Some of the most consequential family office decisions may take place before the family office even exists. For families anticipating a liquidity event and considering setting up a family office with the proceeds, careful planning can help set up the family office for success.
“Pre-liquidity planning can be very complex, depending on the size of the family, or pretty straightforward,” says Justin Bakewell, managing director and head of client strategy for Pitcairn.
Families need to first decide whether the family wants to invest as a collective group or if family members want to be independent.
“There’s nothing wrong with wanting independence — for some family members, that may be why they voted for the exit — but it’s better to have that out on the table early,” Bakewell says.
Assuming they do want to form a family office to continue investing together, they need to work through a number of questions. Most of these have no right or wrong answer, but how the family answers them will determine the shape of the family office and their future investments.
“There are a lot of variables,” says Mohsen Ghazi, partner at Ashurst Perkins Coie, where he advises family offices. “How much wealth are they coming into? Are they going to have a taxable estate?If they have a taxable estate, does it make sense to do some gifting so that they reduce the value inside of their estate and move some appreciation outside of their estate?What are the founders’ needs? How much do they want to pass on? What role, if any, do they see the next generation having — and what should this capital ultimately accomplish?”
Setting goals
When it comes to the details of setting up the family office, the family’s overarching goals may dictate some of the structure.
“The first question is, what are you trying to achieve?” Bakewell says. “Are you trying to achieve family legacy and unity? Or are you trying to optimize the dollars for investment because there’s scalability and leverage with fees? There is always a tradeoff. Those two goals require a thoughtful approach.”
Families also need to consider what services the family members desire from the family office, Bakewell says. These can include investment advisory and reporting, family engagement and education, bill pay services, and tax advisory including trust and estate planning and insurance needs. Understanding what services will be provided can help make decisions about what to do internally and what to outsource.
The governance structure should be an early decision.
“Perhaps the most important consideration is the architecture and the governance around the family office,” Bakewell says. “What is the governing body? Is there a family council? Are there operating documents that help everyone understand the job of that family council, succession planning, who has decision-making authority? What committees will there be?”
If the family is planning to invest via a pooled collective vehicle, there needs to be a governing document that lays out roles and responsibilities.
“The families that don’t have that can get paralyzed — they can’t make a decision,” Bakewell says.
If the goal is to preserve the legacy and the values that created the family’s company, the type of pooled investments is important to consider.
“Maybe the investment committee runs the investment decisions, and you have some sort of philanthropic entity with a committee gives money based on the collective values of the family,” Bakewell says.
Another tricky issue is tailoring communication and participation for each household.
“Let’s say you have got 12 households that want to participate in the family office,” Bakewell says. “How are you communicating across all of those households to understand the family’s individual household needs? Are you being inclusive, transparent? And how do they want to participate?”
And when drawing up governing documents for a family office that is expected to last for generations, it’s important to think beyond the current family members.
“When you’re dealing with a multigenerational family, you have to build flexibility into the documents so that future generations can adapt — but still honor the legacy of the generation that created and stewarded the wealth,” Bakewell says.
Choosing a model
For families that are interested in continuing the legacy and family unit through a family office, the first step is to educate themselves on the types and structures of family offices.
“You can organize a family office all by yourself. You have complete control and total confidentiality if you own everything and have no real outside providers. That’s one model,” Bakewell says. “Another model is a hybrid, with some internal employees and other functions outsourced.”
A third option is to outsource everything.
“Each one of these requires a different set of skills and a different cost structure. Unless the family has a massive liquidity event, the family office usually falls in the middle: some sort of hybrid,” Bakewell says.
Formulating goals, drafting governance documents and choosing the best family office model all require good family communication. Ghazi recommends taking a step back first.
“Start with the family story before the balance sheet,” Ghazi says. “Explain where the wealth came from, what sacrifices created it, what the business meant to the family, what values they hope to impart. Those all can be helpful conversation points with the children.”
Those conversations should include gauging the next generation’s interest in continuing the family office.
“One angle is succession planning before the family office is even formed: If my kids are put in charge, are they equipped to come into this immense wealth?” Ghazi says. “Should we have some sort of progressive transition process? There’s also the question of how much to disclose to the next generation about the scale of the wealth, and when.”
And these conversations may not be just G1 talking to G2.
“G2 may be in their 40s and have sophisticated Wall Street experience,” Ghazi says. “They may be hearing what their friends are doing, seeing the cost leakage they’re incurring, and seeing investment opportunities like club deals and saying, ‘We need to think about operationalizing our portfolio.’”