There are many layers to family offices — portfolio allocation, investment strategy and philanthropy to name a few — but education and focus are at the heart of everything.
Ann Dugan, who founded and led the Institute for Entrepreneurial Excellence at the University of Pittsburgh for 30 years, has worked with family enterprises and family offices across the country. She’s noticed increased interest in direct investing in deals, as well as the need to be both a producer and a consumer.
“Over the last few years, families and their family office directors have wrapped their arms around [the idea] that we need to produce new wealth and not just consume what we inherited from past generations,” she says.
However, this kind of shift requires careful consideration, says the senior managing director of advisory and educational services at the Family Office Exchange.
Know where you’re going
As a family moves into more direct investing, it needs to be focused, Dugan says. What ideas, topics, industries and areas are the family interested in? What geographies does it want to focus on?
“Those are the two first hurdles that I see families often get in disarray because they haven’t really done those first steps,” she says.
An outside facilitator can help gather the thoughts of all family members. Dugan says the strategy shouldn’t be emotional such as — let’s find the next Uber — or too broad — real estate.
If you want to invest in real estate, that’s fine, but will it be managed real estate or part of a REIT? Is it a direct partnership? Does the family want to create separate LPs for each parcel that it brings on?
This kind of thinking around the focus can help shape the legal and organizational structure that the family would like to see, she says. Will these investments be 51 percent, in terms of equity, or should they be 30 percent because the family doesn’t want the responsibility of controlling ownership?
It’s also important to consider the emotions of the family members, especially as younger generations come on board and would like to do things a little bit differently, Dugan says. Impact investing, for example, means something different to everybody.
“The younger generation want to change/improve the world but have to learn balance in understanding that their parents want a reasonable return,” she says. “For some, it means we’re not going to do tobacco, but we’re going to do these other things.”
Another factor is how the deals will be sourced. Some family offices ferret out the deals, do the due diligence and then bring it to the family. In other families, a small percentage is kept back for family interests.
However, it’s better if all the family members know upfront what handful of criteria needs to be met to bring a deal to the table, Dugan says. It doesn’t have to be onerous, but this avoids a family member saying, “I brought five deals in front of them in the last year and they haven’t taken any of them.”
Finally, a family needs to consider what role it wants to have in the investment. Does it want a seat on the board or a direct role helping the company grow?
“Those are things you have to get out because you can’t put the money in and say, ‘Oh, by the way, I want you to hire me as a consultant.’ It doesn’t happen that way,” Dugan says.
In some instances, families members want John and Mary to have a job in the invested company. However, it needs to be structured so that if John or Mary don’t perform, everybody understands they can’t stay, she says.
Along with growing the wealth through direct investing and deals, it’s equally important to develop that next generation to assume, at a minimum, deal performance oversight and must have some knowledge of how a business works, Dugan says. If mom and dad are setting up complex instruments — like trusts or dynasty trusts — are the children prepared to understand those structures?
For instance, Dugan got a call from a man who had inherited substantial wealth from his father. Over the course of several decades, he had directly invested in about 45 different businesses, but then he experienced a health scare. His daughter, who had just had her first child, wasn’t involved with any of the companies.
Dugan’s advice: Start the process to shed those businesses and get them down to a manageable level.
“He wanted to keep them,” she says. “He loves tinkering with all of them, but I said, ‘There’s no way you can educate a 22-year-old mother who’s never been in business as fast as you need her to be for all these businesses. Sell them.’’’
Wealthy families often tell Dugan they’re worried about entitlement.
“Sometimes there’s a disconnect,” she says. “‘I don’t want my children to be entitled. I want them to go out and do their own things. I want them to feel good about their lives.’ And I go, ‘What’s the pathway? Tell me what you’ve done to help them get there?’”
A family learning plan can help those children build their confidence and self-esteem, while also lowering their sense of entitlement.
“I have a rule with all families I work with: Everybody does something,” Dugan says. “If you’re creating trust fund babies to wait for the check in the mail, you’ve got the wrong consultant because it’s not me.
“If you really start to build this kind of knowledge and experience and responsibilities and accountabilities, then chances are you’re not going to have a trust fund baby or lethargy. Instead you'll have an engaged and interested family member building their life in dynamic and productive ways.”