UK: 2023 Review: UK Family Offices and Fund Structuring

The Environment 

Macroeconomic conditions and innovation have been two big drivers for family office investment and fund structuring in the UK in 2023.

According to the United Nations Department of Economic and Social Affairs (World Economic Situation and Prospects) 16 May 2023, “prospects for a robust global economic recovery remain dim amid stubborn inflation, rising rates and heightened uncertainties. Instead, the world economy faces the risk of a prolonged period of low growth as the lingering effects of the COVID-19 pandemic, the ever-worsening impact of climate change and macroeconomic structural challenges remain unaddressed”.

However, whilst it is the case that inflation has been higher and rather stickier than we would like in the UK, it appears that consumer spending and employment is still strong and investment appears to be driving rapidly into improvements in productivity, technology, innovation, projects addressing UNDSG goals and in particular climate change.

Current Government Policy on UK Innovation  

Many businesses in the UK used the pandemic to make improvements in productivity. According to the Department for Business, Energy and Industrial Strategy, which published UK Innovation Strategy: Leading the Future by Creating It, “since the start of the coronavirus (COVID-19) pandemic 33.1% of all businesses (excluding businesses with 0-9 employees) had adopted digital technologies and 29.5% had changed management practices. Also, 28.8% of all businesses (excluding businesses with 0-9 employees) expected that these innovations would increase their business’s productivity over the next 12 months”.

The strategy also sets out the government vision to make the UK a global hub for innovation by 2035 and sets a target to raise public and private sector investment in R&D to 2.4% by 2027. This is intended to support businesses to reap the benefits of commercial opportunities available, through science and technological development.

The Opportunity in UK University Commercialisation of R&D, Incubation and Scale-Ups

According to the Institute of Manufacturing University of Cambridge UK Innovation Report 2022, “the UK’s higher education sector stands out from comparator countries, performing 23.1% of the country’s R&D in 2019.”  

There is a real willingness by UK universities to produce research to solve real world problems, often working in conjunction with industry. UK universities are working on helping industry and the world to achieve Net Zero, to protect biodiversity, on making advances in chemistry, biology, life sciences, producing new composite materials, and in developing productive technologies such quantum computing, machine learning and artificial intelligence amongst many other things.

Several UK universities have developed strong incubators and accelerators with good ecosystems and premises, producing companies to join the strong pipeline of other UK tech companies in SaaS, fintech, artificial intelligence and machine learning, technology, media, telecoms and mobile.

The level of tech investment in the UK has also risen tenfold from USD2 billion in 2010.

“By the end of 2022, UK tech startups had raised USD30 billion: a considerable drop from the heady heights of 2021’s global funding peaks, but still 72% higher than the total from 2020”, according to 2022 Tech Nation report). The drop in investment can be explained by the adverse macroeconomic circumstances discussed above, but should not be regarded as a structural decline. Rather, 2023 has seen a return to more realistic valuations and has given savvy investors with dry powder the opportunity, and with IPO markets running slow time, to buy in at good prices.

Family Office Appetite for Risk  

Family office investors have received this message loud and clear, and family offices are increasingly sought after by founders who value the networks and industry-sector knowledge the right family office can bring.

Family offices do invest in and/or co-invest with venture capital funds, but are increasingly finding, funding and syndicating direct deals themselves.

PwC, in How Family Offices Globally are Investing in a Brighter Future, states that family offices accounted in 2022 for almost one third of all capital invested in start-ups globally. With nine out of ten of those deals being club deals and most deal tickets being between USD1 million and USD10 million.

PwC goes on to explain, and it is an explanation that corresponds with what we have been seeing as a firm increasingly since 2018, that the family offices doing these kinds of deals are very much dedicated family investment offices and family corporate business ventures with inhouse venture and fund expertise properly incentivised via carry and performance structures, and not the traditional family office engaged in wealth-preservation strategies. The founders of the family offices are also increasingly successful business people and/or investment professionals with an increased appetite for alternative investments.

Impact on Fund Structuring 

One of the consequences of the current macroeconomic situation is that the UK government is heavily indebted and will be most likely looking to raise more taxes. How that is done will be driven by policy reasons and will differ depending on the next election. A relevant area at risk as stated by the Labour party in conference would appear to be capital gains tax treatment of carry for private equity firm principals and possibly the remittance treatment for non-domiciled residents.

However, UK resident investors looking to avail themselves of the opportunities in UK innovation can still take advantage of very favourable SEIS, EIS and VCT regimes.

Family office investors participating in these opportunities may look to onshore to the UK and simplify their structures so that they can avail themselves of these incentives, consolidate their reporting jurisdictions using structures that allow them to transfer wealth intergenerationally in a manner that doesn’t affect their ability to service calls for capital by the funds and companies they invested in.

The choice of family office investment structure depends heavily on the residence of the beneficiaries, the purpose of the structure and the nature of the holdings.

Investment structures such as non-UCITS (NURS), which are UK FCA authorised funds (subject to the restrictions on asset types and concentration rules) can be used for holding exposure to a wider range of asset classes, such as structured products and direct property, and have less restrictions on portfolio construction than UCITS. Sub-funds to the NURS can be created with differing risk and return profiles for example, creating specific sub-funds for income, capital and balanced. Units in the sub-funds can then be allocated to family members depending on personal risk profile, need for income and age.

The Agency and Adaptability of the English Legal System

The UK also benefits from having a legal system that protects intellectual property rights and promotes commercial freedom to contract which also encourages the development of innovation. We also have an independent judiciary able to issue urgent injunctions to enforce and protect the rights of owners in digital assets. For example, the High Court in November 2022 ordered six cryptocurrency exchanges in differing jurisdictions to hand over customer details to a rival operator to track USD10.7 million in stolen funds. This level of agency and adaptability is needed to match the pace of innovation investors are seeking.