The modern family office is more complicated than ever. There are the inevitable emotions, relationships, life situations and needs of increasingly diverse generations of family members. And then there's the growing number of privacy and digital security concerns, investment structures and asset types. In some ways, a private family office may be more challenging to run than a business of the same size.
For some families, it might make sense to outsource the family office to a qualified professional firm. Whether you're starting a new family office or making changes to your existing one, there are several factors you should consider before deciding whether to manage your own family office in-house or outsource parts of it to a professional service provider.
Who will the family office clients be?
In general, the fewer adult family members and the fewer family units, the more likely a private family office can work. As the size and complexity of the family increases, it may make more sense to look at an outsourced family-office arrangement where you can leverage experienced employees and additional resources for managing the family's finances.
Another benefit of an outside firm is that it can help family members avoid conflict with each other while still enabling them to manage family assets and make decisions as a family. Outsourcing may also make more sense when there are multiple family units involved. An outsourced office can more easily cater to family units' individual needs.
Alignment of financial philosophy among family members is also an important consideration. A strong shared risk profile and the same level of patience with funds can make a private family office a good choice, but remember to reassess regularly because financial philosophies and needs can change over time.
Who will work in the family office?
Keep in mind that a modern family office is a business, with all its requirements and headaches. Is there a family member who wants the job of running it? Are other family members on board with that choice? If a family member wants the job and responsibilities, and the family agrees, a private office could make sense.
However, a private family office with family members working in it has unique challenges. These include determining compensation and deciding who will take over when needed, as well as dealing with family-member employees who may not be right for their job.
Often, family offices will need to hire employees who aren't family members. This allows for expert insights, but it also introduces potential privacy and liability concerns, as well as paperwork and regulatory complexities. In addition, incentive compensation is often required to attract and retain excellent financial professionals, but incentive compensation for non-family-members is heavily regulated. Even an office that manages only one family unit may employ as many as five to 10 people, plus outside consultants for specialized assistance. A family office that manages multiple family units can become even larger and more complex.
An outsourced family office can ease worries about compensation, and outsourcing means that trained – and in many cases, licensed– professionals are handling the work.
If family members are counting on having jobs in the family office, consider outsourcing much of the work while retaining some of it in a private family office. A qualified professional can help guide you through setting this up in a way that aligns with your needs, goals, tax planning strategies and relevant regulations.
What services will the family office clients need, want and be willing to pay for?
Typically, the primary purpose of a family office – whether private or outsourced – is to act as an investment vehicle for the family's assets. It may invest directly, via third-party managed funds or through a combination of both. Assets and investments are often extensive and complex, including a mix of liquid and illiquid investments that must be managed and reported on in a holistic fashion.
Many family offices also provide a range of other services, including coordination of real estate management, domestic staff management, family governance, philanthropy and more. They may also deal with family members' collectibles, such as art, automobiles, or wine.
An outsourced private office can pull together the appropriate experts for investment and non-investment services. If family members need a wide range of services, this may be a better option than a private office. Another option is to separate non-investment activities into a different entity from investment activities – outsource some and keep others within the private office. This can also offer a path to employing some family members in the family office.
Finally, consider how much personal attention family members will want, need or expect. If having someone immediately available to talk to many times throughout the day is a priority, a private office and/or a personal assistant may likely best meet this need.
How much money will the family office manage?
In general, consider the combination of net worth, assets under management, number of personal assets the office will manage, and the total number of investments to understand the financial complexity of a family office.
More assets under management means more regulatory complexity, and more of a reason to consider outsourcing. One important threshold to keep in mind is that additional regulation kicks in at $100 million in assets under management. Investment managers with more than that in Section 13(f) securities may be required to file with the U.S. Securities and Exchange Commission (SEC). In certain cases, family offices may be considered investment advisers and be required to file as well.
Are you willing to deal with registration and compliance requirements for your family office?
Even private family offices with less than $100 million in assets under management may be required to comply with a variety of regulatory requirements. Most notably, the Investment Advisers Act of 1940 requires SEC registration as a registered investment adviser for an asset manager that advises others regarding securities for compensation, unless an exception applies.
The Family Office Rule (Rule 202(a)(11)(G)-1) provides an exemption from registration if family offices meet all prongs of a three-part test:
- The family office can only advise lineal descendants of a common ancestor; their spouses, "spousal equivalents" and "former family members"; and certain trusts, estates, companies and charitable entities that belong to those individuals. The exemption may extend to key employees and "former key employees" of the family office.
- Those family members must fully own and exclusively control the family office.
- The family office cannot hold itself out to the public as an investment adviser.
While the Family Office Rule may exempt some private family offices from registration, an office that serves more than one family or common ancestor of more than 10 generations removed typically does not fall under the exemption and would likely have to register.
Registered investment advisers are overseen by the SEC and must have formalized compliance policies and a chief compliance officer. They are subject to regulations that restrict certain performance-based fees and changes of control, as well as to custody rule requirements and ethics code requirements.
An outsourced family office provider will be equipped to handle reporting and compliance requirements, significantly easing the regulatory burden on the family.
What are the family's security and privacy concerns?
Maintaining family members' privacy depends on both employees and family members keeping information confidential. The smaller size of a private family office might make it feel safer, however, it only takes a single individual to make private information less private – intentionally or unintentionally.
The smaller size of a private family office can also increase fraud risk. Family offices should implement internal controls designed to mitigate employee fraud. A key aspect of internal controls is segregation of duties, which is difficult to implement with fewer people. One example of this is not giving a single employee both signature authority and the ability to disburse funds without proper oversight. Private family offices – like small businesses – can be particularly vulnerable to an employee or family member having too much access.
An increasing area of concern is cybersecurity. A family office needs cybersecurity procedures and processes that keep up with the evolving threatening landscape and minimizes the risk of theft of money or information. This includes a comprehensive plan for responding to attacks or intrusions, regular evaluation of threats and defenses against them, and an incident response plan in the event of a successful cyberattack. Engaging outside cybersecurity professionals can help your family office mitigate cyber risk and be ready to respond if needed.
One issue family members may be nervous about with an outsourced family office is whether regulators and outside examiners will have access to their personal financial information. The compliance requirements that a professional services firm is subject to means their work is reviewed regularly, with client files randomly selected for inspection. Inspectors look at the firm's work for technical accuracy, as well as adherence to regulatory and professional standards. Some families consider this aspect of outsourcing their family office to be a benefit, and private family offices sometimes hire an outside auditor to get this level of reassurance.
Making the modern family office
The more complex the family's needs are, the more complex the family office will be to run – and the more reason to consider outsourcing some or all of its functions. Talk with your financial advisors and an attorney with expertise in family offices to understand the legal and financial considerations for your family office.
If you're considering creating a single family office or bringing multiple family units together in a multi-family office, or if you're wondering whether to outsource some or all family office functions, contact Kaufman Rossin's Family Office Services team. They can assist with planning, administration, monitoring, compliance and a wide range of outsourced concierge services for U.S. and international clients.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.