The Family Office Guide to More Effective AI Investing

Recently, artificial intelligence (AI) has come to the forefront as a leading source of investment prospects. Hyped or not (debatable, but perhaps irrelevant), AI has become the main driver of venture capital. According to Goldman Sachs, over $1 trillion worth of capital will be invested in generative AI in the coming years — with much of it going into supporting the necessary infrastructure for it to reach its full potential. The global AI market is projected to grow from $638.23 billion in 2024 to $3,680.47 billion by 2034, expanding at a CAGR of 19.1%, while the median revenue multiple for AI companies stood at 25.8x in 2024, significantly higher than other tech sectors.

Breaking the Chain of Old Assets – Hedging in AI

This signals a clear shift from traditional assets into AI-related investments, and family offices are no exception. The likes of Jeff Bezos and Bernard Arnault, together with other billionaires, have been pouring tremendous amounts of capital into AI projects. While a tech pioneer like Bezos is used to the dynamics between startups and VCs, for most legacy family offices, these are totally foreign. In some cases, this may create a disadvantage for favorable deal flow. However, based on my experience, this impacts the odds of securing successful deals. A 2024 UBS survey found that 78% of family offices plan to invest in AI in the next 2-3 years, making it the top investment category.

Direct-to-Family-Office: The Good, the Bad and the Ugly

An emerging trend is that family offices are making direct investments in tech startups rather than through VCs. For startups, this shift may seem beneficial, providing an easier route to secure funding and access to "patient capital," which is crucial for long-term projects.

However, for family offices, this direct approach may present challenges. Many lack in-house expertise to conduct thorough due diligence on high-tech investments, potentially increasing the risk of unfavorable outcomes. Motivations for going direct include:

• Cost Reduction: By investing directly, family offices can avoid traditional VC fees, typically around 2% annual management fees and 20% carried interest. The new generation leading today's family offices is more tech-savvy and interested in disruptive opportunities, feeling confident in bypassing intermediaries.

• Control Over Investment Selection: Venture funds are increasingly offering project-based investments through Special Purpose Vehicles (SPVs). This structure allows investors to participate on a per-deal basis and reduces the liquidity gap, as family offices can sell assets without waiting for an entire fund to close.

Family Offices' Approach to AI Investment

From firsthand experience working with family offices managing significant assets, there is a noticeable bullish sentiment toward AI's potential. Their investments in AI have grown substantially in recent years. While companies like x.AI, Groq, OpenAI, Anduril, Anthropic, and Perplexity may not yet be profitable, family offices strongly believe in their long-term prospects and are keen to avoid missing out on rapidly evolving opportunities.

Despite skepticism regarding the current lack of profitability—OpenAI, for instance, has reported significant losses—family offices expect that the economics will evolve similarly to previous technological revolutions, such as the internet and personal computing, but at a faster pace.

The Intangible Risks: Going Big Without Research

These family offices tend to skew towards investing in startups that have some traction or reputation, particularly if the rounds are backed by some big-name VCs or corporations, or if the startup happens to have Fortune 500 companies as clients or partners. And you know what? This is a good strategy but there is a caveat: family offices can invest without thinking when big names are concerned.

For example, if prominent entrepreneurs like Elon Musk or Sam Altman launch new ventures, family offices may rush to invest without conducting thorough due diligence, relying solely on the founders' reputations. This approach can be risky, as it overlooks critical assessments of the company's financials, market potential, and operational viability. 

What it Means for Start-ups and VCs

High Net Worth Individuals (HNWIs) also outsource their ship-sized amounts of capital to family offices, bringing in a mass of assets under management (AUM)  to the family office space. Deloitte reported that they manage more than $3 trillion. Hence, their reallocation of assets comes with some implications, as follows:

For Startups: Family offices often ask fewer questions and do not involve themselves as much in the day-to-day operations when compared to VCs. Besides patient capital, they are also able to add value to startups with their extensive network.

For VCs: The direct investment trend could change the VC landscape. With the rise of family offices as significant tech startup investors, this will create competition and ultimately push VCs to recalibrate some of their strategies. In fact, VC funding for AI startups reached $12.7 billion in the first half of 2024, a 2,100% increase compared to $581 million in all of 2019.

Insights for Family Office

To mitigate the risks associated with direct investments in AI and other high-tech sectors, family offices should consider:

• Building In-House Expertise: Developing a team with the necessary technical and financial expertise to conduct proper due diligence on potential investments.

• Engaging External Advisors: Partnering with industry experts and consultants who can provide insights into the technology, market trends, and competitive landscape.

• Implementing a Disciplined Investment Approach: Establishing clear investment theses based on thorough analysis of a company's financial performance, growth prospects, and strategic positioning.

For example, instead of investing based solely on a company's association with a prominent founder, family offices should evaluate metrics such as year-over-year revenue growth, annual recurring revenue (ARR), and positive adjusted EBITDA, which can indicate readiness for an initial public offering (IPO) and potential for significant returns.

AI is a tremendous investment opportunity, and family offices are in prime position to help drive this revolution forward. With global private investment in AI reaching $91.9 billion in 2022, family offices can capitalize on the AI boom while mitigating their risk with a disciplined investment strategy adapted for this new era. Doing so will allow them to play a serious role in the development of AI advances and ensure beneficial investments for their P&L.