Despite the economic downturn and residual challenges, entrepreneurs in the United States have created enormous wealth over the past 10-to-15 years. This new class of ultra-affluent individuals and families that’s emerged is looking for professional advice and guidance in managing not only their wealth, but also the myriad details that ensue from managing that wealth.
The options for help in managing their wealth and its associated risks and rewards are greater now than at any other time. The choices run the gamut from creating a dedicated family office to using a multi-family office to seeking the assistance of private banks and wealth managers. But, for those who desire ultimate control, privacy and dedicated staff, a single-family office may present the obvious choice. But is it their fathers’ family office that they want? Probably not.
How do next-generation wealth makers and first-generation family offices differ from the more mature, established family offices serving multiple generations? While the adage, “If you’ve seen one family office, you’ve seen one family office” certainly fits, comparisons can be made and generalizations applied about how this new generation of wealth thinks about and uses the family office structure, how their approach to risk may be different than mature, multi-generational family offices and what the challenges are for family office practice leaders in working with these innovators and risk takers.
New Breed of Wealth Creators
While many factors distinguish first-generation family offices from their mature legacy predecessors, one area of difference is the perception and planning around risk. The formation of family offices during the past couple of decades has resulted from wealth created primarily in the tech and financial services sectors. These wealth creators may have experienced a completely different success and wealth trajectory than wealth creators of the past. This new class of entrepreneurs has not, in most cases, spent decades building their businesses to the heights of great value like some of the wealthiest industrialists of the past. Their approach to wealth may be more “next gen” than “last gen,” which may influence the types of advisors they choose, their philanthropic focus and their methods and styles of communication. Family office founders are typically very involved in the majority of decisions made by the family office they founded and are comfortable with taking risks in a number of areas. The wealth maker doesn’t necessarily relate to traditional optics of risk management and/or risk transfer methodologies and may look to non-traditional solutions to address various risks.
When it comes to recognizing, addressing and mitigating risk, a broad variance of risk tolerance emerges among entrepreneurs. One common tactic is avoidance; not necessarily intentional, but situational. The family office, often with limited staff, must manage myriad details for the principal family. As such, some risk issues, including protection for the family office itself, simply get overlooked or are constantly relegated to the back burner.
Fewer Employees Focused on Risk
Newer family offices usually have few employees who handle a range of tasks directed by the principal. These newer offices are apt to use numerous investment advisors, and, as the “U.S. Trust 2012 Insights on Wealth and Worth” survey points out, younger wealth holders are more likely to take risks in the financial arena, including allocating a greater percentage of assets to alternative investments, such as private equity and hedge funds.1 This risk taking is evident in other areas as well. The notion of professional liability insurance for family offices isn’t new, but it’s often overlooked. Newer family offices are unlikely to buy professional liability insurance that offers indemnification for a host of professional services provided by the family office. The concern about litigation from family members and others seems remote, particularly when the founder and children are still involved in managing the office. Newer family offices are typically very busy with tax and estate-planning strategies; investment planning and monitoring; managing philanthropy; providing real estate services; and much more, so they need to take a step back, capture a holistic view of the structures and understand what, if any, new exposures to loss have been created.
Established, professional family offices that have matured in this space are more likely to seek professional assistance in understanding and insuring the risks they face. As entities and increasingly complex ownership structures are created, which often include multiple trusts, limited liability companies, qualified personal residence trusts and family limited partnerships, the need for coverage, such as trustee’s liability insurance, may be more obvious. Family offices that create private funds, invest in private equity or have a high degree of discretionary investment decisionmaking face risks that should be protected against. A private trust company may be established as a means of achieving certain goals and objectives for the family. This structure requires specific risk assessment and insurance. The risk of being an employer, regardless of size, is another area that exposes the family office to potential litigation around wrongful termination, discrimination or harassment, but again, the first-generation wealth maker who’s integral to the family office may not recognize that even loyal employees, who are “like family,” have been known to sue.
When we think about mature, established family offices that have been around for generations, the term “sustainability” comes to mind—sustainability of financial, human and social capital, as well as sustainability of family values and purpose and service to the family. It’s imperative that the family office has a clear path forward. Is the intention to align the family office’s exit plan with the owner’s exit and only serve the first-generation wealth maker during his lifetime? Or, is the intention around maintaining sustainability for the future so that the family office continues over the years and generations? The wealth maker’s point of view will inform what type of structure and framework the family office ultimately has.
Philanthropy can play an important role in the sustainability prospects of a family office and the family it serves. There are numerous options for achieving philanthropic goals—from establishing foundations to giving via donor advised funds.
Wealth owners who desire longevity of family success often see the value of engaging the younger family members in the family’s philanthropy. Newly minted family offices can learn much from those family offices that have successfully used philanthropy as one way to maintain shared family goals.
Adapt to Change
Advisors working with family offices need to recognize that all family offices fall along a spectrum of maturity and professionalism and that the risk tolerance of the wealth creator is going to be palpably different from the risk tolerance exhibited by a fourth-generation inheritor. Communication style and personal interactions may vary greatly among these populations, and the well-informed advisor will recognize and adapt accordingly.
1. “U.S. Trust 2012 Insights on Wealth and Worth,” www.ustrust.com/survey.