It’s no secret that an increasing number of family offices want to increase their exposure to direct investments—including start-up companies. A recent Wall Street Journal report called family offices, “a new force on Wall Street” because of the direct investments many are making.

By their very nature, start-ups represent a unique investment challenge, particularly for family offices that have a mandate to preserve wealth while still generating capital appreciation. That’s because start-ups are inherently risky.

For family offices assessing opportunities, there are “dos” and “don’ts” to consider, shared by family offices and the entrepreneurs they invest in.

The “Dos”
Start-up companies don’t usually have much in the way of traditional metrics to measure, such as client bases, sales histories, capital structures, or other tangible data. But there are ways to evaluate a company’s prospects for success and they boil down to these five:
1. Focus on industries that can preserve wealth. These are sectors that aren’t going away, but that could benefit from new or disruptive technology. Among such stalwart industries are distribution and logistics, health care, discrete manufacturing with differentiating intellectual property, and technology-enabled business services.

2. Invest in the entrepreneur/CEO. It’s become something of a cliché, but the person driving the start-up will largely determine its success or failure. Bradley Berger of Kompass Kapital Management, a family office in Kansas, offers the following advice: “There are two areas of experience that are critically important: Look for a founder who has a proven track record in their industry and preferably one who has past experience working with private equity investors,” he says. “You want a CEO who knows the nuance of his or her industry. This makes their assessment of the business potential and larger market dynamics more credible. If they’ve worked with a private equity fund before, they know how to be in a collaborative relationship—and how to accept help when an investor can add value.”

The CEO’s capacity for collaboration also speaks to the type of employee culture he or she would establish.

3. Pick companies that solve problems. You can’t quantify a start-up’s performance history, but you can assess whether it has a value proposition that demonstrates its need to exist. Would it have a diversified client base—i.e., customers who can clearly benefit from what the company is offering?

4. Go in with a long-term investment view. Start-ups always encounter unanticipated hurdles that can hinder progress. This requires patient capital with the capacity to work through mid-course adjustments. One of the key differentiators for family offices is that they can be patient investors. By contrast, many entrepreneurs argue that large private equity firms are structured to sell their portfolio companies before they can fully realize their potential.

“They sell a company for a stand-up double rather than a home run,” says Tom Knauff, the CEO of Energy Distribution Partners and a veteran of several start-ups where he raised capital to consolidate suppliers in the oil and gas industry.

Knauff points out that early investors benefit from being positioned as general partners. Subsequent investors can often be limited partners, with less of a role and upside. He adds that entrepreneurs can benefit from partnering with family offices that are “consistent and long-term” players and who believe it’s “in their own enlightened self-interest to help CEOs achieve their goals.”

5. Structure a deal that is appealing to the entrepreneur, but fair to the family office. With an early investment like a start-up, experienced entrepreneurs can be turned off by investors seeking a majority position, even if they’re family offices. One option is to accept a minority position, but to negotiate for consent rights over such operating decisions as budgets, hiring, acquisitions, capital expenditures and any strategic decision to sell the company.

These five suggestions add up to a risk-mitigation strategy with high growth potential. By focusing on the essential industries that can benefit from new or disruptive technology, and by homing in on experienced entrepreneurs with companies that provide necessary products or services, the family office investor is attending to its first responsibility of protecting wealth. And by having a long-term investment horizon, the family office is setting the company up for future growth by providing a flexible capital structure that can accommodate new investors as the company’s growth warrants.

The “Don’ts”
In terms of the “don’ts” of start-up investing, it’s tempting to simply warn against doing the opposite of the “dos.” For example:
1. Avoid industries where you have no expertise. Biotech is exciting, but it takes scientific expertise to evaluate a start-up’s potential.
Unless that expertise is available to you, you put wealth at risk. The same goes for any volatile industry you may be considering.

2. Look out for egotistical CEOs. Confidence is key to being a successful entrepreneur, but there are warning signs to help you gauge whether it spills over into excessive egoism. For example, does the entrepreneur want the family office to buy him or her out completely, yet still remain the CEO? Are the entrepreneurs willing to put real principal at risk, or is their entire contribution to the enterprise coming only from their participation?

3. Don’t invest in a start-up that can’t substantiate its need to exist. What do customers and potential customers say? Is there a compelling reason for them to change what they’re doing and engage with the start-up?

4. Know your limits, but don’t be a volatile investor. It’s challenging to run a start-up, and entrepreneurs look to their investors as sources of stability and strength. It’s critical that your family office investments be guided by a set of principles the start-up entrepreneur and his or her team can count on. Unpredictable behavior on the part of investors is only destabilizing and puts your investment at risk.

5. Don’t make having a majority stake a deal-breaker. There are lots of ways to structure a deal with a start-up so future investors can be incentivized to help bring the company to its next level—which only benefits early family office investors.

However, that’s not the extent of the “don’ts” for family offices interested in start-up ventures. Here are others to keep in mind:
• Don’t overdo the concept of change. It depends, of course, on a family office’s operating style, but having a start-up investment can seem like a blank piece of paper. Keep in mind that entrepreneurs and their teams can be wary of the pace of change, and overwhelmed if it’s too much and too divergent from their original vision and plan. It’s great to add value and contribute to the energy of the start-up culture, but recognize that people can see change as disruptive and disempowering.

• Don’t try to run the company. Everyone’s familiar with the horror stories entrepreneurs tell about investors who change immediately after the deal is signed. Some become overbearing and actually move in with the company.

Every private equity firm says it provides operating expertise to its portfolio companies. Usually that’s interpreted as interference. Family offices are uniquely positioned to be “investee-friendly.” That’s because they have a heritage of offering stability and strength, and that has great appeal to entrepreneurs. Family offices are the port in the storm. They shouldn’t mimic the policies and behaviors of the larger private equity firms when dealing with start-ups. Otherwise, the only difference between them would be the depth of resources each offers—and that’s where the family offices will lose to the PE firms.

“I consider whether the investor is going to be helpful and honest,” says Dan Weinfurter, the CEO of GrowthPlay LLC and a serial entrepreneur. “When things go sideways, will they be working with me or casting blame? Who the people are at the investment firm is just as important as the money.”

• Don’t accept anything less than a strong business infrastructure from the start-ups. For entrepreneurs, part of the fun of start-ups is the freedom they afford. But forecasting and tracking budgets and other business disciplines are fundamentals that every start-up must bake into its operations. Of course, the start-up must formalize management functions and develop uniform policies and procedures, if only so it can properly scale. This is so the company can protect your investment. It must be able to track and evaluate that investment, as well as create the infrastructure to attract new employees and investors.

• Don’t let management ignore how the company’s culture is developing. Particularly with start-ups, where people are frenzied and growth comes fast, the employee culture needs to be cultivated. That’s because it impacts the company’s productivity and ability to hire—and just one bad employee can sink a shorthanded start-up.

The start-up your family office invests in comes to you in part because of the values and principles you demonstrate. The management of that start-up has the same responsibility to develop its culture using highly motivating values and principles that will govern its decision-making.

These “don’ts” of investing in a start-up determine whether it will have the underbelly to fully seize its growth potential. Infrastructure—be it management systems, accounting procedures or a company’s culture—will determine its ability to scale. And there’s no sense in investing in a start-up that doesn’t have high growth potential.

The family office investor is in a unique position to nurture a start-up through its initial phase. The capital is essential, but so is the “finishing” a family office can add, helping the start-up turn from a great idea into a serious player.

Eli Boufis is managing director of Driehaus Private Equity LLC.