Family Office 101

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Unless you’re a successful, post-exit entrepreneur or an investor raising money for your own fund, your touch points with family offices might be somewhat limited. Still, their role in capital markets as well as their number has grown steadily over the recent years, so you might rightfully wonder what they actually are. 

Today, I’ll give you the background on where family offices come from and what they do. Next week, we’ll go one step further and look at how family offices are changing — and how you might set up your own one day.

What is a family office, anyway?

The family office as we know it today was first created in the 19th century by families such as the Morgans and Rockefellers, who had built immense wealth and decided that instead of working with banks or lawyers, they would set up their own privately-owned investment firms. 

Fundamentally, the role of the family office has not changed much since then. They are entities set up by an individual, family or group of associates with the purpose of helping them manage their affairs, including personal matters (i.e. assistant or concierge services), administrative efforts (i.e. tax or legal services) and/or investment services (from managing partners to essentially being stand-alone investment firms).

Still, family offices do vary significantly in both their scope and in the services they provide to their owners. While I’ve seen most family offices start with one core offering, such as concierge services to the family or providing investment management solutions, they slowly grow their remit over time. 

In other words, to quote a somewhat overused phrase in the world of family offices: “if you know one family office, you know one family office.” 

The two types of family office

Another important differentiation is between single-family offices (SFOs) and multi-family offices (MFOs). 

SFOs are what they say on the tin: family offices that provide services to a single family. These are what the Rockefellers of the world set up in the 1800s. Since then, things have evolved, with some family offices being founded by either a single successful individual or groups of individuals, such as business partners or co-founders. An MFO on the other hand is, you guessed it, a family office that supports several families at once to manage their wealth.

There is a lot of debate around what should be considered an SFO or MFO, let alone a family office to begin with. For example, some people think a family office started by business partners that don’t come from the same family is an MFO.

In my view, the distinction is not the family connection, but how they are financed.

An SFO typically does not charge any management fees to the family and is financed on a ‘pass-through’ basis, meaning it is paid for, ideally, with the profits generated by the family office’s investments. An MFO, on the other hand, will usually charge a fee for its services, which covers the cost of the team and any expenses incurred to offer the required services. As a result, MFOs (especially when offering investment services) tend to be regulated entities, while SFOs often attempt to stay unregulated. 

How family offices come to be — and how they evolve

The decision to set up a family office is not always made consciously. 

Sometimes it will happen that way, like when an entrepreneur sets up their own investment firm after selling their business. But in just as many cases, there is no one event that leads to the family office being set up. Instead, things happen organically over time.

Take your traditional Mittelstand company. As it grows, there might be excess liquidity that cannot feasibly be reinvested into the business, and the owners will start to wonder what they can do with those funds instead. To start with, they might hand this task over to their CFO to manage. But as those assets outside of the company grow, they might see that the CFO — who is supposed to run the business, not manage money — isn’t the right person for this task, and they will make the decision to set up a family office.

Another example is a family office that evolves out of a small investment structure. Especially in the tech ecosystem, many founders use their networks to actively source investment opportunities in early-stage start-ups. As their portfolios grow, many founders decide to hire a (usually junior) investment associate to help them manage those angel investments. With or without an exit, the founder and the associate build up trust and rapport — and naturally, the founder starts entrusting them with a wider range of wealth-related matters. Once again, intentional or not, a family office is born. 

In my experience, family offices set up in this almost unplanned way tend to start out focusing simply on investing available funds. As time goes by and the family office has found its long-term investing strategy, the focus shifts from new investments to portfolio optimization. 

I call this ‘sophistication’. It can happen in many shapes and forms, including but not limited to:

• Investing into new asset classes 

• Rethinking how the family office invests into asset classes, such as moving from asking advisors to pick funds to making direct investments

• Insourcing (or outsourcing) certain investment capabilities that were previously provided by external advisors and/or managers

• Expanding the investing team in or across asset classes

• Adding non-investment-related services such as tax, accounting, legal, or personal services to the owners

• Creating and improving processes, for example defining a clear investment strategy and process

• Finding ways to reduce costs, including renegotiating fees, consolidating service providers, or implementing new technologies

Once a family office has found the long-term strategy that best serves its owners, simply operating as intended can be a desirable final outcome. 

But that’s not where every family office’s evolutionary journey ends. Today we have covered the fundamentals behind how these firms are set up, but what about the forward thinkers who are challenging this 200-year-old model? And what about you? 

Tune in next week to find out.

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