From the March 2005 issue of Investment Advisor • Subscribe!

March 1, 2005

Avoiding Family Trouble

Family offices can be great--but they're not for every wealthy clan

Family offices have become the rich person's strategy du jour for managing wealth on behalf of future generations. By some accounts, there are now over 2,500 family offices in the nation. They take care of family members who are not ready to manage their own finances. Family offices prepare taxes; offer concierge services, such as bill paying and travel planning; handle legal matters, including prenuptial agreements and trusts with added privacy; and provide a forum for the family to work together. The dynamic is simple: Entrepreneurs or corporate executives take the skills that created their wealth and apply them to help their families.

While wealth-creating clients are reading about the benefits of family offices, financial advisors have been reading about how the family office structure can boost their own practices. With a family office, advisors can, in theory, enjoy a steady source of retainer income, streamline their operations, and avoid working with other, potentially uncooperative advisors. They also can enjoy the prestige of working with wealthier clients, and perhaps develop more intimate relationships with fewer clients over the long term.

Unfortunately, the family office bandwagon is having unintended effects on future generations who share in the wealth. Before advisors recommend or create a family office solution, I would recommend that they explore the proposed family office's long-term objectives and compare that vision to the probable long-term outcome. If you take a hard look before you leap, you may be able to help third- and fourth-generation family members avoid any unintended surprises.

I routinely see these issues with my own clients, who are third-generation inheritors and beyond. Some are members or shareholders of family offices. Their typical experience with the family office is very different from the creator's original vision; after all, what begins as a good intention can change drastically over time. By the third generation, the family office is probably run largely by non-family members, so a disconnect develops between the family members and their wealth.

Virtual Reality

Consider the case of one fourth-generation family office member I work with. I'll call her Mary. In her early 50s, she feels infantilized by the family office. She has never signed her own tax return. She didn't know it was legal to hire a non-family office attorney and write her will the way she wanted. Her family office planned her prenuptial agreements before both of her marriages. Her weddings were fun and her divorces were nothing more than a little inconvenient. Mary has never, ever worked. Even though her tax return shows several million dollars in adjusted gross income, she is afraid to ask for a raise in her monthly distributions because she doesn't want to have to explain herself. The family office pays all her bills. She feels like Jim Carrey in The Truman Show: Her life is an open book to others, but the real world is not available to her.

Mary's family office has close to 50 employees, none of whom are family members. The vast majority of the family office employees are attorneys and accountants; their pay is based on the assets in the office, not on the welfare of the family members. The family office thus has no incentive to help family members in trouble--the fewer family members, the easier their job. All told, Mary is scared of the family office. Its president is trustee of all the trusts for life, and Mary does not know how to find out if anything can be done about it.

This is not the case for families that have not been handcuffed by a family office. The Kennedys are a good example. Family members have had the liberty to thrive and succeed, or to make mistakes and fail--and they have done both. Some members have chosen to capitalize on the family name and others have woven their lives into the mainstream. Others have failed and learned the hard way that the family name will not always protect them. No matter what, however, they are free to choose their own paths.

Changing the Rules

Sadly, many family office members in the third and fourth generations and even further down the line don't have that luxury. They have been trained to be good family office "shareholders" who toe the company line. So when advisors consider whether to recommend or offer family office services, they should also take into account some additional real-world challenges that future-generation family members have had to deal with. Here are some that I have encountered:

  • Whether or not to participate in the family office's decision to displace a low-income housing project for a modern loft development downtown
  • How to get equal family office benefits after deciding not to participate in the family jet or vacation home
  • How to convince the family office to treat adopted descendants of the family office founder the same way they treat genetic descendants
  • Whether to widen the scope of the family foundation's charitable intent to include more charities than for the benefit of families of the railroad workers that made this wealth possible
  • Convincing the family office to provide separate investment policy statements for individual trusts, charitable funds, or family limited partnership portfolios
  • Getting a global investment policy statement for the office's entire portfolio
  • Learning to trust anyone on the "outside," because they have been taught that family assets are private matters, and that the rest of the world is ready to take advantage of them
  • How to have a fifth-generation member's same-sex spouse receive the same family office spousal benefits as those available to spouses of straight siblings.

If you are involved in the creation of a family office, you can provide a great service by reminding your client that there is a big difference between running a business and running a family. There is no such thing as a well-run family. Help your client focus on what is important to him or her for future generations. She may ultimately decide that she would rather give her great-grandchildren more autonomy, not restrictions.

If the decision is made to go forward with a family office, encourage the creator to develop bylaws that have the flexibility to adjust to changing times. The bylaws should also allow reasonable partial or total buyout provisions.

For example, a family office might be working well for some family members, but not for others. One family member may want to start her own business with significant start-up costs, while other members do not want to invest in the venture. The entrepreneurial family member should be able to sell some or all of her family office ownership to raise money to fund her startup.

Strongly caution your client against forming a family office that forces their progeny to choose between their family and their own independence. Family members should be allowed input on how things are run, and should be guaranteed a hearing. These family office member rights can be defined in the corporate and company bylaws.

Isn't that what we all want, to have a voice and be heard? We should not deny these privileges to the grandchildren and great-grandchildren of our most successful clients.

Myra Salzer is the founder of The Wealth Conservancy, a firm in Boulder, Colorado, specializing in multigenerational planning and philanthropy issues. She can be reached at myra@thewealthconservancy.com.

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