The Pros and Cons Of Different Family Office Structures

“Level of wealth to start a family office. How fat do I need to be?”

That question as the title of a recent thread in a Reddit forum grabbed my attention. Reddit is a popular social media site known more for being a bastion of memes, gaming and entertainment news, and user-generated content than being a place to find reputable information about family offices. But the posting of this question in a Reddit forum illustrates the increasing level of interest and curiosity that the general public has regarding wealth in general and family offices in particular.

Managing significant wealth, whether it is generations-old or recently created, can be a full-time job. It requires a level of knowledge and expertise beyond the reach of most individual financial advisors, which is why wealthy people often choose to join or launch a family office.

The primary goal of a family office is to preserve and grow a family’s wealth through investments while also providing a range of other services such as trust and estate planning, tax strategies, insurance, philanthropy, and personal development for younger family members. But setting up and running a family office is not an inexpensive undertaking. Expenses typically run one to two percent of the value of the family’s wealth, meaning that for a family with assets totaling $100 million running a family office generally costs between $1 million and $2 million annually.

But even if you’ve got that amount of wealth, you still need to decide what type of family office you need. Do you need basic administrative help such as bill payments, consolidated reporting, and managing cash flow? Or do you need more sophisticated professional help managing investments of multiple households, succession planning, and preparing the younger generation to inherit wealth? The types of family offices generally fall into one of the following four categories, although in practice each family office is likely to be as unique as the family behind it.

The Virtual Family Office

This first category is probably the easiest to launch and can be very effective for families with assets ranging between $25 million and $100 million. In many cases, a virtual family office involves one or two family members who are fully engaged in managing the family’s finances working with a range of outside service providers such as investment advisors, CPAs, and attorneys. This arrangement differs from an independent single-family office using outsourced providers because in this case there are family members doing all the coordination.

But this arrangement often doesn’t work beyond the first generation. I know of a virtual family office run by the patriarch who created the wealth. He is a retired corporate CFO in his 60s who is extremely well organized and enjoys coordinating investments, taxes, and cash disbursements to his family members. But he’s also aware he’s not going to enjoy it forever. When this individual no longer wants those day-to-day responsibilities, his family will need to find another solution, such as hiring a multi-family office, which I’ll explain a little later.

The Embedded Family Office

Frequently an embedded family office starts organically, in many cases almost accidentally, within a successful family business. Because it’s tied to an existing operation, this family office is “embedded” within the business and naturally evolves and expands over time.

For example, a company’s bookkeeper’s responsibilities are expanded to include handling personal bill paying for the family or a tax accountant is hired to prepare the family members’ income taxes outside the business. And it grows from there. As family wealth grows, other professionals are brought in to coordinate family investments. Eventually, there is a small group of employees embedded in the family business, devoted strictly to the wealth administration of the family.

A positive to a situation like this is that it initially can offer a family a measure of control, continuity, and support. But on the not so positive side, there’s no privacy and the family’s personal finances can get mixed up and co-mingled with the family’s business. There can also be tax risks if the company’s employees are doing significant work for family members but being expensed as part of the business.

At some point the family may decide that it is in their best interests to separate the embedded family office from the family business. After several generations there are just too many family members to serve or the need for more privacy becomes paramount. Regardless, separating an embedded family office from the business needs to be addressed before selling the business, bringing in outside investors, or taking the business public.

The Single-Family Office

The next step beyond the embedded family office is often the creation of an independent single-family office that continues to serve only the needs of one family or multiple generations of the founding family. A single-family office can either hire all the necessary talent and expertise in-house or outsource some or all its needs to a range of trusted external professionals who can assist with investments, taxes, trust and estate planning, insurance, cyber security, and other interests such as advising their family foundation or overseeing philanthropic activities. The advantage of a dedicated single-family office is that it is independent of the business enterprise that created the wealth and is solely focused on the wealth administration of the family. But it takes a lot of work on the part of family members to run a single-family office, particularly the founding matriarch and patriarch who might be at a point in their lives where they’re thinking of retiring, or at least not working full-time.

The Multi-Family Office

For some families the best option is joining a multi-family office, a term that describes a broad range of firms and service models. Generally, a multi-family office is the most comprehensive service model because it provides a broad range of both financial and family-centric services, enhanced cybersecurity, and access to best-of-breed service providers, ultimately making it a less expensive arrangement than running a single-family office.

But the downside of a multi-family office is that the family often has less control than they would with a single-family, embedded, or virtual family office. For that reason, a family should determine in advance whether a particular multi-family office offers will meet the needs and suit the temperament of the family.

In conclusion, each type of family office offers both advantages and disadvantages to wealthy families, and families should carefully consider their own specific needs and resources in choosing the most appropriate option. Ultimately, a family office can help alleviate some of the administrative burden of managing wealth and also ensure that a family’s financial legacy extends far into the future.