The second family business

Over the past few years, several environmental factors have forced business-owning families—many for the first time—to think about the management of their personal wealth as a separate issue from the family business. For some families, basic demographics are the impetus. As the older generation prepares for retirement, financial planning and estate planning take on new importance and focus. In other families, the recent economic crisis served as a wake-up call, heightening family members’ awareness of their dependence on income from the business and the reliability, or lack thereof, of other investment and financial resources. In many cases, families are dealing with both of these issues. Regardless of the key motivating factor, business-owning families are entering a new era in which current practices for managing personal assets must be revisited and reexamined.

But revisiting this issue is more easily said than done. For many reasons, the balance between managing business assets and managing personal assets is often far over-weighted on the business side. To a large degree, this dominating, almost obsessive focus on the family business is a key factor in the enterprise’s success. The core business serves as both the financial and the emotional hub of the family, and the day-to-day responsibilities of running the business loom so large that they can quickly eclipse all other areas of family life. In some families there may even be a sense of guilt about spending time and efforts on non-business issues. With this drive and dedication to the business, it is easy to see how families often put management of personal assets on the back burner.

Unfortunately, a driving focus on the success of the business, no matter how justified, does not make it any easier to handle the repercussions of procrastination in addressing personal financial affairs. Adding to the complications, many families have done some financial or estate planning inside the family business but usually not in a comprehensive or integrated fashion.

Regardless of what has been done in the past, the ability to preserve wealth (liquid or illiquid) across future generations is a complex and challenging goal. To understand how private wealth management decisions are made by a family who owns and operates a thriving business, Family Office Exchange (FOX)—a membership-based firm that provides research, education, and advice to ultra-affluent families and their advisers—initiated a study that examines how these families manage their personal assets and the key motivators that influence their decisions.

Typical, but risky

Interestingly, there are some clear similarities across families when it comes to personal wealth management. Interviews with more than 40 business owners from throughout the country revealed that most families followed a typical three-stage pattern. (See Exhibit 1.)

• Stage 1: The family leans on a trusted executive inside the company.

• Stage 2: A formal department is organized within the business to handle the family’s personal financial affairs.

• Stage 3: The family separates management of all personal matters from the business.

This is a natural pattern and can evolve over generations or in a very short time frame, depending on a variety of external factors and influences. However, while natural, it is not ideal. The personal and legal risks involved with intermingling the management of personal and business affairs can be extremely detrimental. Concerns in Stages 1 and 2 range from basic worries about privacy, to wealth being managed by employees who lack specific wealth management expertise, on up to potential violations of federal tax codes and SEC regulations.

In an ideal situation, Stages 1 and 2 would be avoided altogether and a family would instead determine to keep business and personal management separate from the very start. The sooner a family makes this decision, the more they will reap the benefits of an independent and integrated approach to wealth management and avoid some of the risk associated with co-mingling business and personal affairs.

A review of the options

What options are available to families interested in independent, integrated wealth management? Put simply, there are two main choices: do it yourself or contract out. Said another way, a family can decide to take a more hands-on approach to the structure and day-to-day management decisions by opening their own dedicated family office; or they can hire a multi-family office or other wealth advisory firm to take on these responsibilities. The desirability of each choice depends largely on the family members’ personal preference about control and level of direct involvement.

The first thing a family must decide before evaluating any wealth management options is whether they want to hold wealth together as a family in the future. A family who shares assets has far greater buying power. They will have access to more investment opportunities, and they will receive better pricing for services than individual family members could obtain if they sought out options and services independently. However, the emotional aspects of sharing wealth as a family must also be considered. It requires multiple generations to be able to make decisions together and a willingness to recognize and appreciate the needs of other family members or branches.

Single family offices

A private family office provides the highest degree of customization for a family and can be a cornerstone structure that binds the family together with a sole focus on their specific financial, family and philanthropic goals.

Exhibits 2 and 3 highlight the average costs for running a single family office and the typical service menu of an office. While these averages can vary dramatically depending on a wide range of factors, the data, taken from the FOX benchmarking research of more than 100 single family offices, illustrate that a family office manages a family’s financial capital as well as its human capital. This combination of concrete and more abstract (emotional) management responsibilities has cost implications. Finding the talent and skill sets to fulfill both responsibilities can be difficult, and the costs involved can fluctuate.

Furthermore, the data seem to suggest that as the amount of wealth overseen increases, so do costs. This is not surprising, since many families with large asset pools have a lot of entities as well as multiple family members and households. They are simply more complex on both the financial and human capital side, and the costs reflect this complexity.

Beyond cost considerations, starting a private family office requires a significant commitment in time from the family. Creating an office is starting a new business and requires the same level of discipline in terms of planning and structuring. When a family fails to apply the same level of stringency to their personal financial affairs that they do to their operating company, the goals of that business are put at risk, and the effectiveness of the office is hampered.

Wealth adviser options

Over the past several years both the number and quality of wealth adviser options have grown. Whether a family is seeking a small, boutique multi-family office or is more interested in having all the resources of a large financial firm, there are many possibilities for outsourcing the management of family wealth.

Exhibits 4 and 5 highlight the typical costs and service offering for wealth adviser firms by level of assets under management. Exhibit 4, based on data from FOX wealth adviser members, provides a fee baseline for clients with varying wealth, notwithstanding the variance in pricing methodologies and the prevalence of customized fees. For a typical client with assets of $100 million, the median fee starts at approximately 40 basis points. Fee data represent the following:

• The median basis points fee charged by firms that primarily use a bundled, asset-based fee for most services. To facilitate comparison, fees for firms that levy an asset-based fee and retainer are excluded.

• The fee for a core set of wealth management services. This set typically includes investment management services such as manager research and selection but does not include third-party fees paid to outside managers or fees for internal asset management.

Importantly, each of these data points represents the low end of the range used by multi-family offices. Clients who have complex situations or receive a broad set of services are likely to pay significantly higher fees.

Determining fee levels for firms that use both an asset-based fee and a retainer fee is more difficult since, for many reasons, retainer fees are almost always customized. FOX members estimate a typical retainer fee for a client with assets of $100 million and “average” complexity ranges from $200,000 to $275,000 for a variety of services. Most of these services are non-investment management services and typically include many of the following: planning services (estate, financial and tax), insurance, cash flow management and bill payment. In addition to the retainer fee, clients pay an asset-based fee for investment management services. Assuming total client revenues of $400,000 to $500,000, the incremental fee for investment management services can range from 15 to 30 basis points.

Long-term benefits

Regardless of the family’s current situation, it is likely that some event or catalyst will eventually motivate them to separate the management of their business from management of their personal finances. The sooner they reach this stage, the more the family will reap the benefits of an independent and integrated approach to wealth management. Whether a family chooses to create a private family office or work with a multi-family office or other integrated wealth adviser, the objective is the same: a dedicated focus on family members’ personal financial needs. The decision to organize the management of family assets in a separate entity from the business will provide benefits for generations to come.

Anna Nichols is managing director, content, at Family Office Exchange in Chicago (www.familyoffice.com).