What (New) Family Offices Get Wrong

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After building and often selling their business, many entrepreneurs are left with considerable sums of investable capital. And after hearing and reading about what a well-run family office can do, they set out to set up their own. And that’s somewhat easy to start - but often challenging to implement in practice.

And that’s where we come in. At Cape May, one of our areas of expertise advising newly set up family offices (or advising the entrepreneurs just looking to start on setting up their own). While no two family offices are alike, we’ve learned from personal experiences as family officers, and the family offices that we have advised, on what to look out for in those first months. What things to do, which processes to follow.

Or as one family officer described it: “You help us avoid the mistakes that you made when you worked in a family office yourself.”

So today, let’s dive into five common mistakes we see for newly set-up family offices. But maybe there’s even something to learn here for family offices that have been around for a while. 😉 Let’s dive in!

(This topic was inspired by an answer to our recent reader survey. Whoever you might be, thank you for the inspiration!)

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Mistake #1: Setting up a family office in the first place

If you’re sufficiently wealthy individual these days, it seems like it is odd not to have a family office. And I’ll admit that I might also be contributing to this trend through my ‘small family office’ thesis. But just as I hold the view that family offices can make sense much earlier than traditional market participants might say, it doesn’t necessarily mean that you need to have one. 

We covered that topic a few weeks back in ‘Who Needs A Financial Advisor’: If you have 100M€+ or more, but want to keep things very simple - perhaps as far as only buying a handful of ETFs -, you don’t necessarily have to hire a person inhouse to manage this portfolio. Yes, it might make financial sense, and yes, that person might offer you more personalized service around the clock. But for a simple task, the hassle associated with having actual employees might simply not be worth it for a very simple investment setup. Or as one client described it after a €100M+ liquidity event: “I used to manage 1.000 employees, Now that I’ve made my money, I don’t want to have to manage people again.”

And just because you’re not hiring a handful of employees for your own family office doesn’t mean you can’t receive personalized service. In our network, we support many UHNW individuals (think 100M€+) who don’t have their own family office but instead utilize service providers (think banks, GPs, tax advisors, lawyers) or even a full-service multi-family office to take care of all investment- and structure- related questions. Instead of having a family office team, they either act as their own family officer in all investment-related questions, and/or work closely with a handful of GPs/entrepreneurs for certain asset classes in which they see Alpha potential (i.e. real estate, venture capital).

Mistake #2: Getting started without a clear strategy

If you ask 100 freshly-founded family offices about their investment strategy, you’ll likely hear a lot of different answers. But I would bet with you that all of them, if asked, would describe their strategy as opportunistic. And that’s not a bad thing - you shouldn’t close your eyes to good opportunities even if they’re outside of your defined strategy. But that is often where the issue lies: Family offices call themselves opportunistic because they don’t have a defined strategy at all.

If anything, this could be the most costly mistake that I’ve seen in action. In my personal experience in a family office position, it resulted in a variety of opportunistic investments ranging from incubations to late-stage investments in ventures to ‘network tickets’ in venture funds to investing in a friend’s public equity fund despite no clear track record. The result? Luckily, not too much of a loss of capital, as those opportunistic investments only made up a small percentage of the portfolio - but unfortunately, a seven-figure sum invested across a variety of companies and funds where we’ll likely wait for years to see our money back.

Another frequent ‘opportunistic investment’ worth highlighting is setting up one or even multiple companies under the roof of the family office. Incubating companies is an art and a science that even institutional venture funds struggle with - so you can imagine how a freshly-started, small family office might fare without thinking it through first: Subpar founder teams hired from the family’s network (former colleagues, cousins, etc.). No clear definition which milestones companies are supposed to reach, and how much runway they get from the family office. High ownership stakes that make it hard, if not impossible, for external investors to consider an investment. 

But the most costly mistake associated with incubations? Hiring numerous employees in the family offices to set up and manage those companies - only for them to either not last long enough, to be overly reliant on those employees, or actually not having enough to do for them. More than once have I seen family offices double their investment team for incubation efforts, but more often than not are those efforts wound down sooner than later, and employees have to be let go.

You’re a newly set-up family office, and want to avoid such mistakes? Make sure to define your Investment Objectives, and know where you and your family office can (and cannot!) generate Alpha. 

Mistake #3: Being reactive, not proactive

So you’ve listened to my advice. You’ve set up a family office because you see clear potential in a personalized structure (and team) for you and your family. You’ve defined your Investment Objectives, and you know in which asset classes you think you can generate excess return on your time and capital.

Time to get started on sourcing investments - and if you’ve ever let it slide that you’re setting up a family office, dealflow will likely not be an issue for you. Even I (on my private email!) receive investment opportunities daily, ranging from venture deals to newly-set up funds to more odd investments like buying a KFC franchise in the rural US (how I ever got on that distribution list, I don’t know). But as most investors have to painfully learn, there is a big difference between dealflow and good dealflow.

Take venture capital, for example. If people know you are active as a business angel, you’ll likely receive many investment opportunities a week to invest in a highly innovative, early-stage start-up, both through cold outreach as well as your immediate network. And even after filtering out the opportunities that are clearly bad, chances are that there are numerous deals that sound interesting. As you conduct your due diligence, you might find a few issues here and there, allowing you to further filter those deals. But chances are you’ll end up with more than one deal that sounds good on paper. So why not invest into all of them? I call this being reactive instead of proactive. To name a few issues that we’ve seen arise in practice:

First, only looking at dealflow that you receive from external sources (i.e. cold emails, your immediate network) subjects you so-called adverse selection. Especially as a newly setup family office, you’re likely not on top of a list for a Tier 1 founder. Hence, deals that reach you are likely not the best out there. Finding good deals means a lot of proactive outreach to make sure you’re on the minds of founders and lead investors - and unless you’re a expert in your industry, they’ll likely not think of you on their own.

Secondly, being reactive often implies a lack of selectiveness. Once again taking venture as an example: If you’re really getting to the point that you have two, three, or more attractive investment opportunities a week, you’re likely not strict enough in your approach. Most of the deals you receive should be immediately filtered out due to little overlap with your criteria (i.e. industry, sector, stage, etc.). A much smaller number should warrant a first look, and maybe one deal a month should actually be attractive enough among those deals to warrant execution. If you end up with two or three deals a week, i.e. 8 to 12 deals a month, you should be focused on figuring out which of those 12 deals (a big number!) is actually the best one.

Especially in high-Alpha asset classes like venture or private equity, many opportunities are described as once in a lifetime deals. But I can tell you from experience - once in a lifetime deals (or atleast the ones described that way) end up coming around much, much more often than that.

(For continued reading on getting venture right, check out last year’s two-part Series - here’s Part 1 and Part 2.)

Mistake #4: Not (re-)negotiating fees / optimizing your banking setup

One of our main ‘business lines’ at Cape May is advising family offices on matters ranging from investments, to structure, to hiring. As we get to know a family office’s owner(s) and staff, and talk about their main challenges, one challenge that almost always comes up is dissatisfaction with existing advisors. Examples include an perceived high ongoing fee for dissatisfactory service, underperformance of liquid mandates relative to public benchmarks, or simply a lack of coverage and attention from their advisors.

And our ‘solution’ to that is simple: Why not revisit your overall banking setup? Or at the very least renegotiate the fees? Yet in practice, a shockingly small number of family offices actually conduct such exercises in a proactive, regular manner. But admittedly, there’s at least a few good reasons for that.

First, for owners and families without a financial background, it might be tough to assess what pricing is actually fair. In the end, many start with the banks that make the most compelling offer and with which they get along the best (definitely not the worst way to decide) - but don’t further challenge whether the pricing that they’ve agreed upon is actually fair. Furthermore, as family offices start out, they often have few wealthy peers with whom they can compare pricing - although that is slowly changing for a younger generation of owners.

Secondly, family offices and their owners often emphasize personal relationships over ideal pricing. Even as we tell them that whatever pricing they have is above what we’d want to see for their asset size, they are often hesitant to ask for lower fees. “They helped us early on with structuring their wealth.” “They were the quickest in opening a bank account where I could hold my cash after the exit.” All valid reasons to not burn bridges or be overly aggressive - but in my view, no reason to accept excessive pricing, especially for a service as commoditized as wealth management.

Third and last, they don’t renegotiate their fees over time. Financial advisors often sell their AUM-based fees on the basis of also providing you with unlimited support in setting up and managing your family office. And they are indeed often involved in the first months or years. But as you get more structured and move to a relationship that is more limited to their asset management services, their pricing might not be reflective of what you receive anymore. Make sure to revisit what you are paying on a regular basis - they’ll likely not reduce your fees from the kindness of their hearts, so make sure to ask. Worst that they can say is no.

As a final remark on this topic: I believe it was fellow family office newsletter author / podcaster Shaun Parkin (definitely give his newsletter and his podcast a follow!) who said that investors need to make sure that they make their service providers (think banks, asset managers, etc.) actually work for the annual fee you are paying them - and I couldn’t agree more! Have them to do some industry research for you. Have them find you a personal assistant. Or at least make sure that they get you tickets to the next sports event of your choice.

(For continued reading on working with financial advisors, check out Advice on Financial Advisors and Managing Your Managed Account.)

Mistake #5: “Perfect is the enemy of good”

Being a family officer can be a tough job. In a single day, you juggle topics that might range from million-dollar ETF portfolios, to a private equity fund commitments, to an accounting question, to a personal matter of the owners. You might do everything right for weeks, but forget to check one little due diligence item on a small venture investment. If your experience is anything like mine and that of many family office peers, chances are that you’ll hear about that mistake for weeks, if not months. Even a year later, they might ask if you’ve checked that little due diligence item on any new investment that you make.

Hence, it’s no surprise that many family officers are extremely perfectionistic - often even more so than their institutional counterparts. Think asking your bank about questions in their T&Cs that nobody has ever asked before, or digging into little due diligence items in a data room that even institutional investors might’ve missed. (Nothing more fun than being the only investor among 20+, including a venture fund, to realize that there’s a mistake in the convertible loan conversion formula!)

While I as a former family officer might be biased to say that that level of perfectionism is good, I’ve also seen cases where things might go to far. Or as the common saying goes, “perfect is the enemy of good.” To name a few examples:

• A new family office spends the first 18+ months sitting in cash because they want to be 100% sure that they’ve talked to every bank to get the best terms and the perfect asset allocation. In the meantime, bonds and public equities rally 5-10%. (Other family offices opted for a beta-oriented outsourcing approach and didn’t miss out.)
  
  

• An established family office wants to reach its private equity target allocation, but annual distributions from their well-performing operating company keep on putting their target out of reach despite committing heavily to closed-end funds. Finally, they find an evergreen fund that ticks all the boxes in regards to investment strategy and that could help them close that gap - but they end up deciding against it because the (very large, very institutional) GP could theoretically, in a catastrophic scenario, limit redemptions permanently. So they decide against the investment. (I think they got semi-liquid private equity wrong.)
  

• A family officer tries to find the perfect family office reporting tool that can span multiple countries and countless banks. They almost find one, but decide against it because it can’t connect to a small German local bank where one of the family members holds a few ETFs. (I suggested that he should urge that family member to switch banks so they can use that tool - he never even thought of it.)

All the meanwhile, some of the most inspiring family offices I know have accepted that perfect is impossible in something as fuzzy as the world of investing, and instead try to find something that covers most of the challenges. Based on my experiences today, I would very much recommend that approach as well, especially when it comes to ‘commoditized’ parts of your portfolio. Time spent on trying to find an unlikely perfect outcome is better spent on topics such as ‘fuzzy’ high-Alpha asset classes - in which the excess returns are likely to easily exceed the difference between a perfect and almost-perfect Beta-oriented investment.

There are definitely some parts where “80/20” absolutely isn’t the way to go. That includes topics such as accounting, estate planning, or tax structuring, where I think aiming for 99.9% correct is reasonable. But when it comes to investing or other day-to-day tasks in a family office, almost perfect is a much more achievable standard.

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