Find out the advantages and drawbacks of three types of capital investors: venture capital, family office and mutual funds.
JOHN COLLMER, HEAD OF WEST COAST PRIVATE CAPITAL MARKETS, J.P. MORGAN
Growing a technology company is undeniably resource intensive. Whether you’re developing new products, reaching new consumers, scaling operations or moving toward exit, gaining access to capital, guidance and partnership are likely at the top of your to-do list. Luckily, the types of capital investors available to technology companies present unique advantages, as well as specific considerations, for entrepreneurs.
“When working with technology companies, we find there are many things to consider when seeking funding,” said Tim Sandel, Managing Director of Middle Market Technology Banking. “Weighing the benefits of each funding source and ensuring your strategies are aligned are crucial to the success of your business. Every company has different needs depending on their goals, but finding the right funding source can be the key to ensuring your business grows and prospers.”
Here’s what you should to know about three distinct types of investors: venture capital, family offices and mutual funds.
Venture capitalists (VC) can provide critical expertise and experience. There are two important trends in VC today.
First, the low interest rate environment has drawn investors to this asset class, resulting in an abundance of capital available to technology companies. The VC asset class offers an opportunity to accelerate a founder’s vision by supporting sales and marketing, in part because a VC’s reputation as a profit-driven investor can enhance a technology company’s credibility. What’s more, VCs have seen multiple successes and failures. Not only can they provide mentorship to early entrepreneurs, they can help company founders navigate pitfalls and seize opportunities. This is made possible, in part, because they can turn to the internal resources and networks of mentors and capital they’ve cultivated.
The second trend that’s becoming apparent is the growth of corporate venture capital (CVC). CVC represents about a third of the capital available in this asset class. Through their parent companies, corporate funds invest, in part, to secure access to a company’s supply chain, talent and/or other resources. For technology companies, in addition to capital, CVC offers a larger network of potential customers, a deeper bench of experts and support, and the credibility that results from the due diligence performed before capital is offered.
While there are many advantages to VC and CVC funding, there are also potential challenges. While many VCs are often happy to join a company’s board of directors as a silent partner or observer, some VCs can be perceived as “governing” the company; they may want to interject in business decisions and steer the company’s trajectory. This can be reflected in the deal for capital, requiring strict governance and board seats, allowing investors to participate in strategy and financial discussions. Importantly, as they tend to be largely motivated by the return on investment from selling a company or going public, VCs typically focus their efforts on a path to exit.
Technology companies may not realize that a family office could be a viable investor. Ernst & Young reports that there are more than 3,000 family offices worldwide, holding an estimated total asset value of up to $4 trillion. The volume of available capital, as well as increasing interest from family offices in direct investment, make family offices a real option for technology companies.
There are a range of advantages to working with family offices. They often take a softer approach to steering governance and strategic decision making. Unlike other sources of capital, family offices are primarily interested in long-term wealth generation. Thus, they do not demand a rapid and direct path to exit but instead patiently allow their capital to grow with the company’s success. Additional advantages from family office capital include access to a large network of connections and experienced mentors who appreciate the challenges of growing a successful company.
Technology companies considering family office capital should weigh whether they are culturally aligned with the office, which typically employs a small number of people. Additionally, given that they are focused on growing long-term wealth, family offices look for proven products and business models with companies moving into the middle market.
In recent years, given volatile equity markets and fewer initial public offerings (IPOs), hedge funds have been making fewer new investments in growing technology companies. While this asset class was a major source of fuel for the technology boom, of late, hedge funds have underperformed the market, which has resulted in outflows to their funds. Meanwhile, mutual funds have continued to invest in private technology companies.
Mutual funds, or “crossover investors,” are a growing asset class that really didn’t exist before 2014. They have larger pools of capital and are showing a desire to find and partner with companies that want to go public over, generally, a two-year period. Overall, mutual funds are looking for companies with proven technologies that have the possibility to be the next market winner. In addition to capital, their investment creates a partnership and helps validate the businesses with the market before going public.
Selecting the Right Asset Class
Growing technology companies seeking funding need to weigh more than just capital and deal requirements. Entrepreneurs must consider which asset class can offer the best partnership to advance and support their success. VC, family offices and mutual funds each present different advantages depending on where a growing company is in its lifecycle.
For entrepreneurs who have previously built and sold a company, a family office may be the best partner. This type of capital investor gives the entrepreneur freedom and confidence to strategically grow the business, providing support as needed. Younger entrepreneurs desiring mentorship may consider VC, which will help them hone their ability to grow a business and move it towards a buy-out or IPO. Companies seeing strong growth with a proven technology—particularly those that can present a clear path to selling or IPO—could find a partner in a mutual fund. One size does not fit all when it comes to selecting a capital investor, and entrepreneurs should weigh advantages and consult with industry leaders when selecting the asset class best suited to support business growth and success