Family Office: The Five Key Elements of Building a Family Office from Scratch

With the continuous growth of the ultra-high-net-worth population in China, the demand for wealth inheritance has further emerged, and the recognition of family offices (hereinafter referred to as “family offices”) among ultra-high-net-worth individuals has gradually deepened, leading to the gradual rise of family offices.

Due to the short development time, many families face many challenges and confusions in the process of building a family office from scratch.

What are the key points for families when setting up a family office? How should the family office be positioned, and what challenges will be encountered when building a family office team?

Family offices have three core functions – managing money, managing people, and risk control.

1. Managing Money

Unlike LPs acting as GPs, family offices have a stronger demand for liquidity management. They need to ensure that even in the worst-case scenario, the family’s assets can still maintain a decent life for family members.

In general, the investment portfolio of a family office needs to ensure liquidity, and there should be a plan to allocate funds to family members every year.

Therefore, the allocation of primary market, secondary market, and rental real estate by family offices is a very challenging topic.

For family offices, in addition to investing, it is also necessary to establish a mechanism to ensure the return of assets to family members.

In terms of asset structure, most families use the establishment of family trusts to ensure and control the distribution of family funds, maintain a decent life for family members, and at the same time, do not allow family members to directly own too much wealth.

Three Core Elements of Home Office

Two, managing people

In a family office, at least one person is needed to meet the various needs of family members, from core needs such as health management, children’s education planning, and international identity planning for family members, to minor needs such as vacation travel planning and ID card renewal, as well as the management of domestic and foreign banks, insurance policies, and legal documents.

The purpose of setting up a family office is to serve family members and reduce their daily efforts, providing services that cover a wider range of areas than those covered by traditional British butlers.

Three, Risk Management

The family office serves as the family’s “comprehensive risk officer.” In the current environment full of uncertainty, it is particularly important for the family office to build a complete risk control system for the family.

In the risk management system, it includes both proactive risk management, such as the health and personal safety of family members, as well as reactive risk management, such as whether family members should hold too many director positions in their own companies, whether family members should hold positions in the family business, etc.

For ultra-high-net-worth families looking to establish a family office, positioning the family office is the first key step, which includes determining the short-term role and long-term goals of the family office, as well as clarifying the starting point and ultimate direction of the family office.

Among them, the short-term role of the family office determines which employees need to be equipped and which external consultants need to be hired. It usually takes many years of accumulation for a family office to achieve its ultimate goals, rather than achieving them overnight.

When determining the positioning of a family office, the family owner must first answer a multiple-choice question, that is, how much energy and resources they are willing to invest, thereby determining the level of involvement of the family owner or the second generation in the family office.

Secondly, on the investment level, whether the family office, as an LP, is willing to pay tuition fees and try to invest a portion of its assets in some early-stage dark horse funds, through continuous investment adjustments to find the GP that best suits the family’s style.

For families lacking resources in the investment field, when establishing a family office, they need to have a certain amount of patience and be mentally prepared to pay tuition fees: whether it is hiring the right people or forming their own investment system, patience is required, and even trial and error may be necessary, which may involve paying a certain tuition fee.

It should be noted that a family office cannot simply copy someone else’s model, as the probability of success by directly “copying homework” is extremely low. A perfect family office model needs to continuously self-adjust according to the development of time.

How to position home office directional signage?

We found that the initial establishment of a family office often falls into the following two major forms:

1. Boss Resource Family Office

For the “resourceful boss,” with their strong personal influence and network connections, they can often obtain project shares and investment opportunities that others cannot.

Therefore, the boss only needs to hire a few junior employees to assist them in making investment decisions and entrust professionals such as lawyers to implement them.

For this type of family office, it is important not to waste the resources brought by the boss. Secondly, it should be noted that it is difficult for a boss resource family office to achieve sustainable development.

As the boss gradually retires with age, the original investment opportunities will gradually shrink. Therefore, it is necessary to plan ahead and make dynamic adjustments.

Two, Fund of Funds Type Family Office

In the process of serving many family offices, there is a paradox – if the scale of the family office is not large enough, it is difficult to recruit top talents in the industry, and it is also impossible to build a mature and strong industry and data analysis team.

In addition, we often see that employees with strong individual abilities will also lose a lot of information and resources after leaving the original investment platform to join a family office, and this problem is difficult to fully compensate for by purchasing databases.

For family offices, it is crucial to exercise restraint. Specifically, single-family offices need to maintain restraint and not develop towards a multi-family office before maturing; for multi-family offices, it is necessary to control the asset scale and avoid blindly expanding the number of families served.

If a multi-family office serves too many families, it can no longer be called a multi-family office, but rather becomes an asset management company.

The two common early forms of home office

The type of talent that a family office recruits is crucial.

For a family office, it is necessary to first determine the talent profile before recruiting. Among them, the family office needs to determine whether the talent it is recruiting is resource-oriented or technology-oriented. Among them, talent in the primary market should be mainly resource-based, while talent in the secondary market should be mainly technology-based.

In talent management, the family office needs to manage through systems, including how to establish incentive mechanisms, whether to distribute Carry to employees, and whether to establish a mandatory follow-up investment mechanism, etc.

The establishment of a follow-investment mechanism for employees by the family office is crucial, which helps to deeply bind the talents of the family office with the interests of the family.

At present, the first generation of domestic families still have a strong desire for control over assets and the idea of personally investing. In this case, the development space of professionals and professional managers is often squeezed, and the abilities of many professional talents cannot be recognized.

In addition, when the family office gradually becomes more institutionalized and mature in its operation, there is also a risk of the second generation of family members parachuting in and “kicking out” professionals.

For such issues, the core lies in designing the decision-making and profit distribution mechanisms at the inception of the family office to avoid conflicts of interest and make the family office structure more stable.

In the operation of family office teams, it is inevitable that there will be a phenomenon of “parting ways” between professional managers and the family office, due to a variety of factors.

For instance, when a professional manager’s personal abilities are prominent and their performance is good enough, they may no longer be satisfied with managing the assets of a single family office. Instead, they may aspire to manage more funds.

In terms of income, the income a professional manager receives from a single family office is relatively lower in imagination compared to the income model of a fund manager, which includes “Carry and management fees.”

Therefore, we observe that after working for family offices for several years, some professional managers often choose to establish their own funds and attract family offices to become their limited partners (LPs).

In addition, family offices that are not actively investing often tend to cause professional managers to have a diminishing presence in the market, thereby losing their industry influence. This leads to professional managers having to “part ways” with family offices.

Setting up and managing a home office

For family offices, finding the right employees is a long process of trial and error. In the initial stage, family offices can first build in-house investment personnel, while legal, financial, and other needs can be met through outsourcing.

In the early stages of a family office’s establishment, external professionals are often better able to empower the family office.