Succession Planning for the Founder’s Family Office

Succession Planning for the Founder’s Family Office

by | 'Dec 12, 2016' | How-To | 0 comments

This comprehensive article provides thorough analysis and actionable recommendations addressing succession planning in single family offices that are run by their founder. 

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Succession planning in single family offices

For a Single Family Office led by its founder, succession planning is often the last thing on the founder’s mind. But failure to plan for the office’s scope and services after the founder’s demise can leave the family and the family office staff alike in an impossible situation, and put at risk the wealth that the founder worked so hard to create.

The Founder’s Family Office: Hub-and-spoke

A family office created by a wealth creator is an enterprise built to achieve a single vision. The founder sits at the center of the office’s decision-making. They may delegate some decision-making to staff, and perhaps ask for their family’s input on various matters, but in the end, their decision rules.  Investment partners, advisors, service providers, staff—all know that any change to “the way we do things around here” must have the consent of the founder.

The hub-and-spoke system is extremely common as a structure for family enterprise governance because it arises naturally as the founder builds the enterprise. A hub-and-spoke system is resilient, and it can be nimble and efficient—provided the founder’s vision and expectations are clear. There is little bureaucracy, and decisions are generally made quickly (unless the founder prefers to avoid the subject, in which case the decision may languish in limbo indefinitely.) The founder at the hub makes the decisions—or, on occasion, delegates them to trusted individuals on the spokes—and those who operate the spokes carry them out. So long as the founder is capable of making decisions, the system works.

A hub-and-spoke decision-making system can be stable for long periods of time, but it can also be prone to sudden failure if an accident, illness, or sudden death strikes the founder (or, sometimes, it may become mired in long and slow deterioration if the founder’s attention turns away from the office). This is because the system depends on the acquiescence of everyone on the spokes to the founder’s decision-making at the hub: no action will be taken without approval from the top. If the founder is absent, decision-making grinds to a halt.

A founder may find themself too busy with day-to-day responsibilities to spend much time thinking about the future of the family office after they’re gone. But effective strategic planning includes succession planning, and a founder who fails to develop a succession plan puts the wealth managed by the family office—and the well-being of their family—at risk.

After the Founder: Greater Complexity, High Emotion

Typically, the founder’s estate plan will create an entirely new constellation of clients for the family office: individuals, trusts, partnerships, foundations. While many of these may have existed during the founder’s reign, they generally fell under their oversight and guidance (even if only informally). Now, the office staff must deal individually with these clients, each of which has its own leadership, purpose, vision, and investment objectives.

Family members, whose involvement with the office was mediated by the founder during his or her life, now deal with the office directly. Family members will typically see the office as the founder’s stand-in when it comes to financial matters, and will bring requests for money and financial problems directly to the staff. The departure of the founder may trigger a wave of requests for substantial distributions, as estate matters arise or as needs or desires that were denied during the founder’s era come to the surface. Furthermore, requests that the founder once dealt with in private—allowances, impulse purchases—suddenly become the business of the family office. This may put the staff in the uncomfortable position of controlling the family purse strings.

Furthermore, the loss of the founder creates turmoil in the family’s decision-making system in the same way that it creates turmoil in the family office. Without the founder making decisions, family members may come to the family office to mediate disputes—or to get the office to take their side.

This broader constellation of clients can raise uncomfortable questions about the purpose and scope of the family office—questions the office staff does not have the perspective or authority to answer. What if a family member declares themself to be in charge of the office? What is an appropriate spending rate? What if a family member wants to sell an asset that was beloved by the founder—a piece of art, or a vacation property—and the office knows the founder would have disapproved of the transaction? What if the foundation proposes a major one-time contribution that would deplete foundation assets? What if family members won’t speak to each other but instead try to get the staff to intervene? Or what if family members challenge the authority of staff and go around them to achieve their objectives?

Succession Planning in Single Family Offices: Before the Storm

A founder who foresees the potential challenges their office will face in their absence will recognize the value of developing a succession plan well in advance of their departure.

The process of succession planning in single family offices requires a blend of vision and practicality. What will the future look like? What responsibilities will be borne by the family office? How can the office manage its responsibilities most effectively? And, perhaps most important: how must the office be restructured to ensure it will be viable?

A robust succession planning process will require the participation of both the founder and the staff, as well as their trusted advisors. Participants should expect the process to take time—upwards of a year—to gather the necessary data, debate the options, and document the outcome. A quarterback—either an experienced and trusted member of the team, or an outside consultant with experience in succession planning for family offices—will be invaluable.

WHY does the office exist? What is the purpose of the office?

The first question for the succession team is: “Why should this family office continue to exist beyond the founder?”

Note that the first question is not “Who will run the office?” The succession team will want to start with purpose and vision, rather than tactics and talent. The question of who will run the office is certainly important, but the group must decide why the office exists and what it will do, before it can determine who is appropriate to run it. Above all, the team must avoid the temptation to choose a leader as a way of putting off the tough decision-making—naming a successor and saying “they can figure it out” is equivalent to setting the successor and the office up to fail.

The question “Why does this family office exist?” is intended to generate a statement of purpose for the office that articulates the unique roles the office serves for its clients. In turn, it will be used to define the scope of services and responsibilities of the office following the founder’s departure.

The purpose might include one or more of the following:

  • To manage financial assets for the benefit of the founder’s family.
  • To oversee real property and operating businesses.
  • To provide tax, administrative, and compliance services for wealth holding structures such as trusts, partnerships, and foundations.
  • To serve as a central record-keeping vault.
  • To provide education and mentoring on financial matters for next-gen family members.

It may also be helpful to articulate elements that the succession team agrees should NOT be included in the Shared Purpose, such as:

  • Mediating family disputes.
  • Determining amounts of allowances and distributions (other than providing information to a decision-maker, such as prior spending rates).

Once the purpose of the office has been defined, the succession team can consider WHO the office will serve and WHAT assets it will be responsible for overseeing.

WHO will be the clients of the office and WHAT assets will be managed?

The second and third questions for the succession team are Who will be the clients of the family office and What assets will be managed? The objective of this part of the process is to develop a complete inventory of the clients of the office: the type of assets the client owns; the approximate value of those assets; and, in the case of entities, who controls the client—all based on the founder’s family, their collective existing assets, and the founder’s estate plan.

The succession team may be tempted to answer the “WHO” question with “the family.” But doing so could result in a flawed plan—one that doesn’t anticipate all the complexity that the office will face. That is because a founder’s estate plan will often result in assets being held in trust that were previously owned outright. When assets are held in trust rather than outright, administrative and compliance requirements increase substantially. The same is true when assets are held in LLC or partnership form.

By way of example, a complete client inventory might include:

This client inventory makes clear that, following the founder’s death, the family office will be tasked with managing or overseeing a wide range of assets—the founder’s operating business; their art collection; commercial and residential real estate; and a portfolio of hedge fund and private equity investments. These assets will be held in a variety of structures, including layers of trusts and partnerships, many of which were designed to achieve specific tax or asset protection goals. Furthermore, the clients will include individuals and fiduciary decision-makers with varying (and likely conflicting) interests. Quite a different state of affairs from the hub-and-spoke system under the founder!

What services and responsibilities will be borne by the office?

A family office can be like an octopus, with eight arms involved in separate activities. However, for planning purposes, it is important to specify what services will be necessary and whether the office will be charged with handling them.

It can be helpful to consider three categories of functions family offices typically serve: investments, administration, and convening. Every family office is unique; the task for the succession team is to think through the clients and the assets of this specific office to determine what must be done to ensure that assets are managed properly. The following is a necessarily incomplete list of questions that the succession team will want to ask:

  • Investing: Will the office be responsible for investing assets? For overseeing those who do? For all or some of the assets? (For example: Will the office be responsible for serving on the board of operating businesses? For coordinating with hedge fund and private equity managers? For trading securities?) If the founder performed some or all of these functions themselves, which can be absorbed by the office staff, which should be outsourced, and which should be discontinued?
  • Administration: Will the office manage administrative record keeping? Performance reporting? Tax compliance and reporting? Risk management? For all assets or only some of them? Given the increase in the number and complexity of clients being served, how much will the volume and scope of administrative services increase, and what staffing changes—or outsourcing—may be necessary to accommodate the increase?
  • Convening: Will the office take over convening responsibilities—planning family get-togethers, serving as administrator and secretariat for common entities such as foundations or family assemblies—that might previously have been handled by the founder or their spouse? Will the office be responsible for financial education and counseling for younger family members? Financial management for aging and perhaps disabled family members?
What do we need to do to prepare for the future?

Once the succession team is comfortable they have defined the Shared Purpose of the office, inventoried the clients and assets, and determined what responsibilities and services will be borne by the office following the founder’s departure, they need to stop and ask themselves: How must the office be configured, staffed, and funded to deliver these services and manage these responsibilities? A family office built to suit the circumstances and personality of the founder will often need some substantial restructuring if it is to serve the new clients effectively.

It is also important to stop and ask whether the resulting office will be cost-effective. For example, the cost of an office to manage the assets of an individual with $500 million in net worth will generally be lower than the cost to manage those same assets once the individual’s estate plan has gone into effect and the assets are owned by ten or more different individuals and entities. It is possible that an alternative service model, such as a multi-family office (MFO) or a virtual family office (VFO), run by a very small staff that outsources most functions, will make more sense following the founder’s departure.

Ultimately, the succession team will want to memorialize its conclusions in the form of a transition plan that spells out the steps that will need to be taken to accommodate the anticipated changes that will result from the founder’s departure. Major change is never easy; the transition should take place over 3-6 months or more, to ensure that transfers of responsibility among staff members or to third party outsourced providers are handled carefully and are fully documented. The succession team will want to oversee the transition and keep the clients informed as to the plan and their progress in achieving it.

As the succession team develops the transition plan, the following topics deserve thoughtful consideration.

Staffing

If the new office will be structured differently after the founder’s departure, it is likely that staffing will need to change. Family offices tend to reward loyalty, with the result that staffing tends to remain constant over long periods of time. However, a succession transition demands that staffing and leadership both be reconsidered in light of changes in responsibilities and services. It is important for any changes to be handled with transparency, legal propriety, and grace, given the sensitivity of the matters handled by the office. It may also be wise for the succession team to implement or update employment agreements with staff while the founder is living, to clarify non-disclosure and non-solicitation policies as well as procedures for termination, resignation, and retirement.

Funding

Many founder-led family offices are funded directly by the founder from their personal assets (or, in the case of a family office that serves the owner of a substantial operating business, by the business): other entities, such the family foundation or a previously-established trust, may get a free ride, expense-wise. However, after the founder’s departure, every client will stand on its own, from a financial standpoint, and careful thought will need to be given to how costs will be borne. Cost allocation for a family office is tricky—for example, should costs be allocated based on assets under management or on staff time spent? Should older generations pay for younger generations? What if a client feels a service is not valuable or too expensive? When a younger family member wants help dealing with a service provider or starting a business, should they receive a bill? Family office clients may be shocked to find out the true cost of operating the office when they are responsible for paying for it. If cost allocation is handled with transparency and care, it can become an important step in developing effective client-office relations; if mishandled, it can lead to failure of the office.

Governance

It is important to recognize that a family office is a service entity, not a governance entity. The office can serve important roles in a governance structure—for example, as administrator and secretariat for a family assembly—but it is not in and of itself a governance vehicle and should not be tasked with overall decision-making for the family and its assets. The succession team will want to ask how the constellation of clients will be governed—and how they will formally relate to each other, given that their participants and assets will be related to and intertwined with each other. The succession team may also want to recommend that the founder initiate governance work with family, trustees, trusted advisors, and family office staff to develop a more formal governance structure to deal with the increased complexity that inevitably will result from the founder’s departure.

Bricks-and-Mortar vs. Outsourcing

If the family office has handled most responsibilities in-house under the founder, it is worth asking whether some or even all of the services might be handled more efficiently or cost-effectively on an outsourced basis. Services can be outsourced to different specialist providers in a VFO model, or, overall management can be outsourced under an MFO model.

Another option is to consider developing joint ventures with other family offices to leverage specific capabilities and economies of scale, or even to seek out other families or investors with the goal of forming a non-public multi-family office.

Exit

Some founders envision the family office as a kind of glue to keep family members together. However, family members may not be as enthused by the notion of forced togetherness with family members, and may prefer to manage their own assets or seek their own service providers. Family offices that encourage clients to be knowledgeable consumers and to seek the best option to meet their own needs are more likely to be successful in the transition process.

Emergency succession planning in single family offices

What if the founder departs unexpectedly, before any succession planning has been undertaken? While it may be tempting for the office to put aside formal planning to deal with the chaos of the transition, doing so may put clients, assets, and the office itself at risk. In the absence of the founder, the leader of the family office will want to assemble the succession team and undertake a streamlined, yet thorough, version of the planning process outlined above. In particular, developing a detailed understanding of each of the clients and the assets they hold will enable the team to identify service gaps; these should be given priority. Once gaps are filled and short-term emergencies have been dealt with, the succession team will want to shift quickly to the process of developing a comprehensive transition plan.

*****

A founder’s family office is a unique entity, embodying the vision and priorities of the founder. Succession planning is rarely a top concern, but a family office that will serve the founder’s family and manage his or her assets following their departure, will need to redesign its scope and services to deal with the new circumstances it will face. A succession planning team that considers the clients and assets that will remain after the founder’s departure, and defines its purpose and services to meet their needs effectively, will be able to prepare the office to deal successfully with the change that lies ahead.


For more on succession planning in family enterprises, check out “Succession Challenges: Lean Management and Silos

(This article was originally published in conjunction with Angelo Robles of the Family Office Association)