Family Office: The Five Key Points to Creating a Family Office

Since the early 20th century, when the first family offices were established by ultra-wealthy families in the United States, the number of family offices has been steadily increasing, with particularly rapid growth since the beginning of the 21st century. Based on the needs of the family, family offices often take on different forms.

Most family offices continue to evolve to meet the ever-changing needs of the family, starting from a family business and then becoming an independent organization. A successful family office can not only ensure the preservation and appreciation of family wealth, but also help to achieve philanthropic goals and maintain family values.

The family office is “a unique family business, aimed at providing comprehensive, tailored wealth management solutions while promoting and maintaining the family’s identity and values.”

As the guardian of the family’s wealth, the family office works with external professional advisors to develop and implement strategies related to the family’s wealth goals.

Typical family office services include directly providing or coordinating external professional services, such as tax, investment management, wealth succession (including estate and charitable planning), risk management, family governance and financial education, as well as talent development for family members. In addition, the family office has a higher purpose, which is to “connect generations and create continuity and cohesion for the family’s wealth.”

In the United States, family offices were first established by family businesses that became wealthy during the Industrial Revolution. In 1882, John D. Rockefeller established the earliest family office, which helped the Rockefeller family to centrally manage their wealth and philanthropic endeavors. Many other families with substantial wealth began to follow Rockefeller’s example, such as the Mellon, DuPont, and Phipps families, who all established their own family offices.

Today, family offices related to family businesses continue to grow. The latest research found that over 70% of family offices come from existing family businesses, and 60% of family offices continue to hold operational businesses.

01 Definition and history of family office

It is difficult to investigate the exact number of family offices due to their private nature and emphasis on confidentiality. It is estimated that there are currently more than 3,000 single family offices (SFOs) worldwide.

Understand the services provided or coordinated by the family office, which can strongly indicate its relationship with the ultra-wealthy family. Generally speaking, the family office provides six basic types of services:

1. Strategic Wealth Management

This involves long-term strategic planning to achieve family wealth goals for the current and future generations.

In addition to setting goals, strategic wealth management also includes establishing a family governance structure, including a family board of directors and council, as well as a family mission statement and bylaws.

2. Investment Planning

For family offices, whether investments are managed internally or outsourced, proper investment supervision is necessary. The core functions of a family office include asset allocation, portfolio construction, the creation of an investment policy statement, the selection of investment managers, and due diligence.

3. Trusts and Estates

This service involves overseeing the legal documents and execution required for wealth transfer. The family office needs to manage these documents and collaborate with trustees.

In the United States, many ultra-wealthy families choose to establish private family trust companies in trust and tax-friendly states, such as South Dakota, Nevada, and New Hampshire. In some cases, a private family trust company can act as a family office, or the family office can be a subsidiary of the private family trust company.

1. Philanthropy

This service includes developing strategies to help the family make charitable donations effectively.

Creating and overseeing family donation tools, such as family foundations and donor-advised funds, is also a part of the family office’s philanthropic services. Involving the next generation in the family’s charitable activities can be an effective way to pass on values and involve young family members in the overall family governance.

1. Family Governance and Education

Once the family governance structure is in place, the family office will coordinate the necessary meetings and communications to ensure the effective operation of such governance structures. Among them, family education includes teaching each generation of family members the necessary skills to ensure that they become competent shareholders, directors, and managers of the family governance structure and business.

02 Six basic services

6. Tax and Financial Planning

Tax planning involves overseeing individual and corporate tax returns. Financial planning includes cash flow management and personal budgets for family members, as well as bill payment and concierge services, such as family real estate and art management.

Every family office is as unique as the family it serves, and its structure best represents the family’s special needs.

When an ultra-wealthy family considers setting up a family office, the “learning curve” is very steep. Currently, many for-profit entities also provide family office services, including private banks, private wealth departments of large brokerage firms, registered investment advisors, accounting firms, private client law firms, and consultants. These organizations all have a place in the family office industry.

For families, the first thing to consider is the type of family office they want to create or participate in. This includes:

1. Single Family Office (SFO)

A Single Family Office is an entity that manages the financial and personal affairs of a wealthy family. This entity typically has multiple employees, including a Chief Executive Officer, a Chief Investment Officer, accountants, and employees who handle the family’s real estate, art, family education, and governance. Among them, complex tax planning, certain investment categories (such as hedge funds), and wealth succession plans are usually outsourced.

Some family offices, especially those affiliated with family businesses, have extensive expertise, operate closely held enterprises, and decide to use this expertise for direct investments.

Single Family Office Independent of Family Business: For privacy and confidentiality reasons, there is little or no crossover between the staff of a single family office and the family business.

2. Multi-Family Office (MFO)

· Family-owned Multi-Family Office, a company that manages the wealth of a group of ultra-wealthy families. It is usually owned by one or more founding families. Compared to a mature single family office, its purpose is to reduce overall service costs.

· Commercial Multi-Family Office, usually a boutique investment firm owned by a third party, providing investment and other ancillary services to ultra-wealthy families. Its business scope can range from pure asset management to providing a full range of family office services to the family.

3. Virtual Family Office (VFO)

A virtual family office outsources most of its services, typically employing one or two people to handle daily operations and coordinate external consultants and outsourced services.

A virtual family office is usually led by a family member, the family business’s Chief Financial Officer, or a trusted professional (such as a certified public accountant or a lawyer).

03 Classification of family offices

Many private banks and the private wealth departments of large brokerage firms have established specialized divisions to provide comprehensive investment services for these entities, and to offer professional consulting in areas such as wealth succession, succession planning, philanthropy, family education, and family governance.

Generally speaking, most family offices evolve from family businesses or the sale of family businesses.

Most family businesses, regardless of the size of their assets, provide family office-related services for the owners and their family members. For the family, whether to formally establish a family office mainly depends on the following five factors:

1. The scale of family wealth
2. The current development status of the family business
3. The size and complexity of the family
4. Costs
5. The willingness of family members to cooperate on personal financial issues

When a family office is connected to a family business, there are usually three developmental stages:

1. Embedded Family Office

An embedded family office provides services to family members within the family business, typically without separate employees, and is served by employees of the family business, especially long-term trusted employees.

Among them, most services of the embedded family office are outsourced under the supervision of family members or trusted employees. This type of family office structure is suitable for families with a total asset size of less than $250 million.

It is worth noting that there are several drawbacks to the embedded family office structure:

Firstly, employees of the family business may not be adept at supervising or coordinating family office services such as investment, wealth transfer, and family governance;

Secondly, these employees may favor active family members involved in the family business, rather than those who are not actively involved in the business;

Thirdly, these entities often have lower levels of confidentiality and privacy for family members.

Fourth, employees usually have other responsibilities, so there is a certain conflict between business-related responsibilities and family office-related responsibilities. For example, if there is a major transaction, employees may be distracted by dealing with important but less urgent matters, such as estate tax planning.

II. Independent Virtual Family Office (VFO)

Sometimes driven by the scale of family wealth or the increase in the number of family members, the family office services are transferred from the family business to a specialized entity that only handles family office services by establishing an independent VFO.

Although most of the services of VFO are outsourced, the family office will be professionally managed. This type of family office is very suitable for families with an asset management scale of 250 million to 1 billion US dollars.

III. Single Family Office (SFO)

Once a family’s asset management scale exceeds the threshold of one billion dollars, the situation changes, where most administrative services are provided internally. In addition, SFOs usually have a Chief Investment Officer who can invest in various asset classes internally. Overall, the cost of SFOs tends to be the highest.

04 The evolution of family offices

If a family determines that a single family office is the best method for coordinating and centrally managing family wealth, it is important to follow a systematic process to help ensure the provision of the range of services needed by the family, achieve the expected legal and tax outcomes, and establish a governance structure that will serve multiple generations of family members.

I. Mission and Strategy

The mission of the family office includes:

1. Preservation and appreciation of family wealth
2. Coordination of decision-making methods
3. Cultivation of family talent and entrepreneurship
4. Maintenance of family unity
5. Development of philanthropic endeavors

Although the mission of a family office may initially be determined by the family members who establish it, it may evolve over time as younger generations become involved in the decision-making and governance of the family office.

Once the initial mission of the family office is clear, it is easier to evaluate strategies to achieve the goals. A key element of strategic planning for a family office is to align the family’s goals with the goals of the family business (if any), the family office, and the family’s philanthropic endeavors.

Family decision-makers and stakeholders should consider holding several meetings at the outset to ensure that opinions, concerns, and ideas are raised, debated, and resolved. It is important to communicate about topics such as the involvement of spouses, investment philosophies, the roles of family members in the family office, and the hiring process from the beginning to ensure that family members are on the same page.

It is important to note that this strategy will not remain static and should be reviewed and revised every few years, as well as when significant changes occur within the family.

II. Business Plan

Once the mission and strategy are in place, the next step is to develop a business plan. Creating an effective business plan for the family office requires the formation of a team, which includes family members, trusted advisors, and in some cases, family office consultants.

Drawing the current situation is a good starting point. Who is currently providing advice and support for the family? What is effective and where are the gaps? Are the existing tax and legal advisors sufficient, and should new advisory partnerships be established? This will help the team determine the role that the family office will play.

It also helps to determine which services should be handled directly by the family office and which should be outsourced. Among them, the business plan should also involve aspects such as governance, legal structure, staffing, tax, accounting, IT, etc. During the business planning process, the team should keep in mind a principle: “Do not overbuild.”

It is crucial to understand the initial legal, tax, and accounting costs associated with establishing and maintaining a single-family office. According to a recent survey by UBS Global Family Office, the annual cost of a single-family office (including external investment management fees), expressed as a percentage of managed assets, typically ranges between 105 and 118 basis points.

With a strong commitment and governance, family offices can provide high-quality services in investment, organization, legal, and tax aspects for the family through various forms and iterations.

It is worth noting that as the family’s business, wealth, and needs evolve over time, the family should re-examine the existing management and structure of services and the realization of its vision to ensure that it can adapt to the family’s changing needs.

Note: The above content and views are for reference only and do not represent any position of our company, nor do they constitute investment advice. Please treat them with caution.

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