Structuring the family office for flexibility

In his years managing his family office, Gary Katz has seen changes both in how his own family invests and in the broader family office landscape. He talks about what he has learned and how his family office, Downtown Capital Partners, LLC, is structured:

Image by Cassidy Reed

On the professionalization of family offices: A remarkable number of successful business people have family offices but don’t know it. At its core, a “family office” is born each time someone who generates a significant amount of wealth decides to start investing in things outside of their main vocation and core competence. Before you know it, they’re making so many investments that their ‘one off’ side investments become more important to their family than their original business. People never used to call that a family office – it was just what wealthy families did. But in recent years, wealthy families have recognized the importance of running their side investments with the same focus, vision and professional teams as they would any other business. 

There’s no rocket science here — it’s common sense to professionalize your family office. No one who grows pork or beef proteins, for example, would try to do it without a team of people who know how to manage pig farms or cattle feeding lots. But people will invest half a million dollars of equity into a real estate deal or start-up tech business, then another, and before you know it, they’ve got $5 million of equity invested in half a dozen investments levered by millions more of debt. They would never advise their own children to shoot from the hip like that — they would tell them to go follow a passion of theirs, become an expert on it, and become a business leader in their area of expertise. We need to listen ourselves to the advice we would give others: Be deliberate and professional about where we invest.

Building a successful family office requires expertise that is somewhat different than what is used to create and grow an operating business. Like a mutual fund or private equity fund, family offices take capital and passively invest it into businesses that are run by other people. Unlike the CEO of a company, the leader of a family office has to focus on after-tax returns, wealth planning for children and grandchildren, the strategic utilization of trusts, and making difficult decisions about ownership and control over investments driven by concerns about family dynamics, not just maximizing returns. A CEO of a public company or managing partner in a partnership does not care about shareholders who sell or partners who exit a partnership, but in a family office you care a lot about children who decide they want to withdraw some or all of their stake so that they can start their own business. Dealing with all of these issues effectively requires not just expertise, but an independent point of view from investment professionals or board members who are not themselves part of the family.

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On the origins and growth of your family office: My dad ran a parking company based initially in New York City that grew to be the second largest in the U.S. He used to say he spent 80% of his time on the parking company but made 80% of his money buying real estate he liked near the lots and garages his company ran. When he died in 1987, he left behind significant real estate holdings — he owned over 30 buildings in New York City — but because his full-time day job had been CEO of the parking company, he left behind no dedicated staff, apart from outside accountants and lawyers, who knew anything about his real estate. Three years later, when the economy crashed, we ended up being forced to sell most of the properties at terrible prices to minority partners who had the real estate experience to drive value from the investments. At the time, I was in law school, and I decided I was never doing that again: I vowed that like my father, I would be in charge of all of my own affairs, but for the sake of my family, I would make sure I’m not the only one that knows what’s going on and has the experience and skills to immediately pick up the flag and move forward should I falter (or decide to retire, for that matter).

After law school, I worked as a law clerk for a federal judge, a lawyer at a bulge bracket law firm, then as a manager in a hedge fund, all while simultaneously working with my mother (who had zero prior business experience) to manage our family’s remaining investments. We hired a bookkeeper to help, and while we didn’t use the phrase ‘family office’ to describe ourselves, that’s exactly what we had become. But we frankly didn’t do a great job of it until 2009, when my sisters encouraged me to leave the hedge fund and run our family investments full-time. I hired a controller, then a CFO, then investment professionals to focus on real estate and structured lending. Before long, our deal flow was larger than I could handle with our own capital, so I took on a partner and launched a private lending business that syndicated investments to other family offices.

On how your family office invests today: Today, I focus my time primarily on investing for my own family: myself, my two sisters, our nine children, and a cousin (and her three children) who is involved in some of our investing activities. My family office has three broad categories of investments:

  • First, we invest in real estate — properties that we held onto from our late father’s investments in the 1970s, as well as some that we have added. We have one investment professional dedicated to this strategy, and my sister, who is acts as COO of the entire family office, spends a significant amount of her time managing our directly held real estate assets. 
  • We also have a private lending business which originates loans to operating companies, distressed real estate projects, and high-net-worth families who are ‘asset rich’ but face liquidity issues. The specialty lending is probably the most interesting, as we have made loans against world-class fine art, expected distributions to the retired founders of well-known private equity and venture capital funds, and even a loan secured by unique ‘second homes’ in places like Big Sur, California, the Hamptons, and even a castle in France. This part of the business includes a factoring company, which makes loans to small businesses secured by their accounts receivable. 
  • Finally, we are a passive investor with a significant portfolio of stocks, bonds, hedge funds, and private equity funds.  We structure this portfolio in house, but with substantial assistance for an outsourced RIA.

On structuring the family office for flexibility: I think the key to growing wealth in a family office is to have the right mix of in-house and outside investment professionals on your team.  But if I personally am an expert on anything, I believe it’s setting up a family office so you can have the efficiencies of investing collectively with the flexibility to also invest separately. It is critical to me, and my sisters, that we have the ability to unwind the way we have deliberately and thoughtfully tied ourselves together.

Image by Cassidy Reed

The key tools we use are series partnerships (sometimes known as ‘Class Partnerships’). This structure allows each partner to adjust the amount of capital it invests into individual assets, almost like having a family of different mutual funds to choose from. Let’s say in general my sisters and I own equal stakes in our real estate investments, but when I branch out and decide to make a loan secured by fine art through our family office, my sisters are less enamored of the risk-reward profile than I. We simply establish this investment as a new investment ‘Class’ – call it ‘Risky Investment No. 22’ — and for that one, instead of equal investments, I might put in $90 for each $5 that my sisters put in. 

Over the past 20 years, we have found this be an effective way to benefit from economies of scale by having all our money in one family investment pool, while also providing the flexibility to manage each of our risk profiles individually. Our professional staff and counterparties deal with all our money collectively. We share one back office and one set of investment professionals. We use one registered investment advisor to help us choose appropriate third parties to run our managed accounts and help us diversify through hedge funds and private equity funds. But inside our partnership, we keep track of a variety of different investment classes so family members customize in many ways how their share of the family wealth is invested. 

This structure also makes it easier if one family member needs cash for personal reasons or just to go their own way on an investment they don’t want to make through their pooled family vehicle. In a standard partnership, you have to value very single asset in order to accurately adjust partnership ownership stakes following a non-pro rata distribution. But in a series partnership, so long as at least one of the classes is invested exclusively in securities like publicly traded stock or bonds that are readily valued at the end of every day, distributions and ownership adjustments can be made with very little friction. If a single family member needs cash, instead of having to value the whole partnership, including illiquid and hard-to-value assets like real estate, closely-held operating companies, or private equity funds, the series partnership can exclusively adjust the proportional ownership of the stock or bond class of investments, leaving the illiquid investments owned in the same proportions after the non-pro rata distribution as before.

About the Author

Margaret Steen

Margaret Steen is the editor of FO Pro, The Family Office Professional. Based in Silicon Valley, she has written for Family Business Magazine for more than 15 years.


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