Managing intergenerational wealth with a family office

When the family farm you grew up on reaches the end of the line with your father’s passing, you and your siblings have some decisions to make. Will you sell the land to a developer? Work out a joint venture to transform the 400-acre dairy farm into an industrial park or housing development? Or might you manage the project yourselves?

An event that transfers a significant asset or produces a fair amount of cash is a typical trigger for the setup of a family office. Historically, families would only set up a family office for assets of $250 million or more, but more recently, families are forming offices to manage assets of $50 million to $100 million, which includes almost anyone exiting a well-established business. If the family’s wealth gives them enough regular investment income to sustain the administration costs — which run about $1 million annually — the move may make sense.  

Forming a family office formalizes the decisions that go with maintaining and growing intergenerational wealth. Below are six important considerations for family office formation and operation, as well as ways leaders can set themselves up for success, both now and for generations to come:

1. Define your objectives

If you’re looking to establish a family office, you must first define your mission. Goals often include wealth accumulation, financial stability, asset diversification or carrying on a family legacy.

The first (establishing) generation tends to focus on good citizenship. As they bring in the second generation, they typically place a strong emphasis on civic responsibility and philanthropy, with good money management being secondary. The second generation focuses on wealth building, and third and successive generations typically turn their attention to creating a lasting legacy.

However, few family offices become multigenerational success stories. There is a 70% average wealth decline from the first to the second generation and a 90% decline from generations one to three. There’s almost always a generation that spends more than others or lacks strong business acumen. Sometimes the first generation doesn’t want the second generation to know how much money is available. Family conflict or complex dynamics can be threats at any time.

By putting strong governance and transparency policies in place from day one, many of these inevitable challenges can be overcome with good management.

2. Establish solid governance

Choosing the right governance structure will help you set up standard processes around leadership selection, investment decision making and income distribution. This structure could be an investment committee, composed of family members only or including outsiders, with each member elected to serve for a set term. It might be an executive structure, with a CEO, CFO and so on. Or it could be set up more loosely. The complexity of your governance structure will depend on the number of family members involved and the number of activities the office is invested in.

Because so much depends on family dynamics, there are no set “best practices.” But the main purpose of the governance structure is to navigate uncertainty. Current members don’t know who will be involved in the future, what the new family dynamics will be or what the economy may bring. Governance should balance consistency with flexibility. Doing so will create transparency and equitability, as well as allow for the involvement of second spouses and blended families if so desired.

The governance structure also helps ensure there is an agreed-upon decision-making process independent of who the individuals are, which means future decisions are less about personalities and more about meeting objectives. This helps prevent family rifts.

3. Ensure transparency

There are no SEC or audit requirements for family offices. However, those running the office have a fiduciary duty to others in the family, so they’re almost held to the same standards.

Make sure to share information and data in a timely and organized manner. Regular reporting on the “state of union” — investment performance, expected distributions and so on — is a must, whether that’s done annually (for smaller families), quarterly or more frequently. Reporting tends to become more frequent as families grow.

Leaders who don’t act responsibly could be hit with a lawsuit, which tears a family apart and can cost millions in legal fees. Transparency is the antidote. Well-orchestrated documentation helps demystify the process and creates standard procedures that everyone understands. As family offices progress from the first generation to generations two and three, moving from personal to institutional memory is critical.

4. Make decisions equitably

While there are no best practices to ensure that a family office is governed equitably — since that word looks different in practice for every family — equitability is important to consider because it’s often a cause for dispute down the road.

Family office leaders should think about what makes decisions “equitable” from their perspective and how they can achieve that level of fairness now and in the future. Leaders should define those processes before specific people are attached to avoid any accusations of favoritism or discrimination.

5. Collaborate and integrate

Family offices often include a mix of very different businesses. Perhaps one sibling runs an auto dealership while another manages real estate holdings. Consider how each one ties into common goals and objectives. Family office leaders should set expectations and incentives to drive profitability in all divisions, while allowing for the fact that market conditions may affect different divisions in different ways.

More challenging integrations in any family business are among people, whether that’s establishing good working relationships between family and nonfamily members or collaborating with outside investors and advisors. Family offices are often highly trust-driven, which can make leaders reluctant to share information with other parties. But a key component of establishing trust with others, particularly those with whom you have a newer relationship, requires openness.

6. Consider sustainability and succession

Leadership transfers in family offices can be from one generation to the next or from family to nonfamily members in a particular decision-making role. It’s common for family offices to run into a lack of internal talent or desire. When this isn’t recognized or acknowledged, it can be tricky to convince family members they don’t have the required expertise in-house. Many try to mitigate this risk by requiring younger family members to gain “real-world” experience outside of the family business before joining the office, but that strategy isn’t always bulletproof.

Given America’s demographic challenges, talent shortages are as significant for family offices as for almost all other industries. When expertise is needed, even if you agree to look outside the family, it may be hard for you to find the right accountant, lawyer or tax specialist.

Takeaways and recommendations

Family offices bring many benefits, not all of which are measured in dollars and cents. The camaraderie created in annual meetings and retreats can help preserve family history and connection, especially as extended families become more spread out geographically.

For younger generations, the opportunity to voice their opinion at the same table with their parents and grandparents provides a sense of pride and personal impact. And for many families, having their own office adds to the credibility of the family name.

The following guidelines can help keep things running smoothly:

Know your mission and stay grounded to it

An office without a mission is a rudderless ship. The mission needs to be the guiding principle, whether it’s based on good citizenship, religious beliefs or philanthropy. The mission can recenter everyone when emotions run high.

Balance long-term planning and flexibility

Provide enough rigidity to provide comfort, but allow enough flexibility for pivots. Things will change — the market flips, Susie moves abroad, Don has no children — so you’ll need to reassess and adjust over time.

Implement good governance and transparency from the start

Hold annual meetings while the founders are still around. Have Mom and Dad explain the structures and the investment mix. Even if they don’t get into all the dollar amounts, they can make sure everyone understands the mechanics and processes. That way, when the first generation is gone, the next generation won’t be left wondering, “Why did my dad do this?”

Plan for divorces and second marriages

With estimates consistently showing that 40% to 50% of first marriages in the United States end in divorce, and 50 to 60% of divorced individuals remarry within five years, statistics say both possibilities are likely, as much as everyone wants to believe love lasts forever. Families need to plan for those events and decide how blended families with second spouses and stepchildren will be included in the family office.

Integrate redundancy and sustainability into your advisor team

Outside advisors provide some level of continuity between generations, but they, too, will retire, move on or pass away. It’s always smart to get second opinions and build in backups, and it’s also helpful to have different-aged advisors. Each generation feels more comfortable talking to someone their own age, and every individual wants to bring their own relationships with them to ensure their interests are well represented.

As long as there are no conflicts of interest, multiple layers of advisors can help negotiate generational differences. When Advisor 1 gets their perspective from generation 1 and Advisor 2 consults with generation 2, the two advisors can broker a solution, insulating the family members from conflict.

How Wipfli can help

Wipfli advisors bring deep experience working with family offices and businesses of all sizes on topics such as real estate investment, tax services, financial planning, succession and business transition planning, valuation and technology. Learn more about our private client services or the services we provide to real estate firms.