Single-family office nuts and bolts
If you’re thinking of establishing your own family office, here are some important issues you’ll need to consider.
Eric Allyn knows his way around an operating company.
Born into the family that owned the Welch Allyn Inc. medical device company in Skaneateles Falls, N.Y. for 100 years, Allyn could tell you all about ophthalmoscope design when he was in elementary school. In adulthood, Allyn ran company business units, headed specialty markets in Japan and served on the board of directors for seven years. “I was raised to be a good steward of the family business,” Allyn says.
Since the 2015 acquisition of Welch Allyn by Hill-Rom Holdings for $2.05 billion, Eric Allyn has been finding his way in an entirely different business — the Allyn Family Office. It has not been easy, even though the Allyn family has had a family office in some form since 1992.
“It’s an entirely different thing than running an operating business,” says Allyn, who oversees the family office and serves as its chairman. “Most of this has been new to me.”
Many family enterprise leaders like Allyn face the challenging and complex task of setting up a single-family office to manage the family’s wealth, investments and other needs, sometimes after experiencing a liquidity event. Allyn refers to it as “Family Business 2.0.”
“It should be viewed as creating a new business. I worry that families don’t realize the amount of work required,” says Jennifer Pendergast, a professor of family enterprise and executive director of the Center for Family Enterprises at Northwestern University’s Kellogg School of Management. “You need to set up a corporate structure, agree to policies and procedures, hire a team, set up governance structures [and] determine a strategy,” such as what services will be offered and to whom, and how the office will be funded.
The term “family office” covers a sweeping array of unique organizational structures. In general, a single-family office can be defined as a private, family-owned entity that manages a family’s private wealth and other family matters. Under the federal definition that excludes single-family offices from regulation under the Investment Advisers Act, a family office is wholly owned by family clients and is controlled by one or more family members or family entities. It serves no clients other than family clients.
The design and activities of a family office can be as creative as families themselves. Some exist primarily for the purpose of investment management and wealth preservation, while others provide a smorgasbord of services that might include philanthropic planning, next-generation education and family reputation management.
Raphael Amit, a management professor at the University of Pennsylvania’s Wharton School, stresses one key quality of a family office that makes it distinct from a private asset management company.
“A family office addresses the needs of an affluent family in a more holistic way through a range of activities that enable family unity, harmony, happiness and health, as well as activities that enable financial wealth preservation and creation,” Amit says.
There’s a lot at stake for families who embark on the single-family office endeavor. Consider that advisers suggest a family have at least $100 million available for investment to make the operation of a single-family office financially sensible.
What’s more, there is no one playbook for setting up a single-family office, says Nichol MacManus, managing director of Brown Brothers Harriman & Co. and director of 1818 Family Office, a multifamily office. The strategy the family uses to develop its office is not always linear, either.
“It’s just so different for every family,” MacManus says.
Pendergast echoes that. “Each SFO is different depending upon the problem the family is trying to solve by creating it.”
Families should view the creation timeline in “years, not months,” Allyn says. His advice to other family business owners is not to wait until the need for a family office is urgent.
“Have a family office well in advance of ever considering selling the family business,” Allyn advises. “I can’t imagine where we’d be without one. It’s imperative to have a family office more than a year before the sale.”
A new challenge
Over time, family offices have evolved from being primarily money managers “to something much broader with a goal of creating continuity, cohesion and engagement across the family for generations,” Pendergast says.
To Steve Lytle, a fourth-generation member who serves on the board of The Agnew Company, a single-family office based in Vancouver, Wash., the investment part of a family office is “pretty straightforward.” Much more difficult is “the business of ownership,” which he defines as the process of building and executing a system that supports the family’s long-term objectives and principles.
“We want to build a system of governance, decision making and communication that provides us with the best opportunity to own [family assets] well now and in future generations.”
Unfortunately, many families starting a single-family office just “jump in at the deep end of the pool,” says Robert A. (Bobby) Stover, Americas family office leader at Ernst & Young LLP. For example, they’ll run out and buy an operating company.
“They know they want something but they don’t have a plan,” Stover says. “It’s like taking a child to a toy store and saying: ‘You can have anything you want.’ ”
Gary Katz, managing director of Downtown Capital Partners, a family office in White Plains, N.Y., says creating a family office “should be daunting for people whose life experience was to run a successful operating company. A family office is a different animal. It’s a different skillset.
“Just because you’re a brain surgeon doesn’t mean you can do heart surgery.”
Many highly talented entrepreneurs who have run successful operating companies discover they simply don’t enjoy being a chief investment officer and making passive investments, Katz says.
“It’s just not the same level of adrenaline you get from running an operating business,” Katz explains.
Most U.S. family offices are only a few generations old, according to Joan Crain, global wealth strategist with BNY Mellon Wealth Management.
“I’ve seen a couple that have lasted five generations,” Crain says.
She’s also seen some family offices being dissolved.
Sometimes future generations “unwind” family offices created by the wealth generators if they can’t see the value of an organization that was designed by a patriarch or matriarch to meet the founding generation’s needs, Pendergast says.
Following best practices
While “there’s no right or wrong” to the creation of a family office, there are best practices, Crain says. Good governance practices should be the thread running throughout the process, including such things as the responsibilities of owners versus managers, she says.
To begin, families are wise to deliberate among themselves to determine what they’re trying to accomplish with a single-family office.
Asking “why” also can become the basis for the family’s mission statement.
Some families might primarily be interested in investment management, while others may want the organization to focus on philanthropy or NextGen education.
The Agnew Company, for example, is chiefly an investment company that manages a diverse portfolio of assets, including timberlands, commercial real estate, marketable securities and alternative investments, Lytle says.
“Every family should make a thoughtful assessment of how they would benefit from either an MFO [multifamily office] or a SFO [single-family office] before they make the decision to start one,” says Sara Hamilton, founder and CEO of Family Office Exchange, a peer-to-peer network for high-net-worth families and their family offices.
For most families who have started a single-family office, the benefit is family control. A single-family office offers customization, including a framework created specifically to meet the needs of a large, multifaceted family. The office protects the family from prying eyes while managing risks and information flow.
In some cases, the family office becomes the new family business after an operating company is sold, creating the glue for the family, Pendergast says. Post-sale, the family office provides the family identity once conferred by the operating business.
Depending on the asset level, some families might be interested in using their wealth to have family office staff take care of the management of nannies, household staff or private jets.
“Agreement on what services the office will do and, more importantly, what it is not designed to do, is essential to manage expectations of the owners,” Hamilton says. “And developing the specific measures of success for the office will help in the hiring process and in the performance management process.”
The most common service family offices provide is the ability to leverage the family’s collective assets for the best professional services, such as investment, legal or tax advice, in the most cost-effective way, according an article co-written by Crain called “Key Considerations When Creating a Family Office.” The next most-common service is centered on providing the family and family office executives with timely data and analysis of complex investments, trusts and estate plans, and the like.
Setting a mission
Advisers recommend that families develop a mission statement for the family office as well as a constitution (also known as a charter). Ideally, the mission statement should mirror the values of the family the office will serve, Hamilton says. Crain notes that the best practice is for family members to come together to craft the statement as a group.
“You need involvement from all levels of the family,” Crain says. “The worst thing is having an outside adviser do it.”
Crain had a client family who convened a meeting to hammer out a mission statement. But when the family came together, the father had written it himself.
“I felt sorry for him because he had spent a lot of time on it,” Crain says. “But we got input from all the children. If we had just gone with what the father had written, they wouldn’t have felt like it was theirs.”
Candid conversations among family members will result in a mission statement that really clarifies a family’s desired outcomes, Lytle says.
Amit says the vast majority of the nearly 200 family office mission statements he’s seen define their purpose as managing the family assets to promote family unity, harmony, happiness and health.
The constitution or charter spells out governing principles for the family and family office that are intended to endure for generations.
“The constitution is constant and is the guiding principle,” Stover explains. “The laws may change; the principles stay the same.”
Crain suggests families develop a shareholder agreement, policies governing who can work in the family office and a code of conduct. There should also be provisions for family members to exit the office, she says.
Families might also want to create an investment policy statement. Pendergast says an investment policy is needed if it the family office is managing money for family members.
“There may be a blanket policy statement for all clients of the family office, or accounts may be managed separately for different clients who will each need an investment policy statement,” she says.
Not all families feel the need to develop a collective investment strategy, Hamilton says. That could lead to problems down the road, she cautions.
“Through the generations, if you don’t have a set of collective investment vehicles to organize the investment alternatives for each household, that process of making individual investment decisions becomes unwieldy if you are dealing with 20 households and 12 to 16 different asset classes for investments,” she says.
Another critical decision for families starting a family office is its legal structure, such as a limited liability corporation or a corporation.
State law will determine the limitations on liability and the legal life of the structure. The family office does not need to be based in the state where the family resides. Families should consult their legal and tax advisers to determine the structure that is most advantageous for them.
Building a business plan and team
Family offices should have a strategic plan and a business plan, Stover says.
The strategic plan should spell out the results and opportunities the family wants to see in 10 or 20 years. The business plan should list the actions that are needed to get those results in Year 1, Year 3 and Year 5.
The business plan should include an operating budget and should spell out how the family office will be funded.
Family members or households generally pay fees or the family agrees to another arrangement, such as funding the office through a trust, Pendergast says. If the office manages money, family members typically pay a fee based on the assets under management, she adds.
“Typically, SFOs are set up to break even, not to be a money-making entity. The fees charged to family members are set so that they break even,” Pendergast says. “If the family finds that the fees are more costly than what they could get via outsourced providers, then the family office leadership and board need to justify why the family should pay more.”
Staffing needs will depend on the kinds of services the family office will provide, such as investment, philanthropic management and concierge services. Depending on the family asset levels, the staff could range from a handful to hundreds of people.
Hamilton says that because of the complexity of family structures and the importance of risk management today, the latest trend for larger families is to hire someone with a legal background to lead the family office, instead of a person with an accounting or financial planning background.
“As family offices have become more popular in the last 20 years, it has become easier to recruit talented managers into this industry,” Hamilton says. “There are search firms that specialize in finding talented office executives, and today, retention of talent has become more of an issue than the actual recruiting process.”
Compensation, of course, will factor into the cost of running a single-family office and will be an important consideration, particularly if the office hires a CEO, CIO, attorneys, accountants and other staff.
Other operating costs include technology and cybersecurity protections (see page 53), as well as office space.
The Allyn Family Office, which performs wealth management services only, employs four accountants, one attorney and one paralegal.
Family offices, like family businesses, need good governance.
“As a best practice they should have an advisory board at a minimum,” Stover says.
“Just like any business entity, a SFO should have a board,” says Pendergast. “Most don’t have independent directors, but I think they are a good idea.”
Independent directors can bring diverse experience and skillsets to the family office, widening the lens on decision making, including investments.
Lytle says the Agnew family has a family ownership council, which concentrates on “the business of ownership;” a board of directors for The Agnew Company, focused on “the business of investing,” and a board of directors for the family foundation, which addresses “the business of philanthropy.”
Once the office is up and running, the process is far from over, as Allyn can attest. His family office is still evolving after nearly 30 years.
Just as in any business, fine tuning and tweaks to the organization will be needed, including budget honing and performance assessment.
Since a family office is typically planned around generational stages of development, over time the approach might change, Hamilton says. Leadership transitions, for example, are often the time to review and restructure the services and the approach to serving the needs of the family, she says.
“Every family office evolves in its role, just as the family itself evolves through the generations,” Hamilton says. “What works effectively for a founder and his three children in Gen 1 and 2 is dramatically different from what is needed by the same family when they are a Gen 3 to 4 family group with 50 to 60 households to oversee and coordinate.”
As Lytle puts it: “A family office is a means to an end, not an end in itself.”
Maureen Milford, a frequent contributor to Family Business, last wrote about holding companies.
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