Articles and opinion
For some entrepreneurs, having their own family office has acquired something of a trophy status. After the successful sale of a business, what could be more natural than to set up a prestigious structure dedicated to preserving, and if possible enhancing, your wealth? But the successful establishment of a single family office well requires careful planning and could be improved through collaboration.
The most obvious trigger for setting up a new family office is following the sale of part or all of a business. The alternative would be to join a multi family office, or if there is an existing single family office, hope to integrate the assets and shift the philosophy in the present structure.
That very first step already raises the question of what the family office is for. Typically it is to support asset protection structures which hold the family’s wealth, and to manage the investment and protection of that wealth, usually in a privately owned investment fund.
However, it is not always the case that a family office is explicitly planned for. Sometimes, it may start as the head office of a family business, or evolve from the private holdings of an entrepreneur whose affairs are becoming more complex.
Advisors need to grasp the initial situation thoroughly to avoid problems later. Employees who worked for the operating businesses, into a family office, will now have differing goals and objectives to adjust to, compared with recruiting for a “green field” single family office.
The principal objectives of most family offices are to manage complexity, provide transparency, keep control of the management of wealth and provide a mechanism for transferring wealth between generations. However, a family office could also be used at an earlier stage by corporate advisers as a tool to help a family business introduce proper corporate governance into its operating business and prepare for the sale process itself.
This is because setting up a family office forces the family to separate ownership of wealth, from management of the business. This is particularly useful ahead of a sale where there is a large number of family shareholders with differing objectives that can complicate the sale process. Understanding the trigger to setting up the family office will determine the function, structure, and processes.
There are three basic building blocks for a new structure: protection, management and legacy. The first is about protecting the family’s wealth, which will involve creating trusts and maybe even foundations, depending on whether the family has come from a common law jurisdiction (which covers mostly the Anglo Saxon world) or a civil law jurisdiction which covers most of continental Europe. Pre-nuptial agreements which protect an individual’s wealth are also used to protect assets.
Trusts , foundations and pre-nuptials are important tools to protect the family’s wealth from creditors. Wealthy individuals can be beset by claims from people trying to sue. For example, the directors of the family business or a family member may face a claim from a divorce court.
In the recent divorce case of Radmacher v Granatino, seen by lawyers as determining whether pre-nuptial agreements were applicable in law in England and Wales, Katrin Rachmacher’s ex-husband Nicholas Granatino went to the Supreme Court after appeal judges slashed his divorce settlement from more than £5m to £1m. Fortunately for Katrin, said to be worth £100m, the Justices dismissed Granatino’s appeal by a majority of eight to one. Media reports suggest it was her father who insisted on the pre-nuptial agreement.
The well publicised cases of Worldcom and Enron underscore the potential exposure directors of a company face as a result of claims of alleged wrong-doing. Settling such claims can prove costly. The Enron settlement was $7.7bn but individual claim settlement costs continue to increase, with insurers now viewing a major loss for a director as $300m as opposed to $25m, as was the case 15 years ago.
Although these figures involve public limited companies, directors or officers of privately held companies can also be sued by shareholders and held personally liable for the decisions they make. Indeed they may even be more vulnerable because of their close involvement in day to day operations, and because such companies may not have the resource to cope with the myriad of compliance laws relating to investment, employment and other claims.
Creditors may even target directors of private companies facing financial problems by alleging breach of fiduciary duties if a company trades whilst insolvent. In that circumstance, the personal assets of the director may be at risk if the company is in fact insolvent.
Trusts and foundations can usefully protect families with businesses in countries beset by political risk. When setting up asset protection, advisers need to think how much money family members need to live on, what kind of legacy the family wants to leave and how to ensure family wishes are effected through the use of the trust deed, letter of wishes, family charters and most importantly, a good relationship with a responsive trustee.
The second building block for a successful family structure relates to the actual management and monitoring of the family’s wealth. The key here is to determine whether the family wants to outsource the management of its wealth. If so, what will be outsourced and to whom?
Regardless of which option is taken, the family needs to ensure their investment manager is clear who his client is, and what their objectives are. If it is a trust, then the wealth management objectives must address the needs of all the beneficiaries, not just the family member sitting at the table. There should be a clear mandate, separate custody of assets and proper risk management, monitoring and reporting processes.
The legacy will be very dear to the family. It could be a passionate interest in philanthropy or art. It is usually the topic which brings the family together and funnily enough, helps them to communicate and work on issues relating to the trusts and investment management. Some families, like Bill and Melinda Gates, even set up foundations which will pursue the family’s values and serve as their legacy to the world.
Foundations can be beneficial as they help educate the next generation in wealth management and attitudes to wealth. If you have a family who wishes to establish a foundation, then you need to ensure the investment manager understands the future cash requirements for that foundation. It will not be the manager’s client and, accordingly, may not be on his radar screen.
One notoriously tricky area for advisors to handle is the human aspect of the family office, which is a factor that some advisers underestimate at their peril.
You need to understand the motivations of the family members, because regardless of how technically excellent the professional advice provided, if they do not understand the dynamics of the family an adviser will not be around for very long.
Inexperienced advisers may rush in with recommended governance and legal structures without taking time first to get to know the family involved. If those structures later prove inappropriate or ineffectual, they can be a hindrance rather than a help, and extremely difficult to unwind.
The character of the lead family member as the wealth creator is vitally important. Do they see themselves as ‘Moguls’, ‘Stewards’ or ‘Accumulators’, and are they innovative or conservative?
According to American research published in 1998 on family office psychological profiles, growing assets is a top goal for Moguls and Accumulators, but is less important to Stewards and Innovators. Moguls, Accumulators and Stewards are all interested in becoming multi-family offices. Moguls like to keep costs low and maintain control over their assets and families. Innovators are less worried about costs and tend not to focus on the next generation.
These are all important factors, which determine the objectives of the family office and affect who works in or with the office. You also need to think about the other members of the family, the in-laws, stepfamilies, different generations as well as factors such as sibling rivalry, which can have a punishing effect through the generations if left unchecked.
The traditional terms of “patriarch” and “matriarch” are largely irrelevant now, partly because of the gender bias and partly because if women head the family, they need to demonstrate the same sensitivities to various interests as their male counterparts.
The ’death-debt-divorce’ trends evident in societies across the world mean that women now control significant parts of private wealth directly, and even more indirectly. Women on average live longer than their male partners and can, if poorly advised, end up with the responsibility of a family office which does not serve their needs.
And that is just the family members.
With employees involved, the matter becomes even more complicated. Working for a family office is effectively a service role, but not all advisers cope well with the master servant relationship.
For example, the recent trend for hiring hedge fund managers as family office chief investment officers can create tensions where a family is run by a Steward-type leader whose principal investment objective is preservation of capital. The family may have hired the hedge fund manager because they believe he can better manage risk through the investment philosophy of the risk-adjusted return. However, the hedge fund manager is used to being compensated for performance and may act accordingly.
Similarly, the decision path for being a single family office is very different to becoming a multi-family office. Problems can arise when a family want to run only their own money, but find they have staff who want a multi-family office.
Families considering setting up a dedicated structure may not realise the true establishment cost: Breedy estimates a minimum $1bn to set up a single family office, and $1m a year to run it. Cost pressures, especially at the lower end of the family office scale, are well known.
Changing to a multi-family office simply to cut costs is a fundamentally flawed process, Breedy says, because the strategic objectives are quite different. A single family office is all about protection and preservation of wealth, whilst a multi-family office is a wealth management service with a profit motive.
The financial crisis may have pushed some wealthy families to consider merging their existing family office, or in extreme cases shutting them down. Breedy argues that there is a third way and there is an opportunity for single family offices to collaborate to share ideas and achieve an improved purchasing position with the major institutional funds.
Running a single family office can be a lonely enterprise, but just as organisations in other industries work together to share best practice and achieve economies of scale, then so could single family offices. For example, a more collaborative approach to sharing information on compliance and governance practices can lead to a more rigorous way of running family affairs – rather than each new single family office having to reinvent the wheel. There is no single family office start-up pack!
Technology is another area where Breedy believes there is a huge opportunity for collaboration. There is a proliferation of products and services for the private wealth sector, but little independent information about which systems work best or deliver best value.
It is perfectly possible to set up and run an excellent family office but it is a weighty decision. Implementation can take a very long time as all possible issues need to be identified and addressed. Advisers and employees have to have a service ethos and to appreciate that the family’s needs are primary. You need good inter-personal skills to deal with family rivalries.
A final word to would-be advisors: If you are terribly ambitious financially then it is not probably the role for you. But when it works well it can be an engaging and dynamic place where accountability, transparency and openness are second nature.