There are many sensible reasons for setting up a family office – not least is the ability to better control the management of a family’s wealth. But family offices inevitably will need a good governance structure around them for them to work well for everyone concerned with them. Here’s five conundrums families should consider before setting up a family office, as well as for those with one already.
Alignment of interest
The alignment of interest between the family member(s) who set up the family office and those professionals hired to manage the family fortune can often be difficult to achieve. For example, if a family has taken a long-term approach to building up a successful business, hiring bankers and asset managers who are use to being incentivized on an annual basis can, and often does, lead to a misalignment of interest. This situation can create a long-term/short-term conundrum, particularly if family office professionals pursue opportunistic investment strategies designed to benefit them more than the family. So, a coherent governance and pay structure needs to be set up to help align the interest of the family with the interest of those they hire.
What services are better brought into the family office and what services are better outsourced is a big issue for family offices. Obviously, the size of the family office will have a big say in this decision-making process, but family offices need to establish what services they should bring in-house right from the beginning. Yes, hiring a chief investment officer is pretty much required for all family offices, but what about hiring fund managers and research staff as well? Should accountancy services be outsourced, or brought in house? Does the family office need its own lawyer? Of course, the decision to hire in-house, or outsource is rarely binary – CIOs can work with external fund managers as well as internal ones. Nevertheless, if a family is looking to better control their money these decisions can have a big impact on that control, as well as the overall efficiency of the family office.
Most family offices are set up by families that sell their business – and these businesses often have nothing to do with the financial services sector. But family offices, especially if they are staffed by ex-financial sector managers, tend to invest in things understood best by those in the financial sector. But, shouldn’t the family office invest in things the family know best, i.e. the sector they made their money in, and preferably direct investments into that sector? Anecdotal evidence suggests that the best performing family offices are the ones that stick to the investments linked to how the family/entrepreneur made their money in the first place. Hedge fund investing may make little sense to someone who made their money in widgets – so it might be a good idea to steer clear of them if you made your money in widgets.
Yes, a family may agree for the need to set up a family office, but that doesn’t mean they will all agree on its strategic direction, particularly in the longer term. If family offices are a microcosm of the family then inevitable conflicts between family members will be reflected back in the office. Families often set up a family council to help avert conflicts among family members when it comes to ownership – and money. And family offices tend to work best when a council is also set up to mitigate family conflict.
It would be a mistake to think family offices last for ever – actually few of them last more than 30 years. Many of them will morph into multi-family offices and be driven by commercial imperatives different from those of the founding family. Family offices tend to reflect the culture of the individual(s) who set them up – rarely does that culture translate well when a new generation comes along.