As wealth of high-net-worth individuals or family businesses grows with time, keeping track of it could be a quite a task. Wealth can come in many forms: land, shareholdings in various ventures, equity investments, art, wine, and even cigars. With members of family businesses busy either with their individual pursuits, or carrying out their respective roles in their company, it is not uncommon that they lose track of their personal wealth. I know a family whose patriarch, on the behest of a friend, made an investment in a huge land parcel. The family only had the property papers, but no one in the family knew where the land parcel—almost as big as a small town—actually was! A family office can help prevent such a scenario.

So, what are family offices? The purpose of these entities is to protect, invest and grow the wealth of family businesses or high-net-worth individuals with dedicated people keeping track of things and passing on the benefits to their clients.

Family businesses usually have a family member, or a trusted company employee looking into these interests. Some are not convinced that a separate family office team has to be created for this as they feel that costs do not justify such arrangements. There are examples of both cases in India.

But let us look into this argument. It is true that the costs of family offices are not cheap. Hence, families need to consider the size of the assets to be managed to ensure that the costs do not outweigh the benefits.

While the case of a working family member looking into the wealth of the family makes a lot of sense, as he or she would have the best interests of the family at heart, it has been found that the arrangement does not work always, especially if that person happens to be someone who is involved in the main business. A non-working family member could be an option, but whether that person has the requisite skill should be considered.

I know an entrepreneur who is so busy with growing his business that he has no time to devote to diversifying his wealth. And it does not help that he is single. Till a few years ago, all such funds were reinvested in his business. This was done because he thought that no other venture other than his business would give a higher return! He thought that his funds and his business were looked after—two birds with one stone.

Financial advisors would point out the advantages of not putting all eggs in one basket, which is still what a lot of families do. But it is prudent to have multiple streams of income, and have someone whose job is to monitor these revenue streams.

A company executive may be a convenient choice when the corpus is small, but if the corpus is of a larger size, say, Rs 100 crores and above, it is advisable to separate out the family wealth from the business. This would also help in greater accountability and effective oversight.

So, what are the main things to consider while setting up one?

First, the family have to agree on common objectives. Second, the family needs to decide what tasks the family office would be expected to perform. Typical tasks would include handling the investment portfolio, taxes and legal compliances, reporting and maintaining documentation, wealth management, philanthropy, lifestyle management, education, and managing shared assets.

The family office is not just responsible for handling investments and can look after a lot of other administrative issues around the family wealth. These issues are extremely specialised and some of them would have legal and tax implications, and hence it is advisable to appoint experts, either on a retainer, or a full-time basis.

Typical functions that a full-fledged family office would need are: Family office CEO, chief investment officer, chief financial officer and tax and legal experts. The size of the family fund would determine the scope of activities; smaller family offices start with a couple of people initially, supervised by a family member, with most tasks outsourced.

Most family offices prefer to outsource their investments to various financial investment banks, since they are better equipped to handle these. Getting and retaining talent to run investments is difficult, and hence, it may be more cost-effective to outsource it. Some family offices split their equity portfolio among multiple investment bankers and some tasks are kept in-house. Some of the bigger family offices in India have retained the private investing/angel investing arm along with philanthropic spending in-house, to be managed by the family members.

Philanthropical activities are of three types: participation, philanthropical impact investing, and charitable donations. Participation is when the family through its members gets involved in the activities. Philanthropical investing is when they are investing in causes which will bring about a positive change in the long run, and donations are single time activities. Most families prefer the first two activities. Family offices provide a means to ensure that the family’s objectives are met, by studying and vetting various options for such activities.

Again, this depends on the size and structure of the family and wealth managed. Costs play an important role here, and most families would prefer to keep the costs to a minimum, but the estimated figures floating around are anything from 1% to 2% for a Rs 100 crore corpus. These would of course vary.

Since the nature of the family office is confidential, no family would like the size of the funds or assets becoming public knowledge for various reasons, hence having a dedicated team would ensure that secrecy is maintained. In fact, families would prefer to have lower returns rather than risk exposure of their portfolios for various reasons. Hence, secrecy and confidentiality are paramount.

During my course of advising multiple families, I have found that most families prefer to start with a business person handling the family officer part-time, before handing over to a dedicated person over time. Usually a retired company employee, since the trust factor is already there. There are also other challenges. Where the business and family interests diverge, the family office has to be clear in its approach. For instance, would the family wealth portfolio allow investments in a competitor’s company? Or are there any areas where the family will not invest in?

As long as the family and business affairs are kept separate, having trusted family lawyers, accountants and investment advisors is also a good option, as the working relationship is already in place and trust has been established. Other families may want to maintain a second line of relationships and may want to explore another team of professionals. But this depends on the intentions of family members, the size and complexity of the assets, the family member’s comfort levels and goals. I have also seen in some cases, where the next generation prefers to have a separate team of advisors as compared to the earlier one who worked with their parents.

So external professionals do handle the various external tasks like investments, taxes and legal matters. They would not be involved in the operations of the family office, and it is here that the family advisors play a role in helping with the family office processes. Family advisors at the family council level, help in advising the family on the various issues, and provide an independent viewpoint to help the family. Many family offices have an independent family advisor on the family council board, to help in these matters. These advisors do not play any role in the investments, tax or legal matters, except in an advisory capacity.

It is extremely important to get qualified people who have integrity, are independent and act in the best interests of the family for these roles. Any compromise here could prove to be very costly for the family in the long term, since the family would be depending on these people to guide them, in times of need.

In my experience, the biggest fear that family businesses have is that of losing the capital, and hence most families prefer to forgo high returns just to make sure that the capital is secure and risk-free. The historical “money under the mattress” approach came from this desire. The disadvantage for these practices is that the returns from the family wealth are low. Additionally, the family could also lose the asset due to neglect. I know several cases where the share certificates or land documents have been misplaced. In one case, a real estate asset was lost, as the patriarch had made an investment, but did not know where the property papers were. This property was almost auctioned off since the taxes on the property had not been paid for years, as no one in the family knew of the liability. In another case, the investments in shares were scattered all over the family members and no one knew what the size of the portfolio was. In another case, the cash flows from the family properties which were rented out, were not properly accounted for and were used up by the various members of the family.

So how does the family office help?

Besides consolidation of assets, the other advantage of family office, which families do not often realise, is that this structure gives a transparency of the nature and ownership of the assets. Let me explain this. Usually, assets like real estate holdings or shareholdings may be bought in the names of various individual family members for convenience or any other reason, but the ownership may have been that of the family. This may over time, get forgotten or the individual member whose name the assets are, could stake ownership on the assets, thus leading to complications in the future. Having a family office separates out the individual assets from the family assets as these are monitored separately. I know an example of a reputed industrialist family, with multiple family branches, and multi-generation members working in the family business, who have formed a family office which holds the family assets, including the family’s shareholding. The cash flow investments in the family office are decided jointly by a council where the eldest member of each family branch is present.

This gives transparency and security to all the members since the exact nature of the assets is known, and all the family members or their representatives have a say in how these are treated. This gives further impetus to the family harmony and unity and helps the family bond together, since the wealth is managed in the best way possible in a transparent manner. The importance of getting good professional advice in forming these processes cannot be overemphasised.

We shall see more family offices being established in the future, as more and more family businesses are wising up to the advantages of family offices. This could also help them survive the proverbial three generations.

( Views expressed are personal. )

Rajiv Agarwal is a professor of family business at SPJIMR and a family business advisor.

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