September 01, 2010

This article begins with a brief history of family offices and a summary of the major functions of a family office. This article then outlines the evolution of the most common family office models, single-family offices (SFOs), and multi-family offices (MFOs).2 Lastly, this article examines the current challenges family offices are facing and then provides options for families who are contemplating the family office model or determining whether their existing family office model is sustainable.

Overview of the Family Office

History of the Family Office

Family offices were first established over a century ago by families who enjoyed the success of family businesses, which created a need for centralized management of the families’ wealth generated by those businesses.3 Judge Thomas Mellon, John D. Rockefeller, Henry Phipps, and other great American entrepreneurs created the first family offices in the United States.

Major Functions of the Family Office

Over time the family office developed many functions in servicing its family with a holistic approach to managing the family’s wealth. According to the Family Wealth Alliance, a Chicago-based research and consulting organization for family offices, the ten functions most often provided by a family office are:4

1I Comprehensive financial planning

2I Portfolio management

3I Back office/Consolidated reporting

4I Estate and wealth transfer

5I Tax planning, preparation and compliance

6I Risk management

7I Trustee services

8I Life management

9I Family governance and education

10I Philanthropy

However, because family offices are tailored to serve the individual needs of their families, the services offered vary widely.5

Family Office Models

The family office has evolved into different models, primarily the single-family office and the multi-family office.

The Single-Family Office

From the late 19th century until the 1980’s, the single-family office (SFO) dominated. Family Office Exchange (FOX), a Chicago-based advisory, research firm and affiliation of family offices, defines a SFO as “the organization that is created, often after a sale of family business or realization of significant liquidity, to support the financial needs (ranging from strategic asset allocation to record keeping and reporting) for a specific family group.”6 The SFO is comprised of a staff of administrative, legal, accounting, investment and other professionals hired to work in a single office exclusively for the benefit of that single family.7

Thus, one of the primary advantages of a SFO is the focus of all of its efforts and attention to the needs of one family. Each family member benefits from a group of professionals who can develop a deeper understanding of that family member’s needs and wishes and then provide an integrated approach to address the family member’s goals. Having one consolidated group of professionals means that a family member only needs to interact with one central source – the family office – and not a number of different service providers.

Additional advantages of a SFO are control and privacy. Wealthy families want to maintain absolute control over the people advising them, which maximizes their privacy. Other benefits of a SFO include:

  • Delivering objective advice.8
  • Pooled purchasing power across a family group, resulting in better service for a better price than individual family members could attain on their own.9
  • Passing along family heritage, trusts, values, or philanthropy from generation to generation.10
  • Providing leadership in governance and education of family members on responsibilities of ownership.11

The main disadvantage of a SFO is the high cost to operate the office. The physical office, technology, highly qualified personnel and access to the best services and investment vehicles is very expensive. Many experts generally advise that a SFO needs assets of at least $100 million to be economical,12 but other experts estimate that the SFO should have assets in excess of $400 million to support the professional personnel needed to manage the assets.13

The Multi-Family Office

From the 1980’s to present, multi-family offices started gaining traction. FOX defines a MFO as “an organization that provides family office services to more than one family group.”14 The MFO tries to provide the customized, high-quality services of a SFO but for more than one family, which provides cost efficiencies by spreading expenses over a larger asset base.15 MFOs provide their family groups with the advantages of a family office, but without the need to create a separate infrastructure of service professionals.

The biggest disadvantage of a MFO is that the professional personnel is not dedicated solely to one family group so it cannot focus on the needs of one family as a SFO can.

Challenges of Today’s Family Offices

When a family is deciding on which family office model best suits its needs, it often has to weigh factors such as cost against control, privacy, and service level. Recent events, such as the global economic crisis, investment scandals, threats of increasing regulation, increasing costs and higher demands for service, all have highlighted families’ need to re-evaluate their family offices and have raised concerns regarding the long-term sustainability of SFOs.16 Family Wealth Alliance reported in late 2009 that 58.8% of SFOs are somewhat concerned or very concerned about their long-term sustainability.17 That number rose to 83.4% with family offices with less than $100 million in assets.18

Three main areas have affected sustainability: (1) the regulatory environment, (2) investment strategies and risk management, and (3) staffing and governance.19

Regulatory Environment

In the wake of Madoff and other investment scandals, regulatory changes were looming. Family offices were bracing themselves for proposed federal legislation requiring them to register with the Securities and Exchange Commission (SEC) as an investment adviser or a fund.20

Firms with a limited number of clients traditionally had qualified for an exemption from SEC reporting requirements,21 but several bills had been introduced with proposals specifically targeting family offices to eliminate that exemption.22 The loss of the exemption would subject family offices to intensified SEC oversight and new reporting requirements, jeopardizing the family’s privacy and confidentiality and ramping up the family office’s operating expenses.

In a partial win for family offices, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act on July 21, 2010. The Act exempts family offices from the definition of “investment adviser” and, thus, from SEC regulation. However, uncertainty still remains because the Act does not define the term “family office.” The SEC is directed to define “family office” in a manner consistent with its established policies and rulemaking. Thus, family offices and their advisers should continue to monitor the regulatory environment for further updates.

Investment Strategies and Risk Management

Another area family offices should re-evaluate is investment strategy, which goes hand-in-hand with risk management. According to Family Wealth Alliance’s recent 2009 SFO Study Report, investment issues tied as the biggest challenge for SFOs, along with family cohesion and governance.23 The same study reflected that during 2008’s economic downturn, 82.2% of SFOs reviewed their investment practices and 47.7% made changes.24

Family office experts recommend that best practices in re-evaluating investment strategies include:25

Articulating clearly defined investment objectives and policies for each family entity and trust and sticking to them, which includes understanding the family’s liquidity needs and matching those needs with appropriate investment asset allocation and time horizons.

Conducting the appropriate due diligence and research in managing risk.

A good investment policy, however, only is as good as it works for a family member’s particular circumstances, liquidity requirements, and specific investments. Thus, stress-testing these policy guidelines using various analytical tools and performing extensive due diligence and research on investments are important.26

Staffing and Governance

Over time, families have required more services from their family offices. According to a recent Family Wealth Alliance poll, despite the economic downturn, 48% of family office personnel have received new or additional requests for services from family members in the past two years.27 Education of younger generations, estate planning and accounting have become more necessary and complex as families grow. To meet the increased service requirements, the family office must evaluate whether it has adequate staffing to accommodate.

Family offices should identify which services are most critical to the family and decide whether it is more advantageous and efficient to manage the services in-house or to outsource them.28 Regardless, it is critical that the service provider be a good fit with the family office in terms of understanding the family’s goals and needs and being able to assess the family’s entire picture. However, finding the total package sometimes can be challenging. Determining the right compensation structure is equally, if not more, difficult. Family offices find that there is a trade-off when structuring compensation packages – the cost of highly skilled professionals versus attracting the best candidates. Also, the compensation structure should reward the right behavior. For example, when some families re-evaluated their pay structures, they found that they were placing more focus on rewarding for return, rather than on risk management or proper alignment of interests.29

Lastly, governance has become more of an issue as families grow from generation to generation. Education of the younger generation and finding ways to encourage their involvement is increasingly important for the sustainability of the family office. As one expert aptly noted, “You can’t have a family office without the family.”30 One way to solidify the family’s mission for younger generations is to create a family constitution, which can describe the core values of the family and its philosophy, as well as lay out the family’s goals and objectives.31

Family Office Options

Whether a family is considering creating a family office or an existing family office’s sustainability is being challenged, there are alternatives to a SFO structure which can reduce costs and satisfy the family’s long-term objectives. While the SFO model still could be the most suitable structure for a particular family, families also may consider a MFO or a combination SFO/MFO.

Considering a MFO from the Outset

If a family does not have a family office and the cost, time, and effort in building a SFO is too restrictive or daunting, the family could consider a MFO. Many families who do not have the suggested $100 million asset base may not be able to justify establishing a SFO, and as a result, MFO firms have been “taking on larger, more complex families that were once reserved for those who would create or retain their own single family office.”32

Because of its larger asset base than most SFOs, MFOs can provide economies of scale shared across multiple family groups, including new growth capabilities, access to better technologies, improved ability to attract and retain skilled professionals and instant access to deeper expertise and experience in working with affluent families.

Options for Existing SFOs

What are the options for an existing but struggling SFO? The family may decide to (1) close the SFO in favor of an established MFO with similar interests, (2) create a MFO, or (3) maintain the SFO but outsource certain functions to a MFO.

Closing the SFO in Favor of a MFO

Given the tumultuous market, one study found that, while there were no specific plans to close, 31% of family offices felt that closing was a possibility.33 While the decision for a family to close its SFO is very difficult and emotional, the family may find high-level, personalized service from a MFO with similar interests, which can cushion the blow and provide a smooth transition.34

Create a MFO

Another option is to transform the SFO into a MFO. A SFO can open its doors to other families or merge with other SFOs to create a MFO. According to Family Office Exchange, about 15% of its 330 family office clients worldwide have opened their doors to other families, and another 15% are considering doing the same.35 However, building a MFO from a SFO is a considerable undertaking, requiring long-term commitment, experience, significant assets, and a strong belief that the approach will foster family success and unity.36 In addition, families should recognize that by converting a SFO into a MFO, “they will be running a business that has to have a strategy, growth, and provide services for pricing and profit. And that, in turn, changes the culture” of the family office.37 Building out a SFO into a MFO typically requires adding personnel, technology, and policies and procedures, and increases SEC reporting and registration requirements. Because of the various stringent requirements and the cultural issues, very few organizations have been able to successfully build a MFO from a SFO. Glenmede, Rockefeller & Co. and Bessemer Trust are notable exceptions.38

SFO Outsourcing to a MFO

Families do not necessarily have to choose one model. The best fit may be a combination of a SFO working with a MFO. By maintaining the SFO but outsourcing to a MFO, a family can preserve the sense that their SFO is theirs while at the same time accessing the services, technology, resources, and professional talent that may be cost prohibitive to build into the SFO.39

For example, according to Family Wealth Alliance’s 2009 SFO Study Report, SFOs have expressed increasing doubts about their ability to manage their investments in-house.40 33.3% of the SFOs indicated that they did not have sufficient in-house expertise to evaluate investment vehicles and strategies (up from 20.7% in the 2008 study). Because of the insufficient in-house investment expertise, SFOs’ use of external chief investment officers (CIOs) is increasing. The study reported that four in ten participants (39.4%) said that they employ an external CIO (up from three in ten (28.6%) from 2008’s study).

Selecting Existing MFOs

Once a family decides to work with a MFO or outsource to one, how does a family select a MFO from the many in the marketplace? By one estimate, there are about 140 MFOs in the U.S.41

The family first should determine the services it wants and then it can identify the MFOs that provide them. The family should take great care in selecting the MFO because many firms have marketed themselves as MFOs but they are not true MFOs and can fall short on meeting the family’s expectations because they may not actually provide all of the services or the depth of services that true MFOs offer.42

After identifying MFO candidates, the family should interview each to determine the best fit. Some sample questions to ask are:43

  • How long has the firm been working with wealthy families?
  • What is the ownership structure of your firm?
  • What level of experience does my primary adviser have and how many clients does he/she handle?
  • How is my primary adviser compensated?
  • How accessible are the firm’s professionals to me personally?
  • What is your investment platform? What services do you provide in-house, and what do you outsource?
  • What is the firm’s fee structure?
  • How sound is the firm financially?

Conclusion

Despite its recent challenges, the family office, whether a SFO, MFO or a combination of the two, remains a valuable tool for wealthy families in developing a more holistic approach to obtaining long-term success, financially and personally, for its family members.

 


 

1 Family Office Exchange, Frequently Asked Questions Q2 (March 1, 2010), at http://www.foxexchange.com/public/fox/faq.asp.

2 There are various types of family office models: (1) the SFO, (2) the MFO, (3) the multi-client family office (MCFO), (4) family investment management business, (5) external family office, (6) external chief investment officer (external CIO) and (7) virtual family office (VFO). LISA GRAY, THE NEW FAMILY OFFICE 51-52 (2004). This article focuses only on SFOs and MFOs.

3 Id. at 11.

4 Howard M. Zaritsky, Getting the Best from a Family Office, 47 TAX MGMT. MEM. 475, Nov. 27, 2006. For a more comprehensive list of services offered by family offices, see GRAY, supra note 2, at 21.

5 GRAY, supra note 2, at 21.

6 Family Office Exchange, supra note 1, Q1.

7 GRAY, supra note 2, at 11.

8 Pitcairn White Paper Report, TR. & EST., Jan. 12, 2009, at http://trustsandestates.com/press_release/family_offices/pitcairn_white_... (summary of white paper report).

9 Family Office Exchange, supra note 1, Q13.

10 Id.

11 Id.; Pitcairn, supra note 8.

12 Hilary Johnson, Do You Need a Family Office?, BARRON’S PENTA, Sept. 28, 2009, at http://online.barrons.com/article/SB125392425903942689.html.

13 Patricia M. Soldano, When to Use – and How to Choose – a Family Office, 35 EST. PLAN. 20, 21 (Dec. 2008).

14 Family Office Exchange, supra note 1, Q6.

15 GRAY, supra note 2, at 11.

16 Thomas Coyle, Family Offices Turning to Outside Investment Consultants, WALL ST. J., May 17, 2010, at http://online.wsj.come/article/BT-CO-20100517-71848.html?mod=WSJ_latestheadlines.

17 Family Wealth Alliance, SECOND ANNUAL SINGLE-FAMILY OFFICE STUDY EXECUTIVE SUMMARY, at http://www.fwalliance.com/store/exec-summary-2nd-annual.pdf (study consisted of 35 SFOs with average assets under supervision of $605 million); also cited in Coyle, supra note 16.

18 Id.

19 Bessemer Trust, What’s Next for Family Offices?, THE ROUNDTABLE NOTES 1 (Nov. 2009) (white paper notes from a roundtable with Robert Elliott, Senior Managing Director, Bessemer Trust; Amelia Renkert-Thomas, Counsel, Withers Bergman; Theodore Beringer, Managing Director, The Beringer Group; Holly Isdale, Deputy Head of Family Wealth Advisory Services, Bessemer Trust; and Kathryn McCarthy, Family Office Consultant).

20 Id.

21 For an excellent discussion of securities and commodities laws related to family offices before the 2010 Dodd-Frank Act, see Audrey C. Talley, Family Offices: Securities and Commodities Law Issues, 34 ACTEC J. 284 (2009).

22 Family Office Roundtable, Family Offices Face Regulatory Storm, PRIVATE ASSET MGMT. (Feb. 18, 2010), at http://www.iiwealthmanagement.com/Article.aspx?ArticleID=2395683 (summary of roundtable panelists, Tom Guernsey, National Head of Wealth Management, Wilmington Trust; Jamie McLaughlin, CEO, Geller Family Office Services; Carol Pepper, CEO and Founder, Pepper International; and Loraine Tsavaris, Managing Director, Rockefeller & Co.); Joseph Field, Amelia Renkert-Thomas, David Guinn and William J. Kambas, Keeping up with . . .
Family Office Investments, WITHERSWORLDWIDE NEWS & PUBL’N 1-2, Aug. 17, 2009, at http://www.withersworldwide.com/news-publications/600/family-office-investments.aspx.

23 Family Wealth Alliance, supra note 17.

24 Id.

25 Bessemer Trust, THE ROUNDTABLE NOTES, supra note 19 at 1-2.

26 Id. at 2-3.

27 Bessemer Trust, Family Office Conundrum, Sept. 29, 2009 (white paper), citing Gregory Bresiger, Farming It Out, PRIVATE WEALTH (July/August 2009) (article also can be found at http://www.fa-mag.com/component/content/article/4553.html?issue=122&maga...).

28 Id. at 3.

29 Id. at 4.

30 Id.

31 SFOs Worry about Sustaining Legacy, PRIVATE ASSET MGMT. (Nov. 13, 2009), at http://www.iiwealthmanagement.com/SubContent.aspx?articleID=2338642.

32 Average MFO Family Relationship Tops $50 Million, PRIVATE ASSET MGMT. (Oct. 6, 2006), at http://www.iiwealthmanagement.com/SubContent.aspx?articleID=1298725.

33 Family Offices Are Going Back to Basics as Market Events Speed Office Evolution, CANADA NEWSWIRE, Dec. 15, 2009, at http://www.newswire.ca/en/releases/archive/December2009/15/c3237.html.

34 For a list of questions in determining when to close a family office, see Kathryn M. McCarthy, Is It Time to Close the Family Office?, TR. & EST. , August 1, 2009, at http://subscribers.trustsandestates.com/net_worth/0801-when-close-family-office/wall.html?return=http://subscribers.trustsandestates.com/net_worth/0801-when-close-family-office/index.html.

35 Johnson, Do You Need a Family Office?, supra note 12.

36 Id. at 12-13.

37 Patricia Soldano and Kathryn M. McCarthy, SFO to MFO Conversions, TR. & EST. 44 (Aug. 2005).

38 Id. at 13. For the history of the Phipps’ family office’s journey from SFO to MFO, see Robert C. Elliott, From Single-Family office to Multifamily Office, J. WEALTH MGMT. 12 (Spring 2010), quoting Charlotte Beyer and Timothy Brown, Does a Multifamily Office Make Sense for You?, FAMILIES IN BUSINESS 78-80 (Jan. 2008); and Bessemer Trust, Our Heritage (2010), at http://www.bessemertrust.com/portal/site/bessemernew/menuitem.0c3c8d2cfaf3f4fe8bfbfb106e730a6c/.

39 Zaritsky, supra note 4.

40 Family Wealth Alliance, supra note 17.

41 Hilary Johnson, Watching Over the Family Fortune, BARRON’S PENTA, Nov. 30, 2009, at http://online.barrons.com/article/SB125935862713467097.html.

42 Andrew Willmott, Multi-Family Offices Hit Back at Pretenders, FUNDFIRE, Jan. 17, 2003; Sara Hamilton, The Multi-Family Office Mania, TR. & EST. , Dec. 19, 2002, at http://www.trustsandestates.com/news/estate_multifamily_office_mania_2/i.... These articles also lists MFO services. For a more detailed breakdown of services, see Hannah Shaw Grove and Richard J. Flynn, Considering the MFO, PRIVATE WEALTH (July/August 2009) at http://www.fa-mag.com/component/content/article/4551.html?issue=122&maga... (Figures 5, 6 and 7 list three categories of services, financial, administrative and lifestyle, which encompass 18 key service offerings).

43 Bessemer Trust, Family Office Conundrum, supra note 27 (contains additional interview questions).