If you performed an autopsy on a family office, it wouldn’t reveal a universal organisational template structure chart. Instead, its DNA would reveal the simple concept of professionalising a family’s personal and commercial affairs.
Essentially a family office is aiming to be an addition of value. In striving to add value, a common theme is the amount of families benefiting from alternative structures to hold, manage and enhance their wealth.
Our private wealth and funds teams have increasingly been collaborating with advisors and clients, specifically focusing on assisting these family offices in structuring private investments through less traditional routes.
The generation game
One of the biggest challenges facing families is the ability to plan and successfully execute the transfer of inter-generational wealth and the succession or professionalisation of a privately-owned business. Few manage to achieve this whilst maintaining the family’s level of wealth, their reputation and importantly ensuring family harmony. In looking to achieve the holy grail of inter-generational wealth transition, many family offices have traditionally turned to a trust or a private trust company (in common law jurisdictions), or a foundation (in civil law jurisdictions) to hold and structure their family wealth. More often than not, these structures subsequently hold a web of Special Purpose Vehicles (SPV) which own assets as diverse as real estate, private company shares, investments, private equity and institutional equities, through to super yachts, aircraft and fine art.
Funds for families
In the pre-COVID environment, where the world’s richest global families were increasing their wealth, the podium places for vehicles used in structuring family assets remained the preserve of trusts, private trust companies and foundations – all with underlying SPVs. However, among the structuring alternatives, there’s a new challenger to consider – fund structure. As the wealth of the family office grows, it becomes more institutionalised in its approach to managing and structuring its assets. In some cases, the family office begins to behave more like a fund manager and with this change, the fund vehicle becomes more attractive or in the cases of large families or club deals – a real necessity.
Transferring to individuals
The transfer of wealth over the last decade from corporations to individuals has reached an unprecedented level. According to the Boston Consulting Group, privately-owned assets in the Middle East were expected to reach US$11.8 trillion by 2020 (report post-COVID), with the United Arab Emirates, Saudi Arabia and Kuwait, accounting for over 22% of the total.¹ Pre-COVID there was no sign of this trend abating, with key global research (Campden Research, July 2019) quoting that there was estimated to be 7,300 single family offices worldwide, with a collective estimated assets under management of US$ 5.9 trillion2. Meanwhile, the wealth of the families behind them totals a vast US$ 9.4 trillion.
With wealth transitioning into private hands, it’s unsurprising that we’ve seen the emergence of the family office as a significant influencer in the private wealth industry both in terms of structuring trends and fund investors. Wealth held in the Gulf countries also has outstanding liquidity, with 82% held in investable assets compared with a world average of 60%. PwC’s Private Equity Trend Report stated that 73% of private equity firms consider family offices as potential investors in their next fund.
Earlier this year, the Knight Frank Wealth Report4 and Preqin’s 2020 Global Private Equity & Venture Capital Annual Report5 focused on global investment asset allocation by family offices and concluded that private equity and real estate were the clear favourites. In fact, over the last 36 months we’ve seen many of our clients bid against financial institutions and pensions funds for prime commercial real estate. It’s unsurprising then that this increasing trend towards direct investments by family offices is being highlighted by fund managers as being a disruptive force in key markets and sectors.
A myriad of wealth management reports has shown that direct investing by family offices outside the public markets is increasing year on year. Why? When looking at the low yields from bond markets and other traditional investments plays, family offices are clearly adapting to this low yield environment by diversifying their investment portfolios in the hunt for a higher yield often in a sustainable and ethical manner. According to the Deloitte Global Family Office Report 2019³, roughly one in three family offices are currently investing sustainably.
Before COVID-19 real estate, whether it was commercial or residential, was extremely popular as an asset class among our clients as it provided both capital appreciation and solid investment returns in the form of rental income. What this will look like once the COVID-19 pandemic has been eradicated is a moot point. However, when looking at investment diversification, family offices can’t have missed the industry headlines highlighting private equity investments as reportedly delivering the greatest returns for family offices.
Such headlines have increased the appeal of direct investing into assets, which are managed internally by family office team members who have the requisite investment professional skillset.
For many families the desire is to have ultimate control over their investments. They want to decide when the right time is for the family to exit the investment, to decide when to enter the market and to be in control of negotiating deals. Compared with investing indirectly via traditional investment funds, direct investing allows family offices to build an investment portfolio around their own timescale and needs, not those of other investors.
In addition, for most family offices the regulatory overlay associated with investment funds is considered intrusive with the endless requests for due diligence and perceived heavy fees merely adding insult to injury.
Clients are therefore consistently looking at the most appropriate holding structures for family office investments. Often the structure type will differ depending on whether it’s intended to acquire a single real estate asset or a portfolio of private equity sector specific investments.
To that end, family offices have a variety of alternative structures to utilise, ranging from companies, protected and incorporated cell companies, unit trusts often focusing on property or Limited Partnerships (LPs) including both separate and incorporated LPs. The regulatory treatment of such structures will depend on the number of investors in the structure and the nature of the assets acquired.
In many cases the need for regelation is unavoidable for multi-family offices managing multiple assets of unrelated family investors. In such circumstances, it might be more efficient to pool the assets of multiple investors into a regulated collective investment scheme.
Even where the investors are related, the legal framework of a fund structure provides clarity on their rights and obligations as an investor, which acts as insurance if and when a family fall out occurs.
A key benefit for a single-family office, and the Ultimate Beneficial Owner looking to utilise a fund type structure for the assets it manages, is control. If structured correctly a fund can provide control to the family office, like a fund manager controls a private equity fund.
Often a family office owns the shares in the General Partner (GP) that in turn manages the LP and contracts on behalf of the investors – often the family members. Additionally, such fund structures also permit the key family office employees to be remunerated in a way which mirrors industry fund managers and aligns their interests with the families whose assets they manage.
This helps attract star talent into the family office space. The family office employees can and are encouraged to invest alongside the family simply because, if implemented correctly, it can incentivise the family office team to maximise returns and ensure that all parties are aligned when it comes to risk and reward.
For further information, please get in touch. Watch out for part 2 of Ian’s views on Family Office structuring coming shortly.
¹ Source: Middle East and North Africa: Wealth Shift, Global Finance June 2019.
² UBS / Campden Research Report – http://www.campdenresearch.com/
³ Deloitte Global Family Office Report
4 Frank Knight Wealth Report
5 2020 Preqin Global Private Equity & Venture Capital Report