Thoughts on FO to VC FoF transition

Firm Building Series

More sophisticated families are now intentionally allocating capital to emerging managers, even when they can invest in larger, well-known VCs.

Source: Forbes

We believe that specialist venture capital fund-of-funds represents one of the most significant ways in which private wealth management will shape the markets in the near future. This belief is primarily driven by a human capital perspective as it provides an alternative path for next gens instead of 1) continuing to operate in the family business, 2) starting new operating businesses/startups from scratch, and 3) launching direct VC strategies.

According to Deloitte, the number of family offices has grown from 6,130 in 2019 to 8,030 in 2024, with projections reaching nearly 11,000 by 2030. Similarly, aggregate family office AUM is expected to grow from $5.5 trillion today to $9.5 trillion in 2030, a massive $4 trillion increase in just the next five years!

The Paths Available to the Next Generation

An institutionalized fund-of-funds structure creates a unique career path that combines entrepreneurial ambition with professional investment management while preserving family values and long-term orientation.

• Path 1: Traditional Family Business Continuation
  Working within existing family enterprises, often facing constraints of established culture and limited autonomy.

• Path 2: Independent Entrepreneurship
  Starting new operating businesses from scratch, requiring significant operational expertise and capital investment.

• Path 3: Direct VC Strategy
  Building internal VC capabilities through direct investments, demanding extensive resources and specialized expertise that many family offices lack.

• Path 4: Institutionalized Specialist Fund-of-Funds
  Becoming a professional investment platform rather than a generalist allocator that leverages network advantages while accessing institutional expertise, governance, and specialization. Multiple research reports point to a 4-11 percentage point increase in returns for specialists over generalists, likely due to the long-term compounding effects of networks and relationships. This is known as the Performance Premium of Specialization.

Path 4: Pros and Cons

Many family offices will choose to invest directly in companies, akin to building a direct VC strategy. However, recent research demonstrates several challenges family offices face with direct VC investments:

Direct Investment Challenges:

• Only 50% of family offices making direct investments have trained private equity professionals on staff.

• Only 20% of family offices investing directly take board seats and actively engage in portfolio management.

• Deal sourcing remains a primary concern, with family offices struggling to access proprietary deal flow and facing significant adverse selection.

Pros

1. Superior Pattern Recognition and Deal Selection
   Domain expertise enables fund-of-funds managers to identify emerging patterns before the broader market recognizes value creation opportunities. Early pattern recognition manifests in:

   • Enhanced due diligence capabilities through deep understanding of sector-specific value drivers and risk factors.

   • Ability to distinguish between sustainable competitive advantages and temporary market dislocations.

   • Recognition of which fund managers possess genuine operational expertise versus those merely riding sector momentum.

   • Specialized managers consistently demonstrate better capital preservation, with only 14-25% of specialist capital invested below cost, compared to 28-31% for generalists.

2. Privileged Access and Network Effects
   Specialization creates a powerful network flywheel that generalist allocators cannot replicate. Top-tier sector-specific funds increasingly prefer limited partners who understand their strategy and can provide strategic value beyond capital. This leads to:

   • Priority access to oversubscribed funds that regard specialist fund-of-funds as strategic partners rather than passive capital.

   • Co-investment opportunities in flagship portfolio companies, providing additional returns without incremental fees.

   • Early visibility into emerging managers who will define the next generation of sector leadership.

3. Value Creation Through Operational Expertise
   Unlike generalists who primarily focus on portfolio construction, specialists actively contribute to value creation by:

   • Facilitating portfolio company introductions across their specialized ecosystem.

   • Providing access to a talent network for critical executive hires.

   • Offering strategic advisory during pivotal moments such as international expansion or platform acquisitions.

   • Enabling cross-pollination of best practices from concentrated domain expertise.

Cons

While the specialist fund-of-funds model offers multiple advantages, it comes with some inherent challenges that families and investors should consider:

• Narrower Focus Risk: Specialization limits diversification across sectors, which can expose portfolios to sector-specific downturns or regulatory shifts that adversely affect entire industries.

• Dependence on Manager Quality: The model heavily relies on the curation ability of specialist allocator to maintain superior insights and operational expertise. If this declines, performance may lag.

• Potential for Higher Fees: Funds-of-funds will often have layered fee structures, which can erode net returns unless performance substantially exceeds benchmarks.

• Liquidity Constraints: The longer-term nature of private equity and VC may reduce portfolio liquidity, creating challenges for investors seeking flexible capital deployment.

• Scaling Challenges: As family offices grow their specialist fund-of-funds investments, the scarcity of top-performing specialist managers and deals may limit scalability and put pressure on maintaining performance premiums.

Built-in diversification

Counter-intuitively, fund-of-funds provides superior risk-adjusted returns compared to single VC investment yet provides built-in diversification. Additionally, specialists allocators achieve:

• Deeper understanding of sector-specific risk factors, enabling proactive mitigation.

• Ability to distinguish between systematic sector risks and idiosyncratic manager risks.

• More effective portfolio construction within their domain, balancing stage, geography, and strategy while maintaining focus.

In an increasingly complex and competitive investment landscape, the evidence is clear: depth of expertise trumps breadth of multi-asset coverage. Path 4 enables next-generation wealth holders to build professional investment platforms that can compound value for future generations.

Shared Learnings in Firm Building

This transition—from a Family Office to a Venture Capital Firm—is deeply meaningful to me, and I’ve been engaging with peers who aspire to take similar steps. I’m committed to sharing my learnings, highlights, and challenges with the wider community. As part of this commitment, I will continue publishing under the Firm Building Series and welcome reader comments with open arms.

This is an educational post about GEX Ventures investments. It is for informational purposes only and may not be relied on as legal, tax, securities or investment advice and does not constitute an offer to buy or sell interest in any products offered by us or others. Email me at mk@gex.vc or leave a comment if you’d like to exchange ideas.