Seven Considerations Before Creating a Family Office

Transcription

1 Seven Considerations Before Creating a Family Office Should I create a family office to manage my wealth and investments? This is a question that many wealthy families with over $100 million in investable assets ask themselves. For some families, it s a reasonable consideration. For others, the idea of a family office may sound alluring, but in reality it is not the right solution for them, their children or future generations. This article explains family offices, what it takes to create one, who should consider creating one and who is better suited to work with an established private wealth manager focused on ultra-high-net-worth clients. Jake Turner Vice President What Is a Family Office? In its most general form, a family office is a wealth manager created by a family to meet its unique wealth and investment needs. 1 Family office investment services include asset allocation and third-party investment manager selection at a minimum, 1 When a family office is created for one family, it is typically called a single family office. For purposes of this article, the focus will be on single family offices. A multi-family office (MFO) is the same idea, but has the assets of multiple families, oftentimes to achieve scale. MFOs sometimes accept outside money, which makes them similar in many ways to a traditional private wealth manager. The future of wealth since 1818.

2 and larger family offices sometimes offer internal investment management as well. The first hire is oftentimes a chief investment officer (CIO), who, for smaller family offices, often serves as the day-to-day CEO as well. Larger family offices typically have a CEO, a CIO and investment teams that the CIO hires and manages. They also have operations professionals who focus on investment implementation, trading, reporting and systems to manage these and other processes. Many family offices also have wealth planning and ancillary services related to accounting or other financially related activities. Those that offer wealth planning and accounting have lawyers, who advise on trusts and estates or family entities like limited partnerships, as well as accountants on staff. Others have professionals focused on a wide array of services from bill pay to aircraft financing and maintenance, depending on the needs of the family members and what services they want to pay for. The number of professionals employed also depends on the level of insourcing vs. outsourcing. A huge benefit of having a family office is the ability to choose the services that the family wants to include. Having a dedicated staff and tailoring all services based on one s interests allows for a truly personalized, integrated client experience. The wide range of asset levels of family offices from $100 million to billions of dollars coupled with the variety of services found at different family offices and the variation in number of family members served from just a few to hundreds across multiple generations has resulted in the oft-repeated phrase, If you ve seen one family office, you ve seen one family office. All of this leads to the question: Who should consider creating a family office, and who is better suited to work with an established private wealth manager focused on ultra-high-net-worth clients? Seven Questions to Ask Before Creating a Family Office Let s define family offices as a substitute for a private wealth manager for the purposes of this discussion. In that case, the decision to create a family office comes down to seven questions: 1. What are your asset levels? 2. What services are you seeking? 3. How much are you willing to spend to receive those services? 4. How important to you is client service? 5. Do you have an interest in creating a sustainable business? 6. Do you have the time to devote to the creation of a family office and successors who will continue to oversee it? 7. Do you have a strong point of view on investing and an interest in being involved in investment decisions for you and your family? Asset Levels and the Cost of Services To begin, let s review the trade-off between a family office and a private wealth manager for questions one through three by examining Exhibit 1. If you would like to start a family office and require a number of services, you need to be willing to spend a sizable percentage of your assets which is analogous to a fee charged by private wealth managers to receive the services you seek. A family with $50 million or $100 million in assets can likely receive most of those services for less money by hiring a wealth manager, which typically benefits from greater asset levels and scale and may in addition provide access to a broader service suite. However, a family with significant assets, as in the far right column of Exhibit 1, may be able to receive highly personalized services at a lower fee than what it would pay for a private wealth manager. This fact often becomes an important factor for families with billions of dollars, as does the fact that family offices are nonprofits in that the cost to operate them is not meant to create a profit, but solely provide services whereas private wealth management fees cover a number of services but are also meant to create a profit. That said, a family office s assets typically diminish over time, while complexity increases, as future generations are often net withdrawers rather than con- l 2

3 tributors, and more family members require more accounts and client service professionals. 2 Thus, a smaller asset base for a greater service level raises fees. To offset this loss in assets and rising costs over time, many single family offices choose to merge into a multi-family office, resulting in a certain level of lost autonomy as compared to a single family office. Exhibit 1 FEES ASSET LEVELS $50,000,000 $100,000,000 $250,000,000 $500,000,000 $1,000,000, % $200,000 $400,000 $1,000,000 $2,000,000 $4,000, % $250,000 $500,000 $1,250,000 $2,500,000 $5,000, % $300,000 $600,000 $1,500,000 $3,000,000 $6,000, % $350,000 $700,000 $1,750,000 $3,500,000 $7,000,000 Source: BBH Analysis. The information in this table is for illustrative purposes only. In addition, while the greater asset sizes and higher fee figures appear to produce a large amount of money available to service one s family office, it s important to consider that expenses can pile up fast. And more services and greater complexity lead to more of a cost. What follows are some examples of what could contribute to a family office s fee. If it has a physical office, it needs to pay for real estate and occupancy; highquality executives (median CEO annual compensation ranges from $300,000 to $830,000), investment professionals (median CIO annual compensation ranges from $312,500 to $650,000), attorneys and accountants all command six-figure salaries and benefits 3 ; client service, operations, risk and compliance professionals may be necessary and all require salaries and benefits; there are heavy costs for trade management, accounting and reporting systems; a central custody and administration system is necessary to consolidate all assets; and there are a number of essential additional costs, including insurance, travel for staff, outside legal expenses, a customer relationship management system to manage critical information about each family member, human resources and cybersecurity, to name a few. Outsourcing some of these functions is possible, but to do so, families need to source vendors, manage those vendors and costs and accept less control. On the topic of staff, competitive compensation and benefits are just one aspect of finding, attracting and 2 According to Fidelity Family Office Services 2015 SFO Executive Compensation Survey, on average, family offices support four branches of a family, 2.7 generations and 19.7 family members, with the ratio of staff-to-family members at Source: Fidelity Family Office Services, 2015 SFO Executive Compensation Survey. retaining the best individuals to oversee a family office s operations and services. Just like for any other employer, to appeal to candidates, firms must have a strong value proposition and provide prospects with a desirable career path. Post-hire, family office managers need to manage employees and focus on retaining talent in the same ways that other established employers do. This is particularly important when one considers that most C-suite and experienced professionals are likely coming from corporate environments that have structured employee retention programs. Sustainability also comes into play when evaluating family office employees. While someone who is interested in founding a family office may have the appropriate staff at the time, it is important to consider who will oversee the family office and various functions once the owner and key employees reach retirement. For those with limited knowledge or interest in recruiting, fostering and motivating employees or who lack a successful succession plan, an experienced private wealth manager can shoulder that burden. The Importance of Client Service As noted, one of the biggest draws of starting a family office is the ability to pick and choose which services a family wants in order to create a personalized experience. Having a well-resourced staff dedicated solely to one s family can certainly result in valued advice, excellent service and meaningful relationships if the firm hires employees who truly understand the family s needs and motivations. Alternatively, with a private wealth manager, a family can also experience client service excellence and deep l 3

4 relationships. In either case, it comes down to the people servicing the relationships and the time that they have to devote to their clients. One potential benefit of the private wealth manager model is that experience working with many families allows client service professionals to leverage knowledge gleaned from other relationships to provide useful information about what other families have done in similar situations to arrive at the best possible solution for clients. However, client service professionals at family offices, especially smaller ones, have fewer clients and can therefore devote more time to each. For that reason, when considering a private wealth manager, it is important to determine whether client service professionals will be able to devote enough time to meet the needs of one s family. Are You Ready to Start and Run a Business? Underlying much of the prior discussion are questions five and six: Do you have an interest in creating a business and the time required to do so? The steps involved in building a family office, practically speaking, amount to starting a business. It requires a tremendous amount of work and oversight. This article has touched on the former point; on the latter, single family offices need a governance infrastructure, which includes establishing relevant boards of directors and committees, such as a compliance committee and audit committee. Having governance assists the family with succession planning and preparing the next generation to inherit wealth often a leading concern among founders and helps maintain transparency across the family and prevent disputes. It also prevents regulatory violations and fund misappropriation. Individuals who have the drive and motivation to create and run a family office must also determine whether the business will be sustainable. In order for the family office to remain intact once the original founder is no longer able to run it, family offices need a successful succession plan in place to transition to the next generation. For those who enjoy the excitement of creating an organization and have the time, or those who want to occupy retirement with meaningful and personally rewarding work, starting and potentially managing a family office may be a great option. For those who don t want the hassle, the right private wealth manager may be a better alternative because it provides more of a turnkey solution. Even for those who require a service not offered by a wealth manager, hiring two providers can often achieve one s goals while keeping costs, service providers and the time commitment more manageable. Investment Philosophy Finally, families should consider their level of interest and involvement in investing, which is in many ways the backdrop for the entire decision about whether to create a family office. The main focus for most family offices is wealth management. In order to create a wealth management organization to oversee a family s assets, as well as those in the next generation, it is important to begin by defining the family s goals and investment philosophy. For example, at BBH, we have an entire article that lays out our investment beliefs, which focus on 1) performing bottom-up fundamental research on all investments, 2) purchasing securities at a discount to our estimate of their value and holding them over time until they realize their full value and 3) only partnering with third-party investment managers who think and invest the way that we do. If you are contemplating creating a family office but do not have a philosophy on how you would like your assets managed, it may make more sense to interview a number of private wealth managers and hire one. Experienced private wealth managers can help families determine their investment objectives and philosophy, desired level of risk and time horizons in order to oversee asset allocation, outside manager selection and monitoring and investment strategy and performance. For those families that have a clear vision of their investment philosophy and perhaps even investing experience, but that do not want to lead their family s investment office, hiring an outside CIO to manage family office investments in line with that philosophy may be the right solution. l 4

5 One related issue to be aware of: The size of the family office can affect the CIO s ability to implement its defined investment philosophy. Access to the best investment managers may be limited by asset size; for example, until a family office passes the billion-dollar mark, it is difficult to construct a fully diversified private equity offering with top managers, as they often require investments of $10 million or more. Furthermore, a family office needs to hire a team to conduct due diligence on managers, and many only have the budget to hire one or two people, whereas a private wealth manager has an entire dedicated team. Conclusion Like most decisions, there are pros and cons to creating a family office. Some of the attractive features of family offices include highly personalized services, control, exclusivity and lower fees. However, the benefits of highly personalized services are most evident for highly idiosyncratic services. In addition, the benefit of control diminishes as a family grows and more members exert influence on the decision-making process. The benefit of lower fees is only a benefit if a family office has the assets to support the family members and service suite it requires. Downsides to starting a family office include the tremendous amount of work it requires compared with hiring a private wealth manager. Those creating or overseeing a family office need to have a point of view on investing, the ability to hire personnel to implement their investment philosophy and insourced or outsourced wealth planning services at a minimum in order to preserve and grow capital. An execution failure can lead to the permanent destruction of a family s wealth. Finally, like most businesses, family offices take some time to hit their stride, but time is the enemy of a family office that does not have a new asset stream. For example, if the first generation (G1) creates a family business and sells it, and G2 and G3 live off of the wealth created but do not meaningfully create their own, then the assets of the family office will begin to deplete over time, raising fees for the same set of services. However, like the pros, the cons have a flipside as well. For instance, many people enjoy the work of creating and managing a family office and are well-positioned from an investment and hiring perspective to do so. In addition, many family offices have a new asset stream for example, those that receive regular dividends from the current ownership of a family business. Others open their doors to outside families (multi-family offices), and some even become for-profit entities from which the founding family benefits. The considerations for starting a family office are plentiful. This article merely scratches the surface on what it takes to create one and the circumstances under which it is a good decision for families. To learn more about this topic or have a conversation with a BBH professional, please reach out to jake.turner@bbh.com. l 5

6 BBH serves as a family office for many wealthy families who have determined that a private wealth manager is a better fit for their situation and needs. Our service offering includes everything from investment management, asset allocation and manager selection to wealth transfer and tax planning, family business governance and education, and trust and estate administration. Some individuals may be concerned about hiring a private wealth manager because they do not want to get lost in the crowd at a big bank, but BBH provides an option in between that of a smaller family office and a large bank. Because we have the resources of a large, global firm and the feel and approachability of a boutique provider, clients have both a wide range of investment options and opportunities to create tailored portfolios, resulting in a more customized investing and planning experience. In addition, our clients experience service levels that we believe distinguish BBH, as our private partnership structure allows us to focus on their long-term objectives and best interests and creates a true alignment of interests. Our relationship managers are long-tenured professionals who have spent the vast majority of their careers at the firm, and our teams maintain a limited number of clients, which allows them to know clients well and build long-term, trusted relationships that span decades and even generations. This publication is provided by Brown Brothers Harriman & Co. and its subsidiaries ( BBH ) to recipients for informational purposes only. Opinions and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable but should not be assumed to be accurate or complete. This does not constitute legal, tax or investment advice and is not intended as an offer to sell or a solicitation to buy securities or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code or for promotion, marketing or recommendation to third parties. This information has been obtained from sources believed to be reliable that are available upon request. This material does not comprise an offer of services. Unauthorized use or distribution without the prior written permission of BBH is prohibited. BBH is a service mark of Brown Brothers Harriman & Co., registered in the United States and other countries. PB Expires 5/31/2020 l 6