The life cycle of the family office

The life cycle of the family office Leslie C Voth Pitcairn At its best, a family office works at the intersection of wealth and family. It focuses not only on achieving targeted financial results for its clients, but also on helping them understand how to use their wealth as a source of both individual strength and family connectedness. The ultimate goal is to empower family members to be responsible stewards of their wealth and heritage. But like all organisations, family offices are affected by changes over the course of time and must evolve with the changes or lose their effectiveness. To survive and succeed, the office must engage in strategic thinking and long-term planning, communicating with, and helping to educate, family members as they make the transition to new generations. 1. The evolution of the family office At its outset, the typical family office is usually shaped around the needs of the founder the patriarch or matriarch who is the creator of the family s wealth. These founders normally expect the office to coordinate investments and philanthropic activities, and to manage the acquisition of assets like real estate and art. The family office may also provide personal accounting, legal and lifestyle management services. Whatever the exact details of the founder s requirements, the sole purpose is to serve the needs of the family. And of course as the wealth of a high net worth family increases, so does the extent of the family s needs, placing greater responsibilities on the family office. Major changes invariably begin to occur when the family makes the transition to a new generation. During this transition, the family office team must serve the needs of more than one generation, and it must adapt to the needs of each family member s household, even when the needs differ greatly from individual to individual. One of the most important tasks of the family office during this period is to ensure that the next generation understands what it is inheriting whether it is partnerships, foundations, private equity structures, or the family business since it may well be getting a more complex and illiquid wealth structure than the previous generation dealt with. Education is, therefore, the key to empowering good decisions. In some cases, members of the next generation may ask whether there is a reason for the family office to stay intact. They may question whether they need the same services as their parents or grandparents, whether they want to continue paying the fees, whether they want more (or less) income than their predecessors, or whether they want to give the wealth away. 237

The life cycle of the family office Quite obviously, the family members need to come together to develop a shared vision for the future. A positive decision to keep the services of the family office is more likely to be made if the office is able to demonstrate that it can successfully serve multiple generations. This means fostering transparency and open communication, choosing financial advisors who are right for the family, and making a commitment to educating and mentoring young family members as they mature into decision-makers. There are other key questions, too: what is the best way for many decisionmakers to work together, and how does the power of decision-making get shared and then transferred across generations? Ideally, the family office will create an open dialogue in which each family member feels empowered to contribute opinions and take part in decisions that keep the family intact and financially successful over the long term. The goal is a structure that will help the family office continue meeting the family s evolving needs. 1.1 Stepping back to move forward Wealth preservation is always a major goal for both the family and the family office. But it s family preservation that leads to the greatest success. If family members can, so to speak, take a step back from the ordinary flow of events to think strategically about what their needs will be in five, 10 and 20-year timeframes, they ve begun the long-term planning that is essential. To develop these plans and then carry them out, family members will go through some of the hardest discussions they will ever engage in, because inevitably there will be different points of view and conflicts of opinion. Nevertheless, this process will provide them with the means to define individual roles and iron out the ways in which the different generations can work together. For the patriarch or matriarch, this will usually mean giving up a degree of control, a development that can present challenges. But if the result is to instil future generations with the confidence they need to make critical decisions, and even make their own mistakes, the process will put them on the road to sustainability. It is a powerful experience when the senior leaders of a family agree to assume the roles of mentors, as they step back and let the next generation take charge. Putting aside one s own needs and accepting the needs of the family as a whole can be difficult, to put it mildly, but it demonstrates a true desire to see the next generation thrive. That s why these discussions should begin as early as possible. In fact, the development of a good transition plan can stretch over a few years. During this longrange planning process the family office should be run just as a business would be, while carrying out its obligation to help create a shared vision for the future. As the plan moves forward, it will be necessary over time to consider changes. For example, there may come a moment when some family members don t want their affairs managed by the family office any longer. Understanding their reasons for wanting to leave will be critical for the family office if the goal is to preserve the family as a whole. There are various reasons why a family member would want to disassociate from the family office, or even want to dismantle it entirely. One could be the 238

Leslie C Voth administrative costs they have to pay, which may seem onerous. There may be resentment if the patriarch or matriarch has structured the family office as a topdown operation that leaves the next generation with little or no say in decisions. And sibling rivalries, or at least sibling disagreements, are often a crucial factor. Finding a way to keep family members from falling out with one another and hurting their own best interests by dissolving the family office is often not an easy task. Many of these conflicts can be avoided at the outset when the family office is set up if the first generation avoids locking it into a rigid mindset. Following generations will have their own issues and needs and ways of thinking, so it is important not to stay wedded to one patriarchal (or matriarchal) way of doing things. Instead, it s always good practice to begin with a multi-generation mentality. 2. When the transition stages begin Family offices, like the families they serve, go through changes too. It is a similar evolutionary process. In general, there are three possible outcomes for a family office. In dealing with each of these possibilities, planning for the transition is key. A family office sits at the centre of a wealthy family s universe. Normally, its primary role is investing the family s collective wealth. When done successfully, this expands wealth for all the family members in ways they could not achieve as individuals; for example by allowing more risk-taking. In some cases, it also spurs family members who might otherwise focus strictly on the family business to take up exciting new interests. In any case, there is a greater pool of assets in play, with top professionals overseeing the investments. The family office inevitably expands with the growing wealth to add alternative structures, new partnerships and other useful activities. When the wealth reaches a certain level, ancillary services are often added, including estate planning, paying the bills on time, tax accounting and real estate management. As financial affairs become more complex, most family members usually want these matters handled through the family office. But as the family grows, different needs arise, and these needs change with time. This is when the family office s transition to a new phase becomes an important concern. For example, collective investing in the old way may no longer be acceptable because some family members want more of a say. The very existence of the family office may, therefore, be called into question. When that happens, there are three possible outcomes: the family office may be restructured into a very different kind of operation; it may be merged with another family office; it may be dismantled altogether. 2.1 Restructuring: the Pitcairn story The history of our organisation, Pitcairn, offers an instructive example of how a family office can be reshaped over the course of history. When the three Pitcairn brothers decided to create a family office in 1923, the goal was to simplify their lives. The family had amassed enormous wealth in the 239

The life cycle of the family office early part of the 20th century under its Scottish immigrant patriarch, John Pitcairn, a passionate entrepreneur and private equity investor who ranked among the financial giants of his time, including the Rockefellers and Carnegies. One of Pitcairn s most famous investments was in a formula for plate glass that was so successful it led to the creation of the Pittsburgh Plate Glass Company (PPG). Following his death, his three sons wanted a family office to manage their wealth so that they would be free to explore their personal passions architecture, theology and aviation. The brothers saw the value of assembling all their advisers under one roof to coordinate the different aspects of their lives, including the management of PPG, which continued to flourish, management of their private investments, the accumulation of personal assets (real estate, aeroplanes, etc), support for their philanthropic initiatives and lifestyle management services. As the Pitcairn brothers made the transition to the next generation, they selected an in-law as the new leader of the family office. He was a strong executive who, in keeping with the management style of the early years, centralised most decisionmaking, supported by a small board made up of key family members. He put together a professional investment team to give the family access to institutional investing opportunities. The team built good relations with the family and produced outstanding results over 30 years. Senior team members were even encouraged to coinvest with the family, which motivated them to stay with the family office as they built their own wealth. Over the years, however, this also led to a culture of entitlement and resistance to change. Meanwhile, the family was getting bigger, and individual household needs were changing. A group of Pitcairns did not want to be tied together by commingled, illiquid assets. The only way to provide an exit was to liquidate the holding company, including the legacy investment in PPG. In 1986, the liquidation was completed and the family created a new private trust company. Simultaneously, they made the decision to convert the family office into a multi-family office. We can learn as much from things that do not go well as from things that do. The lesson for the Pitcairn family leaders was that they needed a succession plan for key positions in the family office, which to this day is updated every alternate year. In addition, the leaders adopted a policy called free association which allows family members to leave the family office with their trusts, even if the trust instruments technically do not allow it. That has proved to be a successful formula for maintaining family ties while allowing the individuals who want to go in their own direction to do so without creating conflicts. Once the multi-family office was established, a new family leader committed to transparency and open communication took charge. He recognised that while the old command-and-control leadership had produced solid results for many years, it also discouraged the innovation and creativity that are critical to success in today s world. Equally important, the next generation of family members and employees did not respond well to top-down management that just parcelled out benefits. They wanted to understand what was going on, and they wanted a say in how it happened. Transparency was not only desirable, but necessary. 240

Leslie C Voth All these changes over the years have led to a very different kind of structure at the Pitcairn family office. As the current leader, I carry on the policy of transparency and open communications established by my predecessor while operating the office as a forward-thinking business and bringing in the best management techniques. Our goal is to use strategic thinking and continuity planning to ensure our sustainability far into the future. Pitcairn is a classic example of a successfully restructured family office. 2.2 Partnering with other family offices The second possible outcome for a family office in transition is to merge with another organisation. There are several reasons why this may be the best option to pursue. Not every family office has the capacity to offer a full array of services. In some cases, the office may have expertise in some specific areas but must look outside to meet additional needs such as investment advice, administrative capacity, customised education or fiduciary services. Therefore, sometimes a family office chooses to partner with another entity, like a multi-family office, enabling the management team to concentrate on business affairs while the new partner helps manage the added family needs. Let us take the example of a family whose patriarch passed away unexpectedly. He had always managed both the family business and his family s personal assets through its family office. The family office also handled personal tax compliance, insurance, estate planning and household administration. The significance of the patriarch s death was much greater than his wife and children could have imagined, since no family members were involved in the financial affairs of either the business or the family office. Most of the family s assets were maintained within the holding company to support the growth of the business. That meant that none of the individual household s needs were considered independent of one other. Everything was done collectively, which meant the adult children did not have a solid understanding of their financial picture. Not surprisingly, they began expressing a desire for greater control of their portfolios and an end to the family office s centralised control over their families financial affairs. The new president of the company, to whom the patriarch had given just about all his business and financial responsibilities, agreed that a new governance structure was needed. He also saw the need for individual family members to take responsibility for their households. On the recommendation of a business consultant, the president brought in a multi-family office to serve as an external chief investment officer. Financial statements and projections for each family were created. Each of the adult children was given the tools to make his or her investment decisions. Forecasts were made on the business s capital needs over the next 10 years. The multi-family office, working collaboratively with the family members, the president, the consultant, and the family council, determined what each household needed to maintain its lifestyle over the next 10 years. What arises from this process of merging the original family office with a multi- 241

The life cycle of the family office family office is future stability and growth, with individual family members now having a voice in their own financial futures. 2.3 Dismantling the family office There may come a time when a family decides it no longer makes sense to keep the family office. Perhaps a new generation of family members concludes that the office does not serve any meaningful purpose in their lives. Perhaps the wealth of the family has been depleted and the cost of the office can no longer be sustained. Or the Dodd-Frank regulatory changes of 2010 in the United States that sought to clarify what constitutes a family office might lead to the dissolution of an office that cannot meet the standards. One example is a family office that had been around for more than 50 years but was tied to an investment scandal that had significantly reduced the family s wealth. The scandal led family members to question the existence of the office, and since the office had been created by the patriarch and matriarch to meet their own needs, the children concluded that there was no point in funding it any longer. It took two years and a well-crafted transition plan for the family office to be completely unwound. There was a lot involved: the disposition of real estate, artwork and furniture; scanning every record; building a website so the family could easily access everything; and reviewing the long-serving staff. One year was spent conducting the analysis and making tough decisions. The second year was the implementation of the plan. What steps can a family office take to avoid being dissolved? In some cases, the fate may be unavoidable; after all, it is the family that ultimately makes the decision. But the solution is to focus constantly on transition planning so that the office always keeps current with changing family needs. The family office has to be in sync not only with the founder, but also with each succeeding generation. The key is good planning. It s not very different from strategic planning for a business. Typically, one would map out a three-to-five year strategic plan, test it, keep it up to date, and try to anticipate what might be just over the horizon. In the case of family offices, it s the same concept: Get the family and the office together to do a strengths, weaknesses, opportunities and threats analysis. Ask questions like: Where are we going to be in five years? Are there employees at the family office who need to be replaced? Is there anything we are not doing that we should? Part of the process may be getting the patriarch or matriarch to think about a future that one day will not include them. That s hard for them, hard for the family, and hard for the family office. But it is crucial to think down the road. This is an extract from the chapter The life cycle of the family office by Leslie C Voth in Family Offices: The STEP Handbook for Advisers published by Globe Law and Business. 242