The Case for Small Family Offices

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“If you don’t have at least 250M€, you shouldn’t even think about setting up a single family office.”

That is a statement that is frequently made by a famous investor here in Germany. That same view was repeated in a LinkedIn post by the chairman of an American family office syndicate, to which Michael Thrasher (founder of the fantastic family office newsletter Modus!) responded that the figure required for a single family office (SFO) might be as high as 1,5 to 2 billion dollars.

To a degree, those figures are be driven by investment strategy. The mentioned LinkedIn post refers to direct investments, stating that family offices “with just one or two people [lack] the resources to effectively source, diligence, and execute direct deals.” Instead, such SFOs should team up as multi-family offices, making use of their respective expertise while outsourcing the other tasks.

It might also be driven by the perception of what a family office actually is. By the prior definition, a family office unable (or unwilling?) to make direct investments should join a MFO. But to  me, it feeds into the misconception that a family office that can’t take care of all their matters internally is not worthy of calling itself a single family office. And I wholeheartedly disagree with that view: At its core, a single family office is designed to help its owner(s) take care of all their wealth-related matters - and regardless of its size, it has the right to exist as long as it provides a benefit beyond its cost.

So today, let us share with you how we’ve seen small family offices work out well for their owners, including the specific ways of how they generate returns covering (or even exceeding) its cost.

Defining the Small Family Office

I’ve covered my views on family offices two prior articles: Family Office 101, where we talk about the history and ‘scope’ of a family office, and The future of the family office, where we speak about their evolution, and my thoughts on who benefits from a family office (and who doesn’t).

But today, we want to talk about the small family office:

They provide services to as little as a single individual (i.e. a founder, investor, heir), or at most, a small group of owners (i.e. two entrepreneurs that teamed up, a family, etc.)

They are constrained by capital. Given their size, there is a clear return on investment on a single family officer or even a small team. However, the investable wealth might not be big enough to warrant insourcing all relevant topics.

They have limited complexity. As they are (typically) not billion-dollar firms with owners across multiple generations, there are many areas where it would actually be uneconomical to not outsource certain activities (i.e. legal, tax, concierge services).

On first glance, that might sound unexciting to affluent individuals thinking about a family office. But as I often say, it’s important to avoid investing guilty pleasures - the highest priority of a family office is to serve the Investment Objectives of their owners, and only once they are served should owners and staff think about adjacent yet perhaps more exciting topics.

So with that in mind, let’s get a bit more specific: Let’s talk about the blueprint that we see for small family offices.

The Small Family Office Blueprint

First, the most frequent question: the question of minimum assets.

As I outlined in The future of the family office, any amount of investable assets is sufficient if the owners see the money spent on a family office as a good investment. But let’s be more specific: While cases are very specific to factors such as preferences or desired asset allocation I’ve generally felt small family offices to be economical in the range of starting between 25-50M€, and with clear economic benefit from the 75-100M€+ range. I know of family offices as small as 5-10M€, but here, the financial benefit needs to come more from the generated incremental return than from cost savings.

Second, the question of team size and skillset. As I mentioned earlier, team size is somewhat constrained by the available capital. But it is also constrained due to a lack of complexity - raising the question of what actually needs to be insourced. Yes, a 100M€ family office could hire an in-house lawyer, a tax specialist, and two accountants. But in most cases, it doesn’t make sense financially: For example, a structure of that size typically does not justify the cost required to have a very specialized resource, like an inhouse tax lawyer or an investment professional focused exclusively on one specific asset class.

So if we take those points of capital constraint and lack of complexity together, what should a small family office team look like?

Typically, it is led by a generalist investment professional. As I outlined in Becoming A Family Officer, that can be a ‘trained’ investor (i.e. a former wealth manager), but is often either a former employee (like a CFO or Head of Finance) or a relative (a sibling, a child, etc.). Regardless of their background, a ‘Head of Family Office’ is less defined by a superior investing skills but by their generalist skillset capable of tackling any sort of challenge ranging from investment to tax to private matters.

Many small family offices are properly run by a single individual. Sometimes, we see one or two additional hires - one being an executive assistant with a basic skillset in business matters in order to help with matters such as accounting or private negotiations, the other a ‘junior analyst’ that supports the Head of Family Office.

And maybe most important: The successful small family office(r) knows how to ‘pick their battles’, meaning that they know which tasks to take care of themselves, and which ones to outsource.  We’ll dive into potential for insourcing in the next section, but in terms of outsourcing, there are two categories that I recommend: One, accounting and taxes, because they have modest expenses but are time-intensive to insource. Two, investments with ‘Alpha Potential’ but an insufficient allocated capital to justify outsized efforts. (For further reading, I recommend What’s your Alpha.)

Breaking Even …

Let’s be specific: I want to give you examples of how I think that small family offices can absolutely be worth their money.

Re-Negotiating / Insourcing of Liquid Assets

Almost every family office starts by having some of their exit proceeds managed by one multiple banks or wealth managers. And while it is rare that the money is invested poorly, there is almost always room for improvements that lead to reduced costs and/or better performance. An employed family officer can add significant value by negotiating for lower fees (either with existing banks and/or by moving to another manager), as well as by adjusting the existing portfolios to better suit the owner’s specific needs (i.e. moving away from the bank’s model portfolios and/or by moving to lower-cost ETFs).

Or your family officer might go so far and just insource your liquid portfolio entirely. Especially in the case of simple structures, insourcing might be as simple as picking a low-cost bank or broker, picking a handful of ETFs, and rebalancing them on a quarterly to semi-annual basis.

Specific example: Assume you are an affluent individual with 50M€ in assets, half of which (25M€) is invested in liquid assets. We see such sums typically split across banks, which typically charge between 0,50% and 0,75% on 10-12M€, meaning you pay at least 125.000€ per year on top of product costs. If your family office can insource these portfolios at comparable return through use of ETFs, even while paying 0,20% in custody and related fees per year (which would be high!), you’d save  75.000€ per year.

Access to Alternative Investments

Many family offices look to alternative asset classes such as private equity boost their long-term expected returns. However, unless you can commit ~1M€/$1M per fund, receiving direct access to high-quality funds is challenging, and requires substantial time and networking efforts to build access. Hence, many turn to banks or tech platforms that pool smaller investors together, which in return charge one-off fees, management fees, and/or carry. A family office can create value by cutting out intermediaries as well as improve your manager selection process, ideally resulting in access to funds that are cheaper to access while also offering higher performance.

Specific example: Your fmaily office wants to allocate 10M€ to PE. Using a feeder fund, you’d pay 0,50% per year, i.e. 50K€ annually. A family officer can likely cut out at least half of those costs by renegotiating feeder fees and/or building direct access - meaning you can save 25.000€ per year, while likely also adding incremental performance through a better manager selection process.

Wealth Reporting

Every family office should have an ongoing overview of all its assets and liabilities - in other words, a wealth reporting. Most affluent individuals have some sort of excel sheet with a simple wealth overview, but almost always, there’s potential for improvement and additional detail. To solve this issue, individuals might mandate a multi-family office or accounting firm to provide such wealth reporting services, often also in combination with day-to-day accounting services like annual reports and tax returns. Prices are considerable, ranging from 10-20.000€ in absolute terms to 0,10% to 0,20% of tracked assets, and often on top of the aforementioned accounting services.

Admittedly, the accounting part is hard to outsource - as I mentioned, it is a task that I’d generally consider to be worth outsourcing. So if you get the accounting services and a wealth report for 25.000-50.000€ per year, by all means, go for it. But more often than not, it is not included, so you pay the aforementioned 0,10-0,20% per year, or in the case of our hypothetical 50M€ in assets, up to 100.000€ per year.

Specific example: A skilled family officer should be able implement a wealth reporting that is more tailored to your needs, and often more accurate, than the “off-the-shelf” reports provided by service providers. Even if we assume that they spend 25-50K€ themselves per year for a self-managed software tool (like Qplix or Addepar), there’s 25-50K€ in potential savings.

… and Going Beyond

Those examples show how a skilled family office(r) might create cost savings that amount to a low- to mid-six figure sum. But at that point, they should also have significant work time left over - which can save you money through harder-to-quantify time savings on the owner’s end, and/or to create additional value and excess returns. Examples include but are not limited to

• Making better investment choices: Helping you avoid bad or non-core investments that would either lose you money or lock up capital.
  

• Taking over “busywork”: Help you with administrative tasks, leaving you with more time for your family and/or time to work on higher-returning projects, like a new business.

• Support in all other matters: Whether it's buying a private residence, looking for their next professional endeavour, or even private matters - a family office’s job is to make your life easier.

So to summarize: Despite what many players in the wealth management space say, I am a keen believer that small family offices, in the most case, make a lot of sense for their owners - and hence, believe that their number will continue to grow steadily. 

So if you are an affluent individual thinking about setting up their own family office, or an investment professional considering taking the leap into a generalist role in a small family office - don’t hesitate to reach out to us. We at Cape May helped set up numerous family offices, going as far as helping them find the ideal hire for their family office, and we’d love to help you as well.

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