A better family office

Recently, a client came to me and said he needed a family office to make his life easier. ‘It is a huge responsibility to grow and protect the family’s assets,’ he said. ‘I want a capable family office to back me up.’ My response was that this was doable, but that a successful family office should be capable of providing three benefits to the family: independent thinking, the ability to mix and match financial solutions, and sustainability.

Independent thinking

A successful family office should be capable of independent thought. Its role is to collect, filter and digest information, conduct due diligence and help the family to make good decisions.

As with my client, members of many wealthy families are approached by different people who tell them what they should do with their money. There is nothing wrong with listening to advice, but one has to understand that everyone speaks from their own perspective, and what works for one family will not necessarily work for another. It is important for anyone like my client to form their own opinion and make their own decision, independent from that of any service provider. 

Sometimes, advice comes not externally but from within the family. When the size of a family and the number of family branches grows, it gets harder to balance the interests of everyone. But, with a family office, there is a neutral platform on which decisions can be made relatively independently from any one family member or family branch. 

How can independence be achieved? The family should have a strategy. A good family office can help the family find its own strategy, bring it to reality and review it regularly. Strategies, and priorities, can differ significantly from one family to another. 

Some families’ strategy is to build an investment-centric family office, with the primary goal of making investments and generating revenue. This type of family office is the family’s asset allocator and manager of internal hedge funds and private equity funds. 

Some families see asset protection and provision of welfare and services to family members as the priority. The strategy would then be to set up a welfare-centric family office that serves the family in many ways. It will work with professionals to form and maintain trusts, take out insurance, draft and implement family constitutions, support family councils, hold family meetings, handle immigration matters and settle disputes within and outside the family. 

Some families might be more suited to a third type of approach, which I call the ‘value-centric model’: a convergence of the investment-centric and welfare-centric models. A successful value-centric family office should be able to offer a total solution for all aspects of the life of an ultra-high-net-worth family. 

Besides strategising, a successful family office should organise the family’s thinktank, which will provide recommendations from the perspective of the family. The family office will play the role of an internal advisor and, at the same time, reach out for external advice and input from members of different family branches. The work includes forming and administering various committees, such as a guardian committee, investment committee, advisory board and donation committee.

Mix and match

The ability to mix and match is the second factor that makes a family office successful. It means a family office should have the ability, when delivering core functions, to find and structure the best solutions to meet the needs of the family. This is important because an ultra-affluent family will have a level of wealth that lets it create its own games and its own rules. 

Top-tier, mature family offices can mix, match and manage an incredible range of investments, such as internal hedge funds, internal private equity funds, external hedge funds and funds of funds, direct investment and loan projects, and discretionary portfolios under multiple private banks. 

Equally, mixing and matching different trust structures can create great solutions to achieve asset protection, confidentiality and risk management in a cost-efficient manner. First, multiple bank trustees can be used to bring down counterparty risk and concentration risk. This mirrors the practice of many wealthy families, which use multiple private banks even if they do not have their own family office. Second, trust jurisdictions can be mixed and matched to allow the family to tap into the benefits of different trust legislation. Third, some families do not want financial institutions to know about all of their investments, which will be unavoidable if all trustees are bank trustees. In this case, private trust companies and independent trustees can be blended so that financial institutions are not involved in the more confidential pocket of the entire trust structure. 

Ultimately, a family office will be successful if it can help the family keep its money and members together for a long time

As for cost optimisation, bank trustees can be used to hold bankable, liquid assets. If the investments are largely self-managed and are alternative, risky, illiquid or hard to value in nature, it usually makes more economic sense to have them held by an independent trustee or private trust company to bring down the assets under management held by the bank, and the overall cost for the trust structure. 

Sometimes, mixing and matching is a must if there is no ready solution in the wealth-management market. A capable family office can bring together different service providers, including private banks, global custodians and execution brokers, to create its own solution. The total cost will be even lower.

Sustainability

The final but perhaps most important factor is sustainability. Ultimately, a family office will be successful if it can help the family keep its money and members together for a long time. It takes four things to achieve sustainability: the money has to last; the family business has to last; relationships have to last; and the family office itself has to last. 

To make the money last, we have to generate capital appreciation in the long term and, at the same time, produce enough cash flow to meet short- to mid-term needs. The long-term goal was aptly summed up by a client of mine who is a member of the second generation of an ultra-wealthy family: ‘My family office is here to generate 200 years of cash flow.’ To make this happen, the family office needs a team of great people to come up with the family’s investment strategies and implement these strategies skilfully. An internal investment policy and internal control guidelines should also be in place, as if the family office were an external service provider. 

To make the family business last, the family office should help put together and implement succession plans. The specific plans will vary depending on the family and the type of business, but there are common benefits that a family office can offer. First, a succession plan should be agreed on as soon as possible. It is important to identify and agree on the key successors and the compensation policy. Leaving things until the last minute is never ideal. Second, it is important to nurture internal talent. The family office can help the family develop an entrepreneurial culture, look inwards for skillsets and inclination, provide education and training, and give the younger generation the opportunities to learn and grow in the family business or other places. Finally, the transfer of ownership of the family business should be actively dealt with. The family office can help the family agree on the rules for ownership, its transfer and the circumstances under which the transfer is to be restricted. The purpose is to keep the company shares together so that the shareholdings do not become too fragmented after many generations. 

Another contribution of the family office is to identify potential exit strategies, such as an IPO or trade sale. It can also put in place a mechanism to decide whether or not to exit at all, and, if it is decided to do so, the price and other key terms and conditions. 

To make the relationship last, the family office can help manage any internal conflict and bring the family together. In reality, that involves much more than just a mission statement or some written rules. Rather, it requires a well-planned and well-executed family governance system, usually including family gatherings, family councils and family constitutions. 

The list of family governance tools goes on, but it is most important to enhance communication, facilitate genuine dialogue among family members and record decisions. During family meetings, the family’s vision, values and strategies, as well as the latest developments in the family business and wealth, should be shared. However, how much should be disclosed is a delicate matter, because, even within the family, transparency and confidentiality should be carefully balanced. 

Making the family office itself last means creating a long-term operation that can be passed onto future generations. It calls for stability of both people and the business. To retain talent in the family office, competitive and tax-efficient compensation will be necessary. However, equity incentive arrangements in family offices are trickier than in a standard corporate environment because the family might have concerns about losing control. But there are always alternative structures that can make it work. A successful family office should also help manage relationships with service providers to ensure service level and continuity.