The opportunities and challenges of establishing a family venture fund
Many business-owning and wealthy families are keen to foster an entrepreneurial spirit in the next generation. For a first-generation entrepreneur, their passion, skills and attributes are perhaps the most valuable qualities they can pass on. The younger generations often absorb these entrepreneurial traits through observation or family conversations around the dinner table as they grow up. In many families, they are now consciously talking about transferring these values.
Cohen and Sharma describe the most successful enterprising families as those in which each generation adds a layer of entrepreneurial contributions to the work of previous generations in order to transition their businesses and develop their families simultaneously1. This idea does not imply that everyone in the younger generation should start up new businesses. Indeed, it may not be relevant. For example, where a family has an operating business, this can translate into opening new markets or bringing in new ways of doing business. In wealthy families, it can mean having the skill and ability to invest in other businesses or entrepreneurs. In both cases, it can mean an entrepreneurial style of leadership.
Why set up a family venture fund?
Many families choose to establish family venture funds as part of their planning for generational transition. This can be seen in families transitioning from the first to second generation where the influence of the wealth-creating entrepreneur is dominant, all the way to the fifth-generation families in business who wish to provide entrepreneurial opportunities for future generations.
Some business-owning families, whether they are located in Asia or Latin America, insist that their main business is managed by professionals. Meanwhile, family members are encouraged to start up new businesses that can be added to the family portfolio over time. This approach can be very motivating for younger generations and offers them a means for self-expression, as well as a way to promote their self-esteem. Starting a new venture can provide a valuable learning curve – whether it is successful or not.
Family venture funds in practice
A family venture fund sounds like an attractive proposition. To make it work successfully – for the family and the entrepreneur – it’s important to pay close attention to the details. The fund needs to appeal to family members as well as be fair and not a potential source of family conflict. Families should ensure they do not send any subliminal message to children that a parent may favour those that choose to be entrepreneurs. A fair process is vital for making funding decisions, and the family needs to agree or at least be clear about what happens if a venture is a success or failure.
At the outset, it is helpful if the following types of questions are considered, discussed and addressed to avoid misunderstandings:
- Why are they setting up a family venture fund?
- Who is eligible to apply for funds? For example, are spouses included?
- What is the process for applying? For example, it is common practice to ask for a business plan.
- Who will decide? Many families engage a non-family executive or a trusted professional adviser in addition to the family council to bring a different perspective and independence.
- Is there any criteria for investment? For example, are there particular sectors or industries that are preferred or not preferred, does the fund provide start-up or growth capital, or both?
- Is the funding provided in the form of a loan or an equity stake? Can it be taken as an advance against future dividends? Is there any non-financial support available – such as encouragement, time and expertise or family networks?
- How will they report to the family board and how often?
- What are the exit options? For example, reversing into the family holding company or the entrepreneur buying the family out?
- What if the business fails?
- What if the venture is very successful?
There are a number of different ways in which families have structured their venture funds. Here we explore three examples:
- A fourth-generation European business-owning family
The family established a venture fund to:
- nurture and encourage entrepreneurship in every generation;
- create new businesses to add to their core portfolio; and
- develop confident and active successors.
- Invests in start-ups and relatively new ventures.
- Bloodline family as well as partners and spouses can apply for funds.
- The family fund invests up to €150,000.
- Family members are expected to invest at least 10% of funds requested from their own money and networks.
- The family entrepreneur receives at least 50% of the shares, regardless of the amount invested by the family fund.
- No penalty for failure – family members can reapply up to three times for different businesses in their lifetime provided they have a proper business plan.
- A third-generation East Asian business-owning family
The family created a venture fund to give younger generations the opportunity to be wealth creators in their own right.
- Any bloodline descendant can apply for funds.
- Family members need to present a full business plan with financial projections, a feasibility study and cash flow requirements – they also need to show that they have engaged independent advisers, such as a non-executive director or finance director.
- The business sector needs to be in line with the family’s values.
- The venture cannot compete with any of the family’s existing lines of business.
- A maximum of $1 million will be provided for an appropriate minority equity stake with an appropriate legal agreement in place.
- The family member is expected to use their personal dividends to fund at least part of the total capital required.
- Quarterly progress reports are expected.
- A wealthy second-generation Middle Eastern family, which has sold its operating business
The family created a venture fund to:
- encourage entrepreneurship and some risk taking in younger generations to give them a sense of purpose and fulfilment; and
- provide start-up or growth capital.
- Open to any bloodline family member.
- Funds of up to $1 million can be applied for, accompanied by a business plan.
- Family office executives will coach the family member in preparing the business plan and financial projections.
- The CEO of the family office will join the family council to review and approve funding.
- The funds will be provided in the form of a loan at 0% interest with a repayment holiday of two years and a further repayment schedule discussed on a case-by-case basis.
- If the business is successful, the entrepreneur can own the business fully (subject to other business partners who may or may not be involved).
- If the business fails, the family member will be expected to review lessons learnt and can apply for funding for a new venture once more in their lifetime.
Finding the right approach
As these case studies demonstrate, there are many different ways to create and run family venture funds. It’s vital to have clear objectives and key principles that everyone understands and agrees with. While family venture funds can present many exciting opportunities, it’s also important to consider any unintended consequences that could occur.
1 Cohen and Sharma, Entrepreneurs in every generation: How successful family businesses develop their next generation (2016)