5 questions to ask when establishing a family office

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Whether you came into wealth through your current efforts, received an inheritance as a result of your family’s efforts, or are transitioning generational wealth into a multigenerational investment business, creating a family office as an investment vehicle to diversify your investments and operations can be a great way to minimize risk and maximize returns. However, there are a number of factors to consider in advance of starting up a family office for investment purposes. Each decision on how you desire to operate your family office may affect a multitude of other structural and regulatory decisions. So, it is best to plan ahead to create the most efficient business for your planned operations and one that remains flexible to grow with your wealth. Below are a few factors to consider when establishing how you will operate.

  1. Is your investment plan to be active or passive? Some entrepreneurs are just looking for monetary gain. They are trying to identify publically traded or privately held businesses that will appreciate over time, in part, due to the management team the target has in place. They are looking to remain passive, invest their money and only periodically check in with the operators. Others are looking for a more active role in the target. This might mean they are pursuing a venture capital, private equity or angel role with their target or that the family office’s specific expertise is needed and compliments the target’s business. In either case, Whether or not active resources will be deployed at a target and how those resources will be monetized or compensated needs to be considered in the family office’s investment structure.
  2.  Are you investing cash, services, or a mix of both? How active a role you want to take in the target’s business may affect your structure, as does the intent to invest more than just cash resources to a target. If services are being provided (directly or indirectly), you need to understand how you will value these services - if they are going to be paid for by the target or if providing such services are part of the overall investment valuation to a deal. There are a variety of tax considerations that also come into play based on how you are monetizing these services.
  3. Do you prefer to structure the family office to be owned within your current company organization or outside the business as a stand-alone? Administratively, you might prefer to have the family office owned as a subsidiary of your current business operations, but you should also weight such factors against the risk of litigation within your current business organization. You should also consider the short- and long-term ownership plans of your operating business and how that might affect who owns your family office. While there might be duplicity in the back office administration of the family office by having it as a standalone, this could be outweighed by the external forces and inputs related to your primary business operations. By having the entity be a standalone business and utilizing contractual mechanisms like shared services agreements, you might be able to lessen the administrative burden while sheltering the risk to the family office.
  4. How do you intend to utilize employees and agents? Whether or not you intend your family office to have its own employees or if you are going to be sharing employees with another one of your businesses might lead to regulatory and registration issues. This is especially true if you have or financial personnel working among multiple companies that are not commonly controlled. In such case, the financial personnel might need to be registered as Financial Managers or Financial Advisors under both Securities and Exchange regulations and guidance as well as state Blue Sky Laws. It is extremely important to be sure you have had an appropriate securities laws analysis done in advance of setting up your family office to be sure you are in compliance with the applicable laws and regulations.
  5. How do you intend to fund your family office? You need to consider both the day-to-day working capital requirements as well as the investment dollars you intend to use to invest in a transaction. Will this money come from the same source or are there multiple funding sources involved? The answers to these questions can play an important role in how the family office is owned and who your financial personnel are “representing”. You need to be sure that you don’t commit a foot fault by changing the source of the closing funds without having considered the unintended consequences resulting therefrom.

There are many other considerations including whether you will advertise or otherwise get your message out that you are looking to invest, whether you will pay broker’s fees for referrals and how those might be structured to ensure you only pay fees for performance, and how you should setup your non-disclosure agreements and confidential information so you don’t inadvertently preclude your family office from entering into certain deals down the road. But there is an interplay between all these items and it is important to seek appropriate counsel up front to be sure you can focus on the success of your new enterprise. 

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