fund documentation also had such an LPAC in place, so I asked him who the investors would be to sit on this LPAC - to which he responded that the LPAC clause was indeed in the LPA, but that they had no intention of actually inviting anyone to this committee. It was just there because the lawyers had left it there.

 In the end, they raised their fund, mostly with tickets by non-institutional LPs who wanted to invest with that entrepreneur. But I also knew of more than one institutional LP staying away exactly because of the lack of structure.

Service: Knowing your priorities

Let’s go back to my prior statement: Entrepreneurs hate it when you tell them no. In the context of their single family office, there might be a number of reasons when something like this can happen. It might be when their family office staff tells them that an investment they like didn’t make it through their due diligence check. It might be when a lawyer or tax advisor advises them against an idea of theirs.

But in a multi-family office, it might be when their staff tells them that they can’t help them right now - they have to help another client first.

The point of a family office is to be quick and diligent in responding to the needs of your owners. In the case of a single family office, those priorities are clear: Even if there might be a more important investment-related task, you typically try to deal first with any urgent personal needs of the family. Even if there’s more than one owner (think a family or a group of founders), this statement typically holds true. It might involve a bit of smart time management, but there’s typically no conflicts about division of time among their staff.

But how about a single family office turned into a multi-family office? It should still be the key priority of the family office staff to serve the founding family, but how do you know to divide your time properly between the founding family, and their desire for you to go out and onboard (and properly serve) external capital? No matter how the size of external clients compares to the family’s wealth, there might be challenges: If new clients are smaller than the family, they might think that they are still the key priority. But even if the new clients are equally large or bigger than the family, they are the founding family - they should come first. From my experience, a problem in the making, whether it comes up sooner than later.

And interestingly, this tends to be the biggest reason - not scale, not structure - due to which I’ve seen entrepreneurs decide against external capital. Especially if they’ve worked with their family office for a few years, they’d rather not share them, especially if it’s a working system generating returns and a satisfying level of service.

And to me, that is not surprising: If you’ve reached a level of wealth that can not only justify a family office structure, but one large enough that you consider opening it to external capital, there’s a good chance that the additional returns from external capital will not move the needle for you that much. So if entrepreneurs then decide that they still want to go ahead, it’s for the right reasons: For the desire to build something new as a successful investor for the sake of being a successful investor, and not just for more money.

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